CAF 8: Audit & Assurance

Suggested Solution – Test # 07

Q.1

Sr. # Audit Risk

Impairment loss needs to be recorded on idle machines.
(1)
Further, idle machines may need to be recorded as “assets held for sale”.
Internal controls over sales might be weak. Auditor should be concerned about preparation
(2)
of correct billing of sales with respect to quantity and price.
(3) This indicates obsolete inventory which might have to be recorded on NRV.
There is no quality and quantity inspection on receiving goods. Using bar codes only to
(4)
accept receiving might result in paying for ‘garbage’.
(5) This may result in theft of inventory and other assets of company.
(01 mark for identification of each risk)

Q.2
(a)
Business risk is the risk that an event or condition may adversely affect the ability of the entity to achieve
its objectives (02 marks).

(b)
Auditor can use Interim financial statements (0.5 mark), Management accounts (0.5 mark), Budgets (0.5 mark),
Forecasts (0.5 mark).
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Q. 3
REVENUE
Justification Procedures to address risk
1. There is an unusual increase of 7.8% (51,260 / 47,560) in  Discuss reasons for the increase in revenue with management.
revenue as compared to less than 2% in previous years.  Vouch entries in the revenue account to invoices and confirmation
Therefore, there is a risk of Occurrence assertions of of successful installation.
sales.  Perform cut-off tests
2. 40% of revenue is received in advance prior to  Evaluate and test the system for recording deferred income and its
commencement of work. There is a risk that revenue may transfer to revenue.
be recognized pre-mature. Therefore, there is a risk of  For a sample of contracts in progress at year-end trace initial
Occurrence assertions of sales. payment invoice to entry in deferred income account

WORK IN PROGRESS
Justification Procedures to address risk
1. Work in process involves estimation of stage of completion  Enquire if there were any systems issues during the year and
(which is subjective); and absorption of overhead (which is if previous years issues have been remedied.
complex). Therefore, Valuation and Allocation assertion of  For a sample of material costs, reperform exchange rate
Inventory is at risk. translation and check the rate to a reliable source.
2. Inventory turnover ratio has increased to 87.8 days (7,500 /  Obtain workings for overhead allocation and ensure only
30,760 * 360) this year from 74.5 days (6,305 / 30,440 * 360) attributable overheads are included
in last year, which indicate overstatement of work in process.  Assess consistency of valuation of work in process with
3. Number of weaknesses in job costing system were identified in previous years.
previous year which may result in erroneous valuation in  Compare actual costs to budget to identify cost overruns
current year too. which may indicate potential losses
4. Suppliers invoice in euro and there may be errors in  Compare contract price to estimated total costs for contracts
translation. in progress at the year end to ascertain whether provision for
5. There may be loss on some contracts in progress due to cost- losses is required.
overrun.  Inspect ageing of WIP to identify any unbilled/irrecoverable
WIP.

TRADE RECEIVABLES
Justification Procedures to address risk
 Obtain aged receivable analysis and review for evidence of
overdue balances
1. Debtors turnover ratio has increased to 46.5 days (6,620 /  Inspect customer correspondence and board minutes for
51,260 * 360) this year from 26.1 days (3,450 / 47,560 * 360) evidence of disputes
in last year, which indicates that debtors may be overstated  Examine bank statement to see if receivables are paid after
e.g. fake debtors may exist or poor debtors may exist from year end
whom full recovery is not expected. Therefore, Existence and  Review credit notes issued after year end
Valuation and Allocation assertions of Debtors are at risk.  Direct confirmation of balances with customers
 Inspect contract with Durcoal
2. A material amount of receivable (1,835,000) is in doubt  Consider basis and adequacy for provisions for Durcoal and
because of dispute. This amount may not be recovered in full. other balances.

FREEHOLD PREMISES
Justification Procedures to address risk

1. Revaluation may be incorrectly Ensure Competence, Capabilities and Objectivity of the Valuer:
calculated and recorded because it Auditor shall obtain knowledge of expert’s independence, qualification, experience,
involves Subjectivity and Complexity expertise, and reputation.
(e.g. deferred tax implication). Ensure adequacy of valuation report:
Therefore, Valuation and Allocation Auditor shall determine adequacy of work by evaluating:
assertion of fixed assets is at risk. 1. Relevance, completeness, and accuracy of significant source data
2. Relevance and reasonableness of significant assumptions and methods
2. The Newcastle site has not been 3. Reasonableness of expert’s findings and conclusions
revalued (IFRS require all properties 4. Consistency of these conclusions with other audit evidence
in the same class to be revalued). Ensure revaluation has been properly accounted for in financial statements:
1. Ensure that entire class of asset has been revalued.
2. Ensure that valuation is up-to-date.
3. Ensure that valuation is appropriately accounted for in accounts.
4. Recalculate “revaluation surplus (or loss)”, and “depreciation expenses” and
ensure these have been correctly recorded in books of accounts.
5. Ensure that appropriate disclosures have been made in accordance with IAS–16.
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Q.4 Risk Factor: Unusual growth in revenue: (0.5 mark)

Revenue has increased by almost 66% as compared to last year, without any apparent reason. There is
a risk that this has been overstated by management by recording fake sales. (01 mark)

Risk Factor: Cost of Sales has increased significantly: (0.5 mark)

Cost of sales (as a percentage of sales) has increased significantly from 65% in last year to 78% in this
year. This indicates that purchases and other manufacturing expenses may have been overstated. (01 mark)

Risk Factor: Increase in inventory turnover ratio: (0.5 mark)

Inventory turnover ratio has increased from 6 days (last year) to 19 days (this year). This indicates that
company is facing difficulty in selling its inventory and some of the inventory may have become
obsolete (01 mark). This risk is further confirmed by the fact that no provision for expired canned food has
been made in the 2014 Financial Statements (01 mark).

Risk Factor: Debtor has gone bankrupt: (0.5 mark)

There is a risk that full amount may not be recovered from this debtor. Therefore, debtors would be
overstated if appropriate amount of provision for bad debts is not recorded(01 mark).

Risk Factor: Increased borrowings during the year: (0.5 mark)

Company’s liquidity position has worsened during the year and company has obtain significant short-
term as well as long-term borrowings(01 mark). There are following risks with higher level of borrowings:
1. Borrowings may not be appropriately classified between short-term and long-term protion(01 mark).
2. Interest expense may not be appropriately calculated and recorded(01 mark).
3. Disclosures relating to debts may not have been appropriately and completely included in financial
statements(01 mark).
4. If company breaches debt-covenant requirements, debt may become immediately payable and
company may not have sufficient resources to pay the debt which may cause going concern
problems(01 mark).

(THE END)