Q1

It is 1 July 20X5. You are a manager in the audit department of Stanley Associates, a firm of Chartered
Certified Accountants, responsible for the audit of the Hammer Group (the Group) for the year ending 30
September 20X5. The Group, which is not a listed company, operates a number of hardware stores
which supply trade customers and the public.

Your firm audits all components of the Group, including a foreign subsidiary acquired during the year.

The following exhibits, available on the left-hand side of the screen, provide information relevant to the
question:

1.Partner’s email – an email which you have received from Paula Sanders, the audit engagement
partner.

2.Group structure and activities – outline of the Group structure and activities relevant to audit planning.

3.Financial information – extracts from the projected consolidated financial statements.

4.Business developments – information relevant to audit planning.

5.Additional services – details in relation to services which Stanley Associates has been asked to
perform.

This information should be used to answer the question requirement within your chosen response
option(s).
Exhibit 1. Partner’s email

To: Audit manager

From: Paula Sanders, Group engagement partner

Subject: Hammer Group – audit planning

Date: 1 July 20X5

Hello

I met with the Group finance director, yesterday, along with representatives from the Group audit
committee. We discussed the Group’s activities during the year, and its plans to expand into further
international markets next year. They also provided me with some extracts from the projected
consolidated financial statements and a selection of key performance indicators. I have also provided you
with some background information about the Group to assist with planning the audit.

Based on the analysis which I have done on this industry, it is appropriate for overall materiality to be
based on revenue. You will need to determine and apply an appropriate materiality threshold in your
briefing notes.

Using the information below, I require you to prepare briefing notes for my use in which you:

(a) Evaluate the business risks faced by the Group.

(10 marks)

(b) Evaluate and prioritise the risks of material misstatement to be considered in planning the audit of
the Group.

(16 marks)

Note: You should refer to Exhibits 2, 3 and 4 when carrying out the requested risk evaluations.

(c) Using Exhibit 4, design the principal audit procedures to be performed in respect of the expenditure
relating to the store enhancement programme.

(7 marks)

(d) Using Exhibit 5, discuss any ethical issues arising, and recommend any actions which need to be
taken.

(7 marks)

Thank you.
Exhibit 2. Group structure and activities

The Group operates a number of large hardware stores within the domestic market. The stores supply
building materials and equipment to the public and to builders. The Hammer brand, which is internally
generated and not recognised in the consolidated statement of financial position, is key to the Group’s
success. One of the Group’s subsidiaries, Wrench Co, is a financial services company specialising in
providing savings accounts and loans to individuals.

(1) Mallet Co is a wholly owned subsidiary and operates the ‘Hammer’ stores. It generates the majority of
the Group’s income. Mallet Co owns 50 retail stores across the country. Mallet Co has been involved
in a price war with another national hardware store during the year offering significant discounts and
heavily marketing the Hammer brand in an attempt to increase market share.

(2) Ladder Co is an overseas subsidiary situated in Farland. The Group obtained a 65% shareholding in
October 20X4 for cash consideration of $82 million. The share purchase was financed partly using a
$32 million bank loan with a variable interest rate which was taken out in October 20X4 and partly
through the Group’s existing cash reserves. The bank loan has covenants attached to it in relation to
interest cover and gearing.

The purpose of the acquisition was to expand the Group’s operations into a new geographical market.
This is the first overseas investment made by the Hammer Group. Ladder Co owns 50 hardware
stores in Farland. The 35% non-controlling interest in Ladder Co is owned by the government of
Farland due to a regulatory requirement that at least that proportion of a company’s share capital is
government owned. The currency in Farland is the same as the country in which the Group is based.

Your firm was appointed as auditor of Ladder Co in October 20X4, and several members of the audit
team have travelled to Farland to become familiar with the company, its key management personnel
and its regulatory environment. Farland does not mandate the use of IFRS® Accounting Standards,
and Ladder Co’s individual financial statements are prepared using Farland’s national accounting
standards.

(3) Wrench Co is the financial services company of the Group, operating the Hammer Bank. Its
customers are mostly trade customers who obtain credit and loans to finance long-term building
projects. In the last year, the financial services regulator has been investigating many banks for
charging excessive fees to customers in relation to loans, meaning that customers can claim back
the excessive fees they have been charged. Wrench Co has received legal claims from more than
25,000 customers in respect of this, and the Group recognises a provision of $22 million in its
statement of financial position.
Exhibit 3. Financial information

Extracts from the projected consolidated financial statements, including notes, for the year ending 30
September 20X5, and comparative information are included below.

Note 1: Exceptional items are those determined by management to be non-recurring. In 20X5,

The exceptional items in the prior year were audited in 20X4 and no exceptions were noted.The
executive directors each earn an annual bonus which is based on annual increases in operating profit
before exceptional items.

Note 2: Inventories include materials such as painting and decorating materials, timber and doors, as
well as tools and equipment for use by professional builders and customers planning to improve their
homes (‘do it yourself’ or ‘DIY’ customers). Inventories are measured in accordance with IAS® 2
Inventories. The Group operates a stocktake once a year on 30 September in their stores.
Exhibit 4. Business developments

Store enhancement programme

In February 20X5, the Group started a programme of extending and renovating all 25 of Mallet Co’s
larger hardware stores which will become ‘destination stores’, and each will have a café or restaurant.
The programme is expected to cost $5·75 million per store. At any one time, five stores are closed while
the renovation and necessary construction work takes place and on average a store will be closed for two
months while the work is carried out. The Group considers this programme to be extremely important to
strengthening the brand and maintaining market share.

The costs relating to the store enhancements included in the statement of profit or loss, which are
projected to total $65 million by the financial year end, will be separately disclosed as an exceptional item
in the Group statement of profit or loss.

In addition to the $65 million included in the statement of profit or loss, $55 million will be capitalised
within property, plant and equipment by the financial year end, including expenditure in relation to:

– Extending car parking facilities including acquisition of land

– Constructing new facilities such as cafés

– Redecorating the stores’ exteriors and interiors

– Purchase and installation of shelving

– Labour costs, including some of the Group’s own employees

Sales promotions

In response to the actions of a major competitor, the Group introduced several sales promotions during
the year. The promotions include heavily discounted product lines and ‘buy one get one free’ offers,
mainly applied to the Group’s paint and wallpaper lines.
Exhibit 5. Additional services

The Group, while not listed, follows best practice corporate governance principles by having an effective
internal audit department which reports to an audit committee of independent non-executive directors.

(1) Investment advice: The Group is now considering further international investments in the next few
years, and the Group audit committee has asked your firm to provide advice on the selection of
target companies and the financing of any investments which take place. A fee has been proposed for
providing this service amounting to 75% of the audit fee.

(2) Consolidation adjustments: As the Group finance director does not have the expertise to complete
the conversion from Farland Accounting Standards to IFRS Accounting Standards, your firm has been
approached for assistance in this matter. They have requested that, as part of the audit, your firm
makes the necessary adjustments to apply IFRS Accounting Standards to Ladder Co5’s financial
statements, and then to consolidate the Group financial statements.

Requirement (50 marks)

Respond to the instructions in the email from the audit engagement partner.

Note: The split of the mark allocation is shown in Exhibit 1 - Partner's email.

(40 marks)

Professional marks will be awarded for the demonstration of skill in communication, analysis and
evaluation, professional scepticism and judgement, and commercial acumen in your answer.

(10 marks)
Q2

It is 1 July 20X5. You are a manager in the forensic department of Aster & Co, a firm which provides audit
and a range of other services to its clients.

You have received a request from Baker Co to perform an engagement in relation to an insurance claim
which the company is going to submit. The insurance claim is in respect of a payroll fraud which was
recently discovered at the company.

This engagement would be conducted as an agreed upon procedures engagement to quantify the loss to
be claimed.

Baker Co is not listed and is not currently an audit client of your firm. The company manufactures medical
supplies for sale to hospitals. Baker Co is wholly owned by a foreign trust, the beneficiaries of which
include the current board of directors. A trust is a legal entity that owns cash or other assets or
investments on behalf of another entity or individuals.

Baker Co is well respected in the medical sector and routinely donates 5% of annual profits to global
healthcare charities.

The following exhibit, available on the left-hand side of the screen, provides information relevant to
requirements a and b of the question:

1. Outline of fraud – details of the request from Baker Co.

This information should be used to answer the question requirements within the response
option provided.
Exhibit 1. Outline of fraud

The payroll fraud was discovered following the commencement of an upgrade to the company’s
management information system. When the system was upgraded at the head office in June 20X5,
analysis performed highlighted an anomaly in the staff costs and margins for the head office. The
regional offices will receive the upgrade over the next three months.

The finance director has reviewed the payroll list for the head office and identified two names on the list
which they know are people who have left the company. Both individuals left the company in 20X3 but
have not been removed from the payroll records. These people are still being paid but the monthly
payments are being made into the same bank account, the beneficiary of which is not yet known.
Over the two years since they left, the finance director has calculated that $30,000 in total has been paid
into the unidentified bank account.

The finance director is not sure if this is the full extent of the issue or if further fraudulent activity exists
across payroll. The losses are expected to be covered by the company’s insurance policy, however, this
requires an independent firm to be used to quantify the loss for the purposes of the claim.

Baker Co wishes to submit this claim within the next three weeks so that it can be resolved prior to the
annual shareholder meeting on 1 August 20X5.

Requirements (25 marks)

With reference to Exhibit 1:

(a)(i) Evaluate the matters in respect of quality management which should be considered by Aster
& Co before accepting the engagement; and

(10 marks)

(a)(ii) Explain the specific aspects of the terms of engagement which should be agreed.

Note: You should NOT consider aspects relating to any police investigation in part (a)(i).

(4 marks)

It is now 10 July 20X5 and your firm has accepted the engagement.

(b) Recommend the procedures to be performed to quantify the loss for the purpose of the
insurance claim.

(6 marks)

Professional marks will be awarded for the demonstration of skill in analysis and evaluation, professional
scepticism and judgement, and commercial acumen in your answer.

(5 marks)
Q3

It is 1 July 20X5. You are an audit manager in Cottrell & Co, a firm of Chartered Certified Accountants
responsible for the audit of Sunningdale Co, for the year ended 31 March 20X5.

The audit of the financial statements for the year ended 31 March 20X5 is nearing completion and you
are preparing for a meeting with management about misstatements identified as a result of audit
procedures in the financial statements.

The following exhibit, available on the left-hand side of the screen, provides information relevant to the
question:

1.Audit working papers – matters noted for your attention by the audit supervisor.

This information should be used to answer the question requirements within the response option
provided.

Exhibit 1. Audit working papers

Sunningdale Co is an online furniture manufacturer and retailer. The financial statements recognise
revenue of $6·5 million (20X4 - $5·9 million), profit before tax of $1·2 million (20X4 - $1·1 million) and
total assets of $18 million (20X4 - $20·5 million). Materiality has been set at $40,000.

Sunningdale Co has profit targets to meet as part of the covenants on their bank loan financing which is
for profit before tax to increase by 6% on the prior year levels. The bank loan would not be repayable
immediately in the event of a breach of the covenants, but Sunningdale Co would have two years to
rectify any breaches. Sunningdale Co has not breached any financial covenants since taking out the
loan.

The audit working papers contain the following schedule of uncorrected misstatements:

(i) Investment properties

During the year, Sunningdale Co adopted the fair value model for its investment properties for the
first time and the valuation exercise was carried out by a qualified and experienced professional
valuation expert as at 31 March 20X5. The valuation showed that all but one of the investment
properties had a value above their carrying amounts. The exception is an investment property which
has a value $25,000 below its carrying amount. The directors are refusing to adopt the fair value
model for this investment property, but have accounted for the revaluation gains for the other three
investment properties correctly in the statement of profit or loss.

(ii) Specialist manufacturing equipment

In addition to revaluing the investment properties, the management of Sunningdale Co has decided
to increase the useful life of the specialist manufacturing equipment by five years as the finance
director believes this more accurately reflects the value of the equipment over its life. The financial
controller has recalculated the carrying amounts and depreciation from the date when each item of
specialist manufacturing equipment was originally capitalised and accounted for a journal in the 20X5
financial statements for the entire difference in cumulative depreciation starting from the date of
original purchase. The change of useful life has resulted in a journal debiting accumulated
 depreciation for total of $180,000 with $140,000 of this adjustment relating to changes calculated to
brought forward accumulated depreciation at 1 April 20X4. The journal has been recognised in the
statement of profit or loss for 20X5.

(iii) Gift of cars to members of director’s family

As part of the review of the depreciation policy, it was found that Sunningdale Co gifted two company
cars to the son and daughter of one of the company’s directors, David Fisher. David Fisher’s son and
daughter do not currently and have never been employed by Sunningdale Co and no payment was
requested or received for the vehicles. The carrying amount of the motor vehicles was $35,000 and
the transactions were correctly accounted for with a loss on disposal being recognised of $35,000.
No disclosure has been made for the transactions.

Requirements (25 marks)

(a) Evaluate the matters which should be discussed with management in relation to each of the
unresolved issues, and recommend the further actions necessary prior to issuing the auditor’s
report.

(16 marks)

It is now 1 September 20X5 and the auditor’s report on the financial statements for the year ended 31
March 20X5 is due to be issued in the next few days. You are considering the form and content of the
auditor’s report.

Following discussions with management and confirming that appropriate adjustments have been made to
the financial statements, you are satisfied that the investment property is now accounted for correctly.

However, management has indicated that they are not willing to make any further adjustments to the
financial statements in relation to the remaining two issues.

(b) Assuming that management does not make any further adjustments to the financial
statements, justify an appropriate audit opinion and explain the aggregate impact of both
misstatements on the auditor’s report.

Note: You should not consider the individual impact of the issues on the auditor's report.

(4 marks)

Professional marks will be awarded for the demonstration of skill in analysis and evaluation, and
professional scepticism and judgement in your answer.

(5 marks)