QUESTIONS

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OBJECTIVE TEST QUESTIONS

Each question is worth 2 marks

1 Which TWO of the following should be included in an audit engagement letter?

(i) Limitations of the audit process

(ii) Results of previous audits
(iii) The final fee for the audit
(iv) Form of any other communication during the audit
A (i) and (ii)
B (ii) and (iii)
C (iii) and (iv)
D (i) and (iv)

2 Which of the following would NOT be an appropriate response when the auditor has
identified a conflict of interest between competing clients?

A Obtain signed confidentiality agreements from the clients

B Appoint separate engagement teams and arrange regular review of the application of
the safeguards by an independent person
C Set in place procedures to prevent access to information such as physical separation
of the team members by using teams from different offices
D Appoint separate engagement partners and ensure secure data filing for confidential
data

3 Which of the following is an appropriate action for the auditor to take when a material
adjusting event has been discovered in the period between the date of the financial
statements and the date of the auditor’s report?

A Issue an auditor’s report with an emphasis of matter paragraph referring to all material
adjusting events
B Request management to take the necessary actions to ensure that shareholders are
informed of any adjusting events
C Modify the audit opinion if the matter has not been accounted for correctly
D Request permission to attend the general meeting at which the financial statements
will be presented

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4 Which of the following substantive procedures provide evidence over the COMPLETENESS
of trade payables?

(i) Trace a sample of purchase invoices from the payables ledger to the goods received
note.
(ii) Review of post year-end payments and, if these relate to pre year-end purchases,
follow through to the payables ledger.
(iii) Agree the total for payables on the payables ledger to the trial balance and financial
statements.
(iv) Compare the list of trade payables against the prior year to identify any unexpected
differences.
A (i), (ii), (iii) and (iv)
B (ii) and (iii)
C (i) and (iv)
D (ii), (iii) and (iv)

5 Which of the following is NOT a right of the auditor on resignation?

A To request a general meeting of the company to explain the circumstances of the

resignation
B To write directly to the shareholders explaining the circumstances of the resignation
C To require the company to circulate the notice of the circumstances relating to the
resignation
D To speak at a general meeting of the company to explain the circumstances of the
resignation

6 Which of the following procedures are tests of controls an auditor could perform in testing
capital expenditure on property, plant and equipment?

(i) Physically inspect the asset to confirm it is in good condition.

(ii) Inspect the capital expenditure requisition to confirm it has been signed by the person
requisitioning the asset.
(iii) Inspect the purchase order for the authorisation signature of an appropriate senior
person.
(iv) Inspect the non-current asset to ensure the asset has been recorded.
A (ii) and (iii)
B (i) and (iv)
C (i) and (iii)
D (ii) and (iv)

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7 Which of the following is NOT a disadvantage of a company outsourcing its internal audit
function?

A Pressure on the independence of the outsourced function if management threaten not

to renew the contract
B Risk of staff turnover is passed to the outsourcing firm
C The outsourcing company may lack an understanding of the company’s culture
D Outsourcing fees may be expensive

8 Which of the following could be tested using test data?

A Checking the arithmetical accuracy of the receivables ledger

B Stratifying receivables according to age
C Confirming that any sales invoices issued resulting in a credit balance on a customer’s
account is flagged up for review
D Calculating the receivables collection period

9 Which of the following is an ADVANTAGE of recording accounting and control systems

using narrative notes?

A They will always be faster to prepare than the alternative methods available as they
do not require special training
B As they are very detailed they are less likely to miss out controls
C They can be easily understood by any member of the audit team
D They show a diagrammatic depiction of the system

10 Which of the following statements, if any, are correct?

(i) One element of the control environment is management’s philosophy and operating
style.
(ii) An information system must always be designed to ensure that there is segregation of
duties between all key stages in the system.
A (i) only
B (ii) only
C Both (i) and (ii)
D Neither (i) nor (ii)

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11 Which of the following statements relating to written representations, if any, are correct?

(i) The purpose of obtaining written representations is to minimise unnecessary work

where management can confirm the relevant facts.
(ii) It is inappropriate for the auditor to draft the written representations letter as it is a
communication from the client to the auditor.
A (i) only
B (ii) only
C Both (i) and (ii)
D Neither (i) nor (ii)

12 An audit junior has been assigned to the audit of property, plant and equipment of Johnson
Co. What is the order of reliability of the following audit evidence for cash received on the
sale of a building during the year starting with the LEAST reliable first?

(i) Verbal representations from management confirming the total amount of cash
received.
(ii) The cash received page in the cashbook showing the amount received.
(iii) The completion statement from the legal advisors showing the sales proceeds.
(iv) A photocopy of the cheque from the purchaser taken prior to the cheque being
banked.
A (iv), (i), (ii), (iii)
B (i), (iv),(iii), (ii)
C (iv),(i), (iii), (ii)
D (i) ,(ii), (iv), (iii)

13 In which of the following situations would it NOT be appropriate to use an auditor’s expert
when gathering audit evidence?

A To help in the valuation of a specialised property

B To attend the stocktake because the audit senior will be on holiday at the year-end
C To help assess whether a development project is technically feasible
D To assist in the interpretation of a complex legal document

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14 General IT controls are policies and procedures that relate to many applications. Which
TWO of the following are general controls?

(i) Sequence checks

(ii) Password protection to the network
(iii) Disaster recovery plans
(iv) Exception reporting
A (i) and (iv)
B (iii) and (iv)
C (i) and (ii)
D (ii) and (iii)

15 Which TWO of the following are examples of threats to the fundamental principle of
objectivity?

(i) Litigation with a client

(ii) Negotiating on behalf of the client
(iii) Failing to maintain professional competence
(iv) Disclosure of confidential information
A (i) and (ii)
B (i) and (iv)
C (ii) and (iii)
D (i) and (iii)

16 ISA 230 Audit Documentation requires auditors to prepare audit documentation on a

timely basis. Which of the following statements, if any, are correct?

(i) Audit documentation may be recorded on paper or on electronic or other media.

(ii) Copies of the entity’s records can form part of the audit documentation.
A Neither (i) nor (ii)
B Both (i) and (ii)
C (i) only
D (ii) only

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17 Which of the following statements relate to a limited assurance engagement?

(i) Gathers sufficient appropriate evidence to be able to draw reasonable conclusions.

(ii) Gives a lower level of assurance than that of an audit.
(iii) Mainly detailed substantive testing performed.
(iv) Concludes that the subject matter is plausible in the circumstances.
A (i) and (iii)
B (ii) and (iv)
C (ii) and (iii)
D (i) and (iv)

18 An Other Matter paragraph is used in the auditor’s report to communicate matters that
are not presented or disclosed in the financial statements. Which of the following
statements is/are correct in relation to an Other Matter paragraph in the auditor’s report?

(i) This paragraph would be used to further explain the auditor’s responsibilities or
auditor’s report.
(ii) The inclusion of this paragraph would mean additional communication had been
provided.
(iii) This paragraph would be used where there is a material inconsistency between the
financial statements and the other information included in the annual report.
(iv) This paragraph would be included before the opinion paragraph.
A (i) only
B (i) and (ii) only
C (i), (ii) and (iii)
D (iii) and (iv)

19 During the completion of the final audit, the auditor discovers that there is inadequate
disclosure of a material non-adjusting event in the financial statements. What are the
implications for the auditor’s report if management refuses to amend the disclosure?

A Include an emphasis of matter paragraph referring to this issue

B Include an ‘except for’ opinion and an emphasis of matter paragraph referring to this
issue
C Include an ‘except for’ opinion and no emphasis of matter paragraph
D Issue an unmodified opinion as the event occurred after the year-end and is non-
adjusting

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20 The audit of Harry Co has been completed and the auditor’s report has been signed and
issued to the client. The AGM is due to take place in 4 weeks’ time. The engagement partner
has just discovered that a major customer has decided not to renew its contract with Harry
Co resulting in significant uncertainty about whether the company is a going concern. What
actions, if any, should the auditor now take?

A No action required as the auditor’s report has been issued

B Request that management discloses this event in the following year’s financial
statements
C Write to all users of the financial statements informing them of the issue
D Request management to amend the financial statements, audit the amendments and
issue a new auditor’s report

21 ISA 500 Audit Evidence identifies different types of procedures the auditor can adopt to
obtain audit evidence. Which of the following is NOT an example of such a procedure?

A Cut - off testing

B Re-performance
C Observation
D External confirmation

22 Which of the following statements is correct in respect of a modified audit opinion?

A A qualified opinion refers to any type of modified opinion

B An adverse opinion is used when the auditor has been unable to obtain sufficient
appropriate evidence
C A disclaimer of opinion means the auditor does not express an opinion on the financial
statements
D An adverse opinion uses the ‘except for’ wording

23 Which of the following describes the main contents of the basis for opinion paragraph?

A Explains management’s responsibilities

B Explains a material uncertainty in relation to going concern
C Explains that the auditor must follow ISAs when performing the audit and must be
independent of the client
D Explains that the auditor has to obtain reasonable assurance about whether the
financial statements give a true and fair view

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24 Which of the following shows the correct order of sections in an auditor’s report?

A Auditor responsibilities, management responsibilities, other information

B Opinion, other information, auditor responsibilities
C Basis of opinion, opinion, auditor responsibilities
D Management responsibilities, opinion, other information

25 Which of the following statements is TRUE in respect of the Key Audit Matters (KAM)
section in the auditor’s report?

A KAM are only required to be included in an auditor’s report of a listed entity but may
be included in the auditor’s report of a non-listed company at the client’s request
B KAM can be referred to in an emphasis of matter paragraph to ensure the matter is
brought to the attention of the user
C An issue which has resulted in the audit opinion being modified must also be explained
in the KAM section
D KAM are those matters that have been discussed with the finance director during the
audit

26 Which of the following are key elements of quality management procedures that should
be applied during each audit engagement by the audit firm?

A Leadership, supervision, direction

B Supervision, review, monitoring
C Monitoring, review, leadership
D Direction, supervision, review

27 Which of the following describes the purpose of supervision during an audit engagement?

A Informing the team of their roles and responsibilities

B Tracking the progress of the audit and ensuring issues are identified and resolved on a
timely basis
C Ensuring the work has been performed to the required standard
D Ensuring that significant judgments have been justified and documented on the audit
file

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28 Which of the following options correctly describes post-issuance and pre-issuance reviews?

Post-issuance Pre-issuance
A Conducted before the auditor’s Also referred to as a hot review
report is signed
B Performed by an engagement Conducted after the auditor’s
quality reviewer report is signed
C The objective is to identify quality Involves a review of all working
issues in the work papers on the audit file
D Involves a review of all working The objective is to ensure the
papers on the audit file appropriate opinion is given

29 Which of the following options correctly identifies the sampling methods described?

(i) The auditor selects the sample without any pattern

(ii) The auditor tests every Nth item
(iii) The auditor tests the last 20 items of the year and the first 20 items of the following
year
(i) (ii) (iii)
A Random Monetary unit sampling Block
B Block Haphazard Random
C Haphazard Systematic Block
D Monetary unit sampling Systematic Random

30 Which of the following options correctly identifies the assertions relevant to account
balances such as receivables and payables?

A Classification Existence Accuracy, valuation,

allocation

B Cut-off Accuracy, valuation, Rights and obligations

allocation

C Rights and Occurrence Existence

obligations

D Classification Completeness Cut-off

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OBJECTIVE TEST CASE QUESTIONS

The following scenario relates to questions 31 - 35

You are an audit manager in Potter & Co, a large audit firm and have recently been allocated two
new clients detailed below.
Paramore Co
Paramore Co has recently approached your firm to request an audit. This is the first year the
company has met the size threshold for requiring an audit. The directors have recently discovered
a fraud where the sales ledger clerk has been stealing receipts from customers and posting ledger
entries to conceal the fraud. The directors consider that an audit will only be worthwhile if the
auditor can guarantee that any further frauds will be detected during the audit.
To try and prevent future instances of fraud, the directors have also asked your firm to review the
company’s system of internal control and as part of this they would like your help to select a new
accounting software package to be used as part of their accounting system.
Applewood Co
Applewood Co, an existing audit client, is a retail company planning to list on a stock exchange
within the next six months. They have provided some details about their existing board structure
and plan to make some changes so that they are in line with corporate governance best practice
once the company is listed.
The board of directors currently comprises the chair (who is also the chief executive), four executive
directors and two non-executive directors. Further details relating to the board are noted below.
Baylee Campbell has been chair and chief executive for over 15 years and is now planning to retire.
The company has decided it would be best to have someone who knows the company well to step
into the position, so has identified Sefton Whistler to take over the role from Baylee. Sefton has
worked for Applewood Co for 10 years and has been operating as second in command for the
majority of that time, so is well placed to take over the role.
Shirley Moore is an independent non-executive director of Applewood Co. Shirley has been a
member of the board for six years and has extensive experience of the retail industry.
Tam Green was an employee of Applewood Co until retirement seven years ago. On retirement
Tam became a non-executive director. Tam currently receives a pension from Applewood Co and a
fixed salary for being a non-executive director. Tam previously owned shares in the company but
sold these on retirement.

31 Which TWO of the following procedures need to be performed if your firm decides to
accept the engagement to audit Paramore Co?

A Contact the previous auditor to request working papers to assist with planning the
audit
B Perform background checks on the directors of Paramore Co
C Prepare an engagement letter setting out the scope and objectives of the engagement
D Review the prior year audit file to identify issues which may be relevant when planning
the forthcoming audit

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32 Which of the following statements is TRUE in relation to the directors’ expectation that the
auditor will guarantee detection of fraud?

A The auditor will only identify instances of material fraud during the audit
B The auditor may identify instances of fraud during their work to identify any material
misstatements in the financial statements
C The auditor is only providing a limited level of assurance during an external audit so
cannot guarantee to detect all frauds
D The auditor will test every transaction and balance so should identify any fraud
occurring

33 In respect of the additional services requested by Paramore Co, which of the following
correctly identifies the threat or threats to Potter & Co’s independence and proposes an
appropriate course of action?

Threats Course of action

A Self- review Provide both services with safeguards
B Self-interest and familiarity Must not accept appointment as auditor
C Familiarity Provide both services with safeguards
D Self-review and familiarity Must not accept appointment as auditor

34 Which of the following recommendations is NOT required to be implemented by

Applewood Co to bring the company in line with corporate governance best practice?

A Sefton cannot take over as chair of the board

B The chair and chief executive roles should be held by separate individuals
C More independent non-executive directors must be appointed to ensure at least half
of the board are independent
D Shirley will need to be replaced as independent non-executive director next year

35 In respect of Tam Green, which of the following will compromise independence?

A Tam owned shares previously in Applewood Co

B Tam receives a fixed salary from Applewood Co
C Tam receives a pension from Applewood Co
D Tam was an employee of Applewood Co seven years ago

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The following scenario relates to questions 36 - 40

You are an audit manager at Otillie & Co and one of the audit partners has asked you to review the
arrangements with some of the firm’s long-standing audit clients to make sure there are no ethical
issues with the services being provided.
Grisaille Co
Grisaille Co, a listed company, is one of Otillie & Co’s largest clients. Last year the fees for audit and
other services was $2.1m and this year fees are expected to be $2.3m which represents 15.5% and
16.1% of Otillie & Co’s total income respectively.
Ochre Co
Ochre Co is a large private company and has been an audit client of Otillie & Co for many years.
Rachel Craig, a partner of Otillie & Co, has acted as the audit engagement partner for seven years.
This year, Ochre Co has requested Otillie & Co provide tax advice to minimise the company’s tax
liability, in addition to the external audit. The directors have suggested that the fee could be based
on the level of tax saving achieved to ensure the payment for the service does not outweigh the
benefit obtained. The fee is expected to be significant.
Payne Co
Otillie & Co is the external auditor of Payne Co, and also provides other non‐audit services to the
company. The audit team comprises an engagement partner, a recently appointed manager, an
audit senior and a number of audit assistants. The previous audit manager left the firm before the
completion of the prior year audit and is now the finance director of Payne Co. The finance director
and new audit manager are good friends.

36 In relation to Grisaille Co, which of the following threats to independence may arise as a
result of the level of fees?

1 Self-interest
2 Advocacy
3 Self-review
4 Intimidation

A 2 and 3 only
B 2, 3 and 4
C 1, 3 and 4
D 1 and 4 only

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37 Which of the following actions would NOT be relevant in order for Otillie & Co to maintain
their objectivity in relation to the level of fee income from Grisaille Co?

A Assign an engagement quality reviewer

B A pre-issuance review to be conducted by an external accountant
C The use of separate teams to provide the audit non-audit services
D Disclosure to those charged with governance that fees from Grisaille Co represent
more than 15% of Otillie & Co’s total fee income

38 In relation to Rachel Craig being the audit engagement partner of Ochre Co, which of the
following correctly identifies the threats to Otillie & Co’s independence and proposes an
appropriate course of action?

Threats Course of action

A Familiarity only Can continue with appropriate safeguards
B Self-interest and familiarity Must resign as auditor
C Self-review and self- interest Can continue with appropriate safeguards
D Self-review and familiarity Must resign as auditor

39 Which of the following statements is TRUE in respect of Ochre Co’s request for the tax
advice fee to be based on the tax saving achieved?

A The fee basis is acceptable if both Otillie & Co and Ochre Co agree to it
B The fee basis is not acceptable as contingent fee arrangements are not acceptable for
any accountancy work
C The fee basis is acceptable as it does not relate to the audit fee
D The fee basis will not be acceptable as the fee is significant to the firm

40 In relation to the audit of Payne Co, select the type of threat which could arise as a result
of the finance director’s relationship with the audit manager and select an appropriate
safeguard.

Type of threat Safeguard

1 Intimidation A The firm should resign from the
engagement
2 Self-review B A different audit manager should be
appointed
3 Familiarity C The finance director must not have
contact with the audit manager
whilst the audit is ongoing

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The following scenario relates to questions 41 – 45

It is 1 July 20X5. Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has
a wide customer base across Europe and Asia. You are an audit manager in Nate & Co and you are
planning the audit of Abrahams Co for the financial year ending 31 August 20X5. You attended a
planning meeting with the finance director and audit engagement partner and are now reviewing
the meeting notes in order to prepare the audit strategy and plan. Revenue for the year is forecast
at $25 million and profit before tax is forecast at $1.6m.
During the year the company has spent $2.2 million on developing several new products. Some of
these are in the early stages of development whilst others are nearing completion. The finance
director has confirmed that all projects are likely to be successful and is intending to capitalise the
full $2.2 million.
Once products have completed the development stage, Abrahams Co begins manufacturing them.
At the year-end it is anticipated that there will be significant levels of work in progress. The company
uses a standard costing method to value inventory. The standard costs are set when a product is
first manufactured and are not usually updated. In order to fulfil customer orders promptly,
Abrahams Co has warehouses for finished goods located across Europe and Asia. Approximately
one third of these are third party warehouses where Abrahams Co rents space.
In April 20X5 a new accounting package was introduced. This is a bespoke system developed by the
information technology (IT) manager. The old and new packages were not run in parallel as it was
felt that this would be too onerous for the accounting team.
In order to fund the development of new products, Abrahams Co has restructured its finance and
taken out a long-term loan of $2.5 million. There are bank covenants attached to the loan, the main
one relating to a minimum level of total assets. If these covenants are breached, the loan becomes
immediately repayable.
The reporting timetable for completion of the audit is quite short, and the finance director would
like to report results within four weeks of the year end.

41 Which of the following is the LEAST significant audit risk to be considered when planning
the audit of Abrahams Co?

A Overstatement of intangibles
B Valuation of work in progress
C Overstatement of trade payables
D Inadequate disclosure regarding the loan

42 Which of the following factors increases the inherent risk for the audit of Abrahams Co?

A Change of the accounting system in April 20X5

B Tight reporting deadline
C One third of the warehouses belonging to third parties
D Covenants attached to the loan

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43 In respect of the work in progress, which one of the following audit procedures is NOT
appropriate?

A Discuss with management the basis of the standard costs

B Agree the total standard cost to purchase invoices for a sample of products
C Review the level of variances between standard and actual costs and discuss how these
are treated
D Observe the procedures carried out in assessing the level of work-in-progress at the
year end

44 Which TWO of the following describe appropriate auditor responses to the audit risk
related to the tight reporting deadline?

A Increase the number of staff allocated to work on the audit

B Increase the reliance on controls so that the number of substantive procedures are
reduced
C Perform some audit procedures before the year end during an interim audit
D Increase materiality so that fewer balances need to be tested
E Inform the finance director that it will not be possible to complete the audit in four
weeks

45 Which of the following is the LEAST appropriate materiality level to be used in the audit of
Abrahams Co?

A $90,000
B $150,000
C $200,000
D $300,000

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The following scenario relates to questions 46 – 50

You are an audit senior in Brennon & Co. You are preparing the audit programme for the revenue
and receivables system of Seeley Co. Seeley Co is a wholesaler of electrical goods such as kettles,
televisions, music systems, etc. The company maintains one large warehouse in a major city. The
customers of Seeley Co are small retailers who sell to consumers.
Audit documentation is available from the previous year’s audit, including internal control
questionnaires and audit programmes for the despatch and sales system. The audit approach last
year did not involve the use of automated tools and techniques and the same approach will be
taken this year. As far as you are aware, Seeley Co’s system of internal control has not changed in
the last year.
Despatch and sales system
Seeley Co only sells to authorised customers following appropriate credit checks. Each customer is
given a Seeley Co identification card to confirm their status and the card must be used to obtain
goods from the warehouse. Customers visit Seeley Co’s warehouse and load the goods they require
into their vans after showing their Seeley identification card to the despatch staff. A goods despatch
note (GDN) is produced and signed by the customer and a member of Seeley Co’s despatch staff
confirming goods taken. One copy of the GDN is sent to the accounts department, the second copy
is retained in the despatch department. Accounts staff enter goods despatch information onto the
computerised sales system. The computer system produces the sales invoice, with reference to the
inventory master file for product details and prices, maintains the sales day book and also the
receivables ledger. Invoices are sent to each customer either by post or email and a copy is
maintained by the accounts department. Invoices are compared to GDNs by accounts staff and
signed.
Prior year deficiencies
On the prior year audit file the following deficiencies within the sales system were identified:
(i) The system used in the warehouse allows customers to take goods which exceed their credit
limit.
(ii) Goods despatch notes were not sequentially numbered.

46 Which of the following is NOT an objective of Seeley Co’s despatch and sales system?

A To ensure that all goods despatched are correctly invoiced

B To ensure that discounts received are accounted for completely and accurately
C To ensure that goods are despatched to creditworthy customers only
D To ensure that all orders are recorded completely and accurately

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47 Which of the following would be the LEAST appropriate procedure to check the accuracy
of the previous year’s internal control questionnaires?

A Obtain system documentation from the client and review this to identify any changes
made in the last 12 months
B Interview client staff to ascertain whether systems have changed this year and to
ensure the internal control questionnaires produced last year are correct
C Complete a new internal control questionnaire with the sales staff
D Perform walk-through tests to ensure the previous year’s internal control
questionnaire is still accurate and can be relied upon this year

48 Which of the following control objectives is addressed by the accounts department staff
comparing the invoice to the GDN and signing it?

A To ensure all orders are processed

B To ensure all goods despatched are recorded on the system
C To ensure all goods despatched are invoiced
D To ensure only valid sales are recorded

49 For each of the following procedures, select whether it is a test of control or a substantive
procedure.

Review a sample of GDNs for signature of Test of control Substantive procedure

the accounts staff.
For a sample of goods despatched Test of control Substantive procedure
immediately before and after the year
end, trace the GDN to the invoice to
ensure it has been recorded in the correct
period
Discuss with management the process for Test of control Substantive procedure
determining the allowance for
receivables.
Observe Seeley staff inspecting the Test of control Substantive procedure
customers’ identification card prior to
goods being loaded onto the vans

50 Which TWO of the following risks arise as a result of the two deficiencies noted in the prior
year file?

A Risk of irrecoverable debts

B Risk of orders not being fulfilled on a timely basis
C Risk of revenue being understated
D Risk of invoices being recorded inaccurately
E Risk that revenue is not recorded in the correct accounting period

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The following scenario relates to questions 51 – 55

It is 1 July 20X5. You are an audit supervisor in Maldives & Co and you are currently performing the
audit of an existing client, Seychelles Co, for the year ended 31 March 20X5. Seychelles Co
manufactures wooden furniture such as chests of drawers, tables and wardrobes.
The following information has been obtained during discussions with the finance director.
Inventory
The items made by Seychelles Co take up to 14 days to complete, so work-in-progress (WIP) is a
material balance in the financial statements. The WIP is valued using standard costs, which have
not been updated since the start of the previous year. For the first time, Seychelles Co has sourced
some of their raw materials from overseas suppliers, paying in foreign currency. In addition,
Seychelles Co has experienced increased competition during the year, which has led them to cut
their selling prices by up to as much as 40%. Despite the reduction in selling prices, inventory levels
are significantly higher this year compared to the prior year.
Receivables
One of Seychelles Co’s key customers has a significant overdue balance. The finance director does
not believe an allowance is required based on the reassurances given by the customer that they
will pay soon. Your review of recent industry news articles indicates that the customer is
experiencing financial difficulties and may soon cease trading.
Lawsuit
One of Seychelles Co’s employees had an accident in the factory on 5 April 20X5 and has filed a
legal claim against the company, claiming that they were not given the appropriate safety
equipment for their role. The employee is claiming compensation of $40,000 which is material to
the financial statements. The finance director believes that the company will lose the case, although
doesn’t want to reflect the issue in the financial statements until the exact amount of compensation
has been confirmed.

51 Which of the following factors may indicate overvaluation of inventory at Seychelles Co?

A Increased inventory turnover ratio

B Increased competition resulting in reduced selling prices
C Purchase of raw materials from overseas suppliers
D Use of standard costs for WIP valuation

52 Which of the following procedures would be performed in respect of the valuation of

Seychelles Co’s WIP?

A Select a sample of WIP on the count sheets and trace through into the final inventory
listing
B Enquire of management whether there is any third party inventory included
C Review the financial statement disclosure of inventory to ensure that the correct
amounts are shown for raw materials, WIP and finished goods
D Enquire of management how overheads are allocated into WIP and assess whether
this appears reasonable

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53 Which of the following substantive procedures will provide the MOST reliable evidence as
to the recoverability of the outstanding balance from Seychelles Co’s key customer?

A Compare the current outstanding balance from the customer to the prior year
B Obtain a direct confirmation letter from the key customer
C Review post year-end cash receipts from the key customer
D Obtain a written representation letter from management confirming that the balance
will be paid

54 Which TWO of the following substantive procedures will provide evidence over the
EXISTENCE of Seychelles Co’s other trade receivables?

A Perform a receivables circularisation

B Review post year-end cash receipts from customers
C Recalculate the allowance for irrecoverable receivables
D Calculate the receivables collection period and compare with prior year
E Trace a sample of GDNs relating to sales made just before the year end to the
receivables ledger

55 Which of the following are appropriate responses to the legal claim?

1 Contact the employee to understand the details of the claim

2 Ask the finance director to include a provision in the financial statements
3 Inspect correspondence between the client and their legal advisers
4 Ask the finance director to include a disclosure note in the financial statements

A 1 and 3 only
B 1, 2 and 3
C 2, 3 and 4
D 3 and 4 only

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 LECTURER RESOURCE PACK : QUESTION S

The following scenario relates to questions 56 – 60

It is 1 July 20X5. You are an audit manager in Chestnut & Co. You are reviewing the key issues
identified in the files of two audit clients which are nearing completion. The company’s year end in
each case is 31 March 20X5.
Palm Industries Co (Palm)
The draft financial statements of Palm show revenue of $28.2 million, total assets of $15.6 million
and profit before tax of $4.8 million. A customer of Palm owed an amount of $350,000 at the year-
end. Testing of receivables in April 20X5 highlighted that no amounts had been paid to Palm from
this customer as they were disputing the quality of certain goods received. The finance director is
confident the issue will be resolved and no allowance for credit losses has been made for this
balance.
Ash Trading Co (Ash)
Ash is a new client of Chestnut & Co and the firm was only appointed as auditor in April 20X5, as
the previous audit firm was suddenly unable to undertake the audit. The inventory count at Ash’s
warehouse was undertaken on 31 March 20X5 and was overseen by the company’s internal audit
department. The inventory count was not attended by Chestnut & Co or the previous auditor.
Detailed inventory records were maintained but it was not possible to undertake another full
inventory count subsequent to the year-end.
Ash sells its goods with a two-year assurance type warranty, for which there is a provision of
$800,000 included within the statement of financial position. The audit team has performed testing
over the calculations and assumptions and have concluded that they are reasonable. The team has
requested a written representation from management confirming the basis and amount of the
provision are reasonable. Management has yet to provide this representation.
The draft financial statements show a profit before tax of $2.4 million, revenue of $10.1 million and
inventory of $510,000.

56 Which of the following statements is correct regarding the materiality of the irrecoverable
debt in Palm Industries Co?

A The matter is material by nature

B The matter is not material as the debt is less than 5% of revenue
C The matter is not material as the debt is less than 10% of profit
D The matter is likely to be material as it is over 1% of assets

57 Which THREE of the following procedures would allow the auditor to form a conclusion as
to the level of adjustment required to the receivables balance?

A Perform a direct confirmation of the balance outstanding at the year-end

B Review the latest customer correspondence with regards to an assessment of the
likelihood of the customer making payment
C Discuss with management whether the issue of quality goods sold to the customer has
been resolved, or whether it is still in dispute
D Inspect the sales invoice and GDN relating to the receivable balance
E Review post year-end bank statements to identify whether any payments have been
received by this customer since the audit fieldwork was completed

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58 Assuming Palm’s directors have refused to make an adjustment in the financial statements,
what is the appropriate opinion to be issued?

A Unmodified with additional communication

B Qualified with the except for wording
C Adverse stating the financial statements do not present fairly
D Disclaimer stating that no opinion is expressed on the financial statements

59 In respect of Ash Trading Co, assuming no further procedures on inventory can be

performed and the evidence relating to the provision is sufficient and appropriate, which
of the following statements is TRUE in respect of the audit opinion?

A An unmodified opinion can be issued because the inventory balance is not material
B An unmodified opinion with an Emphasis of Matter paragraph referring to the lack of
evidence over inventory should be issued
C A qualified opinion should be issued because the inventory balance is material but not
pervasive
D A disclaimer of opinion should be issued due to the lack of evidence over inventory

60 If the directors of Ash Trading Co refuse to provide a written representation to the auditor,
which of the following statements is TRUE?

A The refusal to provide a written representation may cast doubt over management
integrity and as such the reliability of other evidence provided by the client may be
called into question
B The refusal to provide a written representation will only be of concern if it relates to a
material area of the financial statements
C The refusal to provide a written representation will result in the need for the auditor
to report the directors to the industry regulator
D The auditor will need to notify the shareholders of the issue in person

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 LECTURER RESOURCE PACK : QUESTION S

The following scenario relates to questions 61 – 65

It is 1 July 20X5. You are an audit manager in Kiwi & Co responsible for the audit of Strawberry
Kitchen Designs Co (Strawberry) for the year ended 31 March 20X5. Strawberry is a kitchen
manufacturer. You have been provided with the following information about your client. The final
audit is almost complete and the financial statements and auditor’s report are due to be signed
next week.
Strawberry has recently been experiencing trading difficulties. A major customer of Strawberry,
Blossom Co, has ceased trading owing the company $0·6m. Blossom Co’s administrator has
confirmed this will not be paid. The sales director is confident that some of the business can be
replaced as discussions are taking place with a new customer and a contract is expected to be
signed in August 20X5.
The monthly cash flow statement has shown a net cash outflow for the last two months of the
financial year and is forecast as negative for the forthcoming financial year. Due to its financial
difficulties, Strawberry missed a loan repayment and, as a result of this has breached one of the
loan covenants.
Having performed the going concern audit procedures, you have serious concerns in relation to the
going concern status of Strawberry. The finance director believes the cash flow issues are short
term and does not intend to make any going concern disclosures, or make any amendments to the
financial statements.

61 Which of the following procedures would provide the MOST reliable evidence in relation
to the new customer mentioned by the sales director?

A Review post year-end sales orders from the new customer

B Inspect correspondence between the sales director of Strawberry and the new
customer
C Review board minutes confirming the level of business agreed with the new customer
D Obtain a written representation confirming the level of business agreed with the new
customer

62 Which of the following audit procedures should be performed as part of the subsequent
events review of Strawberry?

A Review post year-end management accounts to assess the accuracy of the cash flow
forecast
B Inspect the loan agreement to confirm the breach of covenant
C Review the post year-end bank statements for payment from Blossom Co
D Perform a sensitivity analysis on the cash flows to understand the margin of safety
Strawberry has in terms of its net cash flow

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63 Which of these statements is TRUE in respect of the directors and auditor responsibilities
in relation to going concern?

A The auditor must assess whether the company can continue to trade for the
foreseeable future
B The directors must assess a period of at least twelve months from the date the financial
statements are issued
C The auditor will evaluate management’s assessment of going concern
D The auditor and directors must make disclosure of going concern uncertainties in the
financial statements

64 What will be the impact on the auditor’s report of Strawberry in the following
circumstances?

Adequate Unmodified Unmodified

Unmodified
disclosure of going opinion with opinion with
opinion with no Modified
concern Going Emphasis of
additional opinion
uncertainties is Concern Matter
communication
NOT made paragraph paragraph
Adequate Unmodified Unmodified
Unmodified
disclosure of going opinion with opinion with
opinion with no Modified
concern Going Emphasis of
additional opinion
uncertainties is Concern Matter
communication
made paragraph paragraph

65 What will be the impact on the auditor’s report if the auditor believes the basis of
preparation of Strawberry’s financial statements is incorrect?

A Unmodified opinion with no additional communication

B Unmodified opinion with an Emphasis of Matter paragraph
C Qualified opinion with Basis for Qualified Opinion
D Adverse opinion with Basis for Adverse Opinion

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AUDIT FRAMEWORK AND REGULATION

66 LEE KEY CO
Lee Key Co has undergone a period of substantial growth following its establishment five
years ago by two plumbers using their redundancy pay. Because of a lack of accounting
expertise within the company it has traditionally looked to its auditors, Tickit, Hopit& Co, for
accounting services in the preparation of annual financial statements as well as for the
statutory audit function. As the fees have grown significantly over the last five years the
company has recently asked the audit firm whether, going forward, it would be possible to
calculate the audit fee as a percentage of profit.
Tickit, Hopit & Co is a small firm of certified accountants and registered auditors whose clients
are mainly small businesses. Although Lee Key Co was originally a typical small company
client, its growth over the last five years has meant that it now accounts for approximately
20% of Tickit, Hopit & Co’s gross fee income and the company has indicated that it may wish
to issue shares on the stock market in the near future.
Ticket, Hopit & Co have been keen to expand their client base and have recently launched an
advertising campaign in which they guarantee that to maximise the efficiency of the audit
they will only allocate staff to the audit who have experience in the relevant business sector.
As a result Cran and Western Co, a major competitor of Lee Key Co have asked Ticket, Hopit
& Co to replace their existing auditors immediately.

Required:
(a) From the information above identify and explain FOUR ethical threats and for each
threat explain the steps which Tickit, Hopit & Co should take to reduce the threat.
(8 marks)
(b) If, despite having been re-elected as the company’s auditors, Tickit, Hopit & Co
decide to resign during the year, state the procedures they should go through.
(2 marks)
(c) Outline the benefits to companies of having an external audit (4 marks)
(d) The IAASB International Framework for Assurance Engagements permits two types of
assurance engagements.
Required:
Compare the level of assurance provided by these two types of engagements.
(6 marks)
(Total: 20 marks)

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67 BRAMPTON CO
It is 1 July 20X5. You are the senior in charge of the audit of Brampton Co for the year ending
30 June 20X5 and are currently planning the year-end audit. Brampton specialises in the
production of high quality bread of various kinds.
During the interim audit you noted that the company has suffered as its costs are increasing
and its prices have been higher than its competitors because of lower production runs. One
indicator of the problems facing the company is that it has consistently used a bank overdraft
facility to finance its activities.
At the time of the interim audit you had discussed with company management what actions
were being taken to improve the liquidity of the company and you were informed that the
company plans to expand its facilities for producing white bread as this line had maintained
its market share. The company has asked its bank for a loan to finance the expansion and
also to maintain its working capital generally.
To support its request for a loan, the company has prepared a cash flow forecast for the two
years from the end of the reporting period and the internal audit department has reported
on the forecast to the board of directors. However, the bank has said it would like a report
from the external auditors to confirm the reasonableness of the forecast. Following this
request the company has asked you to examine the cash flow forecast and then to report to
the bank.

Required:
(a) Explain the difference between the interim audit and the final audit. (4 marks)
(b) Explain the matters the external auditor should consider before relying on the work
of the internal auditors.
(6 marks)
(c) Describe SIX procedures you would adopt in your examination of the cash flow
forecast. (6 marks)
(d) Explain the level of assurance you could give in the context of the request by the
bank. (4 marks)
(Total: 20 marks)

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PLANNING AND RISK ASSESSMENT

68 BRIDGFORD PRODUCTS
It is 1 July 20X5. You are the audit supervisor of Bluebird & Co and are currently planning
the audit of your existing client, Bridgford Products Co, for the year ending 31 August 20X5.
Bridgford Products Co is a listed company. During a recent visit to the company you
obtained the following information.
The management accounts for the first 10 months of the year show a significant increase in
revenue and profit compared to the prior year. This was achieved by attracting new
customers by offering extended credit. The new credit arrangements allow customers three
months credit before their debt becomes overdue, rather than the one month credit period
allowed previously. As a result of this change, the receivables collection period has increased
from 55 to 123 days.
Unfortunately there have been some recent reliability problems with the company’s
products, which have resulted in legal claims being brought against the company by
customers, and customers refusing to pay for the products. Partly as a result of this the chief
financial officer and purchasing manager were dismissed on 15 March 20X5. A replacement
purchasing manager has been appointed but it is not expected that a new chief financial
officer will be appointed before the year-end. The accounts supervisor will be responsible for
preparing the financial statements for audit.
The company installed a new computerised inventory control system which has operated
from 1 January 20X5. The new inventory control system has been designed with password
controls to prevent unauthorised access. As the system records inventory movements and
current inventory quantities, the company is proposing to use the inventory quantities on
the computer as a basis for the year-end inventory figure, rather than carrying out a full year-
end count as has happened in previous years. Perpetual inventory counts have been carried
out on a monthly basis.
Required:
(a) Explain the purposes of planning an audit. (4 marks)
(b) Explain FIVE audit risks, and explain the auditor’s response to each risk, in planning
the audit of Bridgford Products Co. (10 marks)
(c) (i) Explain the purpose of password controls. (2 marks)
(ii) List FOUR tests of control you would carry out in order to ensure that the
password controls are operating effectively. (4 marks)
(Total: 20 marks)

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69 PHONES ANYWHERE
It is 1 July 20X5. Your firm has been invited to tender for the audit of Phones Anywhere for
the year ending 30 September 20X5. Phones Anywhere was established two years ago, and
it provides a mobile phone service for individuals and businesses. All the shares are owned
by three non-executive directors who do not plan to make any further investment in the
company.
Currently the local relay stations cover one large city with a population of about 1,000,000.
The cost of the relay stations and central computer are capitalised and depreciated over six
years.
Within the next year the directors hope that the system will cover all cities with a population
of over 250,000 in the country. By 20X9, the system will cover all motorways and cities with
a population of over 100,000. Establishing the network of relay stations and subscribers will
result in the company making losses for at least three years. Extending the coverage of the
system will involve considerable capital expenditure on new relay stations and require
additional borrowings. Current borrowings are about 20% of shareholders’ funds. To obtain
additional finance the owners plan to list the company on a stock exchange in 20X7. The
listing will involve issuing new shares to the general public to provide funds for the company,
and the three non-executive directors selling some of their shares.
You are aware that Phones Anywhere has a number of very large competitors, each of which
has a large number of users and comprehensive coverage (over 90% of the population are
within range of a relay station).
Required:
(a) Explain FIVE audit risks, and explain the auditor’s response to each risk relevant to
Phones Anywhere. (10 marks)
(b) Describe the substantive procedures the auditor should perform to obtain sufficient
and appropriate evidence in relation to:
(i) Capital expenditure (5 marks)
(ii) Borrowings (3 marks)
(iii) Share capital (2 marks)
(Total: 20 marks)

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70 TEMPEST
It is 1 July 20X5. You are the audit manager in charge of the audit of Tempest, a limited liability
company. The company’s year-end is 31 August 20X5, and Tempest has been a client for
seven years. The company purchases and resells fittings for ships including anchors,
compasses, rudders, sails etc. Clients vary in size from small businesses making yachts to large
companies maintaining large luxury cruise ships. No manufacturing takes place in Tempest.
Information on the company’s financial performance is available as follows:
Statement of profit or loss 20X5 Forecast 20X4 Actual
$000 $000
Revenue 45,928 40,825
Cost of sales (37,998) (31,874)
–––––– ––––––
Gross profit 7,930 8,951
Administration costs (4,994) (4,758)
Distribution costs (2,500) (2,500)
–––––– ––––––
Operating profit 436 1,693
–––––– ––––––

Statement of financial position

Non-current assets (at carrying value) 3,600 4,500
Current assets
Inventory 200 1,278
Receivables 6,000 4,052
Cash and bank 500 1,590
–––––– ––––––
Total assets 10,300 11,420
–––––– ––––––
Equity and liabilities
Share capital 1,000 1,000
Retained earnings 5,300 5,764
–––––– ––––––
Total equity 6,300 6,764
Non-current liabilities 1,000 2,058
Current liabilities 3,000 2,598
–––––– ––––––
Total equity and liabilities 10,300 11,420
–––––– ––––––

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Additional information
The industry that Tempest trades in has seen moderate growth of 7% over the last year.
● Non-current assets mainly relate to company premises for storing inventory. Ten
delivery vehicles are owned with a carrying value of $300,000.
● One of the directors purchased a yacht during the year.
● Inventory is stored in ten different locations across the country, with your firm having
offices close to seven of those locations.
● A computerised inventory control system was introduced in August 20X5. Inventory
balances are now obtainable directly from the computer system. The client does not
intend to count inventory at the year-end but rely instead on the computerised
inventory control system.

Required:
(a) Explain why it is important to plan an audit. (5 marks)
(b) Using the information provided above, prepare the audit strategy for Tempest for
the year ending 31 August 20X5. (15 marks)
(Total: 20 marks)

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INTERNAL CONTROL

71 WICKETS
Your firm has been appointed auditor of Wickets Co, a company which manufactures
furniture. The company employs 60 weekly-paid employees comprising upholsterers,
carpenters, joiners and general labourers. All employees are paid by bank transfer directly
into their accounts.
Hours worked are recorded on clock cards. Employees clock in and out on arrival at and
departure from the premises. The clocking in and out process is not monitored. At the end
of each week, the factory manager, Mr Lamb, gives the accounts supervisor, Mrs Gooch, the
clock cards for that week and collects the clock cards for the following week. Each employee’s
name and number is entered on the card by Mrs Gooch.
The payroll is processed using a computer with a hard disk which stores the payroll program,
standing data and transactions relating to employees. On completion of payroll processing,
the hard disk is copied onto a CD which is stored in one of the filing cabinets in the accounts
office.
Mrs Gooch calculates the hours worked for each employee, split between basic and
overtime. The cards are then passed to Miss Smith, the payroll clerk, who enters the details
into the computer. Batch controls are not used. The figures for gross and net pay are
calculated by the program and the following reports are generated:

Payroll: details per employee of gross pay, deductions and net pay; totals
thereof and total hours split between basic and overtime;
Summary: cumulative details to date per employee;
Payslips: details of gross pay, deductions and net pay;
Bank payment list: bank account details, net pay per employee and total net pay.

No checks are performed on the calculations as it is assumed the computer calculates the
amounts correctly. The finance director, Mr Lewis, reviews the total net pay on the bank
payment list to ensure this is comparable to previous months and signs it to authorise the
bank transfer.
Mr Lamb gives a list detailing starters and leavers to Miss Smith who enters these changes
into the computer as and when the situation arises. She uses the same password as for
payroll preparation even though there is a facility within the software for hierarchical
passwords. Miss Smith then files the list with the personnel records in her filing cabinet.
Required:
(a) In respect of the wages system of Wickets Co:
(i) Identify and explain FIVE deficiencies in the system
(ii) Provide a recommendation to alleviate each deficiency
(iii) Describe a test of control the auditor should perform to assess whether the
control, if implemented, is effective.
(15 mark)
(b) Describe substantive procedures the auditor should perform to confirm Wickets Co’s
payroll expense. (5 marks)
(Total: 20 marks)

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72 DEAN MANUFACTURING
You are the senior in charge of the audit of Dean Manufacturing. To assist you in your audit
planning, one of the audit team has provided the following description of the purchasing
system. No other controls exist apart from those described.
The company has no buying department so employees place orders in their own area of
responsibility. A three part order form is used; copy 1 is retained by the originator, copy 2 is
sent to the goods inward department and copy 3 is sent to the supplier.
Goods are received, but not checked, by the goods inwards clerk. Once received, the
supplier’s delivery note and the purchase order for those goods are sent to the purchase
ledger clerk.
When the supplier’s invoice is received the purchase ledger clerk checks the calculations on
it, initials it and staples the delivery note and purchase order to it. She enters the invoice on
to the purchase ledger.
The invoice is then sent to the manager responsible for the employee who ordered the goods.
The manager codes the invoice and returns it to the purchase ledger clerk. Coded purchase
invoices are entered onto an analysis sheet and posted to the nominal ledger monthly by
journal entry.
The cashier pays suppliers monthly on instructions from the purchase ledger clerk. The
purchase ledger control account is reconciled monthly by the purchase ledger clerk who also
reconciles suppliers’ statements.

Required:
For each internal control deficiency in the purchasing system:
(a) Identify the deficiency and briefly explain its audit significance (if any), in terms of
the type of errors that could result from it. (14 marks)
(b) Describe the effect it would have on your normal audit procedures in terms of any
additional or extended procedures required. (6 marks)
(Total: 20 marks)

73 LINKS FAMINE RELIEF

You have recently been appointed auditor of Links Famine Relief, a small registered charity
which receives donations from individuals to provide food in famine areas of the world.
The charity is run by a voluntary management committee, which has monthly meetings and
employs two full-time staff:
Mr Roberts, a director, who suggests fund raising activities and payments for relief of famine
and implements policies adopted by the management committee, and
Mrs Beech, a secretary and book-keeper, who deals with correspondence and keeps the
accounting records.
You are planning the audit of the charity for the year ended 5 April 20X5 and are considering
the controls which should be implemented over income.

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The draft accounts show the following income:

$
Gift aid declarations (by standing order) 25,874
Postal donations 52,436
Autumn fair 5,687
Bank deposit account interest 3,714
Legacies 8,300
––––––
96,011
––––––
Notes:
Gift Aid Declarations are completed by each person who intends to make contributions
during the year. These are paid directly into the charity’s bank account on a monthly basis by
standing order. Gift Aid Declaration forms are kept by Mrs Beech. (Gift Aid Declarations are
used in the UK. Tax on these payments can be reclaimed but this should be ignored for the
purposes of this question.)
Postal donations, which can be cash or cheques, are dealt with by Mrs Beech who prepares
a daily list of donations. She also updates the cash book and prepares the bank paying-in slip.
The Autumn Fair takes place every year on a Saturday in October. Supporters of the charity
provide items to sell (e.g. cakes, plants, clothing) and a charge is made for entrance. Mrs
Beech collects the takings from each of the stalls, prepares a summary of receipts and banks
them the following Monday.
Bank deposit interest is paid gross by the bank as the Links Famine Relief is a charity.
Legacies, which are received irregularly, are usually sent to the director of the charity who
gives them to Mrs Beech for banking.

Required:
Describe the controls that you would like to see in operation and audit work you would
perform over the following sources of income:
(a) Gift aid declarations (5 marks)
(b) Postal donations (5 marks)
(c) Autumn fair (5 marks)
(d) Bank interest (3 marks)
(e) Legacies (2 marks)

(Total: 20 marks)

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74 EASTFIELD DISTRIBUTORS
Your firm is the external auditor of Eastfield Distributors Co (ED), a listed company, which has
revenue of $25 million and a profit before tax of $1.7 million. The company operates from a
head office at Eastfield and has inventory holding centres in different parts of the country.
The directors have decided the company has reached a size where it needs an internal audit
department. The directors are unsure whether to establish an in-house internal audit
function or whether to outsource to your firm. The directors would like to know if there
would be any issues if your firm were to provide this service as well as being the external
auditor of the company’s annual financial statements.

Required:
(a) Describe THREE advantages and THREE disadvantages to Eastfield Distributors Co of
outsourcing the internal audit function to your firm. (6 marks)
(b) In relation to your audit firm becoming internal auditors of Eastfield Distributors Co
describe the matters you should consider to ensure your firm remains independent
as external auditor of the annual financial statements. (7 marks)
(c) Assuming that Eastfield Distributors decide to establish an in-house internal audit
department, describe the matters which the external auditor should evaluate to
determine this whether they can rely on the work of internal audit. (4 marks)
(d) Internal auditors perform many different types of assignment including value for
money assignments.
Required:
Briefly explain the three ‘Es’ which are reviewed as part of a value for money
assignment. (3 marks)
(Total: 20 marks)

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AUDIT EVIDENCE

75 POWERFAST
(a) Identify and describe five of the procedures for obtaining audit evidence. (5 marks)
(b) For each of the procedures, describe an audit test using that procedure to obtain
evidence over the balance of plant and equipment. (5 marks)
Your client Powerfest Co utilises large quantities of coal in order to produce their output. The
coal is stored in large piles and is transported to the factory by means of a conveyor system.
Perpetual inventory records are maintained showing the amount of coal on hand, receipts
and withdrawals of coal. No annual physical inventory count is performed on coal as the
company intends to rely on the perpetual inventory records when determining closing
inventory.
Required:
(c) Describe the substantive audit procedures, other than those relating to cut-off, the
auditor should perform in relation to the inventory of coal. (7 marks)
One method of determining the inventory value at the year-end is to use standard costs.
Required:
(d) Describe THREE audit procedures that should be carried out when auditing standard
costs. (3 marks)
(Total: 20 marks)

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76 FIREFLY TENNIS CLUB

It is 1 July 20X5. You are an audit supervisor in the firm of Whedon & Co and you are about
to commence the final audit for The Firefly Tennis Club for the year ended 30 April 20X5.
The FireFly Tennis Club owns 12 tennis courts. The club uses ‘all weather’ tarmac tennis
courts, which have floodlights for night-time use.
Members pay an annual fee to use the courts and participate in club championships. The club
had 430 members as at 1 May 20X4.
Income is derived from two main sources:
(1) Membership fees: Each member pays a fee of $200 per annum. Fees for the new
financial year are payable within one month of the club year-end. Approximately 10%
of members do not renew their membership. New members joining during the year
pay 50% of the full year fees. During the year, 50 new members joined the club. No
members pay their fees before they are due.
(2) Court hire fees: Non-members pay $5 per hour to hire a court. Non-members have to
sign a list in the club house showing courts hired. Money is placed in a cash box in the
club house for collection by the club secretary.
All fees (membership and court hire) are paid in cash. They are collected by the club secretary
and banked on a regular basis. The paying-in slip shows the analysis between membership
fees and court hire income. The secretary provides the treasurer with a list of bankings
showing member’s names (for membership fees) and the amount banked. Details of all
bankings are entered into the cash book by the treasurer.
Main items of expenditure are:
(1) Court maintenance including repainting lines on a regular basis.
(2) Power costs for floodlights.
(3) Tennis balls for club championships. Each match in the championship uses 12 tennis
balls.
The treasurer pays for all expenditure using the club’s debit card. Receipts are obtained for
all expenses and these are maintained in date order in an expenses file. The treasurer also
prepares the annual financial statements.
Under the rules of the club, the annual accounts must be audited by an independent auditor.

Required:
(a) Describe the audit work that should be performed to confirm the income figure for
the FireFly Tennis Club. (10 marks)
(b) Describe the audit procedures that should be performed to confirm the
completeness and accuracy of expenditure for the FireFly Tennis Club. (5 marks)
(c) Discuss why internal control testing has limited value when auditing not-for-profit
entities such as the FireFly Tennis Club. (5 marks)
(Total: 20 marks)

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 LECTURER RESOURCE PACK : QUESTION S

77 HAVE A BITE CO
(a) Identify and explain FOUR assertions relevant to accounts payable at the year-end
date. (6 marks)
You are the audit senior responsible for the audit of Have A Bite Co, a company that runs a
chain of fast food restaurants. During the final audit it has come to your attention that one
month before the year-end, a customer filed a claim for $200,000 against the company for
personal injury caused by food poisoning. This amount is material to the stated profit of the
company, but management believes that it has a good defence against the claim.

Required:
(b) (i) Explain TWO controls that the company should have in place to reduce the risk
associated with purchases of food and its preparation in the kitchen.
(ii) Describe TWO tests of control the auditor should perform to assess whether
the controls stated in (i) are operating effectively. (4 marks)
(c) In respect of the potential claim state THREE items of evidence you should obtain
and explain how they might enable you to form a conclusion on the likelihood of the
claim being successful. (6 marks)
Following your audit you have concluded that there is a possibility, but not a probability, that
the claim will be successful. However, management have decided not to make a provision or
include a disclosure note in the financial statements in respect of this matter.

Required:
(d) Describe how the matter should be reported in the financial statements and explain
the effect on your auditor’s report. (4 marks)
(Total: 20 marks)

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COMPLETION & REPORTING

78 HOPE ENGINEERING
It is 1 July 20X5. You are auditing the financial statements of Hope Engineering for the year
ended 31 March 20X5. During the audit you discover that the contract of the previous chief
executive, Mr Jones, was terminated during the year and compensation of $500,000 was paid
to him on 2 March 20X5. Mr Smith was appointed as his replacement in March 20X5. It has
since been discovered that two months prior to his dismissal, Mr Jones had contractually
agreed to join the board of directors of a rival company. The company’s solicitor has informed
Hope Engineering that Mr Jones’ actions constitute a breach of contract, and that an action
could be brought against the former chief executive for the recovery of the moneys paid to
him. The solicitor has advised that it is probable that this action will be successful. Mr Smith
informs you that the company is going to bring an action against Mr Jones for the recovery
of the compensation paid to him.

Required:
(a) Describe FIVE audit procedures which should be performed with regard to the
dismissal of Mr Jones and the subsequent legal action. (5 marks)
(b) Explain THREE steps the auditor should take if Mr Smith announces that he is going
to amend the draft financial statements to include a gain of $500,000 with regard to
this legal action. (3 marks)
(c) Describe the impact on the auditor’s report if this gain is included in the financial
statements and the amount is considered material. (4 marks)
ISA 580 Written Representations requires the auditor to obtain written representations
towards the end of the audit.
(d) State FOUR matters that would be included in a written representation letter.
(4 marks)
(e) Explain the implications for the auditor’s report if the client fails to provide a signed
written representation letter. (4 marks)
(Total: 20 marks)

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 LECTURER RESOURCE PACK : QUESTION S

79 DRUMMOYNE
It is 1 July 20X5. Reddy and Co, Chartered Certified Accountants, are the external auditors of
Drummoyne, a listed company. On completing the audit for the year ended 31 March 20X5
the following list of matters was prepared for the partner’s attention.
(a) On 25 April 20X5 Drummoyne agreed to a pay rise of 5% for all of its employees
backdated to 1 January 20X5. No provision for this has been made in the financial
statements. (5 marks)
(b) The draft Chair’s Statement, to be included in the Annual Report, states that profit
before tax has increased by 25%. It is true that operating profit has increased by 25%
but, after deducting reorganisation costs and losses on disposals of property, plant and
equipment profit before tax has increased by only 4% compared with the previous
year. (5 marks)
(c) The audit revealed a major control deficiency in the management of investments. The
company recently recruited a financial analyst to manage the investment of surplus
funds. Company policy is to invest in the shares of large quoted companies. The audit
discovered a number of situations where the financial analyst had made substantial
profits for the company by speculating in risky investments such as derivatives. Such
investments could result in massive losses. The matter was reported verbally to the
chief financial officer four months ago but no action has yet been taken. (4 marks)
(d) One of the company’s oil tankers has just run aground off the coast of California. There
is a risk of a serious oil spill which could cost a significant amount to clear up as is
required by local legislation. This could have a significant effect on the future of the
company. Further information will not be available until after the auditors’ report has
been signed. (6 marks)
Assume that each of these matters is potentially material and is to be considered
independently of each other.

Required:
Consider what further actions Reddy and Co should take with respect to each of the
matters listed including the potential impact on the auditor’s report. (Total: 20 marks)

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80 GREEN CO
Green Co grows crops on a large farm according to strict organic principles that prohibits the
use of artificial pesticides and fertilizers. The farm has an organic certification, which
guarantees its products are organic. The certification has increased its sales of flour, potatoes
and other products, as customers seek to eat more healthily.
Green Co is run by two managers who are the only shareholders. Annual revenue is $50
million with a profit before tax of 5%. Both managers have run other businesses in the last
10 years. One business was closed due to a suspected tax fraud although no case was ever
brought to court.
Green Co’s current auditors provide audit services. Additional assurance on business controls
and the preparation of financial statements are provided by a different accountancy firm.
Last year, a neighbouring farm, Black Co started growing genetically modified (GM) crops,
the pollen from which blows over Green Co’s fields on a regular basis. This is a threat to Green
Co’s organic status because organic crops must not be contaminated with GM material.
Green Co is considering court action against Black Co for loss of income and to stop Black Co
growing GM crops.
You are an audit partner in Lime & Co, a 15 partner firm of auditors and business advisors.
You have been friends with the managers of Green Co for the last 15 years, advising them on
an informal basis. The directors of Green Co have indicated that the audit will be put out to
tender next month and have asked your audit firm to tender for the audit and the provision
of other professional services.

Required:
(a) Using the information provided, identify and explain the ethical threats that could
affect Lime & Co. (8 marks)
(b) In respect of the going concern concept:
(i) Define ‘going concern’ and state two situations in which it should NOT be
applied in the preparation of financial statements; (3 marks)
(ii) Explain the directors’ responsibilities and the auditors’ responsibilities
regarding financial statements prepared on the going concern principle.
(4 marks)
(c) List the audit procedures that should be carried out to determine whether or not the
going concern basis is appropriate for Green Co. (5 marks)
(Total: 20 marks)

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