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Examination Papers
Examiners Reports

E XT

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AL PROG RA

Examination papers and

Examiners reports

Auditing
Economics, Management, Finance
and the Social Sciences

2001, 2002, 2003

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Examiners report 2003

Zone B
General remarks
This years paper followed the same format as for the previous two years: Section A
comprised case study style questions that are designed to test knowledge and
understanding of practical aspects of auditing; and Section B consisted of essay
questions covering general topics on audit theory and practice.
In general, students appeared to be well prepared for this examination. There were
some excellent scripts and only a few very weak ones. Scripts which received
excellent or above average marks tended to display the following distinguishing
features, in addition to depth of knowledge of the subject matter:
1. In case study questions: the ability to focus on and analyse facts and details rather
than reproducing general points.
2. In essay questions: the ability to discuss and to evaluate arguments as opposed to
simple repetition of relevant factual information.
3. The ability to answer the question posed.
4. Allocation of an appropriate amount of time for each question or part of a
question.
The examiners would like to stress how important it is for students to master these
aspects of examination technique as well as to be thoroughly familiar with the
contents of the syllabus.
Students should note that there will be some minor changes to the examination in
2004 and further information about this is given at the end of this report.
Specific comments on questions
The comments that follow are not to be regarded as model answers but as revision
aids, highlighting areas where common problems arose.
Section A
Question 1
This question was generally answered well. Part a) required students to identify small
company audit problems that may be relevant to Highlife Ltd. and explain how these
factors could affect audit work. Weaker answers ignored the importance of the term
small company and many students failed to consider the consequences for the
auditors. Marks were awarded for stating that small companies often have fewer
internal controls and a more informal organisational structure. Segregation of duties is
clearly an issue for Highlife Ltd. There is only one part-qualified clerk reporting to a
dominant managing director who is also a shareholder. The risk of possible
management override of controls is a key issue. There may also be a lack of
evidential material.
Few students mentioned liquidity pressures. Highlife is dependent on a small
customer base. Trade has recently slowed down and the company is probably
dependent on the renewal of the overdraft facility if it is to remain a going concern.
Better answers commented on the consequential need to extend substantive testing,

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advising the client of a possible need to increase the audit fee. If there are
insurmountable difficulties in obtaining sufficient audit evidence, the auditors may
need to consider qualifying the audit opinion.
In answer to part b), many attempts were too general. Marks were only awarded for
raising circumstances specific to Highlife Ltd. Better answers correctly identified that
the stock valuation may be a problem area, especially if gliders have been built
without orders. Foreign currency exposure, liquidity and going concern issues are also
relevant. It was disappointing that only a few answers noted the possible creation of a
duty of care if Highlife Ltd.s bank were to place reliance on the audited accounts.
The risk is increased by the tight reporting deadline.
Question 2
This was a straightforward question and again was generally answered well. Some
answers to part a) were far too long given that this part was worth only five marks.
A number of students lost marks because they described internal controls but did not
mention why they are significant for auditors. If auditors can rely on internal controls
they may be able to reduce the level of substantive testing.
In part b) a mark was awarded for identifying each weakness and a further mark for
discussing the risks. Those students who identified all the weaknesses and commented
on risks therefore obtained a higher mark than those who did not identify as many
problems or who did not consider risks. The errors in a number of answers showed
that the question had not been read with sufficient care; whereas in other cases,
imaginary details (which could not reasonably be inferred from the question) were
introduced. Marks were not awarded for including recommendations because these
were not required.
Segregation of duties is clearly one of the problems here. Other issues include: the
risk of error, fraud, fraudulent collusion, stock shortages, accepting defective stock,
unrecorded liabilities and overpayment for goods.
Question 3
There were only five marks for each part of this question. Some students wrote far
more than was required and others too little.
Part a) was generally answered well. The key points to be raised regarding the
different roles of external and internal auditors could include:
1. The role of external auditors is to arrive at an opinion as to whether or not the
financial statements disclose a true and fair view.
2. Externals have an independent role.
3. Internal auditors conduct an objective review but cannot be truly independent
because they are salaried employees.
4. Internal auditors identify weaknesses in controls and formulate action plans with
heads of department for improvement and to effect change.
In part b), the scope of many answers was too narrow. Some aspects of external and
internal work may be similar, including documenting and understanding systems, risk
assessment and compliance testing/substantive testing. However, external auditors set
materiality levels that impact on their audit approach and work performed. The audit
scope of internal auditors may be restricted or extended by management to Value For
Money auditing and special investigations. Internal auditors are interested in all risks
and not just those that have an impact on the effectiveness of the control environment.

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Part c) is a straightforward question but answers were often far too brief or simply
incorrect. The external auditors report on the financial statements is addressed to
shareholders and not to the directors as some answers suggested. A management letter
is usually produced that reports weaknesses in systems to management.
Internal auditors normally report to the chief executive and the audit committee if
applicable. Most answers just mentioned reporting to management, which is not
specific enough. Some mentioned the finance director but this could compromise the
objectivity of the internal audit department. Internal auditors also prepare reports for
different departmental heads.
Marks were also awarded to students who discussed respective responsibilities for
reporting fraud.
In part d), good answers applied general points to the situation outlined in the case
study.
The extent of reliance by the externals on the internals will depend on:

Whether the work of assistants has been properly supervised, reviewed and
documented. This has been a problem in the past. Conclusions reached about
work performed and reports need to be appropriate in the circumstances. Any
exceptions or unusual matters disclosed by internal audit must be properly
resolved and may have an impact on the external audit work programme.

Competence and qualifications of staff morale has been low in the past, possibly
because of staff shortages and the resulting pressure. Such circumstances can have
an impact on the quality of work performed.

Apparent problems with management integrity/control environment.

There is always a need to test the work of internal audit to confirm its adequacy.

Question 4
This question was answered fairly well. A main weakness in answers to part a) was a
tendency to write a short essay on general audit risk, whereas the majority of marks
were available for identifying risks specific to Racewell plc. This was a new audit
client, with a new management team, following a reorganisation. The bonus scheme
could be manipulated if it is profit-based. A new product has been introduced but
there is no warranty provision in spite of a three-year guarantee. Production has been
sub-contracted resulting in a possible loss of control over quality.
Students were also asked to suggest internal control procedures that might reduce
these risks. Again, many answers were too general and talked generically about types
of control such as authorisation, without explaining why this control would be helpful
in the context of the case study. Recommendations about internal control procedures
should have focused on monitoring the quality of sub-contracted stock, controlling
stock movements and on the implementation of monitoring controls over refunds
under warranty. Authorisation controls over sales and reasonableness checks
regarding management bonuses would also be helpful.
Part b) was answered well. Weaker answers focused only on stock count procedures
and lacked breadth. Better answers showed awareness of procedures to test
presentation, ownership, valuation and existence and included analytical procedures.

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Section B
Question 5
This question was not answered as well as others. For the well-prepared student it
should have been a straightforward question but many essays simply described a
succession of legal cases and did not attempt to evaluate the rationale. This approach
would not merit an above average mark. Some essays were poorly structured and did
not cover cases in a chronological order. A few students misunderstood the question
completely and wrote essays about limited liability partnerships.
To hold accountants liable would open the floodgates. Later commentators termed this
the social utility rationale. In the early twentieth century, judicial opinion held that it
was socially useful to protect the accounting profession from wide-scale liability. As
the profession and firms grew in economic terms, it was perhaps more difficult to
sustain this argument. The existence of professional indemnity insurance also meant
that accountants could buy protection from elsewhere.
There has been a gradual expansion of liability. Relevant cases would include
Candler v Crane Christmas (1951 LT 96), Scott Group v McFarlane (1978 NZLR
553), Twomax v Dickson, McFarlane & Robinson (1982) and Caparo Industries v
Dickman (1990 1 All ER 568).
Question 6
This was a very well answered question and there were many excellent essays.
Students demonstrated knowledge and understanding of theoretical notions of
evidence and were able to comment on their relevance for the collection of evidence
in practice.
Types of evidence:

Substantive/compliance

Inspection of documents:
(a) created and provided to auditors by third parties
(b) created by third parties and held by the entity
(c) created and held by the entity

Observation

Enquiry and confirmation

Computation

Analytical procedures

Subsequent events

General presumptions:

Documentary evidence is more reliable than oral evidence.

Original documents are more reliable than photocopies or faxes.

Audit evidence from the accounting records is more reliable when the accounting
and internal controls are effective.

Evidence from external sources is more reliable than that obtained from the entity.

Evidence obtained directly by the auditor is more reliable than evidence obtained
by or from the entity.

Consistent evidence is more persuasive than inconsistent.

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Question 7
Students had prepared thoroughly for this topic but there was a tendency to describe
the regulations rather than comment on the extent to which regulations ensure that
auditors can be and be seen to be independent. Many students referred to threats to
independence but did not develop these points further or discuss the issue of extent.
This is also a good example of the type of question where students need to indicate
which set or sets of regulations they are referring to because they may vary in
different countries.
Threats to independence:
1. Self-interest
2. Self-review
3. Advocacy
4. Familiarity
5. Intimidation.
Laws generally prohibit employees/officers (directors) acting as auditor. Professional
regulations deal with other relationships to be avoided, namely:
1. Undue Dependence
2. Participation in client affairs
3. Principal or senior employee joining client break all links
4. Mutual business interests
5. Beneficial Interest in Shares
6. Trusteeships
7. Loans to or from a client
8. Hospitality and other benefits
9. Connections and other influences
10. Provision of Other Services
11. Acting for Prolonged Period.
The issue of other services deserved serious attention in the light of the Enron and
other recent scandals and the proposals contained in the Sarbanes-Oxley legislation
introduced in the US.
Question 8
This was another straightforward question but an above average answer needed to
combine information from a number of related topics. A few essays were excellent
but many were limited in scope, with little evidence of planning or structure.
One of the difficulties with understanding the term true and fair is that it has not
been defined in legislation or by the courts. It can be paraphrased as meaning that
financial statements should be relevant and reasonable.
One definition of long-standing is:
true and fair has become a term of art. It is generally understood to mean a
presentation of accounts drawn up according to accepted principles, using accurate
figures as far as possible and reasonable estimates otherwise; and arranging them so
as to show within the limits of current accounting practice as objective a picture as
possible, free from willful bias, distortion, manipulation or concealment of material
facts (G. A. Lee).

A few students mentioned that true and fair represents a clear and unambiguous
picture to the outsider but did not cite D. Tweedie as a source.
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The factors that need to be considered include risk, materiality, evidence and the
adequacy of disclosures.
Underlying subconcepts:
1. Adequate Disclosure quantity and quality
a) Concept of materiality, not too much, not too little.
b) Proper descriptions and layout, e.g. avoid netting off.
c) Compliance with the Companies Act.
2. Compliance with GAAP
Disclosure not sufficient must have some authority and general acceptance.
a) Accounting Standards are authoritative statements and compliance will
normally be necessary for financials to show a true and fair view.
b) Auditors should be satisfied that the accounting policies and estimation
techniques are:

most appropriate to circumstances of the enterprise

consistently applied (provided most appropriate)

adequately disclosed.

3. Substance over form

ASB recognises that this is part of faithful representation. It is necessary that
transactions and events are accounted for and presented in accordance with their
substance and economic reality and not merely their legal form.
Final comments
The examiners were pleased with the general standard of examination scripts. There
were some outstanding papers from students who had prepared thoroughly for the
examination. Even in relation to the majority, it is encouraging that so many answered
questions by producing thoughtful analyses rather than memorised essays to questions
which were not asked. The demonstration of knowledge, the ability to apply ideas and
analytical skills enable students to obtain high marks. A short, well-planned and wellstructured essay will obtain better marks than a long, rambling essay that does not
focus on the question and includes irrelevant details. Also, when preparing an essay or
answer plan, students should make sure that they have addressed all parts of the
question; failure to do so will inevitably limit the number of marks that can be
obtained.
The importance of time allocation cannot be over-emphasised. If students do,
however, run out of time, then marks can still be obtained for noting down key points
in bullet format. The reduction in the number of questions required to be answered
from 2004 onwards may make it easier for students to keep to the appropriate time
allocation.
Examination paper in 2004
In the 2004 examination paper, the number of questions students will be required to
answer will be reduced from five 20-mark questions to four 25-mark questions. The
structure of the paper, however, will remain the same with four case study questions
in section A and four essays in section B. The reduction in the number of questions to
be answered is intended to reduce time pressure on students. It will also afford wellprepared students the opportunity to demonstrate depth of understanding and
knowledge. Studying previous case study questions on past examination papers will
continue to be the best way to prepare for next years paper.

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