Chapter 6 Audit Evidence and Audit Testing: Answer 1 (A)

Chapter 6 Audit Evidence and Audit Testing
Answer 1
(a)
(b)
(c)
P. 1
(d)
Re-performance will not be applied as risk assessment procedures.
Analytical procedures will not be applied as test of controls procedures.
(e)
Answer 2
(a)
Analytical procedures refers to the analysis of significant ratios and trends including the
resulting investigation of fluctuations and relationships that are inconsistent with other
relevant information or which deviate from predicted amounts.
(b)
Analytical procedures are used for the following purposes:
(i) To assist the auditors in planning the nature, timing and extent of the other audit
procedures;
(ii) As substantive procedures when their use can be more effective and efficient than tests
of details in reducing detection risk for specific financial statement assertions;
(iii) As an overall review of the financial statements in the final review stage of the audit.
P. 2
(c)
Analytical procedures can assist the auditors in the following ways:
(i) Understanding the clients industry and business
An auditor considers knowledge and experience about a client company obtained in
prior years as a starting point for planning the audit for the current year. By conducting
analytical procedures where the current years unaudited information is compared
to audited information of prior year, changes are highlighted. These changes can
represent important trends or specific events, all of which will influence audit planning.
(ii) Assessment of the entitys ability to continue a going concern
Analytical procedures are often used as an indication that the entity is encountering
severe financial difficulty. The likelihood of financial failure must be considered by the
auditor in the assessment of audit-related risks as well as connection with
managements use of the going concern assumption in preparing the financial
statements.
(iii) Indication of the presence of possible misstatements in the financial statements
Unusual fluctuations occur when significant differences are not expected but do exist, or
when significant differences are expected but do not exist. In either case, one of the
possible reasons for an unusual fluctuation is the presence of an accounting error or
irregularity. Thus, if the unusual fluctuation is large, the auditor must determine the
reason for it and must be satisfied that the cause is a valid economic event and not an
error or irregularity.
(d)
When intending to perform analytical procedures as substantive procedures, the auditor would
consider a number of factors such as:
(i) Plausibility and predictability of the relationship identified for comparison and
evaluation;
(ii) Objectives of analytical procedures and the extent to which their results can be relied
upon;
(iii) Nature of the entity and the degree to which information can be decomposed;
(iv) Availability of information, both financial and non-financial;
(v) Reliability of the information available;
(vi) Relevance of the information available;
(vii) Comparability of the information available;
(viii) Source of information available;
(ix) Knowledge gained during previous audits, together with the auditors understanding of
the effectiveness of the accounting and internal control systems and the types of
P. 3
problems that in prior periods have given rise to accounting adjustments.
(e)
Shortcomings may occur on a comparison of the account balance of the current year with the
balance of previous year. First, there would be a failure to consider any growth or decline in
business activity. Second, relationships of data to other data, such as sales to cost of goods
sold, would be ignored.
An analytical procedure that can overcome such shortcomings is the comparison of ratios and
percentage relationships.
(f)
In addition to the use of analytical procedures, auditors can obtain audit evidence by one or
more of the following procedures:
(i) Inspection
(ii) Observation
(iii) Enquiry and confirmation
(iv) Computation
Answer 3
Net profit
Overall, Zaks result has changed from a net loss to a net profit. Given that sales have only
increased by 17% and that expenses, at least administration expenses, appear low, then there
is the possibility that expenditure may be understated.
Sales increase 17%

According to the directors, Zak has had a difficult year. Reasons for the increase in sales
income must be ascertained as the change does not conform to the directors comments. It is
possible that the industry as a whole, has been growing allowing Zak to produce this good
result.
Cost of sales fall 17%

A fall in cost of sales is unusual given that sales have increased significantly. This may have
been caused by an incorrect inventory valuation and the use of different (cheaper) suppliers
which may cause problems with faulty goods in the next year.
Gross profit (GP) increase 88%

This is a significant increase with the GP% changing from 33% last year to 53% in 2008.
Identifying reasons for this change will need to focus initially on the change in sales and cost
P. 4
of sales.
Administration fall 6%
A fall is unusual given that sales are increasing and so an increase in administration to support
those sales would be expected. Expenditure may be understated, or there has been a decrease
in the number of administration staff.
Selling and distribution increase 42%

This increase does not appear to be in line with the increase in sales selling and distribution
would be expected to increase in line with sales. There may be a mis-allocation of expenses
from administration or the age of Zaks delivery vans is increasing resulting in additional
service costs.
Interest payable small fall

Given that Zak has a considerable cash surplus this year, continuing to pay interest is
surprising. The amount may be overstated reasons for lack of fall in interest payment e.g.
loans that cannot be repaid early, must be determined.
Investment income new this year

This is expected given cash surplus on the year, although the amount is still very high
indicating possible errors in the amount or other income generating assets not disclosed on the
balance sheet extract.
Answer 4
(a)
P. 5
(b)
The audit shall agree, in writing when appropriate, on the following matters with the auditors expert:
The nature, scope and objectives of that experts work.
The respective roles and responsibilities of the auditor and that expert.
The nature, timing and extent of communication between the auditor and that expert,
including the form of any report to be provided by that expert.
The need for the auditors expert to observe confidentiality requirements.
(c)
The inherent risk of material misstatement of the existence of SHE Limiteds investment properties
should be low to medium.
The reasons are as follows:

There is no indication of fraud.
Investment properties are not subject to misappropriation.
Investment properties are immovable.
(d)
The five major components are:
Control environment
Entitys risk assessment process
Information system
P. 6
Control activities
Monitoring of controls
P. 7

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Chapter 6 Audit Evidence and Audit Testing

Sales increase 17%

Cost of sales fall 17%

Gross profit (GP) increase 88%

Selling and distribution increase 42%

Interest payable small fall

Investment income new this year

The reasons are as follows:

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