THE PROFESSIONALS ACADEMY OF COMMERCE

Auditing
(Suggested Answer)
(Mock Exam Autumn 2013)

Q#1:
Part a)
Following are the threats that may affect the independence of the Zafar Imad and Cos audit of the Orange
Financials
i.

Orange Financials Co (Orange) has asked the engagement partner of Zafar Imad and Co, Chartered
Accountants to attend meetings with potential investors. This represents an advocacy threat as the audit
firm may be perceived as promoting investment in Orange and this threatens objectivity.

ii.

Orange has requested that Zafar Imad and Co, Chartered Accountants produce the financial statements.
This represents a self-review threat. Orange is seeking a listing and therefore these financial statements
will be critical to the potential investors and this increases audit risk.

iii.

The assistant finance director of Orange has joined Zafar Imad& Co as a partner and has been proposed as
the review partner. This represents a self-review threat, as he was in a position to influence the financial
statements whilst working at Orange; if he is the review partner there could be a risk of him reviewing his
own work.

iv.

Orange has several potential assurance assignments available and Zafar Imad and Co, Chartered
Accountants wish to be appointed to these. There is a potential self-interest threat as these assurance fees
along with the external audit fee could represent a significant proportion of Zafar Imad & Cos fee income

v.

Orange has implied to Zafar Imad and Co, Chartered Accountants that they must complete the audit quickly
and with minimal questions/issues if they wish to obtain the assurance assignments. This creates an
intimidation threat on the team as they may feel under pressure to cut corners and not to raise the issues that
could compromise the objectivity of the audit team.

vi.

The finance director has offered the team a free weekend away at a luxury hotel. This represents a selfinterest threat as the acceptance of goods and services, unless insignificant in value, is not permitted.
(One mark per threat identified)

Part b)
Following are the measures that could reduce the threats to an acceptable level
i.

The engagement partner should politely decline this request from Orange to attend meeting with potential
investors, as it threatens the independence.

ii.

Ideally, ZafarImad and Co, Chartered Accountants should not undertake the preparation of the financial
statements. Due to the imminent listing, this would probably represent high risk. If ZafarImad and Co,
Chartered Accountants chooses to produce the financial statements then separate teams should undertake
each assignment and the audit team should not be part of the accounts preparation process.

iii.

This partner must not be involved in the audit of Orange for a period of at least two years and an alternate
review partner should be appointed.
Page 1 of 7

iv.

The firm should assess whether these assignments along with the audit fee represent major portion of its
income. If this is the case then additional consideration should be given as to whether these assignments
should be sought by the firm

v.

The engagement partner should politely inform the finance director that the team will undertake the audit in
accordance with all relevant ISAs and their own quality control procedures. This means that the audit will
take as long as is necessary to obtain sufficient, appropriate evidence to form an opinion. If any residual
concerns remain or the intimidation threat continues then Zafar Imad and Co, Chartered Accountants may
need to consider resigning from the engagement.

vi.

As it is unlikely that a weekend at a luxury hotel for the whole team has an insignificant value, then this
offer should be politely declined.
(One mark per threat response)

Answer #2:
Part a)
Acceptance of the premise, relating to the responsibilities of the management and, where appropriate, those charged
with governance, is a precondition of audit acceptance. ISA 210 requires that the auditor shall obtain the agreement
of management that it acknowledges and understands its responsibility:
(i) For the preparation of the financial statements in accordance with the applicable Financial reporting
framework, including where relevant their fair presentation;
(ii) For such internal control as management determines is necessary to enable the preparation of financial
statements that are free from material misstatement, whether due to fraud or error; and
(iii) To provide the auditor with:
a) Access to all information of which management is aware that is relevant to the preparation of the
financial statements such as records, documentation and other matters;
b) Additional information that the auditor may request from management for the purpose of the
audit; and
c) Unrestricted access to persons within the entity from whom the auditor determines it necessary
to obtain audit evidence.
Marking scheme: Total Six points (including sub points). One mark for each correct point.
Part b)
For audits of financial statements of listed entities, the engagement quality control reviewer, on
performing an engagement quality control review, shall also consider the following:
(a) The engagement teams evaluation of the firms independence in relation to the audit
engagement;
(b) Whether appropriate consultation has taken place on matters involving differences
of opinion or other difficult or contentious matters, and the conclusions arising from those
consultations; and
(c) Whether audit documentation selected for review reflects the work performed in
relation to the significant judgments and supports the conclusions reached.
For audits of financial statements of listed entities, and those other audit engagements, if any, for
which the firm has determined that an engagement quality control review is required, the engagement
partner shall:
(a)

Determine that an engagement quality control reviewer has been appointed;

(b) Discuss significant matters arising during the audit engagement, including those
identified during the engagement quality control review, with the engagement quality control
reviewer; and
Page 2 of 7

(c)

Not date the auditors report until the completion of the engagement quality control review.
Marking scheme:1 mark for each point

Q#3:
Part a)
Audit riskThe risk that the auditor expresses an inappropriate audit opinion when the financial statements are
materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.(Mark1)
Financial statement risk: Another name of Risk of material misstatements (i-e Inherent risk and control risk
combined).
(Mark1)
Part b)
Objective of an audit:
The purpose/objective of an audit is to enhance the degree of confidence of intended users
in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial
statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.
(Mark1)
Scope of an audit:
The scope of an audit refers to the audit procedure deemed necessary for;
i)

Auditors opinion on the financial statements as to whether the financial statements are
prepared, in all material respects, in accordance with the applicable financial reporting
framework.
(Mark1)

ii)

Providing opinions on other specific matters, such as the effectiveness of internal control,
or the consistency of a separate management report with the financial Statements, in cases,
law or regulation require auditors to report on that.
(Mark1)

Part c)
Depth test, also referred as walkthrough tests or cradle to grave test, referred to tracing a few transactions through
the financial reporting system.
(Mark1)
Teeming and lading is a fraud used to misappropriate cash carried out through book keeping. It involves the
allocation of one customer's payment to another in order to make the books balance and often in order to detract
from a possible shortfall. This process is often continued until it gets discovered. It is also known as short
banking or delayed accounting or lapping.
(Mark1)

Part d)
Business risk A risk resulting from significant conditions, events, circumstances, actions or inactions that could
adversely affect an entitys ability to achieve its objectives and execute its strategies, or from the setting of
inappropriate objectives and strategies.
(Mark1)
Significant risk An identified and assessed risk of material misstatement that, in the auditors judgment, requires
special audit consideration.
(Mark1)
Q #4:
Auditors use the concept of performance materiality, as mentioned in ISA 320 Materiality in planning and
performing of an audit to reduce the probability, that the aggregate of uncorrected and undetected misstatement in
financial statements do not exceed the materiality for the financial statement as a whole.
(Mark 1)

Page 3 of 7

Performance materiality;
When an audit is planned solely to detect individually material misstatements, it overlooks
the fact that the aggregate of individually immaterial misstatements may cause the financial statements to be
materially misstated, and leaves no margin for possible undetected misstatements. The concept of Performance
materiality (materiality for practical purposes which is set at lower level than the materiality for the whole financial
statements ) is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements in the financial statements exceeds materiality for the financial statements as a whole.
(Marks 4. Award marks based on clarity of concept)
Similarly, performance materiality relating to a materiality level determined for a particular class of transactions,
account balance or disclosure is set to reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements in that particular class of transactions, account balance or disclosure
exceeds the materiality level for that particular class of transactions, account balance or disclosure. (Marks 2)
Q#5:
Part a)
a) Assertions which will be tested includes:
Occurrence
Completeness
Rights and Obligation
Accuracy
Cut-off
Marking scheme: 0.5 marks for each point.
b) It represents a Preventive control. As these are the controls implemented by the company to keep a
problem from occurring.
(1 mark)
c) Matching of Receiving Reports with Purchase order and Sales invoice is an application control. Further
production of list of unmatched items is also an application control.
(1mark)
Part b)
a) Test of Controls
b) Analytical Procedures
c) Dual Purpose
d) Test of Controls/ Test of Account Balances
(One mark per correct answer)
Q#6:
Appendix 1 to the ISA 240 relating to Fraud mentions the following as the attitude/rationalization for
Fraud;
i)

Known history of violations of securities laws or other laws and regulations, or claims against the
entity, its senior management, or those charged with governance alleging fraud or violations of laws
and regulations.

ii)

Excessive interest by management in maintaining or increasing the entitys stock price or earnings
trend.

iii)

The practice by management of committing to analysts, creditors, and other third parties to achieve
aggressive or unrealistic forecasts.

iv)

Management failing to remedy known significant deficiencies in internal control on a timely basis.

v)

An interest by management in employing inappropriate means to minimize reported earnings for taxmotivated reasons.

vi)

Low morale among senior management.

vii)

The owner-manager makes no distinction between personal and business transactions.

Page 4 of 7

viii)

Dispute between shareholders in a closely held entity.

ix)

Recurring attempts by management to justify marginal or inappropriate accounting on the basis of

materiality.

x)

Communication, implementation, support, or enforcement of the entitys values or ethical standards by

management, or the communication of inappropriate values or ethical standards, that are not effective.

xi)

Nonfinancial managements excessive participation in or preoccupation with the selection of

accounting policies or the determination of significant estimates.
(One mark per one point to the maximum of 8)

Q#7:
Part a)
The objectives of internal audit functions vary widely and depend on the size and structure of the entity and the
requirements of management and, where applicable, those charged with governance. The activities of the internal
audit function may include one or more of the following:
a) Monitoring of internal control. The internal audit function may be assigned specific responsibility for
reviewing controls, monitoring their operation and recommending improvements thereto.
b) Examination of financial and operating information. The internal audit function may be assigned to
review the means used to identify, measure, classify and report financial and operating information,
and to make specific inquiry into individual items, including detailed testing of transactions, balances
and procedures.
c) Review of operating activities. The internal audit function may be assigned to review the economy,
efficiency and effectiveness of operating activities, including non-financial activities of an entity.
d) Review of compliance with laws and regulations. The internal audit function may be assigned to review
compliance with laws, regulations and other external requirements, and with management policies and
directives and other internal requirements.
e) Risk management. The internal audit function may assist the organization by identifying and evaluating
significant exposures to risk and contributing to the improvement of risk management and control
systems.
f) Governance. The internal audit function may assess the governance process in its accomplishment of
objectives on ethics and values, performance management and accountability, communicating risk and
control information to appropriate areas of the organization and effectiveness of communication among
those charged with governance, external and internal auditors, and management.
(One mark per point to the maximum of 5)
Part b)
ISA 610 Using the work of internal auditor describes the following tests/points to assess the OBJECTIVITY of
internal auditor;
a. The status of the internal audit function within the entity and the effect such status has on the ability of the
internal auditors to be objective.
b) Whether the internal audit function reports to those charged with governance or an officer with appropriate
authority, and whether the internal auditors have direct access to those charged with governance.
c) Whether the internal auditors are free of any conflicting responsibilities.
d) Whether those charged with governance oversee employment decisions related to the internal audit
function.
e) Whether there are any constraints or restrictions placed on the internal audit function by management or
those charged with governance.
f) Whether, and to what extent, management acts on the recommendations of the internal audit function, and
how such action is evidenced.
(One mark per point to the max of 5)
Page 5 of 7

Q#8:
Audit programs
Part a)
Customer deposits:
i)
Obtain a listing of individual deposits
ii)
Compare the total of the list with general ledger.
iii)
Obtain confirmation from customer.
iv)
Check subsequent settlement.
(One mark per valid step of the audit program- Max 4)
Part b)
Stock held by third party:
The auditor would obtain direct confirmation from third party as to the quantities and condition of inventory held
on behalf of the entity. Depending on the materiality of this inventory the auditor will also consider:
i)
Integrity and independence of third party
ii)
Observing and arranging to observe physical inventory count.
iii)
Obtaining another auditor report on the adequacy of third party internal control for ensuring inventory
is correctly counted and adequately safeguarded.
iv)
Inspect documentation regarding inventory held by third parties.
(One mark per valid step of the audit program- Max 5)
Part c)
Contingent liabilities;
i)
Inspect minutes of the directors
ii)
Examine correspondence with company lawyers
iii)
Obtain written representation for the contingent liabilities
iv)
Ensure compliance with the requirement of IAS 37, especially recognition criteria
v)
Verify subsequent payment.
(One mark per valid step of the audit program- Max 5)
Q#9:
Materiality calculation:
Despite variation in different method and consideration of different factor and the use of professional
judgment by auditor, a suitable percentage of total assets, or turnover or net profit is often considered as a standard
benchmark for materiality.
Generally 1-2% of total assets, or 0.5 to 1% of turnover, or 5-10% of profit after tax is taken as a basis.
Eye-deology Garments materiality level:
Basis
Lower level
Total assets
535,677
Turnover
478,386
Profit before tax
517,267

Higher level
1,071,340
956,772
1,034,534

Based on the level of risk assessed materiality can be decided between 0.5 million to 1.0 million. We assume Rs
750,000 materiality level as the mean of the two figures.
Marker note: Allow for variation in methods for materiality calculation. Allow any single basis as
well.[Marks 2]
Part a)
IAS 2 requires that inventory be valued at lower of cost and NRV. IAS 2 outlines a number of methods in arriving
at cost in the absence of satisfactory costing system. One such method is the use of a selling price less an estimated
profit margin. This method is permitted only if it can be shown that the method gives a reasonable approximation of
cost. In the absence of any information to the contrary, we assume this to be satisfactory.
(Mark 1.5)
Page 6 of 7

ISA 501 required that if an inventory cannot be physically verified, then the auditor shall perform alternative audit
procedures to obtain sufficient appropriate evidence. In this case neither we were able to physically verify the
inventory nor were we able to perform alternative audit procedure. Hence this is a case of limitation of scope.
(Mark 1.5)
The amount of inventory which we were unable to verify is 10% of the total inventory (valuing Rs 10,265,000)
equals toRs 1,026,500. As, this amount is greater than the materiality level set for the financial statement taken as a
whole. Therefore, we need to assess whether its impact is pervasive on the financial statement as a whole or is
limited to a specific section of the financial statement.
(Marks 2)
ISA 705 provides two possibilities in case of a limitation of scope.
If the effect of the limitation is material but not pervasive An except for qualified report is issued.
If the effect of the limitation is material and pervasive A disclaimer of opinion report is issued. (Mark 1)
In this case, the effect of the limitation of scope, relates to inventory whose impact is limited to two areas
inventory and Gross/net profit. Therefore, an except for qualification will be appropriate.
(Mark 1)
Part b)
The company offers return policy of 28 days. And experience has shown that 2% of the sales are returned by
customer. Therefore it is not prudent on the part of the company not to record provision for the sales return/ stock
return or provision against profit instead if the amount involved is not material.
(Marks 1)
The company total turnover is Rs 95,677,300, which is uniformly distributed. Therefore the last 28 days sales is
equal to 28x95,677,300/365= 7,339,628. Out of this 2% return is expected. That is equal to Rs 146,792. (Marks 2)
As this amount is significantly lower than the materiality for the financial statement as a whole, therefore, an
unqualified report would be appropriate.
(Mark 1)
Alternatively: Subsequent events will determine the exact impact of not recording the provision. By comparing the
exact impact to materiality a more considered judgment can be made.
(1 Mark)
Q#10:
Part a) Eligible and not disqualified. Being director of an associate is not prohibited from acting as auditor.
Part b)Eligible and not disqualified. Investment by brother of auditor is not prohibited. What is prohibited is
investment by auditor, spouse and his minor children. To be precise, they are required to divest shares within 90
days once the person is appointed auditor.
Part c) not eligible. A body corporate is not permitted to be the auditor of a company.
Part d)not eligible. Separated wife is a wife, i.e. a spouse. The spouse a director is not eligible to act as auditor.
(2 Marks per correct answer)

(The End)

Page 7 of 7