20. Discuss the difference between a review engagement and a statutory year–end audit.
Answer
21 The Chairman’s Report of Pudding plc states that investment property rental forms a
major part of revenue. However, a note to the financial statements shows that property rental
represents only 1·6% of total revenue for the year. The audit senior is satisfied that the
revenue figures are correct. The audit senior has noted that an unmodified audit report
should be given as the audit opinion does not extend to the other reports.
Is the audit senior correct?
Answer
Use the information in the following paragraph to answer questions 22 and 23
You are a member of the audit team for the audit of Learnersinnit plc , a private provider of high
quality educational services. The team have just completed the interim audit for the current
year. You performed the work on the salaries system where you have noted the following
issues:
The company currently has over three hundred teaching and office staff, organised into several
different departments. The staff are paid on a fixed scale with annual increments agreed by the
board. The Salaries Department prepares one month‘s payroll from the names on the previous
payroll, adding or deleting names as instructed by the personnel department. Details of
increased pay rates resulting from promotion are also supplied by the Personnel Department.
Sometimes, however, the Personnel Department is so busy that they forget to telephone the
Salaries Department with details of staff changes or promotions. To correct these oversights,
there is sometimes an extra payroll run to prepare additional cheques where necessary.
The payroll is prepared on a personal computer by either of the two Salaries Department staff,
depending on whoever is available. The payroll calculations are usually checked for accuracy
by the other employee in the department, unless one of them is absent through illness or is on
holiday. The Personnel Department manager corrects any payroll errors identified on her own
personal computer, which is part of the same computer network, and then signs the payroll to
indicate overall approval. She does not have time to authorise any additional runs which are
necessary, however, as these are usually required urgently.
One or other of the payroll staff will usually run off the cheques, which are all restrictively
crossed, on the computer. A rubber–stamp signature for the cheques is kept by the personnel
manager in her drawer, but the payroll staff know where it is in case she is not available to
stamp the cheques. The cheques are then sent in the internal mail to each departmental head
for distribution to staff. Cheques for the deductions for Pay As You Earn (PAYE), National
Insurance, savings accounts, the holiday club, and charitable donations, are similarly drawn
monthly and paid by cheque.
22 Describe TWO different ways in which fraud could be carried out in the above salaries
system.
Answer
23 Draft a formal Management Letter (or Letter of Weaknesses) in respect of the internal
control systems of Learnersinnit plc, as outlined above. The structure of the letter should
be as follows:
Body of management letter:
• Identification of weaknesses in the existing internal control system
• Potential implications of these weaknesses
• Recommendations for improvement
Answer
24 State whether the following are true or false
Emphasis of matter reports are not a modification of opinion but merely draw attention to
some disclosure in the financial statements True/False
Negative assurance is given in all non audit engagements True/False
Failure of auditors to obtain sufficient, appropriate evidence will result in an adverse audit
opinion True/False
Compilation assignments require no audit opinion at all True/False
Answer
25. Demand for increased regulation of the audit profession has come from audit firms
themselves, particularly medium sized firms that find it difficult to secure audit contracts for
public limited companies (PLCs) given the predominance of the ‘Big Four’ firms. One
medium sized firm has written to the House of Lords inquiry asking for a cap on the number
of big audit contracts any one firm can have.
Set out in not more than 500 words the effect of increased regulation to compel Big 4 audit
firms to give up large multinational audits.
Answer
26. Sniffit & Coff plc is an established pharmaceutical company that has for many years
generated 90% of its revenue through the sale of two specific cold and flu remedies. Sniffit &
Coffl plc has lately seen a real growth in the level of competition that it faces in its market
and demand for its products has significantly declined. To make matters worse, in the past
the company has not invested sufficiently in new product development and so has been
trying to remedy this by recruiting suitably trained scientific staff, but this has proved more
difficult than anticipated.
In addition to recruiting staff the company also needed to invest $2m in plant and machinery.
The company wanted to borrow this sum but was unable to agree suitable terms with the
bank; therefore it used its overdraft facility, which carried a higher interest rate.
Consequently, some of Sniffit & Coff’s suppliers have been paid much later than usual and
hence some of them have withdrawn credit terms meaning the company must pay cash on
delivery. As a result of the above the company’s overdraft balance has grown substantially.
The directors have produced a cash flow forecast and this shows a significantly worsening
position over the coming 12 months.
The directors have informed you that the bank overdraft facility is due for renewal next
month, but they are confident that it will be renewed. They also strongly believe that the new
products which are being developed will be ready to market soon and hence trading levels
will improve and therefore that the company is a going concern. Therefore they do not intend
to make any disclosures in the accounts regarding going concern.
Identify any potential indicators that the company is not a going concern and outline the
procedures the auditors should carry out in this situation.
Answer
27. The audit of Bouncy Co is nearly complete and the financial statements and the audit
report are due to be signed next week. However, the following additional information has just
been presented to the auditor. The company’s year end was 30 September 2X11.
The springs in a new type of mattress have been found to be defective making the mattress
unsafe for use. There have been no sales of this mattress; it was due to be marketed in the
next few weeks. The company’s insurers estimate that inventory to the value of £750,000
has been affected. The insurers also estimate that the mattresses are now only worth
£225,000. No claim can be made against the supplier of springs as this company is in
liquidation with no prospect of any amounts being paid to third parties. The insurers will not
pay Bouncy for the fall in value of the inventory as the company was underinsured. All of this
inventory was in the finished goods store at the end of the year and no movements of
inventory have been recorded post year–end.
What actions should the auditors take and what will be the effect on the accounts for the
year ended 30 September 2X11?
Answer
28. State whether the following are true or false
The purpose of a management letter is to provide good audit evidence about the state of the
company’s finances True/False
A significant deficiency in internal control is one which must be reported to the management
or those charged with governance True/False
A Type 2 report is useful when evaluating service providers where a company has
outsourced services but it is does not replace independent audit evidence True/False
Auditors may rely on representations made by the directors in identifying related parties as
they are often very difficult to identify True/False
Answer
29 The audit team at Harmonium Ltd , a manufacturer of toys and games, have noted
several points which they have brought to the attention of you, the audit partner. These
include
• Harmonium’s product range hasn’t changed in five years and newer products are
appearing in the market in direct competition
• The management of Harmonium have not replaced their Head of Marketing who has
left the company to join a competitor
• The bank has refused to increase Harmonium’s overdraft and turned down an
application for as loan for new equipment
• Orders from two key customers have declined steadily over the year and turnover
volume is dropping. The directors point out that revenues are equivalent to those of
the previous year but the auditors point out that this is due to price rises not to
volumes of goods sold
• The audit team reviewed the future budgets and cash flows of Harmonium prepared
by the directors and stated that, whilst some of the assumptions were optimistic the
projections were not completely unreasonable
There are no other points which give any indication that the financial statements are
incorrectly stated and the audit process was satisfactory.
You have to decide whether any of these issues affect your audit opinion for the year
and which course of action is the most appropriate
a) The company is likely to be in trouble so issue a qualified auditors’ report on the
financial statements on the basis that it is not a going concern
b) None of these points are of significance to the financial report for the current year
and it is not for the auditors to tell the directors what to do so no action is required
c) None of these points are of significance to the financial report for the current financial
year. However they indicate a worrying trend which it might be appropriate to discuss
with the directors after the audit is finalised.
d) The audit team should go back to the company and try to discover further evidence
that the company is not a going concern so the audit report can be modified
Answer
30. The auditing profession has been criticised recently by politicians for its role in
monitoring potential corporate failure. Radical reforms have been called for in the way the
audit is regulated.
For example, politicians have stated that there should be a change of legislation in the
following ways:
(i) Auditing standards
Auditing standards should be set and enforced independently from the accounting
profession.
(ii) Fraud
Auditing firms should have a duty to detect and report fraud.
(iii) Non–audit services
Non–auditing services supplied to an audit client should be stopped.
(iv) The duration of the appointment of auditors
The appointment of auditors should be for a maximum period of seven years.
Discuss the reasons why you feel that the audit profession has been criticised over the
current regulations in the above areas.
Answer
