September/December 2021

Question 1
This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor with Apricot & Co and have been assigned to
the audit of Peach Co, a soft drinks manufacturer which sells to wholesale customers. You
are currently planning the year-end audit for the year ending 31 August 20X5 and have
received the following notes from the audit engagement partner. Materiality for the draft
financial statements has been calculated as $153,000, which is 5% of profit before tax.

Planning meeting notes

A new accounting system was introduced via direct changeover in March 20X5. It had been
successfully tested prior to its implementation and management had such confidence in the
new system that they did not consider it necessary to undertake further testing after
implementation.

Peach Co has been developing a new production process which will help to reduce sugar in
its drinks by 50%. Development commenced on 1 November 20X4 and the total amount
capitalised was $0.8m. On 1 May 20X5, the food safety authority approved the process and
production of the new reduced-sugar soft drinks commenced.

Peach Co has inventories of high-sugar drinks costing $227,000 which it can no longer sell in
its home market due to a lack of demand. The directors believe Peach Co can sell the
remaining inventories to an international customer at a price that marginally exceeds cost
but Peach Co will be responsible for all costs relating to the delivery and shipping of the
drinks.

Peach Co replaced two items of machinery in its production line to accommodate a change
in the type of bottles used. There were significant staff costs involved in preparing the site
for the new machinery and in testing that the new machinery was operating correctly. These
costs have been included within the wages and salaries expense for the period. Despite the
old machinery being sold at a significant loss, during the year the directors of Peach Co
decided to extend the useful lives of plant and machinery by an average of five years.
A member of the finance team was dismissed by Peach Co in May 20X5 after it was
discovered that they had been fraudulently purchasing non-current assets for personal use.
Peach Co started to investigate the fraud at the beginning of June 20X5 by reconciling all
physical assets to the non-current asset register but will not have completed the
reconciliation by the year-end date.

Peach Co entered into a contract on 1 May 20X5 with a new supplier of bottles. Peach Co has
committed to a minimum order quantity of 150,000 bottles per month for a period of 12
months commencing 1 May 20X5. No costs have been accounted for to date as no amounts
are payable for the first six months. Three equal instalments are then payable across the
remainder of the contract term. Peach Co's previous supplier has launched a legal claim
against Peach Co for breach of contract, stating that Peach Co did not have the right to exit
the agreement early. Peach Co's lawyers have indicated that it is likely to lose the case and
have estimated the amount payable to be in the region of $0.3m.

In order to fund the development of the new production process and the purchase of new
machinery, Peach Co obtained an interest-bearing bank loan of $1.2m on 1 March 20X5
repayable over the next three years in arrears. In order to secure the bank loan, Peach Co
agreed to maintain a minimum net profit margin and meet specific sales targets.

(a) Describe EIGHT audit risks, and explain the auditor’s response to each risk,
in planning the audit of Peach Co. (16 marks)

(b) Describe Apricot & Co's responsibilities in relation to the prevention and
detection of fraud and error. (4 marks)

Peach Co has been an audit client of Apricot & Co for the last 15 years. The audit staff of
Apricot & Co and the client staff of Peach Co have always enjoyed a meal together at the
start of the final audit. Alan Edward, the managing director of Peach Co has this year
suggested that instead of a meal, all the audit staff and client staff go away for the weekend
to a luxury hotel at Peach Co's expense.

Alan Edward has also suggested that the current year audit fee is renegotiated to be based
on a percentage of Peach Co's net profit for the year.
This year, for the first time, Apricot & Co has been approached by Peach Co to help identify
potential acquisition targets. Discussions are currently at an early stage and no work has
been undertaken at present. The total fees in relation to the audit and other work would fall
within acceptable levels in line with ACCA’s Code of Ethics and Conduct.

(c)(i) Identify and explain TWO ethical threats which may affect the independence of Apricot
& Co’s audit of Peach Co; and

(ii) For each threat, recommend an appropriate safeguard to reduce the threat to an
acceptable level. (4 marks)

(d) Describe substantive procedures the auditor should perform to obtain

sufficient and appropriate audit evidence in relation to Peach Co's
development expenditure. (6 marks)

(30 marks)

Question 2
This scenario relates to two requirements.

It is 1 July 20X5. Pomeranian Co is a manufacturer of fizzy drinks and operates across the
country. The company’s year end is 30 September 20X5. You are an audit supervisor with
Poodle & Co and you are reviewing extracts from the internal controls documentation in
preparation for the forthcoming audit.

Sales
All new customers of Pomeranian Co are required to pass suitable credit checks. Upon
passing the credit check, customers are set up in the receivables ledger master file and a
credit limit is set by the sales director. The credit limits are only then changed when a
customer requests an increase.

Customer orders are processed by Pomeranian Co’s sales ordering department and goods
are dispatched from one of the company’s warehouses. Sequentially numbered multi-part
goods dispatched notes (GDNs) are completed and a copy is filed in the warehouse when the
goods are dispatched. Copies of the GDNs are sent to the sales ordering department and the
finance department on a weekly basis.
Pomeranian Co’s credit controller is currently on maternity leave for six months and no one
has taken over her duties. As part of the month-end procedures, a clerk reconciles the
receivables ledger control account to the receivables ledger and the reconciliations are only
reviewed by the financial controller if there are any unreconciled differences.

Non-current assets
An annual capital expenditure budget is set for each department within Pomeranian Co and
is referred to as part of the approval process. Board approval is required for any capital items
costing more than $0.5m. Capital expenditure below this level can be authorised by the
relevant head of department.

Pomeranian Co has a head office and five factories, each of which includes a warehouse. The
company has an internal audit (IA) department which is required, over a three-year cycle, to
carry out a comparison between all the assets recorded on the non-current assets register to
those physically present in each of the company’s 11 sites. The programme of visits for the
current year means that by the year end, IA will only have completed this comparison at one
factory and one warehouse.

Purchases and inventory

Pomeranian Co maintains a perpetual inventory system in which finished goods and raw
materials, stored in the warehouses, are counted monthly throughout the year rather than
just being counted at the year end. Each of the five warehouse managers are responsible for
supervising the inventory counts at their sites and ensuring that the counting teams are
following the issued instructions.

The company calculates the cost of its inventory using standard costs, both for internal
management reporting and for inclusion in the year-end financial statements. The basis of
the standard costs was reviewed by the production department approximately two years
ago.

The company has a central purchasing department which is based at its head office. All
members of this department have full access to the supplier master file data and a monthly
exception report of any changes to master file data is automatically generated and then filed
by a purchasing clerk.
Sequentially numbered goods received notes (GRNs) are produced by the warehouse
department when goods are received, a copy of which is promptly sent to the purchasing
and finance departments. On receipt of the purchase invoices, the finance clerk matches the
invoices to the relevant purchase order and then passes the documents to the finance
director for authorisation prior to input.

In order to obtain sufficient appropriate audit evidence, an auditor cannot place complete
reliance on an entity’s system of internal control. In addition to performing tests of controls,
auditors must always perform some substantive procedures due to the limitations of internal
control.

(a) Describe the LIMITATIONS of internal control.

Note: You do not need to refer to the scenario to answer this requirement. (4 marks)

(b) Identify and explain EIGHT deficiencies in Pomeranian Co’s internal

control system and provide a control recommendation to address each
of these deficiencies. (16 marks)

(20 marks)

Question 3
This scenario relates to five requirements.

It is 1 July 20X5. Danube Co is listed on a stock exchange and sells consumer goods to
wholesale customers. The company has a large head office and 18 warehouses. You are an
audit supervisor of Mississippi & Co and the final audit for the year ended 31 March 20X5 is
due to commence shortly. The draft financial statements show total assets of $198.5m and
profit before tax of $56.1m. The following three matters have been brought to your
attention:

Land and buildings

Danube Co historically recorded all property, plant and equipment (PPE) at cost less
accumulated depreciation. However during the year, management decided to change the
accounting policy for land and buildings from the cost model to the revaluation model. The
finance director hired an external independent valuer to undertake the valuation of all land
and buildings, and this took place in July 20X4. Depreciation is calculated monthly on a pro
rata basis. Danube Co's year-end balance for PPE includes land and buildings of $79.2m
(20X4: $64m).

Trade receivables circularisation

Danube Co’s year-end trade receivables balance of $9.3m (20X4: $7.7m) has significantly
increased compared to the prior year. Danube Co’s receivables ledger is made up of a large
number of customers with balances ranging from $15,000 to $150,000. A positive trade
receivables circularisation has been undertaken by the audit team based on the year-end
balances. The majority of responses from customers agreed to the balances as per Danube
Co’s receivables ledger at 31 March 20X5, however the following exceptions were noted:

Customer Balance per Danube Co Response from customer

Nile Co $141,102 No response
Congo Co $136,321 $122,189

Provision and receivable arising from the sale of defective goods

In December 20X4 Danube Co sold a number of hoverboards to a customer, Kalama Kids Co.
It is alleged by Kalama Kids Co that these hoverboards are faulty, as there have been a few
instances of the hoverboards overheating and catching fire. As a result, Kalama Kids Co is
suing Danube Co for $3.9m. The court case is due to take place in August 20X5 and
management believes that Kalama Kids Co’s claim is likely to be successful. No hoverboards
remain in Danube Co’s inventory at the year end.

Danube Co purchased the hoverboards from a supplier, Thames Co. In February 20X5
Danube Co contacted Thames Co and requested that they reimburse Danube Co for
damages which may become payable as a result of the sale of defective hoverboards.
Danube Co is requesting a sum of $3.9m from Thames Co. The draft financial statements
contain a provision of $3.9m in respect of the customer’s claim and a receivable of $3.9m in
respect of Danube Co’s counter-claim against its supplier.

(a) Describe substantive procedures the auditor should perform to obtain

sufficient and appropriate audit evidence in relation to Danube Co’s land and
buildings. (6 marks)
(b) Describe the procedures the auditor should perform in relation to the
exceptions noted during the trade receivables circularisation in respect of Nile Co
and Congo Co.

Note: The marks will be split equally between each customer. (4 marks)

(c) Describe substantive procedures the auditor should perform to obtain

sufficient and appropriate audit evidence in relation to the PROVISION and
the RECEIVABLE arising from the sale of defective goods. (5 marks)

The audit engagement partner has determined that the issue relating to the provision and
receivable arising from the sale of defective goods should be communicated as a key audit
matter (KAM), in accordance with ISA 701 Communicating Key Audit Matters in the
Independent Auditor's Report.

(d)(i) Describe the factors which the audit engagement partner would have considered in
determining that this issue is a KAM; and

(ii) Describe the content of the KAM section of the auditor’s report for Danube Co.
(5 marks)

(20 marks)