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ACCT 2161 Auditing

Revision guide Semester 2, 2015


When you use this revision guide, please remember these following rules:

This is just a guideline. It only intends to improve your revision process. Although it is meant
to give you some focus, it does not intend to cover everything in the exam.
You should refer primarily to other material, such as textbook, lecture notes and class
exercises. There will be some additional practical application exercises included in this
guide. However, please note that you are required to review and understand the weekly
exercises thoroughly (e.g the exercises in the weekly interteaching materials) as well as to
attempt these additional exercises.
When you use this guideline, try to understand the fundamental principles and please dont
try to memorize the information.

Topic 1 Overview of audit and assurance (Chapter 1)


After studying this chapter you should be able to:
1. Define an assurance engagement and the parties involved in an assurance engagement.
2. Differentiate between different types of assurance services (financial report audits, compliance
audits, performance audits, internal audits, CSR assurance)
3. Differentiate between the responsibilities of the preparer (those charged with governance) and the
auditor: refer to the content of the audit report for a detail of respective responsibilities
4. Understand and explain (using examples) the different types of audit opinions and the conditions
that that may result in different types of audit opinion. Be able to compare and contrast the
different types of audit reports (that contain different types of opinions).
Topic 2 Ethics, legal liability and client acceptance (Chapter 2)
After studying this chapter you should be able to:
1. Understand the fundamental principles of professional ethics (integrity, objectivity, professional
competence and due care, confidentiality, professional behaviour)
2. Define and understand auditor independence and why it is important.
3. Understand and be able to give examples of specific circumstances that may give rise to each of
the potential threats to independence (self-interest, self-review, advocacy, familiarity,
intimidation) as well as the available safeguards to address each of the threats (pp 54-56Moroney)
4. Explain the circumstances that may give rise to auditors liability to their client and to third
parties, and explain what auditors can do to avoid litigation.

ACCT 2161 Auditing


Revision guide Semester 2, 2015
Note: although you need to be able to explain legal concepts related to the liability of the auditor,
you do not need to remember the cases of law that established them
Topic 3 and 4 Audit planning (Chapter 3 and 4)
After studying this chapter you should be able to:
1. Identify the different stages of an audit (planning, execution, completion)
2. Explain the process used in gaining an understanding of the client (entity, industry and economy
level)
3. Fraud and error
Distinguish fraudulent financial reporting (management fraud) and misappropriation of
assets (employee embezzlements) and their effects on the financial statements
Identify circumstances which may indicate management frauds (red flags that indicate an
increased risk of fraud).
Understand how frauds and errors are of importance to an audit and understand the required
audit work in relation to detecting frauds and errors.
4. Explain the going concern assumption and its importance to auditors.
5. Define audit risk and its components (inherent risk, control risk, detection risk)
6. Describe the concept of materiality. Explain how materiality is used by the auditor (including
how materiality level would affect the planned audit procedures and how materiality at account
level or tolerable error would be used when auditing the accounts.
7. Explain the purpose(s) of using Analytical Procedures in Planning and describe the different
types of analytical procedures used in the planning stage (trend analysis, common-size analysis,
ratio analysis)
Topic 5 Audit evidence (Chapter 5)
After studying this chapter you should be able to:
1. Understand meanings of the management assertions related to classes of transactions
(occurrence, completeness, accuracy, cut-off, classification), balances (existence, rights and
obligations, completeness, valuation and allocation) and presentation and disclosures
(occurrence, rights and obligations, completeness, classification and understandability, accuracy
and valuation)
2. Define the meaning of persuasiveness (i.e sufficient and appropriate) of audit evidence.
AUDIT EVIDENCE

ACCT 2161 Auditing


Revision guide Semester 2, 2015
1) Explain the specific audit decisions to be made by the auditors (i.e reg. nature, timing
and extent of audit tests performed) in order to gain sufficient and appropriate audit
evidence.
- Explain the meanings of nature, timing and extent of audit testing.
- Explain the factors that may affect each of the above aspects of audit testing.
2)

Be able to rank the different types of evidence from the least to the most persuasive, i.e:
Internally generated evidence
Externally generated evidence held by the client
Externally generated evidence sent directly to the auditor

and explain the implication of this ranking in determining the persuasiveness of audit
evidence.
3) Understand and describe the types of audit evidence and evidence gathering procedures
Understand the nature and purpose of different types of evidence, their relative reliability, their
relative costs.
Physical evidence (inspection)
Confirmation
Documentary evidence
Representations (legal representation letter, management representation letter)
Observation
Verbal evidence (enquiry of the client)
Computational evidence (recalculation, re-performance)
Electronic evidence
Analytical procedures
and understand how the auditor applies these procedures to auditing specific accounts (e.g
Accounts receivable, inventory, sales, expenses)
Topic 7 Internal Control and Control risk (chapter 7)
After studying this chapter you should be able to:
1. Understand the control objectives to be met by the controls on classes of transactions and
describe how these control objectives (if satisfied) help ensure the truth and fairness of the
financial statements (i.e how are the objectives linked to the assertions of the financial accounts).
2. Understand and explain the objectives of internal control activities that are of interest to the
auditors.
3. Build a good background knowledge of:
o Internal controls at entity level
4. Understand specific controls required for the key business processes/transactions (sales &
despatch process, cash receipt process, cash payment process, purchase process). For each class
of transactions:

ACCT 2161 Auditing


Revision guide Semester 2, 2015
-

State the common key controls needed (that build up the strengths of an internal control
system)
Give examples of common evidence of those controls identified above (that allow for
verification/testing of those controls)
Be able to evaluate strengths and weaknesses of a particular control system in relation to
each of those classes of transactions.

Topic 8 and 9 Substantive procedures (Chapter 9, 10 and 11)


After studying this chapter you should be able to:
1. Define substantive audit procedures and be able to understand the common procedures used
when performing these tests (e.g specific documentation procedures such as vouching and
tracing, confirmation, physical count, physical observation, substantive analytical procedures
etc.)
2. Understand the link between the audit risk model and the nature, timing and extent of
substantive procedures for balance sheet and income statement accounts
3. Explain the different levels of audit evidence obtained when performing substantive procedures
(persuasive, corroborative, minimal).
4. Understand and be able to describe the main substantive procedures (referred to as tests that
are always performed in Moroney) to audit the specific balance sheet accounts e.g cash, trade
receivables, inventory, payables.
5. Understand why analytical procedures are important often used as the main tests for significant
income statement accounts such as revenue and costs of sales.
Topic 10 Completing the audit (Chapter 12)
After studying this chapter you should be able to:
1. Explain the needs of performing the typical audit procedures in the completion phase (e.g
engagement wrap-up, review for subsequent events). Understand and describe the key procedures
used in the completion phase.
2.

Be able to distinguish the two types of (material) subsequent events to determine what effect
they have on the financial report (if any)
Events that provide additional evidence with respect to conditions that existed a year-end
(bankruptcy of a debtor, insurance claim received on a pre-balance date disaster)
Events that provide evidence with respect to conditions that developed subsequent to
year-end (uninsured loss of plant or inventory, purchase of a business)

ACCT 2161 Auditing


Revision guide Semester 2, 2015
3. Understand (and give examples when appropriate) the circumstances giving rise to an unqualified
audit report with an emphasis of matter (note: an emphasis of matter is not a type of opinion, its
an additional paragraph that comes before the opinion).

Additional disclosures
Significant uncertainties
Inconsistent other information
Revised audit report on revised financial report

Practical application questions


Question 1
You are the auditor of Oak Pty Ltd, which is involved in the manufacture of quality wooden
furniture. One of the directors of Oak Pty Ltd has requested that you perform a review of the internal
controls within the purchases and payment cycle of the companys operations. From your discussions
with management and staff you ascertain that the company is a small operation and only has the
following staff:

Warehouse manager
Assistant to the warehouse manager
Four machinery operators who are involved in the manufacturing process
Accounts payable clerk
Banking clerk
Secretary/receptionist
Four directors (one of whom is responsible for the day to day operations of the company the executive director)

All operations are contained at one location


The warehouse manager is able to order from any supplier and will usually telephone a number of
suppliers to obtain quotes. The warehouse manager will then order from one of these suppliers by
telephone and confirm the order by facsimile. The only documentation kept is the facsimile
confirmation of order, which is kept by the warehouse manager.
Once the order is confirmed, the warehouse manager will complete a purchase order (PO). The
warehouse manager keeps one copy of the PO and signs the delivery note as evidence of this check.
The delivery note comprises two copies, one of which is retained by the persons delivering the goods
and the other by the warehouse manager.
The warehouse manager forwards a copy of the signed delivery note to the accounts payable clerk
who posts a journal entry to the creditors ledger for the amount shown on the delivery note. The
clerk then stamps the delivery note entered and files the delivery notes by supplier.

ACCT 2161 Auditing


Revision guide Semester 2, 2015
Required
a) Identify the strengths and weaknesses in Oak Pty Ltds internal control for the purchasing
area
b) What impact will your assessment of internal controls affects the risk to the
accounts/assertions on the financial statements?
Question 2
Assume your risk assessment procedures in relation to CocoNott Ltds business processes indicate
there is a risk that payments to suppliers are made prior to goods being received.
As part of your examination of the information system and related control activities, you note the
following process is in place in relation to payments:
A prenumbered cheque requisition is prepared by accounting staff for all payments
Accounting staff then perform the following procedures:
o Match the details on the suppliers invoice to the appropriate receiving report; and
o Match the details on the suppliers invoice and receiving report to an authorised
purchase order
The cheque requisition, together with the above supporting documents, is then forwarded to
the appropriate senior staff member for review and authorisation.
Assume that you intend to rely on controls over the payments function.
Required
1) Identify the internal control that address the risk of payments being made to suppliers before
the goods are delivered.
2) What assertions does this internal control address?
3) How might you test this control?
1)

2) Assertion
3) Test of control
Existence/accuracy
of
the Test the evidence of matching
purchase (accounts payable and the invoice to receiving report
inventory accounts)
(e.g initial/signature).
Same as above

Question 3
Consider each of the following material independent situations:
i)
You are auditing the sales and trade debtors of Eastern Block Limited (EB). All of
EBs customers are in Eastern Europe. Due to language differences, and the current
political situation in many countries, direct confirmation of debtors balances is
unlikely to give satisfactory results.

ACCT 2161 Auditing


Revision guide Semester 2, 2015
ii)

You are auditing the purchases and trade creditors at FE Pty Limited (FE). One of the
FEs major creditors is very slow in sending invoices for the goods delivered. Also,
owing to a quality control problem a large number of goods supplied to FE have been
deemed faulty and have had to be returned with a request for credit.

Required
a. Identify key assertion(s) at risk in relation to the balances described in each of the situations
above
b. Describe the audit procedures you would perform in order to gather sufficient, appropriate
audit evidence on each of these assertions.
(note: evidence is considered appropriate when they are appropriately designed to address
the some particular relevant assertions. The auditor is considered to have obtained sufficient
audit evidence when they have sufficient work (and no further evidence is necessary) to help
them confidently conclude on the accounts/assertions)

Question 4
You are a manager in the audit firm of Ali & Co; and this is your first time you have worked on
one of the firms established clients, Stark Co. The main activity of Stark Co is providing
investment advice to individuals regarding saving for retirement, purchase of shares and
securities and investing in tax efficient savings schemes. Stark is regulated by the relevant
financial services authority. You have been asked to start the audit planning for Stark Co, by Mr
Son, a partner in Ali & Co. Mr Son has been the engagement partner for Stark Co, for the
previous nine years and so has excellent knowledge of the client. Mr Son has informed you that
he would like his daughter Zoe to be part of the audit team this year; Zoe is currently studying for
her first set of fundamentals papers for her ACCA qualification. Mr Son also informs you that Mr
Far, the audit senior, received investment advice from Stark Co during the year and intends to do
the same next year. In an initial meeting with the finance director of Stark Co, you learn that the
audit team will not be entertained on Stark Cos yacht this year as this could appear to be an
attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less
than one-tenth of the expense of using the yacht and hopes this will be acceptable. The director
also states that the fee for taxation services this year should be based on a percentage of tax saved
and trusts that your firm will accept a fixed fee for representing Stark Co in a dispute regarding
the amount of sales tax payable to the taxation authorities.
Required:
(i)

Explain the ethical threats which may affect the auditor of Stark Co.

(ii)

For each ethical threat, discuss how the effect of the threat can be mitigated (in other
words, identify the possible safeguards for the threats identified.

ACCT 2161 Auditing


Revision guide Semester 2, 2015

Question 5
In the audit of Bright Chemicahs Ltd, a large public company, you have been assigned
responsibility for obtaining background information for the audit. Your firm is auditing the client
for the first time as a result of a dispute between Bright and the previous auditor over valuation of
work-in-progress inventory.
Bright Chemicals has been highly successful in the past two decades, primarily because of
successful mergers negotiated by Bert Randolph, the managing director and chairman of the
board. Even though the industry as a whole has suffered dramatic setbacks in recent years, Bright
has been able to secure strong earnings and growth until the last financial year when results
began to show a downturn. Randolph has hired an aggressive group of young executives by
combining modest salaries with an unusually generous profit-sharing plan.
A major difficulty you face in the new audit is that the computer software system installed five
years ago now has serious problems in handling and processing the increased volume of data.
Randolph believes that profits come primarily from intelligent and aggressive action based on
forecasts, not relying on historical data. Most of the forecast data are generated by the sales and
production department seem competent but are somewhat overworked and underpaid relative to
other employees. A recent change that will potentially improve record keeping is the progressive
installation of sophisticated new computer equipment. Not all the accounting records have been
changed to the new system as yet, but perpetual inventory and sales/accounts receivable modules
have been converted. Because of the serious problems with the old computer system software,
the old and new inventory/sales systems were not run in parallel before implementing the new
system and discarding the old one. Most the computer time is being reserved for production and
marketing, as Randolph considers that these areas are more essential to operations than
bookkeeping.
The first six months financial statements for the current year include a profit that is only about
10% less than the first six months of the preceding year, which is somewhat surprising
considering the reduced sales volume and the disposal of a segment of the business. Mercury
Supplies Pty Ltd. The disposal of this segment was considered necessary because it had become
increasingly unprofitable over the previous four years. At the time of its acquisition from Roger
Randolph, who is a brother to Bert Randolph, the company was highly profitable and was
considered a highly desirable purchase. The main customer of Mercury Supplies was Saturn
Holding Ltd, a company owned by Roger Randolph. Gradually, the market for Mercury products
declined as Saturn Holdings Ltd began diversifying and phasing out its primary products in
favour of more profitable business. Saturn Holdings is no longer buying from Mercury, so Bright
had no option but to sell Mercury.
According to financial analysts, the main difficulties facing Bright are severe under-financing
and a pending legal case arising from employee health problems at one of the chemical

ACCT 2161 Auditing


Revision guide Semester 2, 2015
production plants. Cash flow is also tight because of an excessive amount of current and longterm debt because of the depressed capital markets. Management is reluctant to obtain equity
capital at this point because the increased number of shares would decrease the earnings per
share by more than 10%. At present, Randolph is negotiating with several cash-rich companies in
the hope of being able to merge with them as a means of overcoming the capital problems and
restoring liquidity.
Required
a. List the main concerns (representing inherent risks) you should have in the audit of Bright
Chemicals and explain why they are potential problems.
b. Identify the accounts that may have been affected by the above risks and explain how such
accounts may be affected.
Question 6
Shiny Happy Windows Co (SHW) is a window cleaning company. Customers windows are cleaned
monthly, the window cleaner then posts a stamped addressed envelope for payment through the
customers front door.
SHW has a large number of receivable balances and these customers pay by cheque or cash, which is
received in the stamped addressed envelopes in the post. The following procedures are applied to the
cash received cycle:
1. A junior clerk from the accounts department opens the post and if any cheques or cash have been
sent, she records the receipts in the cash received log and then places all the monies into the locked
small cash box.
2. The contents of the cash box are counted each day and every few days these sums are banked by
which ever member of the finance team is available.
3. The cashier records the details of the cash received log into the cash receipts day book and also
updates the sales ledger.
4. Usually on a monthly basis the cashier performs a bank reconciliation, which he then files, if he
misses a month then he catches this up in the following months reconciliation.
Required:
For the cash cycle of SHW:
(i) Identify and explain THREE deficiencies in the system;
(ii) Suggest controls to address each of these deficiencies; and list tests of controls the auditor of
SHW would perform to assess if the controls are operating effectively.

ACCT 2161 Auditing


Revision guide Semester 2, 2015
Note: Together with this revision guide, you should conduct a thorough review of the Interteaching
questions as well. Together with understanding the theoretical concepts specified above, focus on the
practical application questions, in particular try to understand the methodology for answering them.