Auditing Solutions ACC09109 2020 May Main Diet PDF

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EDINBURGH NAPIER UNIVERSITY SCHOOL OF ACCOUNTING, FINANCIAL SERVICES AND LAW

AUDITING ACC09109

Academic session:

2019/20

Diet:

April / May

Exam duration:

3 hours

Reading time:

15 minutes

Total exam time:

3 hours 15 minutes

(excluding reading time)

SUGGESTED SOLUTIONS

Examiner(s):

Dr Rachel Findlay

1

SECTION A: Attempt ALL Questions Each question is worth 2 marks. Candidates should clearly identify the answer to each question in their answer booklet. Only one answer per question should be identified. 1. Which of the following documents MUST be followed by external auditors? A B C D

Practice notes Bulletins International Standards on Auditing Exposure Drafts

2. Which of the following are statutory rights of the auditor under the provisions of the Companies Act 2006? i. The right to be heard at any general meeting or any part of the business that concerns them as the auditor; ii. The right to obtain from the parent company and its auditor such information and explanations as they may reasonably require iii. The right to requisition a general meeting on resignation iv. The right to make a written statement to shareholders which should be distributed by the company upon removal as auditors A. B. C. D.

i, ii and iii only i, iii and iv only ii, iii and iv only None of the above

3. Which of the following tests would give the auditor evidence over the existence and/or valuation of machines in the factory of a manufacturing company: i. ii. iii.

A. B. C. D.

Trace a sample of machines from the fixed asset register to the physical asset in the factory Trace a sample of machines from the fixed asset register to the original purchase contract Trace a sample of machines in the factory to the fixed asset register

i and ii only i and iii only ii and iii only All of the above

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4. You have heard from a worried auditor colleague that he did not detect a fraud during the three years he has audited his client company Aldo and Ladle plc. Which one of the following best represents the responsibility the auditor bears in relation to detection of fraud: A. The auditor is responsible for implementing the controls which should prevent fraud and should test those controls for material misstatements B. The responsibility for detecting fraud lies solely with the directors C. If the auditor plans and executes the audit so that there is a reasonable chance of detecting material misstatements arising from fraud then the auditor has no further responsibility D. The auditors should have designed audit testing to detect all frauds.

5. Which of the following would best give the auditor assurance over completeness of creditors: A. B. C. D.

Agreeing a sample of invoices to goods received notes Verifying the authorization of a sample of purchase orders Agreeing a sample of sales invoices to the sales ledger Calculating the creditor days’ ratio and comparing it to the ratio in previous years

6. Identify which one of the following audit procedures would be most likely to detect the inclusion of a fake employee on the payroll:

A. Checking employee overtime sheets have been correctly authorised B. Performing a review of changes in total employee pay for each pay date in the accounting period C. Inspecting personnel records for a sample of employees listed on the payroll D. Re-casting the totals of all the pay roll amounts made for a sample of pay dates. 7. The auditor attends a client stock count and observes client staff counting stock in accordance with documented client procedures. Which of the following best represents this audit activity: A. Test of controls 3

B. Substantive testing of the rights and obligations assertion C. Walk-through testing D. Consultancy service

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8. You are auditing your new client Hogg Ltd. Hogg Ltd. are a high tech company developing new software code. 50% of the balance sheet value is recorded as a non-current asset being intangible Research and Development (R and D). Which of the following best represents the audit risk associated with the R and D balance at Hogg Ltd. A. B. C. D.

Fraud risk Inherent risk Control risk None of the above

9. Which of the following procedures is/are an example(s) of an application control activity: i. Back up of files and contingency planning ii. Marking invoices on files as paid iii. Computer access controls in the form of passwords A. B. C. D.

i only ii only iii only All of the above.

10. Which of the following provides the strongest form of audit evidence for existence and valuation of receivables: A. Customer responses to the auditor’s circularisation of debtors B. Aged debtor analysis C. Recalculating the total of the sales ledger and agreeing to the receivables balance on the draft financial statements D. Evidencing that the correct product price has been applied to a sample of invoice copies sent to customers (SECTION TOTAL 20 MARKS)

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SECTION B: This Question MUST be attempted Question 11 Note also 2 presentation marks (noted in requirements below) (a)

(b)

(c)

(d)

Weaknesses

Explanation

Recommendation

Test of Control

(1 mark each (1 mark each to maximum of to maximum of 6) 6)

(1 mark each to maximum of 6)

(1 mark each to maximum of 6)

1 The wages calculations are generated by the payroll system and there are no checks performed.

Therefore, if system errors occur during the payroll processing, this would not be identified. This could result in wages being over or under calculated, leading to an additional payroll cost or loss of employee goodwill.

A senior member of the payroll team should recalculate the gross to net pay workings for a sample of employees and compare their results to the output from the payroll system. These calculations should be signed as approved before payments are made.

Review a sample of gross to net pay calculations for evidence that they have been performed and signed as evidence of approval.

2 Annual wages increases are updated in the payroll system standing data by administrators.

Payroll administrators are not senior enough to be making changes to standing data as they could make mistakes leading to incorrect payment of wages. In addition, if they can access standing data,

Payroll administrators to have no access to standing data changes within the system.

Observe an administrator making a change to payroll standing data. Observe if the system rejects this attempt or not.

The annual wages increase should be performed by a 6

they could make unauthorised changes.

senior member of the payroll department and this should be checked by another responsible official for errors.

3 Overtime worked by employees is not all authorised by the relevant department head, as only overtime in excess of 30% of standard hours requires authorisation.

This increases the risk that employees will claim for overtime even though they did not work these additional hours resulting in additional payroll costs for Laldy.

All overtime hours worked should be authorised by the relevant department head. This should be evidenced by signature on the employees’ weekly overtime sheets.

Review a sample of employee weekly overtime sheets for evidence of signature by relevant department manager.

4 Time taken off as payment for overtime worked should be agreed by payroll administrators to the overtime worked report; however, this has not always occurred.

Employees could be taking unauthorised leave if they take time off but have not worked the required overtime.

Payroll administrators should be reminded of the procedures to be undertaken when processing the overtime sheets. They should sign as evidence on the overtime sheets that they have agreed any time taken off to the relevant overtime report.

Select a sample of overtime sheets with time taken off and confirm that there is evidence of a check by the payroll administrator to the hours worked report.

5 The overtime worked report is emailed to the department

If department heads are busy or do not receive the

All department heads should report to the payroll department

For a sample of hours worked reports

7

heads and they report by exception if there are any errors.

email and do not report to payroll on time, then it will be assumed that the overtime report is correct even though there may be errors. This could result in the payroll department making incorrect overtime payments.

on whether or not the overtime report is correct. The payroll department should follow up on any non-replies and not make payments until agreed by the department head.

emailed to department managers confirm that a response has been received from each manager by reviewing all responses.

6 Department heads are meant to arrange for annual leave cover so that overtime sheets are authorised on a timely basis; however, this has not always happened.

If overtime sheets are authorised late, then this can lead to employee dissatisfaction as it will delay payment of the overtime worked.

Department heads should be reminded of the procedure with regards to annual leave and arrangement of suitable cover.

Discuss with payroll administrators the process they follow for obtaining authorisaion of overtime sheets, in particular during periods of annual leave. Compare this to the process which they should adopt to identify any control exceptions.

During annual leave periods, payroll administrators should monitor that overtime sheets are being submitted by department heads on a timely basis

Obtain a sample of payments list and review for signature by the company accountant as evidence that the control is operating

8

and follow up any late sheets.

7 The company accountant reviews the total list of bank transfers with the total to be paid per the payroll records.

correctly

The company accountant, when authorizing the payments should on a sample basis perform checks from payroll records to payment list and vice versa to confirm that payments are complete and only made to genuine employees.

There could be employees omitted along with fictitious employees added to the payment listing, so that although the total payments list agrees to payroll totals, there could be fraudulent payments being made.

The company accountant should sign the payments list as evidence that she has undertaken these checks.

24 Marks (e) Interim audit / Final audit Award points for any sensible points made. The interim audit takes place before the year end and is used to carry out procedures which assist assess audit risk and direct the focus of the final audit procedures. Internal controls reviews and systems documentation are often carried out at the interim audit to assess how well controls were working and thus how much substantive testing to carry out at the final year end audit. There is no requirement to undertake an interim audit; factors to consider when deciding upon whether to have one include the size and complexity of the company along with the effectiveness of internal controls. Performing an interim audit can help to reduce time pressures at the year-end audit. The final audit takes place after the year end and the draft accounts are produced. The audit ends with the auditor forming and expressing an opinion on the financial statements. Typical activities at the final audit include substantive testing, post balance sheet event reviews, analytical reviews and a review of the directors’ going concern assessments. 4 Marks

9

Note: presentation marks for laying out sections a, b, c and d in a table format. 2 Marks

(TOTAL 30 MARKS)

10

SECTION C: Attempt TWO Questions

Question 12 You are part of the external audit team at Oatmeal Ltd, a supplier of biscuits and energy bars to retail outlets in Scotland. You are about to commence the final audit of receivables for the financial year ending 31 March 2020. The interim audit was carried out during January 2020 and it showed that there was a good system of internal control in the sales system, with no serious errors being identified by the audit procedures that were carried out. You have the following information available that relates to past financial year: £ 832,050 120,035 10,035 16,641

Revenue Receivables Bad debt write off Provision for bad debts An aged list of receivables balances

REQUIRED: (a)

Identify and discuss at what points analytical procedures should be used during the course of an audit. Analytical review will be performed: 1. At the planning stage: as risk assessment procedures (ISA 315) 2. During the audit: substantive analytical procedure (ISA 520 & ISA 330) 3. The overall review at the end of the audit: to assist with forming an overall conclusion (ISA 520) (6 marks)

(b) Explain the difference between tests of control and substantive audit procedures. Tests of control are those tests that seek to provide audit evidence that internal control procedures (control activities) are being applied as prescribed. Substantive audit procedures are those tests of transactions and balances which seek to provide audit evidence as to the completeness, accuracy and validity of the information contained in the accounting records or in the financial statements. (4 marks) (c)

Identify THREE audit objectives for the substantive testing of the receivables balance. The audit objectives could include: • Receivables balances represent amounts owed by customers • Receivables include all claims on customers 11

• Receivables at balance sheet date represent legal claims on customers • Receivables balance represents gross claims on customers less a reasonable estimate of the difference between the gross claim and the net realisable value (3 marks) (d) Prepare a schedule that details the substantive audit tests that you will perform on Bakers Ltd’s receivables balance. • Reconcile the sales ledger control account to the detailed sales ledger listing • Review the individual accounts of major customers and those that appear unusual either by their nature, composition or size of the balances or transactions therein • Review and test the year-end cut-off procedures for credit sales • Carry out direct confirmation of receivables balances through a circularisation of the debtors • For a sample of receivables balances check cash received from customers after the balance sheet date • Use the schedule of aged receivables and agree the total to the control account • Test a sample of balances on ledger accounts to the aged schedule and vice versa • Analytical review, including: • comparison of receivables days ratio with budget and/or prior years • comparison of the proportion of debts in different age bands to prior years • Discuss any significantly overdue debts with management to identify action to be taken, and whether or not the debts are likely to be paid (this will assist the auditor in verifying the reasonableness of the provision for doubtful debts) • In regard to the provision for bad and doubtful debts, the auditor should check whether balances have been settled after the year end • Check the authorisation for debts written off as bad and review external correspondence relating to these debts. (12 Marks) (TOTAL 25 MARKS)

12

Question 14 Write notes under each of the following headings to explain their significance to the external auditor: (a) Audit engagement letter. 

 

The auditor shall agree the terms of the audit engagement with management or those charged with governance...the agreed terms of the audit engagement shall be recorded in an audit engagement letter (ISA 210) Purpose of the engagement letter e.g. to confirm verbal arrangements; to help minimise any misunderstandings between the auditor and the client Content of engagement letter e.g. objectives and scope of the audit; audit fee (5 marks)

(b) Fraud. The responsibilities of the auditor are: (i) To identify and assess the risks of material misstatement of the financial statements due to fraud; (ii) To obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses; and (iii) To respond appropriately to fraud or suspected fraud identified during the audit (5 Marks) (c) True and Fair Concept  The Companies Act 2006 states that directors are required to prepare financial statements that give a true and fair view.  The commonly accepted view in the UK is that true and fair can be achieved through compliance with company law and applicable accounting standards.  It is accepted overall that the auditor needs to check whether directors have followed the applicable accounting standards and have exercised appropriate judgement.  Occasionally, the directors may find that compliance with the CA2006, company law or accounting standards will not result in the accounts showing a true and fair view. The CA2006 allows, on these occasions, the ‘true and fair’ override – and allows directors to depart from the accounting requirements normally required. (5 marks) (d) Using the work of an expert to obtain audit evidence. In deciding whether expert evidence will be required in arriving at an audit opinion, the auditor should consider the following factors: (i) the importance (materiality) of the matters being considered in the context of the company’s financial statements, 13

(ii) the risk of misstatements based on the nature and complexity of the matter being considered, and (iii) the quality and quantity of other available relevant audit evidence. (5 marks) (e) Events occurring after the reporting period. IAS 10: Events after the Reporting Period Events after end of financial year, but before directors sign the accounts Amend accounts if: Provides new evidence on figures in accounts Makes going concern concept inappropriate Auditors responsibility: “..all events up to the date of the auditor’s report that may require adjustment of, or disclosure in, the financial statements have been identified” (ISA 560). After the date of the audit report, but before the accounts are issued, it is the directors responsibility to inform the auditors of any material subsequent event (5 Marks) (TOTAL 25 MARKS)

END OF QUESTION PAPER

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