Question # 1

(a) Auditors are required to plan and perform an audit with professional scepticism, to exercise
professional
judgement and to comply with ethical standards.
Required
(i) Explain what is meant by ‘professional scepticism’ and why it is so important that the auditor
maintains professional scepticism throughout the audit. (3 marks)
(ii) Define ‘professional judgement’ and describe two areas where professional judgement is
applied
when planning an audit of financial statements. (3 marks)
(b) You are an audit senior for Mills & Co. Mills & Co were recently appointed as external auditors of
Sleeptight
Co for the year ending 31 March 20X0 and you are in the process of planning the audit. The previous
auditors issued an unmodified audit opinion last year and access to prior year working papers has been
granted.
Sleeptight's principal activity is the manufacture and sale of expensive high quality beds which are largely
sold to luxury hotels and owners of holiday apartments. Each bed is crafted by hand in the company's
workshop. Construction of each bed only begins once a customer order is received, as each customer will
usually want their bed to have a unique feature or to be in a unique style.
The business is family run and all the shares in Sleeptight are owned by the two joint Managing Directors.
The directors are two sisters, Anna and Sophie Jones and they both have a number of other business
interests. As a result they only spend a few days a week working at the company and rely on the small
accounts department to keep the finances in order and to keep them informed. There is no finance director
but the financial controller is a qualified accountant.
Sleeptight requires customers who place an order to pay a deposit of 40% of the total order value at the
time
the order is placed. The beds will take 4 to 8 weeks to build, and the remaining 60% of the order value is
due
within a week of the final delivery. Risks and rewards of ownership of the beds do not pass to the
customer
until the beds are delivered and signed for. Beds also come with a two year guarantee and the financial
controller has made a provision in respect of the expected costs to be incurred in relation to beds still
under
guarantee.
Although the company does have some employees working in the workshop, it often uses external
subcontractors to help make the beds in order to fulfil all its orders. These sub-contractors should invoice
Sleeptight at the end of each month for the work they have carried out, but sometimes do not get round to
it
until the following month.
The company undertakes a full count of raw materials at the year end. The quantities are recorded on
inventory sheets and the financial controller assigns the costs based on the cost assigned in the previous
year or, if there was no cost last year, using the latest invoice. Most beds are made of oak or other durable
woods and the cost of these raw materials is known to fluctuate considerably.

It is expected that work in progress will be insignificant this year, but there will be a material amount of
finished goods awaiting despatch. Anna Jones will estimate the value of these finished goods and has said
she will take into account the order value when doing so.
There has been steady growth in sales in recent years and, in January 20X0 Sleeptight purchased a
building
close to its existing workshop. Anna and Sophie plan to turn this into another workshop which should
more
than double its existing manufacturing capacity. The new workshop is currently undergoing extensive
refurbishment in order to make it suitable for bed manufacturing.
The purchase of the new premises was funded by a bank loan repayable in monthly instalments over 12
years and has covenants attached to it. These covenants are largely profit related measures and if they are
breached the bank has the option to make the remaining loan balance repayable immediately.
Required
(i) Identify and explain EIGHT audit risks in respect of the financial statements of Sleeptight for
the year ending 31 March 20X0. For each risk suggest a suitable audit response. (16 marks)
(ii) Describe Mill & Co’s responsibilities in relation to the physical inventory count that will take
place atthe year end (4 marks)

Question #2

(a) Explain the components of audit risk and, for each component, state an example of a factor
which can result
in increased audit risk. (6 marks)
Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has a wide customer base
acrossEurope and Asia. You are the audit manager of Nate & Co and you are planning the audit of
Abrahams Co whosefinancial year end is 31 January. You attended a planning meeting with the finance
director and engagement partnerand are now reviewing the meeting notes in order to produce the audit
strategy and plan. Revenue for the year is forecast at $25 million.During the year the company has spent
$2·2 million on developing several new products. Some of these are in theearly stages of development
whilst others are nearing completion. The finance director has confirmed that allprojects are likely to be
successful and so he is intending to capitalise the full $2·2 million.Once products have completed the
development stage, Abrahams begins manufacturing them. At the year end it is anticipated that there will
be significant levels of work in progress. In addition the company uses a standard costing method to value
inventory; the standard costs are set when a product is first manufactured and are not usually updated. In
order to fulfil customer orders promptly, Abrahams Co has warehouses for finished goods located across
Europe and Asia; approximately one third of these are third party warehouses where Abrahams just rents
space. In September a new accounting package was introduced. This is a bespoke system developed by
the information technology (IT) manager. The old and new packages were not run in parallel as it was
felt that this would be too onerous for the accounting team. Two months after the system changeover the
IT manager left the company; a new manager has been recruited but is not due to start work until January.
In order to fund the development of new products, Abrahams has restructured its finance and raised $1
million through issuing shares at a premium and $2·5 million through a long-term loan. There are bank
covenants attached to the loan, the main one relating to a minimum level of total assets. If these covenants
are breached then the loan becomes immediately repayable. The company has a policy of revaluing land
and buildings, and the finance director has announced that all land and buildings will be revalued as at the
year end. The reporting timetable for audit completion of Abrahams Co is quite short, and the finance
director would like to report results even earlier this year.
Required
(b) Using the information provided, identify and describe FIVE audit risks and explain the
auditor’s response to each risk in planning the audit of Abrahams Co. (10 marks)
(c) Describe substantive procedures you should perform to obtain sufficient appropriate evidence in
relation to:
(i) Inventory held at the third party warehouses; and
(ii) Use of standard costs for inventory valuation. (4 marks)
(Total = 20 marks)

Question # 3
Recorder Communications Co (Recorder) is a large mobile phone company which operates a network of
stores in countries across Europe. The company’s year end is 30 June 20X4. You are the audit senior of
Piano & Co. Recorder is a new client and you are currently planning the audit with the audit manager.
You have been provided with the following planning notes from the audit partner following his meeting
with the finance director. Recorder purchases goods from a supplier in South Asia and these goods are
shipped to the company’s central warehouse. The goods are usually in transit for two weeks and the
company correctly records the goods when received. Recorder does not undertake a year-end inventory
count, but carries out monthly continuous (perpetual) inventory counts and any errors identified are
adjusted in the inventory system for that month. During the year the company introduced a bonus based
on sales for its sales persons. The bonus target was based on increasing the number of customers signing
up for 24-month phone line contracts. This has been successful and revenue has increased by 15%,
especially in the last few months of the year. The level of receivables is considerably higher than last year
and there are concerns about the creditworthiness of some customers. Recorder has a policy of revaluing
its land and buildings and this year has updated the valuations of all land buildings. During the year the
directors have each been paid a significant bonus, and they have included this within wages and
salaries. Separate disclosure of the bonus is required by local legislation.
Required
(a) Describe FIVE audit risks, and explain the auditor’s response to each risk, in planning the audit
of Recorder
Communications Co. (10 marks)

Question #4
You are the audit supervisor of Maple & Co and are currently planning the audit of an existing client,
Sycamore Science Co (Sycamore), whose year end was 30 April 20X5. Sycamore is a pharmaceutical
company, which manufactures and supplies a wide range of medical supplies. The draft financial
statements show revenue of $35.6 million and profit before tax of $5.9 million.Sycamore’s previous
finance director left the company in December 20X4 after it was discovered that he had been
claiming fraudulent expenses from the company for a significant period of time. A new finance director
was appointed in January 20X5 who was previously a financial controller of a bank, and she has
expressed surprise that Maple & Co had not uncovered the fraud during last year’s audit.
During the year Sycamore has spent $1.8 million on developing several new products. These projects are
at different stages of development and the draft financial statements show the full amount of $1.8 million
within intangible assets. In order to fund this development, $2.0 million was borrowed from the bank and
is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the
loan covenants. The new finance director has informed the audit partner that since the year end there has
been an increased number of sales returns and that in the month of May over $0.5 million of goods sold in
April were returned. Maple & Co attended the year-end inventory count at Sycamore’s warehouse. The
auditor present raised concerns that during the count there were movements of goods in and out the
warehouse and this process did not seem well controlled. During the year, a review of plant and
equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of
$210,000.
Required
(a) State Maple & Co’s responsibilities in relation to the prevention and detection of fraud and
error.
(4 marks)
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit
of Sycamore
Science Co. (12 marks)
(c) Sycamore’s new finance director has read about review engagements and is interested in the
possibility of
Maple & Co undertaking these in the future. However, she is unsure how these engagements differ
from an
external audit and how much assurance would be gained from this type of engagement.
Required
(i) Explain the purpose of review engagements and how these differ from external audits; and
(2 marks)
(ii) Describe the level of assurance provided by external audits and review engagements. (2 marks)
(Total = 20 marks)