CAF-8 Audit and Assurance

Question 1:
Your firm recently accepted appointment as external auditor of Pappu Ltd for the year ended 31
December 20X9. You are the audit senior responsible for planning the audit. The engagement
partner has asked you to consider the key areas of audit risk:
Pappu operates call centres on behalf of multinational corporate clients who contract with
Pappu to manage telephone, email and online queries from their customers. Contracts run for
an average of four years. Pappu invoices its clients a full year’s contract fee at the start of each
12-month period.

Invoices are in the client’s local currency.

For each six-month period, where service levels are not met, Pappu pays the client a service
level credit (ie, a refund) equal to an agreed percentage of its contract fee.

Pappu has call centre employees based in the Pakistan (head office), UK and Dubai.

Payroll is processed locally; employees are paid in their local currencies and are subject to local
taxation rules. Staff turnover in each call centre is high. Pappu’s employees receive a bonus in
February each year equal to a percentage of their basic salary. The percentage depends on how
closely Pappu has met its service levels in the previous year.

In December 20X9, Pappu’s internal audit department identified the following issues:

 some account managers have under-reported to clients the extent to which Pappu has
failed to meet service levels.
 the payroll software used in Australia has never been updated.

Yusuf has provided you with the following financial information:

Statement of profit or loss for the year ended 31 December (extract):

20x9 20x8
(draft) (audited)
‘000 ‘000
Revenue
Contract Fees 120,654 111,876
Less: Service level credits (2,255) (3,237)
118,399 108,639
(Loss) / profit before interest and tax (4,903) 2,543

From the Desk of Sir Akash Kumar (AMK)

 CAF-8 Audit and Assurance

Employees payroll costs:

20x9 20x8
(draft) (audited)
‘000 ‘000
Wages and salaries 38,750 46,800
Social security costs 6,450 9,360
45,200 56,160

Average number of employees during the year: 1,340 1,560

The engagement partner recently met with Laurena Thestral, Pappu’s CEO. Laurena is worried
that Pappu has lost major contracts to competitors which are using new technologies, such as
chatbots (software used to simulate online conversations), to manage call centre queries more
efficiently and cheaply. In October 20X9, Pappu ran a trial using chatbots which was funded by
a bank loan. The bank requires Pappu to maintain a minimum interest cover of 2.5.

The trial failed due to inappropriate handling of some queries by the chatbot. One of Pappu’s
clients received adverse publicity due to inappropriate handling of queries and has submitted a
legal claim against Pappu for the losses it has suffered.

Requirements:

1. Identify the Audit risks

2. Assume your firm has concluded that there is a material uncertainty over whether
Pappu is a going concern. State with reasons, the implications for your auditor’s report if
Pappu’s directors:
(a) adequately disclose the uncertainty in the financial statements
(b) refuse to disclose the uncertainty in the financial statements

Question 2:

Described below are situations which have arisen at two unrelated external audit clients of your
firm.

a. Gable is an international company operating in the construction sector. The financial

statements for the year ended 31 March 2024 include cranes disposed of during the year
with a carrying amount of Rs.220,000. Gable has accounted for the proceeds of the
disposal in other income in the statement of profit or loss but has not removed the
carrying amount of the disposed cranes from the statement of financial position. The
directors refuse to amend the financial statements in respect of this matter because the
buyer of the cranes has not yet collected the cranes which are still on Gable’s premises.

From the Desk of Sir Akash Kumar (AMK)

 CAF-8 Audit and Assurance

Gable uses sub-contractors who are paid a variable daily rate depending on the location
and complexity of the construction project. The system used to process the payments to
subcontractors developed a fault during the year and many sub-contractors were paid at
incorrect daily rates. The directors estimate that Rs.340,000 was overpaid and they have
recorded a receivable for this amount at 31 March 2024. At the time of completion of the
audit, Rs.25,000 had been received in respect of this balance. Your firm’s enquiries during
the audit revealed that Gable has not had any success in contacting any of the
subcontractors that are still to reimburse the company as they no longer undertake work for
Gable. The directors refuse to include an allowance for doubtful debts in respect of the
outstanding amount. Gable’s total assets as at 31 March 2024 are Rs.42.3 million and profit
before tax for the year then ended is Rs.7.6 million. The year end is 31 March 2024.

b. Bullfinch.com is a website design company whose year-end was 31 March 2024. The
audit is almost complete and the financial statements are due to be signed shortly.
Revenue for the year is Rs.11.2 million and profit before tax is Rs.3.8 million. A key
customer, with a receivables balance at the yearend of Rs.283,000, has just notified
Bullfinch.com that they are experiencing cash flow difficulties and so are unable to make
any payments for the foreseeable future. The finance director has notified the auditor
that he will write this balance off as an irrecoverable debt in the 2025 financial
statements.

Required:

For each of the above situations, state, with reasons, the implications for your firm’s audit
reports.

From the Desk of Sir Akash Kumar (AMK)