Audit and Assurance

Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

A.1 (a) The firm should take the following actions:

 Obtain the prior permission of the client, preferably in writing, to initiate

discussions with the outgoing auditor.
 Request the outgoing auditor to provide known information regarding any facts
or other information of which, in outgoing auditor’s opinion, our firm needs to
be aware before deciding whether to accept the engagement.
 If unable to communicate with the existing or predecessor accountant, the
proposed accountant shall take other reasonable steps to obtain information
about any possible threats.
 If the client fails or refuses to grant the outgoing auditor permission to discuss
the client’s affairs with our firm, consider such failure or refusal when
determining whether to accept the appointment.

(b) A self-interest threat to compliance with the principles of objectivity and professional
competence and due care is created if a chartered accountant pays or receives a referral
fee or receives a commission relating to a client. The firm may be interested in earning
greater commission from referring the client and might not refer it to the firm which
best meets the client’s requirement.

(c) There is a self-review threat because Ahmed may not appropriately evaluate the work
performed by him in the role of accounting and tax consultant.

There is also a familiarity threat due to Ahmed’s long association with MPL, and he
might be too sympathetic to their interests or too accepting of their work.

Ahmed’s objectivity may be compromised because of his bias, conflict of interest or

undue influence of the audit client.

Evaluation of significance of threat:

Self-review threat
The consultancy service related to preparation of annual budget and management
accounts may not pose a significant threat as the preparation of annual budget is based
on expected amount which is not subject to audit. Therefore, there may not be a self-
review threat.

It needs to be ascertained whether the preparation of management accounts is based

on the historical amounts and whether any adjustments are made to the accounting
records on the basis of the management accounts prepared by Ahmed.

However, the calculation of tax provision would be subject to audit which would
result in a significant self-review threat.

Familiarity threat
The closeness of Ahmed’s relationship with the senior management and frequency of
interaction with the management needs to be determined. In any case this is a
significant threat.

It also needs to be determined that since how long Ahmed has been providing these
services to the audit client.

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

A.2 (a) (i)  The financial reporting framework used (for example, international
financial reporting standards).
 Any industry specific reporting requirements
 The location of the components of the entity (for example, there might be
overseas branches).
 The nature of the business segments to be audited, including the need for
specialized knowledge.
 The reporting currency to be used, including any need for currency
translation for the financial information audited.
 The need for a statutory audit of standalone financial statements in addition
to an audit for consolidation purposes.
 Whether the entity has an internal audit function and, if so, whether, in
which areas and to what extent, the work of the function can be used, or
internal auditors can be used to provide direct assistance, for purposes of
the audit.
 The expected use of audit evidence obtained in previous audits, for
example, audit evidence related to risk assessment procedures and tests of
controls.

(ii)  The entity's timetable for reporting such as at interim and final stages.
 The organization of meetings with management and those charged with
governance to discuss the nature timing and extent of the audit work.
 The discussion with management and those charged with governance
regarding the expected type and timing of reports to be issued and other
communications both written and oral including the auditor's report
management letters and communication to those charged with governance.
 The discussion with management regarding the expected communication
on the status of audit work throughout the engagement.

(b) (i) The maximum amount held in petty cash should be restricted to approximately
one month of petty cash spending. This is to avoid holding unnecessarily large
amounts of cash that might be stolen.
(ii) All petty cash spending should be authorized in advance by a properly
authorized person (and not by the person withdrawing the cash). Authorization
should be indicated by signing and dating the petty cash voucher.
(iii) All withdrawals of petty cash should be recorded on a petty cash voucher and
vouchers must be sequentially numbered. This is to prevent the fraudulent
withdrawal of cash and failures to record cash withdrawals
(iv) Receipts should be provided for petty cash spending and attached to the petty
cash voucher.
(v) There should be occasional checks of petty cash by a senior person (not the
person responsible for holding and issuing petty cash) to ensure that the person
responsible for holding petty cash has not been taking money fraudulently.

(c) (i) Evaluate whether to:

 use interim or final balances for circulating confirmation;
 sent positive confirmation or negative confirmation.
(ii) Obtain an aged listing of receivables ledger balances at the chosen date.
(iii) If the list is prepared by the client, check the completeness and accuracy of the
list of balances and the total of the balances in the list.
(iv) If the population of receivables ledger balances is not homogeneous, stratified
sampling might be used.
(v) A suitable sampling method should be chosen. As with all sampling, the sample
selection process should as far as possible ensure that the sample is
representative of the population of receivables.
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

(vi) In selecting the sample, certain types of account should be considered for
inclusion, such as overdue accounts, credit balance and nil balance.

A.3 (a) Brief evaluation of the situation:

It is necessary for the auditor to obtain written representation that management has
fulfilled its responsibilities. It supports the overall control and the managements
attitude over the financial reporting process. It also supports the other audit evidence
obtained by the auditor.

Managements refusal to provide the written representation is inability to obtain

sufficient appropriate audit evidence arising from a limitation on the scope of the audit
imposed by the management.

Reporting implication:
Since the limitation of scope is related to preparation of financial statements, the effect
is pervasive.

Auditor will therefore disclaim the opinion and mention it in the opinion paragraph
that the auditor does not express an opinion on the financial statements.

Since the modification results from an inability to obtain sufficient appropriate audit
evidence, the auditor shall include in the basis for opinion section the reasons for that
inability.

Implication on key audit matter:

Since we are disclaiming the opinion, key audit matter section will not be made part
of the audit report.

(b) Brief evaluation of the situation:

Inventory is measured at the lower of cost and net realizable value. Increase of fuel
prices in international market will not have any impact on fuel quantities already
procured and held by Power Generation Limited. Any upward valuation of fuel
inventories would result in misstatement.

Reporting implication:
The effect of upward valuation is Rs. 250 million which is 10% of the profit before
tax. Since the effect is confined to a single element of the financial statement, the effect
is material but not pervasive.

The misstatement being material, auditor will have to express a qualified opinion. The
auditor shall include in the basis for opinion section, a description and quantification
of the financial effects of the misstatement.

Implication on key audit matter:

Qualified opinion is by nature a key audit matter. Therefore, a reference to the Basis
for Qualified Opinion should be included in the Key Audit Matters section.

(c) Brief evaluation of the situation:

Since the going concern basis is not appropriate, the management has rightly prepared
the financial statements on liquidation basis.

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

Reporting implication:
The auditor may be able to express an unmodified opinion on those financial
statements, provided there is adequate disclosure therein about the basis of accounting
on which the financial statements are prepared.

However, the auditor will include an Emphasis of Matter paragraph to draw the user’s
attention to that alternative basis of accounting and the reasons for its use.

Implication on key audit matter:

There will not be any impact on the key audit matter section of the audit report and it
would be presented as usual.

A.4 (a) Cash collection:

Majority of the collection is in cash which is to be held at an outlet for up to 2 days,
therefore there is a risk of misappropriation in cash.

Inventory:
 The existing inventory of NFL might not be used because of its perishable
nature and decline in demand. Therefore, there is a risk that the inventory may
not be recorded at lower of cost or its net realizable value.
 The expired inventory is also not properly identified at some of the outlets,
therefore, there is a risk that the inventory may not be written-off.

Fines and litigation:

 Since proper control are not being followed at two outlets, there is a risk that
fines might be imposed by the government authority on inspection.
 There is a risk that expired stock might be used which may cause illness to the
consumer.
 There is a risk that provision might not be recorded for the possible fines or
litigation or disclosed as a contingency.
Interest based loans:
 NFL has obtained interest based loans. Due to the increasing interest rates,
there is a risk that NFL may be in breach of covenants.
 There is also a risk that interest accrual may not be properly recorded.
 Due to the adverse operational and economic condition, there is a risk that
management may fraudulently misstate the financial statements.

Impairment of Assets:
 Due to the decrease in demand there is a risk that property, plant and equipment
may need to be considered for impairment.

Foreign exchange translation:

 Since NFL imports ingredients, there is a risk there might not be proper
recording of foreign exchange gain or loss.
 There is also a risk that inventory might be translated using incorrect exchange
rate.

(b) Going concern assessment:

 The imported raw materials are used in their most selling items. Considering
this, it would be important to identify the quantum of revenue attributed to
those items. If it constitutes NFL’s major revenue, it may impact the future
revenue and profitability of NFL.

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

 Due to rupee devaluation, raw material costs have risen significantly. However,
if NFL is able to find local substitute of these imported products than they might
be able to bring down the operational costs.
 NFL’s profitability has significantly declined in the current year. It may further
decline in the coming year as there is a recession in the economy and NFL may
witness low customer turnout.
 It also needs to be determined that how the increase in interest rates and
electricity will impact the profitability and whether NFL will be able to fulfill
its liabilities.

Audit procedures:
 Discuss the above situation with the management and obtain management
plans to address the ban on import of raw materials used by the Company.
 Review the management plans including identification of substitutes in the
local market, availability, impact on future purchase price, consumption and
change in recipe and customer behavior.
 Identify the quantum of those materials in the production cycle and related
revenue.
 Obtain management forecasts for next twelve months including the impact of
above factors.
 Evaluate the assumptions used by the management in preparation of the
forecast.
 Review the board minutes to identify the action plan being adopted by the
management.
 Obtain and review interim financial statements to assess the effect of the above
events.
 Read the terms of loan agreements and determine whether any of them have
been breached.
 Confirm the existence, terms and adequacy of the borrowing facilities.
 Obtain written representation from the management that their assumptions are
reasonable and that NFL will continue as a going concern.

A.5 Payroll cost:

Completeness and accuracy of the payroll cost can be determined by performing analytical
procedures. However, projecting the payroll cost of June 2021 on the basis of revenue is not
correct, as certain payroll costs are fixed and do not move in line with the revenue.

Changes to be incorporated in the analytical procedures:

Payroll cost of June 2021 would be projected to the payroll cost of year ended June 2022 by
taking the effect of the following:
 The effect of those employees who have joined and left during the year
 The effect of increments
 The effect of any deductions made in the salary
 Discuss any significant differences/inconsistencies with the management

A.6 Inventory count procedures:

Chemical stored in container

 Obtain the report prepared by agency’s officials and verify the quantities as at
30 June.
 Obtain the documentation and verify related to purchase and issuances from 1 July
to 30 September and reconcile the movement of inventory from 30 June to 30
September.
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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

 Ask the management to request the agency’s official to be present at the inventory
count on 30 September.
 Consider involving an expert to verify the quantities within the container.

Inventory held abroad

 Send direct confirmation to third party in Malaysia to confirm condition and quantity
of raw materials held.
 Consider visiting to Malaysia for attending the stock count.
 Arrange another auditor to attend the physical count in Malaysia, if practicable.
 Inspect documentation regarding inventory held by third parties (e.g. warehouse
receipts), order received from Columbia (e.g. purchase order received) and the
subsequent shipment made to the customer.
 Consider performing observing the an online inventory count.

Work in process
 Check the stage of completion of the work in progress, in respect of both materials
and conversion costs.
 Check the batch/production records and verify the finished goods subsequently
produced and reconcile it with raw material issued.

A.7 (i) Evaluation:

Even though HL came to know about the issue after the year-end, the existence of
defect in HL products provide evidence of conditions that already existed at the end
of the reporting period. Therefore, it is as an adjusting event. The provision for sales
return and NRV provision should be reassessed on the basis of the identified defect
and the financial statements should be adjusted accordingly.

Auditor’s course of action:

Sales return:
 Obtain reports to verify the quantity of those batches sold during the year.
 Obtain production reports to calculate the total production of those batches.
 Consider whether quantity of such inventory could be verified through
inventory count performed at year end.
 Obtain any subsequent claims made by the distributor for return of inventory.
 Obtain the managements working for the net realizable value of the inventory
and assess its adequacy.
 Evaluate the management assumptions for the revised provisions.
 Obtain management representation that the sales return provision and NRV
provision reflects the management best estimate.
 Ask the management to revise the financial statements and get it approved by
the board of directors.

(ii) The acquisition of OL occurred after the year-end and therefore, it is a non-adjusting
event for which the financial statements do not need amendment. It is a material
acquisition and therefore, CL shall disclose the details of the acquisition in the
financial statements.

Auditor’s course of action:

 Obtain from the management the agreement made for the acquisition.
 Assess the adequacy of the disclosure made in the financial statements.

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 Audit and Assurance
Suggested Answers
Certificate in Accounting and Finance – Autumn 2022

A.8 Haider should follow the following process if he alone or together with other willing
shareholders, holds 10% shareholding in Green Limited.

 The shareholder(s) should first obtain the consent of the proposed auditor.
 A notice should be given to the company in this regard not less than seven days before
the date of the annual general meeting.

Responsibilities of GL:
 GL shall forthwith send a copy of notice received from Haider to the retiring auditor
and shall also post it on the company’s website.
 Since an auditor, other than the retiring auditor is proposed to be appointed, GL’s
board shall ensure that:
– the retiring auditor is given an opportunity to make a representation in writing to
the company at least two days before the date of general meeting.
– representation received from the retiring auditor is read out at the meeting before
taking up the agenda for the appointment of the auditor.
– within fourteen days from the date of any appointment of an auditor,
an intimation is sent to the registrar thereof, together with the consent in writing
of the auditor concerned.

(THE END)

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