Audit and Assurance June 2011 Marks Plan

Professional Stage Audit & Assurance June 2011

Copyright The Institute of Chartered Accountants in England and Wales 2011 Page 1 of 15

EXAMINERS MARK PLAN COMMENTARY The marking plans set out below were those used to mark these questions. Markers were encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks were available than could be awarded for each requirement. The available marks for each part of the question are shown after the commentary to each question. This allowed credit to be given for a variety of valid points which were made by candidates

SFQ 1 Erica may continue in order to maintain audit quality ES 3 permits when substantial change in the business provided: - only for additional period of up to two years/no longer than 7 years in total - expanded review of work undertaken by Engagement QC Reviewer - fact and reasons disclosed to shareholders as early as practicable If company not prepared to make such disclosures, should not accept Answers to this question were mixed. A significant number of candidates attained full marks, as they were aware of the new provision in ES3 Long Association with the Audit Engagement, but an equally significant number of candidates were unaware of the relevant provisions and therefore scored no marks on this question. A significant number of candidates did not answer the question and, instead, discussed the ethical threats presented by the situation described in the scenario.

Maximum marks

Total available

2

3 SFQ 2 The primary responsibility for the prevention and detection of fraud rests with management External auditor is responsible for obtaining reasonable assurance that the financial statements are free from material misstatement The amount involved is not material It represents 0.12% of revenue and 2% of profit before tax Audit involves sampling Fraud is often concealed or involves collusion making it difficult to detect This question was well answered with many candidates attaining full marks. The points most commonly overlooked were in relation to audits being conducted on a sample basis and the fact that fraud is often concealed or involves collusion.

Maximum marks

Total available

4

6

General comments It was pleasing to note that the improvement in time management identified in recent sessions was sustained. There were notably fewer unfinished last answers and answers to the short-form questions (SFQs) appeared less rushed. However, a significant number of candidates are still failing to take advantage of the facility to present the short-form answers in note form, with some candidates answers extending over a page in length. 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.



SFQ 3 Analytical procedures Comparisons with - previous corresponding six months - month by month - industry sector data - budget/forecast Relationships between figures/changes in ratios Use of proofs in total Obtain plausible explanations for significant movements Limitations A good knowledge of the business is required to understand results Consistency of results may conceal an error May be a tendency to carry out procedures mechanically, without appropriate professional scepticism Requires an experienced member of staff to be done properly Reliable data may not be available Lack of comparability if business is growing/changing This question was generally well answered with most candidates providing a number of methods of how analytical procedures could be used when reviewing interim financial information as well as a number of limitations of such procedures. Weaker candidates failed to answer the question and, instead, wrote in general terms about how analytical procedures might be used at the various stages of an audit. A number of candidates wasted time writing about the level of assurance that would be provided by a review of interim financial information this was outside the scope of the requirement and did not score any marks.

Maximum marks

Total available

4

6 SFQ 4 All boxes to be uniquely numbered Register of numbers and to whom distributed/where located Provision of means of securing boxes to counters (eg chains) Sealing of boxes so that opening prior to collection by entity is apparent Regular collection of boxes from retail outlets and restaurants by trusted persons Dual control (ie 2 people) over opening and counting of cash donated Immediate recording of amounts in boxes Prompt banking of cash Independent reconciliation of amount recorded with bank records This question was very well answered with many candidates achieving either three or four marks. The most significant shortcoming related to recommendations not appropriate to the scenario. A common example was the recommendation to install CCTV to monitor the collecting boxes. A number of candidates confused segregation of duties with dual control. Many candidates failed to observe the instruction to limit their response to four procedures and wasted time listing more than four. Marks were not awarded beyond the first four procedures listed.

Maximum marks

Total available

4

9



SFQ 5 May be window dressing/cut off error May be material misstatements in financial statements if: - excluded from inventory - included in sales and receivables - goods are faulty/no provision for cost below NRV May be indicative of: - need for further provisions re additional returns/items in inventory - lack of management integrity/unreliable management representations Answers to this question were mixed. Most candidates explained the potential window dressing or cut-off issue and were able to identify at least one area of the financial statements that would be impacted. However, candidates were often unable to extend their discussion to the further implications such as doubts over management integrity and the possible indication that there may be additional returns unaccounted for.

Maximum marks

Total available

2

3 SFQ 6 Consequences Assets recorded in the register may not exist or may have been stolen Assets in existence, acquisitions or disposals may not be recorded Incorrect capital allowances may be claimed Assets may be fully written down but still in use and consequently undervalued Assets may be impaired or no longer in use and consequently overvalued Depreciation charges on assets may be inappropriate Resulting in misstatements in the financial statements Recommendations Regular/monthly/quarterly reconciliation of register and assets - physical to register to ensure completeness of recording - register to physical to ensure existence and in good condition Reconciliation to be performed independent of custodian Differences to be reported and investigated Train staff on how to carry out procedures Monitoring of procedures to ensure checks undertaken Answers to this question were disappointing. Most candidates identified some of the potential consequences of not undertaking periodic comparisons of the plant and equipment register with physical assets, such as assets no longer existing or unrecorded acquisitions. However, candidates recommendations tended to be vague such as carry out reconciliations. Furthermore, many strayed beyond recommendations relating to the lack of comparison of register and physical assets and discussed other controls relating to tangible non-current assets, such as controls over ordering. A minority of candidates confused plant and equipment with inventory.

Maximum marks

Total available

4

10



Question 7 Total marks: 40 General comments Although answers to this question attained the lowest overall average mark on the written test questions, there were some very good answers. In general, candidates provided good answers to part (a) but there were mixed answers to parts (b) and (c). Part (a) Justify why revenue, purchases and payables, inventory and e-commerce development costs have been identified as 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. Revenue Justification There is a risk of understatement if cash from outlet sales is misappropriated and not recorded as a sale. However, the risk of overstatement is greater due to the significant increase of 11.9% which is out of line with movements in purchases and inventory days. This may be caused by:

deliberate overstatement due to the bonus which is linked to profit;

failure to deduct post year-end returns which relate to pre year-end sales;

the unreliability of the new on-line system and failure to deduct duplicate sales; and

inappropriate revenue recognition policies for on-line sales (e.g. on order instead of despatch).

Purchase and trade payables Justification Foreign suppliers are paid in their local currency, which may result in translation errors due to calculation errors or use of inappropriate exchange rates. Payables days have fallen from 39.4 to 35.3 days, which may indicate that payables are understated due to unrecorded invoices and/or deliberate understatement due to the profit-related bonus.

Revenue Audit procedures Review gross profit margins on an outlet by outlet

basis to identify any which are out of line with expectation.

Review the results of the periodic inventory counts to identify any shortfalls between physical inventory and records, which may indicate unrecorded sales.

Trace goods returned records/credit notes to adjustments to revenue figure.

Evaluate and test the system of control over cash sales and on-line sales.

Discuss the reason for the increase in revenue with management and obtain a breakdown of revenue on outlet by outlet and on-line bases to identify movements out of line with expectation.

Purchase and trade payables Audit procedures Evaluate and test controls over recording of

invoices and payments to suppliers. Reperform a sample of foreign currency

translations, checking the rates to a reliable external source.

Trace a sample of goods received records to invoices recorded in the purchases and payables records.

Inspect invoices/payments after date to see if they relate to the year under review.

Reconcile suppliers statements with the balances on the payables ledger or, if necessary, undertake direct confirmation of balances.

Inspect suppliers invoices/contracts to ascertain whether there has been any change in suppliers terms of trading.



Inventory Justification Inventory days have increased from 61.8 to 64.9 days and may indicate overstatement. This may be caused by:

unreliable inventory records if adjustments for differences identified during the periodic counting are not accurately reflected in the records;

translation errors in respect of inventory purchased from overseas suppliers;

slow-moving items due to end of shelf life/out of fashion/damaged;

a failure to account for returns in the relevant accounting period;

a failure to write down damaged goods that have been returned; and/or

the deliberate overstatement of inventory due to the profit-related bonus

Inventory Audit procedures Evaluate and test controls exercised over the

inventory system and the periodic counting procedures (e.g. segregation of duties, counting in pairs, noting damaged items).

Review results of the clients counting procedures, in particular, evaluate the level of discrepancies and consider the implications for the reliability of the EPOS system.

Attend an inventory count during the year and undertake test counts involving two way counting.

Trace a sample of goods returned records to inventory records.

Review the aged inventory report to identify slow-moving items and discuss provision with management.

Inspect the inventory valuation listing and selling prices after the year end to identify items which may have an NRV below cost.

Test a sample of items to suppliers invoices to check cost is correctly recorded.

Website development costs Justification Costs may have been misstated due to: the inclusion of incorrect material and labour

costs and inappropriate items such as training or scrapped costs;

the misclassification of tangible and intangible elements; and/or

deliberate overstatement due to the profit-related bonus.

Depreciation and amortisation may have been calculated over inappropriate useful lives. There is potential impairment if the internet business does not prove to be profitable.

Website development costs Audit procedures Obtain a schedule of costs capitalised and

review items to ensure they are capital in nature.

Vouch amounts to contracts with/invoices from suppliers.

Vouch labour costs to payroll details and time sheets.

Ensure scrapped costs have been expensed. Discuss the basis for useful life with

management and reperform depreciation and amortisation calculations.

Inspect post year-end management accounts to ensure internet sales are holding up.



This part of the question was very well answered in respect of revenue and purchases and trade payables. However, inventory and e-commerce development costs were generally not well answered. As noted in previous examiners commentaries, 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. Almost all candidates followed the examiners guidance to use a columnar format to layout their answers. 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. The procedures were often too vague or unrelated to the justification of the audit risk. A minority of candidates failed to appreciate the importance of using analytical procedures as a risk assessment tool and lost the marks available for performing such procedures. Revenue Most candidates were able to provide a number of reasons to justify why revenue was an area of audit risk and provide some relevant audit procedures. The audit procedures most commonly overlooked were the review of revenue and margins on an outlet by outlet basis to identify any results that were out of line with expectation and the review of results of the periodic inventory counts to identify shortfalls between physical inventory and records. Purchases and trade payables Almost all candidates were able to justify why purchases and trade payables was an area of audit risk. The audit procedures most commonly overlooked were the evaluation and testing of controls over the purchase and payments system and the tracing of goods received records to invoices posted in the purchase and payables accounts. Inventory Stronger candidates identified slow-moving and damaged goods and the failure to correctly account for returns as justifications for the audit risk and were able to describe relevant audit procedures. However many candidates provided weak answers to justify why inventory had been identified as a key audit risk and consequently were unable to describe any associated audit procedures. A large number of candidates failed to appreciate the significance of the perpetual inventory records in both the valuation of inventory and the identification of aged inventory. There was a general lack of appreciation of the importance of checking the reliability of the records and ensuring that the results of inventory counts were reflected in those records. These candidates were therefore unable to describe any audit procedures that would adequately test the reliability of the records, for example the need to attend an inventory count during the year to evaluate controls over the counting procedures and perform two-way test counting. Some candidates incorrectly cited the need for auditors to organise their own inventory count at the year end or demanded that the client undertake such a count. A number of candidates incorrectly calculated inventory days using revenue instead of purchases. As noted by examiners in previous commentaries, a number of candidates lost marks by being too vague. For example, many candidates cited check inventory is stated at the lower of cost and NRV but failed to explain how they would do this or attend inventory count but failed to explain what they would do at the count. E-commerce development costs Most candidates were able to score some marks by identifying that e-commerce development costs may have been misstated and that capitalised costs needed to be reviewed to ensure that they were capital in nature. A significant minority of candidates ignored the requirement to justify why e-commerce development costs in the statement of financial position had been identified as an audit risk but justified why weaknesses in the e-commerce system were an audit risk. Consequently these candidates failed to identify any associated audit procedures. Almost all candidates overlooked the fact that there is a potential impairment if the on-line business does not prove to be profitable.

Maximum marks

Total available

24

51



Part (b) Identify and explain the threats to objectivity and state how your firm should respond to those threats in respect of the boards requests for the provision of services regarding: (i) the internal audit function; and (ii) the recruitment and remuneration package of the finance director. Internal audit function Threats A self-review threat arises as the external auditor will have to re-evaluate the work of the internal audit function and may be reluctant to identify shortcomings or rely too heavily on the work. A management threat arises if the internal audit function is required to make judgements or take decisions that are the responsibility of management. A self-interest threat arises if the firm becomes over-dependent on the fees from Brandsco and fear of losing the fees impairs the external auditors objectivity. Response The firm may accept the internal audit engagement if the following safeguards are in place: - there is informed management (i.e. management is capable of making decisions); - the work is performed by partners and staff who have no involvement in the external audit; - the work is properly and effectively assessed by the external audit team; - responsibilities do not include the taking of decisions as to the scope and nature of the services to be

provided and the design of internal controls or implementing changes thereto; - respective responsibilities are set out in an engagement letter; and - an engagement quality control review is undertaken. However, the engagement should be refused if it is reasonably foreseeable that the external auditor would place significant reliance on the work of the internal audit function. The firm should ensure that the total fees from Brandsco do not exceed 15% of the annual fee income of the firm. Where fees are between 10% and 15% of the annual fee income, the matter should be disclosed to those charged with governance and the ethics partner and an external quality control review should be arranged. Appointment of finance director and advice on remuneration package Threats A familiarity threat arises as the audit team may be reluctant to criticise the information or explanations provided by the finance director. A management threat arises if the directors expect the firm to be involved in the appointment of the finance director. The firm may become too closely aligned with the views and interests of management. Response Appointment of finance director The firm should not provide recruitment services to an audit client that would involve taking responsibility for the appointment of any director. As Brandsco is not listed, ES 5 Non-audit Services Provided to Audited Entities (ES 5) does not expressly prohibit recruitment services. If the directors are considered to be informed management, which they appear to be in this case, the service can be provided in less formal ways such as the provision of salary surveys and advice on a candidates financial competence. Remuneration package ES 5 prohibits the provision of services to an audit client that would involve the audit firm advising on the quantum of remuneration package or the measurement criteria because the familiarity threat is too high. Consequently this service should be refused.



Answers to this part of the question were mixed. In respect of the internal audit services, the majority of candidates identified the self-review threat. However, a significant number failed to identify the management and self-interest threats and consequently failed to attain marks available for those threats and the safeguards in relation to those threats. Those who identified the self-review threat often correctly identified the safeguard of separate teams. However, many of those stated, incorrectly, that information barriers should be in place between the two teams. These candidates failed to appreciate that confidentiality was not an issue and that there should be discussions between the internal and external auditors. Part (ii) regarding the recruitment and remuneration package of the finance director was not well answered. Of those who did correctly identify the management and familiarity threats, few were able to state how they could be mitigated. Disappointingly, a large number of candidates overlooked completely the remuneration package of the finance director in their answer and so lost marks. There was some (but less than in previous sessions) evidence of the scattergun approach where some candidates just listed all the possible threats to independence without linking them to the circumstances in the question no mark was awarded unless the threat could be linked to the circumstances in the question.

Maximum marks

Total available

10

25 Part (c) Describe the matters to be included in your firms engagement letter for the examination of the profit and cash flow forecasts in respect of: (i) the directors responsibilities; and (ii) the purpose and scope of your firms work. The matters to be included in the letter of engagement are as follows: Directors responsibilities The directors are responsible for: the preparation and presentation of the forecasts, including the identification and disclosure of the

assumptions on which the forecasts are based; providing the reporting accountant with all relevant information and source data used in developing the

assumptions; and providing written representations on the intended use of the forecasts, the completeness of significant

assumptions and acknowledgement of their responsibility for the forecasts. Purpose and scope of work The assurance firm is responsible for: examining (not auditing) the profit and cash flow forecasts for the period specified by the directors for

the purpose of supporting the application for funding; considering the reasonableness of the assumptions and providing limited assurance as to whether the

assumptions provide a reasonable basis for the forecasts. This will be expressed negatively in the form of nothing has come to our attention, which causes us to believe that these assumptions do not provide a reasonable basis for the forecast; and

providing an opinion as to whether the forecasts are properly prepared on the basis of the stated assumptions.

A statement as to whether the engagement is to be conducted in accordance with the provisions of ISAE 3400, The Examination of Prospective Financial Information.



Although there were some very good answers to this part of the question, many answers were disappointing. Weaker candidates strayed beyond the requirement and provided matters to be included in engagement letters generally including the basis of fees, restrictions of circulation of the report and limitation of liability, none of which scored any marks. Many candidates were unaware of the scope of the work undertaken when examining profit and cash flow forecasts. A significant number of candidates failed to appreciate the role of assumptions in the preparation of forecasts and their impact on both the directors and the assurance firms responsibilities. In respect of directors responsibilities, a number of candidates strayed beyond the requirement and wasted time writing at length about their responsibilities regarding the financial statements, the prevention and detection of fraud and error and the implementation and maintenance of internal controls. In respect of the assurance firms responsibilities, a significant number of candidates cited, incorrectly, that the forecasts should give a true and fair view. The majority of candidates correctly stated that the level of assurance would be limited and expressed negatively. However, few candidates stated that an opinion would be expressed on whether the forecasts were properly prepared on the basis of the assumptions.

Maximum marks

Total available

6

9



Question 8 Total marks: 20 General comments Answers to this question attained the highest overall average mark on the written test questions. This was generally due to very strong answers on part (a) as answers to part (b) were generally disappointing.

Part (a) Identify and explain the matters that should be considered by your firm in deciding whether to accept appointment as external auditor to Traveluxe. Your answer should include any preliminary audit risks identified from the information provided. Matters to be considered Reason for the change in auditor Whether there has been a disagreement between the retiring auditor and the management of Traveluxe, as it may indicate that management lacks integrity and the firm may not wish to be associated with such a client because of the adverse impact on its reputation. Adequacy of resources Whether the firm has: - experience in the industry sector and, if so, whether the firm has sufficient resources for separate teams

if the firm acts for a competitor; - the ability to cover the Irish subsidiary as the firm does not have an office in Ireland; and - the ability to cope with a popular year end (i.e. December) and to complete the audit within three

months as required by the client. Source of funds introduced by Alison Stableford Whether the funds are from a legitimate source to ensure compliance with Money Laundering Regulations. Outsourced payroll Whether the service organisation will grant access to its records and whether the service organisations auditors produce a report on internal controls. Otherwise there may be a limitation on scope. Extended liability Whether the firm owes a duty of care to Traveluxes bank, thereby exposing the firm to potential claims for damages if Traveluxe defaults on its loan repayments. Audit risk analysis New client A lack of knowledge and understanding of the business may result in failure to identify events and transactions, which impact on the financial statements and, in addition, opening balances may be misstated. Bank reviewing the financial statements There is a risk of management bias in order to comply with any covenants attached to the loan. In addition, detection risk is higher due to the time pressure involved in having to complete the audit within three months. Regulated industry Failure of Traveluxe to comply with industry regulations may result in fines which may not be provided for or disclosed as a contingent liability in the financial statements.

Going concern A number of factors point to the potential failure of Traveluxe and in particular: - the government contracts are renewable so there is no guarantee of future revenue streams; - if Traveluxe fails to comply with laws and regulations, its operating licence may be withdrawn; and - if Traveluxe fails to comply with any terms and conditions of the bank loan, the facility may be recalled. Acquisition of Roaches Coaches The parent company will be preparing consolidated financial statements for the first time and may lack proficiency in their preparation. This increases risk of error with respect to consolidation adjustments such as goodwill. The risk of misstatement is compounded by the fact that the Euro is the local currency, which may result in translation errors. There may be an impairment issue regarding the investment in the parent companys financial statements arising from the state of the Irish economy.



This part of the question was very well answered. The majority of candidates were able to provide a wide range of matters to be considered in deciding whether to accept appointment as external auditor and audit risks. Weaker candidates just listed general points without linking them to the scenario. For example, some candidates correctly identified resources as an issue but did not link it into geographical coverage or a tight deadline. A significant number laboured professional clearance, failing to appreciate that topic was more relevant to part (b). Many candidates wasted time discussing the fee dependency threat, failing to appreciate that this was unlikely to be the case for a firm with 15 offices throughout England and Wales. Although the majority identified that the preparation of consolidated financial statements for the first time increased the risk of error, few considered the potential for impairment of the investment in the parents financial statements. Weaker candidates failed to appreciate that it was the clients proficiency that was in doubt and instead wondered, incorrectly, whether the audit firm had the ability to deal with consolidated financial statements. A minority wasted time listing procedures to be carried out this was outside the scope of the requirement and no marks were awarded for such points.

Maximum marks

Total available

14

25



Part (b) State the responsibilities of the outgoing firm of external auditors relating to the change of appointment as set out in the ICAEW Code of Ethics. Give reasons for each of the responsibilities. Note: You are not required to refer to the Companies Act 2006 provisions in respect of a change of external auditor. Obtain authority from the company to discuss Traveluxes affairs with the incoming auditor. This authority is required to comply with the fundamental principle of confidentiality. If the client refuses to grant permission to discuss the clients affairs, this should be reported to the incoming auditor to alert him that the client may be hiding information. Answer promptly any communication from the incoming auditor about the clients affairs. A prompt response will avoid the perception of lack of professionalism and assist in a smooth changeover. Record in writing any discussions with the incoming auditor to provide evidence if questioned in the future. Confirm whether there are any matters which the incoming auditor ought to know, explaining them meaningfully (honestly and unambiguously) or confirm there are no such matters. Matters to be disclosed may include: - unlawful acts by the client, - unpaid fees, - differences of opinion. This ensures that the incoming auditor is in full possession of the facts and can make an informed decision.

If the existing auditor has made one or more suspicious activity reports relating to money laundering or terrorism, the existing auditor should not disclose that fact to avoid the offence of tipping off. Transfer promptly all books and records belonging to the company so that the company can comply with statutory requirements regarding adequate accounting records. Answers to this part of the question were very disappointing as the majority of candidates failed to follow the instruction in the requirement to ignore the Companies Act 2006 provisions. Consequently, they wasted time citing points for which there were no marks. The points most commonly identified in respect of the ICAEW Code of Ethics, were those relating to professional clearance and returning books and records to the company. In general, coverage of responsibilities was better than reasons underlying those responsibilities. For example, although many cited the matters that could be disclosed to the prospective auditor, few stated that it was to assist the auditor to make an informed decision. The points most commonly overlooked were those relating to the recording of discussions with the prospective auditor and the importance of not disclosing suspicious activity reports.

Maximum marks

Total available

6

15



Question 9 Total marks: 20 General comments Answers to this question attained the second highest average mark on the written test questions. It was pleasing to note an improvement in the standard of answers relating to modified audit reports.

Part (a) Explain and distinguish between the following three types of modified audit opinions: (i) qualified opinion; (ii) adverse opinion; and (iii) disclaimer of opinion. Qualified opinion A qualified opinion is expressed when there is a misstatement (i.e. a disagreement) or the auditor is unable to obtain sufficient appropriate audit evidence, (i.e. a limitation on scope) and that the misstatement is/could be material but not pervasive. The opinion is expressed as except for the financial statements give a true and fair view. Adverse opinion An adverse opinion is expressed when misstatements are (a disagreement is) material and pervasive. It is expressed as the financial statements do not give a true and fair view. Disclaimer of opinion A disclaimer of opinion is expressed when the auditor is unable to obtain sufficient appropriate evidence (i.e. a limitation on scope) and the possible effects of undetected misstatements, if any, are material and pervasive. It is also expressed when, in extremely rare circumstances, there are multiple uncertainties. The wording used is we do not express an opinion on the financial statements (or we are unable to form an opinion as to whether the financial statements give a true and fair view.) A qualified opinion is expressed when the issues are confined to specific elements, accounts or items of the financial statements. An adverse opinion or a disclaimer of opinion is expressed when: - many items in the financial statements are affected: - if confined to specific elements, the issues represent or could represent a substantial proportion of the

financial statements; or - in relation to disclosures, are fundamental to the users understanding of the financial statements. This part of the question was generally well answered as the vast majority of candidates provided plausible explanations of the different types of modified opinions. The most common omission was a failure to distinguish between material without being pervasive and material and pervasive. Furthermore, candidates often lost marks by failing to cite the wording used in the opinion, for example, except for in respect of a qualified opinion. A number of candidates stated, incorrectly, that adverse opinion and disclaimer of opinion were qualified opinions. A minority of candidates confused qualified opinions with emphasis of matter paragraphs. Few candidates mentioned that a disclaimer of opinion can be expressed when there are multiple uncertainties.

Maximum marks

Total available

6

7



Part (b) For each of the situations outlined: (i) state, with reasons, the actions you would take; and (ii) discuss the implications for the audit reports on the financial statements of Par and Fairway

and describe the effects, if any, on each audit report. Par plc Actions/reasons Discuss the matter with management as the loss of a major customer gives rise to going concern issues. Discussions should focus on managements contingency plans such as replacement contracts. Review managements assessment of the companys ability to continue as a going concern this should include an examination of profit and cash flow forecasts. Implication for the audit report If there is uncertainty about the going concern status of the company and management is willing to fully disclose the circumstances, the report but not the opinion, should be modified. An emphasis of matter paragraph should be included after the opinion paragraph, highlighting the issue and drawing users attention to the note in the financial statements. There should be a specific statement in the emphasis of matter paragraph that the opinion is not qualified/modified. If management refuses to disclose the uncertainty, the opinion should be modified due to misstatement/disagreement. The modification should be a qualified opinion if the issue is considered material but not pervasive or an adverse opinion if considered material and pervasive. A paragraph, explaining the issue should be included above the opinion. If the company is not considered to be a going concern, the financial statements should be prepared on the break-up basis. If the basis is fully explained in notes to the financial statements, the opinion is not modified but the auditor may modify the report with an emphasis of matter paragraph. If the financial statements are prepared on an inappropriate basis, many items in the financial statements will be materially misstated. This would be pervasive requiring an adverse opinion stating that the financial statements do not give true and fair view. Fairway Ltd Actions/reasons The amount should be noted on the schedule of individually immaterial errors and the directors should be informed of the matter. The subsequent sale is an adjusting subsequent event, providing additional evidence of the value of the work in progress at the year end. The work in progress should be valued at net realisable value (NRV), because it is lower than cost. However, the difference between the cost and NRV is 50,000 and is not material as it is only 2% of profit before tax and 0.25% of total assets. Implications for the audit report Even if the directors refuse to amend the financial statements, there will be no modification to the audit report in respect of this matter alone. However, it must be considered with other individually immaterial items, in case they are material when aggregated.



Par The majority of candidates identified that there was a going concern issue and, consequently, the importance of discussing contingency plans with management. Those candidates who identified that there were a number of different possible outcomes scored high marks. However, weaker candidates did not distinguish between an uncertainty about the going concern and whether the company was definitely going to cease to trade (i.e. not a going concern). In addition, many lost marks by failing to identify that the implication for the audit report depended on whether or not the directors were willing to disclose the situation in the notes to the financial statements. This was particularly so when candidates were dealing with the break-up basis of preparation of the financial statements.

Fairway

The majority of candidates correctly identified that the situation represented an adjusting subsequent event and that work in progress should be included at its net realisable value (NRV) because it was lower than cost. However, there was a considerable misunderstanding in relation to materiality. Many candidates failed to appreciate that it was the difference between the cost of the work in progress included in the financial statements and the NRV that should be considered. Instead, they considered the materiality of the work in progress figure and consequently concluded that the amount was material when in fact the difference between cost and NRV was not material. As a result, these candidates reached the wrong conclusion in respect of the implication for the audit report.

Maximum marks

Total available

14

22

EXAMINERS MARK PLAN COMMENTARYGeneral commentsSFQ 1SFQ 2SFQ 3

Analytical proceduresLimitationsSFQ 6RecommendationsPart (a)

Question 7 Total marks: 40Revenue Revenue Audit proceduresJustificationJustificationAudit proceduresInventory RevenuePurchases and trade payablesAlmost all candidates were able to justify why purchases and trade payables was an area of audit risk. The audit procedures most commonly overlooked were the evaluation and testing of controls over the purchase and payments system and the tracing of goods received records to invoices posted in the purchase and payables accounts. InventoryE-commerce development costs

Inventory Part (b)Internal audit functionThreatsResponseAppointment of finance director and advice on remuneration packageThreatsResponseAppointment of finance directorRemuneration packageThe matters to be included in the letter of engagement are as follows:Directors responsibilitiesPurpose and scope of workQualified opinionAdverse opinionDisclaimer of opinionPart (b)Par plcActions/reasonsFairway LtdActions/reasonsImplications for the audit reportParFairway

Audit and Assurance June 2011 Marks Plan

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