Unisa Study Notes



1993909525AUDITING 3A - 2014QUESTION BANK : THE AUDIT PROCESSSUGGESTED SOLUTIONS020000AUDITING 3A - 2014QUESTION BANK : THE AUDIT PROCESSSUGGESTED SOLUTIONSQUESTION AP-1(i) Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.(2)(ii) Audit Risk and materiality have an inverse relationship. The higher the audit risk, the lower materiality needs to be in order to reduce audit risk to an acceptable level, ie the lower the materiality, the larger the extent of audit coverage obtained will be and the greater the scope will be, ie the greater the amount of audit evidence gathered on which to base a conclusion. (3)(iii) Planning materiality:Stability of indicatorsIn comparison to the previous year, all items seem to be fairly stable, except for “net profit”, (1) as a result of high “other expenses” from the previous year, and “Revenue” – possibly as a result of the incorrect revenue recognition policies applied by the company. (1)Actual vs budgetBudgeted figures may be used if it seems likely that actual figures will approximate budgeted figures.(1) Upon calculation (extrapolation) of actual figures for the year, budgeted figures are found in this case to be well below the expected actual figures and thus unreliable. Actual figures for the year will thus be used. (1)Income Statement vs Balance sheetAs the income statement figures have been found to be unreliable (incorrect revenue policies applied) (1) emphasis would rather be placed on the balance sheet indicators (1)Calc: max 5ActualActual (extrapolated) (?)1/01/2011 - 30/11/20111/01/2011 - 31/01/2011Materiality rangeTurnover (0.5%-1%) (?)350,698382 5801 913 – 3 826 Cost of Sales112,439122 661Gross Profit (1%-2%) (?)238,259259 9192 599 – 5 198 Other expenses101,987111 259Net Profit (5%-10%) (?)136,272148 6607 433 – 14 866 Total assets (1%-2%)(?)786,000786 0007 860 – 15 720 (1)Current assets657,000657 000Fixed assets129,000129 000Total equity (2%-5%) (?)654,879629 86612 597 – 31 493 (1)Note: Students to receive max marks for calculations if correct basis used, i.e. balance sheet indicators, and range %.Due to the fact that there were a number of risks that were identified; such as management integrity is in question and that this is a first time audit client. It would be considered prudent to be more conservative with our approach to planning materiality, and thus a lower materiality will be chosen.(3)Thus materiality is set at R8?000 {as long as student decides on an amount – not range – towards the lower end of range due to high risk}(1)ORDue to the instability of the current year (refer above to “stability of indicators”) income statement the prior year audited figures can also be used as a basis. (1)Calc: max 5Actual – prior year1/01/2010 - 31/12/2010Materiality rangeTurnover (0.5%-1%) (?P) 232,923 1?165 – 2 329 (?)Cost of Sales 115,274 Gross Profit (1%-2%) (?P) 117,6491 176 – 2 353 (?) Other expenses 132,722Net Profit (5%-10%) (?P) -15,073754 – 1 507 (?) Total assets (1%-2%) (?P) 698,0006 980 – 13 960 (1)Current assets 525,000 Fixed assets 173,000Total equity (2%-5%) (?P) 460,700 9 214 – 23 035 (1)Available 15 : Max 10b)Nature, timing and extent of audit procedures:Based on the information provided, it does not appear that SKSC has a very good system of internal control. (1) Reliance can therefore not be placed on the company’s system of internal control. (1) The audit approach will be based on the auditors Risk Assessment Procedures (1)Nature:No reliance on internal controls, thus no testing of internal controls. A Substantive audit approach will be used. (1)Timing:As no reliance can be placed on internal controls, early verification procedures cannot be performed(1) Substantive procedures will thus be performed at or post year end. (1)Extent:Due to the high risk profile in the company, and due to the fact of that the company does not have an adequate system of internal control and management lacks integrity, extended substantive procedures (1) need to be performed in order to reduce detection risk and ultimately overall audit risk to an acceptable level. (1) Available 8 : Maximum 5c)Risks identified at the overall financial statement level:Integrity / behaviour of managementManagement uses company profits for entertainment purposes (1) – these transactions are illegal as it results in tax evasion (1)Previous auditors resigned as a result of a disagreement with management – could indicate that managements integrity is questionable to cause the previous auditors to resign (1)Management implements incorrect accounting policies – not willing to adopt IAS 18 (1)Theft of money and manipulation of the accounting records by management (1)Management believes that implementing a system of internal control is not cost effective (1)Nature of businessHigh level of competition in the market – new competitor started operations in close vicinity to SKSC (1)Financial PositionThe company has made losses since incorporation. Small profit made in the current year. Uncertainty regarding the company’s ability to continue as a going concern (1) Unusual pressure on management caused by the increased competition and the past history of losses creates incentive for management to misstate the financial statements. (1)Control EnvironmentThere seems to be a weak control environment – management might not be committed to tight internal controls (1)Mr Zidane’s lack of experience and knowledge of accounting standards may lead to errors in the financial statements at an overall level. (1)GeneralThis is the first year that our audit firm is auditing the company. Reliance must therefore be placed on the opening balances audited by the previous auditors (1). The risk is thus that opening balances may be misstated. (1)Available 11 : Maximum 8d) Risks at the assertion level for significant account balancesIncome received in advanceRisk of understatement as accounting policies have not been applied correctly – income from subscriptions are accounted for revenue at date of receipts, rather than spreading the subscription fees over the term of the soccer season. (2)Assertion: Completeness, cut-off (1)Accounts receivableMoney is being taken by members of management and the accounting records (accounts receivable balances) are being manipulated to hide the theft of money. Risk that accounts receivable are incorrectly stated. (1)Assertions: Completeness, valuation and allocation (1)Bank and cashRisk of understatement as management is stealing cash from the corporate teams. (1)Assertion: Completeness (1)Revenue – subscription feesRisk is overstatement as all income received is recorded, and not allocated on a time-proportion basis over the soccer season. (1) IAS 18 has not been applied correctly.Assertion: Occurrence, cut-off (1)Rent paid – soccer fieldsManagement is not aware of and does not seems to apply the accrual concept of accounting for rent paid for the soccer fields. Rent is charged in advance, and at the end of the year, a risk exists that rent charged for the new year, could possibly be accounted for during the current year (i.e. not accrued)(1)Assertion: Occurrence, cut-off (1) Entertainment ExpenseRisk of overstatement as personal/private expenditure of the managers is being paid by the company and processed as a company expense. (1)Assertion: Occurrence, classification (1)Provisions or estimates at year endThere is a tight audit deadline. Risk therefore that post balance sheet events may not be fully investigated and thus not recorded correctly at year end. (1)Risks relating to these account balances can thus be over or understatement. (1)Mr Zidane’s lacks of accounting knowledge could lead to incorrect estimates/ understated provisions.(1)Assertions: Either existence or completeness, Valuation (1)Taxation expenseThe incorrect accounting treatment of the revenue recording or the rent expense should not affect the tax expense account, as taxation principles need to be applied to calculate the tax. (1)There is a risk however, that the expense may be understated as management has processed personal entertainment expenditure through the records and would most likely have claimed for them – reducing their tax bill. (1)Mr Zidane’s tax knowledge is “shaky” could lead to incorrect tax calculations and result in penalties from SARS. (1)Assertions: Completeness, Valuation (1)Available 19 : Maximum 15Presentation 2Logic, layout and handwritingQUESTION AP-2Pre-engagement considerations (1 mark per area, 1 mark per consideration listed in area)New client investigation. In favour of engagement:Client has good reputationClient is successful Good business decision (client would pay audit fee)Client has good audit record Management integrity appears good Industry is one we would be associated with. Consider any litigations/ law suitsSkills and competence No information provided in question about the skills therefore do not answer on skillsCompetence: need to mention 2 areas:Potential use of CAATS experts and need for audit software to audit in electronic environment Budget and means to travel internationally Letter of engagement Mention ISA 210 and the need to agree the terms of engagement via a written letter of engagement signed by both auditor and client Ethical requirements as per SAICA Code of Professional Conduct are adhered to. There is no threat to the firm’s independence or self interest threats. Consider reason for previous auditors leaving and consider if a vacancy exists in accordance with s90 of Companies Act.(Max 6) Audit strategy refers to Scope, Direction and Timing. (To be assessed in context of demonstrated level of understanding) MAX 10Matters affecting the scope:It is a statutory audit, being a (Pty) LtdThe number of locations of warehouses would require travel and/or use of other auditorsConsider the different legislation required due to the fact that there are different warehouses in different countries.The accounting system requires specialized knowledgeUse of CAATS and related rmation technology will impact greatly on the performance of audit proceduresDue to foreign exchange transactions and inventory valuation issues, the application of IFRS may be complexMatters affecting the timing:Timing of conducting of year end stock countsTiming of gathering audit evidence from debtors (eg circularisations – when to perform?)Timing of audit deadline – 6 weeks after year endMeetings with managementContact previous auditors and hold discussions with them.Matters affecting the direction:Volume of transactions – appear to be low based on information about debtorsVolume of material balances – low in number based on information about debtorsManagement’s system of internal controls – sound and highly technicalSignificant business developments – changes in industry (references to being highly specialized etc)Consideration of contingent liability from the fire in Tokyo. Assign more experienced staff to deal with high risk account balances.Audit evidence – special considerations (1 mark for item WITH explanation) MAX 4:InventoryAttendance at stock counts will require international travel and/or use of experts. Refer ISA 501.Bank and cashSend out bank confirmation to gather evidence re FEC Contracts, bank balances, commitments, obligations etcDebtors CircularisationDue to revaluation requirements of foreign debtors, obtain external confirmation of foreign currency balances outstanding at year end and re-perform calculation of year end valuationsAttorneys ConfirmationObtain attorneys confirmation due to litigation by clientAssertions are : Occurrence (1) – transactions and events that have been recorded have occurred and pertain to the entity (1)Completeness (1) – all transactions and events that should have been recorded have been recorded (1)Accuracy (1) – amounts and other data relating to recorded transactions and events have been recorded appropriately (1)Cutoff (1) – transactions and events have been recorded in the correct accounting period (1)Classification (1) – transactions and events have been recorded in the proper accounts (1)Max 10QUESTION AP-3Part Aa.1.In order to develop an effective audit strategy and audit plan the auditor is required to:make a preliminary judgement of “planning” materialityobtain an understanding of the accounting and internal control systemassess the risk of material misstatementidentify significant risksIdentify any significant business risks due to the industry conditions, court cases/ litigations.2.None of the above can be achieved unless a thorough understanding of the client’s business is obtained, and hence an effective audit strategy and plan cannot be developed.The auditor’s understanding of the client’s business is also the framework within which the auditor exercises professional judgement. In addition to 1.1. 1.3 and 1.4 the auditor will need to apply professional judgement to numerous important aspects of the audit engagement e.g.evaluating estimatesrecognising conflicting informationevaluating management’s responses to audit queriesconsidering the appropriateness of accounting policiesdeveloping expectations for use when performing analytical reviewsUnderstanding the trends of the industry and economic situations to compare performance to.We can ensure that the audit is effective and efficient being able to plan and budget, managaing resources and staff or the need for experts. Helps provide a good service to the client.Obviously, if the auditor does not have a thorough understanding of the business, inappropriate judgements on important matters may be made, and responses to risks are likely to be inappropriate.Max 5I would:conduct a detailed review of the prior year’s audit work papers.review (and update) the permanent audit file.examine any trade journals/articles which may be relevant to the client.Research on the internet or newspapers for relevant articles on the client/ industry.discuss the audit with my audit manager and any members of the previous audit team who are available.familiarise myself with any legislation applicable to Signage (Pty) Ltd e,g, Road Transportation Act, (size of signs, colours etc).contact the holding company auditors to discuss such matters ascontent of, and our obligations and duties in respect of, the audit pack e.g. how questionnaires are to be completed, nature of additional schedules.Reconciliation of inter company/group balances.Group accounting policies which must be adhered to by Signage (Pty) Ltd.Deadlines and reporting requirements.meet (as soon as possible) with Mr Rock (financial controller) to discuss e.g.risks faced by the company/industry as a wholeaccounting policiesthe extent of the cash flow problems (request budgets/ forecasts)the relationship with major customers.Related Party transactions?? 8.meet with Mr Stone to discuss the role of internal audit and review available internal audit reports e.g. on systems.9.contact Signage (Pty) Ltd legal advisors or review correspondence with them, to gain an understanding of any pertinent legal matters, particularly with regard to the disputes with the provincial and national roads authorities.10.visit the Durban manufacturing facility to obtain an understanding of the company’s operations and processes. (System walkthroughs with production manager) Hold discussions with employees holding discussions with employees/floor managers to gain a better understanding of operations/ entityreview relevant documents produced by Signage (Pty) Ltdminutes of meetings, particularly the minutes of the monthly meetings between Mr Rock and Mr Stone policy and procedure manualsmonthly financial reportsgeneral correspondence company publications e.g. newsletters, brochures. perform a preliminary analytical review on the most recent financial data available to gain an insight into the company’s liquidity, solvency and profitability.MAX 10Part B: 2 marks per factor – 1 mark for effect (increase/decrease) + 1 mark for reason1.Increase of sample size due to increase in the auditor’s assessment of misstatement. The higher the auditor’s assessment of risk of misstatement, the larger the sample size needs to be. For example, an assessment of material misstatement as high indicates that the auditor cannot place much reliance on the effective operation of internal controls with respect to the particular assertion. Therefore, in order to reduce audit risk to an acceptably low level, the auditor needs a low detection risk and will rely more on substantive tests. The more audit evidence that is obtained from substantive tests (that is, the lower the detection risk), the larger the sample size will need to be.2.Decrease - The use of other substantive procedures directed at the same assertion. The more the auditor is relying on other substantive procedures (tests of detail or analytical procedures) to reduce to an acceptable level the detection risk regarding a particular account balance or class of transactions, the less assurance the auditor will require from sampling and, therefore, the smaller the sample size can be.3.Increase - The amount of misstatement the auditor expects to find in the population (expected misstatement). The greater the amount of misstatement the auditor expects to find in the population, the larger the sample size needs to be in order to make a reasonable estimate of the actual amount of misstatement in the population. Factors relevant to the auditor’s consideration of the expected misstatement amount include the extent to which item values are determined subjectively, the results of risk assessment procedures, tests of controls, the results of audit procedures applied in prior periods, and the results of other substantive procedures.4.Decrease - Stratification. When there is a wide range (variability) in the monetary size of items in the population, it may be useful to group items of similar size into separate sub-populations or strata. This is referred to as stratification. When a population can be appropriately stratified, the aggregate of the sample sizes from the strata generally will be less than the sample size that would have been required to attain a given level of sampling risk, had one sample been drawn from the whole population.5.Negligible effect/none - The number of sampling units in the population. For large populations, the actual size of the population has little, if any, effect of sample size. For small populations, however, audit sampling is often not as efficient as alternative means of obtaining sufficient appropriate audit evidence.QUESTION AP-4Factors that will affect the amount of planning of an audit:The auditors understanding of an entity and its environment(1)Size of the company(1)Complexity of the company(1)Previous experience of the entity(1)Factors the auditor will consider in obtaining a knowledge of the company:As part of the planning stage of the audit, I will obtain a knowledge of the business and document it in the working papers.(1)reference to the previous years working paper files (where possible) as well as permanent audit file(1)through discussions with the following:(1)the management/directors of the company( ? )internal auditors( ? )consultants and advisors to the company( ? )knowledgeable parties outside the entity (eg. Other auditors of similar companies) ( ? )through discussions with the previous auditors of the entity(1)publications related to the industry (financial newspapers, trade journals etc)(1)Legislation and regulations that significantly affect the entity(1)Visits to the entity’s premises and facilities(1)Documents produced by the entity (eg minutes of meetings, previous years financial statements, budgets, management reports)(1)General economic factors(1)The industry of the client(1)- the demand for sport/team building for corporate teams( ? )- SA is a country that enjoys sport( ? )The entity(1)Management and ownership of the company( ? )Business operations( ? )Financial performance( ? )Reporting requirements( ? )Laws and regulations( ? )Available 16 ? ; Maximum 12Importance of obtaining a sufficient level of knowledge of the entity:Assists the auditor in:assessing the audit risks and identifying problems(1)planning and performing the audit efficiently and effectively(1)evaluating audit evidence(1)providing a better service to the client(1)QUESTION AP-5a) Pre-engagement activitiesPerformed a client investigationDetermine our independence as auditors(1)Determine the nature of the business and the integrity of management (1)- the previous auditors resigned as a result of a disagreement with management – possible indication has questionable integrity(1)Determine whether the previous auditor has been informed of our appointment(1)Determine whether management has given us permission to communicate with the previous auditors(1)If client refuses to give us permission, consider not accepting appointment as auditors(1)If permission granted, write a letter to previous auditors to determine whether or not there are any professional reasons not to take on the position as auditors.(1)If no response, try another means to contact previous auditors, if still no response, assume no professional reasons not to take on position as auditor(1)Determine whether the client has the financial ability to pay the audit fee.(1)Determine whether a casual vacancy exists(1)Determine skills and competenceDetermine whether or not, we as auditors have the necessary knowledge, skills and competence to take on the engagement – we are a small to medium sized audit firm(1)Determine terms of engagementIssue an engagement letter that sets out the responsibility of both management as well as that of us as auditors(1)Available 12 ; Max 10b)5 components of internal control:1)Control environment – integrity and ethical valuesCompetence of employeesManagement’s philosophy and operating styleAssignment of authorityStaff development(any 1 example)(2)2)Risk assessment - Management to ID evaluate and manage risks, estimate likelihood of occurrence, decide to terminate, transfer, mitigate or accept risks(any 1 example)(2)3)Information and communication – System to have clear audit trails, clear communication to employees(any 1 example)(2)4)Control activities - Segregation of duties, CIS controls, Physical controls,operating reviews, Reporting(any 1 example)(2)5)Monitoring Deviations from actual to expected, rectify weaknesses, confidential reporting process(any 1 example)(2)Available 10Max 10c)Inherent risk:The susceptibility of an account balance or class of transaction to misstatement (1) that could be material, individually or when aggregated with misstatements in other balances or classes, assuming that there were no related internal controls.(1)Control risk:Risk that a misstatement will occur in an account balance or class of transaction and that could be material, (1) individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected and corrected on a timely basis by the accounting and internal control system. (1)Inherent risk and control risk together, has an effect on detection risk (1). If the overall assessment of inherent risk and control risk combined, is assessed as high, detection risk must be set as low, in order to reduce overall audit risk to an acceptable level. (1)If the combined level of inherent and control risk is assessed as low, detection risk may be set at a higher level.(1)Available 7Max 5Audit strategy:Performed after risk assessment and materiality (1)Comprises scope, direction and timing (3)Refers to audit strategy at a higher level – contains no detailed procedures (1) Audit plan:- performed based on the audit strategy (1)Puts strategy into detailed procedures and determines(1)Nature, timing and extent of procedures (3)Available 8Max 5Overall risk assessment at financial statement level should be assessed as HIGH (1), with the following risk factors having contributed to this assessment:Diving is a high risk activity and the potential for liability for negligence on the part of the company is a high risk item (1)Company is listed on the JSE which has more stringent and complex compliance and disclosure requirements (1)The company is reliant on foreign trade and this may pose a going concern risk where the SA environment may not be deemed to be safe for travel by the foreigners (1)Business operates on a largely cash basis which brings inherent risk due to the nature of cash (1)The company has a wide geographical dispersement which may make the control environment less effective (1)The company’s financial system was inadequate and transactions may have been omitted / misstated / corrupted (1)Staff are not familiar with the new system which could lead to errors being made and remaining undetected (1)The IT manager does not appear to have the right level of skill and experience to manage the IT risks (1)The company was found guilty by a court which indicates management is unethical in its business practices (1)The company lost a damages claim and this may give rise to further claims and losses(1)Available 11Max 10QUESTION AP-6DEVELOPMENT OF THE OVERALL AUDIT PLAN 1.Obtain an understanding of the entity, and its environment(1)-The homeopathic / pharmaceutical industry is subject to various regulations - gain knowledge of the legislation / regulations which apply to the industry(1)-Any valid point with regards to the method of gaining information.(1)2.Obtain an understanding of the accounting information and internal control systems(1)-Document the system. (1)-Study the accounting policies followed. (1)-Perform a provisional evaluation of controls and determine whether reliance can be placed on the system. (1)3.Consider audit risk and the risk of material misstatement(1)The following inherent risks influence the audit risk and must be considered: 1st time that our firm is responsible for the audit. (1)Audit team and audit partner has no prior experience with the client. (1)The company manufactures and sells only 1 product and is thus dependent on the demand in the market.(1)When the product’s patent expires, the company’s going concern might be challenged, unless the company will be able to compete against its generic rivals. (1)The machines used to manufacture the ear drops are designed specifically for the product and will not be able to manufacture other products to allow the company to diversify its product range.(1)The homeopathic market is small. (1)The manufacturing process increases the risk relating to valuation.(1)The company’s machine is supplied and serviced by a Hungarian company which increases the risk in the event that the Hungarian company is no longer willing / able to do so. (1)There is a risk relating to the accounting accuracy of the maintenance costs and foreign currency transactions.(1)Seeing that the company is the only one of its type, it will be difficult to find statistical information for benchmarking purposes. (1)Part of the company’s inventory is supplied on a consignment basis. The risk increased relating to existence, rights and valuation thereof. (1)The management director is newly appointed and does not have adequate experience in the industry. (1)The company is currently under financial pressure due to:Sales that have decreased during the past year.(1)There is pressure on net income as it appears that the company will suffer a net loss.(1)Liquidity ratio is decreasing.(1)4.Determine planning materialityStability of indicators:Figures do not appear stable. The company’s profitability is decreasing.(1)Forecast or Actual numbersThe question indicated that the forecasted numbers have been reviewed by the auditors and that we are satisfied therewith. We will use the forecasted numbers.(1)Balance Sheet or Income StatementUsers of the financial statements decision making will be influenced by the Income Statement.(1)Calculation of ranges:IndicatorRangeForecastLower rangeTop rangeTurnover? - 1% 40 000200 400 Gross Profit1-2% 4 00040 80 Net Profit5-10% (56)- -Equity2-5% 400 0008 000 20 000 Assets1-2% Not indicatedPercentages(5 x ?)Calculations(5 x ?)ConclusionDecreasing profits can lead to management manipulating results.(1)A good accounting and internal control environment reduces CR.(1)Audit risk assessed as medium(1)Because the net income is not stable, we will use either gross profit or revenue as indicator.(1) Materiality is set at R200 000 representing the lower range for Turnover.(1)(Marks awarded for an acceptable level of materiality within the prescribed ranges and for motivation given). 5.Audit approach (nature, scope, timing)(1)-As it is a new client, additional procedures must be performed on opening balances. (1)-Careful consideration should be given to the timing of the inventory counts and debtors’ circularisation. (1)-The possible use of specialists must be considered. -There is a time limitation and we must complete our audit before the deadline. (1)6.Co-ordination, supervision and review and other considerations(1)-Careful consideration should be given to staff needs. (1)Maximum 35 Of which presentation: 2QUESTION AP-7 Part (a)Budgeted indicators are used, as the company appears likely to achieve its budget. (1)All figures reported appear stable. (1)The nature of the company indicates that users of the financial statements may rely on both the statement of financial position and income statement indicators. ?%Amount per BudgetMateriality Lower limitMateriality Upper limitTurnover1/2% - 1% 10 000 000 50 000 100 000 Gross Profit1% - 2% 6 000 000 60 000 120 000 Net income?5% - 10% 2 500 000 125 000 250 000 Total assets1% - 2% 4 100 000 41 000 82 000 (3)Materiality is set at R80 000 representing the lower to middle range for profit and Revenue while within the range for assets. (1)Materiality should be set at a conservative level as risk is slightly higher due to this being a first-time audit and to mitigate the problems associated with under-auditing (in the event of final materiality revealing a lower level). (1)Max (6)Part (b)NATURE:As we have arrived at a favourable preliminary assessment of the risk of material misstatement, we will probably follow a system-based combination audit approach involving test of controls. (1)This would be necessary in view of the extent of computerisation, the likely dependence on systems of control for recording sales as well as the tight audit deadline. (2)This would be possible as the company has sound controls, competent management and accurate management accounts displayed by the reliable budgeted figures. (1)If a combination audit approach is adopted, we would need to perform detailed evaluations of key internal controls.This would include both computerised and manual controls. (1)If computerised application controls are to be tested, a review of the general control environment must be performed. This may require the use of system based CAATs.(2)The combination system-approach would enable us to reduce the extent of substantive testing.Detailed testing would be reduced and be more reliable in order to perform analytical review procedures. (1)The use of analytical procedures is strengthened by the accurate management accounts and the probably similarities between various fast food outlets in the industry. (1)The use of data CAATs may enable us to further reduce test of detail (TOD). (1)TIMING:Due to the tight audit deadline and strong controls, we are likely to perform most verification procedures in advance of the year-end, i.e. interim audit procedures, and then perform roll-forward procedures. (2)The services of a CAATs specialist may be required. We would also need to consider access to the computer environment and scheduling of audit staff, including the expert (specialist). (1)EXTENT:Materiality of R80?000 will determine the sample sizes. (1)Due to the medium risk profile of the company, and due to the fact that the company has an adequate system of internal control, substantive procedures will not have to be as extensive as the audit approach includes test of controls. (1)Sufficient procedures must be performed to reduce the overall audit risk to an acceptable level. (1)QUESTION AP-8Steps in the audit sampling process:Objective√: to establish the objectives of the audit procedure, ie they type of audit evidence that we are seeking to gather and over which assertion or item√Determine the procedure√: to establish the actual audit procedure that must be performed in order to gain the evidence required√Confirm the completeness and appropriateness of the population√: in order to ensure that the population is the same as that on which an opinion must be expressed and that the data being used is complete an up to date in this regard, and will provide the most appropriate audit evidence to address the audit objective√ Define the units of the population√: to ensure that the sampling is applied to and the identification of items is done on the correct units that make up the population, so that a true result can be obtained on which a conclusion on the sample may be extended to the population√Determine the sample size√: with reference to the influencing factors, being confidence level, tolerable misstatement, expected misstatement and the population size√Select the sample√: to ensure that a sample of the correct size is selected in the method most likely to produce a sample that is representative of the population, using one of the following methods: random, systematic, haphazard or block√Perform the audit procedures√: carrying out the intended procedure on the sampling units selected in the sample size√Analyse the nature and cause of deviations and misstatements√: to determine whether they are anomalous or recurring and their effect on the evaluation√Project the sample results over the population√: to extrapolate the error rate in a sample over the population to identify the potential misstatement in a population√Evaluate√: to compare the projected error against the tolerable misstatement√Marks 20 ; Max 15Error 1 is an anomalous error and will not be projected. √An anomaly is a misstatement or deviation that is demonstrably not representative of misstatements or deviations in the population , i.e. one in which the circumstances giving rise to the error are not deemed to carry a risk of recurrence in the remaining balance of the population. √√Errors 2 and 3 are deemed to be recurring errors and must be extrapolated across the population to estimate the error in the population. √ Recurring errors are deemed to be representative of errors or misstatements in the population, and the weaknesses in the internal control system which resulted in the error are of such a nature that they would have recurred throughout the population. √√Marks: 5QUESTION AP-9Working paper heading: Risk assessment and materiality (1)Client: Pills (Pty) Ltd (1) File reference: P2/2 (1)Year end: 31 May 2012 (1) Prepared by: A Student (1)Date: 08-Jun-12 (1) Reviewed by: A Moderator (1)Max 5 (working paper format)a) Inherent risk assessment at financial statement level is assessed as high (1) due to the following reasons:Poor control environment as no standard approach followed by all companies in group – each company’s management encouraged to use their “entrepreneurial spirit” (1)Management compensation based on entrepreneurial spirit applied (1)And performance of the company (1)Poor financial results to date (1)Possible liquidity problems (1)Possible payment of bribes (1)Possible non-compliance with laws and regulations relevant to pharmaceutical companies (1) i.e. alleged price fixing and fast-tracking of registrationPossible supply problems related to imported raw materials may cause going concern problems. (1)Foreign transactions may result in misstatements due to inappropriate application of foreign exchange rates. (1)Possible pressure by management of holding company on management of subsidiary to manipulate financial statements OR manipulation by management of subsidiary to meet expectations of holding company. (1)New audit client therefore risk related to opening balances & lack of knowledge regarding client history. (1)The new computerised system: (2)We have no background on this system and may have difficulty in obtaining it. We were not involved in the conversion which increases the risk of not detecting incorrectly converted accounts.The staff of Popping Pills (Pty) Ltd may still be unfamiliar with data capture and preparation procedures for the accounting system. This adds to the risk of errors and/or misstatement being undetected by internal controls and could affect numerous assertions.Max 12 (risk assessment)b) Materiality (max 8):IndicatorRevenue, orNet income before tax (1)ReasonCompany is profit driven;Investors will rely on these figures;Holding company interested in these results. (1)Financial statements usedActual 2011 (1)ReasonBudget not used due to recent events in company and do not represent actual achievable results (1). Recent events in company and system conversion might have an effect on company’s actual current 2012 results. (1)2010 results outdatedCalculation (3)Actual 2012:Revenue ?% - 1% 260k * 12/9 = 347k1?735 - 3?470 Net income 5% - 10%21?000 * 12/9 = 28k1?400 - 2800Actual 2011:Revenue ?% - 1% 370 0001850 - 3700Net income 5% - 10%32 0001?600 - 3 200%Conservative percentage due to high risk audit client;Lower % due to possible manipulation in light of information provided. (1)ConclusionPlanning Materiality set at R1 400 (1)A mark was awarded if the student concluded on a materiality amount based on their own calculations.QUESTION AP-10 PART Aa)1.Servicing the client (ISA 220 and ISQC 1) (1)1.1the firm would have had to decide whether the firm had, or had access to, the necessary technical competence (1) to service this client.*the previous auditors felt compelled to resign the audit despite having acted for many years as they did not have these attributes.1.2as this is a large company the firm must be satisfied that it has the necessary resources and time to perform the audit, e.g. staff members available to deal with the 31 July year end, a particularly busy period for our firm. (1)2.Ethical requirements – Independence (ISA 220 and ISQC 1) (1)2.1A potential problem here is the fact that senior partner is providing other services in the form of tax consulting to the family. (1) The nature of the relationship between your senior partner and the Zee family members must be considered. If the relationship is such that other parties, such as the investment bank, might question the ability of our firm to provide a truly independent audit opinion, then the engagement should not have been accepted. (1)2.2On the other hand the business is essentially a "family" business and if independence is not impaired, it would make sense for the family to consolidate their professional relationship with our firm.(1)3.Integrity of Hipvibes (Pty) Ltd’s management (ISA 220 and ISQC 1) (1)As the firm already has a professional relationship with the management of the firm, we should be satisfied with the integrity of the directors. (1)4.Establishing a professional relationship - Sound business decision (1)4.1The firm would also have considered whether there were any negative aspects to taking on Hipvibes (Pty) Ltd. (1)4.2An important point here is the potential high audit risk (1) arising out of the nature of the business. The potential for material misstatement in inventory and revenue and debtors, key account headings in both the balance sheet and income statement is high. The firm must be confident that it is not laying itself open to unnecessary risk of litigation, etc. (1) Also marks may be awarded for listing as per the 3 stagesClient acceptance issues or similar (1)Capacity skills competence requirements or similar (1)Establishing the terms of the engagement or similar (1)Available marks: 16Maximum: 10PART Bb)1.Account Balance : Property - low risk (1)Justification1.1None of the assertions relating to the property will present any difficulties. (1)*existence - simple physical inspection. (1) *completeness - one property only and no incentive to include fictitious properties (1) *rights - no encumbrances (1) *valuation - cost is easily established and as the property is situated in a sought after area (the market value is unlikely to be below cost). (1)2.Account balance – Foreign Debtors – high risk (1)Justification2.1Debtors represent a material amount of current assets and material misstatement could therefore occur in the account balance.(1)2.2Foreign debtors increase audit risk in the risk that not all debtors included in the balance actually exist. (1)2.3As debtors are foreign the risk of material misstatement relating to the valuation (1) assertion is increased.*determining the recoverability (1) of the debts may be more difficult.*incorrect conversion rates and transaction dates may be used when converting foreign currency invoices to rand values, resulting in incorrectly valued debtors (debtors are valued in foreign currencies). (1)2.4 Local debtors – high risk (1)* valuation – because debtors are only invoiced if they are completely happy, the amount of the debt cannot be established until a month after the sale (1), and because credit terms are so generous (60 days), debts may not be collected easily (pple take advantage) (1)* completeness – because debtors are only invoiced a month after the items have been fitted, debtors owing at year end and not yet invoiced may not be recognized as debtors (1)*rights – because debtors have no contractual obligation to pay for the goods in the first month, there may be doubt as to whether the debtors may be sufficiently owned by the company (1)3. Account Balance - Inventory - High risk (1)Justification3.1Inventory in its various forms represents a high value of current assets and of total assets. (1)3.2In a company like this inventory is fundamental to fair presentation as numerous figures in the financial statements would be affected by material misstatement in the account heading, e.g. profit, taxation, current assets, etc. (1)3.3As the items are so state-of-the-art and desirable in nature and are imported (1), the inherent risk relating to the existence and valuation assertions is significant. (1)*when attempting to test pricing of the raw materials to invoices we will be unable to determine whether the invoice presented to us refers to the item of inventory we are attempting to price (foreign currency) (1)*although finished goods and work in progress can be identified to a job card, we would still be unable to determine whether the costs allocated to the job are correct (1)*when attending the inventory count we will probably not know what we are looking at. (1)*we will have difficulty in establishing what to include in inventory where items have been fitted into customers’ vehicles but have not yet been invoiced therefore completeness carries a high misstatement risk (1)3.4The risk associated with the valuation assertion is increased by the following factors:3.4.1determining cost is complicated by the fact that:*items are imported, involving currency translation, (correct conversion dates and rates? forward cover?). (1)*import duties, freight charges must be correctly calculated and included in the cost calculation. (1)3.4.2determining whether the net realisable (1) value of each unique item will be very difficult and risk is increased as:*there is no standard price list to compare the item to (each piece is unique). (1)*MP3 players run a very high risk of technical obsolescence (1)*there is a small risk from the fact that stock items may not be supplied in future or that supply will take too long due to the current economic circumstances in Japan and its adverse affect on supply globally. (2)3.4.3the previous valuator has retired*there may not be consistency between the assumptions and methods (1) Account Balance - Current Liabilities – medium (1)4.1The completeness assertion (1) is normally the one most at risk with current liabilities. However, as Hipvibes (Pty) Ltd has a very limited number of long standing suppliers, there is little risk that the account heading could be understated materially, and should be easily picked up by comparison to prior year creditors on the list. (1)4.2Risk relating to the valuation assertion may be slightly increased by the fact that there are foreign creditors. (1)*use of the correct transaction date and conversion rate in establishing the amount owed. (1)*forward exchange contract complications. (1)Available marks: 40Maximum: 40 ................
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