CONFIDENTIAL 1 AC/JUNE 2016/AUD589

SUGGESTED SOLUTION

QUESTION 1

A
a. List the importance of an engagement letter.

i) Formalized the arrangement between auditor and client

ii) Serve as a contract, outlining the responsibilities of both parties
iii) Prevent from misunderstanding between the two parties
(3 points @ 1 mark each = 3 marks)

b. State THREE (3) principal content of an engagement letter

1. Arrangements involving the use of experts of internal auditors

2. Explanation of the auditor’s responsibilities to communicate audit matters of
governance interest with those charged with governance
3. Any limitation of the liability of the auditor or client
4. Arrangements to be made with the predecessor auditor in the case of an initial audit
5. Additional services to be provided relating to regulatory requirements
6. Arrangements regarding other services
(Any 3 points @ 1 mark = 3 marks)

B a. Reasonable assurance is the level of certainty which is presumably less than absolute
assurance and more than a low level of assurance
(2 marks)
b. Objectives of internal controls:

1. Reliability of financial reporting – management is responsible to prepare reliable

financial statements that are free from material misstatements for stakeholders.
Therefore, this objective is to fulfill this responsibility.

2. Efficiency and effectiveness of operations – The objective of internal control is to

encourage efficient and effective use of organisation’s resources to optimize the
company’s goal. Thus, the internal controls implemented ensure efficiency and
effectiveness of operations.

3. Compliance with law and regulations – the client company is required to report on
the effectiveness of internal control over financial reporting.

4. Safeguarding assets- Effective internal control systems ensures there will be no

misappropriation of assets,
(Any 3 points @ 2 marks = 6 marks)

C. Inherent limitations of internal controls:.

1. Management circumvention.
2. Cost and benefits.
3. Human limitations.
4. Collusion.
(any 3 points + explanation x 2 marks = 6 marks)
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SUGGESTED SOLUTION

QUESTION 2

A.

a) Explain the meaning of ‘sufficiency’ and ‘appropriateness’ in the context of

audit evidence.

Sufficiency: The measure of quantity of the audit evidence i.e. whether the
quantity of evidences accumulated from the performance of audit procedures
is adequate to enable the auditor to arrive at a conclusion.
Appropriateness: The measure of the quality of audit evidence and its
relevance to a particular assertion and its reliability.
(1.5 x 2 = 3 marks)

b) Distinguish a negative confirmation letter from a positive confirmation letter.

Positive confirmation: a letter, addressed to the debtor requesting the

debtor to indicate directly on the letter whether the stated account balance is
correct or incorrect.
Negative confirmation: a letter, addressed to the debtor requesting the
debtor to response only if he disagrees with the states account balance.
(1 mark x 2 = 2 marks)

c) Discuss THREE (3) factors that should be considered by auditor when

assessing the reliability of audit evidences.

1) Independence of the source of evidence

2) Effectiveness of internal control
3) Auditor’s direct personal knowledge
4) Documentary evidence
5) Original documents
(Discuss any 3 x 2 marks = (6 marks)
. d) Working papers divided into two types:
a) Permanent files
b) Current files

Permanent files – contain historical data about the client which is of

continuing relevance to the audit. Examples: copies of the articles of
association, organization charts, charts of accounts, copies of important
contract.

Current files – Include information and data related specifically to the current
years engagement. Example: audit plan and programs, copies of important
committee meeting, and working trial balance.
(3 marks x 2 = 6 marks)

e) TWO (2) disadvantages of using a standardized audit program

The disadvantage of Audit Programme are as follows:

1.         Work may become mechanical.
2.         Parts may be executed without regard to whole scheme.
3.         Programme may rigidly followed.
4.         Initiative may be lost.
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SUGGESTED SOLUTION

5.         Audit staff may not have opportunity of showing independent thinking,
intelligence and initiative due to adherence to audit programme.
6.         Audit programme may not cover everything that might come up during the
course of audit.
7.         It may create rigidity in audit examination if not frequently reviewed and
updated.
8.         Audit staff is bound to follow audit programme mechanically irrespective
of changes in internal control introduced by the client.
9.         Audit staff may defend by claiming that a particular audit examination was
not provided by audit programme.
10.       Fixed auditing programme will have its own limitations.

(Any 2 x 1.5 mark = 3 marks)

QUESTION 3

a. Purposes of internal controls:

 The reliability of the entity’s financial reporting.

 The effectiveness and efficiency of the entity’s operations.
 The entity compliance with applicable laws and regulations.
(Any 2 x 1.5 mark = 3 marks)

a. Deficiency b. Suggestion c.Possible Misstatement

i. The foreman has The hiring process should be None existent or
the ability to hire done by a panel appointed by the incompetent employees
employees and management. may be hired at the
enter their names foreman’s option.
into the pay
system with no
other approval.
ii. The foreman may The adjustment to the salary rates Employees or nonexistent
make changes to should be approved by the Board employees may be paid at
salary rates of Directors. rates which are higher than
without approval of their skill warrants
company
management.
iii. No investigation of Before an applicant is hired, his or Dishonest or unqualified
new employees to her background should be employees may be hired.
determine investigated by contacting
background references to determine that he or
experience and she is not dishonest and has no
dependability is other undesirable personal
performed. characteristics.
iv. No control exists The supply of blank time cards Employees may report and
over time cards should be removed. At the be paid for time they did
and the completion beginning of each week the not work.
thereof. payroll department should provide
each worker with time card
stamped with his or her name.
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SUGGESTED SOLUTION

A time clock should be installed

and the workers required to punch
in and out. A responsible
employee should be stationed at
the time clock to determine that
workers are not punching the time
cards of other workers who may
be late or absent, or who have left
the work early.

The foreman should collect the

time cards at the end of the week,
approve them, and turn them over
to the payroll clerk. All the time
cards should be encountered for
and any missing cards are
investigated.
v. No review or The payroll clerks’ work should be Misstatements made by
internal verification arranged so that they check each the payroll clerks in favor
of the amount on other. Under the existing system of employees would likely
the payroll checks of computing the payroll, the clerk not be discovered.
is performed who does not do the original
computing should check the
original work of the other clerk.
vi. Payroll checks are The payroll check should be The chief accountant could
not prenumbered prenumbered to control their prepare, sign, and cash an
or controlled by the issuance. extra payroll check without
payroll clerks. detection.
vii. The payroll From time to time an officer of the Cheques could be issued
distribution is done company should witness a payroll to none existent employee
by the foreman. distribution on surprise basis. and pocketed by the
foreman.
(Any 4 x 1 marks = (Any 4 x 1 mark = (Any 4 x 1.5 marks = 6
4 marks) 4 marks) marks)

d i. Occurrence
Transactions and events that have been recorded have occurred and pertain
to the entity.

ii. Accuracy
Amounts and other data relating to recorded transactions and events have
been recorded appropriately

iii. Completeness
Agree the balance from listing to general ledger.

(Any 3 points x 1 marks = 3 marks)

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SUGGESTED SOLUTION

QUESTION 4

A.
a. Briefly explain the purpose of analytical procedures

The purpose to confirm the evidence previously obtained and to provide update
about the performance and financial standing of the client.
(2 marks)

b. Describe two (2) analytical procedures for each of the elements below that will be
carried out by the auditor at the end of the accounting period:

i. The profitability of a client company;

Compare profit ratio with industry average to determine its performance in the
industry.
Compare sales figure with the operating expense for the accounting period
with last year, to determine return any inconsistencies.

ii. The liquidity of the client company.

Calculate liquidity ratio and compare with last year to determine whether its
liquidity position has worsen.

Compare the cash balance with accounts receivable or sales figure to

determine bad debts
(Any 3 points x 2 = 6 marks)

Type of assertion Specific audit objectives Substantive procedures

(a) (b) to achieve the objectives
(c)

i) Existence AR in the statement of Undertake debtors’

financial position (SoFP) confirmation procedures,
exist at the balance date or review subsequent
receipts.

ii) Rights and obligations AR in the SoFP is owned Undertake debtors’

by the entity and not confirmation procedures,
restricted and committed or inquire about and scan
any restrictions or
commitments

iii) Completeness AR in the SoFP includes Undertake sequence

all AR at the balance date check of all sales invoices,
or
review subsequent
receipts.

vi) Valuation and allocation AR in the SoFP is stated Review aged trial balance
at the correct amount and undertake follow-up
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SUGGESTED SOLUTION

procedures for amount

overdue such as review of
subsequent receipts, or
Discussion about the
debtor’s ability to pay

(Any 3 point x 1 mark = (Any 3 point x 1 mark = (Any 2 points x 2.5 = 5

3 marks) 3 marks) marks)

QUESTION 5

Audit Report

A a. Unqualified opinion - In an unqualified report, the auditors conclude that the

financial statements of your business present fairly its affairs in all material aspects. The
opinion embodies the assumptions that your business observed compliance with
generally accepted accounting principles and statutory requirements. Also known as a
clean report, such a report implies that any changes in the accounting policies, their
application and effects, are adequately determined and divulged. This opinion does not
tell that your business is in good economic health. It merely states that your financial
report is transparent and thorough and has not hidden important facts.

(2 marks)
b.Scope paragraph contains:
 A factual statement describing what the auditor did in the audit
 The auditor followed approved auditing standards
 The audit is designed to obtain reasonable assurance about whether the
statements are free of material misstatement.
 Discussions of the audit evidence accumulated and evaluated and
sampling methods used was appropriate for expression of an opinion.

(any 2 points = 2 marks)

c. Qualified opinion – A qualified opinion is expressed when the auditor concludes that
an unqualified opinion cannot be expressed but that the effect of any disagreement
with management, or limitation on scope is not so material and pervasive as to
require an adverse opinion or a disclaimer of opinion.

Disclaimer of opinion – A disclaimer of opinion is expressed when the possible effect

of a limitation on scope is so material and pervasive that the auditor has not been
able to obtain sufficient appropriate audit evidence and accordingly is unable to
express an opinion on the financial statements.

Emphasis of matter paragraph – An auditor’s report may be modified by adding an

emphasis of matter paragraph to highlight a matter affecting the financial statements
that is included in a note to the financial statements that more extensively discusses
the matter. Such an emphasis of matter paragraph does not affect the auditor’s
opinion. An emphasis of matter paragraph may also be used to report matters other

than those affecting the financial statements (e.g. if there is a misstatement of fact in
other information included in documents containing audited financial statements).
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SUGGESTED SOLUTION

(3 x 2 marks =6 marks)

(Total: 8 marks)

B. Reason and type of opinion.

a. Type of audit report: Unqualified opinion. The change of estimated life is properly
disclosed in the note to the financial statements and auditor satisfies with the
disclosure on the effect on the 2015 income. Therefore, an unqualified opinion is
appropriate.

(4 marks)

b. The situation might affect the type of audit report to be issued. It is limitation of
scope on audit work. Before concludes the audit opinion on the group level, MY &
Associates need to discuss the findings with the management of the subsidiary
company. They need to perform further audit procedures on the subsidiary
company’s financial statement and to assess the effect of the audit findings on
the fairness of the consolidated financial statement.

If the findings are immaterial to the consolidated accounts, MY & Associates may
express unqualified opinion. If the findings are material and persuasive Kay &
Associates should consider Disclaimer or Adverse Opinion.

(4 marks)