203)Harlem co

Ratios 20x5 20x4

Gross profit margin =4500/23200*100% =4600/21900*100%
=19.4% =21%
Inventory Holding period =2100/18700*365 =1600/17300*365
=41 days =34 days
Gearing =13000/10000 =11000/9500
=1.3 times =1.15 times
Interest cover =(450+290)/290 =(850+250)/250
=2.5 times =4.4 times

Audit Risk Auditor’s response

customers have 60 days during which any returns Discuss with finance director about the rationale
can be made without penalty. The finance behind decreasing the provision and inspect year
director has historically assumed a return rate of end returns to confirm if the judgement of
10%, however, he now feels that this is excessive finance director is reasonable.
and intends to change this to 5%

Proper return liability should be booked in the

statement of financial position. Position of
company has deteriorated over the year but the
liability has been reduced by 5%.

This indicates that there is a risk of

understatement of current liabilities.
The company purchased a patent on 30 Agree the useful life of the patent with
September 20X4 for $800,000, which was supporting document and recalculate the
capitalised in the prior year as an intangible ammortisation charge and verify that it has been
asset. correctly recorded in the statement of profit and
loss.
According to IAS 38 intangible assets, Asset must
be ammortised over it’s useful life of 4 years. It
does not seem that management has correctly
calculated and recorded ammortisation charge.

There is a possible risk that expenses might be

understated and profit overstated.
As part of this review, surplus items of plant and Review the depreciation policy of the company
machinery were sold, resulting in a loss on and verify that total useful life of assets has been
disposal of $160,000. correctly estimated and assess the
reasonableness of the depreciation policy.
Since machines were sold at significant loss
depreciation policy of the company could be
challenged as lower depreciation could have
been charged on those assets.
This indicates that there is a risk of
understatement of expenses, overstatement of
profits and overstatement of non-current assets.
In May 20X5, the financial controller of Harlem Enquire the lawyer of harlem co about the
Co was dismissed after it was alleged that probability of success of the claim and if it is
she had carried out a number of fraudulent probable advice management about it’s inclusion
transactions against the company. She has in the financial statement.
threatened to sue the company for unfair
dismissal as she disputes the allegations.

In accordance with IAS 37 provisions for

contingent liabilities and assets, provision must
be provided if the legal claim is probable.
Organization has recently started to investigate
on this matter.

This indicates that there is a risk of

understatement of current liabilities.

Receivables collection period has increased from Review the credit control policy of the company
38 to 51 days. and assure that proper allowance has been
provided for the increase in receivable days.
The increase in receivable days could be
explained by the increase in revenue of the
company but increase in receivable days comes
with inherent risk of irrecoverable debt. Proper
allowance of Irrecoverable debt must be booked.

There is possible risk that expenses are

understated and profit overstated.
A problem occurred in June 20X5, during Inspect the year end cash receipt from the sale of
production of a significant batch of tyres, which tyre and determine the NRV and verify if the
affected their quality. The issue was identified Inventory has been valued in accordance with IAS
prior to any goods being dispatched and 2.
management is investigating whether the issues
can be rectified and the tyres can subsequently
be sold.

According to IAS 2 inventories should be valued

lower of cost or NRV. The quality of the tyres has
been affected therefore the valuation of
inventory should be done accurately.

There is a possible risk that inventory could be

overstated as NRV could be lower than the Cost
of the tyre.
Corley Appliances

Audit risk Auditor’s Response

The company has a return policy allowing costumer Review the assumptions underpinning the
to return goods within 28 days of purchase if they are refund liability for reasonableness and
dis-satisfied with the product. whether they meet the historic 5% value of
the returns.
IFRS 15 states that revenue should only be booked
when the performance obligation has been fulfilled.
Performance obligation of Corley appliances exists up
to 28 days of sales.

This indicates that there is a risk of overstatement of

revenue and profits.
The company provides a six-month warranty on it’s Obtain the year end claims of the provision
product which require defects to be repaired at and verify the reasonableness of the
Corley appliances at own cost. reduction in warranty provision.

The directors have reduced the provision during the

year on the grounds they feel the products they sell
are built to a high standard. But the company does
not manufacture the product itself.

There is possible risk that the liability and expenses

are understated.

Corley co is responsible for goods in transit from the Review the controls that the company has in
point of dispatch by the suppliers. place to determine the cut-off and verify that
the inventories are recorded as soon as they
The goods in transit should also be included in the are dispatched.
valuation of the inventory at the year-end but they
are not yet physically present in the ware house of
the Corley co.

There is a possible risk that inventory and trade

payables will be understated.
Over the last 6 months the finance director has Review the credit control policy of the
noticed that the company’s receivables collection company and verify that adequacy of booked
period is now average of 55 days, whereas the allowance in respect of the receivables.
company’s target was 42 days.

Increase in receivable collection period comes with

inherent risk irrecoverable debt thus proper
allowances should be made for irrecoverable debt.
But the finance director believes that the allowances
should not be increased.
 This indicates that there is risk of understatement of
expenses and overstatement of receivables.
Since the dismissal of the supervisor, purchase Discuss with management if new employee
invoice have not been recorded in the payable ledger has been appointed for the replacement of
and it is unlikely that this backlog of invoices will be dismissed supervisor and all invoices has
cleared by the year end. been cleared.

All purchases must be recorded and reflected in the

financial statement but Corley co has huge backlog of
invoice yet to be processed.

There is a possible risk that expenses will be

understated and profit overstated.

The captalised cost include the purchase price of done

$0.6m, installation cost of $0.2m and staff training
cost of $0.1m.

IAS 16 states that only direct cost incurred for the

purchase of PPE can be capatalised. Corley co has
capatalised staff traning cost which is deemed to be
indirect cost.
done Done

Hart co

Audit risk Auditor’s Response

Morph & Co responsible for planning the final Experienced audit team must be assigned for the
audit of a new client, Hart Co, for the year ending new audit engagement devoting sufficient time
30 September 20X5. during the audit procedures. Audit engagement
team must gain sufficient understanding about
When a new audit engagement is to be client’s nature, accounting balances and
performed the audit team must ensure that it has transictions.
proper understanding of entity’s nature, account
balances, transictions and accounting balances.

There is a possible risk that mis-statement in

financial statement might goes undetected.
Therefore, there is a high detection risk.

The finance director has indicated that the The audit team should be aware of increased risk
directors are very pleased with the forecast of manipulation in the financial statements and
performance for the year as the directors are should maintain the professional skepticism and
paid a bonus based on a percentage of profit professional judgement during the whole audit.
before tax.
Since bonus are determined on the basis of
accounting profits, directors will be tempted for
the manipulation of the financial statements.

This indicates that there is a risk that financial

statements are misstated.
All playgrounds are constructed to specific Review the underlying assumptions relating to
customer specifications. Customers pay a 25% recognition of deposit and assess it’s
deposit on signing the contract, with the balance reasonableness if in accordance with IFRS 15.
payable when control of the playground is
transferred to the customer.

As Per IFRS 15 revenue recognition, Revenue can

only be recorded if the performance obligations
has been fulfilled. 25% of the revenue is received
as a deposit at Hart co.

There is a possible risk that revenue will be

overstated and so will profits.
Arrangements have been made for the audit Review the basis of choosing the inventory sites
team to attend only five of the WIP counts. and ensure that it has been chosen on the basis
of materiality over the sites.
Inventory valuations are based on the inventory
counts. If all inventory sites cannot be visited
during the count the sites must be chosen on the
basis of materiality of the sites. Only 5 out of 16
sites are being visited during the inventory sites.

This indicates that, there is a risk inventory could

be misstated in the statement of financial
position.
The warranty provision for the current year has Discuss with management the rationale behind
been calculated as 2% of revenue. In the previous the reduction of the provision and assess its
year the warranty was based on 6% of revenue. reasonableness by observing the post year end
claims of warranty.
The provision has been reduced from 6% to 2%
whilst there has been no significant difference in
construction techniques or the level of the claims
in the year.

There is a possible risk that expenses and

liabilities will be understated.
Hart Co has incurred expenditure of $1.8m Obtain the breakdown of the cost incurred and
relating to the research and development of a verify that only cost that meets the development
new type of environmentally‐friendly building criteria has been capatalised and remaining has
material. $0.6m of the expenditure to date has been expensed to profit and loss.
been written off to the statement of profit or
 loss. The remaining $1.2m has been capitalised as
an intangible asset.

According to IAS 38 Intangible assets, Only cost

that meets the development criteria can be
capitalized. $1.2m out of $1.8 m has been
capatalised.

There is a possible risk that intangible assets

might be overstated and expensed overstated.
Due to a supplier problem, the delivery of new Discuss with management about the valuation of
PPE is delayed and is now scheduled to be PPE and ensure only plant and machinery present
delivered in October 20X5. in premises are counted in PPE valuation.

During the valuation of PPE only items that are

present in the premise could be included in the
valuation. Hart co has already paid $1M for the
contract of the machinery.

This indicates that there is a possible risk that PPE

could be overstated.
Hart Co's payroll function is outsourced to an Consideration should be given to contacting the
external service organisation, Chaz Co, which is auditor of the service organization, Chaz co, to
responsible for all elements of payroll processing confirm the level of controls in a place. A type 1
and maintenance of payroll records. or Type 2 report could be requested.

When an internal accounting function of business

is outsourced control over the quality over the
data processing will be lost and auditors would
not be able to perform any audit procedures to
verify the data reported.

There is increase in detection risk of

misstatements in the statement of financial
position.

Scarlet co

Audit engagement letter outlines the responsibilities of both management and the auditor. The purpose
of audit engagement letter is to:

i) Reduce the risk of any misunderstanding between audit team and management.
ii) Forms the basis of the contract.
iii) Highlight the continuance and acceptance of the audit engagement.

The list of items that must be included in the audit engagement letter are:

i) The responsibility of management

 ii) The responsibility of auditor
iii) Any restrictions to auditor’s liability
iv) The fact that some misstatements could go undetected
v) The basis how the management calculates the auditor’s fees.

Audit risk Auditor’s Response

As a result, the company recruited a temporary Review if the draft financial statements produced
financial accountant in early June 20X5 who will by the new accountant is in line with company’s
prepare the draft financial statements. policies and procedures and with relevant
financial reporting framework.
Interim audit procedures are performed on the
basis of draft financial statement. Therefore, the
draft financial statements should be prepared on
proper basis following all the accounting policies
and procedures. New financial accountant is
hired to prepare the draft financial statements.

There is a possible risk that the draft financial

statements produced would be misstated.

The bank has asked for a copy of the audited The audit engagement team should maintain
year‐end financial statements by the end of professional skepticism and professional
September 20X5 before they will agree to the judgement being aware of the fact of possible
loan and the directors are keen to report strong manupulations.
results in order to obtain this financing.

Since the approval of loan is dependent upon the

financial statements the directors to be tempted
to manipulate the financial statement.

This indicates that there is a possible risk that

profits and assets will be overstated and liabilities
understated.
The training costs of $15,000 have been Obtain the breakdown of the cost of PPE
capitalised as part of the cost of the asset. purchased and discuss with management if cost
has been correctly capatalised and expensed in
Only direct cost associated with the purchase of the financial statement in accordance with IAS
PPE could be capatalised in its cost. Staff training 16.
cost is deemed to be indirect cost. Scarlet co has
capatalised staff training cost on the asset.

There is a possible risk that PPE will be overstated

and expenses understated leading to
overstatement of the profits.
The company sources many of its raw materials Inspect the procedures that management
to be used in the chemical manufacturing process adopted to determine the cut-off point and
from an international supplier and goods can be review controls on place to ensure that inventory
in transit for up to three weeks. is recorded from the point of dispatch.
For the inventory valuation at the year-end goods
that are in transit must also be included in the
statement of financial position. The goods could
still be in transit and not physically present in the
warehouse.

There is a possible risk that inventory and

payables will be understated.
The receivables collection period has increased Review the credit control policy and receivables
from 38 days to 52 days. The credit controller control policy of the company and ensure that
has confirmed that some customers are currently adequate allowance has been booked for risk of
taking longer to pay than in previous years as irrecoverable debt.
they are awaiting payment from their customers

Increase in receivable days may be because of

extended credit term of the company to generate
higher revenue. But the increase in receivable
comes with the inherent risk of irrecoverable
debt. Proper allowance of irrecoverable debt
must be booked into the accounts.

This indicates that there is a possible risk that

expenses will be understated and current assets
overstated.
The payroll department has calculated the levels Obtain the calculation of redundancy payments
of termination costs associated with the and agree that provision has been included as a
redundancy and they will be paid in the July 20X5 liability in the year-end financial statement.
payroll run.

As there is a present obligation which can be

reliably measured and which would lead to
economic outflow of funds, IAS 37 provisions,
contingent asset and contingent liability would
require this provision to be reconised in the
statement of financial position.

There is a possible risk that liabilities will be

understated and profits overstated.

During the year the company sold a batch of Inspect the copy of the credit note and confirm
chemicals to a customer for $120,000. At the an adjustment to revenue and receivables has
beginning of May 20X5, the customer returned been recorded pre-year end.
these chemicals because the chemical mix was
not in line with the customer’s specifications.
 Since the chemicals worth $120000 has been
returned the entry for the revenue should be
reversed to reflect this fact.

There is a possible risk that revenue will be

overstated.
The directors each received a significant bonus in Discuss the matter with management and review
the year which has been included in the payroll. the disclosure in the financial statements
charge for the year in the statement of profit or complies with local legislation.
loss. Local legislation requires separate disclosure
of directors’ bonuses in the financial statements.

The director’s remuneration disclosure will be

incomplete and inaccurate if the bonus paid is
included in the payroll and separate disclosure is
not done in accordance with local legislation.

Peony co

Audit Risk Auditor’s response

Peony Co has an internal audit (IA) department Obtain and review the reports prepared by the
which undertakes controls testing across the internal audit department relating to the store
network of stores. Each store is visited at least visits and ascertain the reasonableness of their
once every 18 months. The audit manager has work
discussed with the finance director that the
external audit team may rely on the controls
testing which is undertaken by IA.

If the reliance is placed on irrelevant or poorly

performed testing, then the external audit team
may form an incorrect conclusion on the strength
of the internal controls at peony co.

This could result in them performing insufficient

level of substantive testing ,thereby increasing
detection risk.
The gross margin is expected to increase from Review the allocation of cost between cost of
56% to 60%; and the operating margin is goods sold and operating expenses and compare
predicted to decrease from 21% to 18%. it to previous year for any inconsistency.

There has been increase in revenue and gross

profit margin but operating profit margin is
expected to be deteriorated. There could be
misallocation of cost between cost of goods sold
and operating expenses.

There is a possible risk that cost of goods sold

may be understated and operating expensed
understated.
Peony Co values inventory in line with industry Obtain the breakdown of the cost of the
practice, which is to use selling price less average inventory and compare it to industry practice and
profit margin. The directors consider this to be a ensure if it is close approximation to cost. If any
close approximation to cost. differences are found then valuation must be
based in accordance with IAS 2 lower of cost or
IAS 2 inventory only allows the use of selling price net realiseable value.
less average profit margin to value inventory if it
is close to the cost of the inventory. Directors
considers this industry practice as close
approximation to cost.

This indicates that there is a risk of misstatement

in the inventory valuation.
The company does not undertake a full year‐end Review the timetable of the perpetual inventory
inventory count and instead undertakes monthly counts and the controls over the count and
perpetual inventory counts, each of which covers adjustment to the records must be tested.
one‐twelfth of all lines in stores and the
warehouses.

Under perpetual inventory count system a full

inventory count must be done once in a year with
adjustments made to the inventory records on a
timely basis.

There is a possible risk that inventory may be

under or overstated.
As part of the interim audit which was completed Discuss with the management the materiality of
in May, an audit junior attended a perpetual the variances arising between count and records
inventory count at one of the warehouses and and ensure it has been corrected.
noted that there were a large number of
exceptions where the inventory records showed
a higher quantity than the physical inventory
which was present in the warehouse.

Inventory valuation is based upon the inventory

counts. The inventory record showed higher
quantity then actually present in the warehouse.

This indicates that there is a risk of

overstatement of inventory in the statement of
financial position.
During the year, IA performed a review of the Discuss with the management the
non‐current assets physically present in around appropriateness of the depreciation policy of the
one‐third of the company’s stores. A number of company. Enquire finance director if obsolete
assets which had not been fully depreciated were items has been removed and subsequent
 identified as obsolete by this review. adjustment has been made.

The useful life of the assets must be reviewed on

timely basis to ensure the depreciation policy of
the company is appropriate. Assets that were not
fully depreciated were found obsolete.

This indicates that there is a possible risk that

expenses may be understated and profits
overstated.

The directors have indicated that at the year-end Review supporting documentation for the
a current asset of $0.7m will be recognised, as advertisement to confirm that all were shown
they believe that the advertisements will help to before the 20x5 year end.
boost future sales in the next 12 months. The last
advertisement will be shown on TV in early
September 20X5.

Expenses Incurred during the year must be

charged to the statement of profit and loss as
there is no basis for capatalising the expenses
incurred for operations. Advertisement
expenditure has been capatalised.

There is a possible risk that current assets are

overstated and expenses understated.
Peony Co decided to outsource its payroll Consideration must be given contacting the
function to an external service organisation. This auditor of the service organization to confirm the
service organisation handles all elements of the level of controls over the place. A type 1 or Type
payroll cycle and sends monthly reports to Peony 2 report can be requested.
Co which detail wages and salaries and statutory
obligations.

If the internal business function of an

organization is outsourced, then the company
loses the control over it’s operation and quality
of the system.

There is a possible risk that the material

misstatement goes undetected.

Darjeeling co

Ratios Calculations 20x5 20x4

Payables days =58 Days =40 days
Receivable days =51 days =38 days
Gross profit margin =37% =36 days

Audit Risk Auditor’s Response

During the year Darjeeling Co has spent $0.9m, Obtain the breakdown of the $0.9M incurred and
which is included within intangible assets, on the agree only cost meeting the caitalisation criteria
development of new product lines, some of has been capatalised.
which are in the early stages of their
development cycle.

According to IAS 38 intangible assets, Costs that

meets development criteria can only be
capataised. Darjeeling co has capatalised $0.9M
and some of the items are in early stage of
development.

There is a possible risk that intangible assets

might be overstated and expenses understated.
These capitalised costs include the purchase price Discuss with management the rationale behind
of $2.2m, installation costs of $0.4m and a five‐ capatalising the $0.5M cost and ensure it has
year servicing and maintenance plan costing been correctly expensed to the profit and loss.
$0.5m

IAS 16 PPE allows direct cost incurred during the

purchase of PPE to be capatalised. Five year
servicing and maintenance plan is considered as
indirect cost.

This indicates that there is a risk that plant and

machinery is overstated and expenses
understated.
In order to finance the development projects and Recalculate the split of loan between current and
the new manufacturing line, the company non-current liabilities and agree it to the
borrowed $4m from the bank which is to be statement of financial position and verify that
repaid in instalments over eight years and has an proper disclosures has been made in this regard.
interest rate of 5%..

Whenever any long term long is borrowed it must

be correctly splitted into current and non-current
liability with proper disclosure in the statement
of financial position.

There is a possible risk that current and non-

current liabilities could be misstated.

The long term loan has finance cost of 5% which Inspect the prepared financial statements and
must be taken account for in the statement of verify the inclusion of finance cost.
financial position.

Being trivial but important line item in the

statement of financial statement finance cost
could be omitted during the preparation of the
financial statements.

There is a possible risk that expenses and current

liabilities might be understated.
Developing new products and expanding Sufficient audit time must be allocated for the
production is important as the company intends audit along with experienced audit team
to undertake a stock exchange listing in the next members who should maintain professional
12 months. skepticism and apply professional judgement
throughout the audit being aware of the fact of
For a company to be listed in the stock exchange manipulations.
it must have good performance and it will be
reflected in the statement of financial
statements. Directors might be tempted to
manipulate the financial statements to show the
overall good position of the company.

There is a risk that revenue, profits and assets

might be overstated.
In addition, Darjeeling Co made an Review the assumption underpinning the
announcement in October 20X4 of its ‘price recognition of the revenue and assess it
promise’: that it would match the prices of any reasonableness if in accordance with IFRS 15.
competitor for similar products purchased.
Customers who are able to prove that they could
purchase the products cheaper elsewhere are
asked to claim the difference from Darjeeling Co

In accordance with IFRS 15 revenue recognition,

Revenue can only be reconised when the
performance obligation has been completely
fulfilled. The obligation of Darjeeling co remains
until 28 days because of it price promise.

There is a possible risk that revenue might be

overstated.

The company started a number of initiatives Review the credit control and receivable control
during the year in order to boost revenue. It policy of the company and verify that proper
offered extended credit terms to its customers on allowance has been booked in respect of increase
the condition that their sales order quantities in receivable.
were increased.

Extended credit term could possibly increase the

 revenue which could be seen in the calculation of
gross profit margin but it comes with the
inherent risk of irrecoverable debt which could
be explained with the increase in receivable days
that has been increased from 38 days to 51 days.
Therefore, proper allowance must be booked for
the increase in receivables.

There is a possible risk that revenue might be

overstated and expenses understated.
The company intends to include a refund liability
of $0.25m, which is based on the monthly level of
claims to date, in the draft financial statements.

Adequate refund liability must be booked for any

existing provision of the company.

Blackberry co

A) Loganberry and cos responsibilities in the relation to the prevention and detection of fraud are:

Loganberry must gather sufficient appropriate audit evidence in respect of the assessed risk of material
misstatement due to risk of fraud and error. In addition, they must Respond appropriately to fraud or
suspected fraud during the audit.

Further-more they should apply profession skepticism throughout the audit being aware of the fact that
management could override control that had been in place for the prevention and detection of the
fraud.

All the audit procedures must be communicated to all the members therefore a discussion should be
held to make aware about the extent of fraud and error in the organization. Those who are not present
during the discussion should be communicated by any other means possible.

Audit Risk Auditor’s response

Inventory is valued at the lower of cost and net Discuss with management the nature of
realisable value. Cost is made up of the purchase overheads included in the inventory valuation
price of raw materials and costs of conversion, and ensure that it has been in accordance with
including labour, production and general IAS 2.
overheads.

IAS 2 requires that costs included in valuing

goods and services should only be those incurred
during bringing the inventory in it’s present
location and condition. Production overhead
could be deemed as cost incurred to bring the
good in present location and condition but
General overhead cannot be considered as cost
incurred in bringing the inventory in present
location and condition.

There is a risk that inventory may be overstated

in the statement of financial position.
During the year, Blackberry Co paid $1.1m to Recalculate the ammortisation expense and
purchase a patent which allows the company the verify that it has been correctly recorded in
exclusive right for three years to customise their financial statements.
portable music players to gain a competitive
advantage in their industry.

Intangible assets must be ammortised over it’s

useful life.The exclusive rights for the patent is 3
years.

There is a possible risk that expenses might be

understated and intangible assets overstated.
The $1.1m has been expensed in the current year Obtain the breakdown of the incurred $1.1M and
statement of profit or loss. verify that it has been correctly treated in
accordance with IAS 38.
IAS 38 intangible assets requires, purchased
intangible assets to be capatalised in the financial
statements. Blueberry co has expensed the
$1.1m to statement of financial position.

This indicates that there is a risk of

overstatement of expense and understatement
of profits.
In order to finance this purchase, Blackberry Co Recalculate the split of Share capital and share
raised $1.2m through issuing shares at a premium and verify that it has been correctly
premium. recorded in the financial statement with proper
disclosure.
When shares are issued at premium it must be
correctly splitted into share capital and share
premium account and proper disclosure should
have been made.

There is a possible risk that Equity might be

misstated.
In May 20X5, it was discovered that a significant Discuss with finance director the procedures
teeming and lading fraud had been carried out by adopted to rectify the errors caused due to fraud
four members of the receivables ledger in receivable ledger and auditors should maintain
department who had colluded. the professional skepticism throughout the audit
being aware of the fact of misstatement due to
After discovery of fraud in the receivable ledger, fraud and error.
adjustment s should have been made to correct
all the misstatements that have occurred due to
fraud.
 If the correct adjustment hasn’t been made then
there is a risk that receivable balance might be
misstated.
Blackberry Co decided to outsource its Consideration should be given contacting the
receivables ledger processing to an external auditor of service company to confirm the level
service organization. of controls. A type-1 ore Type 2 report could be
requested.
Whenever internal accounting function of the
organization is outsourced the control over the
procedures and quality over the information
processing will be lost. Auditors would be unable
to perform test of control to verify the data
reported.

There is a possible risk that misstatement goes

undetected thereby increasing the detection risk.

In June 20X5, the financial accountant of Obtain the correspondence from the company
Blackberry Co was dismissed. He had been lawyer about the probability of claim to be
employed by the company for nine years, and he successful and if it is probable then ensure that
has threatened to sue the company for unfair provision has been booked in accordance with
dismissal. IAS 37.

If the Sue is probable to be successful then in

accordance with IAS 37 provision for contingent
liability and assets, Provision of claim should be
provided for.

There is a possible risk that provision will be

understated and so will be expenses.
In July 20X4, a receivable balance of $0.9m was Discuss with management whether any
written off by Blackberry Co as it was deemed notification of payment has been received from
irrecoverable as the customer had declared itself the liquidators and review the related
bankrupt. correspondence.
To comply with IAS 37 Provisions, Contingent
Liabilities and Contingent Assets, this should not
be recognised until the receipt is virtually certain.
With no firm response to date, the inclusion of
this sum overstates profit and current assets.

Prancer co

a) Before entering into the audit engagement with any client the audit team must confirm whether
the preconditions for the audit exists or not. Precondition of audit enables to confirm that the
management realizes it’s responsibility for:
I) Preparation of financial statement with relevant and appropriate financial reporting
framework.
 II) Internal controls relevant for the preparation of the financial statements are in place.
III) Providing auditor with all the necessary and relevant information and support during the
audit.

b)

The three main areas other than audit risk that must be included within the audit strategy document
are:

Audit Risk Auditor’s Response

It is 1 July 20X5. You are an audit supervisor of Sufficiently experienced audit team must be
Cupid & Co, planning the final audit of a new assigned to carry out the audit by devoting
client, Prancer Construction Co, for the year enough time who should maintain their
ending 30 September 20X5. professional skepticism throughout the audit.

When a new audit engagement is due to be

commenced there must be proper understanding
of the client’s business nature, Accounting
policies and transactions.

There is a possible risk that material

misstatement might goes undetected because of
new engagement.
The prior year financial statements recognise Review the procedures and judgement applied by
work in progress of $1.8m, which comprised management for the determination of the cut-off
property construction in progress as well as point and assess it’s reasonableness.
ongoing maintenance services for finished
properties.

Assessment and valuation of the work in progress

is subjective area where management judgement
has great impact. Work in progress of prance
construction seems to be material in nature
therefore cut-off point must be determined
accurately.

There is a possible risk that inventory might be

misstated.
A full year‐end inventory count will be Calculate the materiality level of each 11 sites
undertaken on 30 September at all of the 11 and determine which sites is to be visited during
building sites where construction is in progress. the count based on the materiality level.
There is not sufficient audit team resource to
attend all inventory counts.

To gain sufficient appropriate audit evidence over

inventory material inventory sites must be visited
during the audit. There are 11 sites and
insufficient resources to visit all the sites.

This indicates that there is a risk of misstatement

of inventory.
In line with industry practice, Prancer Obtain the post year end warranty claims and
Construction Co offers its customers a five‐year compare it with the provision booked last year
building warranty, which covers any construction and assess the adequacy of the provisions
defects. booked this year.

A warranty provision will be required in

accordance with IAS 37 provisions, Contingent
liabilities and contingent assets. Calculating
provision is a subjective area which requires
management judgement. The finance director
has states that the warranty provision would be
less than previous year.

There is a possible risk that liabilities and

expenses will be understated.

Customers who wish to purchase a property are

required to place an order and pay a 5% non‐
refundable deposit prior to the completion of the
building.

IFRS 15 Revenue recognition states that revenue

cannot be reconised until the performance
obligation has been fulfilled. 5% non-refundable
deposit are received before the completion of
the performance obligation.

The finance director has informed you that

although an allowance for receivables has
historically been maintained, it is anticipated that
this can be significantly reduced.
A review of the management accounts shows the The audit team should increase their testing on
payables period was 56 days for August 20X5, trade payables at the year end, with a particular
compared to 87 days for September 20X4. The focus on completeness of payables.
finance director anticipates that the September
20X5 payables days will be even lower than those
in August 20X5.
The forecast profit is higher than last year,
indicating an increase in trade, also the
company’s cash position has continued to
deteriorate and therefore, it is unusual for
 payables payment period to have decreased.
There is an increased risk of errors within trade
payables and the year‐end payables may be
understated

Hurling

Audit risk is defined as the risk that the auditor gives an inappropriate opinion because financial
statements are materially misstated. Audit risk is a factor of risk of material misstatement and detection
risk.

Audit risk=Inherent risk*control risk*detection risk.

Inherent risk is defined as the susceptibility of assertions about account balances, transactions or
disclosure before taking consideration of any internal controls applied in an organization.

Control risk is defined as the risk that auditor put reliance over the controls of the place to reduce audit
risk to appropriately low level may not prevent, detect and correct the risk.

Detection risk is defined as the risk that the procedures performed by the auditor to reduce the audit
risk to appropriately low level could not identify

Audit risk Auditor’s Response

Hurling Co distributes its products through Obtain the breakdown of the $1.1M and agree
wholesalers as well as via its own website. The the invoices to assess the nature of the cost and
website was upgraded during the year at a cost ensure that it has been correctly capatalised or
of $1.1 million. expensed according to their nature.

The incurred cost of $1.1M is for intangible assets

and it must be expensed and capatalised
according to their nature.

There is a risk that intangible assets and expenses

might be misstated.
Additionally, the company entered into a Obtain the correspondence from the lawyers of
transaction in August to purchase a new the hurling co about the stage of the legal
warehouse which will cost $3.2 million. Hurling procedures and verify the treatment of new
Co’s legal advisers are working to ensure that the warehouse is in accordance with the
legal process will be completed by the year end. correspondence.

The legal procedures are yet to be completed

thus warehouse transaction may not have been
complete before end but may have been included
in the non-current asset.

There is a risk that non-current asset can be

overstated.
During the year the finance director has Discuss with finance director the rationale behind
increased the useful economic lives of fixtures revising the useful life of the fixtures and assess
and fittings from three to four years as he felt this its reasonableness.
was a more appropriate period.

There must be proper basis for revising the useful

life of fixtures and fittings. Furthermore, an
annual revision of useful life must be done in
accordance with IAS 16 after it has been revised
once.

There is a risk that depreciation expenses might

be understated and profit overstated.
The finance director has informed the Review the credit control policy of the hurling co
engagement partner that a revised credit period and assess proper allowance has been booked for
has been agreed with one of its wholesale the risk of irrecoverable debt.
customers, as they have been experiencing
difficulties with repaying the balance of $1.2
million owing to Hurling Co.

Since the credit costumer is facing the difficulties

with repaying the $1.2M, there is a risk of
irrecoverable debt. Adequate allowance for
irrecoverable debt must be booked.

There is a possible risk that expenses might be

understated and profits may be overstated.
Feedback on product Luge, launched four months Discuss the probability of the success of the claim
ago, has been mixed, and the company has just with the lawyer of the company and if it is
received notice from one of their customers, probable discuss with management about the
Petanque Co, of intended legal action. inclusion of provision in the financial statement.

If success of intended legal action by the

costumer is probable, then hurling co must
provide a provision for the legal claim.

There is a risk that liabilities and expenses might

have been understated.

As a precaution, sales of the Luge product have

been halted and a product recall has been
initiated for any Luge products sold in the last
four months.
The finance director is keen to announce the
company’s financial results to the stock market
earlier than last year and in order to facilitate
this, he has asked if the audit could be completed
 in a shorter timescale.
In addition, the company is intending to propose
a final dividend once the financial statements are
finalised.

Centipede

The safeguards which ant and co should implement to ensure that the conflict of interest is managed
are:

i) Assign different engagement teams (with different team members) who are provided with
clear guidance on maintaining the confidentiality.
ii) Inform both of the client and get consent to act from both of them.
iii) Sign a confidentiality agreement with the client.
iv) Procedures to Limit access to the client files.
v) Review the key judgement and conclusions by an independent person of appropriate senior.

Review the key judgements by an independent person of appropriate senior.

Separate engagement team (with different team members) who are provided with clear guidance on
maintaining the confidentiality.

Review key judgement and conclusions by independent person of sufficient seniority.

The matters that ant co should have considered before accepting the audit of centipede co are:

i) Statement from the outgoing auditor

ii) Management integrity
iii) Basis of fees calculations
iv) Pre-conditions of audit
v) Independence and objectivity
vi) Risk
vii) Competence

Ratios calculations

Ratios 20X5 20X4

Receivable days 23 days 22 days
Payable days 81 days 73 days
Inventory Days 54 days 47 days
Gross profit margin 40% 34%
Operating profit margin 18% 19%
Current Ratio 0.96 times 1.26 times

Audit Risk Auditor’s Response

Centipede is a new client for your firm. Sufficiently experienced audit team must be
chosen who are required to devotee sufficient
When a new audit engagement is due to be time during the audit. They are required to
commenced the audit team must gain sufficient maintain the professional skepticism throughout
understanding of the entity’s nature, account the audit.
balances, transactions and accounting policies.

There is a possible risk that material

misstatement will go undetected.
Rather than undertaking a full year‐end inventory Obtain the timetable of the perpetual inventory
count, the company undertakes monthly counts and controls over the count and
perpetual inventory counts, covering one‐twelfth adjustment made must be tested.
of all lines monthly.

When this type of inventory count system is

adopted a full year inventory count must be done
at the year-end along with making adjustment in
a timely manner.

There is a possible risk that inventory might be

misstated.
There were a large number of exceptions where Review the exception reports and determine the
the inventory records were consistently higher materiality of those exception and discuss with
than the physical inventory in the warehouse. management about the possible adjustment in
When discussing these exceptions with the the inventory records.
finance director, the assistant was informed that
this had been a recurring issue all year.

Inventory valuation is based on the inventory

records that has been maintained. Inventory
records were consistently higher than physical
inventory.

This indicates that there is a risk of

overstatement of the inventory.
A fifth site was closed down in 20X4, however, Review the depreciation policy of the company
the building was only sold in 20X5 at a loss of discuss it with the finance director and assess it’s
$825,000. reasonableness.

The building has been sold at a substantial loss

which questions the depreciation policy of the
company.

There is a risk that the depreciation expenses are

understated and PPE overstated.
One of Centipede Co’s wholesale customers is
alleging that the company has consistently failed
to deliver goods in a saleable condition and on
time, hence it has commenced legal action
 against Centipede Co for a loss of profits claim.
If the legal claim is probable the in accordance
with IAS 37 a provision for contingent liability
must be provided in the financial statements.

There is a possible risk that the

the country in which Centipede Co is based, local
legislation requires disclosure of the names of the
directors and the amount of remuneration
payable to each director.

The disclosure relating to the directors

remuneration would be incomplete and incorrect

Venus co

The factors that indicates that the audit engagement letter must be revised are:

i) Any changes in the existing term or inclusion of any special term must be updated in the
engagement letter.
ii) Significant changes in the size of an organizations because audit procedures might have to
be changed.
iii) Changes in the reporting standards
iv) Changes in the legislation

The six matter that should be included in the audit engagement letters are:

i) The nature and scope of the audit

ii) The auditor’s responsibility
iii) The managements responsibility
iv) Basis of fees calculation
v) Any limitation to auditor’s liability
vi) The fact that some misstatement might goes undetected.

c)The five sources of information that is relevant for gaining the understanding of an entity are:

I) Prior Year reports

II)Journals

iii)company’s websites

iv)Discussion with the management

v)Reviewing major competitors

Audit Risk Auditor’s Response
During the year, the directors reviewed the useful Discuss with the management the rationale for
lives and depreciation rates of all classes of plant the revision of the useful life of the PPE and
and machinery. This resulted in an overall assess its reasonableness.
increase in the asset lives and a reduction in the
depreciation charge for the year.

For the revision of the useful life of assets there

must be proper basis and in Accordance with IAS
16 after the revision of useful life the assets life
must be revised every year.

There is a possible risk that PPE could be

overstated and profits may be overstated.
In July, there was a fire in one of the warehouses. Discuss with the management the basis of the
Inventory of $0.9 million was damaged and this $0.2M scrap value attributed.
has been written down to its scrap value of $0.2
million.

If the goods that has been written down does not

get sold at the year-end, then the scrap value
might need to revised.

There is a possible risk that the scrap value might

be overstated.

An insurance claim has been submitted for the Confirm whether any response has been received
difference of $0.7 million. Venus is still waiting to from the insurance company regarding the claim
hear from the insurance company with regards to of the insurance by discussion with management
this claim, but has included the insurance and verify that the treatment has been in
proceeds within the statement of profit or loss accordance with IAS 37.
and the statement of financial position.

In accordance with IAS 37 provisions, contingent

asset and contingent liabilities, contingent assets
cannot be recognized in the financial statements
unless it is virtually certain. Venues is still waiting
to hear from the insurance company about the
insurance claim.

There is a possible risk that profits and

receivables will be overstated.
 The finance director has informed the audit Maintain a professional skepticism throughout
manager that the July and August bank the audit being aware of the fact of material
reconciliations each contained unreconciled misstatement, especially in bank balance.
differences; however, he considers the overall
differences involved to be immaterial.

Every bank reconciliation must be reconciled

properly because there could be many
misstatement canceling each other out seen as
immaterial one.

There is a risk that bank balances would be under

or overstated.
A directors’ bonus scheme was introduced during Maintain a professional skepticism throughout
the year which is based on achieving a target the audit being aware of the fact of material
profit before tax. misstatement, especially in judgmental areas.

The bonus scheme is related to the profits of the

organization. The directors may have been
tempted to manipulate the financial statement
just to get the bonus.

There is a possible risk that the profits may be

overstated.
In order to finalise the bonus figures, the finance
director of Venus would like the audit to
commence earlier so that the final results are
available earlier this year.

Sycamore

Audit firm is responsible for obtaining reasonable assurance that the financial statement are taken as
a whole are free from material misstatement, whether caused by fraud or error.

In order to fulfill this responsibility audit firm is required to identify and assess the risk of material
misstatements of the financial statement due to fraud and error.

They need to obtain the sufficient appropriate audit evidence of assessed risk of material
misstatement due to fraud or error by designing and implementing appropriate response.
Furthermore, they must respond to the assessed risk appropriately.

When obtaining the reasonable assurance they must maintain the professional skepticism throughout
the audit being aware of the fact that those with power could override the controls and recognizing
the fact the audit procedures which are effevtive in detecting error may not be effective in detecting
the fraud.

To ensure the whole engagement team is aware of the risk and responsibilities
Audit Risk Auditor’s Response
Sycamore’s previous finance director left the Discuss with management about the steps they
company in December 20X4 after it was have taken to rectify the fraud and any controls
discovered that he had been claiming fraudulent in place they have applied to discover similar type
expenses from the company for a significant of fraud.
period of time.

The discovered fraud should be adjusted in the

financial statement and lack of discovery of such
fraud for long time indicates there could be more
fraudulent activity of the organization.

There is a possible risk that misstatement in the

financial statement goes undetected.
During the year Sycamore has spent $1.8 million Obtain the breakdown of the $1.8M and agree
on developing several new products. These it’s nature with supporting invoice and confirm
projects are at different stages of development that it has been recorded in accordance with IAS
and the draft financial statements show the full 38.
amount of $1.8 million within intangible assets.

In accordance with IAS 38 intangible assets, Cost

meeting the development criteria could only be
capatalised in the financial statement. Sycamore
has products in different stages of the
development.

There is a possible risk that intangible assets may

have been overstated and expensed understated.
In order to fund this development, $2.0 million Recalculate the split of the loan to ensure that it
was borrowed from the bank and is due for has been correctly split into current and non-
repayment over a ten‐year period. current liabilities.

Whenever long term loan is borrowed it must be Review financial statements to ensure proper
correctly split into current and non-current disclosure has been regarding the long term loan.
liabilities with proper disclosure in the financial
statement.

There is a possible risk that current and non-

current liabilities has been misstated.
The finance cost of long term loan may have been Review the draft financial statement and ensure
omitted. that finance cost has been included.

Finance cost may have been omitted from the

financial statement.

There is a possible risk that expenses may have

been understated.
 The bank has attached minimum profit targets as The audit team must maintain professional
part of the loan covenants. skepticism throughout the audit being aware of
the fact that profits may have been overstated to
If the loan covenants are broken, then the loan comply with loan covenants.
may have to be repayable immediately and the
covenants are attached to the minimum profit
target.

There is a possible risk that the profits are

overstated.
The new finance director has informed the audit Discuss with management and confirm that they
partner that since the year‐end there has been have recognized required provision of refund in
an increased number of sales returns and that in accordance with IAS 37.
the month of May over $0.5 million of goods sold
in April were returned.

Since there is a probable economic outflow due

to result of past events which could be reliably
estimated, in accordance with IAS 37 provision,
contingent liabilities and contingent assets
provision relating to the refund must be
recognized in the financial statements.

There is a possible risk that the liability and the

expenses may be understated.
Maple & Co attended the year‐end inventory Review the procedures applied over the
count at Sycamore’s warehouse. The auditor movement of the inventory and ensure that no
present raised concerns that during the count items has been omitted or counted twice .
there were movements of goods in and out the
warehouse and this process did not seem well
controlled.

During the inventory count proper procedures

must be applied over the movement of the goods
else some goods could be omitted and some
might be counted twice.

This indicates that there is a risk of over or

understatement of the inventory.
During the year, a review of plant and equipment
in the factory was undertaken and surplus plant
was sold, resulting in a profit on disposal of
$210,000.

Recorder communications
The benefits of audit planning are:

I)Enables auditor devotee time to more important areas of the audit.

ii)Enables auditor to identify any significant matters for the audit.

iii)Enables auditor to properly plan and organize the audit.

iv)It enables auditor to select competent and capable team member for the audit.

v)It helps auditor properly supervise the audit.

vi)Where possible it enables to review or collaborate to the work done by the expert.

The audit procedures that should be performed in order to put reliance on the continuous counts for the
year-end inventory are:

i) Attend at least one of the continuous inventory counts to review whether the controls over
the inventory counts are adequate.
ii) Review the schedule of the perpetual inventory counts under taken and due to be
undertaken to confirm that all line items have been counted or are due to be counted.
iii) Review the adjustment made on the inventory records in timely basis to gain an
understanding about the level of differences arising in the timely basis.
iv) Enquire management how they ensure that year-end inventory counts would be free from
errors if any significant errors have been noted during the year.
v) Consider visiting the year-end inventory count to perform test of controls from floor to
record and record to floor to confirm completeness and existence.

The substantive procedures that should be performed to confirm the director’s bonus payments
included in the financial statements are:

I) For a sample of director, Obtain the schedule of the split of director’s emolument between
wages, pensions, benefits and other emoluments.
II) Review the bank statement to verify amounts actually paid to the directors.
III) Review board minutes to confirm the amount included in respect of the director’s
emoluments are genuine.
IV) Obtain and review the directors service contract to confirm that emoluments are consistent
with the terms of the contract.
V) Obtain the written representation from the management confirming the completeness of
the director emoluments.

Audit Risk Auditor’s Response

Recorder is a new client and you are currently
planning the audit with the audit manager.

The goods are usually in transit for two weeks Review the controls the company has in place to
and the company correctly records the goods ensure that inventory is recorded from the point
when received. of dispatch.
Only the goods that has been received must be Undertake the detail testing of the cut-off of
included in the inventory and payable at the year goods in transit from the supplier in south Asia
end. to ensure cut-off is complete and accurate.

There is a possible risk that inventory cut-off,

Purchase and payables are not accurate.
Recorder does not undertake a year‐ end Obtain the schedules of the perpetual inventory
inventory count, but carries out monthly count system and controls over the count and
continuous (perpetual) inventory counts and any adjustment made must be tested.
errors identified are adjusted in the inventory
system for that month.

Under such inventory count system, a full year

inventory count must be undertaken with
adjustments made on the timely basis.

There is a possible risk that inventory might be

misstated.
When this happens, the old models have to be Review the cash receipt from the year end sale to
sold at a significant discount as customers usually confirm the NRV of the product and ensure
want the latest model. Recorder has a number of inventory has been correctly valued in
older models in inventory. accordance with IAS 2.

There is a probability that the NRV of the older

models may be less than the cost. According to
IAS 2 inventory must be valued at lower of cost or
NRV.

There is a possible risk that the inventory might

be overstated.
During the year the company introduced a bonus
based on sales for its sales persons. The bonus
target was based on increasing the number of
customers signing up for 24‐month phone line
contracts.

New costumer must be signed up by proper

assessment of their creditworthiness. If bonus is
attached to the
Recorder has a policy of revaluing its land and
buildings and this year has updated the
valuations of all land and buildings.
Audit Risk Auditor’s Response

Audit Risk Auditor’s Response