ACCA AA

Knowledge-based questions

Question: Briefly explain how each of the following sources of information will be used by

Hercules & Co to gain an understanding of Knight Electronics Co at the planning stage of the

audit: prior year audited financial statements, current year budgets and management accounts,

prior year report to management, board meeting minutes and company website.

Answer:

Prior year audited financial statements: To gain insight into trends in performance, accounting

policies and changes, company size and financial structure, and outcome of previous audits.

Current year budgets and management accounts: Provides relevant financial information for

the year to date. It will also help the auditor at the planning stage to carry out preliminary

analytical procedures and to identify risks.

Prior year report to management: To gain information on the system of internal control and

any identified control deficiencies as, if these have not been addressed by management, the

deficiencies may still be present and may impact upon the audit approach.

Board meeting minutes: To gain knowledge about the important issues affecting the business

which were discussed by the directors and how these issues were addressed.

Company website: To gain information about the company’s major products and services

Question: In line with ISA 220 Quality Management for an Audit of Financial Statements,

describe the auditor's responsibilities in relation to supervising and reviewing the work

performed during the external audit of Lapis Co.

Answer:

- The auditor should keep track of the progress of the audit engagement.

- The competence and capabilities of individual members of the engagement team should be

considered.

- Creating an environment where engagement team members can raise any concerns without

fear of repercussion.

- Taking appropriate action to address any significant matters arising during the audit.

- Identifying matters for consultation or consideration by more experienced engagement team

members such as the audit manager or audit engagement partner.

- Review the work completed by the team and consider whether this work has been performed

in accordance with the audit firm’s policies, International Standards on Auditing and other

regulatory requirements.

- Consideration should be given as to whether sufficient and appropriate evidence has been

obtained to provide a basis for the auditor’s opinion.

Question: Explain the PURPOSE of an audit engagement letter and list FOUR items which should

be included in an audit engagement letter.

Answer: Its purpose is to minimize the risk of any misunderstanding of the terms of the

engagement between the auditor and the client and it confirms acceptance of the engagement.

The purpose of the engagement letter is to also set out the terms and conditions of the

engagement and the responsibilities of the auditor and management.

- The objective and scope of the audit

- The auditor’s responsibilities

- Management’s responsibilities

- Identification of the applicable financial reporting framework

- The fact that some material misstatements may not be detected

- The basis on which fees are computed

- The expectation that management will provide access to all information relevant to or

affecting the financial statements

Question: Describe the PRECONDITIONS for an audit that Bannock & Co should have

established prior to accepting the audit of Esk Co.

Answer:

- Determine whether the financial reporting framework (for example IFRS®) to be applied by

Esk Co in the preparation of its financial statements is acceptable

- Obtain the agreement of the management of Esk Co that they acknowledge and understand

their responsibility for the preparation of the financial statements in accordance with the

applicable financial reporting framework, for the design and implementation of internal

controls, to provide Bannock & Co with access to all information which is relevant to the

preparation of the financial statements such as records, documentation and other matters.

Question: Describe Apricot & Co’s responsibilities in relation to the prevention and detection of

fraud and error.

Answer:

- Conduct an audit in accordance with ISA 240 & responsible for obtaining reasonable

assurance that the financial statements taken as a whole are free from material

misstatement, whether caused by fraud or error.

- Identify and assess the risks of material misstatement of the financial statements due to

fraud.

- Obtain sufficient appropriate audit evidence regarding the assessed risks of material

misstatement due to fraud, through designing and implementing appropriate responses.

- Respond appropriately to fraud or suspected fraud identified during the audit.

- Responsible for maintaining professional skepticism throughout the audit.

- Report any actual or suspected fraud to appropriate parties

Question: Define the term ‘professional skepticism’

Answer:

An attitude which includes a questioning mind, being alert to conditions which may indicate

possible misstatement due to fraud or error, and a critical assessment of audit evidence.

Question: Explain the benefits of audit planning.

Answer:

- Helping the auditor to devote appropriate attention to important areas of the audit

- Helping the auditor to identify and resolve potential problems on a timely basis

- Helping the auditor to properly organize and manage the audit engagement so

that it is performed in an effective and efficient manner

- Assisting in the selection of engagement team members with appropriate levels of capabilities

and competence

- Facilitating the direction and supervision of engagement team members and the review of

their work

- Assisting, where applicable, in coordination of work done by experts

Question: Explain the safeguards which Morph & Co should implement to ensure that this

conflict of interest is appropriately managed.

Answer:

- Notify each client and consent should be obtained from management of each company.

- Appoint separate engagement teams, with different engagement partners and team members

to each client.

- Adequate procedures should be in place within the firm to prevent access to information

- Set out clear guidelines for members of each engagement team on issues of security and

confidentiality

- Consider the use of confidentiality agreements signed by all members of the engagement

teams

- Work performed should be reviewed by an appropriate reviewer who is not involved

- Regular monitoring of the application of the above safeguards should be undertaken by a

senior individual

Question: Define and explain materiality and performance materiality.

Answer: Misstatements, including omissions, are considered to be material if they, individually

or in the aggregate, could reasonably be expected to influence the economic decisions of users

taken on the basis of the financial statements. A misstatement may be considered material due

to its size (quantitative) and/or due to its nature (qualitative) or a combination of both.

Materiality is often calculated using benchmarks such as 0.5-1% of revenue, 1-2% of total asset

and 5-10% of profit before tax.

Performance materiality is the amount set by the auditor at less than materiality for the

financial statements as a whole to reduce to an appropriately low level the probability that the

aggregate of uncorrected and undetected misstatements exceeds materiality for the financial

statements as a whole. It is used for testing individual transactions, account balances and

disclosures.

Question: Explain why analytical procedures are used during THREE stages of an audit.

Answer:

- During the planning stage, analytical procedures must be used as risk assessment procedures

in order to help the auditor to obtain an understanding of the entity and assess the risk of

material misstatement.

- During the final audit, analytical procedures can be used to obtain sufficient appropriate

evidence.

- At the final review stage, the auditor must design and perform analytical procedures which

assist them when forming an overall conclusion as to whether the financial statements are

consistent with the auditor’s understanding of the entity.

Question: Identify THREE main areas, other than audit risks, which should be included within

the audit strategy document for Prancer Construction Co, and for each area provide an example

relevant to the audit.

Answer:

- Main characteristics of the engagement. Example: Whether automated tools and audit

techniques will be used

- Reporting objectives, timing and nature of communication. Example: The audit timetable for

reporting

- Significant factors affecting the audit. Example: The determination of materiality for the audit

- Preliminary engagement activities. Example: Results of any tests over the effectiveness of

internal controls

- Nature and extent of resources. Example: budget for the audit

Question: Define audit risk and the components of audit risk.

Answer: Audit risk is the risk that the auditor expresses an inappropriate audit opinion when

the financial statements are materially misstated. Audit risk is a function of two main

components, being the risk of material misstatement and detection risk. Risk of material

misstatement is made up of a further two components, inherent risk and control risk.

Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or

disclosure to a misstatement which could be material.

Control risk is the risk that a material misstatement which could occur will not be prevented, or

detected and corrected, on a timely basis by the entity’s controls.

Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an

acceptably low level will not detect a misstatement

Question: Describe FOUR matters the auditor should consider in determining whether a

deficiency in internal controls is significant.

Answer:

- The likelihood of the deficiencies leading to material misstatements in the financial statements

in the future.
- The susceptibility to loss or fraud of the related asset or liability.

- The subjectivity and complexity of determining estimated amounts.

- The financial statement amounts exposed to the deficiencies.

- The volume of activity which has occurred or could occur in the account balance or class of

transactions exposed to the deficiency or deficiencies.

- The cause and frequency of the exceptions detected as a result of the

deficiencies in the controls.

- The interaction of the deficiency with other deficiencies in internal control.

Question: Describe the five components of an entity's system of internal

control.

Answer:

- Control environment: includes the governance and management functions and the attitudes,

awareness and actions of those charged with governance and management concerning the

entity’s system of internal control and its importance in the entity

- Entity’s risk assessment process: how management identifies business risks relevant to the

preparation of financial statements, estimates their significance, assesses the likelihood of their

occurrence, and decides upon actions to respond

- Monitoring: assessing the effectiveness of controls and taking necessary remedial actions on a

timely basis.

- Information system and communication: activities, policies and records designed to initiate,

record, process, and report entity transactions.

- Control activities: controls which are designed to ensure proper application of policies in all

the components of the entity’s system of internal control and include both direct and indirect

controls

Question: Describe the LIMITATIONS of internal control.

Answer:

- Human error: mistakes can be made by those responsible for designing and implementing the

controls

- Collusion of staff: employees can work together to bypass the controls of segregation of duties

- Management override: Management is in a position of power to override an entity’s internal

control regardless of the strength of the system of internal control.

- Use of judgement on the nature and extent of controls: Professional judgement will be needed

to determine the type and extent of internal controls needed within the company and certain

controls may be absent or ineffective.

- Ineffective controls: controls might not work as intended.

Question: Methods of internal control documentation and their advantages and disadvantages.

Answer:

Method Description Advantages Disadvantages

Narrative notes A written description - simple to records - may be time
of a system - facilitates consuming and
understanding by all cumbersome if the
audit staff system is complex
- may be more
difficult to identify
missing controls
Flow charts A diagrammatical - easy to view the - may be difficult to
representation of a whole system in one amend as the whole
system diagram diagram may need to
- easy to spot missing be re-drawn
 controls due to the - there is still a need
use of standard for narrative notes to
symbols accompany the flow
chards increasing the
time needed
ICQs A list of controls is - quick to prepare as - controls may be
given to the client a standard overstated as the
and they are asked questionnaire can be client knows the
whether or not these used for all clients answer the auditor is
controls are in place - can ensure all looking for is yes
common controls are - unusual controls are
present unlikely to be
included on a
standard
questionnaire and
may not be identified
- may contain a
number of irrelevant
controls
ICEQs The client is asked to - quick to prepare - the client may still
describe the controls - controls are less overstate controls
they have in place for likely to be - the checklist may
a given control overstated contain control
objective objectives not
relevant to the client
- unusual risks and
therefore objectives
may not be identified

Question: Explain why it is important for auditors to communicate throughout the audit with

those charged with governance; and Identify TWO examples of matters which the auditor may

communicate to those charged with governance.

Answer:

Importance:

- It assists the auditor and those charged with governance in understanding matters related to

the audit, and in developing a constructive working relationship.

- It helps the auditor in obtaining, from those charged with governance, information relevant

to the audit.

- It helps those charged with governance in fulfilling their responsibility to oversee the

financial reporting process, thereby reducing the risks of material misstatement

- It promotes effective two‐way communication between the auditor and those charged with

governance.

Matters to be communicated:

- The auditor’s responsibilities with regards to providing an opinion on the financial

statements and that they have carried out their work in accordance with International

Standards on Auditing.

- The auditor should explain the planned approach to the audit as well as the audit timetable.

- Any key audit risks identified during the planning stage should be communicated.

- Any significant difficulties encountered during the audit should be communicated.

- Any significant deficiencies in the internal control system identified should be communicated

in writing or verbally.

- Those charged with governance should be notified of any written representations required by

the auditor.

- If any suspected frauds are identified during the audit, these must be communicated.

Question: Compare and contrast the role of external and internal audit.

Answer:

External audit Internal audit

Objective Express an opinion on the Improve the company's
truth and fairness of the operations by reviewing the
financial statements in a efficiency and effectiveness
 written report of internal controls
Reporting Reports to shareholders Reports to management or
those charged with
governance
Availability of report Publicly available Not publicly available.
Usually only seen by
management or those
charged with governance
Scope of work Verifying the truth and Wide in scope and
fairness of the financial dependent on management's
statements requirements
Appointment and removal By the shareholders of the By the audit committee or
company board of directors
Relationship with company Must be independent of the May be employees (which
company limits independence) or an
outsourced function (which
enhances independence)
Question: Describe assignments the internal audit department of Raspberry Co could carry out.

Answer:

- Value for money review: The IAD could be asked to assess whether Raspberry Co is obtaining

value for money in areas such as asset expenditure.

- Review of financial/operational controls: The IAD could undertake reviews of controls at head

office and the power station and make recommendations to management over such areas as

the purchasing process as well as the payroll cycle.

- Monitoring asset levels: The IAD could undertake physical verification of property, plant and

equipment (PPE) at the production site and head office and compare the assets seen to the PPE

register.

- Regulatory compliance: The IAD could help to monitor compliance with these regulations.

- Fraud investigations: The IAD can be asked to investigate any specific cases of suspected fraud

as well as review the controls in place to prevent/detect fraud.

- Cash controls: Raspberry Co’s internal auditors could undertake controls testing over cash

payments.

Question: Explain the steps the auditor should take to confirm the accuracy of the purchases

and payables flowcharts and systems notes currently held on file.

Answer:

- Obtain the system notes from last year’s audit and ensure that the documentation on the

purchases and payables system covers all expected stages and is complete.

- Review the audit file for indications of weaknesses in the system and note these for

investigation this year.

- Review the prior year report to management to identify any recommendations which were

made over controls in this area as this may highlight potential changes which have been made

in the current year.

- Obtain system documentation from the client, potentially in the form of a procedure manual.

Review this to identify any changes made in the last 12 months.

- Interview client staff to ascertain whether systems and controls have changed

- Perform walk‐through tests by tracing a sample of transactions through the system.

Question: Describe FOUR different types of control activities as given in ISA 315.

Answer:

- Segregation of duties: Assignment of roles or responsibilities to ensure the tasks of authorizing

and recording transactions and maintaining custody of assets are carried out by different

people. Example: the payables ledger clerk recording invoices in the list of individual suppliers,

and the finance director authorizing the payment of those purchase invoices
- Verifications: Controls which compare two or more items with each other or compare an item

with a policy. Example: use of batch control totals when entering transactions into the system

- Authorization: Approval of transactions by a suitably responsible official or higher level of

management to ensure transactions are valid and genuine. Example: authorization by a

responsible official of all purchase orders

- Physical or logical controls: Restricting access to physical assets as well as computer programs

and data files. Example: cash being stored in a safe which only a limited number of employees

are able to access

- Reconciliations: Reconciliations compare two or more data elements to confirm completeness

or accuracy of the data. Example: the bank ledger account being reconciled to the bank

statements

Question: Explain the advantages and disadvantages for Equestrian Co of outsourcing the

internal audit department.

Answer:

Advantages

- Staffing: If it outsources, there will be no need to spend money on recruiting further staff as

the service provider will provide the staff members.

- Immediate solution: Outsourcing can provide the number of staff needed straight away.

- Skills and experience: A service provider is likely to have a large pool of staff available to

provide the internal audit service to Equestrian Co and is likely to have staff with specialist skills

already available.
- Flexibility: Staff can be requested from the service provider to suit the company’s workload

and requirements.

Disadvantages

- Increased costs: As well as the cost of potential redundancies, the internal audit fee charged

by the service provider may increase over time, proving to be very expensive.

- Knowledge of company: This may mean that each visit the staff members are different and

hence they may not fully understand the systems of the company.

- Confidentiality: Although the engagement letter would include confidentiality clauses, this

may not stop breaches of confidentiality.

Question: State FOUR control objectives of Caterpillar Co’s cash receipts system.

Answer:

- To ensure that all valid cash receipts are received and banked promptly.

- To ensure all cash receipts are recorded in the bank ledger account.

- To ensure that all receipts are recorded at the correct amounts in the bank ledger account.

- To ensure that cash receipts are correctly posted to the general ledger.

- To ensure that cash receipts are recorded in the correct accounting period.

- To ensure that cash is safeguarded to prevent theft.

Question: Describe the factors which the audit engagement partner would have considered in

determining that this issue is a KAM.

Answer:

- whether the matter was communicated to those charged with governance.

- the level of risk and judgement involved.

- whether, in their professional judgement, the matters regarding the valuation of the provision

were of most significance in the audit.

Question: Describe the content of the KAM section of the auditor’s report

Answer:

- include a reference to the audit risk

- detail why this issue was considered to be an area of significance in the audit

- how the matter was addressed in the audit