[March/June 2024]

Green Co
It is 1 July 20X5. You are an audit supervisor with Teal & Co, which has recently been appointed as
auditor to Green Co, and you are planning your first audit which will be for the year ending 31 July 20X5.
Green Co sells a variety of plants, garden equipment and garden furniture to wholesale customers and to
retail customers via a network of stores. The company was formed 13 years ago by Aidan White who is the
Chief Executive Officer (CEO) and is the company's only shareholder. Aidan is planning to retire within
the next year and is intending to sell his shares in the company.

The audit engagement partner had a meeting with Aidan White and has advised you of the following:

In August 20X4, the company began to refurbish the retail stores in order to incorporate cafes into each
one. Refurbishment costs of $14.2m were recognised within property, plant and equipment and this was
partly financed by a loan of $10m, which is to be repaid in five annual instalments commencing in
September 20X5. In November 20X4, Green Co spent $400,000 on an advertising campaign and the
cafes were opened in December 20X4. The advertising expenditure has been included within intangible
assets and is being amortised over 24 months as Aidan White expects the advertising to generate
additional revenue for that period of time. In May 20X5, Green Co received notification that the building
authority had received a complaint that the refurbishments had not been performed in accordance with
building regulations. The building authority is currently investigating and, if found to be in breach of the
regulations, Green Co would be required to remedy any deficiencies in addition to paying a fine.

Green Co sells a range of tropical plants. In August 20X4, Green Co began a project to develop new
technology for maintaining the correct temperature and humidity in its greenhouses. The project is
expected to be completed in August 20X5 and Green Co has incurred costs of $350,000 which are
recognised within intangible assets.

In May 20X5, a flood caused water damage to inventories of plants which had cost $425,000. The
company believes that the plants can still be sold but at a reduced selling price.

The financial statements for the year ending 31 July 20X5 are expected to show revenue of $88.2m
(20X4: $85.1m), gross profit of $23.3m (20X4: $16.9m) and operating profit of $6.3m (20X4: $9.4m).

As part of your planning you have calculated the following ratios:

Forecast 20X5 Actual 20X4

Gross profit margin 26% 20%
Operating profit margin 7% 11%
Receivables collection period 67 days 40 days

Aidan White has attributed the increase in the receivables collection period to the absence of the credit
controller, who has been on long-term sick leave since April 20X5.

(a) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Green Co.
(b) Explain the responsibility of Teal & Co under ISA 250 Consideration of Laws and
Regulations in an Audit of Financial Statements.

c) Describe substantive procedures which Teal & Co should perform in order to obtain
sufficient and appropriate audit evidence in respect of ADDITIONS to Green Co's property,
plant and equipment.

It is now 2 November 20X5 and the audit of Green Co has been completed. The auditor’s report was
signed in October and, in line with Teal & Co’s quality management procedures for new clients, a
post-issuance review has been carried out. During the review of Green Co’s audit files, the engagement
quality reviewer noted the following:

The members of the audit engagement team who carried out the audit of Green Co had previously audited
educational organizations, not retail or manufacturing companies.

The audit engagement partner held a planning meeting with the engagement team. However, several
junior team members were unable to attend due to a training course which was held on the same day. No
additional briefing on key audit risks associated with Green Co was held for these team members.

The audit supervisor was absent due to illness during the last two weeks of the final audit. The audit
assistants continued their work but no other senior team members were assigned to Green Co’s audit.

Due to the audit supervisor’s illness and absence, the audit of intangible assets was reallocated from the
audit supervisor to a junior member of the team who had never audited intangible assets before.

(d) Identify and explain THREE quality management deficiencies in the approach adopted
by Teal & Co and provide a recommendation which would have addressed each deficiency
to ensure compliance with quality management requirements.

Francisco Co
It is 1 July 20X5. You are an audit supervisor with Canyon & Co, preparing the draft audit programmes
and reviewing extracts from the internal control documentation in preparation for the audit of your client,
Francisco Co. The company’s year-end is 30 September 20X5, and it is a wholesale food operator with 18
distribution depots and one central warehouse.

Payroll
Francisco Co employs distribution depot staff who are paid monthly based on the number of hours
worked. Each employee has a staff identity card which they use to sign in and out of the depot at the
beginning and end of each shift to record their hours worked, and this process is supervised by security
staff as well as CCTV cameras. The hours worked per employee are automatically transferred from the
signing-in system into the payroll system. The hourly wage rate is pre-set, and the payroll system
automatically calculates the gross and net pay along with relevant statutory deductions and produces pay
slips which are immediately emailed to employees.

Access to employees' standing data in the payroll system is restricted to payroll managers through the use
of a password, which the system requires to be changed on a monthly basis.
Distribution depot employees are paid by bank transfer on a monthly basis. The senior payroll manager
reviews the list of bank payments and agrees this to the payroll records. If any discrepancies are noted,
these are investigated by the senior payroll manager who then makes the required adjustment in the
payroll records.

Purchases
Francisco Co has a central purchasing department based at its head office. When goods are required, a
production supervisor submits a request to the purchasing department. A multi-part purchase order is
then generated. The purchasing manager authorises all orders below $3,000 and the purchasing director
authorises orders of $3,000 and above.

On receipt of goods, the quality and quantities received are checked by a warehouse team member against
the supplier's delivery note, and a goods received note (GRN) is produced. A copy of the GRN is sent to
both the finance and purchasing departments.

When purchase invoices are received from the suppliers, they are logged into an invoices received file and
the accounting system assigns each invoice a unique number based on the supplier’s code and date of
input. The finance clerk then matches the invoices to a copy of the relevant purchase order and passes
those two documents to the finance director for authorisation prior to the invoice being input into
payables.

Non-current assets
Francisco Co owns approximately 55% of its distribution depots and the remainder are leased premises,
which have been confirmed as correctly capitalized in line with relevant accounting standards. The lease
agreements and ownership documents are held in the finance department. Earlier in the year, members of
the company’s internal audit department undertook a review of the lease agreements and ownership
documents but were unable to locate a number of the relevant documents.

Each distribution depot is set up as a separate cost centre and is given an annual capital expenditure
budget, but some cost centres have already significantly exceeded their annual budgets. When new
equipment is purchased, the finance manager classifies the purchase order as capital or revenue
expenditure. The classification is made with reference to formal company policy established by the finance
director, who sample checks that the capital or revenue expenditure allocation has been correctly applied
and then evidences this review by way of signature.

ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management, provides guidance on communicating significant deficiencies in internal control.

(a)
(i) Define a significant deficiency in internal control; and

(ii) Describe THREE matters the auditor may consider in determining whether a deficiency
in internal control is significant.

Note: You do not need to refer to the scenario to answer this requirement.

(b) In respect of the system of internal control of Francisco Co:

(i) Identify and explain THREE DIRECT CONTROLS which the auditor may seek to place
reliance on; and

(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of these
direct controls is operating effectively.

(c) Identify and explain FIVE DEFICIENCIES in Francisco Co’s system of internal control
and provide a control recommendation to address each of these deficiencies.

Cookit Co
It is 1 July 20X5. Cookit Co owns ten shops selling kitchen equipment. Your firm, Beeny & Co, is about to
commence the final audit for the year ended 31 May 20X5. Draft profit before tax is $22.8m (20X4:
$19.7m) and net assets are $84.3m (20X4: $77.7m). The following matters have been brought to your
attention:

Inventory
Cookit Co sells a range of cookery products endorsed by a famous TV chef, Remy Gusteau. In February
20X5, the TV company that produced his show cancelled the programme which led to a reduction in
demand for Remy Gusteau products. Cookit Co stopped purchasing these goods in March 20X5. Total
inventory in the draft financial statements for the year ended 31 May 20X5 is $4.25m. Cookit Co's
system-generated inventory valuation report shows that this includes Remy Gusteau products at a cost of
$1.7m. A member of the audit team attended the year-end inventory count of Cookit Co.

Decrease in trade payables

The accounts payable clerk left the company in January 20X5 and no replacement has yet been hired. The
following information has been provided by the finance director of Cookit Co:

31 May 20X5 31 May 20X4

Trade payables $2.8m $3.5m
Payables payment period 53 days 72 days

The finance director also mentioned that no reconciliations of supplier statements had been performed
since December 20X4. The audit team has decided not to perform a year-end payables circularisation as
response rates in previous years were low.

Redundancy provision
In May 20X5, the management of Cookit Co decided to close down one of the shops as it is unprofitable.
An announcement of this decision was made on the company’s website on 28 May 20X5 and staff
informed of the timetable for closure. All 32 staff employed in the shop are to be made redundant and a
redundancy provision of $1.8m is included in the draft financial statements for the year ended 31 May
20X5. The closure is expected to take place in September 20X5.

(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Cookit Co’s inventory.
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Cookit Co's trade
payables.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Cookit Co’s redundancy provision.

The final audit is now nearing completion and you are reviewing the financial statements. The directors
have told you that they have decided against including the redundancy provision of $1.8m in the financial
statements for the year ended 31 May 20X5 as the closure of the shop will not take place until September
20X5.

(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved.

[March/June 2023]
Petra Co
It is 1 July 20X5. Petra Co is a company listed on a stock exchange. It manufactures handbags which it
supplies to retailers across the country. The company’s year end is 30 September 20X5. You are an audit
supervisor with Babylon & Co, preparing the draft audit programmes and reviewing the internal controls
documentation in preparation for the forthcoming interim audit.

Payroll
Petra Co employs factory staff, who are paid based on the number of hours worked. They are paid in cash
on a weekly basis due to commercial reasons. These staff each have a unique clock card which they use to
enter and exit the factory at the beginning and end of their shift, and this process is supervised by security
staff. The clock card system and the payroll system are linked.

The payroll system automatically calculates the gross and net pay along with relevant deductions and
generates employee payslips. The payroll supervisor selects a sample of the payslips, reperforms the gross
to net pay calculations and investigates any discrepancies. The sampled payslips are then signed as
evidence of this review.

Factory staff receive an annual inflation-based pay increase every April. The revised hourly wage rates are
communicated to the payroll department. The revised pay rates are entered into the system in April by a
payroll clerk and each entry is checked by a senior clerk for input errors prior to processing that week’s
wages. The senior clerk signs a payroll listing of factory staff employees, which includes the revised hourly
wage rates as evidence of undertaking this review.

Two members of the payroll department produce the cash pay packets. One member is responsible for
preparing the pay packets by reference to the payslips generated by the system. The second member
recounts the contents of the finished pay packets and confirms that this agrees to the payslips. Both
members of staff are required to sign the weekly payroll listing on completion of this task.

Sales
Petra Co carries out credit checks for all new customers. Upon passing these checks, new customers are
set up by an accounting clerk in the receivables ledger master file and a credit limit is set by the finance
director. The credit limits are only reviewed if an increase is requested by the customer.

Petra Co generates revenue through visits by members of its sales department to customers' premises.
When a customer places an order, sales staff check that the customer is within its credit limit and that the
inventory is available and then complete a three-part pre-printed order form. One copy is left with the
customer, the second is sent to the warehouse and the third to the finance department. The sales staff
have monthly sales targets and are able to use their discretion in granting discounts up to a maximum of
8%. No review is undertaken of discounts granted.

Purchases
The company has a purchasing department based at its head office. All members of this department have
full access to the supplier master file data and are able to make changes. When goods are received from a
supplier they are processed by the warehouse team, who agree the delivery to the purchase order,
checking the quantity and the quality of goods, and complete a sequentially numbered goods received
note (GRN). The GRNs are matched to the purchase orders and are filed in the warehouse.

On receipt of the purchase invoice from the supplier, a payables ledger clerk, logs them into the payables
ledger using document count controls to ensure that the correct number of invoices has been input. The
total on the payables ledger is not compared to the control account in the general ledger at the end of each
month as the payables ledger clerk believes this process is unnecessary.

(a) List FOUR control objectives of Petra Co's sales system.

(b) In respect of the PAYROLL system of Petra Co:

(i) Identify and explain THREE DIRECT CONTROLS which the auditor may seek to place
reliance on; and

(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of these key
controls is operating effectively.

(c) Identify and explain FIVE DEFICIENCIES in Petra Co’s SALES AND PURCHASES
systems and provide a recommendation to address each of these deficiencies.

Petra Co produces monthly management accounts which include a detailed analysis of key expense
categories.
(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Petra Co's purchases and other expenses.

Petra Co has been a listed company for six years and the directors are aware of the need for compliance
with corporate governance principles. The finance director has requested that the audit team undertakes a
review of whether the company complies with the principles.

The board of Petra Co is appropriately comprised of executive and independent non-executive directors
(NEDs). The Chair is planning to retire at the end of the financial year, and it is proposed by the
nomination committee that the current marketing director is appointed into this role and that a new
marketing director is recruited. Two directors are subject to re-election at each annual general meeting.
The NEDs are all members of the audit committee and are highly experienced in the industry in which
Petra Co operates. Before joining Petra Co they were all previously involved in sales or purchasing roles.
The level of executive directors' pay is set by the remuneration committee, composed of independent
NEDs. The remuneration for the NEDs is in the form of an annual bonus based on profit growth over the
prior year.

(e) Describe THREE corporate governance deficiencies faced by Petra Co and provide a
recommendation to address each deficiency to ensure compliance with corporate
governance principles.

Lapis Co
It is 1 July 20X5. You are an audit supervisor with Indigo & Co and are planning the audit of your client,
Lapis Co, for the year ending 30 September 20X5. Forecast profit before tax for the year is $68.9m and
forecast revenue is $192.3m. The audit manager has attended a planning meeting with the finance
director and has provided you with the following notes of the meeting:

Planning meeting notes

Lapis Co manufactures televisions at six factories located across Europe and purchases most of its raw
materials from overseas suppliers. These raw materials are shipped directly to one of the company’s
factories and the goods are usually in transit for up to six weeks. Lapis Co has responsibility for goods in
transit from the point of dispatch by the supplier. The company’s internal audit department undertakes
controls testing across all factories, visiting each site at least once every year. The audit manager has
discussed with the finance director that the external audit team may rely on the controls testing which is
carried out by the internal audit department.

The company sells televisions to wholesale customers and directly to individual members of the public via
the company’s website. A significant wholesale customer has recently informed Lapis Co that it is
experiencing financial difficulties, however the finance director indicated that an allowance for receivables
is not required in the year-end financial statements.
Lapis Co offers customers a three-year warranty on any new televisions purchased. The finance director
has confirmed that the warranty provision for the year ended 30 September 20X5 will remain at a similar
level to the prior year. In December 20X4 Lapis Co changed one of its television speaker suppliers to a
cheaper alternative. This has resulted in an increase in warranty claims for television speaker deficiencies.

In May 20X5, a payroll clerk was dismissed after it was discovered that they had carried out a number of
fraudulent transactions. Controls have since been implemented to prevent this reoccurring.

The finance director has informed the audit manager that she only intends to disclose the amount of
remuneration payable to each director in the financial statements. Local legislation in the country in
which Lapis Co is based requires disclosure of the names of the directors and the total amount of
remuneration payable to each director.

One of Lapis Co’s suppliers is offering the company an annual rebate on the condition that it purchases a
minimum number of units by 30 September 20X5. The amount of the rebate will be claimed in November
20X5. It is likely from orders placed to date and forecast orders that Lapis Co will exceed the minimum
volume required to claim this rebate, therefore, it is anticipated that the draft financial statements will
include a receivable of $0.8m.
Lapis Co is developing a new smart television model. All $1.6m of costs incurred to date will be capitalized
within intangible assets by the year end. The model is still under development and it is not anticipated
that it will be available for commercial production until 20X6.

In order to finance the development of the new smart television model, Lapis Co secured a $2.5m
interest-bearing bank loan in April 20X5. This is repayable in arrears over four years in quarterly
instalments.

The directors of Lapis Co are intending to propose a final dividend once the financial statements are
finalized.

(a) In line with ISA 220 Quality Management for an Audit of Financial Statements, describe
the auditor's responsibilities in relation to supervising and reviewing the work performed
during the external audit of Lapis Co.

(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Lapis Co.

Heron Co
It is 1 July 20X5. You are an audit supervisor of Owl & Co, responsible for the final audit of Heron Co for
the year ended 31 May 20X5 which is due to commence shortly. Heron Co is a manufacturer of color dyes
used in the textile industry. Its draft financial statements show total assets of $65.4m and profit before tax
of $8.9m. The following matters have been brought to your attention:

Additions to plant and equipment

Heron Co incurred significant capital expenditure in the year as it purchased a new manufacturing line.
All costs incurred in the purchase and installation of the manufacturing line have been recognised as plant
and equipment within non-current assets. The amount capitalized of $3.6m includes the purchase price of
$2.7m, delivery and installation costs of $0.3m, refundable purchase tax of $0.5m and $0.1m incurred in
training staff on how to operate the new plant and equipment.

In addition to the $3.6m capitalized, Heron Co incurred costs of $0.2m testing the quality of the dye being
produced by the new manufacturing line. The finance director has also capitalized this cost within the
plant and equipment. Heron Co started using the new manufacturing line in December 20X4 and it has a
useful life of eight years.

Bank balances
The bank figure included in Heron Co’s draft financial statements comprises four bank account balances:
an overdraft of $2.4m which is the company’s main current account and a total of $0.6m relating to three
savings accounts. The finance director has informed the audit team that all four accounts have been
reconciled as at the year end.

Provision for legal claim

Parrot Co, a customer of Heron Co, has made a claim for $0.8m against the company. Parrot Co is
claiming that a customized yellow dye purchased from Heron Co in March 20X5 was sub-standard and
that, as a result, Parrot Co had to scrap a large batch of clothes it was producing. The finance director has
included a provision of $0.6m in the draft financial statements for the year ended 31 May 20X5 as she
believes that this is the likely sum to be paid to settle the claim. The yellow dye was not sold to any other
customers and Heron Co does not hold any inventory of the dye at the year end.

(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the matters identified regarding Heron Co’s
ADDITIONS to plant and equipment.

(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Heron Co’s bank balances.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Heron Co’s provision for the legal claim.

It is now 28 August 20X5 and the audit of Heron Co is almost complete. The auditor's report is due to be
signed shortly. The following matter has been brought to your attention:

On 14 July 20X5, Sparrow Co, a customer of Heron Co with a receivables balance of $692,000 at 31 May
20X5, notified Heron Co that it was experiencing significant cash flow difficulties and would be unable to
make any payments for the foreseeable future. The finance director of Heron Co believes that as Sparrow
Co is a long-standing customer and has been trading for many years, the outstanding amount will be
received in full in due course, and has therefore not adjusted the receivable balance in the financial
statements for the year ended 31 May 20X5.

(d)
(i) Explain whether the 20X5 financial statements of Heron Co require amendment in
relation to the outstanding balance with Sparrow Co; and

(ii) Describe TWO audit procedures which should be performed in order to form a
conclusion on any required amendment.

[Sep/Dec 2023]
Knight Electronics Co
It is 1 July 20X5. Your firm, Hercules & Co, has recently won the audit of a new client, Knight Electronics
Co, for the year ending 30 September 20X5. Knight Electronics Co sells products enabling 'smart building'
systems which allow customers to efficiently control their security, lighting and networking needs. The
audit manager held a preliminary meeting with the finance director and has provided you with the
following notes:

Planning meeting notes

Since its launch five years ago, Knight Electronics Co has experienced high levels of growth such that the
founder and CEO, William Knight, is considering a stock exchange listing next year.

Knight Electronics Co has both corporate and domestic customers. On 1 October 20X4 Knight Electronics
Co began to offer customers the option to purchase a three-year servicing agreement. This provides three
annual services for products purchased. Customers pay for the servicing agreement in full at the start of
the agreement.
Component parts are purchased from a number of suppliers. Prices of components have been steadily
increasing over the past two years leading to a reduction in the gross profit margin. The forecast financial
statements for the year ending 30 September 20X5 show inventory valued at cost.

In June 20X5, Knight Electronics Co decided to revalue its premises, which had previously been
accounted for using the historic cost model. Properties with a carrying amount under the cost model of
$3.8m were revalued to $8.4m based on a valuation performed by management. The finance director also
carried out an extensive review of non-current asset lives and decided to extend the useful life of plant and
equipment from five years to eight years.

In May 20X5, defective equipment used by Knight Electronics Co resulted in a small fire at its premises.
The company has commenced legal action against the supplier of the equipment. Knight Electronics Co's
lawyers have advised that the legal action is likely to be successful and, as a result, the finance director has
included a receivable for the damages likely to be received from the supplier in the forecast financial
statements.

During the year the company's credit controller was ill and was absent from work for four months. Due to
staff shortages, no replacement credit controller was appointed. The receivables collection period has
increased from 45 days to 75 days.

An instance of payroll fraud was also discovered during the year. A payroll clerk had set up a number of
fictitious employees and the wages were then paid into the clerk’s own bank account. Controls have now
been implemented to prevent this from re-occurring and the clerk involved no longer works for the
company. However, the audit manager is concerned that additional fraud may have taken place in the
payroll department prior to the controls being implemented.

William Knight would like the audit to be completed by 31 October 20X5.

(a) Briefly explain how each of the following sources of information will be used by
Hercules & Co to gain an understanding of Knight Electronics Co at the planning stage of
the audit: prior year audited financial statements, current year budgets and management
accounts, prior year report to management, board meeting minutes and company website.

(b) Describe EIGHT audit risks and explain the auditor's response to each risk in planning
the audit of Knight Electronics Co.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Knight Electronics Co's revenue.

ISA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements provides
guidance for auditors regarding fraud and error. Auditors must obtain sufficient appropriate audit
evidence regarding the assessed risks of material misstatement due to fraud through designing and
implementing appropriate responses.

(d) Describe procedures which should be undertaken during the audit of Knight
Electronics Co as a result of the payroll fraud.

Silver Co
It is 1 July 20X5. You are an audit senior with Golden & Co and you are in the process of reviewing the
inventory count arrangements for your audit client, Silver Co, in preparation for attendance at the full
year-end inventory count on 30 September 20X5. The company manufactures household furniture such
as tables, sofas and beds and has a factory and a large warehouse which are located on a single site.

Inventory count arrangements

The company manufactures goods 24 hours a day, seven days a week to meet customers’ demands.
Production will still be continuing during the inventory count as it is not possible for the company to stop
producing goods. Movements of goods in and out of the factory and warehouse will also have to continue
for operational reasons.

The count will be undertaken by 20 teams of two counters from the warehouse, and the warehouse
supervisor will be overseeing the inventory count. Each team will be given a specific area of the warehouse
to count using sequentially numbered inventory sheets which detail the items of inventory together with
quantities held at the date of the count as per the inventory system. It has been left to the individuals
within each team to decide how to allocate the responsibilities between them.

All goods present in the warehouse on 30 September 20X5 will be allocated into separate warehouse bays
(designated areas of the warehouse) in preparation for counting. When a warehouse bay has been
counted, it is crossed out on the warehouse map which is held in the office by the warehouse supervisor.
As the warehouse supervisor is confident that the 20 teams are familiar with the warehouse and the
location of the inventory, he has said that each bay only needs to be counted by one team. One area of the
warehouse, which includes a large quantity of spare parts left over from production, will be segregated so
that this inventory will not be counted, as the warehouse supervisor has stated that these items are
unusable.

A numerical sequence check of the sheets will be carried out by the warehouse supervisor once the count
is finished. The inventory sheets will then be passed to a warehouse assistant to update the inventory
records to reflect the inventory physically present as per the inventory sheets.

Work in progress valuations have previously been carried out by an external inventory valuer. However,
the warehouse supervisor has suggested that he undertakes this valuation this year as he is familiar with
the company’s products. The directors have agreed to this on the basis that it will save costs.

Last week the company agreed to store 30 sofas belonging to a third party in its warehouse for the next
four months as the third party’s storage facilities became flooded. For convenience, these sofas have been
stored alongside similar products which belong to Silver Co.

Auditors have a responsibility under ISA 265 Communicating Deficiencies in Internal Control to Those
Charged with Governance and Management to communicate significant deficiencies in internal controls
to those charged with governance.

(a) Describe FOUR matters the auditor should consider in determining whether a
deficiency in internal controls is significant.
(b) Identify and explain EIGHT deficiencies in Silver Co’s inventory count arrangements
and provide a control recommendation to address each of these deficiencies.

Latte Co
It is 1 July 20X5. You are an audit supervisor with Macchiato & Co currently working on the final audit of
Latte Co, a supplier of catering equipment, for the year ended 31 March 20X5. Latte Co is a listed
company with total assets of $22.7m and profit before tax of $3.2m. You are responsible for finalizing the
audit fieldwork in respect of the following:

Trade receivables
Latte Co's net trade receivables balance is $5.1m which comprises trade receivables of $5.5m and an
allowance for receivables of $0.4m at 31 March 20X5 (20X4: receivables of $4.4m and an allowance of
$0.6m). As a result of a lack of responses in prior years, the audit engagement partner has decided that a
trade receivables circularisation will not be performed this year. Instead, he has asked you to identify
alternative substantive procedures to confirm the existence and valuation of trade receivables.

Provision for legal claim

A former employee of Latte Co has made a claim for $0.6m against the company in respect of an injury
suffered while operating equipment which did not have the correct safety equipment installed. The
directors have recognised a provision of $0.25m in the current year financial statements which is the
maximum amount they are willing to pay to settle the claim.

Bank loan
Latte Co obtained a new three-year bank loan of $1m on 1 October 20X4 to finance the purchase of new
equipment. The loan attracts an interest rate of 5%. Under the terms of the loan, 10 payments of
$105,000, comprising capital and interest, are due to be made on a quarterly basis commencing 31
December 20X4. Latte Co did not make the quarterly payment due on 31 March 20X5 until 15 April 20X5.

(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to the EXISTENCE and VALUATION of Latte Co’s trade
receivables.

(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Latte Co’s provision for the legal claim.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Latte Co’s bank loan.

It is now 12 August 20X5. During the audit of the legal claim against Latte Co, the audit team concluded
that a provision of $0.6m should be recognised, rather than the $0.25m originally provided for. A
significant increase in the provision was required, in order to comply with IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. The audit engagement partner has determined that the provision is now
appropriately valued and that this issue should be communicated as a key audit matter (KAM) in
accordance with ISA 701 Communicating Key Audit Matters in the Independent Auditor's Report.

(d)
(i) Describe the factors which the audit engagement partner would have considered in
determining that this issue is a KAM; and
(ii) Describe the content of the KAM section of the auditor’s report for Latte Co.