Lsbf-Mock Answer f8

ACCA

Paper F8 (INT & UK)

Audit and Assurance Revision Mock Examination

December 2010

Answer Guide

Health Warning!

How to pass Attempt the examination under exam conditions BEFORE looking at these suggested answers.

Then constructively compare your answer, identifying the points you made well and

identifying those not so well made.

How to fail Simply read or audit the answers congratulating

yourself that you would have answered the questions as per the suggested answers.

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Question 1

Tutorial help and key points

This question is typical of the 30 mark case study you can expect to see in Q1 of

the F8 paper. 30 marks may seem rather daunting at first! Our best advice is –

deal with each individual requirement as though it were a separate question and

this will help you to manage your time more effectively.

Part (a) asks you to identify FIVE weaknesses in a client’s payroll system then

to say what the consequences of those weaknesses are and to suggest controls

to mitigate the weaknesses. You should be identifying the more obvious

weaknesses such as the lack of authorisation of timesheets, the fact that there

is little segregation of duties, no checking of the payroll and no authorisation

needed to make changes to the system

Parts (b) is more theoretical and asks you to think about why control systems

are never 100% perfect at preventing and detecting fraud. Remember that

controls are operated by humans, so there is always a chance that they will

make mistakes or worse, deliberately override the controls to commit fraud.

Part (c) may seem tricky at first. The way to approach this question is to

remember which types of analytical procedures the auditor can use:

● This year to last year

● Actual to budget

● Client to industry

● Auditor calc to client calc

Then apply these ideas to the payroll costs.

Part (d) is a popular type of question asking you how audit software can be

used to audit payroll costs. It helps to think about the type of substantive

procedures that would normally be carried out on payroll and then choose the

ones that can be done with the help of a computer, rather than manually.

Part (e) Those of you who have thoroughly revised the class notes should have

no problem listing the disadvantages and advantages of using audit software.

Marking scheme

(a) Each weakness 1 mark/max 5

Each consequence 1 mark/max 5

Each control 1 mark/max 5

(b) Each reason 1 mark/max 5

(c) Each procedure 1 mark/max 3

(d) Each procedure 1 mark/max 3

(e) Each advantage or disadvantage 1 mark/max 4

Total maximum marks = 30


(a)

Weakness Consequence Recommended Control

Timesheets are not

reviewed or

authorised by a

supervisor or manager

before submission to

the payroll

department

Employees may be

claiming for hours that

they did not actually

work and as a result, the

company’s cashflow will

be adversely affected

All timesheets should be

reviewed and signed by

the relevant site supervisor

and manager before

submission to payroll

The timesheets are

not numbered in a

sequence

Timesheets may go

missing en-route to

payroll leading to

employees not being

paid

All timesheets for the week

should be sequentially

numbered and Lynn should

check the sequence for

missing numbers

Lynn does not

formally stamp or file

away the time sheets

once the hours have

been entered onto the

system

Lynn may accidentally

enter the details on a

timesheet twice so an

employee is paid for

extra hours

Each time sheet should be

stamped and filed away

once the details have been

entered onto the system.

An exception report should

be printed off the PC

detailing employees who

have worked over the

average number of hours

in the week and this

should be investigated

The MD signs the

payroll but does not

scrutinise it or carry

out spot checks

There may be obvious

errors in the payroll that

will not be picked up

The payroll list should be

scrtuinised by a manager

before sending to the MD

to check.

A spot check should be

carried out on some of the

calculations and a sample

of hours worked should be

agreed back to time sheets

The payroll details are

kept on a disc in

Lynn’s drawer

This is not a very safe

location and could lead

to the disc being stolen,

tampered with or

damaged

The disc should be kept in

a safe in a director’ s office


Supervisors do not

need authorisation in

order to ask Lynn to

add new joiners onto

or take leavers off the

payroll

Lynn does not repeat

the details back to the

supervisors

The supervisors could

give fictitious employee

details for Lynn to add

to the system or, Lynn

could add the fictitious

employees herself

Lynn may take the

details down incorrectly

leading to the wrong

people being paid/wrong

amounts being paid

Authorisation should be

obtained in writing from a

director before an

employee is added or

removed from the system

Before adding an

employee, Lynn must

check that there is a

contract/offer letter and a

form of ID for that

employee

New joiner details/leaver

details must be provided to

Lynn on a written form

which is sent to the MD for

authorisation before a

change can be made to the

system

The MD should obtain a

monthly print off of

changes to standing data

and review it for

reasonableness

Overall there is a lack

of segregation of

duties in the payroll

department

If Lynn has control over

too many parts of the

process, she will be able

to keep fraud hidden

Duties should be shared

out between a number of

employees.

(b) Why an internal control system cannot give complete assurance

● There is potential for human error/misunderstanding

● Senior staff members may use their authority to override controls

● People may collude to override controls

● Internal controls may become inadequate overtime – especially if the

business changes rapidly/significantly

● Non-routine transactions will usually not have established internal

controls.


(c) Analytical procedures – employment costs

● Recalculate total employer tax liability as ‘total salaries x tax rate’ and

compare to the client’s calculation to ensure it is reasonable

● Divide total payroll costs by average number of employees and compare

to prior year

● Compare current year payroll costs with budget to assess the overall

reasonableness of salary costs.

(d) Ways in which audit software can assist in the audit of payroll costs

● Cast the payroll list to ensure that the totals agree with the amount in

the control account

● Assist with analytical procedures such as recalculation of employee tax

figures and average wage per employee

● Stratification of balances so that material balances can be identified and

items chosen for testing

● Produce an exception report detailing any employee working more than

a specifies number of hours or earning more than a specified amount so

that this can be investigated

(e) Benefits and disadvantages of using audit software on the audit of

Fitta Ltd

Benefits Disadvantages

● Once suitable audit software has

been designed for the client, it

can speed up the audit and

ultimately reduce costs

● If the auditor uses live client

files to perform the tests on,

they can be sure that data has

not been tampered with

● The development of suitable

audit software requires a

thorough understanding of the

client’s system which will

enhance the auditors knowledge

of the client for future years

● There can be significant set up

costs when developing audit

software for the first time

● Use of audit software limits

audit tests to test on data in

electronic form – for inventories,

a number of physical tests will

still need to be carried out such

as test counts

● If the client provides copy files

the auditor needs to be sure

that they have not been

tampered with


Question 2


The 10-mark knowledge Q on the F8 paper is often a good place to start. There

is very little application needed here – you will either know the answer or not!

If you know the answer, use this opportunity to gain some quick, easy marks.

If not, do not spend ages trying to remember it! Leave yourself some time at

the end of the paper to come back and try and jot down as many points as

possible.

Marking scheme

(a) For each relevant point 1 mark/max 2

(b) Definition of detection risk 1 mark/max 1

Each factor 1 mark/max 3

(c) For each factor 1 mark/max 4


(a) Engagement letter

● Sets out the respective responsibilities of the directors and the auditors.

● Minimises the possibilities of misunderstandings between the client and

auditor.

● Legally binding contract once signed that sets out the scope of the work

and creates a legal basis for payment.

(b) Detection risk

If detection risk is high, it means that there is a high risk that the auditor’s

procedures will fail to spot a material misstatement

Detection risk will be higher where:

● Client is new.

● Auditor chooses unrepresentative samples.

● Auditor is inexperienced or untrained.

● Client has placed pressure on auditor to meet a tight deadline.


(c) Reliance on external experts

● Is the expert independent?

● Qualifications and experience.

● The scope of their assignment.

● Was their work adequately planning, supervised, reviewed and

documented?

● Did they have the necessary resources?

● Were their assumptions and methods reasonable?


Question 3


Explaining ethical issues and safeguards is a very popular requirement at F8.

Part (a) asks you consider why the concept of independence is crucial to

external auditing. Pick up an easy mark by explaining the term ‘independence’

and then go on to explain why it is important that the external auditors are

independent, ie to protect the shareholders who are relying upon their opinion.

Part (b). In this part of the question, you need to explain the threats that arise

specifically from the provision of other services (here, internal audit and

consultancy services to the client). These will be the self-review threat (as we

may be giving advice on systems that we then come to audit at a later date),

the management threat and the self-interest threat (as the increased fee

income from the services may result in the auditor becoming too dependent on

the client).

Remember to explain the threats fully in order to gain the marks available

Part (c). If you have revised your class notes carefully you should easily be

able to explain the activities carried out by the internal audit department within

a company.

Marking scheme


(b) For each threat explained 1 mark/max 6

For each safeguard 1 mark/max 6

(c) For each activity 1 mark/max 3


(a) Independence

Auditors should be free from influence/be unbiased/have an objective state of

mind.

They should also be seen to be independent.

Users need financial statements that portray as closely as possible the true

financial position of the company. However, management may desire to show

the results of its stewardship in the most favourable light.

Auditors are therefore required to be independent to protect shareholders

If users do not perceive auditors to be independent there will be:

● A lack of credibility in the financial information

● A loss of confidence in the profession.


(b) Threats to independence and how they many be resolved

Threat

The provision of internal audit services presents a self-review threat as

those carrying out the audit may:

● Place too much reliance on the work of colleagues

● Be reluctant to inform management of any shortcomings in their

colleagues’ work.

It also represents a management threat which may be unacceptably high.

By taking on the role of internal auditors, the external auditors may have to

take decisions or make judgements that are the responsibility of

management.

Safeguards

● Ensure that audit firm does not make management decisions regarding:

o the scope and nature of the internal audit services to be provided;

o the design of internal controls or the implementation of changes to

internal controls.

● The audit should be reviewed by an independent partner not involved in

the audit engagement.

Threat

Acting for a long period of time poses familiarity, self interest and self-

review threats as the auditor may be too sympathetic to their client/too

trusting/have reduced professional scepticism.

Safeguards

● As Stanley plc is a listed company the engagement partner should be

changed every five years.

● Key audit partners and senior staff should be rotated regularly (every

seven years).

Threat

The provision of additional services (ongoing consultancy work) presents a

self-interest/fee dependency threat as fear of losing the fee may tempt

the auditor to ignore any problems found. There is also depending upon the

actual work, a self-review threat.

Such work should not be taken on if a ‘reasonable and informed third party’

would perceive that the work is incompatible with an independent audit.

Safeguards

Ensure that fees from Stanley plc are less than 10% of total fee income.

Use a separate team for the additional services.

Do not take on management role.

Ensure an independent partner review is carried out on the audit files.


(c) Activities of internal auditors

● Review of the economy and efficiency of operations.

● Special investigations.

● Review of compliance with laws and regulations.


Question 4


Part (a) is a typical ‘audit risk’ style question where you are asked to explain

the audit risks from the information in the scenario. It helps to think of two

things:

i) What is the factor that concerns you?

ii) How can that lead to an error in the financial statements?

You must be very careful to explain the risk properly, ie focus on the errors

that could arise in the FS. No credit is given in these questions for explaining

the risks to the business – they must be audit risks.

Part (b). Once you have identified the possible risks to the audit, you must

then say what the auditors will do to address them.

The answers to questions such as this lend themselves very nicely to a column

format.

Marking scheme

(a) For each risk explained 1 mark/max 10

(b) For each procedure 1 mark/max 10


Audit risks Audit work

Import/export trade may involve

foreign currencies

Misstated amounts in respect of

translation of purchases, payables,

receivables, revenue or inventory if

wrong FX rates are used.

Check appropriate exchange rates have

been used

Garden furniture is sold with a 10

year warranty

Warranty provision is judgemental

and/or difficult to calculate and may be

misstated

Re-perform calculation

Assess reliability of provision calculation

in the past

Compare post year end warranty costs

to the provision

Online ordering

May give rise to income recognition

problems/incomplete recording of data

Check cut off procedures


Investment in the website

Inappropriate accounting treatment of

development costs

Review costs incurred on website to

ensure appropriate capitalisation

Lack of familiarity with payroll

processing due to previous

outsourcing

Failure to account for payroll costs and

liabilities in particular, tax liabilities

Evaluate and test controls over payroll

system

Perform detailed analytical procedures

on payroll costs

Confirm that tax liabilities are paid on

time

Cancellation of contract with service

provider

Failure to disclose provision/contingent

liability for damages

Inspect correspondence with legal

advisors

Inspect terms of contract for potential

penalties to be paid on cancellation

Pending sale of business

Overstatement of assets and

understatement of liabilities to impress

new buyer (especially receivables and

inventories)

Receivables circularisation

Review after date receipts from

receivables

Evaluate controls over inventory

Attend inventory count

Limited period to complete audit

Audit may be rushed so not enough

attention paid to risk areas or failure to

spot material misstatements

Limited time for identification of events

after the reporting period.

Independent partner review of files

Remind current owner of importance of

the audit and stand firm in face of

pressure to rush.


Question 5


Question 5 on the paper often covers issues such as audit reports, going

concern or subsequent events.

Part (a). It will help to break down your answer as per the requirement.

• Explain the term = define materiality and explain that items in

the FS can be material by size or by nature

• Discuss its role in the audit = auditors only care about errors

that are material

• Explain why it it’s a difficult area for the auditors =

remember that it is subjective and judgemental and will change

for every client.

Part (b) describes three separate audit clients, each with an issue with their FS.

You are then asked how the auditors will need to modify the audit report in each

case. For each scenario describe:

● The type of problem (disagreement or insufficient audit evidence)

● Its materiality

● The resulting modification

Marking scheme


(b) For each relevant point 1 mark/max 12


(a) Materiality

A matter is material if its omission or misstatement would reasonably

influence the decisions of the users of the financial statements.

Materiality is determined either by the size of an item or its nature.

To determine whether or not something is material by its size, yardsticks are

used such as % of pretax profit or a % of revenue.

Items that are material by their nature include transactions such as directors’

emoluments.

Role in the audit

Materiality influences:

● The nature, timing and extent of the audit work.

● Whether or not an error is corrected before the financial statements are

published.


● Whether the audit report is modified.

Why it is a difficult area for the auditor

The users of financial statements are diverse and so will all have a different

opinion as to what is material or not.

Materiality does not have a mathematical definition and requires the use of

professional judgement and should be determined by a responsible person.

(b) Audit report modifications

Vista plc

● The repairs and maintenance costs should have been expensed and not

capitalised.

● Since $8.5m exceeds pre-tax profits, if the error were to be adjusted the

profit would turn into a loss so the matter is clearly material, most

probably pervasive considering its significance.

● Modify the audit opinion with an adverse opinion due to the material

misstatement.

● The report would state that the financial statements do not give a true

and fair view with the reason and amount stated before the opinion

paragraph.

Rayton Ltd

● There is a difference between cost and NRV of $60,000.

● Cost = $240,000.

● NRV = $320,000-$140,000 = $180,000.

● At 2.5% of pre-tax profits it is unlikely to be considered material.

● Audit opinion will not be modified.

● All audit differences however should be noted on a schedule of

differences.

Viva Ltd

● The payment to Mary Benton represents a related party transaction and

must be disclosed regardless of its size.

● It is material by nature.

● The audit opinion will be modified with an ‘except for’ due to a material

misstatement.

● The reason and amount involved would be stated in a paragraph before

the opinion paragraph.

Lsbf-Mock Answer f8

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