AUDI TI N G
MI LLI CHAMP & TAYLOR
AN W ERS TO PRACTI CE QUESTI ON S CH APTERS 2 1 –3 2
Not e: Som e of t hese answers are indicat ive rather than prescriptive and
lect urers should use their own resources t o aid st udent learning
1. Chugalug Ltd has three subsidiary companies and is engaged in a joint venture with an
Italian company called Intervole. It has an agreement with one of its major suppliers whereby
they share information so they can arrange for materials deliveries on a ‘just–in–time’ basis.
The wife of the managing director , who runs her own furnishings business, won a tender to
supply and fit tables and chairs to the conference area in the head office. Chugalug is also
part of a business consortium which shares good practice and lobbies the local Member of
Parliament to make representations to the government on their behalf. This is operated
through the local Chamber of Commerce. Chugalug owns shares in a rival company, Gluggit
plc which it shows as an investment in its Statement of Financial position.
a) What is meant by a ‘related party’
b) Which of the involvements of Chugalug shown above a not involvements with related
party
Answer
2. You are an audit manager with Tickett & Run. One of your clients, Bolington Limited, has
recently asked your firm to perform a limited review of the financial statements.
During your review, you discovered a cash payment of $50,000. You have asked the
company for details of this payment, and the directors have told you that it was an agency
fee, and they cannot tell you any more details as the company would lose its competitive
advantage. Profit before tax is $2m.
Your audit supervisor is happy with this explanation, and has proposed a draft review
report with the following opinion paragraph:
‘Based on our review nothing has come to our attention which indicates that the financial
statements do not give a true and fair view’.
Discuss the validity or otherwise of the suggested opinion, and discuss the appropriateness
of alternative opinions and suggest suitable wording for the opinion you consider to be most
appropriate.
Answer
Use the information in the following paragraphs to answer questions three and four
You are the auditor of Whizzipop plc a manufacturer of soft drinks. The draft consolidated
financial statements for the year ended 30 September 2X11 show revenue of $125 million
(2X10 – $114 million), profit before taxation of $12.4 million (2X10 – $10.9 million) and total
assets of $110 million (2X10 – $93 million).
It has several subsidiaries, some of which are audited by firms other than yours.The financial
statements of one such subsidiary company, Twizzle, for the year ended 30 September
2X11, are audited by another firm. Profit before taxation of $0.4 million and total assets of
$34.1 million have been included in the draft consolidated financial statements of Whizzipop.
The notes to Twizzle’s financial statements as at 30 September 2X11 disclose a contingent
liability for a pending legal matter estimated at $0.2 million. In November 2X11, the courts
found Twizzle to be liable for costs and damages amounting to $1.1 million. However,
Twizzle’s directors have refused to make a provision, for any amount, as they have lodged
an appeal against the judgement.
3. What evidence would you expect to see in respect of this liability?
4. What action would you, as group auditor, take in respect of this liability?
Answer
Answer
5. List three advantages and three disadvantages to firms’ outsourcing
Answer
6. State whether each of these statements are true or false
Auditors have no responsibility for validating comparative figures providing the audit report
for the previous financial period has not been modified True/False
Auditors must check that the opening balances have been brought forward correctly into the
new accounting period True/False
Where the financial statements for the previous accounting period were audited by another
firm the incoming auditors must get confirmation from the outgoing auditors that their
auditor’s report is unchanged True/False
Answer
7. Give three examples of where auditors’ routine audit procedures involve periods after the
year end date, excluding consideration of post balance sheet events.
Answer
8 Management representations are a source of audit evidence. These representations may
be oral or written, and may be obtained either on an informal or formal basis. The auditors
will include information obtained in this manner in their audit working papers where it forms
part of the total audit evidence.
Discuss the implications for the auditor of a small company, if the directors refuse to sign the
letter of representation.
Answer
9. To which of the following stakeholders do the auditors of Tesco plc have a legal as
opposed to a moral responsibility
a. The bank
b. The employees
c. HM Revenue and Customs
d. People intending to buy shares in the company
e. A supplier of goods to Tesco plc
f. The shareholders
g. The government of the United Kingdom
h. The council of the Stock Exchange
10 You are reviewing the audit files of Monty Ltd with a view to finalising the audit. From your
review of the files you identify the following factors . Identify whether or not they can be
a) Ignored
b) Whether the financial statements might have to be amended
c) Whether or not the financial statements should include a reference by way of a note
without any adjustment to the figures
In the table below tick the response you feel is the most appropriate
Ignore
Amend financial
statements
Refer by way
of note
A Receivable amounting to
£15,000 has gone into liquidation
after the year end and no
amounts will be recovered. Total
Receivables amount to £1.2m
and the pre tax profit for the year
is £750,000
Since the year end the company
closed four out of its eight
branches
Audit investigations have
indicated that the latest position
on one of the long term contracts
in progress is that it is likely to
make a loss of £200,000. The
value of Long term work in
progress is £5.0m and the pre tax
profit for the year is £750,000
Since the year end the company
acquired one of its smaller
competitors for £1.25 m. They
financed this acquisition by
means of an issue of shares
amounting to £1m.
The bank financing arrangements
were revised and renewed shortly
after the year end. There were no
changes to previous
arrangements except an increase
in the overdraft limit of £250,000
The Chief Executive left one
month after the year end. The
Chairman is currently carrying out
her duties whilst a replacement is
being sought
After the year end the Head
Office was flooded and the
ground floor meeting rooms and
staff kitchens were badly
damaged. The accounting
function and IT facilities were not
affected. The costs of repair are
covered by insurance.
11. An external auditor is required to carry out a final review to ensure their conclusions are
supported by sufficient reliable evidence
Select whether each of the statements below is true or false in connection with the final audit
review
True
False
a) Auditors should carry out analytical review
procedures on the financial statements
b) The audit report should include a disclaimer to
the effect that the auditor’s report is purely for the
shareholders
c) Where audits are particularly complex or large
the files should be subject to a hot review by a
second audit partner before being signed off
d) All weaknesses in internal controls should be
reported to management in a letter of weakness
even if they have been reported in previous years
a) Auditors should carry out analytical review
12. Bludger Ltd’s auditors were appointed after the end of the financial year and discovered
that the company had also changed banks shortly after the year end. The directors refused
permission for the auditors to contact the previous bankers for confirmation of the year end
bank balance without giving any good reason. The total of net current assets was £1.2m of
which the bank balance amounted to £123,000 overdrawn.
Which of the following options should the auditors take when considering their audit report?
Not modified
Modified
‘Except for’ – limitation of audit scope
‘Except for – material disagreement
Disclaimer – pervasive limitation of audit scope
Adverse opinion – pervasive disagreement
Not modified
Modified
Disclaimer – pervasive limitation of audit scope
Adverse opinion – pervasive disagreement
13 Explain in not more than 500 words why the auditors would not consider an aircraft
landing on the main office building and totally destroying it after the year end to be a non
adjusting event?
14 List the basic assumptions under which an entity would be considered to be a going
concern
Answer
15 The audit of your client Sprightly plc revealed a major control weakness in the
management of investments. The company recently recruited a financial analyst, as an
employee, to manage the investment of surplus funds. Company policy is to invest in the
shares of large quoted companies. The audit discovered a number of situations where the
financial analyst had made substantial profits for the company by speculating in risky
investments such as derivatives. Such investments could result in massive losses. The
matter was reported in writing to the chief financial officer four months ago but no action has
yet been taken.
What action should the auditors take in respect of this discovery?
Answer
16 When an auditor has decided that it is necessary to issue a qualified audit report there
are four forms of qualification available.
State the four forms of qualified audit report and give the circumstances in which each one
would be used and outline what additional information should the auditor give in an audit
report, when the report is qualified?
Answer
17 At the completion stage of an audit there are a number of final review procedures which
must be carried out prior to signing the audit report. In not more than 500 words explain
these procedures and the reasons for them.
Answer
18. Decide whether or not these statements are true or false
Auditors owe a duty of care to potential investors in their client True/False
Auditors may reduce the consequences of a negligence claim against them by operating as
a limited liability partnership True/False
In order to prove a successful claim for negligence the client only has to suffer a loss which
is the fault of the auditors True/False
Answer
19. In order to prove a successful claim for negligence against an audit firm there has to be a
duty of care which was breached by the audit firm with the result that a loss was incurred.
Auditors Tickett & Run were amazed to receive a negligence claim from one of their client’s
bankers Gurney plc who had lent money to their client,Megabuild, after the year end and
subsequently lost their money when a construction project Megabuild had been involved in
went badly wrong and bankrupted them. The claim said that the auditors had significantly
failed to estimate the losses on the project with the result that the bank, had they known the
true position, would not have lent money to Megabuild.
Gurney plc is claiming its losses from Tickett & Run. What advice would yopu give to Tickett
& Run in this situation?
Answer