AUDIT & ASSURANCE

Time allowed – 3 hours

[N.B. – The figures in the margin indicate full marks. Questions must be answered in English. Examiner will
take account of the quality of language and the manner in which the answers are presented. Different
parts, if any, of the same question must be answered in one place in order of sequence.]

Marks

1. a. The audit Firm ABC, Chartered Accountants has been performing the audit of Modern Fittings
Ltd., for a number of years. The firm decides to review some relationship with the company as
part of its efforts to ensure independence.
Requirements:
Comment on each of the three situations below in the context of audit independence stating the
fundamental principles involved as per IFAC’s Code of Ethics for professional accountants.
i. The audit manager in charge of the audit of Modern holds 10,000 Tk.10/= ordinary shares
in the company (Total shares on issue Tk.1,000,000). The audit partner holds no share. 2
ii. An audit partner of ABC is a personal friend of the Chief Accountant of Modern. The Chief
Accountant is not a director of the company and the audit partner is not the engagement
partner of Modern audit. 4
Iii. The engagement partner of Modern audit also the engagement partner of Dhaka Hardware
Ltd. Modern has tendered a contract with Dhaka Hardware for the supply of a material
quantity of fixtures over the next few years. Dhaka Hardware has asked the engagement
partner to advise on the matter. 4
b. Stanley Ltd is a frozen food processor, selling its products to wholesalers and supermarkets.
From your review of the audit working papers, you have noted that the level of materiality was
determined to be $ 1.5 million at the planning stage, and this materiality threshold has been
used throughout the audit. There is no evidence on the audit file that this threshold has been
reviewed during the course of the audit.
From your review of the audit planning, you know that a new packing machine with a cost of
$1·6 million was acquired by Stanley Ltd in March 2015, and is recognised in the draft
statement of financial position at a carrying amount of $1·4 million at 31 December 2015. The
packing machine is located at the premises of Aberdeen Ltd, a distribution company which is
used to pack and distribute a significant proportion of Stanley Ltd’s products. The machine has
not been physically verified by a member of the audit team. The audit working papers conclude
that ‘we have obtained the purchase invoice and order in relation to the machine, and therefore
can conclude that the asset is appropriately valued and that it exists. In addition, the managing
director of Aberdeen Ltd has confirmed in writing that the machine is located at their premises
and is in working order. No further work is needed in respect of this item.’
Inventory is recognized at $2 million in the draft statement of financial position. You have
reviewed the results of audit procedures performed at the inventory count, where the test counts
performed by the audit team indicated that the count of some items performed by the
company’s staff was not correct. The working papers state that ‘the inventory count was not
well organized’ and conclude that ‘however, the discrepancies were immaterial, so no further
action is considered necessary’.
The audit senior spoke to you yesterday, voicing some concerns about the performance of the
audit. A summary of his comments is shown below:
‘The audit manager and audit engagement partner came to review the audit working papers on
the same day towards the completion of the audit fieldwork. The audit partner asked me if there

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 had been any issues on the sections of the audit which I had worked on, and when I said there
had been no problems, he signed off the working papers after a quick look through them.

When reading the company’s board minutes, I found several references to the audit engagement
partner, Joe Lantau. It appears that Joe recommended that the company use the services of his
brother, Mick Lantau, for advice on business development, as Mick is a management
consultant. Based on that recommendation, Mick has provided a consultancy service to Stanley
Ltd since September 2015. I mentioned this to Joe, and he told me not to record it in the audit
working papers or to discuss it with anyone.’
Requirement:
Comment on the quality of the audit performed discussing the quality control, ethical and other
professional issues raised. 10

2. a. Andromeda Industries Co (Andromeda) develops and manufactures a wide range of fast moving
consumer goods. The company’s year-end is 31 December 2015 and the forecast profit before tax is
$8·3 million. You are the audit manager of Neptune & Co and the year-end audit is due to
commence in January. The following information has been gathered during the planning process:
(i) Andromeda spends over $2 million annually on developing new product lines. This
year it incurred expenditure on five projects, all of which are at different stages of
development. Once they meet the recognition criteria under IAS 38 Intangible Assets
for development expenditure, Andromeda includes the costs incurred within intangible
assets. Once production commences, the intangible assets are amortized on a straight
line basis over five years.
Requirement:
Describe audit procedures you would perform during the audit of Andromeda Industries
Co. in relation to research and development expenditure. 4
(ii) During the audit, the team discovers that one of the five development projects, valued at
$980,000 and included within intangible assets, does not meet the criteria for capitalization.
The finance director does not intend to change the accounting treatment adopted as she
considers this an immaterial amount.
Requirement:
Discuss the issue and describe the impact on the audit report, if any, if the issue remains
unresolved. 3
b. Mr. Abdul Hassan is the Managing Director and Chairman of AS Jute Mills Ltd. and Fine Auto
Bricks Ltd. both are private limited company and situated at Birol Upazila in Dinajpur but head
office is at Gulshan Dhaka. Due to low demand in international market and prevalence of
polybag in local market his jute business is struggling. Jute exports are reduced by 60% and
machineries are getting older. On the other hand, despite production of high quality bricks his
sales are stumbling due to long distance from metropolitan cities and poor demand in the
district town and peripheries. Recently Mr. Hassan has bought a 3 storied luxurious house from
profit of its two companies. The house will be used as residence of Managing Director. It is
known that the management is unable to pay monthly instalments to bank for last 10 months in
2016 though both the companies’ books of account shows profit. The existing auditor has
issued unqualified opinion for the financial year 2015. As part of its recovery initiative bank
has pursued Mr. Hassan for a fresh audit of both companies by your firm for the year ending
December 31, 2016.
Requirement:
Identify, from the information provided above, the factors which should be taken into account
when assessing the risk of misstatement in the financial statements of AS Jute Mills Ltd. and
Fine Auto Bricks Ltd.? Explain, why such factors should be taken into account when
conducting the audit? 8

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3. a. According to ISA 240 The auditor’s responsibilities relating to fraud in an audit of financial
statements:

‘When identifying and assessing the risks of material misstatement due to fraud, the auditor
shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate
which types of revenue, revenue transactions or assertions give rise to such risks.’
Requirement:
Discuss why the auditor should presume that there are risks of fraud in revenue recognition and
why ISA 240 requires specific auditor responses in relation to the risks identified. 5
b. Kowloon Ltd works on contracts to design and manufacture large items of medical equipment
such as radiotherapy and X-ray machines. The company specialises in the design, production
and installation of bespoke machines under contract with individual customers, which are
senior has left the following note for your attention:
‘One of Kowloon Ltd’s major customers is the Bay Medical Centre (BMC), a private hospital.
In June 2015 a contract was entered into, under the terms of which Kowloon Ltd would design
a new radiotherapy machine for BMC. The machine is based on a new innovation, and is being
developed for the specific requirements of BMC. It was estimated that the design and
production of the machine would take 18 months with estimated installation in December 2016.
As at 31 December 2015, Kowloon Ltd had invested heavily in the contract, and design costs
totalling $350,000 have been recognised as work in progress in the draft statement of financial
position. Deferred income of $200,000 is also recognised as a current liability, representing a
payment made by BMC to finance part of the design costs. No other accounting entries have
been made in respect of the contract with BMC.
As part of our subsequent events review, inspection of correspondence between Kowloon Ltd
and BMC indicates that the contract has been cancelled by BMC as it is unable to pay for its
completion. It appears that BMC lost a significant amount of funding towards the end of 2015,
impacting significantly on the financial position of the company. The manager responsible for
the BMC contract confirms that BMC contacted him about the company’s financial difficulties
in December 2015.
The matter has been discussed with Kowloon Ltd’s finance director, who has stated that he is
satisfied with the current accounting treatment and is not proposing to make any adjustments in
light of the cancellation of the contract by BMC. The finance director also advised that the loss
of BMC as a customer will not be mentioned in the company’s integrated report, as the finance
director does not consider it significant enough to warrant discussion.
Kowloon Ltd is currently working on six contracts for customers other than BMC. Our audit
evidence concludes that Kowloon Ltd does not face a threat to its going concern status.’
Your review of the audit work performed on going concern supports this conclusion.
Requirements:
(i) Comment on the matters to be considered, and recommend the actions to be taken by the
auditor; and 9
(ii) Explain the audit evidence you would expect to find in your review of the audit working
papers. 6
c. (i) Discuss why understanding the entity and its environment is highly critical for a successful
audit. 6
(ii) Formulate the approach how you will review an entity to develop your overall
understanding about the entity and its environment. 7
(iii)Explain how you will utilize your understanding about the entity and its environment in
your audit planning and audit conclusion. 7

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4. Go through situations below which have arisen at three unrelated clients of your firm.
ABC Ltd. (ABC)
Your firm is the external auditor of ABC, a pharmaceutical company, for the year ended June 30,
2016. ABC maintains an inventory system that is perpetual in nature to use this to calculate the
value of inventory for inclusion in its year-end financial statements. In July 2016, a computer virus
corrupted the data held on the inventory system resulting in the loss of records relating to the value
of inventory as on June 30, 2016. ABC’s antivirus software was out of date and no recent back up of
data was stored because the IT manager responsible for this process had been on annual mandatory
leave. The directors have included an estimate for inventory of Tk. 200 million in the financial
statements but your firm has been unable to corroborate this value.
The draft financial statements show that ABC’s profit before tax is Tk.1, 849.62 million.
SSRM Ltd (SSRM)
Your firm has been engaged to perform an independent review and to report on the financial
statements of SSRM for the year ended 30 June 2016. SSRM’s bank has requested the review. Your
firm identified payments made in July 2016, totalling Tk.13.50 million, which related to goods
received in May 2016. Invoices relating to these goods were posted to the payables ledger in July
2016. SSRM does not reconcile supplier statements and did not identify the invoices until after the
year end. The directors of SSRM have refused to include an accrual in the financial statements in
respect of these invoices.
The draft financial statements show that SSRM’s profit before tax is Tk. 7.56 million.
Shah Denim Ltd. (SDL)
Your firm is the external auditor of SDL. The financial statements include a note relating to a
significant uncertainty over going concern. The uncertainty has arisen because a major customer has
threatened to terminate its contract early due to SDL’s failing to comply with service levels required
by the contract. Contracted service levels are not regularly monitored by SDL. Your firm has
concluded that the note included in the financial statements is appropriate and adequate.
Requirements:
a. Explain the attributes of auditors’ communications to those charged with governance that make
such communications effective when reporting deficiencies in internal control identified during
an audit. 5
b. In each of the situations outlined above:
i. Identify the internal control deficiencies. For each deficiency, outline the possible
consequence(s) of each deficiency and provide recommendation(s) to address it. 
 10
ii. State whether you would modify your firm’s report. Give reasons for your conclusions and
outline the modifications, if any, to each report. 10

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