Brief solution for Case study in Chap 11 – page 187:

(a)
(i) Definite of sampling risk and non – sampling risk.
(ii) How to control:
- 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 is controlled by providing appropriate training for staff so they know which
audit techniques to use and will recognize an error when one occurs.
(b) Comments on three suggests of audit team:
- 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) Definition of Materiality.
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 they may have made; the auditor has a
responsibility to the members to ensure that the 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.

5 factors to determine nature/extent of audit procedures on expert work:

- Nature of matter to which expert’s work relate.
- Risk of MM to expert’s workdone.
- Significance of expert work in the audit.
- Auditor experience & knowledge on previous work performed experts.
- Expert work is subject to the auditor quality control.
NCA procedure:
- Summarize and Reconcile/Agree: Account balance (FS/TB)/General Ledger/Asset register
(Existence/Comleteness): Historical cost, Accumulated Depr value, Carrying value.
- Test addition:
+ Make a sample of addition and check to supporting documents (Accuracy, R&O).
+ Physical Inspection: a sample of asset register (Existence) to the site or reverse
(completeness).
+ Review capitalization transaction and inquiry management --> Evaluate. (Existence,
Valuation): construction cost, finance cost, insurance cover, income from asset,….
+ Check whether assets are pledged for loans. (R&O/Presentations)
+ test cut-off: sample addition before year end/after year end.

Note: The criteria for capitalization in IAS 16 & 38.

- Revaluation: Inquiry management; obtain and review the policies --> Evaluate the recognize
amount ---> consistent with IAS 16/38 and policies (Valuation).
- Disposal:
+ Make a sample of Disposals and check to supporting documents (Accuracy, R&O): Cost,
Accumulated Depr, Remaining Amount, Residue value.
+ Check profit & loss on Disposal (Accuracy/Valuation).

- Depreciation:
+ Recalculate the depr expense in period related to: asset lives, cost, ….
(Accuracy/Valuation).
+ Check consistency of Depr policies (Presentation/Accuracy/Valuation).

- Review Impairment on asset: Inquiry management: Policies, factor (internal/external),

management estimate of the impairment amount -----> Evaluation ….. (Valuation/Accuracy)
- The remaining assets for PY:
+ Physical inspection: sample of the remaining assets from PY to the site (existence)
+ Check whether assets are pledged for loans. (R&O/Presentations)
- Check presentation and disclosure of NCA on the FS.

Case study Solution Chap 12 – Page 207:

(a) Audit work on railways:
- Reconcile the non-current asset ledger; agree total of railway trucks to the general ledger
and financial statements (completeness)
- Ensure that railway trucks are actually stated as such in the non-current asset note. As a
material item, separate disclosure of this category is allowed (disclosure)
- Cast the non-current asset note in the financial statements. Ensure the note agrees to the
amount disclosed in the balance sheet (disclosure)
- For a sample of assets from the ledger, confirm existence by physically seeing the trucks
(existence)
- Identify the supplier of railway trucks from a purchase invoice. Obtain all invoices from this
supplier and confirm completeness of recording in the non-current asset register
(completeness). Also, during non-current asset inspection, record details of some railway
trucks and ensure those trucks are recorded in the non-current asset register
- Examine a sample of purchase invoices to confirm ownership of the trucks (rights and
obligations)
- Review company policy for depreciation. As this is a new category of non-current asset,
obtain representation letter point regarding accuracy of amount. Confirm with amount
charged in similar companies that the depreciation percentage appears to be correct
(valuation and allocation)
- Agree depreciation charged in the non-current asset note to the amount on the profit and
loss account (valuation and allocation)
- Check a sample of depreciation calculations to ensure that they are accurate and that they
conform to company policy(valuation and allocation)
- Ensure that any sales tax has been correctly treated e.g. capitalized where this is non-
recoverable (valuation and allocation)
- Current value may also be confirmed using a specialist or appropriate trade journal and
compared to the net book value shown in the non-current asset register (valuation and
allocation).

(b) AP on the NCA note:

- Land & Buildings:
+ Issue: The depreciation rate has been correctly applied at 2% – given an estimated life for the
land and buildings category of 50 years. However, the rate has been applied to the whole
balance – that is land and buildings. In most companies, the value of land is not thought to
decrease and therefore depreciation is not appropriate.
To allocate depreciation accurately, a split is required between the land and buildings amounts
in the financial statements. Buildings will then be depreciated, but not the land.
+ Solutions:
Summarize and Reconcile the FS note/ledger/asset registers.
Inspection of supporting documents: ownership, tittle deeds,…. To identify whether ITA has
finite/indefinite useful life.

- Plant & Machinery:

+ Issue: Depreciation has been charged in full in the year of acquisition, but not charged at all in
the year of disposal. This appears to be an appropriate accounting policy – charging
depreciation in the year of disposal would only amend the profit or loss on sale in that year and
so have a neutral effect on the financial statements.

There appears to be an error in the disposals calculation as the depreciation amount exceeds
the cost being eliminated. There does not appear to be any logical reason for this situation and
it should be discussed with the directors to identify the reason, if any, for this treatment.
If an error is found, then the depreciation amount must be decreased (or cost eliminated
increased) and the profit or loss on sale amended accordingly.
+ Solution:
Summary of disposal assets and agree to FS/Ledger (Cost, Accumulated Dep, Proceeds,
Date of disposal).
Check Disposal and check to supporting documents (Accuracy, R&O): Cost, Proceeds.
Recalculated Depr of Disposals, Carrying amounts.
Check profit & loss on Disposal.
Make adjustments if needed.

- Motor vehicles:
+ Issues: The depreciation percentage stated in the financial statements is 33%. However, the
calculation is either 25% on the year-end balance or about 21% on cost brought forward and
additions for the year. To be consistent, the non-current asset disclosure note must agree to the
actual calculation in the non-current asset note.

The reason for the difference must be found and either the disclosure note or the depreciation
calculation amended. If there has been a change in the depreciation rate, then this must also be
disclosed in the financial statements. There has not been change in accounting policy – the
policy of depreciation is unchanged, it is only the method of applying that policy that has
changed. There is no need to amend the prior year figures.
(Or you can comments of the potential of Understatement of Depreciation)
+ Solutions:
Recalculation of Depreciation if Depr is understated by errors.
Inquiry the management for changing in Accounting polycies/Depr rate.
Make a sample of assets to compare the useful life in this year to PY to check the consistency.
Audit prodedures on Inventories:
- Opening/Closing Balances:
+ Summarize and Reconcile FS balances/TB/Ledger/Inventory listing (Existence,
Completeness, Accuracy).
+ Physical inspection on inventory count:
Make a sample of Inventory listing, compare to the site. (Existence)
Make a sample of inventories in the site and compare to Inventory listing (Completeness).
+ Send comfirmation for inventory held by 3rd parties, compare to Inventory listing, evaluate the
results,… (Existence, R&O)

- Purchasing:
+ Make a sample of puchasings in year, chase to supporting docs
(Existence/Occurrence/Accuracy)
+ Cut-off:
Early: Make a sample of purchasing after year end to chase….:
Late: Make a sample of purchasing before year end to chase….:

-Other cost: conversion cost (valuation).

-Cost of Goods sold:
+ Make a sample of sold goods to check/recalculate cost fomula (FIFO, WC) ---> Valuation,
Accuracy.
+ Inquiry management for policies in cost fomulas and check a sample to ensure
consistency.
- Discount: Policies to allocate discount to COGSs.
+ Inquiry management for policies in cost fomulas and check a sample to ensure consistency.
+ Make a sample of sold goods to check/recalculate cost fomula (FIFO, WC) ---> Valuation,
Accuracy.
+ AP: develop auditor expectation of discount allocations to COGSs, compare to client’s
recognized amount, investigate diff, evaluate the results.
- Provisions: Policies: NRV = lower (cost; selling price – costs to sell)
+ Inquiry management for provision recognition policy.
+ Inspect management point on the amount of Provision on Current year.
+ Make audit point: develop selling price/cost to sell)
Inspect sales prices in next year/before year end
Inspect ratio of cost to sell over Cost of Inventories.

- Inquiry managent about assets to pledge/mortages and inspect the docs (R&O, Disclosure
& Presentations).
- Check FS note: Disclosure & Presentations, Accuracy.
Brief solution for Case study in chap 13 – page 218:
(a) Importance of inventory count in this situation:
- The inventory count provides important audit evidence as to the existence and
completeness of inventory included in the financial statements.
- In this case, the inventory count is particularly important because the company does not
maintain perpetual inventory records. As no perpetual records are maintained, the only
basis for the inventory entries in the financial statements is the result of this inventory
count.
- Inventory is generally material to the statement of financial position of a manufacturing
company and is also one of the higher risk areas on the statement of financial position.
The inventory count provides important audit evidence reducing the risk of material
misstatement in relation to inventory.
(b)
From: Audit assistant.
To: Audit partner in the engagement of Sitting Pretty Co for the year ended at …..
Subject: Note for inventory count attendance.
Dear audit partner, I send you my planned procedures o undertake in relation to the inventory
count attendance:
- Gain knowledge: I must review the notes of last year's inventory count and I must contact the
factory manager to obtain details of this year's. I must review this year's details to ensure that
the inventory count appears to be planned efficiently and effectively.
- Assess key factors: There are various key factors given in the scenario:
+ Nature and volume of the inventory. There should be no WIP, so I will count raw materials
(approximately 10% of the inventory) and finished goods. However, raw material plastic should
be low because a delivery is required to continue with production.
+ Possible obsolescence: I must make a note of the number of old chair legs maintained in raw
materials as these are now obsolete, a new specification having been agreed.
+ Cut-off issues. I need to ensure that the delivery on the day is isolated and that I obtain details
of the delivery made during the inventory count. I need to determine whether this should be
included as deliveries for the year, but most of all ensure that it does not get counted twice (as it
arrives, and if it is put into stores). I should also obtain copies of the relevant documents, for
example, the last invoices in the year and the last goods received and despatched notes.
+ Off-cuts. I need to consider whether any off-cuts are maintained on site and whether these are
being included in the inventory count. As the company receives a discount relating to them, they
are unlikely to be considered Sitting Pretty's legally and so should not be included.
+ Staff issues. It appears that the inventory count is undertaken by the people who work in the
factory and handle the inventory on a daily basis. This is not best practice, although in practical
terms it is difficult to avoid. However, I should discuss this with the factory manager to assess
whether staff can be allocated to counting inventory they have not produced. Also, as the staff is
allowed to go home as soon as the inventory count is completed, there is a risk that the
inventory count will be rushed and mistakes will be made.
- Plan procedures: I need to determine my sample sizes and whether there is a need for expert
assistance at this inventory count.
+ Procedures. I will carry out test counts, checking from a sample of physical items to the count
sheets and a sample of count sheet items to the physical items.
+ Samples. There are no higher value items that I should concentrate particularly on. Materiality
for the year has been set at $5,000 currently. Dividing last year's figures for inventory by this
materiality level would give a sample size of six items for raw materials and 34 items for finished
goods. I need to determine the batches in which inventory is valued to ensure that I count the
correct items. I need to assess the levels of inventory when I arrive to ascertain whether this
remains appropriate.
(c) Cut-off at final audit:
- Inventory count: Auditor should determine whether this delivery should count as this year's
inventory (which it should if the inventory count was the year-end date), the delivery information
should be traced to purchase invoices and ledgers to ensure that the purchase is recorded in
the year and that the creditor is accounted for in the year. The inventory should then also be
included.
- Inspect document: The audit team should take a sample of delivery notes for sales and
purchases on either side of the year-end and trace these to invoices and ledgers and inventory
records to ensure that sales and purchases have been included in the correct period and that
inventory is accounted for where appropriate (that is, sales have not been counted twice and
purchases have been included in inventory).
(d) Valuation: The auditors should obtain the client's working papers relating to the valuation of
inventory in areas:
- Cost:
The auditors should then trace a sample of items to purchase invoices to ensure that cost has
been correctly applied. Cost of purchase excludes trade discounts and rebates, so the auditors
should ensure that the valuation cost excludes the 10% discount received for returning the
offcuts of plastic.
The auditors should then ensure that for a sample of finished goods items, costs of conversion
(comprising costs of labour and overheads) have been included. This should be on a
comparable basis to the previous year and therefore can be audited by analytical review.
- COGs: The auditors should then trace a sample of items which had been sold to review the
application of cost fomulas for sold units.
- NRV: The auditors should ensure that cost is lower than net realisable value by tracing their
sample to after-date sales. If no invoices are yet available, the auditors can make confirmations
by reviewing sales orders and price lists.
Audit procedure for AR:
- Balances:
+ Summarize and Reconcile (FS/Ledger/Balances by customers): Existence/Complete,
Accuracy.
+ Make a sample of balances by customer and send confirmations (existence, R&O, Accuracy)
+ Follow confirmations, Identify Diff between per confirmation and per book, Clear Diff, Evaluate
the results.
+ For non-replies, provide alternative procedures:
Obtain customer statement to compare with the balances if IC is effective and reliable.
Subsequent payments for the balances or inspect supporting docs if unpaid made in the audit
field.
- Sales:
+ Summarize and Reconcile (FS/Ledger/Sale report): Existence/Complete, Accuracy.
+ AP: Compare difference in sales or Gross-profit in this year to PY and with industry ratio.
(Completeness/Occurrence)
+ Make a sample of GDN to chase to invoice/accounting entries (Completeness, Accuracy).
+ Cut-off: Early & Late.
- Provision: valuation, Accuracy.
+ Inquiry the management for the policies in CY.
+ Obtain aging report by customers for the year end.
+ Make a sample of balances on the aging report to check the reliability.
+ Review the payments of customers on aging report in NY.
+ Develop auditor estimate, compare,….
- Disclosure & Presentation.