SCHOOL OF ACCOUNTING

MOCK EXAM

Course:

ACCT 1111 AUDITING AND ASSURANCE SERVICES

EXAMINERS SOLUTIONS

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ACCT 1111 AUDITING AND ASSURANCE SERVICES SOLUTIONS MOCK EXAM

SECTION A
QUESTION ONE Financial report audits are needed to provide an assurance that the financial information is relevant and reliable. Four factors that contribute to the need for independent audits are: a) b) c) d) conflict of interest, consequence, complexity, and remoteness.

QUESTION TWO The element of materiality implies importance relative or absolute and the materiality of an item may be dependant upon its nature or its size, or both. Materiality is not a universally quantifiable concept; it must be determined in light of professional judgement on a case-by-case basis. There is some general agreement however that materiality should be based on what would influence the users of financial statements. Materiality may depend on either quantitative or qualitative characteristics, often on a combination of both. Auditors generally view materiality in terms of its importance in the context of presenting fairly, primarily in quantitative terms, the financial position, results of operations, and changes in financial position for an enterprise in conformity with generally accepted accounting principles. In assessing a matters importance, auditors consider its nature as well as its relative magnitude and relative financial effect, either singly or cumulatively, in light of the surrounding circumstances.

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QUESTION THREE Conditions or events that increase the risk of fraud or error are: doubt as to the integrity or competence of management; unusual pressures within an entity; unusual transactions; problems in obtaining sufficient appropriate audit evidence; and weaknesses in internal control.

If the auditor suspects fraud they should extend the scope of their examination to either dispel or confirm their beliefs. The auditor should consider the potential effect of the fraud on the financial statements. The auditor should report their findings to the appropriate level of management, such level depending on the circumstances. Such reporting should be on an urgent basis. QUESTION FOUR Negligence can be classified as any conduct that is careless or unintentional in nature and entails a breach of any contractual duty or duty of care in tort owed to another person or persons. To be successful in a claim for negligence, a plaintiff must prove that: Duty was owed to the plaintiff by the defendant (duty of care) A breach of the duty of care (negligent conduct) occurred Loss or damage was suffered by the plaintiff A causal relationship existed between the breach of duty by defendant and harm suffered by the plaintiff.

QUESTION FIVE carry out a circularisation of debtors review cut off procedures to ensure all accounts are recorded in the correct year. perform audit tests on a sample of invoices to determine accuracy of the accounts. review doubtful debts to ensure accuracy of the valuation of debtors review correspondence file for accounts in dispute. discuss with management whether there are any concerns regarding payment of debts. review aging of debtors. review prior years balances. perform an analytical review.

QUESTION SIX Because of the test nature of the audit function auditors only examine a certain percentage of the population under examination. The accounts are subjective in the first place.
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Because of the inherent limitations of an audit.

QUESTION SEVEN The audit risk model expresses the relationship among the audit risk components as follows: AR = IR x CR x DR where AR = audit risk, which is the risk that the auditor gives an inappropriate audit opinion when the financial report is materially misstated. IR CR DR = Inherent risk = Control risk = Detection risk

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SECTION B
PRACTICAL APPLICATION QUESTIONS Section B totals 50 marks. Answer all questions. QUESTION ONE a) The auditor would carry out an inventory count to verify the assertion that the inventory exists and that it might be at the correct valuation. b) Some of the weaknesses in control include the following: The security of the store is questionable. The store should be locked at all times. Documents for acquisition of the store needs to be restricted to a number of authorised personnel. The quantity and quality of goods received at the store should always be checked on delivery. Regular counts should be made of stock to identify any discrepancies.

c) The procedures that the auditor should follow in identifying obsolete stock include: identifying slow moving stocks. identifying stocks where withdrawals have not been made for a significant time. discuss with production department the use of raw material. have an expert review existing stock. question management regarding obsolete stocks.

d) The actions the auditor should take are as follows: Prepare a management letter outlining the weaknesses and suggestions for improvements. Liaise with management with a view to having the value of stock amended in the financial statements otherwise a qualification may be required.

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QUESTION TWO a) The auditor should request the company to remove the contingency note and include the actual payment of $350,000 in the accounts ended June 2008. This is because it is no longer an estimate and the decision has been made to pay the customer therefore making it an actual cost and not a potential payment. b) (i) The auditor wanted a management representation letter to reassure them that to the best of the clients knowledge that adequate provision has been made for obsolete stock and that there are no further stocks that should be written off. The management letter is only part of the evidence that an auditor should collect in respect to the obsolete stock. They should also carry out their own review and discuss stocks with the inventory staff. The review would include assessing stock that has a slow turnover or stock that has not been used for a long time.

(ii)

c) The auditor although they have signed the audit report still needs to act on the discovery of the sale of the subsidiary. The auditor has a responsibility to search for after balance day events up until the time that they sign the audit report. However, if they come across new material information and there is sufficient time to take action they must proceed with that action. The sale of the major subsidiary represents material information that ought to be brought to the attention of the users of the report. In this instance the auditor should request the company to amend the financial report and include a note to the financial accounts about this issue, and then sign a new audit report. The auditor then has a responsibility to search for other balance date events in the usual manner, up until the date of signing of the new report.

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SECTION C : WIKI QUESTION At the conclusion of an audit, the communication with those charged with governance is usually in the form of a letter (known as a management letter) that contains recommendations for improving the efficiency and effectiveness of those matters noticed during the course of the audit. The principal purpose of such a letter is to advise management of weaknesses in the internal control structure. It also tangibly demonstrates the auditors continuing interest in the welfare and future of the entity. As a professional auditor, Arthur Andersen had the responsibility to check if the Financial Statement was in accordance with the generally accepted accounting standards and express an opinion. In this case Arthur Andersen found out the revenue that Sunbeam declared in the report was highly overstated using unacceptable transactions. However the auditor was persuaded by Sunbeam that it was immaterial and issued an unqualified opinion. Andersen should have maintained their professionalism by seeking further evidence, information and findings to oversee that the overstatement of the revenue is material and should not have supported Sunbeams irregular activity by issuing them an unqualified opinion. As the Financial Report did not provide a true and fair view of its revenue thus it is materially misstated, an adverse opinion should have been given.

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