Answers

Applied Skills, September/December 2020 Sample Answers

Audit and Assurance (AA) and Marking Scheme

Section B

Hart Co

(a) Audit planning is addressed by ISA 300 Planning an Audit of Financial

Statements. It states that adequate planning benefits the audit of financial
statements in several ways:

− Helping the auditor to devote appropriate attention to important areas of the

audit.
− Helping the auditor to identify and resolve potential problems on a timely basis.
− Helping the auditor to properly organise and manage the audit engagement so
that it is performed in an effective and efficient manner.
− Assisting in the selection of engagement team members with appropriate levels
of capabilities and competence to respond to anticipated risks and the proper
assignment of work to them.
− Facilitating the direction and supervision of engagement team members and the
review of their work.
− Assisting, where applicable, in coordination of work done by experts.

(b) Risks and responses

Audit risk Auditor’s response

Hart Co is a new client for Morph & Co. Morph & Co should ensure it has a
suitably experienced team assigned to
As the audit team is not familiar with the audit and that adequate time is
the accounting policies, transactions allowed for team members to obtain an
and balances of Hart Co, there will be understanding of the company and the
an increased detection risk on the risks of material misstatement,
audit. including a detailed team briefing to
There is also less assurance over cover the key areas of risk.
opening balances as Morph & Co did Increased audit procedures should be
not perform the audit last year. performed over opening balances.

The directors are paid a bonus based The audit team should be aware of the
on a percentage of profit before tax for increased risks of manipulation and
the year. should assign more experienced audit
members to significant estimates and
There is a risk that the directors will try judgemental areas.
to overstate the profit, and therefore
their bonuses by increasing the
revenue and income recorded and
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Audit and Assurance (AA) and Marking Scheme

decreasing expenses. This is a Also, adequate time should be

particular risk relating to judgemental allocated for team members to obtain
areas such as provisions and an understanding of the company and
estimates. the significant risks of overstatement of
profit, including attendance at an audit
team briefing.

The team needs to maintain

professional scepticism and be alert to
the increased risk of manipulation.
Increased testing should be performed
relating to adjusting journal entries.

Customers pay a 25% deposit on The audit team should obtain a copy of
signing the contract to purchase the the contracts with customers and
playgrounds. review them to understand the
performance obligations. They should
The deposits should not be recognised discuss with management the criteria
as revenue immediately and instead for determining whether performance
should be recognised as deferred obligations have been satisfied and the
income (contract liabilities) within treatment of deposits received to
current liabilities until the performance ensure it is appropriate and consistent
obligations, as per the contracts, have with relevant standards.
been satisfied. This is likely to be at a
point in time, when control of the During the final audit, the audit team
playground is passed to the customer. should undertake increased testing
over the cut-off of revenue and the
There is a risk that revenue is completeness of deferred income
overstated and current liabilities (contract liabilities).
understated if the deposits have been
recorded within revenue.

The audit team will only attend the WIP The auditor should assess which
counts at five of the 16 sites. inventory counts the team will attend,
most likely to be those with the most
WIP is a material balance and the material WIP balances or which are
valuation of WIP is a judgemental area. assessed as having the greatest risk of
As the audit team is not attending all misstatement.
sites, detection risk is increased as the
team will be unable to directly obtain For those inventory counts not
evidence relating to WIP. attended, the audit team will need to
obtain and review documentation
relating to the controls surrounding the
counts and will need to review reports
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

from any experts used to value the

WIP, and any exceptions noted during
the count and discuss with
management any issues which arise
during the count.

Hart Co offers its customers a warranty The audit team should discuss with
at no extra cost, which guarantees the management the basis of the provision
playgrounds will function as expected calculation and compare this to industry
for three years. The provision is averages and the level of post year-end
calculated as 2% of revenue in the claims, if any, made by customers. In
current year against 6% in the prior particular, they should discuss the
year, despite there being no changes in rationale behind reducing the level of
the construction techniques or the level provision this year.
of claims.

Under IAS® 37 Provisions, Contingent

Liabilities and Contingent Assets this The audit team should also compare
should be recognised as a warranty the prior year provision with the actual
provision. Calculating warranty level of claims in the year, to assess
provisions requires judgement as it is the reasonableness of the judgements
an uncertain amount. made by management.

There is a risk that the warranty

provision could be understated, leading
to understated expenses and liabilities.

Hart Co has recognised $0.6m of The audit team should obtain a

research expenditure in profit or loss breakdown of the research expenditure
with the remaining $1.2m having been recognised in profit or loss and of the
capitalised as development development costs capitalised and
expenditure. review supporting documentation to
determine whether they have been
IAS 38 Intangible Assets has strict correctly classified. Any development
criteria as to which costs can be expenditure should then be agreed as
capitalised as development meeting the relevant criteria for
expenditure. There is a risk that the capitalisation as set out in IAS 38.
requirements of the standard have not
been applied correctly. The team should also discuss the
accounting treatment with the finance
If research costs have been incorrectly director and ensure it is in accordance
classified as development expenditure, with IAS 38.
there is a risk that intangible assets
could be overstated and research
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

expenses understated.

Hart Co placed an order for $2.4m of Review the non-current asset register
machinery, paying $1m in advance. to determine if the $1m paid in advance
The machinery was due to be received has been capitalised. Discuss the
in July 20X5 but will now be delivered correct accounting treatment with
post year end. management to confirm that the
amount paid in advance is recognised
Only assets which physically exist at as a prepayment and if incorrectly
the year end should be capitalised as recognised review the correcting
property, plant and equipment (PPE). journal entry.
The $1m deposit paid in advance
should be recognised as a prepayment.

If the deposit of $1m paid in advance

has been capitalised within PPE then
prepayments are understated and PPE
will be overstated.

Hart Co made a rights issue in the year. The audit team should obtain legal
This is a non-standard transaction and documentation in support of the rights
there is increased risk that the issue issue to agree the number of shares
has not been recorded correctly. issued and the rights price. They
should recalculate the split of share
The rights issue has been made at a capital and share premium and agree
premium and therefore requires to be this to the journal entry to record the
split into its share capital and share rights issue.
premium elements.
The audit team should also agree that
There is a risk that the split between disclosures are adequate and
share capital and share premium has consistent with standards and
not been accounted for correctly and legislation.
that these balances are misstated.
There is also a risk that the rights issue
has not been disclosed in accordance
with accounting standards and local
company legislation.

Hart Co’s payroll function is outsourced Discuss with management any changes
to an external service organisation. to the extent of records maintained at
Hart Co since the prior year audit and
A detection risk arises as to whether any monitoring of controls which has
sufficient and appropriate evidence is been undertaken by management over
available at Hart Co to confirm the payroll.
completeness and accuracy of controls
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

over the payroll cycle and liabilities at Consideration should be given to

the year end. contacting the auditor of the service
organisation, Chaz Co, to confirm the
Consideration should be given to the level of controls in place. A type 1 or
level of controls in place at the service type 2 report could be requested.
organisation and whether the data is
reliable. If any errors occurred these Consider the extent to which sufficient
could result in the wages and salaries appropriate audit evidence can be
expense and any accruals being obtained from records held at Hart Co
misstated. in respect of the wages and salaries
expense and liabilities.

Directors’ remuneration disclosures Discuss this matter with management

have been made in line with IFRS® and review the requirements of local
Standards but not local legislation. legislation to determine if the disclosure
in the financial statements is included
Where the local legislation is more appropriately.
comprehensive than IFRS Standards it
is likely that the company must comply
with local legislation.

The directors’ remuneration disclosure

will not be complete if the additional
information is not disclosed.

(c) Substantive procedures for directors’ bonuses

• Obtain a schedule of the directors’ bonus and cast the schedule to ensure its
accuracy. Agree the amount to that disclosed in the financial statements.
• Review the schedule of current liabilities and confirm the bonus accrual is included
as a year-end liability.
• Agree the individual bonus payments to the post year-end payroll records.
• Recalculate the bonus payments and agree the criteria to supporting documentation
and the percentage rates to be paid to the directors’ service contracts.
• Confirm the amount of each bonus paid by agreeing to the post year-end cash book
and bank statements.
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

• Compare the profit before tax used in the bonus calculation to the final profit before
tax figure to confirm whether any adjustment is required to the bonus paid and
discuss any differences with management.
• Agree the amounts paid to each director to board minutes and contracts to ensure
the amounts included in the current year financial statements are fully accrued and
disclosed.
• Review the board minutes to identify whether any additional payments relating to
this year have been agreed for any directors.
• Obtain a written representation from management confirming the completeness of
directors’ remuneration including the bonus.
• Review the disclosures made regarding the bonus paid to directors and assess
whether these are in compliance with local legislation.

(d) Safeguards

• Both Hart Co and its competitor should be notified that Morph & Co would be acting
as auditors for each company and consent should be obtained from management of
each company.
• Morph & Co should consider advising one or both clients to seek additional
independent advice.
• Morph & Co must ensure it appoints separate engagement teams, with different
engagement partners and team members to each client; once an employee has
worked on one audit, such as Hart Co, then they should be prevented from being
on the audit of the competitor for a period of time.
• Adequate procedures should be in place within the firm to prevent access to
information, for example, strict physical separation of both teams, confidential and
secure data filing.
• Morph & Co must set out clear guidelines for members of each engagement team
on issues of security and confidentiality. These guidelines could be included within
the audit engagement letters sent to each client.
• Morph & Co should consider the use of confidentiality agreements signed by all
members of the engagement teams of Hart Co and the competitor.
• Work performed should be reviewed by an appropriate reviewer who is not involved
in the audit to assess whether key judgements and conclusions are appropriate.
• Regular monitoring of the application of the above safeguards should be
undertaken by a senior individual in Morph & Co not involved in either audit.
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

Swift Co

(a) Documenting systems

Description Advantage
Narrative notes Narrative notes consist of a They are simple to record;
written description of the after discussion with staff
system. They detail what members, these discussions
occurs in the system at each are easily written up as notes.
stage and include details of
any controls which operate at They can facilitate
each stage. understanding by all
members of the audit team,
especially more junior
members who might find
alternative methods too
complex.
Flowcharts Flowcharts are a With flowcharts it is easy to
diagrammatic illustration of view the system in its entirety
the internal control system. as it is all presented together
Lines usually demonstrate the in one diagram.
sequence of events and
standard symbols are used to Due to the use of standard
signify controls or documents.
symbols for controls, it can be
effective in identifying missing
controls.
Questionnaires Internal control questionnaires Questionnaires are quick to
(ICQs) or internal control prepare, which means they
evaluation questionnaires are a timely method for
(ICEQs) contain a list of recording the system.
questions for each major
transaction cycle; ICQs are If drafted thoroughly they
used to assess whether ensure that all controls
controls exist whereas ICEQs present within the system are
assess the effectiveness of considered and recorded,
the controls in place. hence missing controls or
deficiencies are clearly
highlighted by the audit team.
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

(b) Key controls and tests of control

Key control Test of control

Swift Co has a separate human Review the job descriptions of payroll
resources (HR) department, which is and HR to confirm the split of
responsible for setting up all new responsibilities with regards to setting
employees. up new joiners.

Having a segregation of roles between Discuss with members of the payroll

HR and payroll departments reduces department the process for setting up
the risk of fictitious employees being set new joiners and agree new joiners to
up and also being paid. documentation initiated by HR.
All new employees are assigned a Attempt to add a new joiner to the
unique employee number by HR. The payroll system without a unique
payroll system is unable to process new employee number, the system should
joiners without the inclusion of the reject this addition.
unique employee number.

As payroll staff are unable to set up

new joiners without the employee
number from the joiner form it reduces
the risk of fictitious employees being set
up by payroll.
On a monthly basis an exception report Select a sample of monthly exception
of changes to payroll standing data is reports and review for evidence of
produced and reviewed by the payroll review and follow up of any unexpected
manager. changes by the payroll manager.

This ensures that any unauthorised

amendments to standing data are
identified and investigated on a timely
basis so that the data used when the
payroll is run is valid and accurate.
The payroll supervisor selects a sample Review the monthly payslips sampled
of payslips and recalculates the gross by the payroll supervisor for their
to net pay calculations, compares the signature for evidence the review of
results to the output from the payroll calculations has been undertaken.
system and investigates any
discrepancies. For a sample of monthly payrolls
reperform the gross to net pay
This reduces the risk that the calculation and compare to the payroll
automated system generates errors system, discuss any discrepancies with
during the payroll processing. Any the payroll supervisor.
errors would be identified on a timely
basis to prevent wages being over or
under paid.
Purchase orders up to $5,000 are Select a sample of purchase orders
authorised by the purchasing manager and review for evidence of
and above $5,000 by the purchasing authorisation in accordance with
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

director. authorisation limits. Agree this to the

appropriate signature on the approved
This ensures that goods are only signatories list.
purchased which are required by Swift
Co and relate to genuine business
expenses.
The warehouse department agrees the During the interim audit observe the
receipt of goods from suppliers to a warehouse department when receiving
copy of the purchase order and goods to understand the level of
confirms the quantity and quality of the checks being undertaken.
goods received and signs the goods
received notes (GRNs) to evidence the Review a sample of GRNs held in the
checks. warehouse department for signature,
as evidence of checks being
This ensures that Swift Co is not undertaken on receipt of goods.
recording liabilities and subsequently
paying for the receipt of inferior quality
goods or for goods it did not order.
Purchase invoices are logged into the Select a sample of control total sheets
purchase day book in batches, utilising and review for evidence of control
control totals. totals being utilised and the clerk’s
signature.
Utilising control totals ensures both
completeness and accuracy over the
input of purchase invoices. If the
invoices are not all input completely
and accurately payables may be
misstated.
Supplier statement reconciliations are Review the file of reconciliations to
undertaken on a monthly basis and ensure that they are being performed
these are reviewed by the financial on a regular basis and that they have
controller. been reviewed by a responsible official.

This ensures that any errors in the Re-perform a sample of the

recording of purchases and payables reconciliations to ensure that they have
are identified and corrected in a timely been carried out appropriately and
manner and therefore that payables are discrepancies investigated.
complete and accurate.
The finance director authorises the Review the payments list for evidence
bank transfer payment list for suppliers of review by the finance director.
after agreeing the amounts to be paid
to supporting documentation and Enquire of accounts staff what
reviewing for any duplicate payments. supporting documentation the finance
director requests when undertaking this
This reduces the risk that suppliers review.
could be being paid an incorrect
amount, or that sums are being paid to
fictitious suppliers.
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

Sagittarii Co

(a) Substantive procedures for Vega Vista Co’s income

– Obtain a schedule of all Vega Vista Co’s income and cast to confirm completeness
and accuracy of the balance and agree to the trial balance.
– Compare the individual categories of income of festival ticket sales, sundry sales
and donations against prior years and investigate any significant differences.
– For the annual festival, construct a proof-in-total calculation of the number of tickets
sold, approximately 15,000, multiplied by the ticket price of $35. Compare this to the
income recorded and discuss any significant differences with management.
– For tickets sold on the day of the festival reconcile from ticket stubs the number of
tickets sold multiplied by $35 and agree these sales to cash banked in the bank
statement.
– Discuss with management their procedures for ensuring advance ticket sales for the
September 20X5 festival are excluded from income and instead recognised as
deferred income in the statement of financial position.
– Select a sample of advance ticket sales made online, agree that the transaction has
been excluded from current year income and follow through to inclusion in deferred
income.
– Agree journal entry to transfer prior year deferred income relating to the 20X4
festival to current year income to the ledger and agree figures to prior year financial
statements.
– For sundry sales, obtain a breakdown of the income received per stall and agree to
supporting documentation provided by each stall holder. Recalculate the fixed
percentage received is as per the agreement/contract made with Vega Vista Co.
– Compare sundry sales per stall holder to prior year sales data and investigate any
significant differences.
– For monthly donations, trace a sample of donations from sign up documentation to
the bank statements, cash book and income listing to ensure that they are recorded
completely and accurately.
– For a sample of new donors in the year, agree the monthly sum and start date from
their completed forms and trace to the monthly donations received account and
agree to the cash book and bank statements.

(b) Substantive procedures for Canopus Co’s restructuring provision

– Cast the breakdown of the restructuring provision to ensure it is correctly calculated

and agree the total to the trial balance.
– Review the board minutes where the decision to restructure the production process
was taken and confirm the decision was made in March 20X5.
– Review the announcement to shareholders and employees in late March, to confirm
that this was announced before the year end.
– Obtain a breakdown of the restructuring provision and confirm that only direct
expenditure relating to the restructuring is included.
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– Review the expenditure to confirm that there are no retraining costs of existing staff
included.
– For the costs included within the provision, including acquisitions of plant and
machinery, agree to supporting documentation, such as purchase invoices, to
confirm validity and value of items included.
– Review post year end payments/invoices relating to the expenditure and compare
the actual costs incurred to the amounts provided to assess whether the amount of
the provision is reasonable.
– Obtain a written representation confirming management discussions in relation to the
announcement of the restructuring and to confirm the completeness of the provision.
– Review the adequacy of the disclosures of the restructuring provision in the financial
statements and assess whether these are in accordance with IAS® 37 Provisions,
Contingent Liabilities and Contingent Assets.

(c) Substantive procedures for Canopus Co’s bank loans

− Obtain a schedule of opening and closing loans detailing any changes during the
year. Cast the schedule to confirm its accuracy and agree the closing balances to
the trial balance and draft financial statements.
− For the new loan taken out in the year, review the loan agreement to confirm the
amount borrowed, the repayment terms and the interest rate applicable.
− For the new loan taken out in the year, agree the loan proceeds of $4.8 million per
the loan agreement to the cash book and bank statements.
− For loans repaid, agree the final settlement amount per bank correspondence to
payments out during the year in the cash book and bank statements.
− Agree the quarterly repayment of the new loan of $150,000 paid on 31 March 20X5
to the cash book and bank statement.
− Recalculate the split of the loan repayment made on 31 March 20X5 between
interest and principal, recalculate interest and agree to inclusion in statement of
profit or loss, and outstanding loan balance reduced by principal amount repaid.
− Review the bank correspondence and loan agreements for confirmation of any early
settlement charges incurred on the loans repaid. Agree that these were charged to
the statement of profit or loss as a finance charge.
− Obtain direct confirmation at the year-end from the loan provider of the outstanding
balances and any security provided. Agree confirmed amounts to the loans
schedule.
− Review all loan agreements for details of covenants and recalculate all covenants to
identify any potential or actual breaches.
− Review the disclosure of non-current liabilities in the draft financial statements,
including any security provided and assess whether these are in accordance with
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

accounting standards and local legislation. Additionally, confirm that the split of
current and non-current loans in the financial statements is correct.

(d) Impact on Auditor’s report

The restructuring provision of $2.1 million includes $270,000 of costs which do not meet
the criteria for inclusion as per IAS 37 Provisions, Contingent Liabilities and Contingent
Assets. Hence by including this amount the provision and expenses for this year are
overstated and profits understated.

The error is material as it represents 2.3% of total equity and liabilities/ total assets
(0·27m/11.6m) and hence the finance director should adjust the financial statements by
removing this cost from the provision and instead expensing it to profit or loss as it is
incurred. The argument that the provision is judgemental and has been deemed
reasonable by the board is not valid. IAS 37 has strict criteria for what can and cannot
be included within a restructuring provision. For example, training costs for existing staff
must be specifically excluded.

If the finance director refuses to amend this error the audit opinion will be modified due
to a material misstatement. As management has not complied with IAS 37 and the error
is material but not pervasive, a qualified opinion would be appropriate.

A basis for qualified opinion paragraph would be included after the opinion paragraph
and would explain the material misstatement in relation to the incorrect treatment of the
restructuring provision and the effect on the financial statements. The opinion
paragraph would be qualified ‘except for’.
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

Marks Marks

Marking Scheme

Hart Co

(a) Benefits of audit planning

Appropriate attention to important areas 1

Identify/resolve potential problems/risks 1

Effective/efficient performance 1

Assists in selection of audit team/assignment of work 1

Facilitates direction/supervision/review 1

Assists in coordination of work performed by experts 1

Restricted to 4

(b) Audit risk and response (only 8 risks required)

New client 2

Directors’ bonus 2

Payment of deposit 2

Audit team not attending all WIP counts 2

Warranty provision decrease 2

Treatment of R&D costs 2

Payment for PPE in advance 2

Rights issue 2

Outsourced payroll function 2

Directors’ remuneration disclosure 2

Max 8 issues, 2 marks each 16

Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

Marks Marks

(c) Substantive procedures for directors’ bonuses

1 mark per well-described procedure

Restricted to 5

(d) Safeguards

1 mark per well-explained point

Restricted to 5

Total marks 30
Applied Skills, September/December 2020 Sample Answers
Audit and Assurance (AA) and Marking Scheme

Marks Marks

Swift Co

(a) Methods of documenting internal controls

Narrative notes 2

Flowcharts 2

Questionnaires 2

(b) Key controls and test of controls (only 7 required)

Segregation of duties – HR and payroll 2

Unique employee number to process joiners 2

Review of exception report 2

Recalculation of gross to net pay 2

Authorisation of purchase orders 2

Goods agreed to purchase order/quality/quantity 2

Control totals used for invoice input 2

Supplier statement reconciliations 2

Authorisation of bank transfer list 2

Max 7 issues, 2 marks each 14

Total marks 20
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Audit and Assurance (AA) and Marking Scheme

Marks Marks

Sagittarii Co

(a) Substantive procedures for income

1 mark per well-described procedure

Restricted to 5

(b) Substantive procedures for restructuring provision

1 mark per well-described procedure

Restricted to 5

(c) Substantive procedures for bank loans

1 mark per well-described procedure

Restricted to 5

(d) Impact on auditor’s report

Discussion of issue 1

Materiality calculation and assessment 1

Type of modification required 2

Impact on auditor’s report 1

5

Total marks 20