Question

ICAP
Bank

Audit and Assurance

Seventh edition published by
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 Certificate in Accounting and Finance

C
Audit and Assurance

Contents
Page
Question and Answers Index v
Questions
Section A Multiple choice questions 1
Section B Objective test and long-form questions 13
Answers
Section C Multiple choice answers 71
Section D Objective test and long-form answers 75

© Emile Woolf International iii The Institute of Chartered Accountants of Pakistan

Audit and Assurance

© Emile Woolf International iv The Institute of Chartered Accountants of Pakistan

 Certificate in Accounting and Finance

I
Audit and Assurance

Index to Objective test and long-form

questions and answers

Question Answer
page page
Audit framework, regulation and ethics
1 ICAP Code of Ethics 13 75
2 Levels of assurance 13 76
3 Shamsuddin 13 77
4 Core concepts 14 77
5 Threats 14 78
6 Burewala and Kamal 14 80
7 Zaman and Bilal 15 80
8 Audit process 15 81
Regulatory and professional
9 15 82
requirements
10 Fundamental principles 16 84
11 Confidential Information 16 84
12 Independence of external auditors 16 84
13 Tahira and Parvez 16 85
14 ABC Limited 16 85
15 Masoom, Chalak and Hoshiyar Limited 16 85
16 Prime Super Markets Limited 17 86
17 Professional Ethics 17 86

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Audit and Assurance

Question Answer
page page
18 Threats and Safeguards 17 87
Planning and risk assessment
19 Durable Cement Limited (DCL) 17 88
20 Saad Co 18 88
21 Alpha 18 89
22 Engagement letter and documentation 18 89
23 Shahid Corporation 19 90
24 Assertions 19 90
25 Companies Act, 2017 19 91
26 ASPL 20 92
27 Distributor 20 93
28 Fraudulent Financial Statements 20 93
29 Kashif and Company 21 94
30 Delicious Biscuits Limited (DBL) 21 94
31 Daud and Company 21 95
32 ABC (Private) Limited 21 95
33 Materiality 21 95
34 Auditor’s Expert 22 96
35 Mineral Limited 22 96
36 AMF 22 97
37 Acceptance and planning 22 97
38 SPL 22 98
39 Fruit and nuts 23 98
40 Discussions and judgment 23 99
41 Dynamic 23 100
42 Changing Terms 24 100
43 EL 24 101
44 Calm Co 24 101
45 Azam 24 102
46 Hurricane 24 103
47 Zakir Co 25 105
48 Educational University (EU) 26 107
49 Hajira 26 107
50 Tahir Co 27 109

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 Index to questions and answers

Question Answer
page page
51 Elegant Limited 27 111
52 Roof Limited 28 111
53 Door Limited 28 112
54 Clocks (Private) Limited 28 112
55 HSB & Company 28 113
56 Debase Co 28 113
57 BFF Co 29 113
58 GHI Company 29 113

59 Serene Limited 29 114

60 Green Limited 29 114

61 Sukkur Limited 30 115
62 Information Limited 30 115
Internal control
63 Training Manager 31 117
64 Vision Limited 31 118
65 Types of Controls 31 118
66 IT Department 31 119
67 Bhurbhan Limited 32 119
68 Audit trail 32 120
69 Supermarkets 32 121
70 Controls 32 121
71 Shahzad Limited 32 122
72 Waheed Engineering 33 123
73 Danish 33 124
74 Roses Anytime 34 125
75 Trade Receivables 34 128
76 Granger 35 129
77 TS Limited 36 132
78 Pacific Shipping Limited 36 132
79 Advanced Limited 36 132
80 Bell Limited 36 134
81 General IT Controls 37 134
Audit evidence
82 Verification of Evidences 37 135

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Audit and Assurance

Question Answer
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83 Rehan Limited 37 135
84 Sehat Pharmaceutical Limited 38 136
85 Nobel 38 136
86 Masoom Limited 39 137
87 Sky Blue 39 137
88 Direct confirmations 1 39 137
89 Chill 39 138
90 Sales sampling 39 138
91 PQR 40 139
92 Hard Stone Limited 40 140
93 Related parties 40 141
94 Kamil Limited 40 141
95 Direct confirmations 2 40 141
96 Working papers 41 142
97 Al-Shams 41 142
98 Auditor’s expert 41 143
99 ADL 41 143
100 Guava & Co 41 144
101 RP Planning 42 145
102 Manufacturing inventories 42 145
103 Framework 42 147
104 MWL 42 148
105 BPR 42 148
106 Taskeen Co 43 150
107 Wings 43 151
108 Glasses2Go 44 153
109 ISA 620 44 154
110 Cuddly World 45 155
111 Auditors 45 156
112 Analytical procedures and materiality 45 158
113 Tahira Transporters 46 159
114 Willow 46 160
115 Sparkle Forever 47 163
116 Bubbles 48 164

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 Index to questions and answers

Question Answer
page page
117 ISA 500 48 166
118 Javeria Co 48 166
119 Porridge 48 167
120 Trembridge Engineering 49 170
ISA 620: Using the Work of an Auditor’s
121 50 171
Expert
122 Heidi Co 50 172
123 Babar Limited 50 174
124 Concordia Limited 51 174
125 Blue Bell Limited 51 175
126 BAC Limited 51 175
127 Stewardship and Accountability 51 175
128 Shahbaz Chemicals limited 51 176
129 Express Limited 51 176
130 Farhan Foods Limited 51 176
131 Fresh Dairies Limited 52 177
Scenarios
132 Zeedin Co 52 178
133 Sahito Co 53 181
134 Bashir Co 55 183
135 Multiple Situations 56 185
Completion
136 Final audit file 56 188
137 Energy Limited 56 188
138 XYZ & Company 56 189
139 XYZ Limited 57 189
140 Noncurrent assets 57 189
141 Customized Machinery Limited (CML) 57 190
142 Nadeem Limited 57 190
143 System logs 57 191
144 Overtime payments 57 191
145 Khanewal Limited (KL) 58 191
146 ABD Limited 58 191
147 Cell Phones (Private) Limited 58 192

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Audit and Assurance

Question Answer
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148 Substantive procedures 58 193
149 Pioneer Textile Limited (PTL) 58 194
150 Multiple Questions 59 194
151 Analytical Procedures 59 196
152 Auditor Responsibility 59 197
153 Al-Badr 60 198
154 The engagement partner 62 198
155 Different audit clients 62 198
Situations have arisen on different
156 62 199
clients
157 MM Electronics (Private) Limited 63 200
158 Ranjha Limited 63 200
159 Pervasive effects 64 201
160 Audit report at the end of the audit 64 201
161 Iqra Industries Limited 65 202
162 Written Representations 65 202
163 Kazmi-Wassan 65 203
164 RK Resourcing 66 204
165 Rake Enterprises 66 206
166 Tariq Limited 67 208
167 GMP & Company 67 208
168 BLC & Company 68 209
169 Audit Partner 68 210
170 Afzal Textile Mills Limited 68 210
Review engagements
171 ISRE 2400 69 211

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 Certificate in Accounting and Finance

A
Audit and Assurance

SECTION
Multiple choice questions
CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE
1 The fundamental objective of the audit of a company is to
A Protect the interests of the minority shareholders
B Detect and prevent errors and fraud
C Assess the effectiveness of the company’s performance
D Attest to the credibility of the company’s accounts
2 The concept of stewardship means that a company’s directors
A Are responsible for ensuring that the company complies with the law
B Are responsible for ensuring that the company pays its tax by the due date
C Safeguard the company’s assets and manage them on behalf of the shareholders
D Report suspected fraud and money laundering to the authorities
3 Why do auditors concentrate their efforts on material items in accounts?
A Because they are easier to audit
B Because it reduces the audit time
C Because the risk to the accounts of their being incorrectly stated is greater
D Because the directors have asked for it
4 Which of the following is NOT the responsibility of a company’s directors?
A Reporting to the shareholders on the accuracy of the accounts
B Establishment of internal controls
C Keeping proper accounting records
D Supplying information and explanations to the auditor
5 International auditing standards are issued by the:
A International Accounting Standards Board
B Financial Accounting Standards Board
C International Audit and Assurance Standards Board
D Auditing Practices Board

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Audit and Assurance

CHAPTER 2 – OBTAINING AN ENGAGEMENT

6 When an auditor is proposed for removal from office, which one of the following is he NOT permitted to
do?
A Circulate representations to members
B Apply to the court to have the proposal removed
C Speak at the AGM/EGM where the removal is proposed
D Receive notification of the AGM/EGM where the removal is proposed
7 Which one of the following is NOT a duty of the auditor?
A Duty to report to the company’s bankers
B Duty to report to the members
C Duty to sign the audit report
D Duty to report on any violation of law
8 Assuming that it is not the first appointment of the auditor, who is responsible for the appointment of the
auditor?
A The shareholders in a general meeting
B The managing director
C The board of directors in a board meeting
D The audit committee
9 The independent auditor's primary responsibility is to:
A the directors
B the company's creditors (payables)
C the company's bank
D the shareholders
10 How long is the auditor’s term of office?
A Until the audit is complete
B Until the financial statements are complete
C Until the next AGM
D Until the directors remove them

CHAPTER 3 – PLANNING AND RISK ASSESSMENT

11 Which of the following is correct in relation to materiality?
A A matter is material only if it changes the audit report
B A matter is material if the auditor and the directors both decide that further work needs to be
done in the area under question
C A matter is material only if it affects directors’ emoluments
D A matter is material if its omission or misstatement would reasonably influence the decisions of
an addressee of the auditors’ report
12 Which one of the following is NOT considered to be part of planning?
A Background i.e. industry
B Previous year’s audit i.e. any qualifications in the report
C Considering the work to be done by the client staff e.g. internal audit
D Considering whether the financial statements show a true and fair view

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 Question bank: Objective test and long-form questions

13 Audit risk is composed of 3 factors. Which of the following is NOT one of those factors?
A Compliance risk
B Detection risk
C Control risk
D Inherent risk
14 Which of the following should NOT be considered at the planning stage?
A The timing of the audit
B Analytical review
C Last year’s written representation letter
D Obtaining written representations
15 At the planning stage you would NOT consider:
A the timing of the audit
B whether corrections from the inventory count have been implemented
C last year's audit
D the potential use of internal audit

CHAPTER 4 – EVIDENCE AND SAMPLING

16 Which of the following describes sampling risk?
A The risk of the auditor carrying out a test the wrong way round
B The risk of reliance on unsuitable audit evidence
C The risk that the sample does not reflect the population
D The risk of the auditor reaching the wrong conclusions from testing
17 Which of the following is NOT an accepted method of selection in sampling?
A Systematic selection
B Pervasive selection
C Random selection
D Haphazard selection
18 Which of the following are you unlikely to see in the current file of auditors’ working papers?
A Memorandum & articles of association
B Audit planning memorandum
C Summary of unadjusted errors
D Details of the work done on the inventory count
19 According to ISA 500, the strength of audit evidence is determined by which two qualities?
A Appropriateness & competence
B Sufficiency & appropriateness
C Reliability & extensiveness
D Objectivity & independence

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Audit and Assurance

20 Which of the following is normally the most reliable source of audit evidence?
A Internal audit
B Suppliers’ statements
C Board minutes
D Analytical review

CHAPTER 5 – INTERNAL CONTROL

21 The degree of effectiveness of an internal control system depends on:
A The design of the internal control system and the implementation of the controls
B The design of the internal controls and the implementation of the control system
C The implementation of the controls and the correctness of the accounting records
D The design of the internal control system and the correctness of the accounting records
22 According to ISA 315, which of the following is NOT an element of the control environment?
A Participation of management
B Information processing
C Commitment to competence
D Human resource policies and practices
23 According to ISA 315, which of the following is NOT a control activity?
A Performance reviews
B Physical controls
C Organisational structure
D Segregation of duties
24 Which of the following is NOT an internal control?
A Authorising purchase orders
B Ensuring cash is locked away
C Performing external confirmation of receivables
D The opening of the post should not be the same person who banks the cheques
25 A walk-through test is designed to do what?
A To check that materiality levels are acceptable
B As a checklist to see if all substantive tests have been performed
C To provide assurance within a letter of representation
D To confirm that the auditor’s understanding of the internal control system is correct
26 Which of the following descriptions is correct?
A An internal control evaluation questionnaire is circulated to staff within the internal control
function of an organisation to ask for feedback about their job satisfaction and targets for the
coming year.
B Narrative notes are a list of questions about controls in a particular aspect of operations or
accounting. They are designed to establish whether appropriate controls exist that meet specific
control objectives.
C An internal control questionnaire is sent from the internal auditors to the external auditors during
the audit to request ideas for improving the internal control system.

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 Question bank: Objective test and long-form questions

D A systems flowchart provides a logical representation of an accounting system (or part of a

system) in the form of a diagram representing documents generated, processes applied and the
flow of documents between departments.
27 Which of the following is not a type of physical access control?
A Taking a weekly backup of data
B Surveillance video
C Fingerprint readers for system log-in
D Fences, doors and door-locks

CHAPTER 6 – TESTS OF CONTROLS

28 Which one of the following is NOT an internal control you would expect to see in a sales system?
A All goods received notes are authorised by the customer
B All orders are checked against credit limits
C All invoices are recorded on pre-numbered sequential documents
D All cash is banked on the same day as it was received
29 Which one of the following is NOT an internal control you would expect to see in a purchases system?
A Preferred suppliers are used
B All invoices are grid-stamped to create the company’s own invoice system
C Employees are only paid for work done
D There is a list of authorised cheque signatories
30 Which of the following is NOT a main element of a sales system?
A Receiving orders from customers
B Marketing
C Despatching the goods and invoicing customers
D Recording sales and debtors in the accounts
31 Which of the following is NOT a test of control?
A Checking that all purchase invoice are authorised by the proper people
B Test checking from purchase invoices to goods received notes
C Where a list of approved suppliers exists, checking that orders are placed only with suppliers on
such a list
D Checking for sequential numbering by the client of purchase invoices received
32 Which of the following is NOT a main element of a purchases system?
A Placing orders
B Receiving purchase invoices
C Goods received
D Decisions at board level on whether to incur capital expenditure

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Audit and Assurance

CHAPTER 7 – INTRODUCTION TO SUBSTANTIVE PROCEDURES

33 Which of the following is NOT a financial statement assertion?
A Completeness
B Occurrence
C Cash flow
D Existence
34 Which of the following is NOT an accepted means of obtaining audit evidence?
A Inspection
B Enquiry
C Analytical procedures
D Estimates
35 Which one of the following types of evidence is the most reliable?
A The client's sales invoices
B Report obtained from a client’s bank confirming balances
C The written representation letter
D Confirmation during a telephone call with the Managing Director that there are no loans
outstanding
36 At what stage of the audit do ISAs 315 and 520 require the auditor to use analytical procedures?
A When tendering for the audit of a new client
B During the planning stage and the review stage
C At the report writing stage
D When deciding whether to rely on the evidence of an expert
37 Which of the following is not an accounting estimate?
A Depreciation
B Provision for claims under a law suit
C Price paid for a new non-current asset
D Accrued revenue

CHAPTER 8 – SUBSTANTIVE PROCEDURES: NON-CURRENT ASSETS

38 Which tangible non-current assets are normally not depreciated?
A Land and buildings
B Land only
C Buildings only
D All tangible non-current assets are depreciated
39 Which of the following should not be shown as an intangible non-current asset?
A Purchased goodwill
B Non-purchased goodwill
C Development costs meeting the criteria in IAS 38
D Other intangible assets having a readily ascertainable market value

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 Question bank: Objective test and long-form questions

40 A non-current asset register holds details of non-current assets.

These details will include:
A Cost, depreciation, service details, location, disposal proceeds
B Service details, serial number, capital allowances, net book value
C Capital allowances, disposal proceeds, supplier, location
D Cost, depreciation, asset number, serial number, location
41 Which of the following is NOT a substantive test for the audit of non-current assets?
A Reconcile the non-current assets register to the receivables ledger control account
B Consider the reasonableness of any revaluations
C Physically check a sample of non-current asset additions
D Vouch disposal proceeds to the bank statement
42 Which term would you NOT associate with non-current assets?
A Net realisable value
B Goodwill
C Investments
D Net book value

CHAPTER 9 – SUBSTANTIVE PROCEDURES: CURRENT ASSETS

43 The principal audit procedure at the inventory count is?
A Analytical review
B Computation
C Observation
D Delegation
44 Which of the following is NOT a substantive test for the audit of inventories?
A Test the updating of all inventory count differences to inventory records
B Test the accuracy of net realisable value through the review of post year-end sales
C Have satisfactory explanations been explained for all material inventory count differences
D Check that all administrative overheads have been correctly accrued for in the valuation of
inventories
45 Which of the following are acceptable valuation methods under IAS 2?
A LIFO and weighted average
B FIFO and base
C LIFO and base
D FIFO and weighted average
46 Which of the following is NOT a substantive test for the audit of receivables?
A Test cash received after the end of the reporting period
B Check adequate provision for doubtful debts
C Check reasons for debit balances (and ensure they are disclosed under payables)
D Check brought forward balance

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Audit and Assurance

47 What is NOT true about bank reconciliations?

A Reconciling items must be followed through to the bank statement
B An error, if below materiality, is acceptable
C If the client has performed the reconciliation, the auditor must cast the whole reconciliation
D It is the primary substantive test for cash

CHAPTER 10 – SUBSTANTIVE PROCEDURES: OTHER AREAS

48 A good way to authenticate sales is to view the authorisation of?
A Goods received notes
B Sales orders
C Goods despatch notes
D Supplier statements
49 Which of the following audit procedures is primarily intended to provide audit evidence as to existence?
A Matching sales invoices to goods despatch notes
B Casting the sales ledger
C Confirming receivables balances with customers
D Checking the dating of outstanding cheques
50 Which of the following is NOT normally a non-current liability?
A Corporation tax payable
B Debentures
C Bank loans
D Finance lease obligations
51 Which of the following does not appear in IAS 37?
A Deferred income
B Contingent assets
C Provisions
D Contingent liabilities
52 Suppliers’ statements are reconciled in order to:
A verify the completeness of payables
B ensure cut-off is correct
C vouch the authorisation of purchase orders
D verify the existence of payables

CHAPTER 11 – RELATED PARTY TRANSACTIONS

53 An example of an external business risk is:
A The existence of related parties
B Having a small customer database
C A customer's insolvency
D Process of dealing with customer relations

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 Question bank: Objective test and long-form questions

54 Which of the following statements about the audit of related parties is correct?
A The materiality of related parties is judged by reference to the company being audited, not the
individual related party.
B The main audit concern in relation to related parties is the adequacy of the disclosures of the
related parties that have been identified.
C It is usually considered unnecessary to obtain written representations from management about
related parties.
D A company should disclose both the nature of related party relationships and the amount of
related party transactions.
55 Which of the following statements are correct?
1 With related party transactions, there is some risk of collusion and fraud.
2 A focus of audit attention with regard to related party transactions should be on significant non-
routine transactions.
A Statement 1 only is correct.
B Statement 2 only is correct.
C Both statements are correct.
D Neither statement is correct.

CHAPTER 12 – RELIANCE ON OTHERS

56 The auditor may work with a specialist. What effect does this have on the auditor’s responsibilities?
A The client must take full responsibility for the specialist
B The auditor’s responsibilities are not diminished in any way
C The auditor and client have joint responsibility for the specialist
D All 3 are equally responsible

CHAPTER 13 – PROFESSIONAL ETHICS AND CODES OF CONDUCT

57 You have been proposed as auditor of a company. What is the first step that you should take?
A Obtain the client’s permission to communicate with the existing auditor
B Obtain the existing auditor’s working papers
C Obtain a copy of the company’s most recent board minutes
D Obtain a copy of the existing auditor’s letter of engagement
58 Which one of the following may auditors NOT perform for their client?
A Taking management decisions
B Preparation of accounting records
C Preparing tax computations
D Advising on weaknesses in the internal control systems
59 Which of the following are fundamental ethical principles for professional accountants?
1 Competence
2 Compliance
3 Integrity
4 Objectivity

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Audit and Assurance

A 1, 2 and 3 only
B 1, 3 and 4 only
C 2, 3 and 4 only
D 1, 2 and 4 only
60 An auditor should not accept a loan on favourable commercial terms from an audit client because of the
threat to his or her independence. The threat would be a:
A Self-interest threat
B Self-review threat
C Advocacy threat
D Familiarity threat
61 Which of the following statements is INCORRECT?
A An auditor may serve on the board of directors of an audit client.
B An auditor who is an immediate family member of the director of an audit client must not be
assigned to the audit team.
C Purchasing goods from an audit client on normal commercial terms does not create a threat to
the auditor’s independence.
D An auditor who was recently a director of an audit client must not be assigned to the audit team
for that client.

CHAPTER 14 – AUDIT FINALISATION AND REPORTING

62 Which of the following is true about written representations?
A They are the best source of audit evidence
B They should be used only when there is a lack of other substantive audit evidence
C They should be used only when there is other substantive audit evidence to complement it
D Shareholders receive a copy of all material written representations
63 Which of the following would you not use as a benchmark for comparison when undertaking analytical
procedures?
A Other audit clients
B Previous years
C Other companies in the same industry
D Budget
64 What is meant by the expression ‘expectation gap’?
A The gap between how the directors of a company perform their duties and how the shareholders
expect them to perform
B The gap between how the directors of a company perform their duties and how the general public
expects them to perform
C The gap between the public perception of the role of company auditors and their statutory role
and responsibilities
D The gap between the auditors’ own perception of their duties and how they are set out in the
Companies Act
65 Which of the following does NOT belong in the auditors’ report?
A Introductory paragraph specifying the pages to which the report relates and the accounting
convention adopted

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 Question bank: Objective test and long-form questions

B Basis of the opinion

C Involvement of any specialist
D Statement of responsibilities of directors and auditors
66 Which one of the following is part of the auditor’s function?
A Conducting the inventory count
B Obtaining and evaluating audit evidence on the financial statements
C Calculating the year-end accruals figure for inclusion in the accounts
D Providing representations to management

CHAPTER 15 – INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS

67 What sort of assurance is provided in a review engagement?
A Positive assurance
B Negative assurance
C High level of assurance
D No assurance
68 For companies required to produce interim financial statements (IFI):
A one audit firm should audit the IFI and a different firm should audit the financial statements for the
year as a whole.
B one accountancy firm should review the IFI and a different firm should audit the financial
statements for the year as a whole.
C the same firm should audit the IFI and the financial statements for the year as a whole.
D the same firm should review the IFI and the financial statements for the year as a whole.
69 What is meant by negative assurance?
A The auditor cannot give an opinion due to lack of evidence.
B The client's financial statements were found to be materially misstated.
C The auditor could not conduct any tests due to lack of controls.
D The auditor did not find anything to indicate that a material misstatement exists.

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Audit and Assurance

© Emile Woolf International 12 The Institute of Chartered Accountants of Pakistan

 Certificate in Accounting and Finance

B
Audit and Assurance

SECTION
Objective test and
long-form questions
AUDIT FRAMEWORK, REGULATION AND ETHICS
1 ICAP Code of Ethics
(a) ICAP’s code of ethics has specified five principles of professional ethics for chartered accountants.
The circumstances in which a chartered accountant operates may give rise to specific threats to
compliance with these principles.
Required:
(i) Briefly describe each of the fundamental principles of professional ethics.
(ii) Briefly describe different categories of the threats to compliance with the fundamental
principles.
(b) Mustansar is the audit manager of a team engaged on the audit of a listed company. During his
initial discussion with the chief executive officer (CEO) of the company, he was informed that
depressed economic conditions have badly affected the company and its liquidity. Due to
uncertainty about the future of the company, certain key employees have left including several staff
members of accounting and finance department. Consequently, the accounting records are in a
bad shape and the management is making efforts to complete the draft accounts quickly. He
therefore requested Mustansir to carry out necessary accounting work and to help prepare the
annual financial statements at a fee to be agreed mutually.
Required:
Briefly describe the guidelines contained in the ICAP’s Code of Ethics and the extent of support
that can be offered by the auditors, in the above situation.
2 Levels of assurance
Distinguish between absolute and reasonable assurance. Identify the type of assurance that is expected
in an audit of the financial statements, clearly outlining the reasons to justify your point of view.
3 Shamsuddin
Shamsuddin a newly qualified chartered accountant has recently established his practice in the name of
Shamsuddin & Co., Chartered Accountants. He is continuously trying to expand his practice and in this
process he came across the following situations:
(i) Fashion Limited, a private limited company, which has suffered heavily on account of recent
financial turmoil, has informed him that it is willing to appoint him in the forthcoming annual general
meeting (AGM) of the company in place of the existing auditors, if he can quote a fee below the
existing audit fee.

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Audit and Assurance

(ii) Design Limited has contacted Shamsuddin and informed him that they are willing to appoint him
as their external auditor in the next AGM at a fee of Rs. 200,000 if he completes the audit in a
month. However, in case of delay in the audit work the audit fee will be reduced to Rs. 150,000.
Required:
Shamsuddin is inclined to accept the above offers. Discuss the options available with him in each of the
above situations.

4 Core concepts
(a) Briefly highlight the management’s responsibilities relating to the financial statements?
(b) During the audit team planning meeting, a member of the audit team passed a comment that based
on past experience with the client, he was confident that the management of the client was honest
and there was no issue as regards management integrity or risk of fraud in the Company. The
audit manager responded that the auditor should always maintain an attitude of professional
scepticism throughout the audit.
Required:
Briefly describe ‘Audit Scepticism’ and elaborate on the response of the audit manager.

5 Threats
(a) A chartered accountant is required to comply with five fundamental principles specified by ICAP’s
Code of Ethics. However, compliance with the fundamental principles may potentially be
threatened by a broad range of circumstances.
Required:
Briefly describe the categories of threats that may potentially affect compliance with the
fundamental principles. Give two examples for each category.
(b) Discuss the threats and the related safeguards in each of the following situations:
(i) Saleem is the audit senior at Mango Industries Limited (MIL). MIL’s finance manager has
requested him to provide the residential addresses of the engagement manager and the
engagement partner. The finance manager wants to send them one of MIL’s latest product.
(ii) Akram is the audit senior engaged on the audit of Dragon Limited (DL). He has informed the
audit manager that he has been offered a job by DL and that he would be joining DL from 1
April 2018. The audit is expected to be completed on 15 March 2018.
(c) Amjad is the audit senior at Orange Limited (OL), a software house. OL has adopted IFRS 15
‘Revenue from Contracts with Customers’ for preparation of its financial statements for the year
ending 31 March 2018. However, the manager finance of OL is indecisive as regards revenue
recognition on certain contracts.
He has asked Amjad to suggest accounting treatment of such contracts in accordance with IFRS
15. Amjad does not have in-depth knowledge of this IFRS and therefore, he has consulted his
friend who has recently attended a workshop on IFRS 15.
Required:
i. Discuss the threats in the above situation.
ii. What actions the firm should take to ensure that such situation is avoided in

6 Burewala and Kamal

Discuss the categories of threats that may be involved in each of the following independent
situations and advise the partners of the concerned firm with regard to the possible course of action that
may be followed, in each case.
(a) Burewala Bank Limited (BBL) is a listed audit client of Umer and Company, Chartered Accountants
(UCC). BBL has granted a house loan of Rs. 5 million to a partner in UCC.
(b) Kamal was the audit manager during the last year’s annual audit of Faisalabad Textile Mills Limited
(FTML). He has joined FTML as their Manager Finance prior to the commencement of the current
year’s audit.

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 Question bank: Objective test and long-form questions

7 Zaman and Bilal

Comment on each of the following independent situations with reference to the applicable rules and
regulations.
(a) Zaman is a partner in a firm of Chartered Accountants and holds 5,000 shares in Mardan Limited
(ML). His firm has received an offer for appointment as auditors of Khanewal Limited (KL). ML and
KL are subsidiaries of Dera Khan Limited (DKL).
(b) Bilal and Company has received an offer for appointment as auditors of IJK Limited. The total
paid up capital of the company is Rs. 990 million whereas its ordinary share capital is Rs. 130
million.
Faryal, the wife of a partner in Bilal and Company, is a director in LMN Limited which holds
50 million non-voting preference shares and 2 million ordinary shares in IJK Limited. Faryal also
holds 10,000 shares in LMN Limited. The par value of both types of shares is Rs. 10 each.

8 Audit process
The purpose of an external audit and its role are not well understood. You have been asked to write
some material for inclusion in your firm’s training materials dealing with these issues in the audit of large
companies.
Required:
(a) Draft an explanation dealing with the purpose of an external audit and its role in the audit of large
companies, for the inclusion in your firm’s training materials.
(b) The external audit process for the audit of large entities generally involves two or more
recognisable stages. One stage involves understanding the business and risk assessment,
determining the response to assessed risk, testing of controls and a limited amount of substantive
procedures. This stage is sometimes known as the interim audit. Another stage involves further
tests of controls and substantive procedures and audit finalisation procedures. This stage is
sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place during the interim
and final audit of a large entity.
(c) Briefly discuss the key benefits which may arise due to splitting of work between interim and final
audit.

9 Regulatory and professional requirements

The profession has been criticised recently by politicians for its role in monitoring potential corporate
failure. Radical reforms have been called for in the way the audit is regulated. For example, politicians
have stated that there should be a change of legislation in the following ways:
Auditing standards
Auditing standards should be set and enforced independently from the accounting profession.
Fraud
Auditing firms should have a duty to detect and report fraud.
Non audit services
Non auditing services supplied to an audit client should be stopped.
The duration of the appointment of auditors
The appointment of auditors should be for a maximum period of seven years.
Required:
(a) Describe the current regulatory and professional requirements relating to each of the headings
listed above.
(b) Discuss the reasons why you feel the audit profession has been criticised over the current
regulations in the above areas.

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Audit and Assurance

10 Fundamental principles
Explain each of the FIVE fundamental principles of ICAP’s Code of Ethics

11 Confidential information
Explain the situations where an auditor may disclose confidential information about a client.

12 Independence of external auditors

The responsibilities of external auditors are not always well understood. When external auditors provide
non-audit services to their audit clients, it is essential that the auditors make a clear distinction between
their audit and non-audit responsibilities.
Required:
Explain why it is essential for external auditors to be independent of their clients.

13 Tahira and Parvez

Your firm is the external auditor to two companies. One is a hotel, Tahira, the other is a food wholesaler,
Parvez, which supplies the hotel. Both companies have the same year-end. Just before the year end, a
large number of guests became ill at a wedding reception at the hotel, possibly as a result of food
poisoning.
The guests have taken legal action against the hotel and the hotel has taken action against the food
wholesaler. Neither the hotel nor the food wholesaler has admitted liability. The hotel is negotiating out-
of-court settlements with the ill guests, the food wholesaler is negotiating an out-of-court settlement with
the hotel. At the year end, the public health authorities have not completed their investigations.
Lawyers for both the hotel and the food wholesaler say informally that negotiations are ‘going well’ but
refuse to confirm this in writing. The amounts involved are material to the financial statements of both
companies.
Required:
Assuming that your firm continues with the audit of both companies, for each company, describe the
difficulties you foresee in obtaining sufficient audit evidence for potential provisions, contingent liabilities
and contingent assets.

14 ABC Limited
Comment on each of the following situations with reference to the appointment of external auditors in
accordance with the requirements of the Companies Act, 2017.
(a) ABC Limited and DEF Limited are associated companies on account of common directorship.
Salman and Company, Chartered Accountants (SCC) have received an offer for appointment as
the auditor in ABC. Salman, a partner in SCC is the spouse of Naveen, who is an employee in
DEF.
(b) All the partners of Kashif Associates are Cost and Management Accountants. The firm has
received an offer for appointment as the auditor of Nihal (Private) Limited (NPL). NPL has a paid-
up capital of Rs. 500,000 and 30% of its shares are held by Siyal Limited which is a public company.

15 Masoom, Chalak and Hoshiyar Limited

Discuss the categories of threats that may be involved in each of the following independent situations
and advise the partners of the concerned firm with regard to the possible course of action that may be
followed in each situation:
(a) Ahmed has recently joined a firm of Chartered Accountants. The firm intends to depute him on the
audit of Masoom (Private) Limited (MPL). Prior to joining the firm, Ahmed had been providing
accounting and taxation services to MPL for many years, in the capacity of a consultant.
(b) It has been discovered that father of one of the trainees posted on the audit of Chalak Limited (CL),
has a financial interest in CL.
(c) Hoshiyar Limited (HL), an audit client of your firm has recently advertised certain vacancies in its
accounts department. The said positions have been applied for by number of individuals including
two staff members who are posted on the audit of HL.

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 Question bank: Objective test and long-form questions

16 Prime Super Markets Limited

Discuss the categories of threats and related safeguards in each of the following situations:
(a) Your firm is the auditor of Prime Super Markets Limited, a chain of super markets. During a
promotional campaign, the management has distributed discount vouchers which have also been
given to the audit team members.
(b) You are the manager on the audit of Abid Textile Mills Limited. The client has requested you to
send two staff members on secondment for three months to assist the chief financial officer as its
two senior accounting team members have resigned recently.
(c) Fine Petroleum Limited (FPL) is the audit client of your firm for five years. During the year, the
engagement partner has been changed due to mandatory rotation as per Code of Corporate
Governance. However, the firm has decided to retain Atif, the audit manager, who has been
involved in the audit of FPL for the past five years.

17 Professional Ethics
Discuss the threat(s) that may be involved and the related safeguards in each of the following situations:
a) Anwar, an ex-trainee has recently re-joined your firm. He is interested in acting as the engagement
manager on Curtains Limited, where he had been employed during the past two years.
b) House Limited (HL) owns the building in which the Karachi office of your firm is located. HL owns
multiple projects across the city and provides its premises to various concerns on rental basis. HL
has requested your firm to become its auditor for the year ending 30 June 2018.
c) Window Limited (WL), an audit client of your firm has approached the taxation department of your
firm to review the income tax return to be filed by WL.

18 Threats and Safeguards

Discuss the categories of threats and related safeguards in each of the following situations:
(a) An unlisted audit client which has recently been incorporated has requested your firm to assist the
finance department in the preparation of financial statements.
(b) Saleem has recently been promoted as a partner and the audit of TTL has been assigned to him.
TTL owns and operates a chain of restaurants. The following matters are under his consideration:
(i) Asif has been involved in the audit of TTL as audit senior for the last three years. He has
recently qualified as chartered accountant and Saleem wants to appoint him as audit manager.
(ii) TTL’s management has requested Saleem to include Rashid, a semi-senior, in the audit team.
Rashid is the son of TTL’s Marketing Director.
(iii) The firm has long cordial relationship with the management of TTL. Saleem has noticed that
the firm often uses the restaurants run by TTL for conducting its internal functions.

PLANNING AND RISK ASSESSMENT

19 Durable Cement Limited (DCL)
You are the Audit Manager on the audit of Durable Cement Limited (DCL). The information contained in
the planning document includes the following:
(i) DCL is presently operating in poor general economic conditions and is also faced with tough
competition, due to the availability of low priced imported cement.
(ii) In addition to the wholesalers, DCL supplies cement directly to various government departments
and real estate developers. The sale is authorized by the credit control department; however,
payments from government departments are often delayed.
(iii) During the year, DCL has made investment in securities of unlisted public companies.
(iv) A long-term loan was obtained in 2007 to finance the existing plant. The amount is repayable in 10
annual installments.
(v) DCL operates a non-funded gratuity scheme for its employees.

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Audit and Assurance

Required:
Assess the inherent risks (high, low or moderate) along with appropriate justification, related to the
following assertions:
 Valuation of factory plant
 Valuation of trade receivables
 Ownership right of finished goods inventory
 Valuation of unlisted securities
 Accuracy of long-term finance
 Valuation of provision for gratuity

20 Saad Co
You are a manager in the audit firm of Ajmal & Co; and this is your first time you have worked on one of
the firm’s established clients, Saad Co. The main activity of Saad Co is providing investment advice to
individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient
savings schemes. Saad is regulated by the relevant financial services authority.
You have been asked to start the audit planning for Saad Co, by Mr Sher, a partner in Ajmal & Co. Mr
Sher has been the engagement partner for Saad Co, for the previous nine years and so has excellent
knowledge of the client. Mr Sher has informed you that he would like his daughter Zhura to be part of the
audit team this year; Zhura is currently studying for her first set of exams for her ICAP qualification. Mr
Sher also informs you that Mr Faisal, the audit senior, received investment advice from Saad Co during
the year and intends to do the same next year.
Required:
(a) Explain the ethical threats which may affect the auditor of Saad Co.
(b) For each ethical threat, discuss how the effect of the threat can be mitigated.

21 Alpha
The following three entities have approached Alpha & Company, Chartered Accountants (the firm) for
appointment as their statutory auditors. In each case there are following issues which need to be
considered before the firm decides to accept the assignments.
(i) Client: Safe Bank Limited
Issue: the firm has acquired office equipment from the bank under finance lease arrangements.
In addition, some partners of the firm are also using the bank’s credit card facility.
(ii) Client: Pride Communication Limited (PCL):
Issue: One of the firm’s partners had remained the director of PCL for many years, as a
nominee of Federal Government.
(iii) Client: Gama Limited
Issue: A partner of the firm holds shares in Beta Limited which is an associated company of Gama
Limited.
Required:
In each case specify the minimum conditions specified by Companies Act, 2017, which should be fulfilled
in order to accept the audit engagement.

22 Engagement letter and documentation

(a) List down the principal contents of an audit engagement letter.
(b) Audit documentation facilitates understanding of the nature, timing and extent of audit procedures,
the results of audit procedures and significant matters arising during the audit.
Discuss briefly:
(i) What are the “significant matters” which are required to be documented?

© Emile Woolf International 18 The Institute of Chartered Accountants of Pakistan

 Question bank: Objective test and long-form questions

(ii) In how many days after the date of auditor’s report, the auditor is required to complete the assembly
of his final audit file?

23 Shahid Corporation
Azeem and Company have been the auditors of Shahid Corporation Limited, a listed company, for
the past many years. You have been appointed as the audit engagement manager.
Briefly explain the matters which you would consider while assessing the following:
(a) acceptance and continuance of client relationship.
(b) need to send a new engagement letter.

24 Assertions
(a) “The auditor shall perform risk assessment procedures to provide a basis for the identification
and assessment of risks of material misstatement at the financial statement and assertion levels.”
(i) Briefly explain what you understand by the risk of material misstatement at financial
statement level.
(ii) List down the risk assessment procedures as referred above.
(b) “The auditor’s assessment of materiality and audit risk may be different at the time of initially
planning the engagement from at the time of evaluating the results of audit procedures.”
Briefly describe the reasons which may lead to such a change in the auditor’s assessment.
(c) Briefly describe the assertions used by the auditors in respect of the following:
(i) account balances
(ii) classes of transactions; and
(iii) presentation and disclosures

25 Companies Act, 2017

Comment on each of the following situations with reference to the appointment of external auditors in
accordance with the requirements of the Companies Act, 2017:
(a) Farrukh & Co., Chartered Accountants, has received an offer to be appointed as the external
auditor of Ebrahim Gas Company. The firm is indebted to the company as it has not paid the last
two months’ bills amounting to Rs. 4,860.
(b) After seventy days of incorporation, the directors of Rahman Limited (RL) decided to appoint Mr
Shahid as the company’s statutory auditor. Mr Shahid was employed by RL before he started his
own practice.
(c) The directors of Fazal Limited (FL) have decided to appoint Syed & Company, Chartered
Accountants, as external auditor of the company. One of the partner’s spouse holds 1,000 shares
in the subsidiary of FL.
(d) The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million have appointed Mr
Dawood to act as the external auditor of the company. Mr Dawood has been awarded a diploma
in International Financial Reporting Standards by the Institute of Chartered Accountants of
Pakistan and has completed the mandatory period of training from a leading firm of chartered
accountants.
(e) All directors of Hussain Associates (Pvt.) Limited are chartered accountants. The company has
recently received an offer for appointment as the external auditor of Masood (Pvt.) Limited which
has a paid-up share capital of Rs. 1,000,000.
(f) Bilal and Company, Chartered Accountants has received an offer for appointment as auditor of
Dawood Limited (DL). Ghalib, a partner in Bilal and Company holds 100,000 Term Finance
Certificates of DL.
(g) Zain and Company, a firm of Chartered Accountants, has received an offer for appointment as
auditor of Haris Limited (HL). Imran, a partner in Zain and Company is also a partner in Pure
Investment Associates, a partnership firm, which owns 100,000 shares in HL.

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Audit and Assurance

26 ASPL
You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the year ended June
30, 20X3. ASPL is engaged in the manufacture of a wide range of plastic products. While reviewing
the initial work performed by the audit team, the following matters have come to your notice:
(i) The quantity of material scrapped during the year is materially different from the quantity of scrap
sold. The company’s records show nil balance both at the beginning and at the close of the year.
No reconciliation for the difference has been provided by the company.
(ii) Sales for the year have increased by 7% over the previous year. However, it has been noted
that sales in the last two weeks of June 2010 have been exceptionally high and represent 15% of
the annual sales. The audit working papers carry the following observations in respect of the
above:
 70% of the sales in the last two weeks of June were made to two new customers whose
credit assessment has not been formally documented;
 a significant portion of the goods sold to the above referred customers were returned in the
first week of July 2010; and
 management bonuses are linked to the operating performance of the company.
(iii) During the year, ASPL purchased a machine for Rs. 25 million. The payment voucher is duly
supported by the invoice from the supplier. However, the fixed assets schedule provided by the
client shows the amount capitalized as Rs. 2.5 million. Depreciation has been charged on this
amount. The difference of Rs. 22.5 million is appearing in the Bank Reconciliation Statement.
Required:
(a) Analyse each of the above situations and assess whether it represents a fraud or an error.
(b) What action would you take to deal with the above matters?

27 Distributor
While reviewing the audit files of four different clients you confronted the following situations:
i. Due to tough competition in the market, the company has been unable to increase the prices of its
products since last 5 years.
ii. Addition to intangible assets, amounting to Rs. 500 million include research cost of Rs. 10 million
which is duly supported by invoices from suppliers.
iii. During the last three years, the Chief Executive and higher management has been earning
handsome bonuses, based on the profitability of the company.
iv. Physical stock take on 31 December 2014 included goods sold but not dispatched, amounting to
Rs. 52 million. The delivering of goods was stopped on the request of a distributor. Upto 20 January
2015, the distributor has taken delivery of goods amounting to Rs. 2 million.
Required:
(a) In each of the above situations, identify with justification whether it represents risk of fraud.
(b) Describe what actions are to be taken by an auditor on identifying a fraud risk factor.

28 Fraudulent Financial Statements

(a) Because of its ability to exert influence, management is in a position to perpetrate fraud and prepare
fraudulent financial statements.
Identify six different ways in which fraud may be committed by management through overriding of
controls.
(b) Briefly state the audit procedures which may be performed to identify the risks of material
misstatement due to fraud.

© Emile Woolf International 20 The Institute of Chartered Accountants of Pakistan

 Question bank: Objective test and long-form questions

29 Kashif and Company

Justify giving reasons whether the appointment of auditors in the following cases is incompliance with the
requirements of Companies Act, 2017.
(a) Kashif and Company, Chartered Accountants (KC) has received an offer for appointment as the
auditor of National Electricity Limited (NEL). On the request of one of the partners of KC, NEL has
allowed him to pay his last month’s electricity bill amounting to Rs. 150,000 in monthly instalments
of Rs. 15,000 each.
(b) Zubair and Company, Chartered Accountants (ZC) has received an offer for appointment as auditor
of Haroon Limited (HL). Saima, who is the wife of a partner of ZC, is the chief executive of Jameel
Limited (JL). JL is an associated company of HL. Saima also holds 100,000 shares in JL.

30 Delicious Biscuits Limited (DBL)

Identify the threats that may be involved and applicable safeguards, if any, in each of the following
scenarios:
(a) Your firm is the auditor of Delicious Biscuits Limited (DBL) for the past three years. On previous
year’s audit, Affan was the audit manager. He has recently joined DBL as GM finance.
(b) ABC leasing company has a lease portfolio of Rs. 500 million. Atif, the Audit Manager on ABC, has
obtained a lease finance amounting to Rs. 800,000 from ABC.

31 Daud and Company

Daud and Company, Chartered Accountants (DC), has received an offer for appointment as auditor of
Jamal Limited (JL). Wife of Daud is a Shareholder and Director in Royal Limited (RL).
Required:
In accordance with the requirements of the Companies Act, 2017 state whether and under what
circumstances DC could accept the audit, under each of the following situations:
(a) JL holds 51% shareholding in RL.
(b) JL is an associated company of RL.
(c) One of the directors in JL also holds 10% shareholding in RL.

32 ABC (Private) Limited

Identify the threats which may be involved and suggest appropriate safeguards, if any, in each of the
following scenarios:
(a) The planning phase of the annual audit of ABC (Private) Limited for the year ended 30 June 2016
is in progress. The engagement partner intends to include Kamran as a member of audit team who
joined the firm last month. Before joining the firm Kamran was employed in the finance department
of ABC.
(b) Nasir is the audit manager on the audit of Diamond Limited (DL) for the year ended 30 June 2016.
Nasir has informed that his father owns 10,000 shares in DL. (04)

33 Materiality
(i) Determination of materiality level requires professional judgment on the part of the auditor.
(a) Briefly describe the importance of materiality in the following stages of audit:
i. Planning stage
ii. Reporting stage
(b) What aspects of materiality should be documented by an auditor in the working papers?
(ii) Apart from profit before tax, list any four benchmarks which can be used to determine the
materiality at the financial statement level.

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Audit and Assurance

34 Auditor’s Expert
(i) You are the audit manager in a firm of Chartered Accountants. Your firm is often required to
engage an auditor’s expert for reporting on matters relating to the audits.
(a) List four key terms of engagement which should be agreed with the expert.
(b) Specify the factors which should be considered in evaluating the adequacy of the work
performed by the expert.
(ii) Identify four examples of situations which may require the engagement of an auditor’s expert.

35 Mineral Limited
Mineral Limited (ML) has incorporated a liability for gratuity payable to its employees on the basis of
actuarial valuation carried out by Professionals Limited (PL). As the audit partner of ML you are not
satisfied with the valuation report prepared by PL, and have decided to appoint Experts Limited (EL) to
carry out the valuation exercise again.
Required:
(a) State the matters that you would consider regarding:
i. The competence, capabilities and objectivity of EL.
ii. Evaluation of the adequacy of EL’s work.
(b) Briefly discuss the course of action in case you are not satisfied with the work performed by EL.

36 AMF
Al-Madad Foundation (AMF) is a charitable organization. It receives donations which are utilized to help
the destitute persons in accordance with the rules and regulations prescribed by the AMF’s Trust Deed.
The donations are received from the following sources:
(i) Cash collected from the general public through charity boxes placed at key points in hospitals,
airports, superstores etc.,
(ii) cash and cheques received from individuals and institutions at AMF’s office; and
(iii) cash from generous individuals who prefer to remain anonymous.
Donations received in case of (ii) and (iii) above, often contain specific instructions for utilisation of the
donated amount for specific purposes e.g. for education of orphan children.
Required:
(a) Identify the inherent risks in the operations of AMF.
(b) Briefly discuss the effect of each of these risks on the audit of AMF.

37 Acceptance and planning

(a) What is the difference between audit strategy and audit plan?
(b) You have been appointed as the auditor of a company which was previously audited by
another auditor. Being a new client, what additional considerations would you take into account
while performing the preliminary engagement activities prior to commencement of the audit?

38 SPL
Strawberry Pakistan Limited (SPL) was incorporated on March 1, 20X3. The directors of SPL are in the
process of appointing the first statutory auditor of the company. They have requested your firm to submit
a proposal for the statutory audit assignment. A partner of your firm has asked you to draft the
proposal after assessing whether the preconditions for the audit exist.
Required:
(a) Briefly discuss the term ‘preconditions for an audit’.
(b) What are the steps that you would perform in order to ensure that preconditions for the audit
exist?

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 Question bank: Objective test and long-form questions

(c) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the
audit is not present.

39 Fruit and nuts

Comment on each of the following independent situations in respect of appointment of auditors, with
reference to the applicable rules and regulations:
(a) Guava and Company, Chartered Accountants, have received a request for appointment as
auditor of Orange Bank Limited (OBL). Most of the partners of Guava and Company maintain their
accounts with OBL and are enjoying credit card facilities from them. The maximum outstanding
balance on the credit card facility, due from any partner is Rs. 399,000.
(b) Apricot and Company, Chartered Accountants, have received an offer for appointment as auditor
of Banana Limited. Mr Pumpkin who is a nominee director of the Government on the Board of
Directors of Banana Limited holds 25% shares in Water Melon Limited. The spouse of a partner
also holds shares in Water Melon Limited.
(c) Mr Zaheer, a legal practitioner, has received an offer for appointment as external auditor of Lychee
(Private) Limited (LPL). The paid up capital of LPL is Rs. 1,500,000 of which 40% is owned by
Blue Black Limited, a listed company.
(d) Walnut and Company, Chartered Accountants, have received an offer for appointment as external
auditors of Wasim (Private) Limited (WPL), in place of the previous auditors, who were removed
before the completion of their term. You may assume that WPL has completed all the legal
formalities before removing the previous auditors.
(e) Mr Sadiq has recently joined your firm as a partner. He has served on the Board of Directors
of Strawberry Limited (SL) until 30 June 20X0, as a Government nominee. In the Annual General
Meeting of SL held on 31 August 20X2, a shareholder has proposed the name of your firm for
appointment as the external auditors for the year ending 30 June 20X3.

40 Discussions and judgment

(a) List the benefits associated with holding timely discussion among the team members in
respect of matters susceptible to material misstatements.
(b) Quite often, the risk of material misstatement is greater in case of non-routine transactions and
judgmental matters.
Required:
(i) What do you understand by non-routine transactions and judgmental matters?
(ii) State the reasons on account of which risk of material misstatement is increased in case of:
 Non-routine transactions
 Judgmental matters

41 Dynamic
In the planning phase of the audit of Dynamic Limited for the year ending 30 June 20X3, you have
calculated the following ratios from the management accounts of the company for the eight months
ended 29 February 20X3:
Eight months period ended Year ended Year ended
29 February 20X3 30 June 20X2 30 June 20X1
Gross profit percentage 35% 40% 40%
Inventory turnover days 120 105 78
Current ratio 1.5 2.3 2.6
Quick asset ratio 0.78 1.6 1.7
Times interest earned 0.91 1.67 2.1
Debtors turnover days 132 86 68

© Emile Woolf International 23 The Institute of Chartered Accountants of Pakistan

Audit and Assurance

Required:
Identify the prospective audit risks which the auditor should consider while planning the audit.

42 Changing terms
An auditor may agree to a change in the terms of engagement provided there is a reasonable
justification for doing so.
Required:
(a) List the circumstances in which the management may request the auditor to change the terms of
an audit engagement.
(b) What factors should be considered by the auditor before accepting a change in the terms of the
engagement?
(c) List the steps that the auditor should consider, if he is unable to agree to a change in the terms of
engagement.

43 EL
(a) List the important matters that are required to be included in an audit engagement letter.
(b) List any four situations that may require revision in the terms of audit engagement letter.
44 Calm Co
ISA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity
and its Environment deals with the auditor’s responsibility to identify and assess the risks of material
misstatement in the financial statements, through understanding the entity and its environment, including
the entity’s internal control.
Required:
(i) Explain the purpose of risk assessment procedures.
(ii) Outline the sources of audit evidence the auditor can use as part of risk assessment procedures.
45 Azam
Azam is a charity whose constitution requires that it raises funds for educational projects. These projects
seek to educate children and support teachers in certain countries. Charities in the country from which
Azam operates have recently become subject to new audit and accounting regulations.
Charity income consists of cash collections at fund raising events, telephone appeals, and bequests
(money left to the charity by deceased persons). The charity is small and the trustees do not consider
that the charity can afford to employ a qualified accountant. The charity employs a part time book-keeper
and relies on volunteers for fund raising.
Your firm has been appointed as accountants and auditors to this charity because of the new regulations.
Accounts have been prepared (but not audited) in the past by a volunteer who is a recently retired
Chartered Accountant.
Required:
(a) Describe the risks associated with the audit of Azam under the headings inherent and control risks
and detection risk and explain the implications of these risks for overall audit risk.
(b) List and explain the audit tests to be performed on income and expenditure from fund raising
events.
Note: In part (a) you may deal with inherent risk and control risk together. You are not required to deal
with the detail of accounting for charities in either part of the question.

46 Hurricane
You are the audit manager in charge of the audit of Hurricane, a limited liability company. The company’s
year-end is 31 December, and Hurricane has been a client for seven years. The company purchases and
resells fittings for ships including anchors, compasses, rudders, sails etc. Clients vary in size from small
businesses making yachts to large companies maintaining large luxury cruise ships. No manufacturing
takes place in Hurricane.

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 Question bank: Objective test and long-form questions

It is now early in 20X4. Information on the company’s financial performance is available as follows:
20X4 20X3
Forecast Actual
Rs m Rs m
Revenue 45,928 40,825
Cost of sales (37,998) (31,874)
――― ―――
Gross profit 7,930 8,951
Administration costs (4,994) (4,758)
Distribution costs (2,500) (2,500)
――― ―――
Net profit 436 1,693
――― ―――
Non-current assets (at net book value) 3,600 4,500
Current assets
Inventory 200 1,278
Receivables 6,000 4,052
Cash and bank 500 1,590
――― ―――
Total assets 10,300 11,420
――― ―――
Capital and reserves
Share capital 1,000 1,000
Accumulated profits 5,300 5,764
――― ―――
Total shareholders’ funds 6,300 6,764
Non-current liabilities 1,000 2,058
Current liabilities 3,000 2,598
――― ―――
10,300 11,420
――― ―――
Other information
The industry that Hurricane trades in has seen moderate growth of 7% over the last year.
 Non-current assets mainly relate to company premises for storing inventory. Ten delivery vehicles
are owned with a net book value of Rs 30m
 One of the directors purchased a yacht during the year.
 Inventory is stored in ten different locations across the country, with your firm again having offices
close to seven of those locations.
 A computerised inventory control system was introduced in August Year
 Inventory balances are now obtainable directly from the computer system. The client does not
intend to count inventory at the year end but rely instead on the computerised inventory control
system.
Required:
(a) ISA 300 Planning an Audit of Financial Statements, states that an auditor must plan the audit.
Explain why it is important to plan an audit.
(b) Using the information provided above, prepare the audit strategy for Hurricane for the year ending
31 December 20X4.

47 Zakir Co
(a) With reference to ISA 520 Analytical Procedures explain
(i) what is meant by the term ‘analytical procedures’;
(ii) the different types of analytical procedures available to the auditor; and
(iii) the situations in the audit when analytical procedures can be used.

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Audit and Assurance

Zakir Co sells garden sheds and furniture from 15 retail outlets. Sales are made to individuals, with
income being in the form of cash and debit cards. All items purchased are delivered to the customer using
Zak’s own delivery vans; most sheds are too big for individuals to transport in their own motor vehicles.
The directors of Zak indicate that the company has had a difficult year, but are pleased to present some
acceptable results to the members.
The income statements for the last two financial years are shown below:
Income statement
31 March 20X4 31 March 20X3
Rs m Rs m
Revenue 7,482 6,364
Cost of sales (3,520) (4,253)
–––––– ––––––
Gross profit 3,962 2,111
Operating expenses
Administration (1,235) (1,320)
Selling and distribution (981) (689)
Interest payable (101) (105)
Investment income 145 –
–––––– ––––––
Profit/(loss) before tax 1,790
‗‗‗‗‗‗ (3)
‗‗‗‗‗‗

Financial statement extract

–––––– ––––––
Cash and bank 253
‗‗‗‗‗‗ (950)
‗‗‗‗‗‗
Required:
(b) As part of your risk assessment procedures for Zakir Co, identify and provide a possible
explanation for unusual changes in the income statement.
(c) Confirmation of the end of year bank balances is an important audit procedure. Explain the
procedures necessary to obtain a bank confirmation letter from Zakir Co.’s bank.

48 Educational University (EU)

You are the audit manager of the Educational University (EU) for the year ended 31 December 2015. EU
has a student base of 2,500 students. It follows a policy of receiving 50% of the fees at the start of the
semester and 50% in the middle of the semester. However, 10% discount is allowed to those students
who pay the entire amount in advance. The cost of course material is included in the fees. The semester
starts in December and June each year. You have noticed that 30% of the students who were registered
in December 2015 had not claimed the course material till 31 December 2015.
Required:
Discuss the audit risks in the above scenario and how you would deal with them.

49 Hajira
(a) Explain the term ‘audit risk’ and the three elements of risk that contribute to total audit risk.
The Hajira charity was established in 1960. The charity’s aim is to provide support to children from
disadvantaged backgrounds who wish to take part in sports such as tennis, badminton and football.
Hajira has a detailed constitution which explains how the charity’s income can be spent. The
constitution also notes that administration expenditure cannot exceed 10% of income in any year.
The charity’s income is derived wholly from voluntary donations. Sources of donations include:
(i) Cash collected by volunteers asking the public for donations in shopping areas,
(ii) Cheques sent to the charity’s head office,

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 Question bank: Objective test and long-form questions

(iii) Donations from generous individuals. Some of these donations have specific clauses
attached to them indicating that the initial amount donated (capital) cannot be spent and that
the income (interest) from the donation must be spent on specific activities, for example,
provision of sports equipment.
The rules regarding the taxation of charities in the country Hajira is based are complicated, with
only certain expenditure being allowable for taxation purposes and donations of capital being
treated as income in some situations.
Required:
(b) Identify areas of inherent risk in the Hajira charity and explain the effect of each of these risks on
the audit approach.
(c) Explain why the control environment may be weak at the charity Hajira.

50 Tahir Co
One of your audit clients is Tahir Co a company providing petrol, aviation fuel and similar oil based
products to the government of the country it is based in. Although the company is not listed on any stock
exchange, it does follow best practice regarding corporate governance regulations. The audit work for
this year is complete, apart from the matter referred to below.
As part of Tahir Co.’s service contract with the government, it is required to hold an emergency inventory
reserve of 6,000 barrels of aviation fuel. The inventory is to be used if the supply of aviation fuel is
interrupted due to unforeseen events such as natural disaster or terrorist activity.
This fuel has in the past been valued at its cost price of Rs.150 a barrel. The current value of aviation fuel
is Rs. 1,200 a barrel. Although the audit work is complete, as noted above, the directors of Tahir Co have
now decided to show the ‘real’ value of this closing inventory in the financial statements by valuing closing
inventory of fuel at market value, which does not comply with relevant accounting standards. The draft
financial statements of Tahir Co currently show a profit of approximately Rs.5m with net assets of Rs.1.7
billion.
Required:
(a) List the audit procedures and actions that you should now take in respect of the above matter.
(b) For the purposes of this section assume from part (a) that the directors have agreed to value
inventory at Rs.150/barrel.
Having investigated the matter in part (a) above, the directors present you with an amended set of
financial statements showing the emergency reserve stated not at 6,000 barrels, but reported as
60,000 barrels. The final financial statements now show a profit following the inclusion of another
54,000 barrels of oil in inventory. When queried about the change from 6,000 to 60,000 barrels of
inventory, the finance director stated that this change was made to meet expected amendments to
emergency reserve requirements to be published in about six months’ time. The inventory will be
purchased this year, and no liability will be shown in the financial statements for this future
purchase. The finance director also pointed out that part of Tahir Co.’s contract with the
government requires Tahir Co to disclose an annual profit and that a review of bank loans is due
in three months. Finally the finance director stated that if your audit firm qualifies the financial
statements in respect of the increase in inventory, they will not be recommended for re-appointment
at the annual general meeting. The finance director refuses to amend the financial statements to
remove this ‘fictitious’ inventory.
Required:
(i) State the external auditor’s responsibilities regarding the detection of fraud;
(ii) Discuss to which groups the auditors of Tahir Co could report the ‘fictitious’ aviation fuel
inventory;
(iii) Discuss the safeguards that the auditors of Tahir Co can use in an attempt to overcome the
intimidation threat from the directors of Tahir Co.

51 Elegant Limited
Your firm has been re-appointed as the auditor of Elegant Limited (EL) for the year ended 30 June 2015.
The firm has been the auditor of EL for the last five years.

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Audit and Assurance

Required:
(a) How would you assess whether it is necessary to send an audit engagement letter to EL for the
year ended 30 June 2015?
(b) State how you would proceed if EL requests your firm to change certain terms of the engagement.

52 Roof Limited (RL)

In response to an audit engagement letter sent to Roof Limited (RL), Mr. Aziz Aslam, the new chief
executive of RL has requested your firm to provide absolute assurance in the audit report.
Required:
Draft an appropriate reply mentioning any four reasons why the above request cannot be complied with.

53 Door Limited
Your firm has recently been appointed as the external auditor of Door Limited. The engagement partner
has planned a meeting with the audit team to discuss the overall audit strategy and finalize the audit plan.
Required:
List the planning activities which you would need to discuss with the engagement partner regarding the
issues related to first year of audit engagement.

54 Clocks (Private) Limited

You are the audit manager responsible for the audit of Clocks (Private) Limited (CPL). While reviewing
the draft planning document prepared by the audit senior, you observed that he has assessed risk of
material misstatement due to fraud and risk of management override of control as low due to the fact that
CPL has been an audit client of the firm for the last 10 years and no material misstatement had been
reported in the previous years.
Required:
(a) Draft an email to be sent to the audit senior to guide him with regard to the above matter.
(b) Suggest appropriate procedures with regard to risk of material misstatement due to fraud.

55 HSB & Company

On 5 March 2018, HSB & Company, Chartered Accountants (HSB) has been offered appointment as
external auditor of Tahir Limited (TL) for the year ending 31 December 2018. TL is the subsidiary of
Crypto Bank Limited (CBL), which is audited by another firm of chartered accountants.
Hatim, a partner of HSB is using credit card of CBL and the balance outstanding against it on 28 February
2018 was Rs. 1.1 million. Hatim plans to clear the dues by 30 July 2018, which is well before the
commencement of audit. It is expected that the audit planning activities will commence from 1 November
2018.
Required:
(a) Comment on the above situation in the light of Companies Act, 2017.
(b) State the matters which an auditor should consider to establish whether the pre-conditions for an
audit are present.

56 Debase Co
You are the audit manager of ABC Company which is the listed Company and the draft financial statement
shows profit before tax of Rs 10 billion and revenue of Rs. 100 billion.
The engagement team includes a part time supervisor and 2 trainees.
Considering the time availability of the supervisor, it was decided that the planned audit approach to trade
payables was to place reliance on internal controls on purchasing. Hence the audit team decided to do
test of controls and reduce substantive tests, where possible.

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 Question bank: Objective test and long-form questions

As per delegation of authority manual, the purchase orders were required to be authorised by Deputy
Manager – Procurement. During test of controls, it was identified by the audit team that atleast seven
purchase orders had not been authorised by the Deputy Manager – Procurement. When the audit team
made enquiries from the staff, it was observed that the purchases were made for business purposes. The
team concluded that no additional procedures were required.
Required:
Discuss the quality issue in the above scenario.

57 BFF Co
You are the audit manager of BFF Co, a listed company. The petty cashier is a relative of the audit
assistant. During review, you found out that the audit assistant identified that the petty cashier incurred
entertainment and fuel expenses for personal use for Rs. 15,000.
Required:
Discuss the quality issue in the above scenario.

58 GHI Company
You are the audit manager of GHI Company, a listed company. The finance director has not completed
the tax computation for the year ended 31 December 2021, instead, he has asked the audit assistant,
who has recently passed his CA examinations, to calculate the company’s tax payable for the year on
the premise that the audit assistant was more up to date with changes in Finance Act.
Required:
Discuss the quality issue in the above scenario.

59 Serene Limited
You have been assigned as audit manager on Serene Limited, a listed company. The audit manager
who was previously assigned is on privilege leave due to personal reasons.
The draft financial statements for the year show profit before taxation for the year of Rs.200.2 million and
total assets of Rs. 650.5 million.
The audit supervisor, who is a part qualified chartered accountant, has shared with you that company has
changed its depreciation policy from cost to fair value. This was not identified at planning as a high risk
area. The valuation was performed by an external firm of valuers. The audit manager and the team has
not heard of their name before. The audit supervisor said that on their website, it has been mentioned
that they have some very well-known companies as their clients. This information has not been
substantiated from any other source.
Required:
Comment on the quality of the planning and performance of the audit of the company, discussing the
quality control and other professional issues raised.

60 Green Limited
Green Limited (GL) is a listed company engaged in the manufacturing of garments and apparels. During
the audit planning meeting for the year ending 31 March 2018, the Chief Financial Officer of GL has
provided the following information:
(i) GL was previously exporting all its production under the brand name of ‘Wearables’. However, it
has been facing the issue of decline in export orders and therefore has decided to start focusing
on the local market. Accordingly, it has made an agreement with BL, according to which GL’s
products would be sold to BL who would market them through BL’s retail outlets spread
throughout Pakistan. A director of GL holds major shareholding in BL.
(ii) Two of the directors of GL holding 16% and 13% shares in GL have informed the Board that they
intend to sell their entire shareholding in GL in order to concentrate on some of their other
businesses.

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Audit and Assurance

(iii) While discussing some of the internal control deficiencies in the payroll processing department,
which were raised in the previous year’s management letter, the CFO has informed that the
matter has been referred to the internal audit department but is pending because of the illness of
the Chief Internal Auditor.
Required:
(a) Identify fraud risk factors in the above scenario.
(b) Describe what actions an auditor should take on identifying a fraud risk factor.

61 Sukkur Limited
You have been assigned the audit of Sukkur Limited (SL), a listed company, for the year ended 31
December 2016. The company engaged in the business of manufacturing security equipment for the local
market. During the planning phase, while reviewing the previous year’s audit file, you have noted that in
2015, due to introduction of many new equipment in the market and changes in technology, SL faced stiff
competition and its market share reduced from 45% to 35%. However, the management has now
informed you that SL has made significant investment in technology which has helped the company to
increase the market share to 38% in 2016.
The following information has been extracted from the draft financial statements:
Extracts from the statement of comprehensive income
2016 2015 2014
(draft) (audited) (audited)
------------- Rs. in million-------------
Revenue 10,742 9,703 9,650
Cost of sales 8,050 7,177 6,740
Financial charges 750 600 350
Profit before tax 1,550 1,601 2,260
Extracts from the statement of cash flows
2016 2015 2014
(draft) (audited) (audited)
------------- Rs. in million-------------
Cash flows from operations (3,361) (1,948) (585)
Cash flows from financing activities 4,000 3,500 1,500
Required:
(a) Identify any four fraud risk factors in the above scenario.
(b) Identify four audit risks which the auditor should consider while planning the audit.

62 Information Limited
(a) Discuss the external auditor’s responsibility relating to fraud in an audit of financial statements.
(b) Sometime the management’s attitude towards the audit/auditors is indicative of the possibility of
material misstatement in the financial statements due to fraud. Give four examples of such
attitude/circumstances.
(c) You are the auditor of Information Limited (IL), which is engaged in the development of customized
software. During the last three years IL has become the leading software developer in the industry
due to completion of large number of projects.
During the initial meeting the client has informed that:
i. IL has achieved a growth of 60% as compared to the growth target of 30% set for the financial
year ended 30 June 2016 and the board of directors are considering to distribute 25% of the
profit to the management staff as performance bonus.
ii. one of the competitors has shown its willingness to acquire IL.
Required:
Identify the fraud risk factors in the above situations.

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INTERNAL CONTROL
63 Training Manager
You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly
inducted trainees, on the following:
(a) Control Environment and its elements.
(b) Walk through tests and why these are performed.
(c) Materiality and Performance Materiality.

64 Vision Limited
Following IT related controls are being employed at Vision Limited:
(i) The general ledger system is automatically updated with sub-ledger transactions (e.g. Accounts
Receivable) every night through batch processing.
(ii) The system automatically maintains second copies of all programs and data files.
(iii) Access to programs and data files is restricted using passwords.
(iv) Invoices that are entered into the system are physically counted.
(v) Firewalls (software and hardware) are installed to restrict unauthorized access.
(vi) Screen warnings are displayed as regards incomplete processing.
(vii) Vision Limited has service level agreements with reliable software companies, for technical
support.
(viii) Review of output against expected values.
Required:
(a) In respect of each control, determine whether it is a preventive, detective or corrective control.
(b) Also classify each of the above between general IT controls and application controls.

65 Types of Controls
Classify the following controls as preventive, detective, or corrective controls. Give brief reasons to justify
your answers.
(i) Training on applicable policies, department policy/ procedures
(ii) Batch totals
(iii) Segregation of duties
(iv) Contingency planning
(v) System logs
(vi) System backup

66 IT Department
You are working in IT department of a firm of Chartered Accountants. The partners are concerned about
the confidentiality of client data which is electronically transmitted by firm’s staff from the clients’ offices.
Required:
(a) Discuss the auditor’s course of action if management refuses to allow auditor to send confirmation
request. (Impact on audit report is not required)
(b) In the context of control activities explain what is included in ‘Performance reviews’.
(c) Explain the term ‘Communication protocols’.
(d) Specify any four main categories of general controls that an auditor would expect to find in a
computer based information system.

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Audit and Assurance

67 BHURBHAN LIMITED
You have been assigned to plan the test of controls in respect of receiving of goods and invoices from
suppliers of Bhurban Limited. In this regard, you are required to identify the following:
(a) The related risks
(b) Controls that you expect to see to address the above risks
(c) Audit procedures that you need to perform to test the controls

68 Audit trail
Briefly describe the following concepts:
(a) Audit trail in a computerized environment
(b) Embedded audit facilities and its significance

69 Supermarkets
You are the CFO of a newly incorporated company which has recently established five supermarkets in
the city. One of your responsibilities is to implement internal controls.
List six key controls:
(a) over cash sales and cash handling;
(b) to reduce possibility of misappropriation of inventory.

70 Controls
(a) If the auditor plans to rely on controls that have not changed since they were last tested, the auditor
should test the operating effectiveness of such controls at least once in every third audit. Identify
the situations in which the auditor may decide to test the controls again, in the very next audit.
(b) Briefly describe the components of internal control.

71 Shahzad Limited
(a) Briefly explain the components of internal control as referred to in the International Standards on
Auditing.
(b) Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a wholesaler of
consumable products. SL records its sale on delivery of goods and maintains up to date
computerised inventory records.
A full inventory count was conducted at the year end. The senior who attended the physical stocktaking
at the central warehouse has observed the following matters:
(i) The inventory count took place on January 1, 20X3 under the supervision of the Inventory
Controller. No movement of inventory took place on that day.
(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was
allocated by the teams among themselves.
(iii) Each team was instructed by the Inventory Controller to remember which inventory had been
counted.
(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. The count
sheets showed the inventory ledger balances, to facilitate reconciliation.
(v) Old, slow-moving or already sold inventories were highlighted on the count sheets at the time
of counting.
(vi) Items not located on the pre-numbered inventory sheets were recorded on separate sheets which
were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from customers had been
received were removed from the physical inventory on the instruction of the Inventory Controller.
Required:
Identify the weaknesses in the system of inventory count. Give appropriate explanations to support your
point of view.

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72 Waheed Engineering
Your firm is the external auditor of Waheed Engineering, a listed company, which has revenue of Rs100
million. The head office site includes the manufacturing unit, the accounting functions and main
administration. There are a number of sales offices in different parts of the country. Waheed Engineering
does not have an internal audit department.
At the interim audit you have been assigned to the audit of the wages system. This will involve obtaining
an understanding of the wages system, testing the controls and performing substantive procedures in
order to verify wages transactions.
The wages records are maintained on a computer and all the wages information is processed at the head
office. Some of the employees in the manufacturing unit are paid in cash, and all other employees have
their wages paid directly into their bank account.
Manufacturing employees are paid their wages a week in arrears. All other employees are paid at the
end of each week or month.
There is a personnel department which is independent of the wages department. The personnel
department maintain records of the employees, including their starting date, grade, current wage rate and
leaving date (if appropriate).
Previous years' audits have revealed frauds by wages department staff facilitated by weaknesses in
controls in the wages system. These frauds have included:
 paying employees after appointment but before they commenced work;
 paying employees after they have left; and
 paying fictitious employees.
A check of current controls in the wages system has revealed that the company has failed to instigate
controls to prevent these types of fraud recurring. So the audit programme requires extensive substantive
procedures to be carried out to ensure that recorded wages transactions have not been misstated by
similar frauds taking place in the current year.
The existence of employees at the head office site can be verified by physical inspection. From a cost
effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has
asked you to consider the audit procedures you would carry out to obtain sufficient appropriate evidence
of the existence of employees at sales offices not visited by the audit staff.
The audit manager has explained that 'unclaimed wages' (in part (c) below) arise when manufacturing
employees are not present to collect their wages (when they are paid out in part (b)). The unclaimed
wage packets are given to the cashier who records their details in the unclaimed wages book and is
responsible for their custody. Any employee who has not received his/her wage packet at the pay-out
can obtain it from the cashier. You have ascertained that there is no system of checking the operation of
the unclaimed wages system by a person independent of the cashier and the wages department.
Required:
(a) Describe the normal controls you would expect to see in a wages system and explain their purpose.
(b) Describe how you would verify that employees are not paid before they commenced work for the
company.
(c) Describe the audit procedures you would carry out in connection with attending a pay out of wages
in cash to manufacturing employees.
(d) Describe the substantive procedures on transactions you would carry out on the unclaimed wages
system.
(e) Describe the evidence you would obtain to verify the existence of employees whose wages are
paid directly into their bank account, including those at sales offices.
73 Danish
Your firm has recently been appointed as auditor to Danish, a private company that runs a chain of small
supermarkets selling fresh and frozen food, and canned and dry food. Danish has very few controls over
inventory because the company trusts local managers to make good decisions regarding the purchase,
sale and control of inventory, all of which is done locally. Pricing is generally performed on a cost-plus
basis.

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Audit and Assurance

Each supermarket has a stand-alone computer system on which monthly accounts are prepared. These
accounts are mailed to head office every quarter. There is no integrated inventory control, sale or
purchasing system and no regular system for inventory counting. Management accounts are produced
twice a year.
Trade at the supermarkets has increased in recent years and the number of supermarkets has increased.
However, the quality of staff that has been recruited has fallen. Senior management at Danish are now
prepared to invest in more up-to-date systems.
Required:
(a) Describe the problems that you might expect to find at Danish resulting from poor internal controls.
(b) Make FOUR recommendations to the senior management of Danish for the improvement of
internal controls, and explain the advantages and disadvantages of each recommendation.
74 Roses Anytime
(a) ISAs identify a number of key procedures which auditors should perform if they wish to rely on
internal controls and reduce the level of substantive testing they perform. These include:
(i) documentation of accounting and internal control systems;
(ii) walk-through tests;
(iii) audit sampling;
(iv) testing internal controls;
(v) dealing with deviations from the application of control procedures.
Required:
Briefly explain each of the procedures listed above.
(b) Roses Anytime sells Roses wholesale. Customers telephone the company and their orders are
taken by clerks who take details of the Roses to be delivered, the address to which they are to be
delivered, and account details of the customer. The clerks input these details into the company's
computer system (whilst the order is being taken) which is integrated with the company's inventory
control system. The company's standard credit terms are payment one month from the order (all
orders are despatched within 48 hours) and most customers pay by bank transfer, An accounts
receivable ledger is maintained and statements are sent to customers once a month. Credit limits
are set by the credit controller according to a standard formula and are automatically applied by
the computer system, as are the prices of Roses.
Required:
Describe and explain the purpose of the internal controls you might expect to see in the sales
system at Roses Anytime over the:
(i) receipt, processing and recording of orders;
(ii) collection of cash.

75 Trade Receivables
There are many reasons for maintaining internal control systems. These include the need to ensure that:
(i) transactions are properly authorised;
(ii) transactions are promptly and accurately recorded;
(iii) access to assets and records is properly authorised;
(iv) recorded assets represent actual assets.
In the absence of internal controls, errors, omissions and misappropriation of assets are likely and
external and internal auditors pay particular attention to both the design and operation of internal control
systems.
Receivables is an area in which most organisations expect internal controls to be operating effectively.
Required:
(a) In the context of receivables, list and describe the types of error, omission and misappropriation of
assets that can occur in practice where internal controls are weak or non-existent.

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 Question bank: Objective test and long-form questions

(b) Explain why even a good system of internal control will not necessarily prevent or detect errors,
omissions and the misappropriation of assets in a receivables system, and explain why a good
system of internal control is important to auditors.
(c) List the main internal controls that you would expect to be in operation in the receivables system
at a small manufacturing company with a computerised accounting system.
(d) Explain why external auditors seek to rely on the proper operation of internal controls wherever
possible.
76 Granger
Granger is a privately owned incorporated business that operates a garage which repairs and services
motor vehicles. Most customers are required to pay by cash or cheque on collecting their vehicle. Credit
accounts are available to business customers, these customers sign the invoice on collection of the
vehicle and their business is billed monthly. Separate series of pre-numbered invoices are drawn up by
the foreman for cash sales and for credit sales. All customer accounts are maintained by the receptionist.
His duties include the following:
Cash sales
Collect cash or cheques from customers on collecting their vehicle.
At the end of the day, check the numerical sequence of cash sales invoices, add the sales total and agree
the total to the amount of cash and cheques received.
Record the total cash sales in the cash receipts book.
Credit sales
Obtain the customer's signature on the copy invoice of business account customers.
Enter the invoices in numerical sequence in the sales journal and post the customer's account in the
accounts receivable ledger.
Send monthly statements to credit account customers and follow up overdue accounts.
List the balances on the accounts receivable ledger at the end of the month and reconcile the total with
the control account in the general ledger.
Write off uncollectible balances to bad debts.
Cash receipts
Open the mail, extract cheques from credit account customers, record them in the cash receipts book
and post the accounts receivable ledger,
Make up the day's banking of cash (and cheques) from both cash and credit sales, prepare the deposit
slip and bank the cash (and cheques).
All other accounting duties are the responsibility of two further accounts clerks and all are subject to
supervision by the garage manager.
Required:
(a) (i) Explain why the functions assigned to the receptionist result in an inadequate segregation
of duties. Your explanation should identify misstatements that could occur and indicate how
those duties could be reassigned to other staff members.
(ii) Identify other control procedures you would consider necessary to ensure the completeness
of the recorded cash receipts and accounts receivable.
(b) As a member of the audit staff of the company's external auditors, you visit the garage and make
a count of cash on hand. You subsequently compare details of unbanked cash receipts that you
counted with the entry in the cash receipts boots for that date. Although the total in the cash receipts
book is the same, the amount of banknotes and coins is less and there is a cheque from a business
customer that you did not record.
Required:
(i) Explain the procedures to be followed in making a cash-count for audit purposes.
(ii) Explain the irregularity that the discrepancy between the cash count and cash receipts book
might lead you to suspect, and describe how you would investigate the discrepancy.

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Audit and Assurance

77 TS Limited
TS Limited is a small software house. Due to the nature of the business no significant human resources
are required except the programmers and system analysts. The Managing Director (MD) oversees all the
operations. Besides the programmers and system analysts there is only one manager, who reports to the
MD.
Required:
Describe the key characteristics of such organisations with respect to internal controls and the risk which
the auditor may face in such audits.
78 Pacific Shipping Limited
You have been assigned the audit of Pacific Shipping Limited (PSL) for the year ended 31 December
2017. During the audit, you have noted that the invoicing system was not operational for four days in
January 2017. Upon inquiry, you were informed that some changes were made by one of the three
programmers working in the IT department, merely on the request of a sales officer. The change caused
the whole invoicing system to malfunction and it had to be closed down. During these four days, all
invoices were generated manually.
Required:
Identify any three control weaknesses in the above situation and suggest any two mitigating controls
against each weakness.
79 Advanced limited
You are audit senior at Advanced Limited (AL) which is engaged in the business of assembling and
marketing of consumer electronics. The process followed by AL for procurement is as follows:
(i) Store Department generates a numerically sequenced purchase requisition (PR), when the
quantity falls below re-order level. PR shows the name of goods and quantity required and is
signed by the store officer. The approved PR is forwarded to the Purchase Department for
procurement.
(ii) Purchase Department has a list of suppliers which was prepared in 2015 by including all the
suppliers who had supplied goods to AL during the previous five years. Later, some suppliers were
added to the list on the recommendation of the store manager.
(iii) When a PR is received, the five most experienced suppliers are contacted and purchase order
(PO) is issued to the most experienced supplier provided he agrees to supply the goods on the
same price which was paid by AL on the latest purchase. The PO is issued in the form of an email
by the purchase manager. A copy of the email is also sent to the store manager and the finance
manager. In case of large or unusual purchases, PR and PO are also authorised by the store
manager prior to sending the email.
(iv) On receiving the goods, the store officer agrees the goods dispatch note (GDN) of the supplier
with the PO to ensure that description of goods is the same as were ordered by AL. An
acknowledged copy of GDN is given to the supplier and another copy is sent to the accounts
department.
(v) Store Department prepares sequentially numbered Goods Received Note (GRN), which is signed
by the store officer after counting the goods received. Entry in the stores ledger is made on the
basis of GRN.
(vi) On receiving the invoice, purchase is recorded by the accounts department after comparing the
quantity received as per the GDN with PO and the invoice.
Required:
Identify the weaknesses in the internal control system of AL and their possible effects and give your
recommendations to AL.

80 Bell Limited
Your firm is the auditor of Bell Limited (BL) which is engaged in manufacturing and assembling of vehicles.
BL has been encountering frequent stock-outs. To address this issue, it has developed an Inventory
Management System (IMS) and connected it with the systems of all the suppliers. IMS generates and
sends purchase orders to the suppliers automatically when the inventory reaches the reorder threshold.

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 Question bank: Objective test and long-form questions

Required:
(a) Discuss the risks to be considered due to the introduction of the above mentioned solution.
(b) What controls would you expect in IMS to mitigate the above risks?

81 General IT Control
(a) Differentiate between General IT controls and Application controls. Also give two examples of each
type of control.
(b) Discuss the effects on Application controls where General IT controls are ineffective.

AUDIT EVIDENCE
82 Verification of Evidences
(a) List any four ways in which the debtor balances may be stratified.
(b) You are the audit incharge on the audit of Opportunity Limited (OL). OL deals in fast moving
consumer goods. For sending of confirmations, an audit team member has stratified the debtors
as follows:
Category A Balances exceeding Rs. 50 million 12 customers
Category B Balances below Rs. 50 million 100 customers
Category C Balances below Rs. 10 million 280 customers
Category D Balances below Rs. 1 million 600 customers
During a meeting some of the team members have expressed divergent views, as follows:
(i) Verification of balances of category A and B will provide sufficient coverage and evidence;
therefore, there is no need to cover other categories.
(ii) Selection should be done on haphazard basis, as under this method all items of population have
equal chance of selection.
(iii) Selection of sample should be done systematically, whereby items constituting 10% of the amounts
in each category should be selected in descending order.
Required:
Discuss the appropriateness of options discussed in the meeting and give your suggestion in this regard.

83 Rehan Limited
You are the Audit Incharge of Rehan Limited for the year ended 31 December 2015. While reviewing the
working papers and discussion with audit team, you have noted the following:
(i) The audit team did not send balance confirmation requests for amounts below Rs. 100,000
because according to the client, lot of efforts were required to follow up the customers and the
balances were also not material.
(ii) One of the conclusions drawn as per the working papers is “there are no unrecorded liabilities, as
confirmations have been received from all selected parties and no differences were noted. Hence,
no further test is required.”
Required:
(a) Discuss with reasons whether you agree with the approach adopted/conclusion drawn by the audit
team.
(b) Provide brief guidance to the audit team in respect of each of the above situations.

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Audit and Assurance

84 Sehat Pharmaceutical Limited

The audit of Sehat Pharmaceutical Limited (SPL) is in progress. Based on the previous experience with
the client and the initial tests of control, the auditor has assessed a low risk of material mis-statement in
the area of debtors.
The debtors’ circularization summary depicts the following information:

Customer No. of Balance Confirmations Amount Nature of Confirmations

segment customers outstanding sent covered confirmations received

---------------------------------- Rs ----------------------------------------------
Distributors 12 75,200 8 70,500 Positive 7
Wholesalers 105 52,500 30 12,500 Positive 28
Hospitals and 250 31,200 75 20,300 Negative 4
clinics
Retailers 130 12,500 50 7,000 Negative 12

Analysis of confirmations received is as follows:

 3 out of 7 confirmations received from distributors did not agree with the amount outstanding in
SPL’s ledger.
 One of the distributors, Saleem Distributors (Private) Limited (SDPL) has gone into winding up.
The balance receivable from SDPL is outstanding since last one year.
 Replies received from the hospitals did not agree with the balance outstanding in SPL’s records.
However, the differences were reconciled by the audit staff.
 All the 12 confirmations received from the retailers showed disagreement with the records of SPL.
However, only 2 could be reconciled.
Required:
(a) Evaluate the decision regarding sending of negative confirmations.
(b) Determine the course of action the auditor should consider in case of balances agreed, balances
not agreed and replies not received.
(c) State the procedures that need to be performed in case of amount due from SDPL.
85 Nobel
You are the manager on the audit of Nobel Limited, a listed company, which manufactures automotive
parts and air-conditioners for motor vehicle assemblers. Annual sale of the Company is Rs. 850 million
and profit before tax is Rs. 60 million.
Your review of the audit working paper file has disclosed the following outstanding issues:
(i) The company is facing a potential legal claim from Mehran Motors Limited (MML) in respect
of defective air conditioners supplied to them. A claim for Rs. 25 million being the cost of
replacement of air conditioners and lost production time has been lodged with the Company by
MML. The management is of the view that the claim is not justified, as the air conditioners were
properly functioning and had been tested for quality and that the defects have arisen because of
the negligence of MML and its technicians. However, a provision of Rs. 2 million has been made
in the financial statements in this respect.
(ii) Depreciation on certain equipment has been charged at 10% per annum on reducing balance
method. This rate is consistent with prior years and the same rate is being used by most other
companies, in the automobile industry. However, significant losses have recently been recorded
on the disposal of similar equipment.
Management has provided written representations in respect of the above matters.
Required:
What audit evidence will you gather to address the above issues?

© Emile Woolf International 38 The Institute of Chartered Accountants of Pakistan

 Question bank: Objective test and long-form questions

86 Masoom Limited
As the manger on the audit of Masoom Limited you want the management to appoint experts to assist
you on certain matters.
Explain the circumstances where auditor may use the work of an expert and the auditor’s responsibilities
in this regard.
87 Sky blue
Mr Mubarak is the audit senior on the audit of Sky Blue Limited. While comparing the draft financial
statements with the previous year, he noted many unusual fluctuations. Briefly explain the procedure he
should follow, in the above situation.
88 Direct confirmations 1
Direct confirmations from third parties provide independent audit evidence that certain account
balances and items in the financial statements are properly recorded and disclosed.
Required:
(a) Distinguish between positive and negative confirmations.
(b) Briefly describe the risks associated with each of the above type of confirmation and the steps that
an auditor usually takes to avert such risks.
(c) Explain why and under what circumstances an auditor may decide to use negative confirmation
requests. Also, identify the circumstances where the auditor may use a combination of positive and
negative confirmations.

89 Chill
You are the engagement manager on the audit of Chill Limited. During the course of audit, you have
been provided an Actuarial Valuation Report on the Company’s Employees Retirement Benefits Scheme.
You have noted that the report has been prepared by M/s Saleem and Company which is not well known
to you.
Required:
Briefly describe the matters that you would consider before using the report prepared by Saleem and
Company.

90 Sales sampling
(a) You are the audit manager on a client where an annual sale is Rs. 640 million. During the course
of annual audit, the following table was developed by an audit team member, to categorize
the annual sales:

Rs.
Category A 50 sales transactions to different customers 300 million
Category B 100 transactions to different customers 200 million
Category C 500 transactions to different customers 140 million
Total 640 million

Sohail, a team member, is of the view that if verification of all the transactions in category A is
carried out, there is no need to perform further procedures. However, other team members do not
agree and consider that proper sampling should be carried out from the total population and
categorization should be ignored.
Required:
As an audit manager of the job, you are required to:
(i) Explain how audit efficiency could be improved by using the above table.
(ii) List other ways in which the sales population may be categorized and what precaution
should be taken while carrying out such categorization.

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Audit and Assurance

(iii) Give your opinion on the views expressed by:

 Sohail
 Other audit team members.
(b) Describe the circumstances in which an auditor may decide to examine entire population of items
that make up an account balance.

91 PQR
During the audit of PQR Limited you have been assigned the task of evaluating the work performed
by the internal audit department of the company on certain specific areas.
Required:
(a) Describe how you would evaluate the work performed, in order to determine the extent of reliance
that may be placed thereon.
(b) List the important differences between internal and external audit with respect to the following:
 Independence
 Objectives
 Reporting

92 Hard Stone Limited

You are the senior member of the audit engagement team, auditing the financial statements of a
manufacturing company, Hard Stone Limited. List down the primary substantive procedures, which you
would carry out in the verification of:
(a) trade debts (excluding receipts from customers).
(b) stores and spares.

93 Related parties
(i) Describe the procedures that the auditor may perform, in order to ensure the completeness of the
information provided by the management, about related parties.
(ii) Briefly describe any three risks of material misstatement in case of significant related party
transactions.

94 Kamil Limited
You are the audit manager on the audit of a listed company, Kamil Limited (KL). Prior to completion of
audit, you came across a prospectus issued by Neelum Limited (NL) according to which a director of KL
is the chief executive of NL. However, the name of NL was not included in the list of related parties
provided by KL. On being confronted the management has advised that the name was omitted
inadvertently as the appointment took place just two months prior to the year end.
Required:
Discuss your course of action in the above situation.

95 Direct confirmations 2
Direct confirmations of balances due from customers are obtained to satisfy the objective of ensuring
that the customer exists and owes the specified amount to the company at a certain date.
Required:
(a) State the circumstances in which an auditor may decide not to circulate the requests for direct
confirmation.
(b) What are the factors that an auditor considers while designing the requests for direct
confirmation?
(c) Describe the alternative audit procedures which may be conducted if the customer does not reply
to a request for confirmation.

© Emile Woolf International 40 The Institute of Chartered Accountants of Pakistan

 Question bank: Objective test and long-form questions

96 Working papers
The preparation of working papers is an integral part of the auditor’s responsibilities.
Identify the factors that the auditor should consider while determining the form, content and extent of
audit working papers.

97 Al-Shams
Al-Shams Limited is an unquoted public company. A large part of its business is carried out with persons
/ organisations related to the management or the shareholders.
Required:
(a) State any eight procedures which an auditor may perform for determining the existence of
related parties or related party transactions.
(b) Give four examples of situations that may be indicative of dominant influence exerted by a
related party.

98 Auditor’s expert
When expertise in a field other than accounting or auditing is necessary to obtain sufficient
appropriate audit evidence, the auditor has to determine whether to use the work of an auditor’s expert.
Required:
List down the sources from where the auditor may get the information regarding the expert’s
competence, capabilities and objectivity.

99 ADL
(a) Differentiate between the following:
(i) Statistical and non-statistical sampling
(ii) Sampling and non-sampling risk
(b) You are the audit manager on Apple Distribution Limited (ADL). While reviewing the audit
planning documentation, you found that the audit team has selected 100 out of a total of 2,550
debtors for balance confirmation. The details are as follows:
 50 largest debtors constitute approximately 40% of total debtors. Out of these, 10 have been
selected.
 90 other debtors were selected through haphazard sampling.
 All debtors below Rs. 5,000 were ignored as immaterial.
 Balances due from government and some of the related parties were ignored as prior years
working papers showed that they never responded to requests for confirmation.
Required:
(i) Comment on the sampling approach adopted by the audit team.
(ii) Suggest alternative means of selecting the sample in which the material balances have
a greater probability of selection.

100 Guava & Co

You are the training manager at Guava & Co., Chartered Accountants. Some trainees in the firm have
requested you to clarify the following issues:
(a) Can the auditor discard any audit document, forming part of his opinion, after the issuance of the
auditor’s report?
(b) The changes that can be incorporated during the final file assembly process citing three such
examples.

© Emile Woolf International 41 The Institute of Chartered Accountants of Pakistan

Audit and Assurance

(c) The circumstances under which it becomes necessary to modify the existing audit documents or
add new audit documents after the issuance of the auditor’s report and the matters that should be
documented in such a situation.
Required:
Offer appropriate explanations for each of the above issues.

101 RP planning
As the auditor of a listed company with a number of related parties, what steps would you consider
as part of your audit planning to ensure that all related party relationships and transactions are identified
and disclosed in the financial statements.

102 Manufacturing inventories

List the substantive procedures that may be performed by the auditor to verify the amount of
inventories as appearing in the financial statements of a manufacturing concern.

103 Framework
(i) Fair presentation framework and compliance framework
(ii) Tolerable misstatement and performance materiality

104 MWL
You are currently in the planning phase of the audit of Mineral Water Limited (MWL) for the year ended
30 June 2012. The following information is available to you:

Customer No. of Balance 10 10-20 21-30 31-90 > 90

Segment Customers outstanding days days days days days
Rs. in thousand…
Super markets 12 20,014 8,125 5,053 6,396 311 129
Wholesalers 65 14,910 5,078 6,019 3,150 454 209
Retailers 553 4,743 1,756 1,798 724 278 187
Five star hotels 7 7,694 2,805 2,793 1,784 201 111
――― ――― ――― ――― ――― ――
47,361 17,764 15,663 12,054 1,244 636
――― ――― ――― ――― ――― ――
50% provision for doubtful debts has been made by MWL against balances outstanding for more than 30
days whereas the balances outstanding for more than 90 days have been fully provided.
Required:
(a) Indicate what would be the basis for selecting debtors for circularising positive and negative
requests for confirmations.
(b) Briefly explain as to how you would deal with a situation where a debtor confirms a balance which
is different from the amount appearing in the confirmation request.

105 BPR
List the substantive procedures that may be performed by an auditor to verify the following:
(a) Bank reconciliation statements
(b) Payroll
(c) Raw material purchases

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 Question bank: Objective test and long-form questions

106 Taskeen Co
(a) (i) In the context of ISA 530 Audit sampling, explain and provide examples of the terms
‘sampling risk’ and ‘non-sampling’ risk.
(ii) Briefly explain how sampling and non-sampling risk can be controlled by the audit firm.
(b) Taskeen Co is owned and managed by two brothers with equal shareholdings. The company
specialises in the sale of expensive motor vehicles. Annual revenue is in the region of
Rs70,000,000 and the company requires an audit under local legislation. About 500 cars are sold
each year, with an average value of Rs140,000, although the range of values is from Rs130,000
to Rs160,000. Invoices are completed manually with one director signing all invoices to confirm the
sales value is correct. All accounting and financial statement preparation is carried out by the
directors. A recent expansion of the company’s showroom was financed by a bank loan, repayable
over the next five years.
The audit manager is starting to plan the audit of Taskeen Co. The audit senior and audit junior
assigned to the audit are helping the manager as a training exercise.
Comments are being made about how to select a sample of sales invoices for testing. Audit
procedures are needed to ensure that the managing director has signed them and then to trace
details into the sales day book and sales ledger.
‘We should check all invoices’ suggests the audit manager.
‘How about selecting a sample using statistical sampling techniques,’ adds the audit senior.
‘Why waste time obtaining a sample?’ asks the audit junior. He adds ‘taking a random sample of
invoices by reviewing the invoice file and manually choosing a few important invoices will be much
quicker.’
Required:
Briefly explain each of the sample selection methods suggested by the audit manager, audit senior
and audit junior, and discuss whether or not they are appropriate for obtaining a representative
sample of sales invoices.
(c) Define ‘materiality’ and explain why the auditors of Taskeen Co must form an opinion on whether
the financial statements are free from material misstatement.

107 Wings
Wings is an airline. The company owns some of its fleet of aircraft. Other aircraft are leased from third
parties. Wings has an internal audit function that has recently expanded. Your firm is the external auditor
to Wings. Your firm has been asked to investigate the extent of which it may be able to rely on the work
of internal audit in the following areas:
 Sales and ticketing;
 Fleet acquisition and maintenance;
 Trade payables and long-term debt financing (borrowings).
The company outsources its in-flight catering and payroll functions to different service organisations.
Required:
(a) Explain why the work of internal auditors, in the three areas noted above, is likely to be useful to
you as the external auditor.
(b) Explain how the quality of the internal audit function is likely to influence the extent of your reliance
on internal audit work.
(c) Describe the audit evidence you will seek relating to internal controls over the out-sourced functions
(in-flight catering and payroll).

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Audit and Assurance

108 Glasses2Go
ISA 230 Audit Documentation establishes standards and provides guidance regarding documentation in
the context of the audit of financial statements.
Required:
(a) List the purposes of audit working papers.
(b) You have recently been promoted to audit manager in the audit firm of Sadia & Co. As part of your
new responsibilities, you have been placed in charge of the audit of Glasses2Go, a long
established audit client of Sadia & Co. Glasses2Go sells spectacles; the company owns 42 stores
where customers can have their eyes tested and choose from a range of frames.
Required:
List the documentation that should be of assistance to you in familiarising yourself with
Glasses2Go. Describe the information you should expect to obtain from each document.
(c) The time is now towards the end of the audit, and you are reviewing working papers produced by
the audit team. An example of a working paper you have just reviewed is shown below.
Client name: Glasses2Go
Year end: 30 April 20X3
Working paper: Payables transaction testing
Audit assertion: To make sure that the purchases day book is correct.
Method: Select a sample of 15 purchase orders recorded in the purchase order system. Trace
details to the goods received note (GRN), purchase invoice (PI) and the purchase day book (PDB)
ensuring that the quantities and prices recorded on the purchase order match those on the GRN,
PI and PDB.
Test details: In accordance with audit risk, a sample of purchase orders were selected from a
numerically sequenced purchase order system and details traced as stated in the method. Details
of items tested can be found on another working paper.
Results: Details of purchase orders were normally correctly recorded through the system. Five
purchase orders did not have any associated GRN, PI and were not recorded in the PDB. Further
investigation showed that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as the internal controls do
not allow for changes in specification.
Conclusion: Purchase orders are completely recorded in the purchase day book.
Required:
Explain why the working paper shown above does not meet the standards normally expected of a
working paper.
Note: You are not required to reproduce the working paper.

109 ISA 620

ISA 620 Using the work of an auditor’s expert contains guidance where the auditor uses the work of an
expert to provide knowledge relevant to the audit, which the audit firm itself does not possess. Before the firm
can rely on the work of the expert, ISA 620 requires the firm to assess that work.
Required:
(i) Set out FOUR examples of financial statement areas where the audit firm might be likely to rely
upon the work of an expert employed by the audit firm.
(ii) Set out the main procedures an audit firm should apply before relying on the work of such an
expert.

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 Question bank: Objective test and long-form questions

110 Cuddly World

You are the auditor of Cuddly World, a company which manufactures and sells small cuddly toys by mail
order. The company is managed by Mr Kabir and two assistants. Mr Kabir authorises important
transactions such as wages and large orders, one assistant maintains the payables ledger and orders
inventory and pays suppliers, and the other assistant receives customer orders and despatches cuddly
toys. Due to other business commitments Mr Kabir only visits the office once a week.
At any time, about 100 different types of cuddly toys are available for sale. All sales are made cash with
order – there are no receivables. Customers pay using credit cards and occasionally by sending cash.
Revenue is over Rs 5.2 million.
You are planning the audit of Cuddly World and are considering using some of the procedures for
gathering audit evidence recommended by ISA 500 as follows:
(1) analytical procedures;
(2) inquiry;
(3) inspection;
(4) observation;
(5) recalculation.
Required:
(a) For each of the above procedures:
(i) explain its use in gathering audit evidence;
(ii) describe one example for the audit of Cuddly World.
(b) Discuss the suitability of each procedure for Cuddly World, explaining the limitations of each.

111 Auditors
(a) State five key substantive audit procedures for verification of Provisions.
(b) Briefly describe how an auditor evaluates the sufficiency of audit evidence.
(c) Briefly explain how an external auditor would evaluate the adequacy of the work performed by the
internal audit function.
(d) List six physical access controls over an IT system.
(e) Briefly discuss the concept of ‘Professional skepticism’.
(f) What course of action should the auditor take, if he doubts the reliability of the management
representation due to its inconsistency with other audit evidence?
(g) State the factors which determine the extent to which an auditor may use Analytical procedures as
a form of substantive audit evidence.

112 Analytical procedures and materiality

(a) Analytical procedures are an important and powerful tool for auditors in explaining the performance
of a business. ISAs 315 and 320 require the auditor to apply analytical procedures at the planning
and overall review stages of the audit.
Required:
Explain the possible reasons for the following changes in accounting ratios found at the planning
stage of the audit:
(i) an increase in the current ratio;
(ii) a decrease in the gross profit margin; and
(iii) an increase in the inventory holding period;
Note: No marks will be awarded for showing the calculation of the ratio, all parts carry equal marks.
(b) The concept of materiality is fundamental to the work of auditors and is covered by ISA 320
Materiality in planning and performing an audit. Matters that are immaterial are not reported in
financial statements.

© Emile Woolf International 45 The Institute of Chartered Accountants of Pakistan

Audit and Assurance

Required:
Explain the concept of materiality and describe how materiality affects the audit work performed by
auditors.

113 Tahira Transporters

You are the external auditor of Tahira Transporters, a public limited company (TT). The company's year-
end is 11 March. You have been the auditor since the company was formed 24 years ago to take
advantage of the increase in goods being transported by road. Many companies needed to transport their
products but did not always have sufficient vehicles to move them. TT therefore purchased ten vehicles
and hired these to haulage companies for amounts of time ranging from three days to six months.
The business has grown in size and profitability and now has over 550 vehicles on hire to many different
companies. At any one time, between five and 20 vehicles are located at the company premises where
they are being repaired; the rest could be anywhere on the extensive road network of the country it
operates in. Full details of all vehicles are maintained in a non-current asset register.
Bookings for hire of vehicles are received either over the telephone or via e-mail in TT's offices. A booking
clerk checks the customer's credit status on the receivables ledger and then the availability of vehicles
using the Vehicle Management System (VMS) software on TT's computer network. E-mails are filed
electronically by customer name in the e-mail program used by TT. If the customer's credit rating is
acceptable and a vehicle is available, the booking is entered into the VMS and confirmed to the customer
using the telephone or e-mail. Booking information is then transferred within the network from the VMS
to the receivables ledger programme, where a sales invoice is raised. Standard rental amounts are
allocated to each booking depending on the amount of time the vehicle is being hired for. Hard copy
invoices are sent in the post for telephone orders or via e-mail for e-mail orders.
The main class of asset on TT's statement of financial position is the vehicles. The net book value of the
vehicles is Rs6 million out of total shareholders' funds of Rs15 million as at 31 March 20X3.
Required:
(a) List and explain the reason for the audit tests you should perform to check the completeness and
accuracy of the sales figure in TT's financial statements.
(b) List and describe the audit work you should perform on the statement of financial position figure
for vehicles in TT's financial statements for the year ended 31 March 20X3.
114 Willow
As a staff member of R and A Chartered Certified Accountants you are assigned to the audit of tangible
non-current assets of Willow for the year ended 31 March 20X3. R and A have been the auditors of Willow
for many years. You obtain the following schedule of movements on property, plant and equipment and
analysis of additions from the company’s accountant.
Property Plant and machinery Total
Rs m Rs m Rs m
Cost or valuation
1 April 20X2 340 275 615
Additions – 123 123
Disposals – (72) (72)
Revaluations 120 – 120
–––– –––– ––––
31 March 20X3 460 326 786
–––– –––– ––––
Accumulated depreciation
1 April 20X2 24 213 237
Provision 5 30 35
Written back on disposal – (65) (65)
Adjustment on revaluation (24) – (24)
–––– –––– ––––
31 March 20X3 5 178 183
–––– –––– ––––

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 Question bank: Objective test and long-form questions

Property Plant and machinery Total

Rs m Rs m Rs m
Carrying amount
31 March 20X3 455 148 603
–––– –––– ––––
31 March 20X2 316 62 378
–––– –––– ––––
Schedule of additions (plant and machinery)
Supplier Description Cost
Rs m
New Models Milling machine Model 38 55
Drill Suppliers Power drill Type 45C 34
Hoist Co Electric hoist no 722 18
Sundry below Rs 1m 16
–––––––
123
–––––––
The company’s accountant also advises you that the property was revalued following a valuation by the
company’s property manager who is a professionally qualified valuer.
During your verification of depreciation you discover that most plant and machinery is fully depreciated.
Moreover you discover that, due to oversight, depreciation has continued to be provided on fully
depreciated items. As at the beginning of the year the amount of overstatement was Rs 43m. The
accountant suggests the correction be made by reducing the current year’s charge for depreciation.
Required:
(a) State, with reasons, the initial audit procedures you would perform on the schedules provided by
the company’s accountant.
(b) Outline the substantive audit procedures you would apply in verifying additions to plant and
machinery. Your answer should identify procedures applicable to each of the financial statement
assertions.
(c) Describe the audit procedures applicable to verifying the revaluation of property.
(d) With respect to the correction to accumulated depreciation, and assuming the amount to be
material, discuss the accountant’s proposed treatment. If you disagree with the accountant’s
proposal, state, with reasons, the correct accounting treatment.

115 Sparkle Forever

You are the audit manager in the firm of Dandy & Co, an audit firm with ten national offices. One of your
clients, Sparkle Forever, purchases diamond jewellery from three manufacturers. The jewellery is then
sold from Sparkle Forever’s four shops. This is the only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for Sparkle Forever. Inventory is the largest
account on the statement of financial position with each of the four shops holding material amounts. Due
to the high value of the inventory, all shops will be visited and test counts performed.
With the permission of the directors of Sparkle Forever, you have employed JJ, a firm of specialist
diamond valuers who will also be in attendance. JJ will verify that the jewellery is, in fact, made from
diamonds and that the jewellery is saleable with respect to current trends in fashion. JJ will also suggest,
on a sample basis, the value of specific items of jewellery. Counting will be carried out by shop staff in
teams of two using pre-numbered count sheets.
Required:
(a) List and explain the reason for the audit procedures used in obtaining evidence in relation to the
inventory count of inventory held in the shops.
(b) Explain the factors you should consider when placing reliance on the work of UJ.
(c) Describe the audit procedures you should perform to ensure that jewellery inventory is valued
correctly.

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Audit and Assurance

116 Bubbles
Bubbles manufactures and distributes soft drinks. Its inventories are controlled using a real-time system
which provides accurate records of quantities and costs of inventories held at any point in time. This
system is known within the company as the 'Stockpop' system and it is integrated with the purchases and
sales system. Bubbles has an internal audit department whose activities encompass inventories.
No year-end inventory count takes place Inventories are held in several large warehouses where non-
stop production takes place.
Your firm is the external auditor to Bubbles and you have been asked to perform the audit of inventories,
Inventories include finished goods and raw materials (water, sugar, sweeteners, carbonating materials,
flavourings, cans, bottles, bottle tops, fastenings and packaging materials).
Your firm, which has several offices, wishes to rely on the 'Stockpop' system to provide the basis of the
figure to be included in the financial statements 'for inventories. Your firm does not wish to ask the
company to conduct a year-end inventory count.
Required:
(a) Describe the audit tests that you would perform on the `Stockpop' system during the year in order
to determine whether to rely on it as a basis for the raw materials and finished goods figures to be
included in the financial statements.
Note: You are not required to deal with work in progress.
(b) Describe the audit tests you would perform on the records held by Bubbles at the year end to
ensure that raw materials and finished goods are fairly stated in the financial statements.

117 ISA 500

ISA 500 Audit evidence identifies seven main testing procedures. One of these is external confirmation.
Required:
(a) List FOUR examples of external confirmations.
(b) For EACH of the examples in (a) above explain:
ONE audit assertion that the external confirmation supports, and
ONE audit assertion that the external confirmation does NOT support.

118 Javeria Co
Javeria Co has a significant number of cash transactions and recent non-current asset purchases have
been financed by a bank loan. This loan is repayable in equal annual instalments for the next five years.
Required:
(a) Explain the procedures to obtain a bank report for audit purposes from Javeria Co.’s bank and the
substantive procedures that should be carried out on that report.
(b) List the further substantive procedures that should be carried out on the bank balances in Javeria
Co.’s financial statements.

119 Porridge
Porridge is a small manufacturing company of which your firm of Chartered Certified Accountants is the
external auditor. You have been assigned to the audit of trade payables.
The audit file indicates that control risk for purchases and payments transactions is assessed as slightly
less than high because of limitations in the extent of segregation of duties due to the small number of
accounts personnel. There are no other identified control problems or prior year audit problems.
Narrative notes on the accounting system contain the following descriptions.
 Purchases are requisitioned by the user department and ordered, using prenumbered order forms,
by the purchasing manager.

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 Question bank: Objective test and long-form questions

 Raw materials and manufacturing supplies are delivered to the receiving department of the factory
where the receiver issues prenumbered goods inward notes (GINs).
 Purchases of other goods and services are delivered directly to the requisitioning department and
no GINs are issued.
 The accounts department checks suppliers' invoices with purchase orders, and
 for production department purchases, with GINs
 for other purchases, sends the invoices to the requisitioning department manager who initials
the invoice to indicate that it is appropriate to pay.
 Invoices are then processed to the accounting records using proprietary software.
 All suppliers are paid at the end of the month following the month of receipt of the invoice.
Payables at 31 October 20X3 therefore represent goods and services invoiced in October. In addition,
invoices received between 1 and 15 November were divided into those relating to goods received or
services provided before and after 31 October, the former being recorded in the accounting records
before the October trial balance was produced. On 15 November, any unmatched GINs relating to
deliveries before 31 October were posted to the accounts as at 31 October at the estimated amounts of
the invoices.
Suppliers' invoices are filed alphabetically with supporting documentation, all of which is cancelled with
the date of payment when the cheque is issued. Suppliers' monthly statements are also filed with the
invoices. These are scrutinised by the accounts department for unusual items, such as overdue invoices,
but are not regularly reconciled with the company's own records.
Required:
(a) In your audit of trade payables in the 31 October 20X3 financial statements explain which of the
financial statement assertions you would regard as presenting the greatest inherent risk.
(b) Discuss the reasons for undertaking or not undertaking a payables’ circularisation.
(c) Outline substantive procedures you would apply in your audit of trade payables relating to
production department purchases.
(d) Explain additional procedures you would perform in verifying the completeness of non-production
department payables.

120 Trembridge Engineering

Your firm is the auditor of Trembridge Engineering, and you have been asked to suggest the audit work
you will carry out in verifying accounts payable and purchase accruals at the company's year end of 30
September 20X3. You attended the inventory count at the year end.
The company operates from a single site and all raw materials for production are received by the goods
inwards department. When the materials are received they are checked for quantity and quality to the
delivery note and purchase order, and a multi-part goods received note is made out and signed by the
storekeeper. If there are any problems with the raw materials, a discrepancy note is raised which gives
details of the problems (e.g. incorrect quantities or faulty materials).
The purchase accounting department receive the purchase invoices, check them to the purchase order
and goods received note and post them to the purchase ledger. At the end of each month, payments are
made to suppliers. The purchase ledger is maintained on a PC.
The main sundry payables and accruals at the year-end include:
(i) wages accruals and associated taxes payable;
(ii) sales taxes payable;
(iii) time dependent accruals, such as interest on loans and overdrafts, telephone, heat and light, and
other expenses paid in arrears.
Most employees' wages are paid weekly in arrears.
Required:
Describe in detail the audit work you will carry out to:

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(a) check suppliers' statements to the balances on the purchase ledger;

(b) verify that purchases cut-off has been correctly carried out at the year-end;
(c) ensure that sundry payables and accruals are correctly stated.

121 ISA 620: Using the Work of an Auditor’s Expert

(a) ISA 620 Using the Work of an auditor’s Expert explains how an auditor may use an expert to obtain
audit evidence.
Required:
Explain THREE factors that the external auditor should consider when assessing the competence
and objectivity of the expert.
(b) Auditors have various duties to perform in their role as auditors, for example, to assess the truth
and fairness of the financial statements.
Required:
Explain THREE rights that enable auditors to carry out their duties.
(c) List FOUR assertions relevant to the audit of tangible non-current assets and state one audit
procedure which provides appropriate evidence for each assertion.
122 Heidi Co
Following a competitive tender, your audit firm Cal & Co has just gained a new audit client Heidi Co. You
are the manager in charge of planning the audit work. Heidi Co.’s year end is 30 June 20X3 with a
scheduled date to complete the audit of 15 August 20X3. The date now is 3 June 20X3.
Heidi Co provides repair services to motor vehicles from 25 different locations. All inventory, sales and
purchasing systems are computerised, with each location maintaining its own computer system. The
software in each location is the same because the programs were written specifically for Heidi Co by a
reputable software house. Data from each location is amalgamated on a monthly basis at Heidi Co.’s
head office to produce management and financial accounts.
You are currently planning your audit approach for Heidi Co. One option being considered is to re-write
Cal & Co.’s audit software to interrogate the computerised inventory systems in each location of Heidi Co
(except for head office) as part of inventory valuation testing. However, you have also been informed that
any computer testing will have to be on a live basis and you are aware that July is a major holiday period
for your audit firm.
Required:
(a) (i) Explain the benefits of using audit software in the audit of Heidi Co;
(ii) Explain the problems that may be encountered in the audit of Heidi Co and for each problem,
explain how that problem could be overcome.
(b) Following a discussion with the management at Heidi Co you now understand that the internal
audit department are prepared to assist with the statutory audit. Specifically, the chief internal
auditor is prepared to provide you with documentation on the computerised inventory systems at
Heidi Co. The documentation provides details of the software and shows diagrammatically how
transactions are processed through the inventory system. This documentation can be used to
significantly decrease the time needed to understand the computer systems and enable audit
software to be written for this year’s audit.
Required:
Explain how you will evaluate the computer systems documentation produced by the internal audit
department in order to place reliance on it during your audit.
123 Babar Limited
On the audit of Babar Limited (BL) you have noted a transaction whereby a loan payable to the holding
company which was overdue for six months was settled by transfer of securities owned by BL.
Required:
Evaluate the above scenario and specify the audit procedures which need to be performed.

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124 Concordia Limited

You are the audit manager in a firm of chartered accountants. Following is the extract of the email
received from the job-in-charge responsible for the audit of your client Concordia Limited (CL) for the year
ending 31 March 2018:
“I am considering to circulate negative confirmations on 1 April 2018 for debtor balances outstanding as
on 31 March 2018 as firstly, the reporting deadlines at CL are very stringent, secondly, the population
comprises of a large number of small balances and thirdly, risk of material misstatement has been
assessed as low.
I have also been offered by CL’s CFO that one of their staff would get all the confirmations signed from
the debtors and deliver them to our firm’s office. This could help us in meeting the reporting deadline.”
Required:
Comment on the suggestions of the job-in-charge. Assuming that the suggestion by job in charge is not
considered appropriate, suggest an alternative approach keeping in view the time limitations.
125 Blue Bell Limited
Faheem is the audit manager on audit of Blue Bell Limited (BBL) for the year ending 31 March 2018,
which is in the planning stage. BBL has a well-established internal audit function which reports directly to
the audit committee. The staff of the internal audit department have adequate level of competence and
are members of professional accounting bodies.
Considering the above, Faheem intends to engage internal auditors to perform audit procedures for
certain audit areas.
Required:
On behalf of the engagement partner, provide appropriate guidance to Faheem to assist him in selecting
the areas where direct assistance of internal auditors can be utilized.
126 BAC Limited
While reviewing the list of ‘trade and other payables’ at BAC Limited, you have noticed that one of the
trade creditors is not in the list. State any two audit procedures to be performed in relation to the
completeness assertions for trade payables.
127 Stewardship and Accountability
Discuss the concepts of stewardship and accountability in the context of a limited company and fair
presentation (true and fair view) in relation to the financial statements.
128 Shahbaz Chemicals Limited
During the audit of Shahbaz Chemicals Limited (SCL) for the year ended 31 December 2016, the audit
team had noticed that sales of SCL has declined due to various reasons and SCL is facing difficulties in
selling the existing stock of inventory at current price levels.
Required:
Explain the steps which the auditor should perform to ensure that carrying value of inventories is based
on lower of cost and net realisable value.
129 Express Limited
Express Limited is a medium size entity engaged in trading of electronic appliances. After the issuance
of financial statements and audit report for the year ended 30 June 2016, a major debtor was declared
bankrupt by the Court. No recovery has been made from the debtor after year-end.
Required:
Evaluate the above situation and state the procedures which the auditor would need to perform.
130 Farhan Foods Limited
You are the audit senior on the audit engagement of Farhan Foods Limited and assigned to attend the
inventory count.

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Audit and Assurance

Required:
a) State what matters you would consider while observing the inventory count.
b) State the procedures to be performed during the final audit in relation to the cut-off assertions for
sales and purchases.
131 Fresh Dairies Limited
You are currently in the planning phase of the audit of Fresh Dairies Limited (FDL) for the year ended 31
December 2016. The information available to you in respect of the company’s debtors includes the
following:

Percentage of customers
Number of Balance outstanding
Customer category who confirmed the
customers (Rs. in ‘000)
balance last year

Distributors 20 30,500 90%

Wholesalers 2,250 12,750 70%

Restaurants 12 20,400 83%

Individual customers 5,700 9,800 20%

73,450

FDL is a low risk client and therefore you are assessing whether to send negative confirmation requests.
Required:
In respect of each of the above categories of customers, discuss the appropriateness of sending negative
confirmation requests.

SCENARIOS
132 Zeedin Co
Zeedin Co assembles fridges, microwaves, washing machines and other similar domestic appliances
from parts procured from a large number of suppliers. As part of the interim audit work two weeks prior
to the company year-end, you are testing the procurement and purchases systems and attending the
inventory count.
Procurement and purchases system
Parts inventory is monitored by the stores manager. When the quantity of a particular part falls below re-
order level, an e-mail is sent to the procurement department detailing the part required and the quantity
to order. A copy of the e-mail is filed on the store manager’s computer.
Staff in the procurement department check the e-mail, allocate the order to an authorised supplier and
send the order to that supplier using Electronic Data Interchange (EDI). A copy of the EDI order is filed
in the order database by the computer system. The order is identified by a unique order number.
When goods are received at Zeedin, the stores clerk confirms that the inventory agrees to the delivery
note and checks the order database to ensure that the inventory were in fact ordered by Zeedin. (Delivery
is refused where goods do not have a delivery note.)
The order in the order database is updated to confirm receipt of goods, and the perpetual inventory
system updated to show the receipt of inventory. The physical goods are added to the parts store and
the paper delivery note is stamped with the order number and is filed in the goods inwards department.
The supplier sends a purchase invoice to Zeedin using EDI; invoices are automatically routed to the
accounts department. On receipt of the invoice, the accounts clerk checks the order database, matches
the invoice details with the database and updates the database to confirm receipt of invoice. The invoice
is added to the purchases database, where the purchase day book (PDB) and suppliers individual
account in the payables ledger are automatically updated.

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 Question bank: Objective test and long-form questions

Required:
(a) List SIX audit procedures that an auditor would normally carry out on the purchases system at
Zeedin Co, explaining the reason for each procedure.
(b) List FOUR audit procedures that an auditor will normally perform prior to attending the client’s
premises on the day of the inventory count.
(c) (i) State the aim of a test of control and the aim of a substantive procedure.
(ii) In respect of your attendance at Zeedin Co.’s inventory count, state one test of control and
one substantive procedure that you should perform.
(d) On the day of the inventory count, you attended depot nine at Zeedin. You observed the following
activities:
 Pre-numbered count sheets were being issued to client’s staff carrying out the count. The
count sheets showed the inventory ledger balances for checking against physical inventory.
 All count staff were drawn from the inventory warehouse and were counting in teams of two.
 Three counting teams were allocated to each area of the stores to count, although the teams
were allowed to decide which pair of staff counted which inventory within each area. Staff
were warned that they had to remember which inventory had been counted.
 Information was recorded on the count sheets in pencil so amendments could be made
easily as required.
 Any inventory not located on the pre-numbered inventory sheets was recorded on separate
inventory sheets – which were numbered by staff as they were used.
 At the end of the count, all count sheets were collected and the numeric sequence of the
sheets checked; the sheets were not signed.
Required:
(i) List the weaknesses in the control system for counting inventory at depot nine.
(ii) For each weakness, explain why it is a weakness and state how that weakness can be
overcome.

133 Sahito Co
Introduction – audit firm
You are an audit senior in Bachani & Co, a firm providing audit and assurance services. At the request
of an audit partner, you are preparing the audit programme for the income and receivables systems of
Sahito Co.
Audit documentation is available from the previous year’s audit, including internal control questionnaires
and audit programmes for the despatch and sales system. The audit approach last year did not involve
the use of computer assisted audit techniques (CAATs); the same approach will be taken this year. As
far as you are aware, Sahito’s system of internal control has not changed in the last year.
Client background – sales system
Sahito Co is a wholesaler of electrical goods such as kettles, televisions, MP3 players, etc. The company
maintains one large warehouse in a major city. The customers of Sahito are always owners of small retail
shops, where electrical goods are sold to members of the public. Sahito only sells to authorised
customers; following appropriate credit checks, each customer is given a Sahito identification card to
confirm their status. The card must be used to obtain goods from the warehouse.
Despatch and sales system
The despatch and sales system operates as follows:
 Customers visit Sahito’s warehouse and load the goods they require into their vans after showing
their Sahito identification card to the despatch staff.
 A pre-numbered goods despatch note (GDN) is produced and signed by the customer and a
member of Sahito’s despatch staff confirming goods taken.

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 One copy of the GDN is sent to the accounts department, the second copy is retained in the
despatch department.
 Accounts staff enter goods despatch information onto the computerised sales system. The GDN is
signed.
 The computer system produces the sales invoice, with reference to the inventory master file for
product details and prices, maintains the sales day book and also the receivables ledger. The
receivables control account is balanced by the computer.
 Invoices are printed out and sent to each customer in the post with paper copies maintained in the
accounts department. Invoices are compared to GDNs by accounts staff and signed.
 Paper copies of the receivables ledger control account and list of aged receivables are also
available.
 Error reports are produced showing breaks in the GDN sequence.
Information on receivables
The chief accountant has informed you that receivables days have increased from 45 to 60 days over the
last year.
The aged receivables report produced by the computer is shown below:

1 to 2 More than 2
Number of Total debt
Range of debt Current Rs months old months old
receivables Rs
Rs Rs
15 Less than Rs 0 (87,253) (87,253)
197 Rs 0 to Rs 20,000 2,167,762 548,894 643,523 975,345
153 Rs 20,001 to 50,000 5,508,077 2,044,253 2,735,073 728,751
23 Rs 50,001 or more 1,495,498 750,235 672,750 72,513
388 9,084,084 3,256,129 4,051,346 1,776,609

In view of the deteriorating receivables situation, a direct confirmation of receivables will be performed
this year.
Required:
(a) Explain the steps necessary to check the accuracy of the previous year’s internal control
questionnaires.
(b) Using information from the scenario, list SIX tests of control that an auditor would normally carry
out on the despatch and sales system at Sahito Co and explain the reason for each test.
(c) State and explain the meaning of FOUR assertions that relate to the direct confirmation of
receivables.
(d) (i) Describe the procedures up to despatch of letters to individual receivables in relation to a
direct confirmation of receivables.
(ii) Discuss which particular categories of receivables might be chosen for the sample.

134 Bashir Co
Introduction
Bashir Co assembles specialist motor vehicles such as lorries, buses and trucks. The company owns
four assembly plants to which parts are delivered and assembled into the motor vehicles.
The motor vehicles are assembled using a mix of robot and manual production lines. The ‘human’ workers
normally work a standard eight hour day, although this is supplemented by overtime on a regular basis
as Bashir has a full order book. There is one shift per day; mass production and around the clock working
are not possible due to the specialist nature of the motor vehicles being assembled.

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Wages system – shift workers

Shift-workers arrive for work at about 7.00 am and ‘clock in’ using an electronic identification card. The
card is scanned by the time recording system and each production shift-worker’s identification number is
read from their card by the scanner. The worker is then logged in as being at work. Shift-workers are paid
from the time of logging in. The logging in process is not monitored as it is assumed that shift-workers
would not work without first logging in on the time recording system.
Shift-workers are split into groups of about 25 employees, with each group under the supervision of a
shift foreman. Each day, each group of shift-workers is allocated a specific vehicle to manufacture. At
least 400 vehicles have to be manufactured each day by each work group. If necessary, overtime is
worked to complete the day’s quota of vehicles. The shift foreman is not required to monitor the extent of
any overtime working although the foreman does ensure workers are not taking unnecessary or
prolonged breaks which would automatically increase the amount of overtime worked. Shift-workers log
off at the end of each shift by re-scanning their identification card.
Payment of wages
Details of hours worked each week are sent electronically to the payroll department, where hours worked
are allocated by the computerised wages system to each employee’s wages records. Staff in the payroll
department compare hours worked from the time recording system to the computerised wages system,
and enter a code word to confirm the accuracy of transfer. The code word also acts as authorisation to
calculate net wages. The code word is the name of a domestic cat belonging to the department head and
is therefore generally known around the department.
Each week the computerised wages system calculates:
(i) gross wages, using the standard rate and overtime rates per hour for each employee,
(ii) statutory deductions from wages, and
(iii) net pay.
The list of net pay for each employee is sent over Bashir’s internal network to the accounts department.
In the accounts department, an accounts clerk ensures that employee bank details are on file. The clerk
then authorises and makes payment to those employees using Bashir’s online banking systems. Every
few weeks the financial accountant reviews the total amount of wages made to ensure that the
management accounts are accurate.
Termination of employees
Occasionally, employees leave Bashir. When this happens, the personnel department sends an e-mail
to the payroll department detailing the employee’s termination date and any unclaimed holiday pay. The
receipt of the e-mail by the payroll department is not monitored by the personnel department.
Salaries system – shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was paid in November.
Required:
(a) List FOUR control objectives of a wages system.
(b) As the external auditors of Bashir Co, write a management letter to the directors in respect of the
shift-workers’ wages recording and payment systems which:
(i) Identifies and explains FOUR weaknesses in that system;
(ii) Explains the possible effect of each weakness;
(iii) Provides a recommendation to alleviate each weakness.
(c) List THREE substantive analytical procedures you should perform on the shift managers’ salary
system. For each procedure, state your expectation of the result of that procedure.
(d) Audit evidence can be obtained using various audit procedures, such as inspection.
APART FROM THIS PROCEDURE, in respect of testing the accuracy of the time recording system at
Bashir Co, explain FOUR procedures used in collecting audit evidence and discuss whether the auditor
will benefit from using each procedure.

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Audit and Assurance

135 Multiple Situations

(a) Explain the term ‘Expectation Gap’ in the context of an audit and give three examples of
expectation gap.
(b) International Standards on Auditing require an auditor to evaluate the control environment and
assess its effectiveness. State the factors that the auditor should consider in evaluating the control
environment.
(c) A schedule of related party transactions provided by the client includes two significant transactions
which are outside the normal course of business. State the substantive procedures that an auditor
should undertake, in respect of these transactions.
(d) State key features of a review engagement which distinguish it from a statutory audit and identify
two types of review engagements.
(e) Identify the factors that are considered in determining the independence of internal auditors.
(f) State four substantive procedures for verification of share premium account appearing in the
statement of financial position.
(g) Briefly explain with examples, the different levels of assurance that can be provided to an
assurance client.
(h) State the conditions under which an auditor may send negative confirmations.

COMPLETION
136 Final audit file
(a) State the auditor’s responsibility in respect of ‘Assembly of final audit file’.
(b) The audit report of Salim Limited was signed on 30 April 2016. After issuance of the audit report,
the auditor was informed that a major debtor has become bankrupt.
Required:
Specify the matters that the auditor would be required to document in the above situation.

137 Energy Limited

(a) Specify the procedures that an auditor should perform to ensure completeness of the list of related
parties provided by the directors.
(b) As part of audit procedure you have requested the management of Energy Limited to provide
specific representation relating to completeness of related parties and related party transactions.
The management is of the view that since the auditor has carried out a detailed review in which no
undisclosed transactions were identified, a written representation is not necessary.
Required:
Evaluate the above situation, comment on the management’s stance and suggest the appropriate course
of action available to the auditor.

138 XYZ & Company

You are the audit partner of XYZ & Company, Chartered Accountants. The following matters are under
your consideration:
(a) Asif Limited has made certain investments and has classified them as long term investments. The
management has also provided written representation in this regard. However, before the
finalization of financial statements the company disposed of some of the said investments.
(b) Mansoor Limited has entered into significant related party transactions during the year which are
approved by the Board of Directors and appropriately disclosed. The management has also agreed
to provide a written representation but you have not received it yet.
Required:
Analyse the above situations and explain how you would proceed in the above matters.

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139 XYZ Limited

While reviewing the final audit file of XYZ Limited for the year ended 30 June 2014, you have identified
that certain amendments were made in the final audit file after the date of the auditor’s report.
Required:
Comment on the above situation in the light of International Standards on Auditing.
140 Noncurrent assets
Briefly state test of details for verifying the valuation assertion of tangible noncurrent assets where the
company follows revaluation policy for valuation of such assets.
141 Customized Machinery Limited (CML)
Your firm is the auditor of Customized Machinery Limited (CML), a listed company, for the year ended 30
June 2015. CML has an asset base of Rs. 3.5 billion and profit before tax of Rs. 350 million. On 10 August
2015, after the issuance of audit report but prior to the issuance of financial statements, you have been
informed as under:
(i) CML had been awarded a contract of Rs. 500 million in April 2015 for supply of specialized
machinery parts in August 2015 to a foreign customer. CML was expecting a profit of 20% on the
contract. However, the government of the foreign country has placed certain restrictions on import
because of which the customer has cancelled the purchase order under force majeure clause.
(ii) The inventory against the above order is lying in the warehouse and requires an expense of Rs.
105 million in order to become usable for other customers.
(iii) According to the management, the cancellation of this order will not affect the operations of the
company in any significant manner.
Required:
Discuss how you would deal with the above situation.
142 Nadeem Limited
As the engagement partner, you have reviewed the working papers of Nadeem Limited (NL) in which the
audit team has highlighted the following matters:
(a) NL provides six months warranty to its customers and has hired an expert to compute the warranty
provision. The management is not willing to provide written representation for the warranty
provision because the provision is in accordance with the expert’s advice.
(b) Certain contingent assets have been disclosed in the draft financial statements in which inflow of
economic benefits is possible but not probable. The management is of the view that International
Financial Reporting Standards does not prohibit making additional disclosures which enhance the
users understanding of the financial statements.
(c) According to the accounting policy for revenue recognition, revenue from sale of goods is
recognized on dispatch of goods to customers. However, during the year, NL has entered into
various agreements in which the goods are required to be delivered at the premises of the
customers.
Required:
Discuss the possible impact on the audit report.

143 System logs

(b) Identify any four types of information that can be extracted from system logs.

144 Overtime payments

You have been assigned to plan the test of controls in respect of salaries and wages. In this regard you
are required to identify the following:
(a) Possible control weaknesses in overtime payments
(b) Principal controls over payment of overtime

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Audit and Assurance

145 Khanewal Limited (KL)

Khanewal Limited (KL) has requested your firm to submit engagement letter for KL’s statutory audit. The
engagement partner has asked you to establish whether preconditions for the audit of KL are present.
Required:
What matters would you consider in order to ensure that preconditions for the audit exist?

146 ABD Limited

Your firm is the auditor of ABD Limited (ABDL). After the acquisition of majority shareholding in HG Motors
(Private) Limited (HGM), ABDL has decided to replace the existing auditors of HGM in the next annual
general meeting and has approached you for appointment as HGM’s auditors for the next year.
Required:
(a) In the light of the Companies Act, 2017 explain the procedures to be followed and formalities to be
complied with for appointment of your firm as the auditor of HGM. Also explain the rights of the
existing auditors in this situation.
(b) Explain the responsibilities of your firm and the existing auditors in the above situation under the
Code of Ethics for Chartered Accountants.

147 Cell Phones (Private) Limited

Your firm is the auditor of Cell Phones (Private) Limited (CPPL), which operates a chain of mobile phone
retail outlets. About 25% of shareholding in CPPL is owned by Anwar and his wife. Anwar is the Chief
Executive of CPPL and also looks after the finance and operations of the company. There are five other
directors and each of them holds 15% shares in CPPL.
The Internal Audit Function comprises of three senior officers who are graduates. Their duties include
checking of accounting records, physical stock taking, preparation of bank reconciliations, reviewing
payments and verification of fixed and current assets.
During the planning phase, Anwar stressed the need for early completion of audit, in order to be able to
submit the audited financial statements for seeking a long term finance. He was of the view that internal
audit working papers would be of enormous help in performing and early completion of the audit.
Required:
(a) Identify and briefly describe the fraud risk factors in the above scenario.
(b) State whether it would be advisable to use the internal audit working papers in the above situation
and give three distinct reasons to support your decision.

148 Substantive procedures

List any five substantive procedures for the verification of each of the following:
(i) Accrued expenses
(ii) Contingencies

149 Pioneer Textile Limited (PTL)

The management of Pioneer Textile Limited (PTL) has provided you with management representation
that they have disclosed to you all known instances of non-compliances with laws and regulations that
are relevant to the preparation of the financial statements.
However, during the field work your team identified a payment of penalty of Rs. 2 million to an
environmental agency. PTL’s management claims that the disclosure of the related non-compliance was
inadvertently omitted.
Required:
Discuss the appropriateness of management representation and how would you deal with the above
situation.

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 Question bank: Objective test and long-form questions

150 Multiple Questions

(a) Briefly describe the term ‘Integrity’ in accordance with the Code of Ethics for Chartered
Accountants.
(b) Briefly describe ‘advocacy threat’ and give an example thereof.
(c) Briefly state the difference between ‘actual independence’ and ‘perceived independence’.
(d) The principle of confidentiality imposes an obligation on chartered accountants to refrain from
disclosing confidential information. State three key exceptions to the above rule.
(e) Briefly describe the term ‘systematic sampling’.
(f) State any three procedures which are generally adopted by the auditor to obtain evidence in review
engagement.
(g) State the auditor’s responsibility with respect to events between the end of the reporting period and
the date of the auditor’s report.
(h) Give any three audit procedures to ensure completeness of list of related parties provided by the
management.
(i) State any two factors which the auditor should consider to ensure reliability of audit evidence.
(j) Discuss the circumstances in which an auditor may include other matter paragraph in the audit
report.
(k) The auditor should actively look for subsequent events up to the date of auditor’s report. State the
procedures which an auditor should perform specifically for identification of subsequent events.
(l) Discuss the course of action which may be adopted by the auditor if pre-conditions of audit are not
present.

151 Analytical procedures

(a) Analytical procedures are an important part of the audit process and a tool which the auditor uses
during the various phases of an audit.
Required:
(i) Describe the nature and purpose of analytical procedures used during an audit.
(ii) Describe the factors that the auditor needs to consider while designing and performing
analytical procedures as substantive procedures.
(iii) Describe the objectives which an auditor expects to achieve while applying analytical
procedures at the overall review stage of an audit.
(b) Representations by management are considered as audit evidence. Describe the basic elements
of a management representation letter.

152 Auditor responsibility

The auditor is required to issue an audit report at the end of the audit, which sets out his opinion on the
financial statements. An important element of the audit report is the statement of auditor’s
responsibility.
Required:
Narrate the matters that should be contained in the statement of auditor’s responsibility as included in an
audit report issued under ISA-700 ‘The Independent Auditor’s Report on a Complete Set of General
Purpose Financial Statements’.

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Audit and Assurance

153 Al-Badr
Al-Badr & Company, Chartered Accountants, have conducted the statutory audit of the financial
statements of Al-Qasim Limited, a listed company, for the year ended June 30, 20X3 under the
requirements of the Companies Act, 2017. The job in charge has drafted the following audit report:
Auditors’ Report to the Directors
Opinion
We have audited the annexed financial statements (or revised financial statements, if applicable) of
Al-Qasim Limited, which comprise the statement of financial position as at June 30, 20x3, and the
statement of profit or loss and other comprehensive income or the income and expenditure statement,
the statement of changes in equity, for the year then ended, and notes to the financial statements,
including a summary of significant accounting policies and other explanatory information, and we state
that we have obtained all the information and explanations which, to the best of our knowledge and belief,
were necessary for the purposes of the audit.
In our opinion and to the best of our information and according to the explanations given to us, the
statement of financial position, statement of profit or loss and other comprehensive income or the income
or expenditure statement, the statement of changes in equity and the statement of cash flows together
with the notes forming part thereof conform with the accounting and reporting standards as applicable in
Pakistan and give the information required by the Companies Act, 2017 (XIX of 2017), in the manner so
required and respectively give a true and fair view of the state of the Company's affairs as at June 30,
20x3 and of the profit or loss and other comprehensive income or loss, or the surplus or deficit, the
changes in equity and its cash flows for the year then ended.
Basis for Opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit
of the Financial Statements section of our report. We are independent of the Company in accordance
with the International Ethics Standards Board for Accountants’ Code of Ethics for Professional
Accountants as adopted by the Institute of Chartered Accountants of Pakistan / Institute of Cost and
management Accountants (the Code) and we have fulfilled our other ethical responsibilities in accordance
with the Code. We believe that the audit evidence we have obtained is sufficient and appropriate to
provide a basis for our opinion.
Responsibilities of Management and Board of Directors for the Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in
accordance with the accounting and reporting standards as applicable in Pakistan and the requirements
of Companies Act, 2017(XIX of 2017) and for such internal control as management determines is
necessary to enable the preparation of financial statements that are free from material misstatement,
whether due to fraud or error.
In preparing the financial statements, management is responsible for assessing the Company’s ability to
continue as a going concern, disclosing, as applicable, matters related to going concern and using the
going concern basis of accounting unless management either intends to liquidate the Company or to
cease operations, or has no realistic alternative but to do so.
Board of directors are responsible for overseeing the Company’s financial reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that
includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an
audit conducted in accordance with ISAs as applicable in Pakistan will always detect a material
misstatement when it exists. Misstatements can arise from fraud or error and are considered material if,
individually or in the aggregate, they could reasonably be expected to influence the economic decisions
of users taken on the basis of these financial statements.
As part of an audit in accordance with ISAs as applicable in Pakistan, we exercise professional judgment
and maintain professional skepticism throughout the audit.

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 Question bank: Objective test and long-form questions

We also:
 Identify and assess the risks of material misstatement of the financial statements, whether due to
fraud or error, design and perform audit procedures responsive to those risks, and obtain audit
evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting
a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may
involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal
control.
 Obtain an understanding of internal control relevant to the audit in order to design audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company’s internal control.
 Conclude on the appropriateness of management’s use of the going concern basis of accounting
and, based on the audit evidence obtained, whether a material uncertainty exists related to events or
conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If
we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report
to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify
our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s
report. However, future events or conditions may cause the Company to cease to continue as a going
concern.
 Evaluate the overall presentation, structure and content of the financial statements, including the
disclosures, and whether the financial statements represent the underlying transactions and events
in a manner that achieves fair presentation.
We communicate with the board of directors regarding, among other matters, the planned scope and
timing of the audit and significant audit findings, including any significant deficiencies in internal control
that we identify during our audit.
We also provide the board of directors with a statement that we have complied with relevant ethical
requirements regarding independence, and to communicate with them all relationships and other matters
that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
From the matters communicated with the board of directors, we determine those matters that were of
most significance in the audit of the financial statements of the current period and are therefore the key
audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public
disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should
not be communicated in our report because the adverse consequences of doing so would reasonably be
expected to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements
Based on our audit, we further report that in our opinion:
a. proper books of account have been kept by the Company as required by the Companies Act, 2017
(XIX of 2017);
b. the statement of financial position, the statement of profit or loss and other comprehensive income
or the income and expenditure account, the statement of changes in equity and the statement of
cash flows together with the notes thereon have been drawn up in conformity with the Companies
Act, 2017 (XIX of 2017) and are in agreement with the books of account and returns;
c. investments made, expenditure incurred and guarantees extended during the year were for the
purpose of the Company’s business; and
d. zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII of 1980), was deducted
by the company and deposited in the Central Zakat Fund established under section 7 of that
Ordinance.
[Signature]
[Place/ location]
[Date]
Required:
Identify and explain (where necessary) the errors in the above audit report.
(Note: You are not required to redraft the report.)

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154 The engagement partner

As the engagement partner, you have reviewed the audit working papers of Samarkand Limited (SL).
The audit team has highlighted the following matters in the working papers.
(a) Twenty percent of the company’s recorded turnover (revenue) comprises of cash sales.
Proper records of cash sales have not been maintained. Consequently, the audit team was unable
to design audit procedures to verify the cash sales.
(b) During the current year, the company changed the method of charging depreciation on its fixed
assets from the straight line to the diminishing balance method. However, all the required
disclosures have been included in the notes to the financial statements.
(c) The previous year’s financial statements were audited by another firm of chartered accountants
which has issued an un-modified opinion on those financial statements.
Required:
Discuss the impact of each of the above matters on your audit report.

155 Different audit clients

The following situations have arisen at different audit clients of your firm:
(a) Zafar Technology Limited (ZTL), a listed company, is engaged in the manufacture of compressors
used in electrical appliances. During the conduct of the audit for the year ended 31 March 2012, a
team member has discovered a letter dated 18 March 2012 from Sartaj Electronics Limited (SEL)
which states that SEL will not pay the current outstanding invoices as according to it the
compressors supplied by ZTL are of an incorrect specification.
ZTL’s Technical Director believes that the problem arose due to changes in the design of
appliances produced by SEL and not because of faulty production by ZTL. However, both the
companies have agreed to refer the matter to arbitration.
Sales to SEL account for approximately 25% of the revenue of ZTL and the balance due from SEL
as at 31 March 2012 amounted to Rs. 3.12 million. The profit after taxation of ZTL is Rs.25 million
with an asset base of Rs.150 million.
(b) The directors’ report of XCP Limited states without any further explanation that the 20% increase
in profit as compared to the previous year is due to increase in sales and austerity measures
introduced by the management. The income statement for the year shows an increase in profits
and sales amounting to Rs. 20 million and Rs. 8 million respectively whereas the costs have
reduced by Rs. 12 million. A review of your working papers however indicates that costs have
reduced mainly on account of reduction in import duty on certain raw materials.
(c) IPL is a manufacturer of diversified products and has factories in seven major cities of the country.
The demand for some of its products has been falling and the company wants to concentrate on
its core products only. Consequently, it has decided to close three of its factories and has made a
provision of Rs. 30 million in respect of redundancies and restructuring. The directors’ report for
the year ended 31 May 2012 comprehensively discusses the restructuring plan and states that the
factories in Lahore and Multan would be closed in the months of July and September 2012
respectively. The third factory will be closed before December 2012 however, the location of that
factory will be decided in November 2012.
The profit after taxation of IPL according to its draft financial statements for the year ended 31 May
2012 is Rs. 80 million.
Required:
Discuss the matters which the auditor should consider for each of the above situations and the possible
impact thereof on the respective audit reports.

156 Situations have arisen on different clients

The following situations have arisen on different clients being audited by your firm. The year end in each
instance is 31 December 2011.

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 Question bank: Objective test and long-form questions

(a) The management of Dir Limited intends to present certain unaudited supplementary information,
with the audited financial statements, in order to comply with the requirements of the parent
company. Before signing the audit report, it has been determined that some of the information is
inconsistent with the information in the draft financial statements.
(b) Malakand Industries Limited (MIL) is engaged in the supply of customised machinery to textile
manufacturers. On 18 February 2012 one of its customers, who owed Rs. 9.6 million, went into
voluntary liquidation. In addition to the above amount, a job was in progress on behalf of that
customer and on which MIL had already spent Rs. 13.9 million.
The directors have refused to make a provision against the debt on the grounds that the liquidator
was appointed after the balance sheet date. They have also refused to make any provision in
respect of the work in process as they are planning to sell the machinery being manufactured to
another customer for Rs. 15.7 million.
The profit after tax of MIL is Rs. 85 million. The materiality level is 10% of profit after tax.
(c) Swat Limited has invested Rs. 150 million in a business which is not mentioned in the object clause
of its Memorandum of Association. However, the object clause was amended a week before the
signing of the audit report.
Required:
In the light of the relevant requirements, discuss how should the auditor deal with the above situations
and describe the impact thereof on the audit report.

157 MM Electronics (Private) Limited

You are the audit manager of MM Electronics (Private) Limited. The company markets its products
through retail outlets in nine major cities. The draft financial statements for the year ended 30 June 2011
show a profit after tax of Rs. 20 million and net assets of Rs. 150 million.
The audit team has noted the following matters for your consideration:
(a) During the year the company has changed its policy of valuation of property, plant and equipment
from historical cost to revalued amount. For this purpose, the services of Professional Valuers
(Private) Limited were hired. They have issued valuation reports of three outlets indicating a
revaluation surplus of Rs. 10 million, which has been recognised in the financial statements. The
management has informed you that the valuation reports of the remaining properties are expected
to be issued in December 2011.
(b) The company was sued for breach of contract by a customer claiming damages of Rs. 10 million.
The legal advisor has confirmed the management’s assertion that no liability existed at the balance
sheet date. However, while reviewing the customers’ files, you found an email from the Manager
(Legal Department) addressed to the Chief Executive in which he has opined that the company will
have to pay atleast 50% of the damages claimed.
(c) With effect from 01 July 2010, the company has introduced a policy of providing one year warranty
on its television sets. No warranty is provided on the other products. Sales of television sets
aggregated Rs. 20 million, whereas the total sales for the year amounted to Rs. 80 million.
The company has a customer support department which provides after sales services on all products.
For defects not covered under the warranty, the company bills the customers at 25% above cost. The
management has included a note in the draft financial statements stating that no provision has been
made in respect of the warranty, as the amount cannot be measured reliably.
(d) The directors have decided not to disclose earnings per share as the same had reduced
significantly on account of issuance of 100% bonus shares. The disclosure was however made in
all previous financial statements.
Required:
Express your views on each of the above situations and discuss the impact thereof on the audit report.

158 Ranjha Limited

Ranjha Limited (RL), a listed company, is engaged in the manufacture of fast moving consumer goods.
The draft financial statements for the year ended March 31, 2011 show a profit before taxation of Rs. 12
million and total assets of Rs. 300 million.

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Audit and Assurance

As the audit manager, you are reviewing the following issues which were brought to your notice by the
audit team:
(i) On June 1, 2010 RL acquired a plant at a cost of Rs. 50 million. The plant has a useful life of 10
years with no residual value. RL follows the policy to depreciate the plant on the straight line
method. On January 1, 2011 the plant suffered physical damage due to a fire in the factory. The
technician from the manufacturer has inspected the plant and reported that the damage has
affected its production capacity which has now been reduced by 30%.
(ii) During the year a petition has been filed against RL by one of its customers for recovery of Rs.
20 million, along with mark-up, damages and compensation, on the ground that materials
supplied by RL were defective. RL has filed a written statement in the Court denying the
allegations.
RL’s legal advisor is of the view that the final liability of the company may range from 0% to 50%.
However, at this point of time, it is not possible to determine the amount with reasonable degree of
accuracy. No provision in this regard has been made in the draft financial statements.
(iii) In April 2007, RL acquired a high-tech production management software for Rs. 10 million. The
useful life of the software is 10 years. During the year it was discovered that in the past the
software was erroneously amortised assuming a useful life of 20 years.
The management has decided to adjust the amount short provided, over the remaining useful life
of the software.
Required:
Discuss the matters that may be of significance to you as an auditor in respect of each of the above
issues. Also explain their implication on the audit report.

159 Pervasive effects

(a) Briefly explain the term ‘pervasive effects on the financial statements’.
(b) As the engagement partner, you have reviewed the audit working papers of Apricot Engineering
Limited (AEL). The audit team has highlighted the following matters in the working papers.
(i) The company has issued a bank guarantee to one of its related parties after the balance
sheet date. No disclosure in this regard has been made in the draft financial statements.
(ii) AEL has paid a dividend after many years. Zakat has been appropriately deducted and
deposited in the Central Zakat Fund.
(iii) Subsequent to the year end, a major debtor has declared bankruptcy. The company expects
to recover only 20% of the outstanding amount. The management has refused to make a
provision but is ready to disclose the fact by way of a note.
(iv) With effect from January 1, 2010, AEL has:
 changed the method of charging depreciation on its fixed assets from the ‘straight
line’ to the ‘diminishing balance’; and
 revised its estimate of useful lives of vehicles from 6 years to 4 years.
Required:
Discuss the impact of each of the above matters on your audit report.

160 Audit report at the end of the audit

(a) The auditor is required to issue an audit report at the end of the audit, which sets out his opinion
on the financial statements. An important element of the audit report is the statement of auditor’s
responsibility.
Required:
Narrate the matters that should be contained in the statement of auditor’s responsibility as included in an
audit report issued under ISA-700 ‘The Independent Auditor’s Report on a Complete Set of General
Purpose Financial Statements’.
(b) Identify the situations in which an auditor may modify his report without affecting his opinion. Also
explain how such a modification should be presented in the audit report.

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 Question bank: Objective test and long-form questions

161 Iqra Industries Limited

You are the senior responsible for the audit of Iqra Industries Limited (IIL). During the course of the audit
you became aware that a legal action has been instituted against IIL by some of its customers, on account
of disputes related to performance of its products.
In response to your request for an opinion the company’s lawyer has simply stated that “We are totally
unable to give any estimate”.
No provision was made in the financial statements for the possible loss as a result of the claims (which
are considered to be material) or for the related legal expenses although details of those legal claims
were fully disclosed in the notes.
Required:
Comment on the implication of the above matter on the auditors’ report and the financial statements of
IIL.

162 Written representations

One of the objectives of obtaining a written representation from management is to ensure that the
management knows and acknowledges its responsibility for the preparation of the financial statements
and for the completeness of the information provided to the auditor.
Required:
Specify the situations which may create doubts as to the reliability of written representations. What
course of action would the auditor take in such a situation?

163 Kazmi-Wassan
You are the manager in charge of the audit of Kazmi-Wassan, a listed company which manufactures
specialist cars and other motor vehicles for use in films. Audited revenue is Rs 140 million with profit
before tax of Rs 7.5 million.
All audit work up to, but not including, the obtaining of written representations has been completed. A
review of the audit file disclosed the following outstanding points:
Tiger’s Purr
The company is facing a potential legal claim from the Tiger’s Purr company in respect of a defective
vehicle that was supplied for one of their films. Tiger’s Purr maintains that the vehicle was not built strongly
enough while the directors of Kazmi-Wassan argue that the specification was not sufficiently detailed.
Dropping a vehicle 50 metres into the river and expecting it to continue to remain in working condition
would be unusual, but this is what Tiger’s Purr expected. Solicitors are unable to determine liability at the
present time. A claim for Rs 4 million being the cost of a replacement vehicle and lost production time
has been received by Kazmi-Wassan from Tiger’s Purr. The directors’ opinion is that the claim is not
justified.
Depreciation
Depreciation of specialist production equipment has been included in the financial statements at the
amount of 10% pa based on reducing balance. However, the treatment is consistent with prior accounting
periods (which received an unmodified auditors’ report) and the companies in the same industry and
sales of old equipment show negligible profit or loss on sale. The audit senior, who is new to the audit,
feels that depreciation is being undercharged in the financial statements.
Required:
(a) Explain the purpose of a written representation letter.
(b) For each of the above matters:
(i) discuss whether or not a paragraph is required in the representation letter; and
(ii) if appropriate, draft the paragraph for inclusion in the representation letter.
(c) A suggested format for the letter of representation has been sent by the auditors to the directors
of Kazmi-Wassan. The directors have stated that they will not sign the letter of representation this
year on the grounds that they believe the additional evidence that it provides is not required by the
auditor.

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Audit and Assurance

Required:
Discuss the actions the auditor may take as a result of the decision made by the directors not to
sign the letter of representation.

164 RK Resourcing
You are the auditor of RK Resourcing, a limited liability company which extracts, refines and sells oil and
petroleum related products.
The audit of RK Resourcing for the year ended 30 June 20X3 had the following events:

Date (20X3) Event

15 August Bankruptcy of major customer representing 11% of the trade receivables on the
statement of financial position.

21 September Financial statements approved by directors.

22 September Audit work completed and auditor’s report signed.

1 November Accidental release of toxic chemicals into the sea from the company’s oil refinery
resulting in severe damage to the environment. Management had amended and
made adequate disclosure of the event in the financial statements.

23 November Financial statements issued to members of RK Resourcing.

30 November A fire at one of the company’s oil wells completely destroys the well. Drilling a new
well will take ten months with a consequent loss in oil production during this time.

Required:
(a) International Standard on Auditing 560 Subsequent Events explains the audit work required in
connection with subsequent events.
List the audit procedures that can be used prior to the auditor’s report being signed to identify
events that may require adjustment or disclosure in the financial statements.
(b) For each of the following three dates:
 15 August 20X3
 1 November 20X3, and
 30 November 20X3:
(i) State whether the events occurring on those dates are adjusting or non-adjusting
according to IAS 10 Events After the Reporting Period, giving reasons for your
decision.
(ii) Explain the auditor’s responsibility and the audit procedures that should be carried
out.
Note: Marks are allocated evenly across the three dates.

165 Rake Enterprises

You are the audit manager of Rake Enterprises, a limited liability company. The company’s annual
revenue is over Rs 100 million.
Required:
(a) Compare the responsibilities of the directors and auditors regarding the published financial
statements of Rake Enterprises.
(b) An extract from the draft audit report produced by an audit junior is given below:

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 Question bank: Objective test and long-form questions

Auditor’s responsibility
'We conducted our audit in accordance with Auditing Standards. An audit includes examination, on a test
basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an
assessment of all the estimates and judgements made by the directors in the preparation of the financial
statements, and of whether the accounting policies are appropriate to the company's circumstances,
consistently applied and adequately disclosed.
'We planned and performed our audit so as to obtain as much information and explanation as possible
given the time available for the audit. We confirm that the financial statements are free from material
misstatement, whether caused by fraud or other irregularity or error. The directors however are wholly
responsible for the accuracy of the financial statements and no liability for errors can be accepted by the
auditor. In forming our opinion we also evaluated the overall adequacy of the presentation of information
in the company's annual report.'
Required:
Identify and explain the errors in the above extract.
Note: You are not required to redraft the report.

166 Tariq Limited

You are the audit partner of the firm and your manager has highlighted the following matters:
(a) The profit before tax of Tariq Limited (TL) for the year ended 30 June 2017 is Rs. 790 million. TL
provides three year warranty to its customers and has made provision of Rs. 80 million in this
regard. The management carries out the computation internally. The process is complex and based
on various assumptions. Therefore, your firm has appointed an expert after following all the
necessary procedures for assessing the competence, capability and objectivity of the expert.
(b) Your firm has been appointed as the auditor of Yaqoob Limited for the audit of the year ended 30
June 2017. The audit team was not able to perform the inventory count at year end because the
appointment was made on 15 July 2017.
Required:
Describe the steps that will be performed in each of the above situation and discuss the possible
implications of the above on the audit report. (Drafting of audit opinion is not required)

167 GMP & Company

You are the audit partner of GMP & Company, Chartered Accountants. The following matters are under
your consideration:
(a) The CEO of a client is travelling out of the country on 20 September 2017 and would not be
available on the date of signing of report which is 29 September 2017. However, he has offered to
sign all the representations before leaving.
(b) A client has modified the representation letter with regard to the responsibility of management to
provide the auditor with all information relevant for the purpose of audit. It has been stated, that
“except for the information destroyed in fire, we have provided all the necessary information for the
purpose of audit”.
(c) The managing director of a client which is a family owned business has sent the following email to
the audit manager:
“I believe the financial statements we have provided to you are final. Although adjustments are required
to correct some of the balances, but being immaterial, they would not affect the decision making of the
owner. We therefore believe that the audit report may now be signed and the required corrections may
be included in the representation letter”
Required:
Discuss how you would deal with the above situations

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168 BLC & Company

You are the audit partner at BLC & Company, Chartered Accountants. The following matters are under
your consideration:
(i) Artificial Technologies Limited (ATL) has recognised an intangible asset of Rs. 100 million in
respect of development costs relating to a software which ATL expects to market in future.
The market research conducted by ATL indicates a promising demand for such software.
However, the expected cost required to complete the software has increased significantly and
ATL requires further Rs. 50 million to complete the project. Since ATL has already utilised its
existing credit limit on other projects, it is facing difficulties in raising financing for the above
software.
ATL’s draft financial statements show profit before tax of Rs. 270 million.
(ii) RL is involved in the manufacturing and supply of beverages throughout Pakistan, through its
plant situated in Lahore. During the year, a fire occurred at RL’s plant due to which a significant
portion of the plant has been destroyed. The management has written off the plant and recorded
an insurance claim amounting to Rs. 400 million. The written down value of the plant at the time
of fire was Rs. 390 million.
RL is negotiating the purchase of another plant and order is expected to be placed soon after
receiving the insurance claim.
RL’s draft financial statements show profit before tax of Rs. 300 million.
Required:
Discuss how you would deal with each of the above situations and the possible implications of the above
on the audit report. (Drafting of audit opinion is not required)

169 Audit Partner

You are the audit partner in a firm of chartered accountants. Some of the audits are in the finalization
stage and presently the following matters are under your consideration:
(a) The management of Sohni Limited has changed its revenue recognition policy. As the audit
engagement partner you are satisfied with the accounting and disclosures related to change in
accounting policy. Further, the impact of the change is significant.
(b) There is a legal dispute between Marvi Limited and one of its customers. In this regard, the legal
advisor has confirmed the stance of the management in a meeting with you.
However, he has refused to provide a written confirmation thereon.
(c) The management of Laila Limited is not willing to make certain disclosures. The management is of
the view that these disclosures will not add any value to the financial statements. Further, the
information required to make these disclosures cannot be compiled before the deadline for
completion of the audit.
Required:
Discuss the possible impact on the audit report and specify the procedures (if any) which you would
undertake in the above situations.

170 Afzal Textile Mills Limited

(a) Briefly state the course of action which should be adopted by a firm if the requested written
representations are not provided by the client.
(b) You are the audit manager at Afzal Textile Mills Limited (ATML). While reviewing the draft financial
statements and the working paper file, the following matters have come to your attention:
i There is a significant decline in the number of related parties and related party transactions.
ii During the year, ATML has acquired 15% shareholding in Bashir Textiles Limited, a listed
company.
iii ATML owns six buildings out of which four have been revalued during the current year while
the remaining buildings would be revalued next year.
Required:
Discuss whether it would be necessary to obtain management representation in respect of the above
matters.

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 Question bank: Objective test and long-form questions

REVIEW ENGAGEMENTS
171 ISRE 2400
(a) Explain the meaning of “assurance” and give two examples of types of assurance which can be
provided, distinguishing between the two in terms of the level of assurance offered by each of them.
(b) ISRE 2400 Engagements to review financial information sets out the objective, general principles
and procedures to be applied to a review engagement.
Required:
Set out the main types of procedures which an accountant should perform when carrying out a review
engagement.
(d) Differentiate between review engagement of financial statements and the annual audit.

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Audit and Assurance

© Emile Woolf International 70 The Institute of Chartered Accountants of Pakistan

 Certificate in Accounting and Finance

C
Audit and Assurance

SECTION
Multiple choice answers
CHAPTER 1 – CONCEPT AND NEED FOR ASSURANCE
1 D
2 C
3 C
4 A
5 C

CHAPTER 2 – OBTAINING AN ENGAGEMENT

6 B
7 A
8 A
9 D
10 C

CHAPTER 3 – PLANNING AND RISK ASSESSMENT

11 D
12 D
13 A
14 D
15 B

CHAPTER 4 – EVIDENCE AND SAMPLING

16 C
17 B
18 A
19 B
20 B

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Audit and Assurance

CHAPTER 5 – INTERNAL CONTROL

21 A
22 B
23 C
24 C
25 D
26 D
27 A

CHAPTER 6 – TESTS OF CONTROLS

28 A
29 C
30 B
31 B
32 D

CHAPTER 7 – INTRODUCTION TO SUBSTANTIVE PROCEDURES

33 C
34 D
35 B
36 B
37 C

CHAPTER 8 – SUBSTANTIVE PROCEDURES: NON-CURRENT ASSETS

38 B
39 B
40 D
41 A
42 A

CHAPTER 9 – SUBSTANTIVE PROCEDURES: CURRENT ASSETS

43 C
44 D
45 D
46 C
47 B

CHAPTER 10 – SUBSTANTIVE PROCEDURES: OTHER AREAS

48 C
49 A
50 A
51 A
52 A

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 Answer bank: Multiple choice answers

CHAPTER 11 – RELATED PARTY TRANSACTIONS

53 C
54 D
55 C

CHAPTER 12 – RELIANCE ON OTHERS

56 B

CHAPTER 13 – PROFESSIONAL ETHICS AND CODES OF CONDUCT

57 A
58 A
59 B
60 A
61 A

CHAPTER 14 – AUDIT FINALISATION AND REPORTING

62 B
63 A
64 C
65 C
66 B

CHAPTER 15 – INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS

67 B
68 D
69 D

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Audit and Assurance

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 Certificate in Accounting and Finance

D
Audit and Assurance

SECTION
Objective test and
long-form answers

AUDIT FRAMEWORK, REGULATION AND ETHICS

1 ICAP Code of Ethics
(a) (i) The fundamental principles of professional ethics for chartered accountants are as follows:
 Integrity:
A chartered accountant should be straightforward and honest in all professional and
business relationships.
 Objectivity:
A chartered accountant should not allow bias, conflict of interest or undue influence of
others to override professional or business judgments.
 Professional competence and due care:
A chartered accountant has a continuing duty to maintain the required professional
knowledge and skill to ensure that a client or employer receives competent professional
service based on current developments in practice, legislation and techniques. A
chartered Accountant should act diligently and in accordance with applicable technical
and professional standards when providing professional services.
 Confidentiality:
Confidential information acquired as a result of professional and business relationships
should not be disclosed to third parties without proper and specific authority unless
there is a legal or professional right or duty to disclose. Confidential information
acquired as a result of professional and business relationships should not be used for
personal advantage of the chartered accountant or third parties.
 Professional Behaviour:
A chartered accountant should comply with relevant laws and regulations and should
avoid any action that discredits the profession.
(ii) The threats to compliance with the fundamental principles may be categorized as follows:
1)  Self-interest threats:
These may occur as a result of the financial or other interests of a chartered accountant
or of an immediate or close family member.

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Audit and Assurance

 Self-review threats:
These may occur when a current assignment requires re-evaluation of the opinion
previously expressed by the same chartered accountant.
 Advocacy threats:
These may occur when a chartered accountant promotes a position or opinion to the
point that subsequent objectivity may be compromised.
 Familiarity threats:
These may occur when, because of a close relationship, a chartered accountant
becomes too sympathetic to the interests of others.
 Intimidation threats:
These may occur when a chartered accountant may be deterred from acting objectively
by threats, actual or perceived.
(b) Assisting financial statement audit client in matters such as preparing accounting records or
financial statements may create a self-review threat when the financial statements are
subsequently audited by the firm.

It is the client’s management responsibility to ensure that accounting records are kept and financial
statements are prepared.

In the above case, the firm can provide assistance provided it does not involve taking management
decisions. Such management decisions include:

 Determining or changing journal entries, or the classifications for accounts or transaction

or other accounting records without obtaining the approval of the audit client;

 Authorizing or approving transactions; and

 Preparing source documents or originating data (including decisions on valuation

assumptions), or making changes to such documents or data.

2 Levels of assurance
Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for
the auditor to conclude that there are no material misstatements in the financial statements taken as a
whole.
Whereas absolute assurance provides a guarantee that the financial statements are free from material
misstatements.
An audit carried out in accordance with ISAs is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement, whether due to fraud or
error. In an audit-engagement, the auditor provides a higher, but not absolute, level of assurance that
the information subject to audit is free of material misstatements.
An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that
affect the auditor’s ability to detect material misstatements. These limitations result from factors such
as:
(i) The use of testing;
(ii) The inherent limitations of any accounting and internal controls system (for example, the
possibility of collusion);
(iii) The fact that most audit evidence is persuasive rather than conclusive.

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 Answer bank: Objective test and long-form answers

Also, the work undertaken by the auditor to form an opinion is permeated by judgment, in particular
regarding:
(i) the gathering of audit evidence, for example, in deciding the nature, timing and extent of audit
procedures; and
(ii) the drawing of conclusions based on the audit evidence gathered, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
Further, other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (for example, transactions between related parties)

3 Shamsuddin
(i) The Code of Ethics for Chartered Accountants issued by ICAP states that:
“Chartered Accountants in practice should be careful not to quote fee lower than that charged by
the chartered accountants in practice previously carrying out the audit unless scope and quantum
of work materially differs from the scope and quantum of work carried out by the previous auditor.”
Keeping in view of the above, it is not advisable for Shamsuddin to accept the audit unless the
reduction in fee is on account of the reason discussed above.
(ii) As per the Code of Ethics for Chartered Accountants, issued by ICAP, the professional fees
should not be contingent upon the findings or results of such services.
Condition imposed by Design Limited impairs the objectivity of the auditor on account of self-
interest threat. Therefore, Shamsuddin should not accept such a proposal.

4 Core concepts
(a) The management’s responsibilities in relation to the financial statements include the following:
 The overall responsibility for the preparation and presentation of the financial statements.
 Identifying the financial reporting framework to be used in the preparation and presentation
of the financial statements.
 Designing, implementing and maintaining internal controls relevant to the preparation and
presentation of financial statements that are free from material misstatement whether due
to fraud or error.
 Selecting and applying appropriate accounting policies.
 Making accounting estimates that are reasonable in the circumstances.
(b) Audit Scepticism
Audit scepticism is an attitude of professional scepticism which means that the auditor should
recognize the fact that circumstances may exist that may cause the financial statements to be
materially misstated. Consequently, he should make a critical assessment with a questioning
mind of the validity of audit evidence obtained. He should remain alert to audit evidence that
contradicts or brings into question the reliability of documents and responses to inquiries and the
reliability of other information obtained from management and those charged with governance.
Elaboration on the response of the audit manager that auditor should always maintain an attitude
of professional scepticism throughout the audit:
Although the auditor cannot be expected to disregard past experience of the honesty and integrity
of the entity’s management and those charged with governance, the auditor’s attitude of
professional scepticism is particularly important in considering the risks of material misstatement
on account of changes in circumstances.

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Audit and Assurance

5 Threats
(a) Following are the categories of threats that may potentially affect the fundamental principles:
(i) Self-interest threats
This may occur as a result of the financial or other interests of a chartered accountant or of
an immediate or close family member.
 A financial interest in a client or jointly holding a financial interest with a client.
 Undue dependence on total fees from a client.
 Having a close business relationship with a client.
 Concern about the possibility of losing a client.
 Potential employment with a client.
 Contingent fees relating to an assurance engagement.
 A loan to or from an assurance client or any of its directors or officers.
(ii) Self-review threat
This may occur when a previous judgment needs to be re-evaluated by the chartered
accountant responsible for that judgment.
 The discovery of a significant error during a re-evaluation of the work of the chartered
accountant in practice.
 Reporting on the operation of financial systems after being involved in their design or
implementation.
 Having prepared the original data used to generate records that are the subject
matter of the engagement.
 A member of the assurance team being, or having recently been, a director or officer
of that client.
 A member of the assurance team being, or having recently been, employed by the
client in a position to exert direct and significant influence over the subject matter of
the engagement.
 Performing a service for a client that directly affects the subject matter of the
assurance engagement.
(iii) Advocacy threats
This may occur when a chartered accountant promotes a position or opinion to the point
that subsequent objectivity may be compromised.
 Promoting shares in a listed entity when that entity is a financial statement audit
client.
 Acting as an advocate on behalf of an assurance client in litigation or disputes with
third parties.
(iv) Familiarity threats
This may occur when, because of a close relationship, a chartered accountant becomes
too sympathetic to the interests of others.
 A member of the engagement team having a close or immediate family relationship
with a director or officer of the client

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 Answer bank: Objective test and long-form answers

 A member of the engagement team having a close or immediate family relationship

with an employee of the client who is in a position to exert direct and significant
influence over the subject matter of the engagement.
 A former partner of the firm being a director or officer of the client or an employee in
a position to exert direct and significant influence over the subject matter of the
engagement.
 Accepting gifts or preferential treatment from a client, unless the value is clearly
insignificant.
 Long association of senior personnel with the assurance client.
(v) Intimidation threats
This may occur when a chartered accountant may be deterred from action objectively by
threats, actual or perceived.
 Being threatened with dismissal or replacement in relation to a client engagement.
 Being threatened with litigation.
 Being pressured to reduce inappropriately the extent of work performed in order to
reduce fees.
(b) (i) Accepting of gift may create self-interest and familiarity threats.
If the value of the gift is not clearly insignificant, the threat to independence cannot be
reduced to an acceptable level by the application of any safeguard.
Consequentially in such situation, the members of the audit team should be instructed not
to accept the gift.
(ii) A self-interest threat is created when a member of the audit team participates in the audit
engagement while knowing that he / she may join the client sometime in the future.
On receiving such notification, the significance of threat shall be evaluated and following
safeguards could be applied:
 Removing the individual from the audit team; or
 A review of any significant judgments made by that individual while on the team.
(c) (i) Following are the threats in the mentioned situation:
 Suggesting the client about accounting treatment would create a self-review threat,
because that accounting treatment will also be the subject matter of the assurance
engagement.
 Even though Amjad’s friend has attended the workshop on IFRS-15, it does not
necessarily mean that he is competent enough to advise the client regarding the
accounting treatment under IFRS-15, as it could involve significant judgment. It would
create a threat to professional competence and due care.
 Sharing of information with his friend may create threat to confidentiality.
(ii) Following actions could be taken by the firm to avoid such a situation in future:
 Regularly conduct professional development of its staff for any recent changes or
updates in professional pronouncement.
 Circulate documented internal policies and procedures requiring compliance with the
fundamental principles.
 Implement an effective disciplinary mechanism to promote compliance with policies
and procedure.

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Audit and Assurance

6 Burewala and Kamal

(a) Burewala Bank Limited:

Threats

(i) A threat to independence may be created if the loan is made under abnormal lending
procedures, terms and requirements and the loan is material to both the firm and the BBL.

(ii) A self-interest threat may be created if the loan amount is material to the firm/ partner.

Safeguards:

As the Companies Act, 2017, restricts a person who is indebted to the company from being auditor
of the said company, therefore the course of action available to the partners of UCC is to withdraw
from the engagement or repayment of the loan by the partner concerned.

(b) Faisalabad Textile Mills Limited:

Threats:

It has created self-interest, familiarity and intimidation threats.

The assurance team’s independence is threatened, on account of the fact that Kamal is in a
position to exert direct and significant influence over the assurance engagement as Kamal was a
member of the assurance team during the previous year audit.

Safeguards:

The safeguards might include:

(i) Consider the appropriateness or necessity of modifying the assurance plan for the assurance
engagement;

(ii) Assigning an assurance team that is of sufficient experience in relation to the individual who
has joined the assurance client;

(iii) Involve an additional chartered accountant who was not a member of the assurance team to
review the work or advise as necessary; or
(iv) Quality control review of the assurance engagement.
(v) Ensuring that the individual concerned is not entitled to any benefits or payments from the
firm unless these are made in accordance with fixed pre-determined arrangements. In
addition, any amount owed to the individual should not be of such significance to threaten
the firm’s independence.
(vi) Ensuring that the individual does not continue to participate or appear to participate in the
firm’s business or professional activities.

7 Zaman and Bilal

(a) As per the Companies Act, 2017 a person shall not be appointed as auditor of a company, if he
is disqualified for appointment of any other company, which is that company’s subsidiary or a
holding company or a subsidiary of that holding company.

Therefore, the firm cannot be appointed as an auditor of KL as Mr Zaman holds 5,000 shares in
ML which together with KL is a subsidiary of DKL.

For appointment as the auditor of the company, Mr .Zaman is required to dispose of the shares
in ML.

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 Answer bank: Objective test and long-form answers

(b) Bilal and Company, Chartered Accountants are eligible to act as the auditor of IJK Limited.

IJK Limited is not an associated company of LMN Limited as LMN Limited holds 15.4% shares of
IJK Limited. Therefore the wife of the partner is not required to dispose of the shares in LMN
Limited.

Holding of non-voting shares is not relevant in determining the status of the company.

8 Audit process
(a) Training materials: purpose of external audit and its role
(i) The external audit has a long history that derives largely from the separation of the
ownership and management of assets. Those who own assets wish to ensure that those to
whom they have entrusted control are using those assets wisely. This is known as the
'stewardship' function.
(ii) The requirement for an independent audit helps to ensure that financial statements are free
of bias and manipulation for the benefit of users of financial information.
(iii) Companies are owned by shareholders but they are managed by directors (in very small
companies, owners and managers are the same, but many such companies are not subject
to statutory audit requirements).
(iv) The requirement for a statutory audit is a public interest issue: the public is invited to invest
in enterprises, it is in the interests of the capital markets (and society as a whole) that those
investing do so in the knowledge that they will be provided with 'true and fair' information
about the enterprise, This should result in the efficient allocation of capital as investors are
able to make rational decisions on the basis of transparent financial information.
(v) The requirement for an audit can help prevent investors from being defrauded, although
there is no guarantee of this because the external audit has inherent limitations. Reducing
the possibility of false information being provided by managers to owners is achieved by the
requirement for external auditors to be independent of the managers upon whose financial
statements they are reporting.
(vi) The purpose of the external audit under International Standards on Auditing is for the auditor
to obtain sufficient appropriate audit evidence on which to base the audit opinion.
This opinion is to the effect that the financial statements give a 'true and fair view' (or 'present
fairly in all material respects') of the position, performance (and cash flows) of the entity.
This opinion is prepared for the benefit of shareholders.
(b) Main audit procedures and processes: interim and final audit
Interim
(i) The interim audit generally involves risk assessment, the testing of internal controls, and
certain analytical and other substantive procedures. Many of these procedures are often
performed concurrently.
(ii) Risk assessment involves gathering information about the business, inquiries, analytical
procedures and determining the response to assessed risk. In practice it also involves the
determination of materiality and tolerable error.
(iii) Risk assessment also involves evaluating the design of internal controls and determining
whether they have been implemented.
Final
(iv) Final audit procedures involve further tests of controls, substantive procedures and audit
finalisation procedures.
(v) Further tests of controls are designed to test transactions occurring between the date of the
interim audit and the period-end. This is to ascertain whether the conclusions from controls
testing during interim work remain valid for the full period.

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Audit and Assurance

(vi) Substantive procedures may involve a blend of substantive analytical procedures plus tests
of detail. The tests of detail typically involve selecting a sample from a source, for example
a collection of purchase transactions, and tracing the transactions through to originating
evidence, for example purchase invoices. Tests of detail are also carried out in the opposite
direction by selecting from the external source (e.g. supplier invoices) then tracing entries
through to the books and records
(vii) Audit finalisation procedures involve a review of the financial statements as a whole to
ensure that they are internally consistent and presented in accordance with the relevant
financial reporting framework (and the auditor's knowledge of the business). This phase
includes the Partner’s review of significant matters raised by the audit team during the audit.
(c) Key benefits that may arise from splitting the work between interim and final audit are as follows:
 More flexible resource planning within the firm (the timing of interim audit is typically more
flexible than the timing of final audit. This helps to reduce demand for audit staff during ‘busy
season’)
 Earlier identification of significant matters
 Shareholders and other users receive audited accounts earlier / earlier completion of the
audit
 Increased audit efficiency

9 Regulatory and professional requirements

(a) Current regulatory and professional requirements
(i) Auditing standards
Both national and international bodies produce Auditing Standards. International Standards
on Auditing (ISAs) are produced by the International Audit and Assurance Standards Board
(IAASB), a committee of the International Federation of Accountants (IFAC). IFAC is an
international organisation of professional accountancy bodies, including ICAP.
National standard-setters are expected to aim for compatibility with ISAs as far as possible
and some (for example the UK) issue their own version of ISAs. National accountancy bodies
will then adopt all of the auditing standards produced by their own standard setting body.
Failure by auditors to comply with auditing standards will then lend them open to disciplinary
action by their own accountancy body.
Local legislation will usually require recognised supervisory bodies to have rules and
practices as to the manner in which these standards are to be applied in practice. Each
supervisory body will adopt auditing standards in order to meet local legislation and each
body will be required to have arrangements in place for the effective monitoring and
enforcement of compliance with those standards. Failure to apply relevant auditing
standards is a factor which a supervisory body will take into account when deciding whether
persons are fit and proper to be eligible for appointment as company auditor.
(ii) Fraud
Currently the responsibility within a company for the prevention and detection of fraud rests
with management. The auditor is not responsible for preventing fraud but audit procedures
should be designed to give the auditor a reasonable expectation of detecting any material
misstatements, whether intentional or unintentional, in a company’s financial statements.
(iii) Non-audit services
There is no objection in principle to a practice providing non-audit services but care must be
taken not to perform management functions or make management decisions. The key factor
is that there is no conflict of interest between audit and the other services provided.
Accountancy work, however, should not be performed for a public company except in
emergency situations. The scale and nature of such work should be regularly reviewed.

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 Answer bank: Objective test and long-form answers

In all cases in which a practice is concerned in the preparation of accounting records for an
audit client, the following safeguards should be observed:
 the client should accept responsibility for the records as its own;
 the practice should not assume the role of management conducting the operations
of an enterprise;
 the practice should make appropriate audit tests even where it has processed or
maintained certain records.
Other types of non-audit work such as valuation services and internal audit services are
prohibited where the management threat or self-review threats are too great.
Local legisalation will also usually provide that an auditor may not be an officer or employee
of a client company. Thus it is necessary for the auditor to ensure that he does not make
executive decisions.
(iv) Duration of appointment
Local legislation (i.e. Companies Act, 2017) provides that a company shall at each general
meeting appoint an auditor to hold office from the conclusion of that meeting until the
conclusion of the next general meeting at which accounts are laid. Although the ICAP Code
does not specifically deal with the length of audit appointments it recognises that using the
same senior personal on an engagement over a long period of time may create a familiarity
threat. Safeguards might include rotating senior staff or review by an independent party. For
listed companies in Pakistan this period have been prescribed as 5 years by the Code of
Corporate Governance 2012.
(b) Reasons for criticism in the above areas
(i) Auditing standards
ISAs are set by the IAASB whose members are mainly drawn from the members of the
auditing profession. The local disciplinary procedures applied against an auditor for non-
compliance with an auditing standard are enforced by the professional bodies of
accountants. Thus politicians have criticised this self-regulatory procedure believing it to be
open to abuse and lacking independence. The argument put forward is that auditing
standards should be set by an independent body.
(ii) Fraud
It is quite apparent from the press and audit research that the public believe that the auditor
should and in fact does search for fraud during the conduct of an audit. In view of the
scandals over the years, the public expectation of the extent of an audit has increased. The
public finds it difficult to accept that an auditor has no responsibility for the detection and
reporting of fraud, especially when one sees the high social cost of recent scandals.
(iii) Non-audit services
Audit firms do not act exclusively in the capacity of auditors for their clients. Audit work is in
some cases, not the main business of audit firms. Auditors provide many other services to
their clients including tax advice, brand name valuation and recruitment advice. Audit firms
are dependent upon the fees earned from non-audit services, and this dependency can
affect the auditors’ attitude to the audit. If an audit firm loses the audit, the financial loss to
the auditors can be significantly more than just the audit fee if he provides other services to
the client.
(iv) Duration of appointment
It has been argued that the long-term nature of the company audit engagement can lead to
a loss in auditor independence due to an increasing familiarity with the company’s
management. In many countries the audit appointment has to be terminated after a fixed
number of years. If the audit appointment was for a fixed maximum period, then auditors
would not be under the same pressure to maintain their client base if they know that their
relationship with the company was for a limited period, and that audit appointments would
be rotated.

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Audit and Assurance

10 Fundamental principles
Integrity
A professional accountant should be honest and straightforward in performing professional services.
Objectivity
A professional accountant should be fair and not allow personal bias, conflict of interest or influence of
others to override objectivity.
Professional competence and due care
When performing professional services, a professional accountant should show competence and duty of
care by keeping up-to-date with developments in practice, legislation and techniques.
Confidentiality
A professional accountant should respect the confidentiality of information acquired during the course of
providing professional services and should not use or disclose such information without obtaining client
permission.
Professional behavior
A professional accountant should act in a manner consistent with the good reputation of the profession
and refrain from any conduct which might bring discredit to the profession.

11 Confidential information
The following are circumstances where chartered accountants are or might be required to disclose
confidential information or when such disclosure might be appropriate:

(a) Disclosure is required by law, for example:

i. Production of documents or other provision of evidence in the course of legal proceedings; or
ii. Disclosure to the appropriate public authorities of infringements of the law that come to light;
(b) Disclosure is permitted by law and is authorized by the client or the employing organization; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
i. To comply with the quality review of a professional body;
ii. To respond to an inquiry or investigation by a professional or regulatory body;
iii. To protect the professional interests of a chartered accountant in legal proceedings; or

To comply with technical and professional standards, including ethics requirements.

12 Independence of external auditors

External auditor independence
(i) External auditors are unable to fulfil their duties to shareholders if they are not independent of the
entity on which they are reporting.
(ii) If external auditors have an interest in the financial statements on which they are reporting, they
may not be objective. For example, if, in the case of a listed company, they have prepared the
financial statements on which they are reporting, their view may not be considered objective.
(iii) If they have financial or employment connections with the company on which they are reporting
they will not be objective.
(iv) If they provide a significant level of additional services to the entity, some argue that they cannot
report objectively as auditors to shareholders.

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13 Tahira and Parvez

Sufficient audit evidence and audit reports
(i) The main problem for the auditors will be gaining sufficient evidence to determine whether any
amounts should be provided for and/or disclosed in the financial statements of the two companies.
(ii) The lawyers refuse to provide anything other than informal evidence and this will almost certainly
not be sufficient to form an audit opinion.
(iii) Unless audit evidence can be obtained elsewhere – a qualified opinion may be needed for both
companies as the amounts involved are material.
(iv) It may be possible for the auditors to suggest to the companies that it would be very helpful for the
lawyers to provide some indication as to their view of the likely outcome and the amounts involved,
in order to avoid a modified opinion.
(v) The auditors should also take note of the progress of any legal proceedings and any proceedings
that may be instigated by the public health authorities as such authorities might impose significant
fines, and they might even close the businesses down, which has implications for the going concern
status of both.
(vi) The auditors may also seek written representation under ISA 580 from the management about the
likely outcome of the case to be obtained.

14 ABC Limited
(a) Salman and Company is eligible to be appointed as the auditor of ABC Limited because, Naveen
is in the employment of DEF which is an associated company and such employment has no
relevance in the context of appointment of an auditor.
(b) Kashif Associates can be appointed as the auditor of NPL as for a private company having paid up
capital of less than Rs. 3 million the auditor can be a chartered accountant or cost and
management accountant.
Holding of 30% shares of NPL by a public company is of no relevance.

15 Masoom, Chalak and Hoshiyar Limited

(a) The previous provision of accounting and taxation services to MPL and long association of Ahmed
with MPL will create self-review and familiarity threat.
Significance of threats needs to be evaluated and if threats are other then clearly insignificant,
safeguards need to be applied to reduce the threats to an acceptable level.
In case Ahmed is included in the Audit engagement the related safeguards may include:
 involving an additional chartered accountant to review the work done by Ahmed
or otherwise advise as necessary.
 independent internal quality reviews.
If the threats are significant, Ahmed should not be part of the assurance engagement team.
(b) In the given situation involvement of such trainees in the audit of CL may result in a self-interest
threat.
The materiality and significance of the financial interest, needs to be evaluated. If the financial
interest is immaterial then the audit trainee may be allowed to work on that client, otherwise only
safeguard available is to withdraw the trainee from this assignment.
(c) A self-interest threat is created when a member of the assurance team participates in the
assurance engagement while knowing, or having reason to believe, that he may join the assurance
client in future.

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Audit and Assurance

The threat created can be reduced to an acceptable level by the application of the following
safeguards:
 Ask the individual to notify the firm when entering serious employment negotiations with the
assurance client;
 Remove the individual from the assurance engagement;
 Perform an independent review of any significant judgments made by that individual while
on engagement.

16 Prime Super Markets Limited

(a) Accepting of discount vouchers may create self interest and intimidation threats.
However, if the value of discount vouchers is not clearly insignificant, the threat to independence
cannot be reduced to an acceptable level by the application of any safeguard.
If the value is other than clearly insignificant, the members of the audit team should be instructed
not to accept the discount vouchers.
(b) The lending of staff by a firm to an audit client will create a self-review threat. However, the threat
may be reduced to an acceptable level if the firm's personnel:
 are not involved in exercising discretionary authority; or
 do not assume management responsibilities.
 are not given audit responsibility for any function or activity that they performed or
supervised.
The audit client should acknowledge its responsibility for directing and supervising the activities of
assigned personnel.
(c) Familiarity and self-interest threats are created by using the same senior personnel on an audit
engagement over a long period of time. This applies to the audit manager also.
The significance of the threats shall be evaluated and following safeguards should be applied if
necessary to eliminate the threats or reduce them to an acceptable level:
 Rotating the audit manager as well;
 Having a professional accountant who was not a member of the audit team review the work
of the audit manager;
 Regular independent internal or external quality reviews of the engagement.

17 Professional Ethics
(a) The association of Anwar with Curtains Limited will create self-review and familiarity threat. If the
threats are significant, Anwar should not be part of the assurance engagement team.
In case Anwar is included in the Audit engagement the related safeguards may include:
 Involving an additional chartered accountant to review the work done by Anwar or otherwise
advise as necessary.
 Independent internal quality reviews.
(b) In the given situation, the acceptance of audit engagement will result in a business relationship
with an audit client which may pose a familiarity threat to objectivity.
However, the significance of the threat in such situation depends upon the following:
 Whether it is in the ordinary course of business;
 Whether the tenancy agreement is on an arm’s length basis; and
 The materiality of the contract for either of the party.

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From the situation given, it can be determined that this business relationship is in the ordinary
course of business on an arm’s length basis and not material to either of the parties, hence, the
engagement can be accepted.
(c) Income tax return contains information which is directly related to a significant figure in the financial
statements. Therefore, the acceptance of review of income tax return would create a self-review
threat.
In case the engagement is accepted the related safeguards may include the following:
 The review may be performed by professionals who are not members of the audit team;
 If the service is performed by a member of the audit team, a partner or senior staff member
with appropriate expertise and is not a member of the audit team, review the tax calculations;
or
 The firm does not get involved in management decision making and clarifies this fact in the
communication with the client.

18 Threats and Safeguards

(a) Assisting financial statement audit client in matters such as preparing accounting records or
financial statements may create a self-review threat when the financial statements are
subsequently audited by the firm.
The related safeguards are as follows:
 Arrange for such services to be performed by an individual who is not a member of the audit
team.
 If such services are performed by a member of the audit team, use a partner or senior staff
member with appropriate expertise who is not a member of the audit team, to review the work
performed by such person, during the audit.
(b) (i) As Asif is associated with the client since last three years it will create a familiarity threat, an
appropriate safeguard would be to exclude Asif from the engagement team.
(ii) Independence of Rashid can be threatened as Rashid is a close family member of marketing
director. Although marketing director is not directly related to the preparation of financial
statements, however, he could be tempted by management for not identifying errors due to
influence of his father. In order to provide safeguard against the threat the firm should not
include Rashid in the audit team.
(iii) Independence of audit firm can be compromised if extra ordinary benefits are obtained for
conducting internal functions at restaurants of TTL. As a precaution, the firm should avoid
using the restaurants of TTL.

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Audit and Assurance

PLANNING AND RISK ASSESSMENT

19 Durable Cement Limited (DCL)
Assessment of
S. No. Assertion Justification
inherent risk
(a) Valuation of High Due to poor economic conditions, there is a risk that
factory plant the value of plant may be impaired.
 Inherent risk is also high due to the complexity
and subjectivity involved in calculation of
impairment loss.
(b) Valuation of Low/Moderate The valuation assertion for trade receivable and
trade allowance for doubtful debts is affected by
receivables judgments. However as the debts from Government
departments are usually secured, the chances of
bad debts are low.
(c) Rights to Low/Moderate Cement bags are usually kept in company’s’
ownership of premises (Godowns) and in the absence of any
finished goods other information the ownership of inventory can be
inventory verified.
(d) Valuation of High Determination of fair value is complex, and involves
unlisted subjectivity and judgment in the absence of any
securities market quotations.
(e) Accuracy of Low Third party confirmation i.e., bank confirmation is
long term available therefore inherent risk is low.
finance
(f) Valuation of High Due to complexity and subjectivity involved in the
provision for calculation of provision for gratuity.
gratuity

20 Saad Co
(a) Ethical threat (b) Mitigation of threat
Mr Sher, the engagement partner has Mr Sher should be rotated from being
been involved with the client for the last engagement partner. He can still contact
nine years. the client but should not be in the position of
This means he may be too familiar with the signing the audit report.
client to be able to make objective
decisions due to this long association.
There is no ethical rule which stops Mr To show complete independence, Zhura
Sher recommending Zhura for the audit, or should not be part of the audit team.
letting Zhura take part in the audit, However, if Mr Sher is no longer the
providing Zhura has the appropriate skills. engagement partner then this removes the
If she does not have the appropriate skills ethical threat and Zhura could be included
then there could be a breach of the need in the audit team so long as she possesses
for an audit team to demonstrate the appropriate skills.
professional competence and due care.
There may also be the impression of lack
of independence as Zhura is related to the
engagement partner. Zhura could be
tempted not to identify errors in case this
prejudiced her father’s relationship with the
client.

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(a) Ethical threat (b) Mitigation of threat

As long as Mr Faisal paid a full fee on To show independence from the client, Mr
normal commercial terms to Saad Co for Faisal could be asked not to use the
the investment advice, then there is no services of Saad Co again unless this is first
ethical threat. This would be a normal agreed with the engagement partner.
commercial transaction and Mr Faisal
would not gain any benefit.
However, continued use of client services
could imply a lack of independence
especially if Mr Faisal is not paying a full
fee and therefore receiving a benefit from
the client.

21 Alpha
(i) The firm is not qualified for appointment as auditor of Safe Bank because it is indebted to the
bank.
The firm may accept appointment by terminating the lease agreement and ensuring that the
credit card balance remains within the limit of Rs 1 million.
(ii) The firm is not qualified for appointment as auditor of PCL as one of the firm’s partners had been
a director of PCL during the past three years.
There is no way for the firm to accept the appointment except that the partner resigns from the
firm.
(iii) The firm is not qualified for appointment as auditor of Gama Limited, as a partner of the firm
holds shares in Beta Limited, the associated company of GL.
Firm can accept appointment if the fact of holding shares is disclosed at the time of appointment
and the share are disposed within ninety days of appointment.

22 Engagement letter and documentation

(a) The form and content of audit engagement letters may vary from client to client, but they would
generally include reference to:
 The objective of the audit of financial statements.
 Management’s responsibility for the financial statements.
 The financial reporting framework applicable to financial statements.
 The scope of the audit, including reference to applicable legislation, regulations, or
pronouncements of professional bodies to which the auditor adheres.
 The form of any reports or other communication.
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitation of internal control, there is an unavoidable risk that even
material misstatements may remain undiscovered.
 Management’s responsibility to provide unrestricted access to whatever records,
documentation and other information that may be required in connection with the audit.
 Management’s responsibility for establishing and maintaining effective internal controls.

(b) i) Significant Matters to be documented

 Matters that give rise to significant risk;
 Results of audit procedures indicating (a) that the financial information could be
materially misstated, or (b) a need to revise the auditor’s previous assessment of
the risks of material misstatements and the auditor’s responses to those risks;

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Audit and Assurance

 Circumstance that cause the auditor significant difficulty in applying necessary audit
procedures;
 Findings that could result in a modification to the auditor’s report.
ii) Completion of assembly of final audit report
The auditor is required to complete the assembly of his final audit file within 60 days of the
date of the audit report.

23 Shahid Corporation
(a) Acceptance and continuance of client relationships and specific audit engagements include
considering:

 The integrity of the principal owners, key management and those charged with
governance of the entity;

 Whether the engagement team is competent to perform the audit engagement and has
the necessary time and resources; and

 Whether the firm and the engagement team can comply with ethical requirements

Deciding whether to continue a client relationship includes consideration of significant matters

that have arisen during the current or previous audit engagement, and their implications for
continuing the relationship.

For example, a client may have started to expand its business operation into an area where the
firm does not possess the necessary knowledge or expertise.

(b) The auditor may decide not to send a new engagement letter for each period. However, under
the following situation it may be appropriate to send a new engagement letter:

 Any indication that the client misunderstands the objective and scope of the audit

 Any revised or special terms of the engagement

 A recent change of senior management or those charged with governance.

 A significant change in nature or size of the client’s business

 A significant change in ownership

 Legal or regulatory requirements.

24 Assertions
(a) (i)  Risks of material misstatement at the financial statement level refer to risks that relate
pervasively to the financial statements as a whole and potentially affect a number of
assertions.
 They are not necessarily identifiable with specific assertions at the class of
transactions, account balance, or disclosure level. Rather, they represent
circumstances that may increase the risks of material misstatement at the assertion
level. For example, through management override of internal control.
 Financial statement level risks mostly relate to situations arising from fraud.
 Risks at the financial statement level may derive in particular from a weak control
environment. For example, weaknesses such as management’s lack of competence.

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(ii) The risk assessment procedures related to the risk of material misstatement at the financial
statement/assertion level are as follows:
 Inquiries of management and of others within the entity who in the auditor’s judgment
may have information that is likely to assist in identifying risks of material
misstatement due to fraud or error.
 Analytical procedures.
 Observation and inspection.
(b) The auditors assessment of materiality and audit risk at the planning stage may change later i.e.
at the time of evaluating the results of audit procedures, on account of the following:
 change in circumstances
 change in auditors knowledge as a result of performing audit procedures
 because the auditor may have intentionally set the materiality at a lower level, to reduce the
likelihood of undiscovered misstatement and hence provide a margin of safety.
(c) Assertions about classes of transactions and events and related disclosures are as follows:
 Occurrence: Transactions and events that have been recorded or disclosed have
occurred and relate to the entity.
 Completeness: There are no unrecorded transactions, events and disclosures.
 Accuracy: Amounts and other data relating to recorded transactions and events have
been recorded appropriately and related disclosures have been appropriately measured
and described.
 Cut-off: Transactions and events have been recorded in the correct accounting period.
 Classification: Transactions and events have been recorded in the proper accounts.
 Presentation: Transactions and events are appropriately aggregated or disaggregated
and clearly described and related disclosures are relevant and understandable.
Assertions about account balances and related disclosures are as follows:
 Existence: Assets, liabilities and equity interests exist.
 Rights and obligations: The entity holds or controls the rights to assets, and liabilities
are those of the entity.
 Completeness: There are no unrecorded assets, liabilities or equity interests and all
related disclosures have been included.
 Accuracy, valuation and allocation: Assets, liabilities and equity interests are included
in the financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded and related disclosures have been appropriately
measured and described.
 Classification: Assets, liabilities and equity interests are appropriately aggregated or
disaggregated and clearly described, and related disclosures are relevant and
understandable

25 Companies Act, 2017

(a) The appointment of Farrukh & Co. will be in order because the firm would not be considered
indebted to the company as the period for which the utility dues are unpaid does not exceed 90
days.
(b) Mr Shahid cannot be appointed as statutory auditor of Rehman Limited because only 70 days
have passed since the company’s incorporation and therefore obviously less than three years
have not elapsed since he left the employment of the company.

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Audit and Assurance

(c) Syed & Co. shall not be appointed as auditor of the company because one of the partners’
spouse holds shares in its subsidiary company. However, the firm can be appointed as auditor
of Fazal Limited if the fact of holding shares is disclosed at the time of appointment and the
spouse of the partner disinvests the shares within 90 days of appointment.
(d) Mr Dawood’s appointment shall be void because only a chartered accountant can be appointed
as auditor of a private limited company having share capital of Rs. 3 million or more.
(e) Hussain Associates (Pvt.) Ltd. being a body corporate cannot be appointed as external auditor
of any company.
(f) According to Companies Act, 2017, there is no bar on Bilal and Company to be appointed as the
auditor of DL as holding of TFC’s in the audit client is not prohibited under the provisions of the
Companies Act, 2017
(g) Zain and Company is ineligible for appointment as the auditor of HL as Imran is a partner in Pure
Investment Associates, which holds share in HL which is prohibited under the Companies Act,
2017. In order to be eligible for appointment, the fact of holding of shares is required to be
disclosed at the time of appointment. Further, the shares are to be disposed-off within 90 days
of such appointment.

26 ASPL
(a) (i) In the absence of any valid explanations from the management, it would be considered as
misappropriation of assets i.e. fraud as it seems to involve the theft of an entity's assets.
(ii) It is a case of fraudulent financial reporting as it seems that management has tried to inflate
the sales in order to deceive financial statement users. An apparent intention behind this
action is the management bonuses which are linked to the operating performance of the
company.
(iii) It is an error on the part of accountant. The underlying records such as the invoice etc. have
not been altered and even the voucher has been prepared with the correct amount which
shows that it is an unintentional misstatement.
(b) (i) If we have identified a fraud or has obtained information that indicate that a fraud may exist,
we should communicate these matters on a timely basis to the appropriate level of
management. This is so even if the matter might be considered immaterial.
We should consider whether there are matters related to fraud to be discussed with those
charged with governance of the entity. Matters may include:
 Concerns about the nature, extent and frequency of management's assessments of
the controls in place to prevent and detect fraud and of the risk that the financial
statements may be misstated.
 A failure by management to appropriately address identified significant deficiencies in
internal control, or to appropriately respond to an identified fraud.
 Our evaluation of ASPL’s control environment, including questions regarding the
competence and integrity of management.
 Actions by management that may be indicative of fraudulent financial reporting, such
as management's effort to manage earnings in order to deceive financial statement
users by influencing their perceptions as to the entity's performance and profitability.
 Concerns about the adequacy and completeness of the authorization of transactions
that appear to be outside the normal course of business
Based on the discussion and our overall understanding of the matter, we should:
 ask the management to reverse the sales made;

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 Answer bank: Objective test and long-form answers

 revise its risk assessment of the entity’s control environment and modify the further
planned audit procedures accordingly.
 Consider the impact on audit report.
(iii) Since this seems to be an error, the appropriate level of management should be informed
about it and the relevant adjustments in fixed assets and depreciation account should be
made.

27 Distributor
(a) i. Inability to increase the prices of its products since last 5 years
The Company’s profitability is under threat due to increased competition therefore the
management may be inclined to manipulate the accounting records.
ii. Research costs wrongly capitalized
It is an error and is not indicative of fraud, as research costs is only 2% of the total amount
capitalized and the underlying records were duly supported by invoices from the suppliers.
iii. Bonuses linked with profitability
It is a fraud risk factor as it is evident that management is receiving profit related bonuses,
therefore the management may be inclined to manipulate the accounting records.
iv. Goods sold but not dispatched
It is a fraud risk factor as it seems that management has tried to inflate the sales in order to
deceive financial statement users, an apparent intention behind this action can be to overstate
the profits of the company.
(b) Course of action:
In response to assessed risk of material misstatement due to fraud, the auditor shall:
 emphasize to the Audit team the need to maintain an attitude of professional skepticism.
 assign more experienced staff or increased supervisor of staff.
 To the extent not already done, the auditor shall obtain an understanding of the entity’s related
controls, relevant to such risks.
 evaluate whether the selection and application of accounting policies by the entity, particularly
those related to subjective measurements and complex transactions, may be indicative of
fraudulent financial reporting resulting from management’s effort to manage earnings; and
 incorporate an element of unpredictability in the selection of the nature, timing and extent of
audit procedures.
 design and perform further audit procedures whose nature, timing and extent of audit
procedures are responsive to the assessed risk of material misstatements.

28 Fraudulent Financial Statements

(a) a(i) Forging or altering accounting records or supporting documentation which form the basis of
the financial statements
(ii) Misrepresenting or intentionally omitting events or transactions from the financial statements
(iii) Intentionally misapplying accounting principles
(iv) Concealing or not disclosing, facts that could affect the amounts recorded in the financial
statements.

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(v) Engaging in the complex transactions that are structured to misrepresent the financial position
or financial performance of the entity.
(vi) Embezzling receipts (for example, diverting them to personal bank accounts)
(b) The auditor is required to perform the following procedures to identify the risks of material
misstatement due to fraud:
 Make inquiries of management in respect of:
 their assessment of the risk of material fraud
 their process in place for identifying and responding to the risks of fraud
 any specific risks of fraud identified or likely to exist
 any communications within the entity in respect of fraud (including to employees
regarding management’s views on business practices and ethical behaviour)
 Make inquiries of management and others within the entity as to whether they have any
knowledge of any actual, suspected or alleged frauds and to obtain views about the risks of
fraud.
 Evaluate any unusual or unexpected relationships identified in performing analytical
procedures which might indicate a risk of material fraud.
 Evaluate information obtained from other risk assessment procedures to see if any fraud risk
factors exist.

29 Kashif and Company

(a) aThe appointment of KCC is valid, as 90 days have not lapsed in case of outstanding bill. However,
the concerned partner should be requested to settle the amount of bill before the expiry of 90 days
as it will result in disqualification of KCC as auditors of NEL.
(b) Appointment of Zubair and Company is valid.
Under the Companies Act, 2017 there is no restriction on the appointment of spouse of chief
executive of an associated company as the auditor.
The holding of 100,000 shares by Saima is required to be disclosed at the time of appointment.
Further, these shares should be disposed of within 90 days of the appointment.

30 Delicious Biscuits Limited (DBL)

(a) aFamiliarity or intimidation threats may be created if a member of audit team joins the audit client.
Following are the safeguards:
i. Modifying the audit plan;
ii. Assigning individuals to the audit team who have sufficient experience as compared to the
individual who has joined the client;
(b) aA loan from an audit client to an audit team member will not create a threat to independence, if the
loan is made under normal lending procedures, terms and conditions.
If the loan is not made under normal lending procedures, terms and conditions, a self- interest threat
would be created that would be so significant that no safeguard could reduce the threat to an
acceptable level. However, as the loan has already been disbursed, the only safeguard available is
to remove the manager from the audit team or ask him to settle the lease obligation.

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31 Daud and Company

(a) JL holds 51% shareholding in RL:
As Daud & Co. (DC) is not qualified for appointment as the auditor of RL due to directorship and
shareholding of partner’s wife in RL, DC cannot be appointed as the auditor of any of its holding
company i.e. JL.
(b) JL is an associated company of RL:
DL is ineligible to act as the auditor of JL, as the spouse of the partner holds shares in the
associated company. However, since Daud’s wife holds shares prior to the appointment, DC can
be appointed as auditor of JL subject to comply with the following requirements:
 Disclose this fact to JL at the time of appointment as auditor.

 Divest her investment in RL within 90 days of appointment.

The directorship of Daud’s wife in RL is not relevant for the appointment of DC as the auditor of
JL.
(c) One of the directors in JL also holds 10% shareholding in RL:
Daud and Company can be appointed as the auditor of JL as there is no disqualification with
respect to common shareholding in another company, which is neither a subsidiary nor an
associated company of the prospective audit client.

32 ABC (Private) Limited

(a) Self-interest, self-review and familiarity threats will be created, as Kamran has served as an
employee in ABC.
Safeguards:
 Conducting a review of the work performed by Kamran as a member of the audit team,

 Not including the member in the audit team.

(b) As the father of Nasir is a close family member, having a direct financial interest in DL, a self-
interest threat is created.
Safeguards:
 Disposing as soon as practicable, of all the shares by Nasir’s father (a close family member)

 Having a professional accountant review the work of Nasir;

 Replacement of Nasir from the Audit team.

33 Materiality
(i) (a) i. Planning stage – The concept of materiality is used in determining the nature, timing
and extent of further audit procedures;
ii. Reporting stage – The materiality concept is used in evaluating the effect of
uncorrected misstatements, if any, on the financial statements and in forming the
opinion in the auditor's report.
(b) The auditor shall document the following aspects of materiality:
i. Materiality for the financial statements as a whole;
ii. Performance materiality;

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iii. Basis of computing materiality; and

iv. Any revision of (i) to (ii) as the audit progresses.
(ii) The following can be the benchmark for determining materiality:
 Gross profit
 Total expenses / Total Revenue
 Total equity
 Total assets / Total Liabilities

34 Auditor’s Expert
(i) (a) ) (i) the nature, scope and objectives of the expert’s work
(ii) the respective responsibilities of the expert and the auditor
(iii) the form of the expert’s report
(iv) confidentiality requirements
(b) ) The factors that should be considered in evaluating the adequacy of the expert’s work,
include:
 reasonableness of the expert’s conclusions
 consistency of those conclusions with other audit evidence
 reasonableness of significant assumptions and methods used
 relevance, completeness and accuracy of source data.
(ii) Following are the situations which may require the engagement of an auditor’s expert:
 legal opinions
 specialist valuation areas, such as property or pension liabilities
 analysis of complex or unusual taxation issues
 specialized inventory counts

35 Mineral Limited
(a) (i) Matters that should be considered by the auditor in determining the competence, capabilities
and objectivity of EL
The competence, capabilities and objectivity of an expert may be assessed in one or more of
the following ways:
 Personal experience with previous work of that expert.
 Discussions with that expert.
 Discussions with other auditors or others who are familiar with that expert’s work.
 Knowledge of that expert’s qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition.
 Published papers or books written by that expert.
(ii) While evaluating the adequacy of the EL’s work, the following would be considered:
 Reasonableness of the EL’s conclusions.
 Consistency of such conclusions with other audit evidence.
 Reasonableness of significant assumptions and methods used.
 Relevance, completeness and accuracy of source data.

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(b) If the auditor decides that the work of the expert is not adequate he is required to:
 agree additional work with the expert, or
 perform other appropriate additional audit procedures.
 hire another expert

36 AMF
(a) Areas of Inherent Risk
(i) Donations
 Donations may fall, especially where donors’ own income is limited or declining, or there
is a change in the circumstances.
 No control over the completeness of donations (especially over the cash donations).
(ii) Expenses
 Donations are spent outside the aims and objectives of AMF.
 Donations are not spent in accordance with donors’ instructions.
(b) Effect on the audit approach
(i) It is difficult to estimate that income in the future will be sufficient to meet the expenditure of
the AMF. Audit of the going concern concept (as in ensuring that the AMF can still operate)
will therefore be quite difficult.
(ii) Audit tests are unlikely to be effective to meet the assertion of completeness. The audit report
may need to be modified and qualified to explain the lack of evidence stating that
completeness of income cannot be confirmed.
(iii) Careful review of expenditure will be necessary to ensure that expenditure is not ‘ultra vires’
the objectives of the AMF. The auditor will need to review the trust deed and other documents
of the AMF carefully in this respect.
(iv) The use of donations received for specific purposes would have to be checked to ensure that
instruction of donors has been followed.

37 Acceptance and planning

(a) The audit strategy sets the scope, timing and direction of the audit. It also provides guidance for
the development of audit plan.
The audit plan is more detailed than the audit strategy and it includes the nature, timing and extent
of audit procedures to be performed by the engagement team members. The planning for these
audit procedures takes place over the course of audit as the audit plan for the engagement
develops.
(b) The auditor should perform the following activities prior to starting an initial audit engagement:
(i) Performing procedures regarding the acceptance of the client relationship and the specific
audit engagement.
(ii) Unless prohibited by law, arrangements to be made with the predecessor auditor, for
example, to review the predecessor auditor’s working papers.
(iii) Any major issues discussed with management in connection with the initial selection as
auditor, the communication of these matters to those charged with governance, and how
these matters affect the audit strategy and audit plan.

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(iv) The audit procedures necessary to obtain sufficient appropriate audit evidence regarding
opening balances.
(v) Other procedures required by the firm’s system of quality control for initial audit engagements.

38 SPL
(a) Preconditions for an audit are as follows:
(i) An acceptable financial reporting framework has been used by the management in the
preparation of the financial statements; and
(ii) the management and, where appropriate, those charged with governance agreed on the
premise on which the audit is to be conducted.
(b) In order to establish whether the preconditions for an audit are present, we will:
(i) determine whether the financial reporting framework to be applied in the preparation of
financial statements is acceptable;
(ii) obtain the agreement of management that it acknowledges and understands its
responsibility:
 for the preparation of the financial statements in accordance with the applicable
financial reporting framework.
 for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether
due to fraud or error.
 to provide us with:
 access to all information of which management is aware, that may be relevant
to the preparation of the financial statements;
 additional information that the auditor may request from management for the
purpose of the audit; and
 unrestricted access to persons within the entity from whom the auditor
determine it necessary to obtain audit evidence.
(c) If a precondition for an audit is not present, the matter would be discussed with the management.
Unless required by law or regulation to do so, we will not accept the proposed audit engagement,
if the pre-conditions are not met.

39 Fruit and nuts

(a) The appointment of Guava and Company, Chartered Accountants, will be in order.
The firm would not be deemed indebted to the company as the amount of debt is not exceeding
Rs. 1 million.
(b) The Appointment of Apricot and Company, Chartered Accountants will be in order.
Banana Limited and Water Melon Limited are not associated companies as the common director
is a Government nominee.
(c) Mr Zaheer cannot be appointed as the Auditor of Lychee (Private) Limited
The auditor of private companies having paid-up capital of less than Rs. 3 million can be a
chartered accountant or a cost and management accountant having a valid certificate of practice
from their respective institutes or a firm of chartered accountants or cost and management
accountants whereof the majority of practicing partners are qualified for appointment by its firm
name to be the auditors of the company.
The fact that 40% of the shareholding is owned by Blue Black Limited does not disqualify Mr Zaheer
as the auditor of LPL.

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(d) Before accepting the offer Walnut and Company, Chartered Accountants, apart from obtaining
professional clearance from the existing auditor is also required to inform the ICAP (Institute) and
obtain prior clearance from the Institute.
(e) Since the three year period has not been lapsed,
Our firm cannot be appointed as the auditor of Strawberry Limited,
The fact that Mr Sadiq was serving on the board as a Government nominee does not make any
difference, in this case.

40 Discussions and judgment

(a) Benefits of discussion among the engagement team about the susceptibility of the entity’s financial
statements to material misstatement are as follows:
(i) Provides an opportunity for more experienced engagement team members to share their
insights based on their knowledge of the entity.
(ii) Allows the engagement team members to exchange information about the business risks to
which the entity is subject to and about how and where the financial statements might be
susceptible to material misstatement, due to fraud or error.
(iii) Assists the engagement team members to gain a better understanding of the potential for
material misstatement in the areas assigned to them.
(iv) Develop an understanding; about the results of the audit procedures that they perform on
specific areas may affect other aspects of the audit including the decisions about the nature,
timing and extent of further audit procedures.
(v) Provides a basis upon which engagement team members communicate and share new
information obtained throughout the audit that may affect the assessment of risks of material
misstatement or the audit procedures performed to address these risks.
(b) (i) Non routine transactions:
Non-routine transactions are transactions that are unusual, due to either size or nature, and
that therefore occur infrequently.
Judgmental matters:
Judgmental matters may include the development of accounting estimates for which there is
significant measurement uncertainty.
(ii) Reasons on account of which risk of material misstatement is increased on account of
Non routine transactions:
(1) Greater management intervention to specify the accounting treatment.
(2) Greater manual intervention for data collection and processing.
(3) Complex calculations or accounting principles.
(4) The nature of non-routine transactions, which may make it difficult for the entity to
implement effective controls over the risks.
Reasons on account of which risk of material misstatement is increased on account of
Judgmental matters:
(1) Accounting principles for accounting estimates or revenue recognition may be subject
to differing interpretation.
(2) Required judgment may be subjective or complex, or require assumptions about the
effects of future events, for example, judgment about fair value.

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41 Dynamic
The prospective audit risks are as follows:
Overstatement of Debtors:
Average period for outstanding debtors has reached to four months which is indicative of a risk of
inadequate provision against doubtful debts.
Overstatement/ Understatement of Inventories:
The inventories turnover rate has decreased to 3 times per year from 5 times in 20X1. It is indicative of
the following types of risks:
(a) Obsolescence of inventories.
(b) Improper valuation of inventories.
Overstating of income as well as understating of expenses:
The income position has weakened and the company has suffered losses as the interest coverage has
moved below 1.0. In such a situation there is a risk that the management may like to overstate its revenue,
and understate its expenses.
Liquidity Problems:
The company is experiencing liquidity problems as are evidenced from the decline in current ratio and
quick asset ratio.
Decline in Gross Profit %:
The decline in GP % needs to be justified. The absence of an appropriate explanation may be indicative
of:
(a) Improper pricing and discounting policies
(b) Improper purchasing policies
(c) Other irregularities like unauthorized spending, intentional manipulation of profitability etc.
Going Concern:
Losses/significant decline in profitability and fast deteriorating liquidity position are financial indicators of
going concern issues, which should not be overlooked.

42 Changing terms
(a) Circumstances in which the management can request the auditor to change the terms of
audit engagement:
(i) Change in circumstances affecting the need for the service.
(ii) A misunderstanding as to the nature of an audit as originally requested.
(iii) A restriction on the scope of an audit engagement, whether caused by management or
caused by other circumstances.
(b) Factors that are to be considered by the auditor before accepting the change in terms of
engagement:
(i) Justification provided for changing the terms of engagement.
(ii) The information in respect of which the change is requested by the management.
(iii) Legal or contractual implications of the change.

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(c) Steps that the auditor can take, if he is unable to agree to a change in terms of engagement:
If the auditor is unable to agree to a change in the terms of the audit engagement and is not
permitted by management to continue the original engagement, the auditor shall:
(i) Withdraw from the audit engagement where possible under applicable law or regulation;
and
(ii) Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or
regulators.

43 EL
(a) Key Components of Audit engagement letter:
 The objective and scope of the audit of financial statements;
 The responsibilities of the auditor;
 The responsibilities of management;
 Identification of the applicable financial reporting framework for the preparation of the
financial statements;
 Reference to the expected form and content of any reports to be issued by the auditor
and;
 A statement that there may be circumstances in which a report may differ from its
expected form and content.
(b) Situations that may require revision in the terms of engagement letter are as follows:
 Any indication that the entity misunderstands the objectives and scope of the audit;
 Any revised or special terms of the audit;
 A recent change in the senior management/ ownership;
 A significant change in nature or size of the entity’s business;

44 Calm Co
Risk assessment procedures
(i) Purpose
The main purpose of risk assessment procedures is to help the auditor obtain an understanding of
the audit client.
The procedures will provide audit evidence relating to the auditor’s risk assessment of a material
misstatement in the client’s financial statements.
The auditor will also obtain initial evidence regarding the classes of transactions at the client and
the operating effectiveness of the client’s internal controls.
Finally, the auditor may identify risks in other areas such as being associated with a particular client
or not being able to follow ethical guidelines of ICAP.
(ii) Sources of audit evidence
The auditor may obtain evidence from:
 Enquiries of management and others connected with the entity such as external legal
counsel or valuation experts

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 Analytical procedures including ratio analysis to obtain high level data on the client
 Observation of entity activities and inspection of documents, etc.

45 Azam
(a) Risks and implications for audit risk
Inherent and control risks
(i) Charities such as Azam can be viewed as inherently risky because they are often managed
by non-professionals and susceptible to fraud. In Azam’s case inherent risk is likely to be
high as there is no full-time accountant and volunteers are used to raise funds.
(ii) As Azam is staffed mainly by volunteers the inherent risk also increases that transactions
are not properly recorded. Volunteers are often more enthusiastic as to what they typically
perceive as the ‘value add’ and ‘making a difference’ activities and hence paperwork can be
overlooked.
(iii) Azam’s small size also reduces the opportunity for segregation of duties and thus increases
control risk and susceptibility to fraud.
(iv) Azam may be at risk of being in violation of its constitutions which is important where funds
are raised from public or private donors who may well object strongly if funds are not applied
in the manner expected. The question states that funds are required for educational projects
so this could be a problem if funds have been used for other purposes.
(v) Azam is likely to have a high level of control risk because formal internal controls are
expensive and unlikely to be in place. This means that donations are susceptible to
misappropriation and Azam will have had to rely heavily on the trustworthiness of volunteers.

(vi) Inherent risk is also increased due to the fact that Azam has not been audited previously
which could lead to a greater risk of misstatement of opening balances.

Detection risk

(vii) Detection risk comprises sampling risk and non-sampling risk. It is possible with Azam that
all transactions will be tested and therefore sampling risk (the risk that samples are
unrepresentative of the populations from which they are drawn) eliminated.

(viii) Non-sampling risk is the risk that auditors will draw incorrect conclusions because, for
example, mistakes are made, or errors of judgement are made in interpreting results, or
because the auditors are unfamiliar with the client. As this is Azam’s first audit non-sampling
risk is increased.

Audit risk

(ix) Audit risk is the product of inherent risk, control risk and detection risk that the auditors will
issue an inappropriate audit opinion. This risk can be managed by decreasing detection risk
by altering the nature, timing and extent of audit procedures applied. As inherent risk is high
and controls likely weak (as is likely to be the case with Azam) more audit work will be
performed in appropriate areas in order to reduce audit risk to an acceptable level by
reducing detection risk.

(b) Audit tests – fund raising events

(i) Attend fund raising events and observe the procedures employed in collecting, counting,
banking and recording the cash. This will help provide audit evidence that funds have not
been misappropriated and that all income from such events has been recorded. Sealed
boxes or tins that are opened in the presence of two volunteers are often used for these
purposes.

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(ii) Perform cash counts at the events to provide evidence that cash has been counted correctly
and that there is no collusion between volunteers to misappropriate funds.

(iii) Examine bank paying in slips, bank statements and bank reconciliations and ensure that
these agree with records made at events. This also provides evidence as to the
completeness of income.

(iv) Examine the records of expenditure for fund raising events (hire of equipment, entertainers,
purchase of refreshments etc.) and ensure that these have been properly authorised (where
appropriate) and that receipts have been obtained for all expenditure. This provides
evidence as to the completeness and accuracy of expenditure.

(v) Review the income and expenditure of fund raising events against any budgets that have
been prepared and investigate any significant discrepancies.

(vi) Ensure that all the necessary licenses (such as public entertainment licences) have been
obtained by the trustees for such events in order to ensure that no action is likely to be taken
against the charity or volunteers.

(vii) Obtain representations from the trustees to the effect that there are no outstanding
unrecorded liabilities for such events – again for completeness of expenditure and liabilities.

46 Hurricane
(a) Importance of audit planning
According to ISA 300, the auditor should plan the audit work so that the engagement will be
performed in an effective manner. Specifically, planning is required for the following reasons:
 To develop a general strategy and detailed approach for the specific nature, timing and
extent of the audit work. This will help to ensure that the audit is carried out in an efficient
and timely manner.
 So that attention is devoted to the important areas of the audit. Planning will also help to
identify problem areas so they can be addressed in a timely fashion.
 To determine the amount of work to be carried out and therefore assist in determining the
number of staff required to perform the audit work.
 To provide a document as a reference for an initial discussion of the approach to the audit
with the company’s audit committee. The plan will also help ensure that audit work is co-
ordinated with client staff: e.g. for production of specific documentation to assist the auditor.
 To act as a basis for the production of the audit program.
(b) Audit strategy
Client: Hurricane
Year ended: 31 December 20X4
Prepared by: A Manager
Characteristics of entity
Hurricane requires a normal statutory audit – there are no audit or filing exemptions available.
The financial reporting framework is the International Accounting Standards and there are no
industry specific reporting requirements.
Hurricane buys and then resells all types of fixtures and fittings for ships from yachts through to
large cruise ships. The company has ten warehouses, seven of which are located near to branches
of our audit firm.

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Key dates
Key dates in the audit timetable are:
 Interim audit
 Final audit
 Meeting with audit committee
 Financial statements approved by management
Specific dates are to be confirmed.
Overview of audit approach
The shipping supply industry has grown by 7% during the last year. Hurricane’s sales increase is
12% indicating that the company continues to perform well within the industry.
There have been no changes to the accounting policies of Hurricane during the year.
This is the first year that International Standards on Auditing (ISAs) are relevant to this company.
A detailed check will be required to ensure that no changes are required to the audit plan.
The overall audit approach will be to use tests of control where possible. However, the fall in gross
profit indicates that sales may be understated or cost of sales (COS) overstated, so additional
substantive procedures may be required in this area.
Materiality determination

Materiality will initially be set at ½ to 1% of revenue as this figure appears to be more accurate than
gross profit.

Materiality on the statement of financial position will be based on net asset values.

Performance materiality will be set for specific areas.

Identification of risk areas with a higher risk of misstatement

A review of the draft financial statements for the company shows the following risks:

 Sales have increased by 12% but COS by 19%. There is a risk of COS being overstated.

 Inventory on the statement of financial position is down significantly on last year indicating
that there may be valuation or quantity errors.

 Trade receivables have increased by about 50%, significantly more than the increase in
sales. This indicates that the company may have debt collection problems. Additional testing
may be required on after date cash collections to check for bad debts.

 Non-current assets have fallen by Rs. 900m, which is significant given that most non-current
assets are land and buildings. The reason for sale must be ascertained.

 Non-current liabilities have also fallen by Rs1 billion. While not necessarily linked to the fall
in non-current assets, there is a possibility that non-current assets have been sold to pay off
the liabilities.

Audit approach – extent of controls testing

Audit testing will focus on the use of tests of controls where possible. However, changes have been
made to the inventory system during the year, limiting the extent of testing of controls. Client
systems have changed in the year with a new computerised inventory control system.
Unfortunately, the change was not identified until audit planning started. Three actions are
necessary in respect of this system:

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 Audit initial installation of the system including transfer of balances. One of the reasons for
the low inventory value could be omission of inventory balances on transfer.
 Test count inventory at the year end and agree to the computerised inventory records (and
vice versa) to test their accuracy. Note that the client will not be counting inventory at the
year-end but relying on the computerised system.
 Test check bookings into and out of inventory from the purchases and sales systems.
Other risk areas
 The client appears to be a going concern, although the fall in gross profit must be
investigated. Cash and profit forecasts for the next 12 months must also be obtained to
confirm ongoing profitability and that the fall in cash balances will not continue.
 There is the possibility of related party transactions. One of the directors purchased a yacht
during the year. Checks to be made to determine whether company products were
purchased, and if so whether these were in the normal course of business.
 A new engagement letter is required in ISA format.
 Assistance may be required on the inventory count; three warehouses are located away
from our offices.

47 Zakir Co
(a) (i) Explanation of analytical procedures
Analytical procedures are used in obtaining an understanding of an entity and its
environment and in the overall review at the end of the audit.
‘Analytical procedures’ actually means the evaluation of financial and other information, and
the review of plausible relationships in that information. The review also includes identifying
fluctuations and relationships that do not appear consistent with other relevant information
or results.
(ii) Types of analytical procedures
Analytical procedures can be used as:
– Comparison of comparable information to prior periods to identify unusual changes or
fluctuations in amounts.
– Comparison of actual or anticipated results of the entity with budgets and/or forecasts,
or the expectations of the auditor in order to determine the potential accuracy of those
results.
– Comparison to industry information either for the industry as a whole or by comparison
to entities of similar size to the client to determine whether receivable days, for
example, are reasonable.
(iii) Use of analytical procedures
Risk assessment procedures
Analytical procedures are used at the beginning of the audit to help the auditor obtain an
understanding of the entity and assess the risk of material misstatement. Audit procedures
can then be directed to these ‘risky’ areas.
Analytical procedures as substantive procedures
Analytical procedures can be used as substantive procedures in determining the risk of
material misstatement at the assertion level during work on the income statement and
statement of financial position (balance sheet).

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Analytical procedures in the overall review at the end of the audit

Analytical procedures help the auditor at the end of the audit in forming an overall conclusion
as to whether the financial statements as a whole are consistent with the auditor’s
understanding of the entity.
(b) Net profit
Overall, Zak’s result has changed from a net loss to a net profit. Given that sales have only
increased by 17% and that expenses, at least administration expenses, appear low, then there is
the possibility that expenditure may be understated.
Sales – increase 17%
According to the directors, Zak has had a ‘difficult year’. Reasons for the increase in sales income
must be ascertained as the change does not conform to the directors’ comments. It is possible that
the industry as a whole, has been growing allowing Zak to produce this good result.
Cost of sales – fall 17%
A fall in cost of sales is unusual given that sales have increased significantly. This may have been
caused by an incorrect inventory valuation and the use of different (cheaper) suppliers which may
cause problems with faulty goods in the next year.
Gross profit (GP) – increase 88%
This is a significant increase with the GP% changing from 33% last year to 53% in 20X3. Identifying
reasons for this change will need to focus initially on the change in sales and cost of sales.
Administration – fall 6%
A fall is unusual given that sales are increasing and so an increase in administration to support
those sales would be expected. Expenditure may be understated, or there has been a decrease in
the number of administration staff.
Selling and distribution – increase 42%
This increase does not appear to be in line with the increase in sales – selling and distribution
would be expected to increase in line with sales. There may be a misallocation of expenses from
administration or the age of Zak’s delivery vans is increasing resulting in additional service costs.
Interest payable – small fall
Given that Zak has a considerable cash surplus this year, continuing to pay interest is surprising.
The amount may be overstated – reasons for lack of fall in interest payment e.g. loans that cannot
be repaid early, must be determined.
Investment income – new this year
This is expected given cash surplus on the year, although the amount is still very high indicating
possible errors in the amount or other income generating assets not disclosed on the balance sheet
extract.
(c) Obtaining a bank letter

– Review the need to obtain a bank letter from the information obtained from the preliminary
risk assessment of Zak.

– Prepare a standard bank letter in the format agreed with banks in your jurisdiction.

– Obtain authorisation on that letter from a director of Zak for the bank to disclose information
to the auditor.

– Where Zak has provided their bank with a standing authority to disclose information to the
auditors, refer to this authority in the bank letter.

– The auditor sends the letter directly to Zak’s bank with a request to send the reply directly
back to the auditors.

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48 Educational University (EU)

Audit risk
There is a risk that revenue from fees income and sale of goods is misstated due to following reasons:
 Fees income may be recognized immediately on receipt of fees rather than recognized on
monthly basis as the services are rendered.
 Discounts given to students may not be accounted for properly, resulting in overstatement of
revenue.
 There is a risk that revenue related to sale of course material is in appropriately classified as part
of the university fees, as a result of which it may have been recognized proportionately on the
basis of time (services provided).
 Entire revenue from sale of course material may not be recognized.
Audit procedures and test
 Understand and test the system of recording revenue i.e. between sale of books and university
fees.
 Review global reconciliation keeping into consideration of number of students registered,
semester fees, and discount allowed, cost of course material etc.
 Ensure that revenue is booked for course material in respect of all registered students
irrespective of whether course material is taken by them or not.
 Ensure that cost of books not yet claimed has been charged off in the accounts.

49 Hajira
(a) Audit risk
Audit risk is the risk that an auditor gives an inappropriate opinion on the financial statements being
audited.
Inherent risk is the susceptibility of an assertion to a misstatement that could be material
individually or when aggregated with misstatements, assuming that there are no related controls.
The risk of such misstatement is greater for some assertions and related classes of transactions,
account balances, and disclosures than for others.
Control risk is the risk that a material error could occur in an assertion that could be material,
individually or when aggregated with other misstatements, will not be prevented or detected on a
timely basis by the company’s internal control systems.
Detection risk is the risk that the auditors’ procedures will not detect a misstatement that exists in
an assertion that could be material, individually or when aggregated with other misstatements.
(b) Inherent risks in charity

Area of inherent risk Effect on audit approach

Income is from voluntary donations It is difficult to estimate that income in the future will
only. There is a risk that donations will be sufficient to meet the expenditure of the charity.
fall, especially where donors’ own
Audit of the going concern concept (as in ensuring
income is limited by the ‘credit crunch’
that the charity can still operate) will therefore be
etc.
quite difficult.

Completeness of income – where there Audit tests are unlikely to be effective to meet the
are no controls to ensure income is assertion of completeness. The audit report may
complete for example sales invoices need to be modified and qualified to explain the lack
are not raised to obtain donations and of evidence stating that completeness of income
donations could be stolen by staff. cannot be confirmed.

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Area of inherent risk Effect on audit approach

Funds can only be spent in accordance Careful review of expenditure will be necessary to
with the aims of the charity. There is a ensure that expenditure is not ‘ultra vires’ the
risk that funds are spent outside the objectives of the charity.
aims of the charity.
The auditor will need to review the constitution of the
Hajira charity carefully in this respect.

Taxation rules relevant to charities. The auditor will need to ensure that staff familiar with
There is a risk that the rules will be the taxation rules affecting the charity are on the audit
broken due to lack of correct analysis of team.
income/expenditure.

Requirement to report expenditure in The trustees may attempt to hide ‘excessive’

accordance with the constitution – expenditure on administration under other expense
administration expenditure can be no headings.
more than 10% of total income. Risks
here include income being overstated As the auditor has to report on the accuracy of
to allow expenditure to be overstated. income and expenditure then audit procedures must
focus on the accuracy of recording of expenditure.

Donations to charity for specific Documentation for any donation will need to be
activities for example provision of obtained and then expenditure agreed to the terms of
sports equipment. There is a risk that the documentation. Any discrepancies will have to be
donations are not spent in accordance reported to management
with donors’ instructions.

(c) Weak control environment

Lack of segregation of duties/responsibilities
There is normally a limited number of staff working in the charity meaning that a full system of
internal control including segregation of duties cannot be implemented. Staff are likely to be unclear
as to their exact responsibilities as they are not formal ‘employees’ and are not part of the formal
authority structure in the charity.
Volunteer staff
Many staff are volunteers and so will only work at the charity on an occasional basis. Controls will
be performed by different staff on different days making the system unreliable.
Lack of qualified staff (human resource issues)
Selection of staff is limited – people tend to volunteer for work when they have time – and so they
are unlikely to have professional qualifications or experience to implement or maintain good control
systems.
No internal audit department (lack of organisational structure)
Any control system will not be monitored effectively, mainly due to the lack of any internal audit
department. The charity will not have the funds or experience to establish internal audit.
Attitude of the trustees
It is not clear how the charity’s trustees view risk. However, where trustees are not professionally
trained or have little time to devote to the charity, then there may be an impression that controls
are not important. The overall control environment may therefore be weak as other charity workers
do not see the importance of maintaining good controls.

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50 Tahir Co
(a) Valuation of aviation inventory
– Review GAAP to ensure that there are no exceptions for aviation fuel or inventory held for
emergency purposes which would suggest a market valuation should be used.
– Calculate the difference in valuation. The error in inventory valuation is Rs. 1,050 * 6,000
barrels or Rs.6.3m, which is a material amount compared to profit.
– Review prior year working papers to determine whether a similar situation occurred last year
and ascertain the outcome at that stage.
– Discuss the matter with the directors to obtain reasons why they believe that market value
should be used for the inventory this year.
– Warn the directors that in your opinion, aviation fuel should be valued at the lower of cost or
net realisable value (that is Rs.150/barrel) and that using market value will result in a
modification to the audit report.
– If the directors now amend the financial statements to show inventory valued at cost, then
consider mentioning the issue in the weakness letter and do not modify the audit report in
respect of this matter.
– If the directors will not amend the financial statements, quantify the effect of the
disagreement in the valuation method – the sum of Rs.6.3m is material to the financial
statements as Tahir Co.’s income statement figure is converted from a profit to a loss of
Rs.1.3m although net assets decrease by only about 0·3%.
– Obtain a written representation letter from the directors of Tahir Co confirming that market
value is to be used for the emergency inventory of aviation fuel.
– If the directors will not amend the financial statements, draft the relevant sections of the audit
report, showing a qualification on the grounds of disagreement with the accounting policy
for valuation of inventory.
(b) (i) External auditor responsibilities regarding detection of fraud
Overall responsibility of auditor
The external auditor is primarily responsible for the audit opinion on the financial statements
following the international auditing standards (ISAs). ISA 240 (Redrafted) The Auditor’s
Responsibilities Relating to Fraud in an Audit of Financial Statements is relevant to audit
work regarding fraud.
The main focus of audit work is therefore to ensure that the financial statements show a true
and fair view. The detection of fraud is therefore not the main focus of the external auditor’s
work. An auditor is responsible for obtaining reasonable assurance that the financial
statements as a whole are free from material misstatement, whether caused by fraud or
error.
The auditor is responsible for maintaining an attitude of professional scepticism throughout
the audit, considering the potential for management override of controls and recognising the
fact that audit procedures that are effective for detecting error may not be effective for
detecting fraud.
Materiality
ISA 240 states that the auditor should reduce audit risk to an acceptably low level.
Therefore, in reaching the audit opinion and performing audit work, the external auditor takes
into account the concept of materiality. In other words, the external auditor is not responsible
for checking all the transactions. Audit procedures are planned to have a reasonable
likelihood of identifying material fraud.

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Discussion among the audit team

A discussion is required among the engagement team placing particular emphasis on how
and where the entity’s financial statements may be susceptible to material misstatement due
to fraud, including how fraud might occur.
Identification of fraud
In situations where the external auditor does detect fraud, then the auditor will need to
consider the implications for the entire audit. In other words, the external auditor has a
responsibility to extend testing into other areas because the risk of providing an incorrect
audit opinion will have increased.
(ii) Groups to report fraud to
Report to audit committee
Disclose the situation to the audit committee as they are charged with maintaining a high
standard of governance in the company.
The committee should be able to discuss the situation with the directors and recommend
that they take appropriate action e.g. amend the financial statements.
Report to government
As Tahir Co is acting under a government contract, and the over-statement of inventory will
mean Tahir Co breaches that contract (the reported profit becoming a loss), then the auditor
may have to report the situation directly to the government. The auditor of Tahir Co needs
to review the contract to confirm the reporting required under that contract.
Report to members
If the financial statements do not show a true and fair view then the auditor needs to report
this fact to the members of Tahir Co. The audit report will be qualified with an except for or
adverse opinion (depending on materiality) and information concerning the reason for the
disagreement given. In this case the auditor is likely to state factually the problem of
inventory quantities being incorrect, rather than stating or implying that the directors are
involved in fraud.
Report to professional body
If the auditor is uncertain as to the correct course of action, advice may be obtained from the
auditor’s professional body. Depending on the advice received, the auditor may simply report
to the members in the audit report, although resignation and the convening of a general
meeting is another reporting option.
(iii) Intimidation threat – safeguards
In response to the implied threat of dismissal if the audit report is modified regarding the
potential fraud/error, the following safeguards are available to the auditor.
Discuss with audit committee
The situation can be discussed with the audit committee. As the audit committee should
comprise non-executive directors, they will be able to discuss the situation with the finance
director and point out clearly the auditor’s opinion. They can also remind the directors as a
whole that the appointment of the auditor rests with the members on the recommendation
of the audit committee. If the recommendation of the audit committee is rejected by the
board, good corporate governance requires disclosure of the reason for rejection.
Obtain second partner review
The engagement partner can ask a second partner to review the working papers and other
evidence relating to the issue of possible fraud. While this action does not resolve the issue,
it does provide additional assurance that the findings and actions of the engagement partner
are valid.

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Resignation
If the matter is serious, then the auditor can consider resignation rather than not being re-
appointed. Resignation has the additional safeguard that the auditor can normally require
the directors to convene a general meeting to consider the circumstances of the resignation.

51 Elegant Limited
(a) In determining the need to send an engagement letter, the firm should assess whether:
 circumstances require a revision in the terms of engagement.
 management need to be reminded of the existing terms of the engagement.
The following factors may indicate that the above is appropriate:
 Any indication that the entity misunderstands the objective and scope of the audit.
 Any revised or special terms of the audit engagement.
 A recent change of senior management.

 A significant change in ownership.

 A significant change in nature or size of the entity’s business.

 A change in legal or regulatory requirements.

 A change in other reporting requirements.

(b) We would consider whether the request is “reasonable”.

 If the request is reasonable then revised terms should be agreed and recorded in
engagement letter.

 If the request is unreasonable, we should discuss the matter with the management and if
the management agrees with our view point, then there is no need for amendment in the
existing terms of engagement.

 If we are unable to agree to the changes and management also do not agree with our
viewpoint then we would consider withdrawing from the engagement and consider whether
there is any obligation to report the circumstances to those charged with governance,
owners or regulators.

52 Roof Limited
To CEO, APL.

An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect
the auditor’s ability to detect material misstatements. These limitations arise because of the following:

(i) The use of testing/sampling techniques;

(ii) The limitations that exist in any accounting and internal controls system (for example, the
possibility of collusion);

(iii) The fact that most audit evidence is persuasive rather than conclusive; and

(iv) The work undertaken by the auditor to form an opinion is permeated by judgment.

Further, other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (for example, transactions between related parties).

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53 Door Limited
Since it will be the first time we will be auditing Door Limited, I will have to discuss the following additional
matters with the engagement partner:
 Arrangements to be made with the predecessor auditor, for example, to review the predecessor
auditor’s working papers;
 Any major issues (including the application of accounting principles or of auditing and reporting
standards) discussed with management in connection with the initial selection as auditor, the
communication of these matters to those charged with governance and how these matters affect
the overall audit strategy and audit plan;
 The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening
balances; and
 Other procedures required by the firm’s system of quality control for initial audit engagements.

54 Clocks (Private) Limited

Email to job-in-charge
To: Audit Senior
Date: 07 September 2017
Subject: Risk of material misstatement due to fraud and management override of control
I have reviewed the draft planning document prepared by you and I want to bring your attention to the
risk of material misstatement due to fraud and management override of control.
When planning and performing an audit, we should adopt an attitude of professional skepticism. We
should have an attitude that includes a questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud, and a critical assessment of audit evidence.
We should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding
our past experience of the honesty and integrity of the entity’s management and those charged with
governance.
Although the level of risk of management override of controls will vary from entity to entity, the risk is
nevertheless present in all entities. Due to the unpredictable way in which such override could occur, it is
a risk of material misstatement due to fraud and thus a significant risk. Irrespective of our assessment of
the risks of management override of controls, we shall design and perform the audit procedures for
management over ride of controls.
If you require any further information on the above, please do not hesitate to contact me
Yours faithfully,
XYZ
(b) Following are the procedures for risk of material misstatement due to fraud:
(i) Make enquiries of management in respect of:
 their assessment of the risk of material fraud;
 processes in place for identifying and responding to the risks of fraud; and
 any specific risks of fraud identified or likely to exist.
(ii) Make inquiries of management and others within the entity as to whether they have any
knowledge of any actual, suspected or alleged frauds and to obtain views about the risks
of fraud.

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(iii) Make inquiries of internal audit.

(iv) Evaluate any unusual or unexpected relationships identified while performing analytical
procedures which might indicate a risk of material fraud.

(v) Evaluate information obtained from other risk assessment procedures to see if any fraud
risk factors are present.

55 HSB & Company

(a) A person shall not be qualified for appointment as auditor if he/she is indebted to the company or
any of its holding or subsidiary company other than in the ordinary course of business of such
entities. Further, a person who owes a sum of money not exceeding one million rupees to a credit
card issuer shall not be deemed to be indebted to the company.

Hatim’s plan that he would pay off all his dues before the commencement of audit is not valid, as
the auditor appointed in the general meeting holds the office from the conclusion of that meeting
until the conclusion of the next annual general meeting. If the firm intends to be appointed as the
auditor of TL, Hatim would have to reduce the amount due on his credit card to less than Rs. 1
million prior to the firm’s appointment as the auditor of TL.
(b) To establish if the preconditions for an audit are present, the auditor shall:
 establish if the financial reporting framework to be used in the preparation of the financial
statements is acceptable; and
 obtain the agreement of management that it acknowledges and understands its responsibility
(the ‘premise’):
 for the preparation of the financial statements in accordance with the applicable financial
reporting framework, including where relevant their fair presentation;
 for internal controls to ensure that the financial statements are not materially misstated; and
 to provide the auditor with all relevant and requested information and unrestricted access to
all personnel.

56 Debase Co
The company is a listed company and having significant profit and revenue, however, engagement team
includes part time supervisor and 2 trainees which creates quality issue on the competency and capability
of engagement team.

If the controls are ineffective auditor needs to perform additional substantive procedures. Failure to
perform such procedures indicates that engagement team does not have competency and is unable to
comply with the professional standards.

57 BFF Co
As per ICAP Code of Ethics there is a family and personal relationship which may create familiarity, self-
interest and intimidation threat. This indicates that engagement threat is not independent.

58 GHI Company
There are two issues:
1. The engagement team is providing services w.r.t tax calculation which may create self-review threat.
2. The engagement team is not competent.

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59 Serene Limited
Following are the quality issues:
 The audit supervisor is a part qualified which creates quality issue on the independence of the
engagement team.
 The Engagement was not properly planned, performed, supervised and reviewed.
 The fair value valuation involves significant estimates and judgement therefore as per ISA 315 it
should be considered as significant risk which engagement team had failed to identify.
 No procedures have been performed on the management expert as per the requirement of ISA 500
such as evaluation of competency, capability and independence along with the evaluation of the
adequacy of expert work.

60 Green Limited
(a) Fraud risk factors:

Significant decline in customer demand:

Due to significant decline in demand of foreign customers, the management may be inclined to
show improved results by manipulating the accounting records.

Significant related party transactions:

Significant related party transactions between GL and BL would provide an opportunity for
engaging in fraudulent financial reporting.

Sale of shares by director:

The directors' intention to sell their shareholding in GL provides them an incentive to manipulate
the annual profits so that they can achieve the maximum possible gain from the sale of shares.

Non-implementation of last year’s external auditor’s recommendations:

Management failure to place controls against weaknesses identified by the external auditor on
timely basis shows the management’s attitude towards the improvement of internal controls and
consequently it increases the risk of fraud.

(b) Course of action:

In response to assessed risk of material misstatement due to fraud, the auditor shall:

 emphasize to the Audit team the need to maintain an attitude of professional skepticism.

 assign more experienced staff or increased supervision of staff.

 to the extent not already done, the auditor shall obtain an understanding of the entity’s
related controls, relevant to such risks.

 evaluate whether the selection and application of accounting policies by the entity,
particularly those related to subjective measurements and complex transactions, may be
indicative of fraudulent financial reporting resulting from management’s effort to manage
earnings.

 incorporate an element of unpredictability in determining the nature, timing and extent of

audit procedures.

 design and perform further audit procedures whose nature, timing and extent are responsive
to the assessed risk of material misstatements.

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61 Sukkur Limited
(a) Fraud risk factors in the scenario are:

 high degree of competition or market saturation, accompanied by declining margins and

profitability.

 high vulnerability to rapid changes, such as changes in technology, product obsolescence, or

interest rates.

 excessive pressure exists for management to meet the requirements or expectations of third
parties due to the need to obtain additional debt financing to stay competitive.

 recurring negative cash flows from operations or an inability to generate cash flows from
operations while reporting profitable operation.

(b) Audit risks

(i) Risk of fraudulent financial reporting by Management override of controls:
In view of the declining earnings trend and declining margin and increase in financing the
management may be inclined to fraudulent financial reporting by overstating the revenues or
understating the expenses.
(ii) Risk of impairment in value of property, plant and equipment:
Due to introduction of new technology there is a possibility that value of existing plant and
machinery is impaired.
(iii) Risk of overstatement of existing inventory:
Due to change in technology, the demand for SL’s products has been affected and there is a
possibility that net realizable value of inventory may have declined and a provision for
obsolescence may be required.
(iv) Risk of overstatement in value of debtors:
In view of the negative operating cash flows, it seems that SL has not been able to generate
operating cash flows despite increase in sale, which might indicate that debtors are either
doubtful or not recoverable.

62 Information Limited
(a) The objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness
of the views presented by the financial statements. The auditor is not primarily responsible for the
prevention or detection of fraud.
The auditor will be concerned with fraud only to the extent that it might impact on the view shown
by the financial statements. He will therefore be concerned with the risk of material fraud.
The auditor should maintain an attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
Further, he must respond appropriately to fraud or suspected fraud identified during the audit.
(b) Management’s attitude towards the auditor which may indicate the possibility of a material
misstatement includes:
 Denial of access to records, facilities, certain employees, customers, vendors, or others from
whom audit evidence might be sought.
 Undue time pressures imposed by management to resolve complex or contentious issues.

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 Unusual delays by the entity in providing requested information.

 An unwillingness to add or revise disclosures in the financial statements to make them more
complete and understandable.
(c) Rapid growth or unusual profitability.
 Significant portions of key management personnel’s compensation i.e. bonus being
contingent upon achieving aggressive targets for operating results.
 Pressure on management to show good profitability considering the proposed acquisition.

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INTERNAL CONTROL
63 Training Manager
(a) Control Environment and its elements

The ‘control environment’ is often referred to as the general ‘attitude’ to internal control of
management and employees in the organization.

The elements of control environment include the following:

 Communication and enforcement of integrity and ethical values

 Commitment to competence

 Participation of those charged with governance.

 Management’s philosophy and operating style

 Organizational structure

 Assignment of authority and responsibility

 Human resource policies and practices

(b) Walk through tests:

Auditor is required to gain an understanding of the various elements of the internal control system
operating within an entity. Once this understanding has been gained, the auditor should confirm
that his understanding is correct by performing ‘walk-through’ tests on each major transaction type
(for example, revenue, purchases and payroll). Walk-through testing involves the auditor selecting
a small sample of transactions and following them through the various stages in their processing
in order to establish whether his understanding of the process is correct.

(c) Materiality:

Information is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of financial statements. The auditor keeping in view the concept of
materiality gives his opinion i.e. whether the financial statements present fairly in all material
respects the financial position and performance of the entity.

Performance Materiality:

Performance materiality means the amount or amounts set by the auditor at less than materiality
for the financial statements as a whole to reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial
statements as a whole.

If applicable, performance materiality also refers to the amount or amounts set by the auditor at
less than the materiality level or levels for particular classes of transactions, account balances or
disclosures.

Performance materiality recognizes the fact that errors/omissions detected in a particular area may
not breach the overall materiality level but when all the errors/omissions in all the areas is combined
or added together, the overall materiality could be breached.

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64 Vision Limited

Type of General IT controls /

Control
controls Application controls

(i) The general ledger system is automatically updated with Preventive Application controls
sub-ledger transactions (e.g., Accounts Receivable) every
night through batch processing.

(ii) The system automatically maintain second copies of all Corrective Application controls
programs and data files.

(iii) Access to programs and data files is restricted using Preventive General IT controls
passwords.

(iv) Invoices are physically counted that are entered into the Detective Application controls
system.

(v) Firewalls (software and hardware are installed to restrict Preventive General IT controls
unauthorized access).

(vi) Screen warnings about incomplete processing. Detective Application controls

(vii) Service level agreements. Corrective General IT controls

(viii) Review of output against expected values. Detective Application controls

65 Types of Controls
(i) Training on applicable policies, department policy/ procedures:
It is a preventive control, as the individuals are trained to perform their duties as per the applicable
policies and procedures that are in place.
(ii) Batch totals:
It is a detective control as program will report any discrepancy between the manually counted batch
total and its own batch total, as an error report.
(iii) Segregation of duties:
It is a preventive control as it involves assigning different people the responsibilities of authorising
and recording transactions and maintaining the custody of assets.
This reduces the likelihood of an employee being able to both carry out and conceal errors or fraud.
(iv) Contingency planning:
It is a corrective control as it involves the corrective measures to be adopted in case of any mishap.
(v) System logs:
It is a detective control as this generates an audit trail that can be used to understand the activity of
the system and to diagnose problems.
(vi) System backup:
It is a corrective control as it will involve any retrieval measures in case of any damage to the original
data.

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66 IT Department
(a) If management refuse to allow the auditor to send a confirmation request the auditor should:
 inquire as to management’s reasons for the refusal, and seek audit evidence as to the
validity and reasonableness of those reasons;
 evaluate the implications of management’s refusal on the auditor’s assessment of the
relevant risks of material misstatement, including the risk of fraud, and on the nature, timing
and extent of other audit procedures; and
 perform alternative audit procedures designed to obtain relevant and reliable audit evidence.
The auditor shall communicate with those charged with governance if:
 the auditor concludes that management’s refusal to allow the auditor to send a confirmation
request is unreasonable; or
 the auditor is unable to obtain relevant and reliable audit evidence from alternative audit
procedures,
(b) Performance reviews – In the context of control activities, performance review includes:
 analyses of actual performance against budget and forecasts;
 analyses of actual performance against prior period performance
 control reporting and variance analysis
(c) Communications protocol
A communications protocol is set of digital rules for message exchange within or between
computers.
When systems communicate they use pre-defined formats for exchanging the messages.
This ensures that each part of the message is recognized and interpreted by the recipient in the
intended fashion.
For each communication a protocol must define:
 Syntax – the arguments used to create the message
 Semantics – how each argument is to be interpreted
 Synchronization – how the sender and receiver will actually exchange the message
Communication protocols are implemented through a combination of hardware and software.
(d) The main categories of general controls that an auditor would expect to find in a computer-
based information system are:
i. controls over the development of new computer information systems and applications
ii. controls over the documentation and testing of changes to programs
iii. the prevention or detection of unauthorised changes to programs (for example, by an
employee committing fraud or by a ‘hacker’ accessing the system)
iv. controls to prevent the use of incorrect data files or programs

67 Bhurbhan Limited
(a) Risks:
Risks related to receiving of goods and invoice from suppliers are as follows:
 Goods may be accepted from a supplier without having been ordered.
 The company may fail to claim discounts from suppliers despite being due.

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 Supplier may raise invoices for goods that have not actually been received / purchased.
 Goods received from suppliers are of inferior quality.
(b) Related controls
Suitable controls may be as follows:
 A copy of all delivery notes should be retained, with a signature of the member of staff who
took receipt and checked the goods.
 Goods received notes should be produced for each delivery, from the delivery note or after
a physical count of the items received.
 A member of the accounts staff or purchasing staff must be responsible for checking
discounts allowed by suppliers.
 There should be a segregation of duties between the individuals who take delivery of goods,
those who place the orders and those who record the purchase invoices in the accounting
system.
 All purchase invoices should be checked against a purchase order and a goods received
note.
(c) Tests of control
 Ensure that goods received notes, purchase orders and purchase invoices are matched with
each other.
 Confirm from documentary evidence that discounts are claimed from suppliers when
available.
 Check that the segregation of duties does exist.

68 Audit trail
(a) Audit Trail in a computerized environment:
An audit trail refers to the ability of the auditor to trace a transaction through all its processing
stages. An audit trail can be provided by a record (‘log’) of how the computer has processed any
transaction.
An audit trail may not exist in ‘paper form’ in an online system, but the computer program should
be written so as to generate the audit trail on request for any transaction.
(b) Embedded Audit Facilities:
It is an audit software that is built into the client’s IT system, either temporarily or permanently.
The purpose of embedded audit facilities is to allow the audit to carry out tests at the time the
particular transactions are being processed, in ‘real time’.
This can be very useful for the audit of online systems where:
 data is continually processed and master files are being continually updated, and/or
 it is difficult, if not impossible, for the system to provide a satisfactory audit trail for the
transactions, through the system.
 an embedded audit facility may also print details of the transactions it has monitored, or copy
them to a computer file, so that the auditor can study the transactions.

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69 Supermarkets
(a) Key controls on cash sales and cash handling:

(i) Responsibility to receive cash should be clearly identified.

(ii) Proper locks should be provided to each person responsible for handling cash.

(iii) Cash should be kept in a locked and secure area until it is deposited.

(iv) Cash registers and credit card machines should be balanced at least once a day.

(v) Proper policies should be made to deal with cash shortages/excesses.

(vi) Timely deposit of cash should be ensured.

(vii) Cash register should be used to record cash sales.

(viii) Transfers of cash from one person to another should be kept at a minimum.

(b) (i) Adequate segregation of duties or independent checks.

(ii) Adequate system of authorization and approval of transactions (for example, in

purchasing, movement between locations etc.)

(iii) Use of door locks and surveillance cameras.

(iv) Surprise physical count and timely reconciliation of inventory items.

(v) Mandatory vacations for employees performing key control functions.

(vi) Periodic rotation of employees.

(vii) Restricted storage area.

(viii) Different entry and exit doors.

(ix) Access controls over automated records, including controls over and review of computer
systems event logs.

(x) Job applicant screening of employees with access to assets.

70 Controls
(i) (a) On account of the following factors, the auditor may decide, not to rely on audit evidence
obtained in prior audits:

 A weak control environment.

 Weak monitoring of controls.

 A significant manual element to the relevant controls.

 Changes in the personnel that significantly affect the application of the controls.

 Change in circumstances that indicate the need for changes in the control.

(b) The components of internal controls are as follows:

(i) Control Environment:

The control environment includes the attitudes, awareness and actions of

management and those charged with governance concerning the entity’s internal
control and their importance in the entity.

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(ii) Entity’s Risk assessment process:

The entity’s risk assessment process includes how management identifies risks
relevant to the preparation of financial statements to ensure that it gives a true and
fair view in accordance with the entity’s applicable financial reporting framework,
estimates their significance, assesses the likelihood of their occurrence, and
decides upon action to manage them.
(iii) Information System, Including the related business processes, relevant to
financial reporting, and communication:
An information system consists of infrastructure (physical and hardware
components). Software, people, procedures, and data.
(iv) Control activities:
These are the policies and procedures that help ensure that management’s
directives are carried out, for example, that necessary actions are taken to address
risks that threaten the achievement of the entity’s objectives.
(v) Monitoring of Controls:
Management’s monitoring of controls includes considering whether they are
operating as intended and that they are modified as and when appropriate.

71 Shahzad Limited
(a) The components of internal controls are as follows:
(i) Control environment:
The control environment includes the attitudes, awareness and actions of management and
those charged with governance concerning the entity’s internal control and their importance in
the entity.
(ii) Entity’s risk assessment process:
It is the entity’s process for identifying business risks relevant to financial reporting objectives
and deciding about actions to address those risks, and the results thereof.
(iii) Information system, including the related business processes, relevant to financial reporting,
and communication.
(iv) Control activities:
These are the policies and procedures that help ensure that management’s directives are
carried out.
(v) Monitoring of controls:
It is a process of assessing the design and operation of controls on a timely basis and taking
necessary corrective actions on account of change in conditions.
(b) Following weaknesses in inventory count are identified from audit senior’s observations:
(i) Lack of segregation of duties
The Inventory Controller is responsible for the physical control of the inventory and is also
supervising the stock count.
(ii) Non availability of detailed plan
Allocation of counting area by the teams themselves indicates non availability of detailed plan
which may lead to certain inventory items being counted more than once while some items
may not be counted at all.

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(iii) No system of marking on counted items

This again may lead to double counting or omission completely.
(iv) Perpetual inventory records available on count sheets
The person responsible for counting may try to match the numbers provided instead of
carrying out an independent count.
(v) Additional count sheets are not pre-numbered
If the separate sheets are numbered as they are used, there is no means of identifying that
all sheets issued have been returned and the last count sheet(s) may go unnoticed.

72 Waheed Engineering
(a) Control Purpose

Payroll data is approved by a senior official. To prevent any unauthorised inaccurate

deductions being made.

Payroll transactions should be recalculated. The correct amount is paid over to employees
or the relevant authorities.

Official notification of starters and leavers i.e. To prevent employees being paid after they
tax documentation. have left or before they have started.

All hours worked are authorised. To prevent the company paying for work not
done.

All employees to collect their wages in person. To prevent loss/theft.

(b) Verifying that employees are not paid prior to commencing work
(i) Two payrolls should be selected from different periods in the year.
(ii) Employees not listed on the second payroll should have left during the year and employees
not listed on the first payroll should have started during the period.
(iii) This can then be verified by examining the permanent payroll information where there should
be a copy of each employee’s contract of employment.
(iv) Also tax authority official forms should confirm departure and start dates. The main reason
for carrying out this exercise is to ensure that all employees are bona fide i.e. payments are
being made to authorised employees.
(c) Attendance at the wages pay-out
(i) Before attendance I will review the payroll to ensure that a pay packet exists for all
employees.
(ii) Each employee should sign for the pay package when they collect it. As they sign, the
auditor should verify the signature to the contract of employment.
(iii) It should be ensured that no one employee collects more than one pay packet.
(iv) All unclaimed wages should be listed; the payroll date, name and amount noted.
(v) The unclaimed wages should then be stored in the safe until collected.

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Audit and Assurance

(d) Procedures re unclaimed wages

(i) All unclaimed wages should be recorded in an unclaimed wages book and it should be
checked that a wage packet physically exists for each entry in the book.
(ii) If someone has collected wages on behalf of somebody else then it should be ensured that
a letter of authorisation exists allowing the pay packet to be collected.
(iii) After a certain period, say a month, all unclaimed wages should be returned to the bank so
the details for each pay package should be agreed from the unclaimed wages book to the
banking slip.
(iv) Any significant delay in banking unclaimed wages should be noted and investigated.
(e) Verification of direct bank payments
(i) Carry out a physical verification of employees to ensure that they actually exist.
(ii) Check employee details to the personal records from payroll information.
(iii) The finance directors could be asked to sign a copy of the payroll to verify that all the
employees are bona fide.
(iv) Employees’ existence can be verified by confirmation of signatures on expense claims.
(v) Also, annual tax authority returns can be reviewed.

73 Danish
(a) Problems expected at Danish resulting from poor internal control
(i) I would expect the company to experience some level of over-ordering, leading to reduced
profitability as a result of inventory going past its ‘best before’ date.
(ii) Inventory that is not well-controlled in a supermarket may result in a breach of health and
safety regulations which may result in fines or even closure of the supermarkets.
(iii) I would expect there to be stock-outs leading to the potential loss of business to other
supermarkets.
(iv) I would expect there to be inefficiencies as a result of a lack of central ordering system
resulting from quality discounts not being obtained.
(v) All of the problems noted above are likely to be exacerbated where local managers or staff
are either inexperienced or possibly dishonest – the question states that poorer quality staff
have been recruited recently.
(vi) Supermarket inventory is very easily pilfered either by staff or customers even where it is
well-controlled. The lack of regular inventory counts in particular means that pilferage is
very easy to hide.
(vii) I would expect there to be a lack of understanding in the business as a whole as to the
availability of new products, products with high margins or other areas in which profitability
might be improved.
(b) Four recommendations to improve internal controls
(i) Recommendation 1: that an integrated system be introduced across all supermarkets that
links sales, purchases and inventory records.
Advantages
This would provide the company with an overall view of what inventory is held at any
particular time, enable it to order centrally and reduce the scope for pilferage. It would result
in reduced stock-outs and reduced inventory obsolescence.

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Disadvantages
This would require considerable capital investment in hardware, software and training. It
would also take control away from local managers which would almost certainly cause
resentment.
(ii) Recommendation 2: the imposition of regular or continuous inventory counting procedures
together with the prompt update of inventory records for discrepancies found and
investigation of the reason for the discrepancies.
Advantages
This would further reduce the possibility of stock-outs and provide evidence of over-ordering,
which would enable purchasing patterns to be refined.
Disadvantages
There are costs in terms of staff time and, again, a certain level of resentment among staff
who may feel that they are being ‘spied on’, or that they are no longer trusted. Training
would also be required and additional administrative work would need to be undertaken by
local managers.
(iii) Recommendation 3: that management accounts are produced on at least a quarterly basis
that figures relating to each supermarket are provided to head office on a monthly basis, and
that an analysis is undertaken by head office on the performance of individual supermarkets
and inventory lines.
Advantages
This would enable the company to determine which supermarkets are performing better than
others. It would also enable the company to identify those inventory lines that well and those
that are profitable.
Disadvantages
The production of more regular and detailed information will be time-consuming. Local
managers may feel that they are unable to service the particular needs of their customers if
decisions are made on a global basis; customers may feel the same way.
(iv) Recommendation 4: that sales price decisions are made by head office.
Advantages
This would enable the company to experiment with the use of ‘loss leaders’, for example,
and to impose a degree of consistency across supermarkets to prevent inappropriate pricing
decisions being taken by local managers.
Disadvantages
Again, loss of control at a local level is likely to result in resentment and the possible loss of
good staff. What sells well in one supermarket may not do so in another. To the extent that
head office have less experience of local conditions than local staff, it is possible that
inappropriate pricing decisions may be made by head office.

74 Roses Anytime
(a) Key procedures

(i) Documentation of accounting and internal control systems

Auditors document accounting and internal control systems in order to evaluate them for
their adequacy as a basis for the preparation of the financial statements and to make a
preliminary risk assessment of internal controls.

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In very simple systems with few internal controls where auditors do not intend to perform
tests of internal controls, it is not necessary to document the internal control system in detail.
It is always necessary, however, to have sufficient knowledge of the business to perform an
effective audit.

For large entities, where the client has already documented the system, it is not necessary
for the auditors to repeat the process if they can satisfy themselves that the client’s
documentation is adequate.

(ii) Walk-through tests

The purpose of walk-through tests is for the auditors to establish that their recording of the
accounting and internal control system is adequate.

Auditors trace a number of transactions from source to destination in the system, and vice
versa. For example, customer orders can be traced from the initial documentation recording
the order, through to the related entries in the daybooks and ledgers.

It is common for walk-through tests to be performed at the same time as tests of controls,
where auditors are reasonably confident that systems are recorded adequately.

(iii) Audit sampling

Auditors perform tests of controls and tests of detail on a sample basis in order to form
conclusions on the populations from which the samples are drawn.

It is not possible in anything but the very smallest of entities to take any other approach, as
testing 100% of a population may be impractical, not cost effective and not accurate because
populations are too large and because of human error.

Samples can be selected in a number of ways – either statistically or on the basis of auditor
judgement. In all cases, the sample selected must be representative of the population as a
whole.

(iv) Testing internal controls

Auditors test internal controls in order to establish whether they are operating effectively
throughout the period under review. If controls are operating effectively, auditors can reduce
the level of substantive testing on transactions and balances that would otherwise be
required.

In testing internal controls, auditors are checking to ensure that the stated control has been
applied. For example, auditors may check that there is a grid stamp on a sales invoice with
various signatures inside it that show that the invoice has been approved by the credit
controller, that it has been checked for arithmetical accuracy, that the price has been
checked, and that it has been posted to the sales ledger. The signatures provide audit
evidence that the control has been applied.

Auditors are not checking to ensure that the invoice is, in fact, correct. This would be a
substantive test. Nevertheless, it is possible to perform tests of control and substantive tests
on the same document at the same time.

(v) Dealing with deviations from the application of control procedures

Where it appears that an internal control procedure has not been applied, it is necessary to
form an opinion as to whether the deviation from the application of the procedure is an
isolated incident, or whether the deviation represents a systematic breakdown in the
application of the control procedure. This is usually achieved by selecting a further sample
for testing.

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If it cannot be shown that the non-application of the procedure is isolated (i.e. there are no
further instances in which the control has failed), it is necessary either to find a compensating
control that can be tested, or to abandon testing of controls and to take a wholly substantive
approach. Where there is a breakdown in internal controls it is also necessary to reassess
the auditor’s preliminary risk assessment. Abandoning tests of control may place strains on
the budget for the audit and auditors should always consider the possibility of compensating
controls before abandoning tests of controls.

(b) Internal controls

(i) Receipt, processing and recording of orders

 All orders taken should be recorded on a pre-numbered multi-part document

generated by the computer. One part might be a copy for the customer, one might
form the invoice, one might be for the despatch department and one might be retained
for accounts receivable ledger purposes. Manual or computer systems should
perform checks on the completeness of the sequence of pre-numbered documents at
various stages. Any documents unaccounted for should be traced and investigated.

 The computer system should apply the credit limits set by the credit controller and the
system should reject any orders that exceed customer credit limits at the point at
which the order is taken, so that the customer can be advised. Any override of credit
limits should be authorised by the credit controller.

 From time to time, there should be a check to ensure that the credit limits within the
system are being properly calculated and properly applied to individual transactions.
Similar considerations apply to prices maintained within the system.

 The computer system should also reject any order for which there are no Roses
available so that orders cannot be taken for Roses that cannot be delivered.

 All invoices should be posted to the sales daybook, the accounts receivable ledger
and the accounts receivable control account automatically by the system and the
accounts receivable ledger and that accounts receivable control account should be
reconciled each month in order for sales and receivables records to be kept up to
date.
 There should be controls in place to deal with credit notes and other discrepancies
involving the price, type or quality of Roses delivered in order to maintain the accuracy
of records and customer goodwill.
(ii) Collection of cash
 At the end of each period, the system should produce a list of overdue receivables.
There should be procedures for chasing these customers and for putting a ‘stop’ on
accounts where amounts are significant in order to control bad debts.
 When bank transfers are received from customers, they should be input into the
system and matched with individual transactions and controls should ensure that the
correct amounts are allocated to the correct customers and transactions.
 An exception report should be produced for any unallocated bank transfers.
Exceptions should be promptly investigated. This will ensure that receivables
information is accurate and up to date and that customers are not chased for amounts
that have been paid.
 A bank reconciliation should be performed on a monthly basis in order to ensure that
the company’s cash records are complete, accurate and up to date.

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Audit and Assurance

75 Trade Receivables
(a) Types of error, omission and misappropriation receivables
(i) Where internal controls are weak, the errors that occur may include the issue of invoices
and credit notes for the wrong amounts, the issue of invoices and credit notes to the wrong
customers, the incorrect recording of invoices, credit notes, cash and contras in the ledgers
and daybooks, and the incorrect setting of credit limits.
(ii) Where internal controls are weak, invoices, credit notes cash and contras may simple go
unrecorded.
(iii) The effect of this will be that receivables may be under or over-stated in the records and that
the company will not receive that money that is due to it, or that goodwill with customers is
damaged.
(iv) The assets that may be misappropriated include cash and inventory. If records are poor, it
will be easy to hide the misappropriation of cash that is received from customers. It will also
be possible for inventory to be misappropriated and hidden by the issue of false or incorrect
invoices, credit notes or contras.
(b) Inherent weaknesses in any internal control system
(i) No internal control system is perfect and all internal control systems are subject to inherent
weaknesses. This means that auditors can never rely on the proper operation of the internal
control systems alone. Even if their tests show that the system appears to be working
perfectly, it will be necessary to perform some substantive testing.
(ii) Inherent weaknesses include human error. People operate the control systems and people
make mistakes.
(iii) Other inherent weaknesses include the abuse of authority. For example, false invoices may
be issued towards the year-end to improve the sales figure and false credit notes to cancel
them out may be issued just after the year-end. This is sometimes known as ‘window
dressing’.
(iv) Fraudulent collusion can happen both within the company and outside the company. Those
who have the right to authorise the issue of credit notes may authorise false credit notes for
customers who are their friends. Those who have access to cash and the receivables
records may collude to misappropriate cash, and make entries in the accounting records to
hide the misappropriation. This is sometimes known as ‘teeming and lading’.
(c) Main internal controls over receivables
(i) Segregation of duties between those who control the accounting records, those who receive
the cash, those who authorise the issue of invoices and credit notes and those who issue
the goods to customers.
(ii) Two people should be involved wherever cash or inventories are being handled in order to
prevent both the misappropriation of assets and to prevent false accusations of
misappropriation.
(iii) The maintenance of a separate receivables ledger showing the individual balances owing
from customers. This ledger should be reconciled at least monthly to the total figure in the
nominal ledger.
(iv) The issue of statements to customers at the end of each month (from the ledger) showing
how much is owed by the customer.

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(v) Arithmetical and accounting controls over the issue of invoices and credit notes, some of
which may be computerised, in order to ensure that they are calculated correctly in
accordance with authorised prices.
(vi) The use of batch and hash totals, document counts and sequence checks in the input of
transactions into the computer system to ensure completeness and accuracy.
(vii) The appointment of a credit controller who limits the credit available to customers, together
with restricted access to those sections of the system that contain credit limits.
(viii) The use of exception reporting to highlight overdue accounts and accounts where the credit
limits have been exceeded, together with a system for investigating and dealing with such
accounts.
(ix) The regular review by the financial controller of amounts receivable and the independent
authorisation of the write-off of bad debts.
(d) Reliance on proper operation of internal controls
(i) Auditors seek to rely on the proper operation of internal controls wherever possible because
where internal controls are operating properly, reliance on internal controls is the most
efficient method of auditing.
(ii) If the auditor’s tests showing that internal controls are operating properly, the volume of
substantive testing on transactions and balances can be reduced.
(iii) It is always possible (in theory) to perform an audit on the basis of substantive testing alone,
but given the volume of transactions in all but the smallest of businesses, such an approach
would be prohibitively expensive for the audited entity.
76 Granger
(a) (i) Inadequate segregation of duties and proposed reassignment
A basic principle of segregation of duties is that an individual employee should not be able
to make errors and be in a position to conceal the fact. Proper segregation means that, if
an error or misstatement is made, it will be detected by another employee in the ordinary
course of his or her duties. A general rule of segregation is that the funtions of processing
transactions, recording transactions and maintaining records over the subsequent assets or
liabilities, should be performed by different individuals.
The receptionist’s duties should be restricted to processing cash receipts transactions. All
other functions should be assigned to other staff members.

Function to be
Possible misstatement Reassignment
reassigned

Checking the numerical The receptionist could This should be assigned to

continuity of invoices, deliberately understate the Clerk 1. (See additional
determining the total cash total in order to procoedure 1.)
sales and entering the cash misappropriate the cash or
receipts journal. conceal a shortage of cash.

Posting the accounts An invoice could be Clerk 1 should post the

receivable ledger. deliberately omitted and the accounts receivable ledger
subsequent cash receipt from credit sales invoices
misapprpriated if done by whose numerical sequence
the same person. is checked.

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Audit and Assurance

Function to be
Possible misstatement Reassignment
reassigned
Errors, such as transaction
errors, made in entering the
sales journal are likely to be
repeated in entering the
accounts receivable ledger.

Cash receipts could be

temporarily
misappropriated and the
shortgage concealed by
delaying recording the
receipt. (See the answer to
part (b)).

Sending out monthly If there are errors in the This function should be
statements and chasing accounts receivable ledger assigned to Clerk 2 since
overdue accounts. the monthly statements Clerk 1 could also falsify
could be altered or statements to conceal
suppressed. errors in recording sales in
the accounts receivable
If payments by customers
ledger. (See additional
have been misappropriated
procedure 2.)
and not credited to the
customer account,
customers’ suspicions
would not be aroused by
chasing apparent overdue
balances.

Reconciling accounts This procedure detects Clerk 2 should perform the

receivable with the control errors, deliberate or reconciliation as having no
account in the general accidental, in the responsibility for recording
ledger. maintenance of accounts either cash or sales
receivable records. If the transactions or maintaining
receiptionist has made the accounts receivable
errors in processing sales ledger. (See additional
and cash receipts procedure 3.)
transactions to accounts
receivable then he would
have an incentive to
conceal their discovery by
falsifying the reconciliation.

Writing off uncollectible If errors have been made Clerk 2 should advise the
balances. resulting in an manager of overdue
understatement of cash balances that may need to
received from credit be written off. (see
customers, their accounts additional procedure 4.)
will appear to be overdue.
The error can be concealed

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Function to be
Possible misstatement Reassignment
reassigned
by writing off the balance.
Such an error could arise
from the deliberate
misappropriation of cash
received from credit
customers.

(ii) Other control procedures needed

1. A bank reconciliation should be performed at least monthly by Clerk 1 to ensure that
cash deposited is in agreement with amounts recorded in the cash receipts book. the
bank reconciliation should be scrutinised and signed by the manager.
2. The garage manager should review the list of customer account balances (which
should, if practicable, be aged), enquire into steps being taken to collect overdue
balances and consider whether further credit may be allowed.
3. The reconciliation of accounts receivable balances with the control account in the
general ledger should be scrutinised by the garage manager to ensure that it appears
to be properly drawn up.
4. Final decisions on bad debt write offs must be approved in writing by the garage
manger.
5. The opening of mail should be done in the presence of a second clerk who should
confirm the total amount of cash receipts enclosed therein to minimise the likelihood
of such receipts being misappropriated.
(b) (i) Procedures to be followed in making cash count
 Control all cash funds until completion of the count to prevent cash from a counted
fund being transferred to an uncounted fund to conceal a deficiency.
 Count funds in the presence of the custodian to prevent any suggestion, in the event
of a shortage, that the funds were complete when released to the auditors.
 List each item in the fund, such as the denominations of notes, details of cheques
and, for petty cash funds, of vouchers so that the count can subsequently be agreed
with the deposit slip and other accounting records.
 Have the custodian sign the record of the count as being in agreement in the event of
any subsequent disagreement.
(ii) Discrepancy
If the details of the items counted differ from the cash receipts book I would suspect a
misappropriation of cash by failing to record a receipt from a receivable. To conceal this
from the receivable, cash received several days later from another customer is credited to
the first customer’s account. The first customer will not notice anything wrong, the delay in
the receipt being attributed to postal delays or just delays in processing cash receipts.
Failure to credit payment by the second customer will be concealed by using a payment
received from a third customer and so on. Providing the amounts involved are reasonable,
the perpetrator can usually conceal the fraud indefinitely. Such a fraud is only possible if the
person responsible for maintaining the accounts receivable ledger also has access to cash
received from customers before any control is established over that cash. This fraud is
sometimes called ‘teeming and lading’ or ‘lapping’.

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Audit and Assurance

It will be necessary to undertake a further investigation by comparing deposit slips receipted

by the bank with details recorded in the cash receipts book and postings to the accounts
receivable ledger for a series of consecutive days. If a pattern of differences emerges
consistent with the pattern associated with this type of fraud, then the existence of the fraud
must be suspected.
77 TS Limited
Many of the control activities that are typically found in a large company such as segregation of duties,
internal audit etc. may be inappropriate for a small entity because they are too costly or impractical for
such smaller organizations. Often, control systems in small entities are based on a high level of
involvement by the directors or owners. Following audit risks may arise when control systems rely
excessively on the involvement of senior management:
(i) There may be a lack of evidence as to how systems are operating.
(ii) There may be lack of evidence of controls.
(iii) Management may override controls that are in place.
(iv) Management may lack the expertise necessary to control the entity effectively.
78 Pacific Shipping Limited

Control weakness Suggested control

It appears that changes are made in  All changes must be authorized at an appropriate level.
the system without proper
 Change requisition, assessment and approval should be
authorization.
properly documented.
 Log of changes in program must be maintained and reviewed
at an appropriate level periodically to ensure that no
unauthorized changes in the programs are made.
 There should be restricted access to program files and only
authorised programmers should have access to them.

It appears that there was lack of  No change shall be made in live environment. All changes
testing in the offline environment made in the program should first be tested in offline
prior to the implementation, which environment.
resulted in the malfunction of the
 Impact of change on existing functioning must be assessed
system.
before implementing the change.

It appears that due to unavailability  Backup policy as per needs of the PSL must be in place.
of last updated backups or improper
 Recorded backups must be restored periodically to assess
backup policy, the invoicing system
their effectiveness.
was not operational for four days.

79 Advanced limited
S. No. Control weakness Possible effect Recommendation

(i) The list prepared by the There might be suppliers There should be a formal process
purchase department has on the list who are not of approving the list and also for
not been approved by competent enough to placing the suppliers on the
anyone other than the make the supply. approved list.
purchase department.

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 Answer bank: Objective test and long-form answers

S. No. Control weakness Possible effect Recommendation

(ii) List has not been updated The list of the suppliers should be
since 2015. updated on a regular basis.

(iii) Lack of proper criteria for Purchases may be made The criteria for addition of new
selecting suppliers as from unreliable suppliers. supplier should be comprehensive
presently suppliers are which should cover both financial
added to the list without and technical capabilities of the
considering their financial suppliers.
soundness, experience,
etc.

(iv) Purchase requisitions are This could lead to All purchase requisitions should be
processed merely on the inappropriate purchases, authorized by the store manager as
initials of the stores officer. i.e. in terms of type of well as the user department.
/There is no formal process goods or their quantity.
of reviewing the purchase
requisition received from
store department.

(v) Purchase orders are not Liabilities for goods PO should be pre-numbered or be
pre-numbered as they are received may not be issued in sequential order controlled
issued in the form of email. recorded or may be by a computer system.
recorded more than once
if there is no sequential
numbering.

(vi) Quotations are not Purchases may be made Prior to ordering of goods the
obtained from the supplier at a higher price or shortlisted suppliers should be
before placing the orders. discounts may not be asked to submit the quotations,
availed. which should be reviewed by the
purchase committee.

(vii) High value or other than This leads to lack of A purchase committee comprising
routine purchases are only segregation of duties of senior officials should be formed
authorized by the purchase which may result in to oversee purchases above a
manager and store inefficiencies. certain amount.
manager.

(viii) There is no system of Sub-standard goods may Proper inspection should be carried
quality inspection. be received. out before accepting the goods.

(ix) Although GRN has been There is a possibility of Before payment, supplier’s invoice
prepared by the store incorrect payment to the should be reconciled with GRN and
department, payment has supplier. PO.
been made on the basis of
GDN instead of GRN.

(x) Inventory and payable are Cut off errors may arise Inventory/payables should be
recorded upon receipt of i.e. where goods are recorded on the basis of GRN.
invoice only. received but invoice is
received after year end.

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Audit and Assurance

80 Bell Limited
(a) The introduction of IMS may create the following risks:
 There is an increased level of dependency on the computer system of the organisation and
also of the supplier. Any computer failure may therefore have an increased impact on the
organisation.
 There is an increased risk of possible loss or corruption of data due to the process of
transmission.
 There are also security risks in the transmission of data and unauthorised individuals may
be able to gain access to the data.
(b) Controls that could mitigate the above risks are as follows:
 Controls over transmission of data (encryption, acknowledgement systems, authentication
codes, etc.);
 Monitoring and checking of output;
 Virus protection systems; and
 Contingency plans and back up arrangements.

81 General IT Controls
(a)

General IT controls Application controls:

General IT controls aim to establish a Application controls are the specific controls over the
framework of overall control over the relevant applications maintained by the computer. The
computer information system’s activities to purpose of application controls is to establish specific
provide a reasonable level of assurance that control procedures over a particular application. In
the overall objectives of internal controls are order to provide reasonable assurance that all
achieved. transactions are authorized and recorded, and are
processed completely, accurately and on a timely
basis.
Examples of General IT controls: Examples of Application controls:
 Segregation of duties  Authorisation controls e.g. data is input only by
 Password protection authorized personnel
 Virus checks  Control totals
 Backup copies  Batch controls
 Authorisation controls e.g. restriction on printing of
document.

(b) Weaknesses in general IT controls may result in IT application controls becoming ineffective.
However it is possible that manual procedures exercised by users may provide effective controls
at the application level.

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 Answer bank: Objective test and long-form answers

AUDIT EVIDENCE
82 Verification of Evidences
(a) Ways in which debtors’ population may be stratified are as under:
 By product
 By customers or category of customers
 Geographically
 Terms of sales such as credit terms/Aging
 By values
(b) Views expressed by the team member:
i. The view that if verification of balances of category A and B is carried out than there is no need
to perform further procedures is not correct as the results of audit procedures applied to items
in category A and B will only provide evidence about the items that make up that category
(stratum).
The auditor should obtain sufficient appropriate audit evidence regarding items in categories
C & D as these can also be material.
ii. The view that sampling should be carried out on haphazard basis to ensure equal chance of
selection is not correct as such assurance is only ensured by using random sampling, i.e. use
of random numbers to select items.
iii. The view related to systematic sampling is not correct, as selection of 10% items is not
systematic sampling. Systematic sampling involves, selection of first item on random basis and
then items are selected with a standard gap between them (for example, every 10th item).
Suggestion:
Both haphazard and systematic sampling may be used in the normal manner, either with or without
stratification. However, these methods cannot be used in the manner as suggested by the team
members because it may result in extensive testing on immaterial items, thereby increasing the cost
which may not be efficient. It may also be appropriate to use random sampling to ensure all items in a
population have an equal chance of selection.

83 Rehan Limited
(a) (i) The approach of not sending confirmation requests to balances below Rs. 100,000 is not
correct unless the total of such balances is clearly immaterial.
(ii) The conclusion documented by the team is not correct as the confirmation received from
creditors only confirms the recorded amount and is not relevant for the purpose of testing
of unrecorded liabilities.
(b) (i) The audit team is required to discuss the matter with client’s management and ask them
to send confirmation as per the normal sampling procedure of the audit firm.
In case the management does not agree, the audit team should evaluate the implications of
management's refusal on the auditor's assessment of the relevant risks of material misstatement,
including the risk of fraud, and on the nature, timing and extent of other audit procedures;
(ii) Following information should be tested by the audit team to draw conclusion related to
unrecorded liabilities:
 subsequent disbursements
 unmatched receiving reports (Inventory Cutoff)

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84 Sehat Pharmaceutical Limited

(a) (i) Hospitals and clinics:
The decision to send negative confirmation was appropriate as all the conditions for
sending negative confirmation i.e. Large number of small account balances, low risk of
material misstatement, low exception rate as only four customers have disagreed with the
balances due and that have been also reconciled and there was no knowledge of
circumstances that would cause recipient to disregard the confirmation request.
(ii) Retailers:
Results of confirmations depict high risk of material misstatement and high exception rate.
However, since the decision to send negative confirmation was taken on the basis of initial
assessment, the decision under the circumstances seems correct.
(b) Balance agreed: No further audit work is required.
Balance not agreed: In this case:
 The client should be asked to review the replies and reconcile the balances in its records with
the balances confirmed by the customer.
 The reconciliation prepared by the client should be checked.
 The reconciling items depicting errors in the client’s records should be investigated and
corrected.
 The client should be asked to resolve the difference in case the reconciling items
depicting errors on part of the customers.
No reply received: In these cases, alternative procedures should be performed (e.g. subsequent
payments and checking of invoices/ dispatch notes in order to obtain evidence to confirm the
customer’s balances.
(c) From the winding up event it appears that the amount receivable from SDPL is
irrecoverable. Therefore, the auditor needs to ensure that the amount of irrecoverable
receivables are written off or is duly provided for.
The following substantive procedures should also be performed:
 Review any correspondence of the SPL with the liquidator/management of SDPL (if any),
relating to recovery of the amount due.
 Review the calculation of amount of provision/write off and basis thereof.

85 Nobel
The audit evidences which may be gathered in the cases referred to in the question are as follows:
(i)  Legal Opinion.
 The terms and conditions of the contract related to defective material and liability thereof.
 Quality Control procedures prevalent in the company.

 Documentation of response of other customers, to whom similar items have been supplied.
 Opinion of independent experts.
 Documentation of the Evaluation of the basis of provision.
(ii)  Industry standards.
 Opinion of independent experts (regarding useful life, pattern of wear tear etc.)

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 The environment (production load, maintenance policies etc.) under which the company is
operating and its comparison with other firms in the industry.
 The reasons for sale of equipment (normal case or otherwise)

86 Masoom Limited
Using the work of an expert
An auditor may need the opinion of an expert on matters which require professional expertise, other than
accounting and audit.
Example of such circumstances are:
 Valuation of assets such as plants, work of art etc.;
 Determination of quantities such as stockpile, underground mineral etc.;
 Determination of amount using specialized methods like actuarial valuation;
 Measurement of work completed;
 Legal opinions.
Auditor’s Responsibility while using the work of expert
 Evaluate the professional competence of the expert;
 Evaluate the objectivity of the expert;
 Obtain sufficient appropriate audit evidence that the scope of the expert’s work is adequate;
 Evaluate the appropriateness of expert’s work regarding the assertion being confirmed;
 Resolve the inconsistency, if any, between results of the expert and other audit evidence.

87 Sky blue
The investigation of unusual fluctuations and relationships ordinarily begins with inquiries of management,
followed by:
(a) Corroboration of management’s responses, for example, by comparing them with the auditor’s
understanding of the entity and other audit evidence obtained during the course of the audit; and
(b) Consideration of the need to apply other audit procedures, if management is unable to provide
adequate explanation.

88 Direct confirmations 1
(a) A positive external confirmation request asks the respondent to reply to the auditor in all cases,
whether he agrees with the information provided in the confirmation request or not.
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request.
(b) Associated risks and necessary steps to be taken by the auditor.
Positive External Confirmation
The risk associated with such type of confirmation is that the respondent may reply to the
confirmation request without verifying that the information is correct. The auditor is not ordinarily
able to detect whether this has occurred.
The auditor may reduce this risk, by using positive confirmation requests that do not state the
amount (or other information) on the confirmation request, but asks the respondent to fill in the
amount or furnish other information.

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Negative External Confirmation

Risk associated is that when no response is received, there is no explicit audit evidence that
intended third parties have received the confirmation requests and verified that the information
contained therein is correct.
Accordingly, the use of negative confirmation requests ordinarily provides less reliable audit
evidence than the use of positive confirmation requests.
The auditor considers performing other substantive procedures to supplement the use of negative
confirmations.
(c) Negative confirmation requests may be used under one or more of the following circumstances:
(i) The assessed risk of material misstatement is lower;
(ii) A large number of small balances is involved;
(iii) Substantial number of errors are not expected; and
(iv) The auditor has no reason to believe that respondents will disregard their requests.
A combination of positive and negative external confirmations may be used, for example,
where the accounts receivables comprise a small number of large balances and a large number
of small balances.
The auditor may then decide that it is appropriate to confirm all or a sample of the large balances
with positive confirmation requests and a sample of the small balances using negative
confirmation requests.

89 Chill
When planning to use the report the auditor should evaluate the professional competence of the expert.
This will involve considering the expert’s:
 Professional certification or licensing by, or membership in, an appropriate professional body; and
 Experience and reputation in the field in which the auditor is seeking audit evidence.
The auditor should also evaluate the objectivity of the expert. The risk that the expert’s objectivity will be
impaired increases when the expert is in some way related to or dependent on the entity.

90 Sales sampling
(a) (i) Audit efficiency may be improved as the auditor has stratified a population by dividing it into
discrete sub-populations which have an identifying characteristic. The stratification reduces
the variability of items within each stratum and therefore allows the sample size to be reduced
without a proportional increase in sampling risk

(ii) Other ways by which sales population may be stratified are as under:

 By product

 By customers or category of customers

 Geographically

 Terms of sales such as credit, cash, advance etc.

Precaution: sub-categorization/sub-populations need to be carefully defined such that any

sampling unit can only belong to one stratum.

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(iii) Views expressed by Sohail

His view that if verification of total transaction of category A is carried out than there is no
need to perform further procedures is not correct due to the following reasons:
 The results of audit procedures applied to all the items within category A can only
provide evidence about the items that make up that category (stratum).
 The auditor should obtain sufficient appropriate audit evidence regarding items in
Categories B & C as these are also material.
Views expressed by other audit team members
Their view that proper sampling should be carried out from the total population of 640 million
and categorization should be ignored altogether is not correct because stratification helps in
improving the efficiency of the audit.
(b) Circumstances in which an auditor may decide to examine entire population of items that make up
an account balance.
The auditor may decide to examine the entire population in the following circumstances:
 when the population constitutes a small number of large value items.
 when there is a significant risk and other means do not provide sufficient appropriate audit
evidence; or
 when the repetitive nature of a calculation or other process performed automatically by an
information system makes a 100% examination cost effective.

91 PQR
(a) For the purpose of determining the extent of reliance that may be placed on the work of internal
auditor in specified areas, it may be evaluated by:
(i) Inspecting the adequacy of the scope of the work and related programs.
(ii) Determining by means of inspection whether the preliminary assessment of Internal audit
function remains appropriate.
(iii) Obtain evidence that:
 The work is performed by staff having adequate technical training and proficiency as
internal auditors and the work of assistants are properly supervised, reviewed and
documented.
 Sufficient appropriate audit evidence was obtained to serve as a reasonable basis for
conclusions reached.
 Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of work performed.
 Any exceptions/unusual matters disclosed by internal audit are properly resolved.
(b) Important differences between Internal Audit and the External Audit
Independence
Since internal audit is a part of the entity, no matter how autonomous and objective it is., it cannot
reach the level of independence enjoyed by the external auditors.
Objectives
The objectives of internal audit function vary according to management’s requirements. Whereas,
the primary objective of external auditor is to ascertain whether or not the financial statements are
free of material misstatements.

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Reporting
 Report of external auditor is addressed to the members (shareholders) / owners / those
charged with the governance of the entity.
 Internal audit reports are addressed to the management and those charged with the
governance.
 The reporting requirement of the external auditor is determined by the framework under
which the audit is being carried out and by applicable legal and regulatory requirements.
 Reporting requirement of internal audit is based on the objectives/scope of work determined
by the management and those charged with governance.

92 Hard Stone Limited

(a) Substantive procedures for verification of trade debts (excluding receipt from customers)
 Investigate any unexpected or unusual movement/differences between current and prior
period as regards the amounts of trade debts, debtor’s turnover, ageing of receivable and
ratio of debtors to credit sale etc.
 Review of period end reconciliation of subsidiary and general ledger and investigate large
and unusual items.
 Reviewing the period-end bank reconciliation statements with specific reference to the list of
cheques deposited but not credited in the bank.
 Review the following:

 Large or unusual postings in the general ledger.

 Large or unusual balances in subsidiary records including, credit balances, past due
balances and balances exceeding credit limits etc.
 Circularization of confirmations and performance of appropriate follow-up of selected
customer balances at the period end and obtaining and testing reconciliation of balances
confirmed with the book balance.
 Review the ageing schedule and ensure reasonableness of provision based on:
 Discussion with the credit manager.

 Examination of the subsequent collections made.

 Past practice and consistency.

(b) Substantive procedures for verification of stores and spares

(i) Obtain the listing of stores and spares balances at period-end and investigate large or
unusual quantities or amounts.
(ii) Review large or unusual entries in the ledger account.
(iii) Review period end reconciliation of subsidiary and general ledger and investigate large and
unusual items.
(iv) Attend inventory counts at period end and ensure that physical differences are appropriately
recorded and resolved and damaged items if any are identified.
(v) Check valuation of selected items using one or more of the recommended sampling
techniques.
(vi) Identify slow moving items and discuss/determine the impact thereof.

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93 Related parties
(i) Procedure to identify Related Parties
The auditor may perform the following audit procedures to ensure the completeness of the
information provided by management about related parties:
(a) Review prior year working papers for names of known related parties;
(b) Review the entity’s procedures for identification of related parties;
(c) Inquire as to the affiliation of those charged with governance and officers with other entities;
(d) Review shareholder records to determine the names of principal shareholders or, if
appropriate, obtain a listing of principal share-holders from the share register;
(e) Review minutes of the meetings of shareholders and those charged with governance and
other relevant statutory records such as the register of directors’ interests;
(f) Inquire of other auditors currently involved in the audit, or predecessor auditors, as to their
knowledge of additional related parties; and
(g) Review the entity’s income tax returns and other information supplied to regulatory
agencies.
(ii)  Accounting systems may not be effective at identifying and summarizing related party
transactions and balances.
 Related party transactions may not be conducted on normal market terms.
 Related parties may operate through complex structures and therefore may be used to
commit fraud.

94 Kamil Limited
In the scenario, a previously undisclosed related party has been identified. I shall:
 communicate the relevant information to the audit team.
 assess as to why the entity’s system failed to identify or disclose the related party relationship.
 request management to identify all transactions with NL and disclose them accordingly.
 perform appropriate substantive procedures on the newly identified related parties or significant
related party transactions.
 assess the reasonableness of the management’s explanation and;
 evaluate the implications on the audit, if the non-disclosure appears intentional.

95 Direct confirmations 2
(a) The auditor may consider not to circulate the direct confirmation to the customers where:
(i) accounts receivables are immaterial to the financial statements; or
(ii) the response rate is not expected to be adequate; or
(iii) the responses are not expected to be reliable; or
(iv) inherent and control risk in aggregate are assessed at low level.
(v) audit evidence expected to be gathered through other substantive procedures (e.g.
analytical procedures) is sufficient to reduce the audit risk to an acceptable level.
(vi) management requests not to send the confirmation and auditor after satisfying himself
from the reason and explanation given by the management.

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(b) While designing the confirmation request, the auditor considers the following factors:
(i) Assertions being addressed through the direct confirmation.
(ii) Form of the external confirmation requests (i.e. positive or negative or combination of both)
(iii) Prior experience on the audit of similar engagements.
(iv) The nature of the information being confirmed.
(v) The intended respondent.
(vi) Type of information respondents will be able to confirm readily.
(c) The auditor may perform one or more of the following steps:
(i) Check receipt from customers after balance sheet date.
(ii) When there is no receipt from customers after balance sheet date, the auditor should
consider the following audit procedures:
 Verify validity of purchase orders, if any.
 Verify goods dispatched note other documents duly acknowledged by the customers.
(iii) Obtain explanations for invoices remaining unpaid, if any, after subsequent one have been
paid.
(iv) Examine sales near the period end to provide audit evidence about cut-off assertion.

96 Working papers
The auditor should consider the following factors while determining the form, content and extent of audit
working papers.
(i) The nature of the audit procedures to be performed;
(ii) The identified risks of material misstatement;
(iii) The extent of judgment required in performing the work and evaluating the results;
(iv) The significance of the audit evidence obtained;
(v) The nature and extent of exceptions identified;
(vi) The need to document a conclusion or the basis for a conclusion not readily determinable from the
documentation of the work performed or audit evidence obtained; and
(vii) The audit methodology and tools used.

97 Al-Shams
(a) (i) Evaluate the company’s procedures for identifying and for properly accounting for related-
party transactions.
(ii) Inquire of management regarding:
 the identity of the entity’s related parties, including changes from prior period;
 the nature of relationship between the entity and these related parties; and
 whether entity entered into any transaction with these related parties during the
period and, if so, the type and purpose of the transactions.
(iii) Inspect information supplied by the entity to regulatory authorities (e.g. SECP, FBR, SBP,
etc.)
(iv) Identify all employee benefit plans and the names of the officers and trustees thereof.

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(v) Review shareholder registers to identity the entity’s principal shareholders.

(vi) Review material investment transactions during the audit period to determine whether the
nature and extent of investments during the period create related parties.
(vii) Review contracts and agreements with key management or those charged with
governance.
(viii) Review significant contracts re-negotiated by the entity during the period.
(ix) Review significant contracts and agreements not in the entity’s ordinary course of business.
(x) Review of internal auditor’s report
(xi) Review of third party confirmations obtained by the auditor
(xii) Minutes of meetings of shareholders and of those charged with governance.
(b) Indicators of dominant influence exerted by a related party include the following:
(i) Significant transactions are referred to the related party for final approval.
(ii) There is little or no debate among management and those charged with governance
regarding business proposals initiated by the related party.
(iii) Transactions involving the related party (or a close family member of the related party) are
rarely independently reviewed and approved.
(iv) The related party has vetoed significant business decisions taken by management or those
charged with governance.

98 Auditor’s expert
Information regarding the competence, capabilities and objectivity of an auditor’s expert may come from
a variety of sources, such as:
 Personal experience with previous work of that expert.
 Discussions with that expert.
 Discussions with other auditors or others who are familiar with that expert’s work.
 Knowledge of the expert’s qualifications, membership of a professional body or industry association,
license to practice or other forms of external recognition.
 Published papers or books written by that expert.
 The auditor’s firm’s quality control policies and procedures.

99 ADL
(a) (i) Statistical and non-statistical sampling
An approach to sampling that has the following characteristics is called statistical sampling:
 Random selection of the sample items; and
 The use of probability theory to evaluate sample results, including measurement of
sampling risk.
A sampling approach that does not have above characteristics is considered non-statistical
sampling.
(ii) Sampling and non-sampling risk
Sampling risk is the risk that the auditor’s conclusion based on a sample may be different
from the conclusion if the entire population were subjected to the same audit procedure.
Non sampling risk is the risk that the auditor may reach an erroneous conclusion for any
reason not related to sampling risk.

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(b) (i) The following shortcomings have been observed in the approach adopted by the Audit Team:
 By ignoring less than Rs. 5,000 debtors, the government debtors and some of the
related parties, for the purpose of sampling, the following important principles have
not been complied with.
 That the auditor should consider the risk of material misstatement on the entire
population.
 That the auditor should attempt to ensure that all items in the population have a
chance of selection.
 In stratification, the audit efforts are directed towards larger value items. However, the
audit planning documentation should explain why the only 10 debtors out of 50 largest
debtors were selected.
(ii) Alternative means of sampling material balances is as follows:
Stratification
This would involve dividing the sample into discrete sub-populations (stratum) which have
an identifying characteristic. In our case, the population may be stratified by monetary value.
For example, following strata may be created:
 Above Rs. 1,000,000
 Between Rs. 500,000 and Rs. 1,000,000
 Below Rs. 500,000
The sample may be made from each strata allowing effort to be directed to the larger value
items.

100 Guava & Co

(a) After the assembly of the final audit file has been completed, the auditor shall not delete or discard
audit documentation of any nature before the end of the retention period.
The firm should establish its own policies and procedures for the retention of engagement
documentation. The retention period for audit engagement ordinarily is no shorter than five years
from the date of auditor’s report.
(b) Changes in the audit documentation during the final file assembly process may only be made if
they are administrative in nature. Examples of such changes include:
(i) Deleting or discarding superseded documentation;
(ii) Sorting, collating and cross referencing working papers;
(iii) Signing off on completion checklist relating to file assembly process;
(iv) Documenting audit evidence that the auditor has obtained, discussed and agreed with the
relevant members of the engagement team before the date of the auditor’s report.
(c) The auditor must respond appropriately to facts that become known to the auditor after the date of
the auditor’s report, that, had they been known to the auditor at that date, may have caused the
auditor to amend the auditor’s report.

Examples might include:

 Evidence as to the valuation of assets e.g. the agreement of a sale price significantly lower
than previously recorded for the disposal of a large property portfolio.

 Evidence that brings into question the appropriateness of the going concern assumption, for
example the non-renewal of financing.

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 The resolution of a legal case for an amount that is materially different from the expected
liability recorded in the financial statements.

 The bankruptcy of a major client.

In this relation the auditor should document:

(i) The circumstances encountered.

(ii) The new or additional audit procedures performed, audit evidence obtained, and conclusion
reached, and their effect on the auditor’s report.

(iii) When and by whom the resulting changes to audit documentation were made and reviewed.

101 RP planning
The steps that I as an auditor would consider as part of the audit planning to ensure that all related party
relationships and transactions are identified and disclosed in the financial statements are as follows:
(a) Obtaining an understanding of the controls, if any, that management has established to identify,
account for, and disclose related party relationships and transactions in accordance with the
applicable financial reporting framework.
(b) Inquiring of the management regarding:
(i) The identity of the entity’s related parties, including changes from the prior period;
(ii) The nature of relationships between the entity and these related parties; and
(iii) Whether the entity entered into any transactions with these related parties during the period
and, if so, the type and purpose of the transactions.
(c) Inspecting the following documents for indications of the existence of related party relationships or
transactions that management has not previously identified or disclosed:
(i) Bank and legal confirmations
(ii) Minutes of meetings of shareholders and of those charged with governance; and
(iii) Any other records or documents as the auditor considers necessary (e.g. Form A, Form 29,
Register of members etc.).
(d) Reviewing the extent and nature of business transacted with major customers, suppliers,
borrowers and lenders for indications of previously undisclosed relationships.
(e) Reviewing the significant transactions outside the normal course of business, paying particular
attention to the transaction recognized at or near end of the reporting period and inquire of
management:
 The nature of these transactions
 Whether related parties are involved in these transactions
(f) Once related parties have been identified, the client should provide the details of transactions with
such parties. I as auditor would ensure that these transactions are disclosed appropriately in the
financial statements as per applicable financial reporting framework.

102 Manufacturing inventories

Substantive Procedures
Physical verification:
(i) Evaluate the client’s physical inventory taking instructions and procedures to their staff.
(ii) Attend physical inventory count to observe the inventory count procedures.

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(iii) Ascertain whether the staff members are carrying out the physical inventory count as per
approved instructions issued to them.
(iv) Perform test counts to ensure the efficiency and effectiveness of the physical count
procedures.
(v) Observe the physical inventory count and identify the matters for appropriate follow-up during
the audit. These matters may include the following:
 Excess/ Shortages found in test count performed by the auditors.
 Items of inventory identified as obsolete, slow moving, damaged or defective.
 Details of instances where the approved inventory count procedures are not followed by
the staff members of the client.
 Instances where the stock records (bin cards, stock and stores ledger etc.) do not contain
adequate details relating to balance of inventory in hand, minimum level, maximum level,
ordering level, specification of inventory and location of inventory etc.
 Cut-off procedures and adherence thereto.
(vi) Check that the adjustments arising out of the physical count have been made in the stock
count sheets.
(vii) Check final stock sheets for quantity, pricing, extensions, casting, summarization, and
signatures of the stock taking staff.
Finished Goods:
(i) Obtain a list of items (schedule) shown as finished goods, with full particulars, quantity and
value
(ii) Compare the list with physical count sheet balances and with stock ledger balances
(iii) On test basis check the items and quantities in the stock ledger with the bin card.
(iv) With regard to cut-off procedures performed during the attendance at the physical inventory
count, check the ‘goods outward book’ or ‘delivery outwards’ book for the last few days of
the year, and early few days of the succeeding financial year.
(v) If goods are sold on consignment, check the closing stock with the consignment account.
Work in Process:
(i) Obtain a list of items shown as work in progress, with full particulars, quantity and value.
(ii) Compare the list with physical count sheet balances and with stock ledger balances
(iii) Check the quantity and items included in the list with the production reports and job cards
etc.
(iv) Check records showing the work in progress opening balances, raw material and other
material issued and labour and overheads charged to production and closing balance of work
in process.
(v) Where it is not possible to quantify or value the work in process for technical reasons, the
auditor should consider to use an expert.
Raw material:
(i) Obtain a list of items shown as Raw material, with full particulars, quantity and value.
(ii) Compare the list with physical count sheet balances and with stock ledger balances.
(iii) Verify the cost of raw material appearing in the financial statements by matching with them
with the purchase invoices etc.

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Valuation of Inventories:
(i) Ensure that stock has been valued in accordance with the valuation policy.
(ii) Ensure that inventories have been valued at the lower of cost and net realizable value.
(iii) Ensure that the cost of inventories comprise of purchase price, cost of conversion and other
costs incurred in bringing the inventories to their present location and condition.
(iv) Check that the following costs have not been included in the cost of inventories:
 Abnormal wastes in labour, material or other production overheads.
 Storage costs unless considered necessary for the production process/ inventory.
 Administrative overheads
 Selling and distribution costs
 Financial charges
(v) Examine and perform test checks to verify the proper allocation of overheads is in accordance
with the requirements of IAS 2.
(vi) Where the inventories are valued at net realizable value, check that valuation is correct and
is based on the most reliable evidence.
(vii) Check that the cost of obsolete and damaged items is properly written down.
(viii) Test arithmetical accuracy of the calculation of the stock sheets.
Disclosure:
Ensure that inventories have been disclosed in accordance with the requirements of International
Financial Reporting Standards and the Companies Act, 2017.
General:
(i) Trace opening balance from last year’s working papers.
(ii) Agree closing balance appearing in the financial statements with books of accounts.
(iii) Ensure that inventories have been appropriately classified.
(iv) Obtain direct confirmation for stocks held by third parties.
(v) Check reconciliations of opening and closing balances with production/ sale records, wherever
possible.

103 Framework
(i) Fair presentation framework and compliance framework:
The term fair presentation framework is used to refer to a financial reporting framework that
requires compliance with the requirements of the framework and:
 Acknowledges explicitly or implicitly that, to achieve fair presentation of the financial
statements, it may be necessary for management to provide disclosures beyond those
specifically required by the framework; or
 Acknowledges explicitly that it may be necessary for management to depart from a
requirement of the framework to achieve fair presentation of the financial statements. Such
departures are expected to be necessary only in rare circumstances.
The term ‘compliance framework’ is used to refer to a financial reporting framework that requires
compliance with the requirements of the framework, but does not contain the acknowledgements
of fair presentation framework.

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(ii) Tolerable misstatement and performance materiality

A Tolerable misstatement is a monetary amount set by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is
not exceeded by the actual misstatement in the population.
Performance materiality means the amount or amounts set by the auditor at less than materiality
for the financial statements as a whole to reduce to an appropriately low level the probability that
the aggregate of uncorrected and undetected misstatements exceeds materiality for the financial
statements as a whole. Performance materiality also refers to the amount or amounts set by the
auditor at less than the materiality level or levels for particular classes of transactions, account
balances or disclosures.

104 MWL
(a) Selection of Accounts Receivable for circulation at year-end
(i) The debtors listing will be stratified in accordance with the different market segments (Super
markets, whole sellers, retailers and five star hotels)
(ii) For positive circulation the selection may be as follows:
 All twelve super markets, as well as the seven five star hotels will be purposely selected
(59% of the total debtors balance will be covered in this manner).
 Whole sellers and retailers will be stratified further according to value and days
outstanding. A sample will be made from the above-mentioned sub-populations, with
greater focus on the high value and long-outstanding populations.
 Debtors with nil and credit balances, as well as overdue debtors should also be selected.
(iii) A negative circulation of non-selected debtors may be considered on sample basis.
(b) Situation where a debtor confirms a balance which is different from the amount appearing
in the confirmation request:
A response that indicates a difference between information requested to be confirmed and
information provided by the confirming party is termed as exception. The exception may be on
account of:
(i) Timing difference
(ii) Misstatement
 In case of timing differences, the auditor will need to reconcile the amount confirmed by the
confirming party and the amount sent for confirmation.
 If the amount cannot be reconciled, the auditor is required to evaluate whether it is indicative
of a fraud or deficiency or deficiencies in the entity’s internal control over financial reporting.
 In either case, the auditor will consider whether he needs to revise his risk assessment and
audit procedures.

105 BPR
(a) Substantive Procedures for verification of Bank reconciliation statements:
 Trace and agree balances per books of accounts (ledger or bank book) as appearing in the
bank reconciliation statement with the general ledger/ bank book.
 Trace and agree balances per bank statement as appearing in the bank reconciliation
statement with the bank statements.

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 Trace reconciling items appearing in the previous month’s bank reconciliation into current
month’s ledger/ bank statement/ bank reconciliation statement.
 Check subsequent clearance of current months reconciling items.
 Review and discuss long outstanding items appearing in the bank reconciliation statement.
 Ensure that all outstanding items requiring adjustments are properly accounted for in the
books of accounts.
 Check arithmetical accuracy of reconciliation statements.
(b) Substantive Procedures for Payroll:
 From the payroll record:

 Select a sample of newly appointed staff and check their salaries with the appointment
letter.
 Select a sample of other staff (appointed in previous years) and check their salaries with
the increment letter.
 In both the above cases check that allowances and deductions are in accordance with
the company’s policies or the relevant legal requirements.
 Select a sample of payroll summaries and:

 Check that payroll summary has been approved by an appropriate authority.

 Trace totals of payroll summaries to appropriate general ledger accounts.

 Check allocation of payroll to cost of sales and operating expenses.

 Compare net payroll after deductions with transfer letter issued to the bank.
 Carryout analytical review by comparing the monthly and annual payroll and inquire reasons
for significant fluctuations.
 Ensure that payroll costs have been properly disclosed in the financial statements.
(c) Substantive Procedures for Raw material purchases:
 Select a sample of transactions and carryout the following tests.

 Check weather appropriate measures have been taken as per the company’s policy to
ensure that purchases are made from most competitive sources.
 Check the relevant invoices.
 Match invoices with
M goods receiving notes to ensure that goods have been received for
all billings made by supplier.
 Match supplier’s invoices with purchase orders to ensure that:

 Purchases were duly authorized.

 Rates and quantities mentioned on the invoice are same as those mentioned on the
purchase order.
 Check posting of supplier’s invoices to creditor’s accounts/ general ledger.

 Perform cut-off procedures

P on purchases.
 Perform analytical procedures on purchases made during the year by comparing current year
purchases with the last year and investigate significant differences, if any.

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106 Taskeen Co
(a) Sampling risk
Sampling risk is the possibility that the auditor’s conclusion, based on a sample, may be different
from the conclusion reached if the entire population were subjected to the audit procedure.
The auditor may conclude from the results of testing that either material misstatements exist, when
they do not, or that material misstatements do not exist when in fact they do.
Sampling risk is controlled by the audit firm ensuring that it is using a valid method of selecting
items from a population and/or increasing the sample size.
Non-sampling risk
Non-sampling risk arises from any factor that causes an auditor to reach an incorrect conclusion
that is not related to the size of the sample.
Examples of non-sampling risk include the use of inappropriate procedures, misinterpretation of
evidence or the auditor simply ‘missing’ an error.
Non-sampling risk is controlled by providing appropriate training for staff so they know which audit
techniques to use and will recognise an error when one occurs.
(b) Sample selection methods
The audit manager suggests checking all invoices, effectively ignoring any statistical sampling; in
other words this is not statistical sampling. Audit tests will be applied to all of the sales invoices.
This approach may be appropriate for the audit of Tam because:
 The population is relatively small and it is likely to be quicker to test all the items than spend
time constructing a sample.
 All the transactions are not large but could be considered material in their own right, e.g.
compared to project. As all the transactions are material, then they all need to be tested.
The audit senior suggests using statistical sampling. This will mean selecting a limited number of
sales invoices from the population using probability theory ensuring a random selection of the
sample and then applying audit tests to those invoices only. This approach may be appropriate
because:
 The population consists of similar items (i.e. it is homogeneous) and there are no indications
of the control system failing or changing during the year. There is the query about how long
it will take to determine and produce a sample, which may make statistical sampling
inappropriate in this situation.
The audit junior suggests using ‘random’ sampling, which the junior auditor appears to understand
as manually choosing which invoices to look at. The approach therefore involves an element of
bias and is not statistical or true ‘random’ sampling.
While this approach appears to save time, it is not appropriate because:
 The sample selected will not be chosen ‘randomly’ but on the whim of the auditor. Human
nature will tend to avoid difficult items for testing.
 Also, as invoices will not have been chosen using statistical sampling, no valid conclusion
can be drawn from the results of the test. If an error is found it will be difficult extrapolating
that error on to the population.
(c) Materiality
Information is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular circumstances of its
omission or misstatement.

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It is important that the auditors of Tam ensure that the financial statements are free from material
error for the following reasons:
 There is a legal requirement to audit financial statements and present an opinion on those
financial statements. If the auditors do not detect a material error then their opinion on the
financial statements could be incorrect
 There are only two owner/directors who will be the initial users of the financial statements.
While the owners/directors maintain the accounting records, the directors will want to know
if there are material errors resulting from any mistakes financial statements are materially
correct
 There are also other users of the financial statements who will include the taxation authorities
and the bank who have made a loan to the company. They will want to see ‘true and fair’
accounts. The auditors must therefore ensure that the financial statements are free from
material misstatement to avoid any legal liability to third parties if they audit the financial
statements negligently.

107 Wings
(a) Use of the work of the internal auditors by external auditors
Sales and ticketing
(i) The sales function is likely to be integrated with the accounting and internal control system
used to produce the figure in the financial statements for revenue, on which the external
auditor reports.
(ii) The internal auditors' work on the ticketing system is less likely to be useful because it relates
to an operational area which does not have a direct impact on the financial statements.
There are, however, regulatory matters that may need to be considered by the external
auditor. Ticketing may also have an indirect effect, because it is likely to be integrated with
the sales system and there is likely to be some crossover between the controls over ticketing
and controls over sales generally. The work of the internal auditors is therefore likely to be
of some use to the external auditor.
Fleet acquisition and maintenance
(iii) The internal auditors' work on the fleet acquisition system is likely to be very relevant to the
external auditors because owned aircraft and leased aircraft will constitute a substantial
element of statement of financial position assets and liabilities, and depreciation and finance
charges in the income statement,
(iv) Much of the internal auditors' work is likely to relate to ensuring that company policy has
been complied with. Policy will relate to the authorisation for and acquisition of aircraft, and
accounting for aircraft in terms of the correct classification of leases (operating or financing)
and depreciation policy, for example. Company policy is likely to be extensive and detailed
for such material items and external auditors will be concerned to ensure that it is both
appropriate and has been complied with.
(v) It is also possible that the internal auditors' work may involve some verification of the income
statement/statement of comprehensive income and statement of financial position entries at
the year-end. Given the likely materiality of the amounts involved, this work will also be of
interest to the external auditors.
(vi) It is possible that the internal auditors' work may also relate to the quality of aircraft, and
other operational aspects of fleet management. These issues may also be relevant to the
external auditors, at least insofar as they relate to compliance with laws and regulations.

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(vii) In relation to maintenance, the internal auditors' work is likely to relate to the authorisation
and correct accounting for maintenance expenditure (capitalisation or expensing), and on
the operational side, to the quality thereof, as for fleet acquisition (above). Maintenance
expenditure in the income statement/statement of comprehensive income may well be
material and the work of the internal auditors is therefore of interest to external auditors.
Trade payables and long-term debt financing
(viii) The extent of the external auditor's interest in the internal auditors' work on trade payables
and long-term financing will depend on the materiality of the amounts involved. Trade
payables (for certain types of routine maintenance, and payables due to the service
organisations, for example) may be material. Long-term debt financing is very likely to be
material as many airlines have substantial debt financing.
(ix) Internal audit work on trade payables is likely to involve ensuring that routine internal controls
are properly designed and are operating. The external auditors may well be interested in the
internal auditors' work in this area.
(x) There are substantial financial statement disclosures required for debt financing. The
internal auditors' assistance with ensuring that disclosures are properly made, as well as
with ensuring that any covenants have been complied with and that the accounting for the
financing is appropriate, may also be helpful to the external auditors.
(b) Quality of internal audit function: extent of reliance
(i) The quality of the internal audit function will have a significant effect on the extent of the
external auditor's reliance. If the quality of work is not adequate, reliance will not be possible,
regardless of the extent and relevance of the work performed.
(ii) The firm will seek to ensure that there is an appropriate structure within the department itself,
with appropriate reporting lines outside the department, preferably reporting to the audit
committee.
(iii) The internal audit function has recently been expanded and there are likely to be changes
in the way that it is organised. The function should have operational independence within
the organisation and formal terms of reference that encompass the recent changes made.
(iv) The function should have a clearly defined set of operating procedures, as well as a work
program. Proper documentation of all work performed is essential.
(v) Staff should be appropriately trained, experienced and qualified. The head of such an
important department should preferably be professionally qualified.
(c) Audit evidence: outsourced functions
(i) Internal controls exercised by the company over in-flight catering and payroll must be
properly designed and operated. The firm will seek to review documentation of controls and
internal audit reports. It will seek to obtain evidence that controls have been applied.
(ii) A breach of regulations or deterioration in the quality of catering could both have a significant
effect on the financial statements, particularly if fines were payable or adverse publicity was
likely. Enquiries into both areas and a review of relevant documentation provided by, for
example, food licensing authorities to the company or the service organisation, and company
lawyers (in relation to passenger complaints, perhaps) will be necessary.
(iii) Evidence of controls sought by the firm will include:
 controls over the selection of the service organisations selected (by competitive
tendering, for example);
 evidence relating to the completeness, accuracy and timeliness of information
provided to, and received from, the payroll organisation (batch summaries and
exception reports, for example);

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 evidence relating to the security measures taken by the payroll organisation to ensure
that confidential information is kept confidential;
 evidence relating to the security measures taken by the catering organisation to
ensure that health and safety standards are maintained and that no 'sabotage' of the
food can take place.

108 Glasses2Go
(a) Purposes of audit working papers
The purposes of audit working papers include:
 To assist with the planning and performance of the audit.
 To assist in the supervision and review of audit work, and
 To record the audit evidence resulting from the audit work performed to support the auditor’s
opinion.

(b) Documentation Information obtained

Memorandum and Details of the objectives of Specs4You, its permitted capital
articles of association structure and the internal constitution of the company.
Most recent published Provide detail on the size of the company, profitability, etc. as well
financial statements as any unusual factors such as loans due for repayment
Most recent management Determine the current status of the company including ongoing
accounts/budgets/ cash profitability, ability to meet budget, etc. as well as identifying any
flow information potential going concern problems.
Organisation chart of To identify the key managers and employees in the company and
Spec4You other people to contact during the audit.
Industry data on To find out how Specs4You is performing compared to the industry
spectacles sales standards. This will help to highlight any areas of concern for
example, higher than expected cost of sales, for investigation on
the audit.
Financial statements of To compare the accounting policies of Specs4You and obtain
similar entities additional information on industry standards.
Prior year audit file To establish what problems were encountered in last year’s audit,
how those problems were resolved and identify any areas of
concern for this year’s audit.
Internet news sites To find out whether the company has any significant news stories,
(good or bad) which may affect the audit approach.

(c) Working paper

The audit working paper does not meet the standards normally expected in a working paper
because:
 The page reference is unclear making it very difficult to either file the working paper in the
audit file or locate the working paper should there be queries on it.
 It is not clear what the client year end date is – the year is missing. The working paper could
easily be filed in the wrong year’s audit file.
 There is no signature of the person who prepared the working paper. This means it is unclear
who to address queries to regarding the preparation or contents of the working paper.
 There is evidence of a reviewer’s signature. However, given that the reviewer did not query
the lack of preparer’s signature or other omissions noted below, the effectiveness of the
review must be put in question.

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 The test ‘objective’ is vague – it is not clear what ‘correct’ means for example, it would be
better to state the objective in terms of assertions such as completeness or accuracy.
 The test objective is also stated as an audit assertion. This is not the case as no audit
assertions are actually listed here.
 It is not clear how the number for testing was determined. This means it will be very difficult
to determine whether sufficient audit evidence was obtained for this test.
 Stating that details of testing can be found on another working paper is insufficient – time
will be wasted finding the working paper, if it has, in fact, been included in the audit working
paper file.
 Information on the results of the test is unclear – the working paper should clearly state the
results of the test without bias. The preparer appears to have used personal judgement
which is not appropriate as the opinion should be based on the facts available, not
speculation.
 The conclusion provided does not appear to be consistent with the results of the test. Five
errors were found therefore it is likely that there are some systems weaknesses.

109 ISA 620

Reliance on the work of an auditor’s expert
(i) Likely areas of reliance
 Legal opinions, for example, the expert’s opinion should be consistent with the results
ongoing court case.
 Specialist valuation areas, such as property.
 Determination of stage of completion of complex work-in-progress in the audit of inventories.
 Determination of likely realisable value of assets, such as plant which is possibly obsolete,
to see if a write-down is needed.
(ii) Assessing the work of an expert
The audit firm should carry out the following procedures.
 Assess the competence, capabilities and objectivity of the expert.
 Obtain an understanding of the field of expertise of the auditor’s expert. This must be
sufficient to allow the auditor to determine the nature, scope and objectives of the expert’s
work and evaluate the adequacy of that work.
 Agree the terms of engagement with the expert, including:
- the nature, scope and objectives of the expert’s work
- the respective responsibilities of the expert and the auditor
- the form of the expert’s report
- confidentiality requirements
 Evaluate the adequacy of the expert’s work, including the:
- reasonableness of the expert’s conclusions
- consistency of those conclusions with other audit evidence
- reasonableness of significant assumptions and methods used
- relevance, completeness and accuracy of source data.

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110 Cuddly World

(a) Procedures
(i) Use in gathering audit evidence
Analytical procedures consist of evaluations of financial information made by a study of
plausible relationships among both financial and non-financial data.
Inquiry means to seek relevant information from sources, both financial and non-financial,
either inside or outside the company being audited. Evidence may be obtained orally or in
writing.
Inspection is the physical review or examination of records, documents and tangible assets.
It may include examination of records for evidence of controls in the form of a compliance
test.
Observation involves looking at a process or procedure as it is being performed to ensure
that the process actually works as documented.
Recalculation means the checking of the mathematical accuracy of documents or records.
(ii) One example for each method
(1) Analytical procedures
Review of sales income year on year to try to identify whether income has been under-
stated, possibly by cash being taken prior to banking. There is no control over the
opening of post so cash could be withdrawn by one assistant, and the deficit made up
by a fraud on customers.
(2) Inquiry
Obtain statements from suppliers to check the completeness of liabilities at the end
of the year. As there is no control over purchases, invoices could have been
misplaced resulting in a lower purchases and suppliers figure.
(3) Inspection
The assets of the company, namely cuddly toys in inventory at the end of the year,
can be inspected to ensure all inventory is recorded and that the toys are saleable in
their current condition.
(4) Observation
Procedures such as the opening of cash and recording of customer orders can be
observed to ensure that the administrator is recording all orders in the sales day book
and cash books.
(5) Recalculation
Checking additions in the cash book to confirm that the total amount of cash recorded
is accurate and can be included in the sales figure (cash receipts normally equal sales
because there are no receivables).
(b) Suitability for Cuddly World
(1) Analytical procedures
This method of collecting evidence will be useful in Cuddly World because it will help to
identify unusual changes in income and expenditure. As Cuddly World is a relatively small
company, monitoring gross profit will show relatively small changes in sales margin or
purchasing costs. Decisions by Mr Kabir to amend margins can therefore be traced into the
actual sales made.

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However, the technique may be limited in its application because it will not detect errors or
omissions made consistently year on year. If either assistant is defrauding the company (for
example by removing cash) each year, then analytical procedures will not detect this.
(2) Inquiry
Inquiry evidence will be very useful in the audit of Cuddly World, especially where this is
derived from third parties. Third party evidence is generally more reliable than client
originated evidence as there is a decreased likelihood of bias. Suppliers can therefore be
verified using statement reconciliations. A review of any customer complaints file (if those
letters are kept) will also help to identify any orders that have not been despatched.
External inquiry evidence will be less useful in the audit of sales and receivables because
goods are paid for prior to despatch – there are no receivables. Internal evidence will be
available from Mr Kabir and the assistant; however the lack of segregation of duties means
that this will not be so reliable.
(3) Inspection
Inspection of documents within Cuddly World will be useful, particularly regarding checking
whether expenses are bona fide. All purchase invoices, for example, should be addressed
to Cuddly World and relate to purchases expected from that company e.g. cuddly toys for
resale, office expense etc.
Inspection of documents can take a long time, however, given the poor internal control
system within Cuddly World, the auditor may have no choice but to use this method of
gathering evidence.
The fact that an invoice is addressed to the company does not confirm completeness of
recording so inspection of the cash book for unusual payments verified by checking the
purchase invoice will also be required. Additional substantive testing would also be required
due to poor controls.
(4) Observation
Observation may be useful because it will show how the assistants check documents.
However, no information is provided on any internal controls with Cuddly World so simply
viewing how documents are checked without any evidence of checking has limited benefit.
Observation tests will be of limited usefulness because the assistants may act differently
when an auditor is present. The same problem will apply to any observation checking carried
out by Mr Kabir.
(5) Recalculation
Recalculation evidence is very useful for checking additions on invoices, balancing of control
accounts etc. This means that the arithmetical accuracy of the books and records in Cuddly
World can be confirmed.
The main weakness of recalculation checking is that calculations can only be carried out on
figures that have been recorded. If there are any omissions then checks cannot be carried
out.

111 Auditors
(a) Key substantive procedures for verification of provisions include the following:
(i) Ensure that all provisions have been recognized in accordance with the IAS 37.
(ii) Review the measurement of the closing balance for each provision and discuss these with
management if appropriate. Consider whether it might be appropriate to take expert advice
on the existence or measurement of a provision.

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(iii) Review the board approval related to provisions booked in the financial statements.
(iv) Review the list of provisions for possible omissions, based on the auditor’s knowledge of
the business and the industry in which it operates.
(v) Relate the testing of provisions to other areas of the audit work, such as correspondence
with lawyers/minutes of Board of director’s meeting (which might reveal more information
about matters to which the provisions relate).
(vi) Compare provisions for the current financial year with provisions in previous years, and
investigate any major differences or omissions.
(vii) R eview the subsequent events to ensure completeness of provisions.
(b) Factors to be considered by auditor in deciding sufficiency of audit evidence:
The decision relating to sufficiency of audit evidence depends upon the judgment of the auditor.
Apart from professional judgment, following factors are also relevant in determining the sufficiency
of audit evidence.
(i) the seriousness of the risk that the financial statements might not give a true and fair view;
when this risk is high, more audit evidence will be required
(ii) the materiality of the item
(iii) the strength of the internal controls in the client’s accounting systems
(c) In order to evaluate the adequacy of internal audit function, the external auditor should assess
whether:
(i) The work was properly planned, performed, supervised, reviewed and documented;
(ii) Sufficient, appropriate evidence was obtained to enable internal auditors to draw
reasonable conclusions;
(iii) Appropriate conclusions were reached, consistent with any reports prepared;
(iv) Any exceptions or unusual matters were properly resolved.
(d) Physical access controls over an IT System might include:
(i) Doors and door-locks
(ii) Alarms
(iii) Surveillance camera or video
(iv) Cables that allow a user to lock a laptop to a desk
(v) Fingerprints readers to log-in to a system
(vi) Lockable briefcase
(e) Professional Skepticism:
It refers to an attitude that includes a questioning mind, being alert to conditions which may
indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
However, it does not mean that the auditors should disbelieve everything they are told, but they
should view what they are told with a skeptical attitude, and consider whether it appears
reasonable and whether it conflicts with any other evidence.
(f)  Perform other audit procedures to attempt to resolve the matter or finalize your view point.
 Consider the effect of the above on reliability of other representations and the audit
evidence.

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 Consider whether the risk assessment remains appropriate and if not, revise the risk
assessment and determine the nature, timing and extent of further audit procedure. The
auditor may also reconsider assessment of the competence, integrity, ethical values or
diligence of the management.
 If the auditor has concerns about the integrity of management, he should document those
concerns and consider withdrawing from the audit and the impact on the report.
(g) The factors which determine the extent to which analytical procedures may be used as a form of
substantive procedures are as follows:
 suitability of particular substantive analytical procedures for given assertions;
 reliability of data from which the auditor's expectation of recorded amounts or ratios is
developed;
 whether the expectation as regards the recorded amounts is sufficiently precise to identify
a misstatement that, individually or when aggregated with other misstatements, may
cause the financial statements to be materially misstated.

112 Analytical procedures and materiality

(a) Possible reasons for changes in ratios

All of the changes noted below may also be due to simple accounting errors or, in some cases,
misappropriation of inventory or cash.

(i) Increase in current ratio

An increase in the current ratio may indicate increased inventory, cash or receivables levels.
The implications of this may be that the company is expanding, or alternatively that it is
experiencing trading difficulties and is unable to sell its inventory or to collect its receivables.
An increase may also be due to a decrease in trade payables or other current liabilities.

(ii) Decrease in gross profit margin

A decrease in the gross profit margin may indicate that the cost of raw materials or bought-
in goods has increased, or that discounts or selling prices have decreased. This may not
be a bad thing if the reason for this is an overall increase in revenue.

(iii) Increase in inventory holding period

The inventory holding period indicates the number of days the company could continue to
trade if supplies were to cease. The longer the period, the higher the level of inventory held.
Inventory holding involves expenditure. Generally, the lower the figure the better provided
that the company does not run out of inventory. An increase can indicate that the company
is unable to sell its inventory. An increase can also indicate that the company is expecting
additional sales, or simply that the business is expanding. Many businesses are cyclical
and increases and decreases are to be expected.

(b) Materiality

Concept

Information is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of financial statements. Materiality depends on the size of the item or
error judged in the particular circumstances of its omission or misstatement. So what might be
material in one year might not be material the next, and what might be material to one company
might not be to another.

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Effect on audit work

The quantitative aspects of materiality are often, in practice, calculated as percentage of revenue,
profit before tax or assets, or a particular class thereof. Auditors calculate materiality for the
financial statements as a whole and calculate performace materialty for individual account areas.
They look at the aggregate (net) effects of misstatements and omissions for the financial
statements as a whole. Companies sometimes adjust the accounting records and financial
statements for immaterial items, sometimes they do not.

Materiality is related to risk and used in the calculation of sample sizes and tolerable misstatement,
and in the performance of analytical procedures. Less work is performed in immaterial areas than
in material areas, although some work is always performed because an area that may appear to
be immaterial may, when tested, provide to be material.

113 Tahira Transporters

(a) Audit test Reason for test
Discuss with booking clerk how orders are The main problem with the sales system in TT is
recorded from the customer. the lack of evidence for the receipt of the telephone
order. checks are therefore required to ensure that
orders are completely and accurately recorded in
the VMS where no input document is available.
Discuss with the directors the recruitment To check on the personnel controls in TT which will
and training of booking clerks. be designed to minimise loss of customer orders.
To ensure that staff have appropriate skill and
training to operate the ordering system without
losing customer orders.
With client’s permission, attempt to enter To confirm the completeness and accuracy of
orders into the VMS from an input terminal. recording of orders by the computer system.
For the sample of confirmed e-mail orders To check for accuracy of transfer of information
held in the e-mail programme, trace details from the e-mail to the VMS.
onto the VMS ensuring that details of The method of filling of the e-mails means that
vehicle hire regarding time and dates are completeness of e-mail orders cannot easily be
accurately recorded. determined. Audit software may be able to re-sort
the orders.
Review hard copy customer complaint files To check for evidence of orders being sent by
and e-mail files on computer for evidence of customers but not entered into TT’s sales system.
unfilled orders.
For a sample of bookings in the VMS, trace To check for completeness of transfer of
details to the list of sales invoices raised information between the two programmes. The
maintained in the receivables ledger test can be carried out manually or using test data.
programme. Manual testing may be difficult where there is no
obvious audit trail between the two systems.
For a sample of sales invoices in the VMS, To check for accuracy of charging for each
trace details to the list of sales invoices individual vehicle hire. Evidence of undercharge
raised maintained in the receivables ledger would indicate that sales are understated.
programme.
Cast the list of invoices in the receivables To ensure that the total sales for that month are
ledger programme for one month. Trace accurate. Transfer of data to the nominal ledger
total sales to the general ledger ensures that the total sales amount is recorded
programme. correctly in the ledger.
Cast the monthly sales figures in the The final cast and checking ensures that the
general ledger and agree to the financial financial accounts figure is accurate.
statements. Investigage any Casting tests can be carried out manually or using
discrepancies. computer audit software.

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(b) Audit work

 Obtain non-current asset register from client. Cast the cost, depreciation and net book value
columns of the register and agree to the financial statements of TT.
For a sample of new additions in the non-current asset register:
 Agree to board minute or similar documentation for evidence of authority to purchase
vehicle. (Occurrence assertion)
 Agree to the physical asset to confirm existence of the vehicle. Where the vehicle is on hire
during the audit visit, obtain alternative evidence of existence such as payment from
customer near year end for hire (Existence assertion)
 Check the physical condition of the vehicle to ensure that repairs and renewal expenditure
is not being understated. (Existence of repair expenditure)
 Agree details to purchase invoice or similar document for evidence of ownership.
(Ownership assertion)
 Test the calculation of depreciation in the non-current asset register, ensuring that the rates
used are those disclosed in the financial statements. (Valuation assertion)
 Review profits and losses generated on sale of vehicles and ensure these are not excessive.
If they are check the accuracy of the depreciation rates used as this may indicate over or
under charge of depreciation. (Valuation assertion).
 Compare sales income to sale of similar vehicles with similar mileage and ensure
comparable.
For a sample of disposals during the year (for occurrence assertion):
 Ensure asset has been removed from the non-current register
 Check calculation of profit or loss on sale
 Agree receipt on sale to the cash book
For a sample of vehicles purchased durin the year, agree details to purchase invoice and purchase
day book (PDB) ensuring details recorded in the correct year. (Occurrence assertion)
For a sample of vehicle purchases in the PBD, agree details to the non-current asset register.
(Completeness assertion)
Agree totals in non-current asset register to the financial statements, ensuring vehicles are
disclosed separately in the non-current asset note (material item). (Disclosure assertion)
Ensure that the accounting policy for depreciation is clearly stated in the financial statements and
is the same as last year. (Disclosure assertion)

114 Willow
(a) Initial audit procedures
Clerical accuracy
This schedule has been prepared by the company’s accountant. If I am to use the schedule as
the basis for planning and performing my audit. I must first ensure that it is correct in accordance
with the company’s books and records. I would, therefore:
 verify the schedule to and from accounts recorded in the nominal ledger and with the draft
financial statements;
 check the correctness of additions and other calculations on the schedule.
The basis for this procedure is that of professional scepticism which requires making no
presumption as to the accuracy of information provided by management.

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Opening balances
I would check that the opening balances are in agreement with the balances in the previous year’s
audit file. This is for two reasons:
 To ensure that any amendments to the previous year’s closing balance agreed at audit had
been properly recorded in the company’s books and records.
 With plant and equipment most audit procedures are applied to transactions that change the
balance. Reliance is placed on audit procedures performed in previous years in verifying
assets brought forward at the beginning of the year.
(b) Audit procedures additions
Existence
 Vouch additions to suppliers’ invoices.
 Examine goods inward notes or evidence confirming delivery of the items prior to the year
end.
 Examine purchase orders, requisitions and other evidence, such as Board approval, that the
purchase had been properly authorised.
 Physically examine some of the items confirming description and serial numbers to the
invoice.
Completeness
 Analyse repairs and maintenance to ensure that no items charged to this account should not
have been capitalised.
 Scrutinise the company’s capital budget and capital commitments recorded in the previous
year’s financial statements for details of proposed additions and enquire as to why any such
items are not recorded as additions.
Rights and obligations
 Ensure that the purchase documentation assigns ownership rights to the company.
Valuation
 Ensure that the amount recorded as additions is in accordance with the cost on the purchase
invoice including all matters properly included, such as delivery, but excluding amounts that
should not be capitalised, such as the cost of removal of plant being replaced. Where other
costs are capitalised, such as own labour for assembly and testing, I would verify the
amounts as appropriate.
Presentation and disclosure
 Ensure that the items properly meet the definition of plant and equipment and are properly
recorded as such.
(c) Revaluation
Competence and objectivity of the valuer
My prime concern would be that the valuer is an employee of the entity. Nevertheless, I may be
prepared to accept the valuation although I would need to be satisfied that the valuation has been
performed with sufficient objectivity that it represents sufficient, appropriate audit evidence. This
depends on factors such as the materiality of the amounts involved and the available of
corroboratory evidence. The revaluation is certainly substantial representing a gain of Rs 144m
on property, plant and equipment having a written down value of Rs.603m.

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It is a common practice for interim valuations to be undertaken by valuers employed by the entity
providing they are confirmed by less frequent independent valuations, such as every five years. If
this is the practice I would examine the record of past valuations to see if the employee’s valuations
tended to be confirmed by the independent valuations.
I would also enquire into the professional qualifications and experience of the valuer to ensure that
he or she is both suitably qualified to perform valuations and sufficiently experienced in valuations
of the type undertaken.
Scope of work
I would obtain a copy of the valuer’s report and:
 check that the valuation given in the report is consistent with the valuation recorded in the
financial statements;
 check that the basis of valuation is consistent with an acceptable basis of financial statement
valuations, such as open market value and, in particular, that it relates to the property as it
is and does not anticipate future uncertain events such as rezoning for planning, new roads
etc. and
 form a view as to how thoroughly the valuer has undertaken his or her work.
Although the valuer was an employee of the company I would need to ensure that no undue
restriction was placed on the valuer’s access to relevant information having a bearing on the
valuation.
Assessing the work of the valuer
When reviewing the work of the valuer I would expect to see the basis of the valuation explained
and justified in the report. Where practicable I could confirm any data used such as recent
transactions involving similar property. I could also consider the reasonableness of any
assumptions made concerning which I have some knowledge, such as the effect of recent changes
in legislation or in the economic climate.
Conclusion
If I find that:
 the valuer is professionally qualified, and sufficiently experienced,
 the scope of the work is adequate; and
 other evidence corroborates the reliability of the valuation
I would probably be prepared to accept the work of the valuer as an expert providing sufficient
appropriate evidence as to the valuation of the property. My confidence in the valuation would be
enhanced if it were an interim valuation subject to periodic confirmation by independent valuers.
(d) Accumulated depreciation
According to IAS 8 the correction of errors which are the natural result of estimates inherent in the
accounting process are normally dealt with in the income statement in the period in which they are
identified. This would appear to be the accountant’s argument.
An alternative view is that this is a fundamental error and the cumulative adjustments applicable to
prior periods have no bearing on the results of the current period. In this case, as a prior period
adjustment, the benchmark treatment required by IAS 8 is to adjust the opening balance of retained
earnings of retained earnings and to amend the comparative figures for the previous accounting
period. However, the accountant’s proposed treatment is consistent with the allowed alternative
treatment providing it is accompanied by additional pro forma information as required by the
benchmark treatment.

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115 Sparkle Forever

(a) Audit procedures and reasons in relation to inventory count
Audit procedure Reason
Perform an overall review with client staff To check that client’s physical count
to ensure that they are following the instructions are being followed as this will help
client’s physical count instructions. to ensure that the count is complete and
Specifically ensure that: accurate.
 Inventory is divided into appropriate To ensure there is a clear layout of inventory,
sections for recording – perhaps by ensuring items are not missed.
type of jewellery
 Staff are counting in pairs with one Prevents collusion and provides a check over
person checking the inventory and security of inventory (jewellery is high value)
another recording. and that the count sheets are not falsified.
 Appropriate checks are in place to To ensure that inventory is not double-counted
ensure that each item of jewellery is
only counted once.
 The shop is closed during the count. To ensure that there is no confusion regarding
which items are sold.
 Count sheets are pre-numbered. To ensure that no count sheets are lost.
Obtain a sample of inventory items To ensure that the inventory recorded on the
already recorded on the count sheets and count sheets actually exists.
agree to the jewellery inventory.
For a sample of jewellery in the shop, To ensure that all inventory is recorded on the
agree to the count sheets. count sheets – check for completeness of
recording.
Obtain a sample of count sheets, To check that details on the count sheets are
photocopy and place on the audit file. not subsequently amended and for agreement
to the final inventory sheets to ensure
quantities are recorded correctly.
Check all count sheets are returned after Ensures that all sheets are accounted for and
the physical inventory count. inventory is therefore not understated.
Obtain last inventory receipt note and To ensure that cut off is correct. Subsequent
sales invoice numbers. checking should show that goods received
notes post physical count are not included in
payables for the year, and sales invoices after
the physical inventory are not included in sales
for the year.
Review the condition of the jewellery with To check that any inventory which is damaged
the independent valuer. Ensure that there or unsellable is correctly valued.
are no reasons why the inventory could
be obsolete (e.g. due to changes in
fashion) or damaged.
Form an opinion regarding the overall To confirm that inventory quantities have been
accuracy of the physical count. correctly recorded.

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(b) Factors to consider when placing reliance on the work of JJ:

Dandy & Co need to confirm that they actually need an expert. It is not clear whether Dandy & Co
have the necessary skills in-house. However, given that Sparkle Forever is the only client in the
diamond industry, then some assistance would be expected as valuing diamonds is difficult.
Check that the specialist has relevant experience in valuing diamond jewellery. Part of the
appointment process will include checking the work portfolio of JJ to show that they have valued
diamonds in other situations.
Ensure that JJ is a member of an appropriate professional body. This will help ensure that JJ
follows the appropriate ethical standards as these will be enforced by their professional body.
Check that JJ cannot be influenced by the client – for example because they are employed by
Sparkle Forever. Being employed by the client would imply less independence and limit the value
of the specialist’s report.
Check that the report produced by the specialist regarding the valuation of the diamonds appears
to be reasonable. Although Dandy & Co do not have any other clients retailing diamonds, basic
price comparisons for a given weight of diamond could still be obtained from other shops or Internet
site to prove the accuracy of JJ’s figures.
(c) Audit procedures to ensure that jewellery inventory is correctly valued
 The jewellery inventory should be valued at the lower of cost and net realisable value.
 For a sample of jewellery on the final inventory sheets, trace the cost of those items to the
original purchase invoice, ensuring that the description of goods on the invoice matches the
jewellery.
 For jewellery sold after the end of the year, check a sample of sales invoices back to the
final inventory sheets ensuring that the sales value exceeds the cost. Where sales value is
less than cost, ensure that the jewellery is stated at the realisable value on the inventory
sheet.
 Review the report of the professional valuer. Ensure that the inventory is genuine. For the
items checked by the valuer, agree the valuation to the items of jewellery on the inventory
statements. Where there is a difference, for example due to age of the inventory or where it
is unlikely to be sold due to changes in fashion, discuss with the client and agree a realistic
valuation. In these situations, the value should be that provided by the professional valuer.
 Where an item has been in inventory for a long period of time (perhaps over one year), check
the valuer’s report to find out whether any allowance is required.

116 Bubbles
(a) Audit tests on ‘Stockpop’ system during the year
(i) There are two main aspects to the audit of the Stockpop system; those relating to quantities
and those relating to costs, in order to rely on the system as a basis for the figure in the
financial statements I would need to ensure that management had a system for ensuring
that:
 the system was accurate and up-to-date;
 errors were investigated and corrected on a regular basis; and
 each item of inventory was counted at least once a year (in practice items are likely
to be counted more often that this as such systems are often relied on to produce
figures for management accounts).
(ii) I would ask management about the procedures for inventory counting and review the related
documentation, including inventory counting instructions, and form a view as to whether the
system was adequate in principle. I would also review the results of any internal audit work
on the system design (assuming that I considered the internal audit function to be adequate).

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(iii) I would need to obtain evidence relating to the three items noted in (i) above. I would
therefore visit the warehouses during the year, possibly on a rotational basis, to ensure that
the system was being operated in the manner prescribed.
(iv) I would perform certain preliminary analytical procedures to establish which warehouses to
visit (such as those where the records indicated that large volumes of inventories were held,
warehouses that were experiencing problems or had experienced problems in the past, or
warehouses that were considered high risk or other reasons). I might use different offices
of my own firm for these purposes, and/or I would enlist the help of internal audit. I would
review the results of the work already performed by internal audit.
(v) I would ask local staff about the procedures performed, especially about any variations from
the procedures prescribed. I would observe procedures being performed.
(vi) I would test check records of goods received and goods despatched and trace them through
the Stockpop system to ensure that records were accurate and input on a timely basis. I
would ensure that the correct corresponding entries for costs had been made in the
purchases and sales systems.
(vii) I would perform my own test checks of inventory and trace my counts through the Stockpop,
sales and purchases systems.
(viii) I would consider using CAATs (computer assisted audit techniques), including test data and
audit software to establish whether, for example, the system is rejecting entries outside
certain pre-determined parameters (cost per unit for example), and that the system
highlights any old inventory, or any exceptions such as negative inventory quantities.
(ix) I would review all exception reports produced by the system to see if there were any
recurring or old items and to ensure that all errors and exceptions were being dealt with on
a timely basis.
(b) Audit tests on records at year end
(i) I would analytically review the year-end records to establish the overall quantities and costs
of inventories and the quantities and costs of raw materials and finished goods.
(ii) I would ask management about any problems experienced with the system at, or close to,
the period-end and about how they had been dealt with to ensure that they had been
appropriately resolved.
(iii) I would also ask management about the likely level of write-down of either raw materials or
finished goods (inventory being of inadequate quality or spoiled, for example). I would
compare this with prior years and form an opinion as to its appropriateness. I would check
the calculation of the allowance for damaged inventory and review exception reports close
to the period-end.
(iv) I would obtain schedules of the costs and quantities to be included in the financial statements
and trace these back to the output of the Stockpop system noting and substantiating any
significant adjustments.
(v) I would enquire as to how accurate cut-off had been achieved. I would perform cut-off tests
on the records by tracing samples of goods received and despatch notes just before and
just after the year-end to the Stockpop, sales and purchases systems in order to ensure that
costs had been correctly allocated to the correct accounting period. I would also perform
this test in reverse, from the Stockpop, sales and purchases systems through to goods
received and despatch notes.
(vi) I would ensure that the valuation method used by Bubbles was in accordance with IAS 2
Inventories and that, for example, the system was adequate to ensure that finished goods
included an appropriate element of labour and overhead costs.

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117 ISA 500

(a) Four examples of external confirmations
Four examples of external confirmations are:
 Accounts receivable letter
 Solicitor letter
 Bank report letter
 Inventory held by third parties.
(b) Assertions achieved and not achieved by each example (only one example of each required).
Accounts receivable letter
This letter provides evidence of the existence of the receivable when a reply is returned from that
receivable direct to the auditor.
The letter provides evidence on cut-off because sales or cash receipts recorded in the incorrect
accounting period will have to be reconciled to the balance provided by the receivable.
The letter does not provide evidence of completeness of the receivables balance because
receivables may not query balances which are understated.
The letter does not provide evidence of the valuation of the receivables balance because the
receivable cannot be expected to list all outstanding balances and external confirmation of the debt
does not mean it will be paid.
Solicitor letter
A solicitor letter provides evidence as to the existence of claims at the period end as the solicitor
will confirm specific claims.
However, the letter does not necessarily confirm the valuation of claims due to uncertainty about
the future or the completeness of any legal claims as solicitors do not normally provide a list of all
claims – they prefer to comment only on claims they are actually asked about.
Bank report letter
A bank confirmation letter provides good evidence on the existence of the company’s bank
accounts as the bank has confirmed this information in writing.
A bank letter cannot necessarily be relied on to provide complete or accurate information. Most
banks place a disclaimer on the letter of ‘errors and omissions excepted’ indicating that the auditor
must review this evidence against other cash and bank evidence obtained.
Inventory held by third parties
A letter from the third party holding the inventory will provide evidence of the existence of that
inventory because the third party has confirmed this in writing.
However, the letter does not provide evidence regarding the valuation of the inventory; confirming
something exists does not necessarily mean it is in good condition.

118 Javeria Co
(a) Procedure for obtaining a bank letter
The auditor should consider if a bank letter is required. For the audit of Javeria Co the letter is
required as the company has significant cash transactions and a loan from the bank.
The auditor will produce an external confirmation letter in accordance with local audit regulations
and practices.

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The letter will be sent to the client to sign and authorise disclosure and then it will be forwarded on
to Javeria’s bank.
Alternatively, the client may already have provided a standard authority for the bank to respond to
a bank letter each year. In this case separate authority would not be required.
Ideally the letter should be sent before the end of the accounting period to enable the bank to
complete it on a timely basis e.g. at the year-end.
The bank will complete the letter and send it back directly to the auditor.
Audit procedures on the bank letter include:
 Agree the balances for each bank account to the relevant bank reconciliation and the year-
end balance in the financial statements.
 Agree total interest charges on the letter to the interest expense account in the general
ledger.
 For any details of loans, ensure repayment terms are correctly disclosed in the financial
statements between current and non-current liabilities.
(b) Substantive procedures for the audit of bank balances
(1) Obtain a copy of the year-end trial balance.
Agree the bank balance on the trial balance to
 the year-end bank balance on the computer system, and
 the balance on the financial statements.
(2) Obtain a copy of Javeria Co.’s bank reconciliation.
 Cast the reconciliation
 Agree the bank balance to the trial balance.
 Agree the bank statement balance to the year-end bank statement.
 Agree any unpresented lodgements to the bank statement after the end of the year
 Agree any unpresented cheques or similar expenses to the cash book before the end
of the year and the bank statements after the end of the year.

119 Porridge
(a) Inherent risk – trade payables
In my audit of trade payables I would regard completeness as presenting the greatest level of inherent
risk for the following reasons:
(i) Management has an incentive to understate purchases and thus payables in order to
improve profits. This applies not only to senior management but to line managers who are
close to budgetary limits on certain expenditures and are under pressure to withhold
recording of suppliers’ invoices until after the year end.
(ii) Senior management may be under pressure to understate payables in order to improve the
company’s apparent liquidity. This would be the case if the company were seeking to raise
additional finance or to renew existing borrowing agreements. The more liquid the statement
of financial position shows the company to be the more favourable the terms are likely to be.
(iii) Principal control procedures placed in operation by the company relate to the occurrence
assertion in order to prevent improper purchasing by employees or overpayments to
suppliers.

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(iv) The primary source of information initiating recognition of a liability is the supplier’s invoice.
During the year the company has no incentive to accelerate the receipt of suppliers’ invoices.
This means that, as at the end of the reporting period, there could be outstanding claims not
yet invoiced by suppliers which the entity has no formalised procedures for identifying
promptly.
(v) Valuation is rarely a problem except in complex contractual situations where the amount due
is contingent upon some future event such as a volume discount dependent on total
purchases at some future date exceeding some agreed amount.
(b) Accounts payable circularisation
In my audit of Porridge I would not normally undertake a payables’ circularisation for the following
reasons.
(i) For payables, much of the documentary evidence available is in the form of third party
sourced suppliers’ invoices and statements, in contrast to accounts receivable for which
most of the available documentation is entity prepared.
(ii) Examination of documentary evidence is usually a cheaper form of substantive evidence
than external confirmation.
(iii) Although examination of third party sourced documentary evidence is less reliable than
external confirmations received directly by the auditor, it usually provides sufficient evidence.
I would, however, consider an accounts payable circularisation in the following situations.
(iv) A substantial proportion of the company’s suppliers does not issue monthly statements.
(v) Statements from suppliers with whom the company does substantial business are
unexpectedly unavailable for the last month of the year.
(vi) Only fax or photocopies of statements are available whose authenticity is doubtful.
(vii) I have reasons to suspect that the company, or a member of the company’s staff, may be
deliberately understating liabilities and there is a possibility that some of the suppliers’
statements may be forgeries given the ease of replicating documents with modern scanning
and desk top publishing technology. Assessment of control risk as slightly less than high,
the limited segregation of duties, and the failure to routinely reconcile all statements with the
accounts payable ledger mean that this is not necessarily a remote possibility.
(c) Substantive procedures applicable to production payables
Initial procedures
(i) Obtain a list of such accounts payable and test its accuracy by testing it to and from the
computer records and adding it and agreeing it to the control account. (If production payables
are not segregated from other payables this procedure will apply to all payables.)
Analytical procedures
(ii) Perform analytical procedures on accounts payable and compare the results with
expectations:
 compare current year’s balance with previous years;
 compare the average age of payables with previous years;
 compare gross profit with previous year and industry average.
Tests of details of transactions
(iii) Ascertain cut-off data for goods received notes (GRNs) (probably obtained during
attendance at the physical inventory count).

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(iv) Check cut-off by obtaining GRNs for two weeks prior to the year end and:
 checking their numerical continuity;
 tracing GRNs to the purchases recorded before 31 October or the accrual journal
entry.
(v) For a smaller sample I would verify the existence of recorded purchases prior to the year
end by vouching a sample of purchases and purchase accruals to GRN’s in the sequence
issued prior to the year end.
(vi) For a sample of the closing accruals I would verify the amount of the accrual by vouching
the amount to a subsequently received supplier’s invoice.
Tests of details of balances
(vii) Select a sample of accounts payable using criteria such as:
 all suppliers from whom the entity bought more than 1% of its purchases during the
year;
 a random sample of all other suppliers including nil and credit balances;
(viii) For each supplier in the sample I would compare the balance with the supplier’s statement
and investigate differences.
(ix) If any supplier’s statements were unavailable I would consider confirming the balance
directly with the supplier.
(d) Verifying the completeness of non-production payables
Detection risk over the completeness assertion must be set as low because of the assessment of
control risk as only just less than high and from problems identified in obtaining the understanding
of the accounting system in that:
(i) there are no goods received notes to determine the date of receipt of the goods;
(ii) invoices are not recorded until after approval by the department manager which could cause
considerable delay and even a failure to record liability for invoices mislaid or even lost
before being recorded;
(iii) suppliers’ statements are not reconciled which would otherwise detect most delayed or
missing invoices.
My audit procedures would be centred on cut-off and the search for unrecorded liabilities.
(i) Vouch purchases entered in the purchase journal as at 31 October (including those entered
while the journal was held open after the year-end) to invoices to verify that they are properly
recorded as accounts payable at the end of the reporting period.
(ii) Vouch larger purchases recorded in the first two weeks of the subsequent year to invoices
to ensure that they are properly recorded after the year-end.
(iii) Obtain suppliers’ statements from major suppliers and reconcile them with the balance in
accounts payable for evidence of invoices missing or mislaid.
(iv) Review outstanding purchase orders for evidence of goods or services received prior to the
year-end not yet invoiced by the supplier.
(v) Similarly vouch cash payments for the first two weeks after the end of the reporting period
for payments for goods and services received before the year-end not processed as
payables.
(vi) Review both purchases and cash payments for items that may relate to goods or services
received prior to the end of the reporting period. This review should be continued up to the
date of signing the auditors’ report.

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(vii) Compare prepayments and accruals with the previous year for items such as rent or utility
bills normally paid in advance or arrears of receipt of goods and services and investigate
differences.
(viii) Analyse expense accounts for significant differences either in absolute amounts or relative
to sales. Any unexpected difference could be due to unrecorded purchases at the end of the
reporting period.

120 Trembridge Engineering

(a) Checking suppliers' statements to the balances on the purchase ledger
(i) Assess the system of control in the purchases system and its reliability. If discrepancies are
found in the audit tests, increase the sample of items checked.
If the company's staff regularly perform checks on the supplier's statements then perform
fewer checks and instead rely on their work as evidence.
(ii) Generally, check a larger proportion of suppliers where the balances are large, or where
there are a large number of transactions. If no statements are available from a particular
supplier then consider telephoning to confirm the balance instead.
(iii) If the balance on the supplier's statement agrees to the balance on the purchase ledger then
no further work needs to be carried out.
(iv) If differences arise they will be due to a number of occurrences, such as:
 goods in transit;
 cash in transit; and
 other differences such as incorrect treatment of discounts.
(v) Goods in transit are invoices on the supplier's statement which are not on the customer's
purchase ledger. If these differences have been included in purchase accruals no further
checks are necessary. However, for large value items, check the goods received note (GRN)
to ensure they were received before the year-end.
(vi) Cash in transit may be verified by checking against the following month's supplier’s
statement.
(vii) Other differences, such as discounts, need only be investigated if they are material.
(b) Verification of purchases cut-off
In order to complete an adequate cut-off test for purchases and goods inwards the ideal starting
point is the population of goods received notes.
A sample should be selected that includes items from both before and after the year end.
For each item, it will be ensured that the date included in inventory, the purchase invoice date and
the date posted to the purchase ledger all correspond. For example a goods received note dated
before the year end means the following.
(i) the items should be in inventory;
(ii) the purchase invoice should be included in the income statement/statement of
comprehensive income and dated before the year end;
(iii) the purchase ledger should include the purchase invoice before the year end.
A cut-off error will exist if the items are not recognised in the correct accounting period.

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(c) Audit work on sundry payables and accruals

(i) Compare to the previous year's figures and identify any material fluctuations.
(ii) Net wages accruals and tax/social insurance payables can be verified by referring to the
monthly payroll. Normally it would be expected that one month of each may be outstanding.
(iii) The sales tax payable is verified by agreeing the amount to the tax return and then agreeing
the tax return calculation by checking input tax to the purchase day book, output tax to the
sales day book and any sundry amounts to either cash book or petty cash book
(iv) Accrued interest on the bank loan and overdraft will be checked to the bank letter.
(v) Other accruals will be checked to invoices received after the year-end (or if no invoices have
been received after the year end, then invoices received before the year end will be used).
(vi) Consider whether there are any circumstances which have arisen in the year which may
result in new accruals, and check if these accruals have been included.

121 ISA 620: Using the Work of an Auditor’s Expert

(a) Competence and objectivity of experts
 The expert’s professional qualification. The expert should ideally be a member of a relevant
professional body or have the necessary licence to perform the work.
 The experience and reputation of the expert in the area in which the auditor is seeking audit
evidence.
 The independence of the expert from the client company. The expert should not normally be
employed by the client.
(b) Auditor rights
 Right of access to the company’s books and records at any reasonable time to collect the
evidence necessary to support the audit opinion.
 Right to require from the company’s officers the information and explanations the auditor
considers necessary to perform their duties as auditors.
 Right to receive notice of and attend meetings of the company in the same way as any
member of the company.
 Right to speak at general meetings on any matter affecting the auditor or previous auditor.
 Where the company uses written resolutions, a right to receive a copy of those resolutions.
(c) Tangible non-current assets – assertions
 Completeness – ensure that all non-current assets are recorded in the non-current asset
register by agreeing a sample of assets physically verified back to the register.
 Existence – ensure non-current assets exist by taking a sample of assets from the register
and physically seeing the asset.
 Valuation and allocation – ensure assets are correctly valued by checking the
reasonableness of depreciation calculations.
 Rights and obligations – ensure the company owns the asset by seeing appropriate
document of ownership for example, a purchase invoice.
 Presentation and disclosure assertions – ensure all necessary financial statements
disclosures have been made by reviewing the financial statements and ensure non-current
assets are correctly categorised in those financial statements.

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122 Heidi Co
(a) (i) Benefits of using audit software
Standard systems at client
The same computerised systems and programs as used in all 25 branches of Heidi Co. This
means that the same audit software can be used in each location providing significant time
savings compared to the situation where client systems are different in each location.
Use actual computer files not copies or printouts
Use of audit software means that the Heidi Co.’s actual inventory files can be tested rather
than having to rely on printouts or screen images. The latter could be incorrect, by accident
or by deliberate mistake. The audit firm will have more confidence that the ‘real’ files have
been tested.
Test more items
Use of software will mean that more inventory records can be tested – it is possible that all
product lines could be tested for obsolescence rather than a sample using manual
techniques. The auditor will therefore gain more evidence and have greater confidence that
inventory is valued correctly.
Cost
The relative cost of using audit software decreases the more years that software is used.
Any cost overruns this year could be offset against the audit fees in future years when the
actual expense will be less.
(ii) Problems on the audit of Heidi
Timescale – six week reporting deadline – audit planning
The audit report is due to be signed six weeks after the year end. This means that there will be
considerable pressure on the auditor to complete audit work without compromising standards by
rushing procedures.
This problem can be overcome by careful planning of the audit, use of experienced staff and
ensuring other staff such as second partner reviews are booked well in advance.
Timescale – six week reporting deadline – software issues
The audit report is due to be signed about six weeks after the year end. This means that there is
little time to write and test audit software, let alone use the software and evaluate the results of
testing.
This problem can be alleviated by careful planning. Access to Heidi Co.’s software and data files
must be obtained as soon as possible and work commenced on tailoring Cal & Co.’s software
following this. Specialist computer audit staff should be booked as soon as possible to perform this
work.
First year audit costs
The relative costs of an audit in the first year at a client tend to be greater due to the additional
work of ascertaining client systems. This means that Cal & Co may have a limited budget to
document systems including computer systems.
This problem can be alleviated to some extent again by good audit planning. The manager must
also monitor the audit process carefully, ensuring that any additional work caused by the client not
providing access to systems information including computer systems is identified and added to the
total billing cost of the audit.

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 Answer bank: Objective test and long-form answers

Staff holidays
Most of the audit work will be carried out in July, which is also the month when many of Cal & Co
staff take their annual holiday. This means that there will be a shortage of audit staff, particularly
as audit work for Heidi Co is being booked with little notice.
The problem can be alleviated by booking staff as soon as possible and then identifying any
shortages. Where necessary, staff may be borrowed from other offices or even different countries
on a secondment basis where shortages are acute.
Non-standard systems
Heidi Co.’s computer software is non-standard, having been written specifically for the
organisation. This means that more time will be necessary to understand the system than if
standard systems were used.
This problem can be alleviated either by obtaining documentation from the client or by approaching
the software house (with Heidi Co.’s permission) to see if they can assist with provision of
information on data structures for the inventory systems. Provision of this information will decrease
the time taken to tailor audit software for use in Heidi Co.
Issues of live testing
Cal & Co has been informed that inventory systems must be tested on a live basis. This increases
the risk of accidental amendment or deletion of client data systems compared to testing copy files.

To limit the possibility of damage to client systems, Cal & Co can consider performing inventory
testing on days when Heidi Co is not operating e.g. weekends. At the worst, backups of data files
taken from the previous day can be re-installed when Cal & Co.’s testing is complete.

Computer systems

The client has 25 locations, with each location maintaining its own computer system. It is possible
that computer systems are not common across the client due to amendments made at the branch
level.

This problem can be overcome to some extent by asking staff at each branch whether systems
have been amended and focusing audit work on material branches.

Usefulness of audit software

The use of audit software at Heidi Co does appear to have significant problems this year. This
means that even if the audit software is ready, there may still be some risk of incorrect conclusions
being derived due to lack of testing, etc.

This problem can be alleviated by seriously considering the possibility of using a manual audit this
year. The manager may need to investigate whether a manual audit is feasible and if so whether
it could be completed within the necessary timescale with minimal audit risk.

(b) Reliance on internal audit documentation

There are two issues to consider; the ability of internal audit to produce the documentation and the
actual accuracy of the documentation itself.

The ability of the internal audit department to produce the documentation can be determined by:

 Ensuring that the department has staff who have appropriate qualifications. Provision of a
relevant qualification e.g. membership of a computer related institute would be appropriate.

 Ensuring that this and similar documentation is produced using a recognised plan and that
the documentation is tested prior to use. The use of different staff in the internal audit
department to produce and test documentation will increase confidence in its accuracy.

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Audit and Assurance

 Ensuring that the documentation is actually used during internal audit work and that
problems with documentation are noted and investigated as part of that work. Being given
access to internal audit reports on the inventory software will provide appropriate evidence.

Regarding the actual documentation:

 Reviewing the documentation to ensure that it appears logical and that terms and symbols
are used consistently throughout. This will provide evidence that the flowcharts, etc. should
be accurate.

 Comparing the documentation against the ‘live’ inventory system to ensure it correctly
reflects the inventory system. This comparison will include tracing individual transactions
through the inventory systems.

 Using part of the documentation to amend Cal & Co.’s audit software, and then ensuring
that the software processes inventory system data accurately. However, this stage may be
limited due to the need to use live files at Heidi Co.

123 Babar Limited

Repayment of loan to the holding company in the form of transfer of securities indicates a significant and
unusual related party transaction, which is outside the entity’s normal course of business. In this regard
following audit procedures may be performed:

 Inspect the underlying contracts or agreements to evaluate whether:

 the terms of the contracts etc. are consistent with management’s explanations.

 the transactions have been properly accounted for and disclosed.

 the contracts and agreements were entered to engage in fraudulent financial reporting or to
hide the misappropriation of assets (a lack of business rationale might indicate this).

 Obtain evidence that the transactions were properly authorised.

 If management has made a statement in the notes to the financial statements that a related party
transaction was made on the same terms as an arm’s length transaction, the auditor must obtain
evidence to support this statement.

124 Concordia Limited

We cannot choose to circulate negative confirmation merely on the fact that risk of material misstatement
has been assessed as low and majority of the balances comprise of large number of small balances.
Before using the negative confirmation as the substantive procedures, we also need to ascertain that:

 exception rate is expected to be low; and

 there is no apparent reason to suspect that the customers would disregard the confirmation
request.

Furthermore, we cannot consider the offer of CFO because we should maintain control over external
confirmation requests which include sending the requests ourselves with an instruction for responses to
be sent directly to us.

Ideally, confirmation of balances should take place after the reporting period, and should be based on
customers’ account balances as at the reporting period. However, to reduce the time pressure at the final
audit stage, the confirmation process can also be based on balances at an interim date before the end of
the financial year (normally no more than three months before the end of the reporting period). However,
while doing so, we should consider the fact that we will need to check the changes in the debtor balances
between the confirmation date and the end of the reporting period.

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 Answer bank: Objective test and long-form answers

125 Blue Bell Limited

Before selecting the areas where direct assistance of internal auditors can be used. Faheem should
consider the following matters:

 The internal auditor should not be involved in making significant amount of judgement in:

 planning and performing audit procedures; and

 evaluating the audit evidence gathered.

 The audit areas assigned to internal auditors should not relate to areas where risk of material
misstatement is assessed as high.

 Evaluate the existence of threats to objectivity and level of competence of the internal audit staff
who will be providing direct assistance

 The areas assigned should not relate to work in which the internal auditors have been involved and
which has already been, or will be, reported to management or those charged with the governance
by internal audit function.

 The areas assigned should not relate to the decisions you make in accordance with ISA regarding
the internal audit function and the use of its work or direct assistance.

 It should be ensured that despite using internal auditors to provide direct assistance to the extent
planned, together with the planned use of the work of the internal audit function, the external auditor
would still be sufficiently involved in the audit, given the external auditor’s sole responsibility for the
audit opinion expressed.

126 BAC Limited

 Review the list to identify major suppliers i.e. regular suppliers of frequentlypurchased items who
are not in the listing of trade payables.

 Compare the list of trade payables with the listing of the previous year’s audit. Look for explanations
as to why any major supplier is not appearing on the current year’s listing.

 Apply other analytical procedures and obtain explanations for any significant differences identified
while carrying out the above tests.

127 Stewardship and Accountability

Stewardship: The directors have a stewardship role. They look after the assets of the company and
manage them on behalf of the shareholders.

Accountability: As agent of the shareholders, the board of directors is accountable to the shareholders.
The directors show their accountability to the shareholders by preparing annual financial statements and
presenting them to the shareholders for discussion and approval.

Fair presentation (True and fair view): Although the phrase ‘true and fair view’ has no legal definition,
the term ‘true’ implies free from error, and ‘fair’ implies that there is no undue bias in the financial
statements or the way in which they have been presented. In preparing the financial statements, a large
amount of judgement is exercised by the directors. Similarly, judgement is exercised by the auditor in
reaching his opinion. The phrases ‘true and fair view’ and ‘present fairly’ indicate that a judgement is
being given that the financial statements can be relied upon and have been properly prepared in
accordance with an appropriate financial reporting framework.

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Audit and Assurance

128 Shahbaz Chemicals Limited

The following steps shall be performed by the audit team:

 Review and test the procedures in place for comparing NRV with cost for each item of inventory.

 Review the information gathered during the physical inventory count (e.g. deterioration of
inventory) which may suggest that NRV may be lower than cost.

 Review the records relating to goods returned by customers or allowances granted to customers.

 Review inventory records and order books for evidence of slow-moving items and compare their
expected NRV with cost.

 Select major items of inventory from the list of stock and compare NRV with cost.

 Review prices at which goods have been sold after the reporting period, for evidence that NRV is
higher than cost.

129 Express Limited

The auditor has no obligation to perform any audit procedures regarding the financial statements after
the date of the auditor’s report. However, the matter has come to the knowledge of the auditor and
bankruptcy of customer is indicative of condition that existed at balance sheet date as no recovery has
been made from the debtor after the balance sheet date. Had the bankruptcy been known to the auditor
at the date of the auditor's report, it may have caused the auditor to amend the audit report, therefore, he
shall:
 discuss the matter with management and, where appropriate, those charged with governance.
 determine whether the financial statements need amendment and, if so inquire how management
intends to address the matter in the financial statements.
 carry out the necessary audit procedures on the amendment.
 review the steps taken by management to inform about the situation to anyone who received the
original financial statements and audit report.
 extend the review of subsequent events up to the date of the new audit report
 if management does not agree to change the financial statements, the auditor should consider the
available alternative to him.

130 Farhan Foods Limited

(a) During the count, the auditor should consider:
 whether or not the count is being conducted in accordance with the written instructions of
the client’s management
 the condition of the inventory, in order to identify items where NRV might be below cost (and
in particular, inventory that seems to have deteriorated in condition)
 whether or not inventory not owned by the client entity is properly identified and labelled (for
example, inventory owned by customers but held on the entity’s premises)
 whether or not, during the count, production of new inventory and the movement of inventory
are controlled and properly documented, in accordance with management’s instructions for
the count
 At the end of the count, whether or not all inventory items have been counted and tagged
accordingly.

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 Answer bank: Objective test and long-form answers

(b) Cut-off at final audit:

The audit team should take last few receiving and delivering notes on either side of the year-end
and trace these to invoices and ledgers and inventory record to ensure that sales and purchases
have been included in the correct periods and related receivables and payables are booked
accordingly.

131 Fresh Dairies Limited

For sending negative confirmation, all of the following conditions are required to be met:
(i) The risk of material misstatement has been assessed as low and controls have been tested.
(ii) The population is comprised of large number of small account balances or transaction.
(iii) A very low exception rate is expected.
(iv) The auditor is not aware of circumstances which would cause the respondent to ignore his request
for confirmation.
Based on the above, my comment on appropriateness of sending confirmation requests for each category
of customers are as follows:

Customer category Comments

Distributors The condition of large number of small account balances is missing,
therefore positive confirmation will be sent.
Wholesalers All the conditions of sending negative confirmation exists, therefore
negative confirmation can be used.
Restaurants The condition of large number of small account balances is missing,
therefore positive confirmation will be sent.
Individual customers It is evident from past experience that confirmation request is usually
ignored, therefore positive confirmation will be used.

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Audit and Assurance

SCENARIOS
132 Zeedin Co
(a) Audit procedures procurement and purchases system

Procedure Reason for procedure

Obtain a sample of e-mails from the Ensure that all orders are recorded and that the order
store manager’s computer. Trace details are correct.
details to the order database.
Obtain a sample of orders in the order To confirm that all goods ordered were received.
database, record details of the order
and trace to the paper delivery note
filed in the goods inwards department.
For the sample of orders above, agree To confirm that goods received were completely and
to the inventory database. accurately recorded in the inventory database.
Obtain a sample of paper delivery To confirm that inventory received has been recorded
notes and agree to the order database in Zeedin’s accounting system and that liabilities are
and inventory database. therefore not understated.
For a sample of orders in the orders To confirm complete and accurate recording of the
database, agree details to the inventory liability in the payables database.
payables ledger database, confirming Note: To ensure goods received have been recorded
details against the purchase invoice. as a payables liability the sample selected from the
order database should be only those orders that have
been received. The invoice number in the order
database is then noted and traced to the payables
ledger in the purchase database.
For a sample of orders in the orders To confirm complete and accurate recording of the
database, agree details to the inventory liability in the payables database.
payables ledger database, confirming Note: To ensure goods received have been recorded
details against the purchase invoice. as a payables liability the sample selected from the
order database should be only those orders that have
been received. The invoice number in the order
database is then noted and traced to the payables
ledger in the purchase database.
Within the purchase database, obtain To confirm that purchase invoice details have been
a sample of invoices recorded in the correctly recorded in the payables database.
purchase day book, agree details of
price and supplier to the purchase
invoice record in the database.
For a sample of purchase invoices in To confirm that the purchase liability has been
the purchase day book, agree details recorded only for goods actually received.
to the delivery notes for items on that
invoice.
For the sample of purchase invoices To confirm that the liability has been recorded in the
above, agree details to the individual correct payables account.
payables account in the payables
database.

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 Answer bank: Objective test and long-form answers

Procedure Reason for procedure

For a sample of supplier invoices, cast To confirm the arithmetical accuracy of invoices and
and cross cast invoice price and ensure the company was charged the correct price for
quantities confirming price to the goods received.
original order.
Select increases in the purchase To ensure that invoiced goods have been ordered,
daybook and vouch to the order confirming the occurrence assertion.
database.
Using computer-assisted audit To confirm the completeness and accuracy of the
techniques, cast the purchase day liability recorded in the general ledger.
book and agree total of liability incurred
to the general ledger.

(b) Audit procedures prior to inventory count attendance

 Review prior year working papers
 Contact client to obtain stocktaking instructions
 Book audit staff to attend the inventory counts
 Obtain copy of inventory count instructions from client
 Ascertain whether any inventory is held by third parties
 Obtain last year’s inventory count memo
 Prepare audit programme for the count.
(c) (i) Aims
The aim of a test of control is to check that an audit client’s internal control systems are
operating effectively.
The aim of a substantive procedure is to ensure that there are no material errors at the
assertion level in the client’s financial statements.
(ii) Regarding the inventory count
Test of control
Observe the count teams ensuring that they are counting in accordance with the client’s
inventory count instructions.
Substantive procedure
Record the condition of items of inventory to ensure that the valuation of those items is
correct on the final inventory summaries.
(d) Weaknesses in counting inventory

Weakness Reason for weakness How to overcome weakness

Inventory sheets stated the Count teams will focus on Count sheets should not state the
quantity of items expected to finding that number of quantity of items so as not to pre-
be found in the store items making judge how many units will be found.
undercounting of
inventory more likely –
teams stop counting when
‘correct’ number of items
found.

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Audit and Assurance

Weakness Reason for weakness How to overcome weakness

Count staff were all drawn Count staff are also Count teams should include staff
from the stores responsible for the who are not responsible for
inventory. There could be inventory to provide independence
a temptation to hide errors in the count.
or missing inventory that
they have removed from
the store illegally.

Count teams allowed to There is a danger that Each team should be given a precise
decide which areas to count teams will either omit area of the store to count.
inventory from the count
or even count inventory
twice due to lack of
precise instructions on
where to count.

Count sheets were not signed Lack of signature makes it All count sheets should be signed to
by the staff carrying out the difficult to raise queries confirm who actually carried out the
count regarding items counted count of individual items.
because the actual staff
carrying out the count are
not known.

Inventory not marked to As above, there is a Inventory should be marked in some

indicate it has been counted danger that inventory will way to show that it has been counted
be either omitted or to avoid this error.
included twice in the
count.

Recording information on the Recording in pencil Count sheets should be completed

count sheets in pencil means that the count in ink.
sheets could be amended
after the count has taken
place, not just during the
count. The inventory
balances will then be
incorrectly recorded.

Count sheets for inventory It is possible that the All inventory sheets, including those
not on the pre-numbered additional inventory for ‘extra’ inventory, should be pre-
count sheets were only sheets could be lost as numbered.
numbered when used there is no overall control
of the sheets actually
being used. Sheets may
not be numbered by the
teams, again giving rise to
the possibility of loss.

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 Answer bank: Objective test and long-form answers

133 Sahito Co
(a) Prior year internal control questionnaires
 Obtain the audit file from last year’s audit. Ensure that the documentation on the sales
system is complete. Review the audit file for indications of weaknesses in the sales system
and note these for investigation this year.
 Obtain system documentation from the client. Review this to identify any changes made in
the last 12 months.
 Interview client staff to ascertain whether systems have changed this year and to ensure
that the internal control questionnaires produced last year are correct.
 Perform walk-through checks. Trace a few transactions through the sales system to ensure
that the internal control questionnaires on the audit file are accurate and can be relied upon
to produce the audit programmes for this year.
 During walk-through checks, ensure that the controls documented in the system notes are
actually working, for example, verifying that documents are signed as indicated in the notes.
(b) Tests of control

Test of control Reason for test

Review a sample of goods despatch notes Ensures that the goods despatched are correctly
(GDN) for signatures of the goods despatch recorded on the GDNs.
staff and customer.

Review a sample of GDNs for signature of Ensures that the GDN details have been entered
the accounts staff. onto the computer system.

Observe despatch system ensuring Sahito Ensures that goods are only despatched to
staff have seen the customers’ identification authorised customers.
card prior to goods being loaded into
customers’ vans.

Review the error report on numeric Ensures that the sequence of GDNs is complete.
sequence of GDNs produced in the accounts
department and enquire action taken
regarding omissions.

Observe despatch process to ensure that the Ensures that goods are not despatched to
customers’ credit limit is reviewed prior to poor/bad credit risks. Note: reviewing credit limits
goods being despatched. is not specifically stated in the scenario; however,
most despatch/ sales systems will have this
control and most candidates mentioned this in
their answers. Hence marks were awarded for this
point.

Ensures the accurate transfer of goods

Review a selection of invoices ensuring they
despatched information from the GDN to the
have been signed by accounts staff.
invoice.

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Audit and Assurance

(c) Assertions – receivables

Assertion Application to direct confirmation of receivables

Existence The receivable actually exists which is confirmed by the receivable

replying to the receivables confirmation.

Rights and obligations The receivable belongs to Sahito Co. The receivable confirms that
the amount is owed to Sahito again by replying to the confirmation.

Valuation and allocation Receivables are included in the financial statements at the correct
amount – the receivable will dispute any amounts that do not relate
to that account.

Cut-off Transactions and events have been recorded in the correct

accounting period. The circularisation will identify reconciling items
such as sales invoices/cash in transit.

(d) (i) Receivables circularisation – procedures

 Obtain a list of receivables balances, cast this and agree it to the receivables control
account total at the end of the year. Ageing of receivables may also be verified at this
time.

 Determine an appropriate sampling method (cumulative monetary amount, value-

weighted selection, random, etc.) using materiality for the receivable balance to
determine the sampling interval or number of receivables to include in the sample.

 Select the balances to be tested, with specific reference to the categories of receivable
noted below.

 Extract details of each receivable selected from the ledger and prepare circularisation
letters.

 Ask the chief accountant at Sahito Co (or other responsible official) to sign the letters.

 The auditor posts or faxes the letters to the individual receivables.

(ii) Specific receivables for selection:

 Large or material items. These will be selected partly to ensure that no material error
has occurred and partly to increase the overall value of items tested.

 Negative balances. There are 15 negative balances on Sahito’s list of receivables.

Some of these will be tested to ensure the credit balance is correct and to ensure that
payments have not been posted to the wrong ledger account.

 Receivables in the range Rs 0 to Rs 20,000. This group is unusual because it has a

relatively higher proportion of older debts. Additional testing may be necessary to
ensure that the receivables exist and to confirm that Sahito is not overstating sales
income by including many smaller receivables balances in the ledger.

 Receivables with balances more than two months old. Receivables with old balances
may indicate a provision is required for non-payment. The lack of analysis in Sahito
Co.’s receivable information indicates a high risk of non-payment as the age of many
debts is unknown.

 Random sample of remaining balances to provide an overall view of the accuracy of

the receivables balance.

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 Answer bank: Objective test and long-form answers

134 Bashir Co
(a) Control Objectives – wages system
 Employees are only paid for work that they have done
 Gross pay has been calculated correctly
 Gross pay has been authorised
 Net pay has been calculated correctly
 Gross and net pay have been recorded accurately in the general ledger
 Only genuine employees are paid
 Correct amounts are paid to taxation authorities.
(b) The Directors
Bashir Co
1701 Any Street
Big Town 12345
Pakistan
3 December 20X3
Dear Sirs
Management letter
We write to bring to your attention weaknesses in your company’s internal control systems and
provide recommendations to alleviate those weaknesses.

(i) Weakness: (ii) Possible effect: (iii) Recommendation:

The logging in process for Employees could bring The shift manager should reconcile
employees is not cards for absent employees the number of workers physically
monitored. to the assembly plant and present on the production line with
scan that card for the the computerised record of the
employee; absent number of employees logged in for
employees would effectively work each shift.
be paid for work not done.

Overtime is not authorised Employees may get paid for All overtime should be authorised,
by a responsible official. work not done e.g. they may either by the shift manager
clock-off late in order to authorising an estimated amount of
receive ‘overtime’ overtime prior to the shift
payments. commencing or by the manager
confirming the recorded hours in the
payroll department computer system
after the shift has been completed.

The code word authorising The code word is not secure The code word should be based on a
the accuracy of time and could be easily guessed random sequence of letters and
worked to the wages by an employee outside the numbers and changed on a regular
system is the name of the department (names of pets basis.
cat of the department are commonly used
head. passwords).

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Audit and Assurance

(i) Weakness: (ii) Possible effect: (iii) Recommendation:

The total amount of net ‘Dummy’ employees – Prior to net wages being sent to the
wages transferred to payments that do not relate bank for payment, the financial
employees is not agreed to any real employee – accountant should agree the total of
to the total of the list of could be added to the the payments list to the total of wages
wages produced by the payroll payments list in the from the payroll department.
payroll department. accounts department.

Details of employees There is no check to ensure There needs to be a control to ensure

leaving the company are that all e-mails sent are all e-mails are received in personnel
sent on an e-mail from the actually received in the – pre-numbering of e-mails or tagging
personnel department to payroll department. the e-mail to ensure a receipt is sent
payroll. back to the personnel department will
help meet this objective.

In the accounts It is inappropriate that a The payroll should be authorised by a

department, the accounts junior member of staff senior manager or finance director.
clerk authorises payment should sign the payroll; the
of net wages to clerk may not be able to
employees. identify errors in the payroll
or could even have included
‘dummy employees’ and is
now authorising payments
to those ‘people’.

If you require any further information on the above, please do not hesitate to contact us.
Yours faithfully
Global Audit Co.

(c) Substantive analytical procedures

Substantive analytical procedure Expectation

Compare total salaries cost this year to Assuming that the number of shift managers has
total salaries cost last year. remained unchanged, the total salary expenditure
should have increased by inflation only.

Ascertain how many shift managers are Total salary should be approximately number of
employed by Bashir and the total salary managers multiplied by average salary.
from the personnel department. Calculate
total salary and compare to the salary
disclosed in the financial statements.

Obtain a listing of total salary payments The total payments should be roughly the same
made each month. apart from July onwards when salaries increased
and November when the annual bonus was paid.

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 Answer bank: Objective test and long-form answers

(d)
Benefit to auditor in testing accuracy of time recording
Audit procedure
system

Confirmation

Confirmation is the process of Obtaining information from a third party will be difficult. The
obtaining a representation of manufacturer of the time recording system could be
information or of an existing approached to discuss known errors with the system;
condition directly from a third however, information provided may be limited by the need to
party. protect the manufacturer’s integrity.
It is therefore unlikely that the auditor will benefit from this
procedure.

Observation

This procedure involves watching Testing will be limited to ensuring all shift-workers actually
a procedure being performed by clock in and out when they arrive to and depart from work.
others – in this case watching The procedure has limited use as it only confirms it worked
shift-workers using the time when shift-workers were observed. It also cannot confirm
recording system. that hours have been recorded accurately.

Inquiry

Inquiry involves obtaining Inquiry only confirms that shift-workers confirm they clock-in
information from client staff or or out. It does not directly confirm the action actually
external sources. happened or the accuracy of the recording of hours worked.

Recalculation

Recalculation means re-checking Recalculation can confirm the hours worked are correctly
the arithmetical accuracy of the calculated as the difference between the clocking in and out
client’s records; in this case the times in the time recording system. When used with
hours worked by the time- reperformance evidence this will confirm the overall
recording system. accuracy of the time recording system.

Reperformance

This is the auditor’s independent If the auditor notes the time of clocking in and out, then these
execution of procedures or times can be agreed to the time recording system confirming
controls that were originally the accuracy of recording (or confirm that client staff actually
performed as part of the entity’s perform this control). Re-performance is therefore a good
internal control. source of audit evidence.

Analytical procedures

Analytical procedures involve

comparing financial or non- This procedure will be useful for the auditor as the total time
financial data for plausible recorded for each employee should be standard hours plus
relationships. any estimate of the overtime worked.

134 Multiple Situations

(a) The term ‘expectation gap’ refers to the fact that the public perception of the role and
responsibilities of the external auditor is different from his statutory role and responsibilities. The
expectations of the public are often set at a level higher than that at which the external auditor
actually operates.

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Some examples of the misunderstandings inherent in the public’s expectations are as follows:
 The public believes that the audit opinion in the audit report amounts to a ‘certificate’ that
the financial statements are correct and can be relied upon for all decision-making purposes.
 The public also believes that the auditor has a duty to prevent and detect fraud and that this
is one reason for an audit.
 The public assumes that, in carrying out his audit work, the auditor tests 100% of the
transactions undertaken during the accounting period.
(b) In evaluating the control environment, the auditor should consider such factors as:
 management participation in the control process, including participation by the board of
directors
 management’s commitment to a control culture
 the existence of an appropriate organisation structure with clear divisions of authority and
responsibility;
 an organisation culture that expects ethically-acceptable behaviour from its managers and
employees; and
 appropriate human resources policies, covering recruitment, training, development and
motivation, which reflect a commitment to quality and competence in the organisation.
(c) If the auditor discovers significant related party transactions outside the entity’s normal course of
business he must:
 Inspect the underlying contracts or agreements to evaluate whether:
– the contracts etc. were entered into in order to engage in fraudulent financial reporting
or to hide the misappropriation of assets (a lack of business rationale might indicate
this)
– the terms of the contracts etc. are consistent with management’s explanations, and
– the transactions have been properly accounted for and disclosed.
 Obtain evidence that the transactions were properly authorised.
(d) The key features of review engagement that distinguish it from statutory audit are as follows:
 Review engagement requires less evidence than an audit
 Opinion in the review engagement is expressed in negative terms
Two types of review engagements:
 Attestation engagement
 Direct reporting engagement
(e) Following factors are considered in determining the independence of internal auditors:
 To whom does the internal auditor reports to
 Who decides the scope of internal audit work
 Frequency of rotation of internal audit staff
 Appointing authority of chief internal auditor
 Conflict of interest i.e. they should not be responsible for designing internal controls
(f) Audit procedures for verification of share premium account:
 Obtain an analysis of movements in share premium account during the period.
 Check the accuracy of these movements by checking supporting documentation.

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 Ensure that any specific legal requirements relating to share premium have been complied
with. (For example, check that the entity has not breached legal restrictions on use of the
share premium account.)
 Check authorization in respect of all movements during the year.
(g) Reasonable Assurance:
A high (but not absolute) level of assurance provided by the practitioner’s conclusion expressed in
a positive form. The reasonable assurance is usually expressed in case of statutory audits.
Limited Assurance
A moderate level of assurance provided by the practitioner’s conclusion expressed in a negative
form. The negative form of assurance is usually expressed in case of review engagements.
(h) A negative confirmation can be used, where any of the following condition is met:
 The risk of material misstatement has been assessed as low and controls have been tested.
 The population is comprised of large number of small account balances.
 A very low exception rate is expected.
 The auditor is not aware of the circumstances which would cause the respondent to ignore
the request for confirmation.

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COMPLETION
136 Final Audit File
(a) The auditor is required to assemble the final audit file(s) on a timely basis after the date of the
auditor’s report. This usually excludes drafts of working papers or financial statements, or notes
that reflect incomplete or preliminary thinking. After the assembly of the final audit file has been
completed, the auditor must not delete or discard audit documentation before the end of its
retention period.
(b) In such case the auditor is required to document:
 the circumstances;
 the new or additional procedures performed, audit evidence obtained, conclusions reached
and their effect on the auditor’s report; and
 when and by whom the resulting changes to audit documentation were made and who
reviewed them.

137 Energy Limited

(a) In order to ensure the completeness of list of related parties provided by the client, your audit
procedures could include the following:
 Review working papers for previous years, to look for names of known related parties.
 Review the company’s procedures for identifying related parties.
 Inquire about the relationships between directors and other entities i.e. whether any director
is a director, CEO, major shareholder etc. in another company.
 Review shareholder records for the names of major shareholders.
 Review minutes of BOD meetings and general meetings of the company.
 Get confirmation from any other audit firms involved in the audit about related parties. (e.g.
in case of audit of a group of companies, more than one firm of auditors are involved)
(b) According to the International Standard on Auditing (ISAs) the auditor is required to obtain written
representations from management and, where appropriate, those charged with governance that:
 they have disclosed to the auditor the identity of the entity's related parties and all the
related party relationships and transactions of which they are aware; and
 they have appropriately accounted for and disclosed such relationships and transactions in
accordance with the requirements of the framework.
In view of the above, the auditor should not accept the argument given by the management.
If management does not provide one or more of the requested written representations, the
auditor shall:
 discuss the matter with management/ those charged with governance;
 re-evaluate the integrity of management and evaluate the effect that this may have on the
reliability of representations (oral or written) and audit evidence in general; and
 take appropriate actions, including determining the possible effect on the opinion in the
auditor's report

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138 XYZ & Company

(a) In this case, the representation provided by the management contradicts with the audit evidence
obtained later and therefore we should:
 consider whether his risk assessment of that area is still appropriate
 consider whether additional audit procedures are needed
 assess the impact on auditors assessment of management’s integrity, document those
concerns and consider withdrawing from the audit.
(b) The written representation from the management must cover:
 the completeness of the information that has been provided about the identity of related
parties and related party relationships and transactions, and
 the adequacy of accounting for and disclosure of such related party relationships and
transactions in the financial statements.
The audit report should not be signed unless the written representation has been received.
If management does not provide the written representation, it will result in limitation of scope and we would
take appropriate actions, including determining the possible effect on the opinion in the auditor’s report.

139 XYZ Limited

(i) After the assembly of the final audit file has been completed, the auditor must not delete or discard
audit documentation before the end of its retention period.
(ii) However the changes to document can be made if:
 the changes are deemed necessary.
 there are exceptional circumstances in which the auditor has to perform new or additional
procedures or reaches new conclusions.
(iii) If it appears that it was necessary to modify existing or add new documentation after this stage,
the auditor is required to document:
 when and by whom the modifications were made.
 the reasons for making them.
(iv) If exceptional circumstances arise after the date of the audit report; the auditor is required to
document:
 the circumstances
 the new or additional procedures performed, audit evidence obtained, conclusions reached
and their effect on the auditor’s report, and
 when and by whom the resulting changes to audit documentation were made and who
reviewed them.

140 Noncurrent assets

Test of details for verification of valuation assertion of tangible non-current assets:
 Check the cost in the financial statements against the purchase invoices/contracts for the assets.
 Check that the purchase expenditure is analysed reasonably between land, buildings and
equipment.
 Review the allocation of total expenditure on non-current assets between capital and revenue
amounts.
 Verify amounts in the financial statements with the valuer’s report.

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 Obtain an understanding of the work of the expert through considering the reasonableness of
valuations/assumptions used in valuations.
 Evaluating the competence, capabilities and objectivity of the expert.
 Check that valuations are regularly updated.
 Check that all the assets of the similar class are revalued.

141 Customized Machinery Limited (CML)

The imposition of restriction by foreign country is an adjusting event as the inventory prepared for the
order cannot be supplied to any other customer, without considerable expense of Rs. 105 million. The
revised net realizable value of the inventory would therefore be approximately Rs. 395 million (500-105),
as against the cost of Rs. 416.67 million (500÷1.2), resulting in an adjustment of Rs. 21.67 million which
is approximately 6.19% of the profit before tax.
As an auditor we have no obligation to perform any audit procedures after the date of the audit report.
However, in view of the fact that the above situation has come to our knowledge, we are required to
discuss the matter with management and inquire how it intends to address the matter in the financial
statements.
If the financial statements are amended, the auditor is required to:
 carry out the necessary audit procedures on the amendment
 extend his review of subsequent events up to the date of the new audit report.
If management do not amend the financial statements for the event identified, then the auditor should
take appropriate action to prevent reliance on the audit report after taking legal advice.

142 Nadeem Limited

(a) The argument that the written representation is not necessary because the provision is
incorporated on the basis of expert’s advice is not correct.
The recognition of provision on basis of expert’s advice will not preclude management from
assuming responsibility for the warranty provision.
If the management do not provide the written representation, the auditor will require to reevaluate
the effect which may have on reliability of representations and audit evidence in general.
The auditor may qualify or disclaim the opinion on the financial statements depending on the
materiality and pervasiveness of the matter.
(b) The argument of management relating to additional disclosures is not valid, as this disclosure will
make the financial statements misleading, as IAS allows disclosure of only those contingent assets
which are probable.
If the amount is material and the management refuses to remove the disclosures from the financial
statements, then the auditor may qualify the audit report.
(c) It is not a change in Accounting policy. However, if the revenue for the customers to whom the
goods are to be delivered to their premises, is material to the financial statements, the auditor will
ask the management to revise the accounting policy for revenue recognition to cover all types of
sales contracts.
If the management refuses to revise the policy accordingly and record the sales based on such
policy then the audit report will be qualified.

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143 System logs

(a) Information that can be extracted from system logs include:
(i) Which user logged-in, when and where from
(ii) Failed log-in attempts
(iii) Who accessed and amended data in a file
(iv) Changes made to a program – what, when and by whom

144 Overtime payments

(a) Following are the possible weaknesses that may exist in overtime payments:
 There may be weaknesses in the system for recording time spent at work. When employees
are paid on the basis of time, there will be a system of ‘time-in’ and ‘timeout’, typically using
employee identity cards and a time recording device. The risk is that employees will ‘clock
on’ on behalf of a colleague, using the identity card that the colleague has given him.
 Overtime payments may not be properly authorized which includes situation where a person
works overtime without proper authorisation.
 Incorrect rates of overtime may be used.
(b) Principal controls over payment of overtime:
 List of overtime payment (time or the amount) should be signed by person duly authorised
in this regard by the organisation.
 A overtime rates should be checked by a person authorised in this regard by the
organisation.
 The process of recording time should be monitored either by an authorized supervisor or by
the use of bio-metric machine.
 It should be ensured that the amount of overtime is correctly incorporated in the salary
sheets and deductions therefore if any have been appropriately made.

145 Khanewal Limited

In order to establish whether the preconditions for an audit are present, I will:
(i) determine whether the financial reporting framework to be applied in the preparation of financial
statements is acceptable;
(ii) obtain the agreement of management that it acknowledges and understands its responsibility:
 for the preparation of the financial statements in accordance with the applicable financial
reporting framework.
 for such internal control as management determines is necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to fraud or
error.
 to provide us with all relevant and requested information and unrestricted access to all
personnel.

146 ABD Limited

(a) Procedures to be followed and formalities to be complied with for removal of existing auditors and
appointment of new auditors:
 ABDL shall give a notice at least 07 days before the annual general meeting to the company,
for a resolution for appointment of your firm as an auditor at a Company’s annual general
meeting.

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 HGM shall forthwith send a copy of such notice to the retiring auditor and shall also post it
on the website.
 HGM shall, within fourteen days from the date of appointment of our firm, send to the
registrar intimation thereof, together with our consent in writing.
Rights of the existing auditors:
The retiring auditor shall have the right to make a representation in writing to the company
at least two days before the date of general meeting. Such representation shall be read out
at the meeting before taking up the agenda for the appointment of the auditor.
Where such representation is made, it shall be mandatory for the auditor or a person
authorized by him in writing to attend the general meeting in person.
(b) Responsibilities of our firm and of the existing auditors:
Our firm will communicate with the existing auditors to establish if there are any matters that it
should be aware of when deciding whether or not to accept the appointment. The following points
should be noted in connection such communication:
 HGM permission is required for any such communication. If HGM refuses to give its
permission, the appointment as auditor should not be accepted.
 If HGM does not give the existing auditor the permission to reply to any relevant questions
of our firm, the appointment as auditor should not be accepted.
 If existing auditor provides the required information, our firm should assess all the available
information and take a decision about whether or not to accept the audit engagement.
 If the existing auditor does not provide any information relevant to the appointment, we may
accept or reject the engagement based on other available knowledge.
 Even if the existing auditor provides professional reasons to suggest that we should not
accept the audit, the final decision in this regard shall be based on our professional
judgment.

147 Cell Phones (Private) Limited

(a) Fraud Risk Factors:

Rapid Changes in Technology:

Products like mobile phones are likely to become obsolete very quickly, as more advanced
products come on to the market. The company faces a threat due to rapid changes in technology;
therefore the management may be inclined to manipulate the accounting records.
Lack of Segregation of Duties/ Dominance of management by a single person:
As Anwar is the Chief Executive and is also responsible for finance and operations of the company,
this gives him a personal motivation to misstate figures to show improved performance.
Long Term Loan:
As the company has applied for long term loan, it may be inclined to manipulate the figure to show
better financial position to the bank.
Demand for early completion of audit:
The demand by Anwar for early completion of audit creates undue suspicion because such
pressures are sometime applied to distract the auditor from his responsibilities.
(b) Whether it would be advisable to use the internal audit working papers in the above situation and
give three distinct reasons to support your decision:

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It is not advisable to use the work of internal audit for external audit purposes due to following
reasons:
Status of the internal audit function within the entity
Administratively all the internal audit staff are under the influence of Anwar and hence their
independence is impaired.
 Conflicting responsibilities:
The internal audit staff’s responsibilities for preparing bank reconciliation statement is in
conflict with its responsibility as a member of the internal audit function.
 Qualifications of internal audit staff:
All the internal audit personnel are graduates and do not have required competence about
various aspects of the internal audit function

148 Substantive Procedures

The audit approach to gathering evidence on contingencies and commitments is as follows:
(i) Accrued expenses:
 Obtain or prepare a listing of accrued expenses as at the end of the reporting period. Check
the calculations and additions for arithmetical accuracy.
 Check the amounts in the listing against the balances in the relevant main ledger expense
accounts and ensure that the amounts are the same.
 Verify the invoices received or payments made after the year end and ensure that the
amount accrued appears reasonable in relation to this evidence.
 Compare the list of accrued expenses with the list that was prepared at the same date in the
previous financial year, and enquire about items not listed in the current year that were in
the list in the previous year.
 Review the list of accruals for completeness, based on the auditor’s knowledge of the
business.
 Relate items on the list of accruals to other audit areas, such as the bank confirmation letter
(which might provide details of unpaid/accrued bank charges).
 Perform analytical procedures on accrued expenses. For example, the auditor might
measure the ratio of accrued payroll expenses to total payroll costs for the year, and
compare this with the similar ratio in previous years. Significant differences should be
investigated.
(ii) Contingencies:
 Ascertain the approach taken by the client’s management for identifying contingencies.
 Review the minutes of board meetings (where such matters are likely to be discussed).
 Review relevant material related to the industry as a whole such as financial statements of
major companies in the industry to identify possible industrywide contingencies.
 Review the client’s correspondence with lawyers.
 Review the invoices for legal services to identify undisclosed contingencies and additional
information about contingencies
 Consider direct confirmation from the company’s lawyers and legal advisors.
 Consider whether expert advice may be required from outside sources other than lawyers.
 Ensure that provisions has been made in case the relevant condition as specified in IFRS
are met.

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149 Pioneer Textile Limited (PTL)

The management representation regarding disclosure of non compliance with law does not remain
appropriate, as it contradicts with the audit evidence obtained.
To address the contradiction, we should:
 consider whether his risk assessment of that area is still appropriate.
 consider whether additional audit procedures are needed.
 consider the integrity of management, document those concerns and consider the possible course
of action.

150 Multiple Questions

(a) Integrity:
Members should be straightforward and honest in all professional and business relationships.
Integrity implies not just honesty but also fair dealing and truthfulness.
A chartered accountant should not be associated with reports, returns, communications or other
information which according to him is materially false or misleading.
(b) Advocacy threat:
Advocacy threat occurs when members promote a position or opinion on behalf of a client to the
point that subsequent objectivity may be compromised.
Example:
Acting as an advocate for an assurance client in litigation or dispute with third parties.
(c) Actual Independence:
Actual independence means that the auditor should not be influenced by anything which results in
compromising his professional judgement while expressing an opinion.
Perceived independence:
The auditor must be seen to be independent, i.e. the auditor should avoid facts and circumstances
due to which a third party may conclude that his integrity, objectivity or professional skepticism had
been compromised.
(d) The following are circumstances where chartered accountants are or may be required to
disclose confidential information:
 Disclosure is permitted by law and is authorized by the client.
 Disclosure is required by law.
 There is a professional duty or right to disclose, when not prohibited by law:
(e) Systematic sampling:
It is a method of sampling whereby a random starting point is chosen from the population and then
items are selected with a standard gap between them (for example, every 10th item).
(f) Procedures of review engagement:
The procedures for the review of financial statements will usually include:
 Inquiry
 analytical procedures
 Agree and reconcile Interim Financial Information with the accounting records.

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(g) Auditor’s responsibility with respect to events between the end of the reporting period and
the date of the auditor’s report:
The auditor is required to obtain sufficient appropriate evidence that all subsequent events that
require adjustment or disclosure in the financial statements:
 have been identified, and
 are suitably reported in the financial statements.
(h) Audit procedures to ensure completeness of related parties
The procedures to ensure completeness of related parties will generally include:
 review of prior year working papers
 review of company’s procedures for identification of related parties
 review shareholder’s records
(i) The auditor should consider the source of audit evidence, effectiveness of related controls,
form of audit evidence etc.
(j) Following are the circumstances in which an auditor may include other matter paragraph in
the audit report:
 Relevant to Users’ Understanding of the Audit: In the rare circumstance where the
auditor is unable to withdraw from an engagement, the auditor may consider it necessary to
include an Other Matter paragraph in the auditor’s report to explain why it is not possible for
the auditor to withdraw from the engagement.
 Relevant to Users’ Understanding of the Auditor’s Responsibilities or the Auditor’s
Report: Law, regulation or generally accepted practice in a jurisdiction may require or permit
the auditor to elaborate on matters that provide further explanation of the auditor’s
responsibilities in the audit of the financial statements or of the auditor’s report thereon.
 Reporting on more than one set of financial statements: An entity may prepare set of
financial statements in accordance with more than one framework and engage the auditor
to report on both sets of financial statements. If both the frameworks are acceptable, the
auditor may include an Other Matter paragraph in the auditor’s report
 Restriction on distribution or use of the auditor’s report: When the financial statements
are prepared for a specific purpose, the auditor may consider it necessary to include an
Other Matter paragraph, stating that the auditor’s report is intended solely for the intended
users, and should not be distributed to or used by other parties.
(k) Obtain an understanding of management’s procedures for identifying subsequent events.
 Inquire of management as to whether any subsequent events have occurred
 which might affect the financial statements.
 Read the entity’s latest subsequent financial statements.
 Read minutes of shareholders’ meetings, meeting of the board of directors held after the
date of the financial statements and inquire about matters discussed at any such meetings
where minutes are not available.
 Obtain written representations in respect of subsequent events.
(l) Pre-conditions of an audit are not present:
If the pre-conditions of audit are not present, the auditor shall:
 discuss the matter with the management and explain to them what the preconditions are
and why they are required.
 unless required by law or regulation, the auditor shall not accept the proposed audit
engagement. If the management is unable to address the auditor’s concern.

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151 Analytical procedures

(a) (i)  Analytical procedures include the consideration of comparisons of the entity’s financial
information with, for example:

 Comparable information for prior periods.

 Anticipated results of the entity.
 Similar industry information, such as a comparison of the entity’s ratio of sales to
accounts receivable with industry averages or with other entities of comparable
size in the same industry.
 Analytical procedures also include consideration of relationships:

 Among elements of financial information that would be expected to conform to a

predictable pattern based on the entity’s experience, such as gross margin
percentages.

 Between financial information and relevant non-financial information, such as

payroll costs to number of employees.
 Analytical procedures are used for the following purposes:

 As risk assessment procedures to obtain an understanding of the entity and its

environment.

 As substantive procedures when their use can be more effective or efficient than
tests of details.

 As an overall review of the financial statements at the end of the audit.

(ii) When designing and performing analytical procedures as substantive procedures, the
auditor will need to consider a number of factors such as:
 The suitability of using substantive analytical procedures given the assertions. These
procedures are generally more applicable to large volumes of transaction that tend to
be predictable over time.
 The reliability of the data, whether internal or external, from which the expectation of
recorded amounts or ratios is developed.
 Whether the expectation is sufficiently precise to identify a material misstatement at
the desired level of assurance.
 The acceptable amount of difference between the recorded amounts and the expected
values.
(iii) The auditor should apply analytical procedures at or near the end of the audit in order to
 form an overall conclusion as to whether the financial statements as a whole are
consistent with the auditor’s understanding of the entity.
 Corroborate the conclusions drawn through other procedures.
 To identify unusual or unexpected balances (if any) in order to identify a previously
unrecognized risk of material misstatement. In such circumstances, the auditor may
need to re-evaluate the planned audit procedures.
(b) Basic Elements of a Written Representation Letter:
Address: It should be addressed to the auditor.
Date: Ordinarily the date should be the same as the date of auditors’ report.

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Signature: It should ordinarily by signed by the members of management who have

primary responsibility for the entity i.e. CEO and CFO.
Contents: It should contain information as may be specified by the auditor.

152 Auditor responsibility

(a) The statement of responsibility should state the following:

(i) It is the responsibility of the auditor to express an opinion on the financial statements.

(ii) The audit was conducted in accordance with International Standards on Auditing.

(iii) Those standards require that :

 the auditor complies with ethical requirements.

 the auditor plans and performs the audit to obtain reasonable assurance whether the
financial statements are free from material misstatement.

(iv) That an audit involves performing procedures to obtain audit evidence about the amounts
and disclosures in the financial statements.

(v) As part of an audit in accordance with ISAs, we exercise professional judgment and
maintain professional skepticism throughout the audit

(vi) That while selecting the procedures to be performed the auditor exercises judgment,
including the assessment of risks of material misstatements and whether due to fraud or
error.

(vii) In making the risk assessment the auditor considers internal controls relevant to fair
presentation of financial statements in order to design audit procedures that are appropriate
in the circumstances but not for the purpose of expressing an opinion on the effectiveness
of the entity’s internal control.

(viii) That an audit includes evaluation of the appropriateness of the accounting policies used,
the reasonableness of estimates and the overall presentation of information in the financial
statements.

(ix) That auditor has concluded on the appropriateness of management’s use of the going
concern basis of accounting and, based on the audit evidence obtained, whether a material
uncertainty exists related to events or conditions that may cast significant doubt on the
Company’s ability to continue as a going concern.
That an audit involves evaluating the overall presentation, structure and content of the
financial statements, including the disclosures
That auditor communicate with those charged with governance regarding, among other
matters, the planned scope and timing of the audit and significant audit findings, including
any significant deficiencies in internal control that auditor identify during the audit.
That auditor also provide those charged with governance with a statement that auditor have
complied with relevant ethical requirements regarding independence, and to communicate
with them all relationships and other matters that may reasonably be thought to bear on
auditor’s independence, and where applicable, related safeguards.

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153 Al-Badr
(i) Audit report should be addressed to the members of the company instead of directors.

(ii) In the opinion paragraph, the word “cash flow statement” has been omitted.

(iii) After the statement “We conducted our audit in accordance with the auditing standards” in the
basis of opinion paragraph, the words “as applicable in Pakistan” have been omitted.
Key audit matters have not been reported, after the basis of opinion paragraph.

(iv) In the auditor’s responsibility paragraph, the sentence “evaluate the appropriateness of accounting
policies used and the reasonableness of accounting estimates and related disclosures made by
management” has been omitted.

(v) In the “Report on Other Legal and Regulatory Requirements” paragraph a) proper books of account
have been kept by the Company as required by the Companies Act, 2017 (XIX of 2017) has been
omitted.
(vi) Name of the engagement partner has not been mentioned.

154 The engagement partner

(a)  The audit report will be modified on ground of limitation of scope.
 Either a qualified or disclaimer of opinion will be given depending upon the materiality and
pervasiveness of the matter.
 We may have to mention that “proper books of accounts as required by the Companies Act,
2017 have not been kept by the Company”.
(b) There will be no impact on the audit report as the change of depreciation method is a change in
accounting estimate.
(c) The auditor will include an other matter paragraph in the auditor’s report, referring to the fact that
the financial statements of Samarkand Limited for the Previous year, were audited by another
auditor, who expressed an un-modified opinion on those financial statements.

155 Different audit clients

(a)  Two significant uncertainties exist for ZTL i.e. recoverability of balance due from SEL and
whether the going concern assumption is appropriate in light of the possible termination of
the contract by SEL.
 The Accounts receivable balance is material to the financial statements as it is 12.48% of
profit after tax.
 The possible loss of contract from SEL is material to the financial statements as the revenue
from SEL contributes about 25% of total revenue.
 It appears that the uncertainty relating amount receivable balance and termination of contract
will not be resolved till the time of signing off the financial statements and audit report.
 If uncertainties are adequately disclosed in the financial statements then an unqualified
opinion can be given, however an emphasis of matter paragraph is to be included in the
auditor’s report to draw user’s attention to the significant uncertainties. In case appropriate
disclosure is not given a qualified opinion or adverse opinion as appropriate.
(b)  If there are material inconsistencies in the other information presented with the financial
statements the auditor should discuss the reasons thereof with the management and ask
them to revise the other information.
 In case of disagreement, the auditor shall communicate the matter to those charged with
governance.

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 Include in the auditor’s report under the paragraph “Information Other than the Financial
Statements and Auditor’s Report Thereon “ describing the material inconsistency in
accordance with ISA 706;
(c)  A provision of Rs. 30 million has been made in the financial statements and it represents
37.5% of the profit after tax and is material to the financial statements.
 A constructive obligation to restructure arises only when an entity has a detailed formal plan
for the restructuring identifying at least the principal locations affected.
 In this case it is unlikely that a constructive obligation exists in respect of third factory because
the factory which is to be closed is not identified.
 The auditor shall determine whether provision of Rs. 30 million pertains to two factories which
are identified or it pertains to three factories (including one which is not identified).
 If the provision relates to three factories, auditor will ask the management to adjust the amount
of provision to reflect the provision for two factories Moreover, the plan for closure of the third
factory should be disclosed.
 If the management refuses to do so, a qualified or adverse opinion may be issued depending
upon the materiality and pervasiveness.

156 Situations have arisen on different clients

(a) (i) If there are material inconsistencies in the additional disclosures the auditor should discuss
the reasons thereof with the management and ask them to revise the other information or
the financial statements, as may be appropriate.
(ii) If the revision of other information is necessary and the management refuses to revise the
same, the auditor shall communicate the matter to those charged with governance and;
(iii) Include in the auditor’s report under the paragraph “Information Other than the Financial
Statements and Auditor’s Report Thereon “ describing the material inconsistency in
accordance with ISA 706;
(iv) If the revision of the draft financial statements is necessary and management refuses to
make the revision, the auditor shall consider giving a qualified opinion or adverse opinion
as may be appropriate.
(v) The auditor should also consider that whether the supplementary information that is not
required by the applicable financial reporting framework, is clearly differentiated from the
audited financial statements.
(vi) If it is not clearly differentiated, he shall ask the management to change the way in which
the unaudited supplementary information has been presented.
(vii) In case of disagreement in respect of the above, the auditor shall explain in the auditor’s
report that such supplementary information has not been audited.
(b) (i) The amount of Rs. 9.6 million which is due from MIL is material to the financial statements.
(ii) With respect to job in progress ,if the auditor can satisfy himself that management would be
able to recover the cost of work in process from another customer, he may conclude that a
provision is not required in this respect.
(iii) In making the above decision the auditor should also consider the expenses that are
required to be incurred on the job, subsequent to year end.
(iv) The auditor should ask the management to provide for the loss of Rs. 9.6 million or any part
thereof depending upon the estimated amount of default, plus any further provision that
may be necessary in respect of the work in process. In case of management’s refusal, the
auditor shall qualify his report.
(c) The auditor shall qualify the audit report by mentioning that investment of Rs. 150 million was not
in accordance with the objects of the company with a clarification that the object clause was
amended a week before the issuance of audit report, to include the said objective.

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157 MM Electronics (Private) Limited

(a) Revaluation of Properties:
(i) In accordance with IAS 16, Property, Plant and Equipment, if a policy of revaluation is to be
applied, it should be applied to all the non current assets in a particular class of assets.
(ii) Since compliance with (i) above is not possible, the auditor should advise the client to not to
change the accounting policy and state the values of the property at cost.
(iii) In case of disagreement the auditor may consider issuing a qualified report.
(b) Suit for damages:
(i) The reliability of audit evidence provided by the legal advisor is high because it has been
obtained from an independent source outside the entity. As management is also of the view
that no liability exists at the balance sheet date, therefore in the presence of legal advisor’s
confirmation a conclusion should not be drawn on the basis of manager’s legal email.
(ii) However, since there is inconsistency in audit evidence obtained and the auditor is unaware
of the context in which the manager (legal) sent the email, he shall investigate the reasons
thereof and may need modification or addition to the audit procedures.
(iii) The auditor should analyze the situation, in the light of IAS 37, Provisions, Contingent
Liabilities and Contingent Assets, and assess whether a disclosure of the event as a
contingent liability is required or not.
(iv) If disclosure of contingent liability is required, and the client disagrees the audit report may
be qualified.
(c) Warranty Provision:
(i) The management’s claim that the amount cannot be measured reliably is not correct
because they were charging the customers at 25% above cost prior to July 01, 2010 i.e.
when there was no warranty on the sale of television sets and hence they must be in a
position to make a reliable estimate based on their past experience and records available
with them.
(ii) If a provision is not made for the warranty then if the amount of provision is material to the
financial statements then the audit report should be qualified
(d) Non Disclosure of Earnings per share in the financial statements:
International Accounting Standards 33, Earnings per share does not apply to non listed entities;
therefore there is no requirement of disclosing earnings per share in the financial statements.

158 Ranjha Limited

(a) (i) Significant matter
 In view of the decline in production capacity, it has become necessary to recalculate the
value in use and recoverable amount in order to assess the impairment in the value of
plant.
 The value of plant is material to the financial statements in terms of total assets as well
as profit before tax of the company.
Impact on audit report
 If the impairment test indicates a decline in the value of plant, the management should
be advised to make appropriate adjustments.
 In case of disagreement with the management, the auditor should give a qualified
opinion.
(ii) Significant matter
 Amount claimed by the customer is material to the financial statements in terms of total
assets as well as profit before tax of the company.

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Impact on audit report

 If management agrees to explain the issue in the note on contingent liabilities, the report
will not be qualified but in view of the material uncertainty an emphasis of matter
paragraph would have to be added to the auditor’s report to draw the user’s attention
to the note in the financial statements.
 In case of disagreement on making appropriate disclosure, the auditor should give a
qualified opinion.
(iii) Significant matter
 It is a fundamental error within the meaning of IAS-8 and its effect should be taken into
account retrospectively. All comparatives figures should be restated accordingly.
 The management’s decision to adjust the short amortization in the future years is in
contravention to the requirements of IAS-8.
Impact on audit report
 Since the error is material in terms of profit after tax, it should be discussed with the
management. They should be advised to make appropriate adjustment and disclosure
in accordance with the requirements of IAS-8.
 In case of disagreement, the auditor should give a qualified opinion.

159 Pervasive effects

(a) Pervasive is a term used to describe the effects of misstatement on the financial statements or the
possible effects thereon if any misstatement remains undetected due to the auditor’s inability to
obtain sufficient appropriate audit evidence.
Pervasive effects on the financial statements are those that, in the auditor’s judgments:
(i) are not confined to specific elements, account or items of the financial statements,
(ii) if so confined, represent or could represent a substantial proportion of the financial
statements or
(iii) in relation to disclosures, are fundamental to user’s understanding of the financial
statements.
(b) (i) Issuance of bank guarantee after the year end does not require any adjustment or
disclosure. Therefore, there will be no effect on the audit report on this issue.
(ii) The audit report shall state that “Zakat deductible at source under the Zakat & Ushr
Ordinance, 1980, was deducted and deposited in the Central Zakat Fund established under
section 7 of that Ordinance”.
(iii) The auditor should consider the materiality of the amount. If the amount is material, the
auditor should express a qualified or adverse opinion.
(iv)  The audit report shall mention the exception to the consistent application of accounting
policies and whether the auditor concurs with it or not.
 The financial statements shall be adjusted accordingly and the effect of change in
estimate shall be disclosed in the notes to the financial statements unless the
differences are material and auditor has reasons to differ with the reviewed estimate.
There would be no impact on the audit report on this issue.

160 Audit report at the end of the audit

(a) The statement of responsibility should state the following:
(i) It is the responsibility of the auditor to express an opinion on the financial statements.
(ii) The audit was conducted in accordance with International Standards on Auditing.
(iii) Those standards require that :

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 the auditor complies with ethical requirements.

 the auditor plans and performs the audit to obtain reasonable assurance whether the
financial statements are free from material misstatement.
(iv) That an audit involves performing procedures to obtain audit evidence about the amounts
and disclosures in the financial statements.
(v) That while selecting the procedures to be performed the auditor exercises judgment,
including the assessment of risks of material misstatements and whether due to fraud or
error.
(vi) In making the risk assessment the auditor considers internal controls relevant to fair
presentation of financial statements in order to design audit procedures that are appropriate
in the circumstances but not for the purpose of expressing an opinion on the effectiveness
of the entity’s internal control.
(vii) That an audit includes evaluation of the appropriateness of the accounting policies used,
the reasonableness of estimates and the overall presentation of information in the financial
statements.
(viii) The auditor believes that the audit evidence the auditor has obtained is sufficient and
appropriate to provide a basis for the auditor’s opinion.
(b) The situations in which a report is modified without affecting the auditor’s opinion are as follows:
(i) If there is a significant uncertainty (other than going concern or multiple uncertainties), the
resolution of which is dependent upon future events and which may affect the financial
statements.
(ii) In case, other information attached with the financial statements are inconsistent with the
information in the financial statements.
How modification is presented:
(i) By adding an emphasis of matter paragraph to highlight an important matter affecting the
financial statements.
(ii) The above paragraph is required to refer to the note to the financial statements that more
extensively discusses the matter.
(iii) The paragraph should preferably be included after the paragraph containing the auditor’s
opinion but before Key Audit Matters.
(iv) The emphasis of matter paragraph should ordinarily refer to the fact that the auditor’s
opinion is not qualified in this respect.

161 Iqra Industries Limited

Significant uncertainty regarding litigation
The ultimate outcome of the matter cannot presently be determined and therefore there is a significant
uncertainty the resolution of which is dependent upon future events.
Since it is not possible to reliably estimate the amount of loss accounting treatment of not recognizing
the provision and giving of disclosure is correct.
The auditor should consider modifying the auditor’s report by adding an emphasis of matter paragraph
referring to the detailed note in the financial statements.

162 Written representations

Under the following situations, the auditor would have doubt as to the reliability of written representation:
(a) When the auditor has concerns about the competence, integrity, ethical values or diligence of
management, or about its commitment to or enforcement of these.
(b) When written representations are inconsistent with other audit evidence obtained.

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Course of action in situation (a)

(i) The auditor shall determine the effect that such concerns may have on the reliability of
representations and audit evidence in general.
(ii) If the auditor concludes that the risks related to management representations on the financial
statements is such that an audit cannot be conducted, the auditor may consider withdrawing from
the engagement
Course of action in situation (b)
(i) The auditor may consider whether the risk assessment remains appropriate and, if not, revise the
risk assessment and determine the nature, timing and extent of further audit procedures to respond
to the assessed risks.
(ii) If the matter remains unresolved, the auditor shall reconsider the assessment of the competence,
integrity, ethical values or diligence of management, or of its commitment to or enforcement of
these, and shall determine the effect that this may have on the reliability of other representations
and audit evidence in general.
(iii) If the auditor concludes that the written representations are not reliable, the auditor shall take
appropriate actions, including determining the possible effect on the opinion in the auditor’s report.

163 Kazmi-Wassan
(a) Purpose of a written representation letter
Written representations are a form of audit evidence. They are usually contained in a letter, written
by the company’s directors and sent to the auditor, just prior to the completion of audit work and
before the audit report is signed.
Representations are required for two reasons:
 firstly, so the directors can acknowledge their collective responsibility for the preparation of
the financial statements and to confirm that they have approved those statements;
 secondly, to confirm any matters, which are material to the financial statements where
representations are crucial to obtaining sufficient and appropriate audit evidence.
In the latter situation, other forms of audit evidence are normally unavailable because knowledge
of the facts is confined to management and the matter is one of judgement or opinion.
Obtaining representations does not mean that other evidence does not have to be obtained. Audit
evidence will still be collected and the representation will support that evidence. Any contradiction
between sources of evidence should, as always, be investigated.
(b) Matters
(i) Tiger’s Purr
The amount of the claim is material being 50% of profit before taxation.
There is also a lack of definite supporting evidence for the claim. The two main pieces of
evidence available are the claim from Tiger’s Purr itself and the legal advice from Kazmi-
Wassan’s solicitors. However, any claim amount cannot be accurately determined because
the dispute has not been settled.
The directors have stated that they believe the claim not to be justified, which is one possible
outcome of the dispute. However, in order to obtain sufficient evidence to show how the
treatment of the potential claim was decided for the financial statements, the auditor must obtain
this opinion in writing. Reference must therefore be made to the claim in the representation
letter.
Paragraph for inclusion in representation letter.
‘A legal claim against Kazmi-Wassan by Tiger’s Purr has been estimated at Rs 4 million by
Tiger’s Purr. However, the directors are of the opinion that the claim is not justified on the
grounds of breach of product specification. No provision has been made in the financial
statements, although disclosure of the situation is adequate. No similar claims have been
received or are expected to be received.’

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(ii) Depreciation
This matter is unlikely to be included in the letter of representation because the auditor appears
to have obtained sufficient evidence to confirm the accounting treatment. The lack of profit or
loss on sale confirms that the depreciation charge is appropriate – large profits would indicate
over-depreciation and large losses, under-depreciation. The amount also meets industry
standards confirming the Kazmi-Wassan’s accounting policy is acceptable. Including the point
in the representation letter is inappropriate because the matter is not crucial and does not
appear to be based on judgment or opinion. The only opinion here appears to be that of the
auditor – unless the ‘feelings’ can be turned into some appropriate audit evidence, the matter
should be closed.
(c) Lack of representation letter
The auditor may take the following actions:
(i) Discuss the situation with the directors to try and resolve the issue that the directors have
raised. The auditor will need to explain the need for the representation letter again (and
note that the signing of the letter was mentioned in the engagement letter).
(ii) Ascertain exact reasons why the directors will not sign the letter. Consider whether
amendments can be made to the letter to incorporate the directors’ concerns that will still
provide the auditor with appropriate and sufficient audit evidence.
(iii) The discussion must clearly explain the fact that if the auditor does not receive sufficient and
appropriate audit evidence, then the audit report will have to be qualified.
The reason for the audit qualification will be uncertainty regarding the amounts and
disclosures in the financial statements.
(iv) Even if the letter is subsequently signed, the auditor must still evaluate the reliability of the
evidence. If, in the auditor’s opinion, the letter no longer provides sufficient or reliable
evidence, then a qualification may still be required.

164 RK Resourcing
(a) Audit procedures to be used prior to the audit report being signed
 Reviewing procedures established by management to try and ensure that subsequent
events are identified.
 Reading minutes of the meetings of directors, the audit committee and shareholders and
enquiring into unusual items.
 Obtaining and reading the company’s latest interim accounts as well as any budgets and
cash flow forecasts.
 Obtaining additional evidence if possible from the company’s lawyers concerning litigation
and claims.
 Asking management as to whether any subsequent events have occurred such as
 New borrowing commitments
 Significant sales of assets
 New shares or debentures issued
 Assets being destroyed by flood, fire etc. or impounded by the government
 Unusual accounting adjustments made or being contemplated
 Checking whether any events have occurred that could call into question the validity of the
going concern assumption.

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(b) The three dates

15 August 20X3
(i) Adjusting or non-adjusting?
The bankruptcy of a major customer provides additional evidence of conditions existing at
the end of the reporting period. The customer will not be able to pay debts due, therefore
receivables are overstated and the bad debt expense in the profit and loss account is
understated. An adjustment for the amount of the receivable should be made in the financial
statements.
(ii) Auditor’s responsibility and audit procedures to be carried out
The bankruptcy of the major customer takes place after the end of the year but before the
financial statements and the auditor’s report are signed. As the auditor’s report has not been
signed, the auditor is responsible for identifying material events that affect the financial
statements. This means that audit procedures should be carried out which are designed to
identify this event.
Specific procedures undertaken include the following:
 Confirming that the customer will not pay to a letter from the receiver or similar
authorised person.
 Confirming the amount due from the customer to invoices raised prior to the year end,
and if possible to a positive confirmation request.
 Auditing the adjustment to the financial statements decreasing the receivable balance
and increasing the bad debt write off in the profit and loss account.
 Including the amount in the written representation letter to confirm no other amounts
are due from the customer.
1 November 20X3
(i) Adjusting or non-adjusting?
The accidental release of toxic chemicals occurred after the reporting period. Assuming that
the inventory was not on the statement of financial position at the year end, then the spill is
indicative of conditions that arose subsequent to the year end. No adjustment appears to be
necessary. However, the event may be significant in terms of the operations of the company
(a large legal claim could arise) and so disclosure of the event would be expected.
(ii) Auditor’s responsibility and audit procedures to be carried out
The accidental release of toxic chemicals takes place after the auditor’s report has been
signed but before the financial statements are sent to the members. At this stage of the
audit, the auditor does not have any responsibility to perform procedures or make enquiries
regarding the financial statements. The management of RK Resourcing are responsible for
telling the auditor about any significant events, such as this one.
However, as the auditor is now aware of the event and this materially affects the financial
statements in terms of disclosure being required, the auditor does have to discuss the event
with management.
Specific procedures to be undertaken include the following:
 Obtain information concerning the chemical release from management, reading local
press and if possible the company’s lawyers – the latter may be able to indicate
whether there is any legal liability.
 Discuss the appropriate accounting treatment with the directors, confirming that
disclosure is required in the circumstances.
 Read the disclosure note to confirm that the matter is adequately explained in the
financial statements.

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 Obtain an updated letter of representation from the directors confirming that there are
no other events requiring disclosure.
 Amend the auditor’s report to include an emphasis of matter paragraph to draw
attention to the full disclosure noted in the financial statements.
 Date the new auditor’s report no earlier than the date of the amended financial
statements and update “active” subsequent events review to that date.
30 November 20X3
(i) Adjusting or non-adjusting?
The fire at an oil well means that RK Resourcing’s oil production and presumably profits will
fall in the next financial year.
The fire though does not provide additional evidence of conditions existing at the end of the
reporting period as at this time there was no indication that this would occur. The event is
therefore non-adjusting in the financial statements. However, disclosure of the event should
be made so that the financial statements do not give a misleading position.
(ii) Auditor’s responsibility and audit procedures to be carried out
The fire at an oil well takes place after the financial statements have been issued. At this
time, the auditor has no obligation to make any inquiry at all regarding the financial
statements. However, if the auditor becomes aware of the event, then the potential effect on
the auditor’s report must be considered.
Specific procedures undertaken include the following:
 Checking the board minutes, insurance claims and similar documents to ensure that
the fire will be covered by insurance and there is no contingent liability for replacing
non-current assets or clearing up any environmental damage.
 Enquiring of the directors how the members will be informed of the situation.
 If the directors plan to re-issue the financial statements, ensure that appropriate
disclosure is made of the event, date the new auditor’s report no earlier than the date
of the amended financial statements and update “active” subsequent events review
to that date.
 If the directors do not intend to amend the financial statements, and the auditor
considers the matter to be material to understanding the accounts, consider
attempting to contact the members directly, depending on the methods available in
your country.
 If necessary, take legal advice to discuss what action can be taken regarding the lack
of disclosure.

165 Rake Enterprises

(a) Comparison of directors’ and auditors’ responsibilities
(i) Preparation of financial statements
The directors are normally required to prepare the financial statements of the company using
the appropriate law of their country and in accordance with the International
Accounting/Financial Reporting Standards (IASs/IFRSs). The auditors are normally required
to check or audit those financial statements, again in accordance with the legislation of their
country and the International Statements on Auditing.
(ii) Fraud and error
The directors are responsible for preventing and detecting fraud and error in the financial
statements, no matter how immaterial this may be. Auditors are responsible for ensuring that
the financial statements show a true and fair view; in other words that the financial
statements are materially correct. Auditors are not required to detect immaterial fraud or
error.

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(iii) Disclosure
The directors must ensure that there is adequate disclosure of all matters required by statute
or IASs/IFRSs in the financial statements. The auditor will check that disclosure provisions
have been complied with, and where certain disclosures have not been made (e.g. ISA 550
regarding related party transactions) provide this information in the audit report.
(iv) Going concern
The directors are responsible for ensuring that the company will continue in operational
existence for the foreseeable future, and report to the members in the published financial
statements if this is unlikely to be the case. The auditor will check the accuracy of the
directors' workings and assumptions and if these are considered incorrect or inappropriate,
then the audit report or opinion may be modified to bring the situation to the attention of the
members of the company.
(b) Errors
The auditor’s responsibility paragraph does not meet the requirements of ISA 700 for the following
reasons:
(i) It does not follow the standard wording set out in ISA 700. For example, it does not state at
the outset that the auditor’s responsibitly is to express an opinion on the financial statements
based on his audit.
(ii) The use of the term Auditing Standards is not clear, because the report does not state which
auditing standards have been used (e.g. ISAs). This provides uncertainty regarding the
actual standard of work performed.
(iii) The assessment of estimates and judgements made by the directors normally relates to
material amounts only, rather than all of those estimates and judgements. The correct
wording from ISA 700 would state that the procedures selected took into account ‘ the risks
of material misstatement’ i.e. showing that the audit testing was probably focused on
material amounts only.
(iv) Stating that time was a factor in obtaining information and explanations for the audit is not
correct as this implies some factor which could have been avoided and that the audit may
therefore be incomplete. The auditor has to plan the audit carefully and ensure that all the
information and explanations considered necessary are obtained to form an opinion, not
simply stop work when time runs out.
(v) The auditor does not confirm that the financial statements are free from material
misstatement as this implies a degree of accuracy that the auditor simply cannot provide.
Making the statement could also leave the auditor liable to claims from members or third
parties should errors be found in the financial statements later. Rather than make such a
categorical statement, the correct wording from ISA 700 states that the auditor provides
reasonable assurance that the financial statements are free from material misstatement,
which clearly implies that audit techniques are limited.
(vi) The disclaimer regarding errors appears to be useful in that it limits the auditor's liability.
However, it does not belong in the auditor’s responsibility paragraph as it appears to severely
limit the auditor's responsibilities stating that the directors are responsible for all errors.
Management’s responsibility is also clearly outlined in another section of the report, and this
statement also appears to extend those responsibilities making the audit report overall less
clear. This could also imply that the auditor has done little or no work.
(vii) Fisrt paragraph of the auditor’s responsibility is wrongly given under this heading; it should
have been classified under the basis of opinion section of the report as per ISA 700
(Revised)
(viii) Some other information decribed by the ISA 700 (Revised) undrer the section of Auditor’s
Responsibility is not provided in the given scenerio.
(ix) Heading should be “Auditor’s Responsibilities for the Audit of the Financial Statements”
instead of “Auditor’s Responsibility”

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166 Tariq Limited

(a) Provision of warranty is 10% of the PBT and therefore it is material to the financial statements
Since the expert has been appointed and matters related to his appointment have already been
considered, we may need to perform the following procedures:
 Evaluate the reasonableness of significant assumptions and methods used
 Evaluate the relevance, completeness and accuracy of source data
 Evaluate the reasonableness of the expert’s conclusions
 Carry out analytical procedures to assess the reasonableness of the provision as compared
to other relevant items
 Confirm that the accounting provisions of IAS 37 have been complied with, in making the
provision
 In case there is a difference between the valuation of the auditor’s expert and the valuation
of the management, discuss the difference with the management.
Reporting implication
In case the difference between the valuation of the auditor’s expert and the valuation of the management
is material and cannot be resolved, we will have to give a qualified opinion.
However, if we have obtained sufficient appropriate evidence regarding the valuation and presentation of
the warranty provision, then we will have to include relevant details under the heading of key audit matters
in our audit report, because it is an area of higher assessed risk of material misstatement due to
involvement of high degree of uncertainty and significant auditor judgment.
(b) Our firm was not appointed as auditors of the YL until 30 June 2017 and thus did not observe the
counting of physical inventories as the end of year 30 June 2017. In this situation, we may perform
the following procedures:
 Conduct physical inventory count after the date of the financial statements.
 Check whether the changes in inventory between the count date and the date of the financial
statements are properly recorded.
 Investigate the reason for significant differences between the information obtained during
the physical count and the inventory records.
 Assess the reliability of inventory records.
Reporting implication
If the auditor concludes that it would be impracticable or not possible to work back the inventory then this
would be a scope limitation and depending upon the material and pervasiveness of the amount of
inventory, the auditor should qualify or disclaim his opinion.
Furthermore, the auditor should include other matter paragraph and mention that the prior period financial
statements were audited by another auditor.

167 GMP & Company

(a) Offer of CEO cannot be accepted as the letter of representation is to be dated as near as
practicable (but not after) the date of audit report, because:
 written representation is also obtained in respect of subsequent events
 further matters might also arise during the course of audit for which we may require
management representation.
However, the written representations are requested from those responsible for the preparation of
financial statements. Therefore, in the absence of the Chief Executive Officer, management
representation may be obtained from the Chief Financial Officer and those charged with
governance.
(b) If the management modifies our requested wording, we may still be able to conclude that it is a
reliable representation.

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 Answer bank: Objective test and long-form answers

However, before arriving at any conclusion, we must consider the effects of the information
destroyed in the fire on the financial statements and on our ability to obtain the necessary audit
evidence and the possible impact on our audit report.
(c) If adjustments are immaterial, representation letter may include the effect of any uncorrected
immaterial misstatements. However, the decision regarding materiality of the uncorrected
misstatements is to be made by the auditor and not by the client.
Further, materiality depends on the fact that omission or misstatement would influence the
economic decision of the user, and the financial statements are relevant not only for the owners
but also for other users which may include bankers, government institutions, etc., therefore, the
comment of the managing director regarding the effect on decision making is not correct.
If financial statements remain uncorrected and the required correction is material also, its impact
on audit report would need to be assessed.

168 BLC & Company

(i) The intangible asset measured at Rs. 100 million is material as it represents 37% of profit
before tax.
 IAS 38 requires that the entity should be able to demonstrate the availability of adequate
technical, financial and other resources to complete the development and to use or sell the
intangible asset. As ATL appears to be short of finance, it is questionable whether sufficient
funds would be available to complete the development work and take the product to market.
Therefore, it appears that the criteria for capitalization of development costs contained in
IAS 38 Intangible Assets is not met.
 Discuss this matter with the management and those charged with governance to assess
their plans for arranging the necessary finance. In case the auditor believes that there is a
doubt as regards the company’s ability to complete the development work, the intangible
asset should be derecognized and the auditor should request the management to amend
the financial statements.
 If the management fails to resolve the issue appropriately, the auditor may have to qualify
the report as the misstatement is material, but not pervasive.
(ii) Since the fire has destroyed a significant portion of RL’s plant, the auditor should consider RL’s
ability to continue as a going concern.
 Evaluate financial condition of RL as the cost of new plant is expected to be much higher
and insurance claim of Rs. 400 million may not be sufficient to purchase a new plant.
 Discuss with the management and those charged with governance that how they intend to
finance the new plant and the operational expenses during the closure of the plant.
 Inspect the insurance policy and the correspondence with insurance company for the
verification of the insurance claim.
 Read the minutes of those charged with governance for further details.
 Analyze the latest available interim financial statements, to assess the impact of the accident
on RL’s financial performance.
 In case the going concern basis is inappropriate but the financial statements have not been
adjusted accordingly we will express an adverse opinion.
 In case going concern basis is appropriate but material uncertainty exists and the
management has not made appropriate disclosures, we will express a qualified or adverse
opinion depending upon the materiality and pervasiveness of the situation.
 If the management has made appropriate disclosures in the financial statements regarding
material uncertainty, we will express an unmodified opinion and will draw attention to the
disclosure through a separate section under the heading material uncertainty related to
going concern.

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Audit and Assurance

169 Audit Partner

(a) Change in accounting policy has to be reported as a key audit matter. For this purpose it is
necessary that it should be discussed with those charged with governance. In the key audit matter
section, the auditor shall:
 include a reference to the related disclosure(s), if any, in the financial statements
 state why the matter was considered to be one of most significance in the audit; and
 specify how the matter was addressed in the audit.
(b) The verbal confirmation from the legal advisor cannot be taken as sufficient appropriate audit
evidence and on account of inability to obtain sufficient appropriate audit evidence. The auditor
may consider to qualify or disclaim an opinion on the financial statements
(c) If in the opinion of the auditor the non-disclosure of information results in material misstatement in
the financial statements, he shall:
 discuss the non-disclosure with those charged with governance;
 describe in the ‘Basis for opinion section’ the nature of the omitted information; and
 issue a qualified opinion on the basis of inability to obtain sufficient appropriate audit
evidence.

170 Afzal Textile Mills Limited

(a)  Discuss the matter with the management.
 Re-evaluate the integrity of the management.
 Take appropriate action including determining the possible effects on the auditor’s report.
(b) (i) This must be included in a representation letter. The written representation must cover the
completeness of the information that has been provided about the related parties and related
party transactions.
(ii) This may not be included in a representation letter. The auditor should obtain sufficient
appropriate audit evidence on this matter such as checking the shareholding in the share
register, etc.
(iii) (This should not be included in a representation letter. This is a matter of incorrect accounting
treatment which the auditor should discuss and resolve with the management.

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 Answer bank: Objective test and long-form answers

REVIEW ENGAGEMENTS
171 ISRE 2400
(a) Meaning and types of assurance
Meaning
‘Assurance’ means confidence. In an assurance engagement, an ‘assurance firm’ is engaged by
one party to give an opinion on a piece of information that has been prepared by another party.
The opinion is an expression of assurance about the information that has been reviewed. It gives
assurance to the party that hired the assurance firm that the information can be relied on.
Types
There are two main types of assurance:
 audit: this may be external audit, internal audit or a combination of the two; and
 review.
An audit provides a high, but not absolute, level of assurance that the audited information is free
from any material misstatement. This is often referred to as reasonable assurance. The opinion is
usually expressed as positive assurance that, in the opinion of the auditors, the financial statements
do present fairly the financial position and performance of the company.
A review is a ‘voluntary’ investigation. In contrast to the “reasonable” level of assurance provided
by an audit, a review into an aspect of the financial statements would provide only a moderate level
of assurance that the information under review is free of material misstatement. The resulting
opinion is usually (although not always) expressed in the form of negative assurance. Negative
assurance is an opinion that nothing is obviously wrong: in other words, ‘nothing has come to our
attention to suggest that the information is misstated’.
(b) Review procedures
 The accountant should obtain an understanding of the entity’s business and the industry in
which it operates.
 The accountant should make enquiries into:
 the entity’s accounting policies, practices and procedures, including the preparation of
financial statements;
 material assertions in the financial statements that are subject to the review;
 decisions taken at board meetings and other meetings of the entity that may affect the
financial statements;
 the completeness of the accounting records that were used to prepare the financial
statements.
 The accountant should use analytical procedures to identify unusual relationships between
items in the financial statements, and individual items that appear unusual.
 Other procedures such as:
 discussions with the company’s auditors;
 obtaining representations from management;
 considering the appropriateness of the accounting policies employed by the entity;
 making enquiries into subsequent events;
 reviewing the statements as a whole.

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(c)
Review Engagement Annual Audit

The procedures performed are The procedures performed in an audit

substantially less than those performed in includes test of controls, substantive
an audit and are mostly limited to procedures, analytical procedures and
analytical procedures and inquiries. inquiries.

A review does not provide a high level of An audit is designed to provide a high level
assurance and in some cases do not of assurance to the users of the financial
provide any assurance. statements.

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