BA8018 PROFESSIONAL AUDITING

Revision questions
1. During the audit of Cairo Ltd, the audit senior discovered that some of the company’s
customers had paid invoices twice. The overpayments had not been refunded and had been
credited to the statement of profit or loss. The managing director told the audit senior that
these customers, which are government bodies, periodically pay the same invoice twice. He
also told the auditor senior that he has no intention of repaying the money unless the
customers ask for it to be repaid.

State, with reasons, the action the audit senior should take in respect of this matter.

2. Your firm acts as auditor to Cucumber Ltd, a retail car dealer. During the course of your audit
for the year ended 30 June 20X5, you discover that the company’s sales manager, helped by
the accounts clerk, has deliberately falsified details of the value of vehicles sold in order to
increase his monthly bonus payments.

Set out your responsibilities in respect of the above matter and contrast these with the
responsibilities of the management of Cucumber.

3. On 1 sep20X3, Dingwall LLP (Dingwall) and Harris LLP (Harris), two audit and assurance firms,
merged to form D&H LLP (D&H). Both firms moved to a single location and staff were
integrated. Each firm’s clients have confirmed that they wish D&H to continue providing the
same audit and assurance services. The following situations have arisen:

(i) As a result of the merger, D&H is now the external audit of both Wisp Ltd (Wisp), a
furniture maker, and Tapestry Ltd (Papestry). Tapestry earns 80% of its revenue
from a contract to supply sofa covers to Wisp and the two companies are currently
negotiating the renewal of this contract which is due to expire. Your firm is due to
commence planning both audit engagement, for the year ending 31 August 20X, but
does not expect the contract negotiation to be finalised before the financial
statements are signed.

(ii) Crow plc (Crow), a listed company, owns 100% of Mordu Ltd (Mordu). Fees earned
from the provision of services, in the 12 months to 31 August 20X3, were as follows:

Fees earned by Dingwall Fees earned by Harris

from Crow $’000 from Mordu $’000
External audit 289 176
Annual tax services 137 82
Annual report on 42 -
regulatory return
Report on forecast info - 18
(one-off engagement)
 Total fee income earned by Dingwall in the 12 months to 31 August 20X3 was $8.2
million. Harris earned $4.7m in the same period. Annual fee income is not expected
to be significantly affected by the merger.

(iii) On 31 march 20X3, Elinor Macintosh was appointed as an audit partner by Dingwall.
Immediately before this Elinor had been finance director at Menhir Ltd (Menhir), a
company which has been audited by Harris for a number of years. Menhir prepares
the financial statements to 30 June each year.

(iv) Before 1 Sept 20X3, Dingwall was the external auditor of Castle Ltd (Castle) and
Harris had been providing an outsourced internal audit function to Castle for 2
years. There were no threats to Harris’s independence or objectivity when it
accepted the internal audit engagement. Combined fees for these engagements
amount to less than 10% of D&H’s total expected fee income.

Requirements:

Identify and explain the principal professional and ethical issues presented by each of the
situations above and state the steps D&H should take to address them.

(a) Wisp
(b) Crow
(c) Elinor Macintosh
(d) Castle

4. Your firm has recently been invited to tender for the external audit of Duckling Ltd (Duckling)
for the year ending 30 September 20X2. Duckling was incorporated on 1 Oct 20X1. Duckling
is wholly owned by the company’s managing director, John Lim, who sold the trade and
assets of his unincorporated business to Duckling on 2 Oct 20X1. Your firm has had no
previous involvement with the incorporated business or Duckling.

The principal activity of Duckling is in the design and manufacturing of soft toys in the shape
of children’s television characters. Soft toys are manufactured from fabrics, fillings and glass
eyes. Snuggly Ltd (Snuggly) is the major supplier of fabrics to Duckling and John is the
majority shareholder of Snuggle. The industry is highly regulated and Duckling has to comply
with a number of quality standards to ensure the safety of its products for children.

The accounting records of Duckling are maintained by John’s son, Alexey, who previously
maintained the accounting records of the unincorporated business. Alexey taught himself
double entry bookkeeping from a textbook in order to help his father when the
unincorporated business was first set up. He has no other accounting experience.

The company has grown rapidly and John is seeking a loan from the company’s bank in order
to expand the business further. Before making a decision as to whether it will provide the
loan, the bank requires a copy of the audited financial statements for the year ending 30
September 20X2.
 Shelly Tan, the partner responsible for considering the invitation to tender for the external
audit of Duckling, is keen to propose a low fee in order to win the tender as she believes this
will place the firm in a strong position to be invited to provide the non-audit services.

Requirements:
(a) Discuss the appropriateness of the suggestion by Shelly Tan to propose a low fee for
the external audit.

(b) Identify, with reasons, the matters to be considered and procedures to be

performed by your firm when considering whether to tender for the external audit
engagement of Duckling for the year ending 30 September 20X2.

5. During your firm’s external audit of Long Ltd (Long), a chemical manufacturer, you were told
by an employee of Long that the company frequently fails to provide its factory workers with
the legally required protective clothing when working with hazardous chemicals. Explain why
this information should be considered by your firm during the external audit.

6. While reviewing the post year-end purchase invoices of Builda Ltd (Builda), a construction
company, the audit senior discovered an invoice for two designer watches costing $5,000
each. On enquiry, the audit senior was informed that the watches were given, by the
directors of Builda, to the managing director of Deluxe Developments Ltd (DD) and his wife.
DD is a property development company to which Builda regularly submits tenders for
construction projects. State, with reasons, the action to be taken by the audit senior.

7. You are the supervisor on the external audit of Plummer Ltd (Plummer) for the year ended
31 December 20X1. While performing the planned audit procedures in the week
commencing 12 March 20X2, the audit team noted the following issues in the schedule of
unadjusted errors:
(i) The balance on a trade receivable account, totalling $435,000, remains unpaid and is
in dispute. No allowance against the receivable has been made.
(ii) Goods despatched and delivered to a customer on 2 Jan 20X2 were included at
$260,000 in both revenue and trade receivables at 31 December 20X1. A member of
the engagement team attended the year-end inventory count and obtained a copy
of the count records.

The materiality is $565,000.

Identify one relevant audit procedure to address the issue noted. State and explain the
appropriate audit opinion.

8. You have completed the tests of controls in your audit. The only deviations found were that
there was no evidence that one particular control had been operated in three cases out of
the 25 tested. Explain what considerations will determine whether you are able to reduce
the substantive procedures in the area of this control.
9. Your firm has completed the external audit of the financial statements of Roses Ltd (Roses)
for the year ended 31 December 20X8 and an unmodified auditor’s report was signed by the
engagement partner on 1 March 20X9. Your firm’s auditor’s report has been provided to the
directors who plan to issue the financial statements and auditor’s report to the shareholders
on 30 March 20X9. While reading today’s newspaper, 23 march 20X9, you discover that
meadow Ltd (meadow), a major customer of Roses, went bankrupt on 15 march 20X9.

You were the audit senior on the audit of Roses and you recall that Meadow owned a
material amount to Roses, at 31 December 20X8, for goods purchased. This amount
remained outstanding at the conclusion of the subsequent events review.

Required:
(i) Explain the issue arising from the subsequent event.
(ii) State the actions to be performed regarding the adjusting subsequent event

10. Described below are situations which have arisen in five audit clients of your firm. The year
end in each case is 30 September 20X2.

Vista plc
Vista plc, a supplier of retail display equipment, has included in its statement of profit or
loss, immediately below profit after tax, an exceptional loss of $3.7 million on the sale of a
trade investment. This accounting treatment is not in accordance with accounting standards,
which require the loss to be taken into account in arriving at the profit or loss before
taxation. The materiality for the year is $694,000.

Expo Ltd
Expo Ltd exports a significant amount of its products, and has a major distribution centre in
an overseas country in which there has been a military coup. As a result of travel restrictions
imposed by the military junta, it was not possible for your firm to attend the year end
physical inventory count. The inventories at the overseas distribution centre at 30
September 20X2 represented 75% of Expo Ltd's inventories.

Pharm plc
Pharm plc, a company engaged in the manufacture of pharmaceutical products, has
extensive interests in an overseas country which requires pharmaceutical products to be
registered. The regulatory situation in that country is undergoing considerable change and
Pharm plc does not expect to obtain drug registration as quickly as originally anticipated.
However, after carrying out the appropriate review, the directors have decided that Pharm
plc has enough resources to continue for the next 12 months. Additional funding will be
required from that point, and the directors believe that this can be achieved by a further
issue of shares within the next 12 months. The directors have included a note to the
accounts explaining the situation which the audit partner deems as adequate.

Mog plc
Mog plc manufactures light fittings. Certain of its finished inventory lines are out of fashion
and have a net realisable value which is $35,000 lower than their original cost. However, the
directors have argued that, overall, the net realisable value of the entire inventories exceeds
original cost and that fashions may well change over the next few years such that the
company can ultimately sell these lines above their current net realisable value.
 The materiality is $90,000.

Requirements
In respect of the situations outlined above, state and explain the most appropriate audit
opinion.

11. Your firm has recently been appointed as auditor of Jog Ltd ('Jog'), a company operating
within the sports and leisure sector. Your audit manager has arranged a meeting with the
company’s finance director for early next week and she has asked you to assist her, in
advance of this meeting, with the audit planning for the year ending 30 June 20X6. Your
audit manager has also asked you to carry out some preliminary analytical procedures on
the year-end financial statements of Jog when these become available.

Jog’s business can be split into the following three divisions

• Sports equipment retail outlets: 35 sports equipment retail outlets located in 'out of town'
retail parks
• Fitness clubs: 15 fitness clubs, each offering a fully equipped gym together with yoga,
aerobics, and circuit training classes
• Machine manufacture: a manufacturing unit in which running machines and rowing
machines are assembled using components sourced from overseas.

Sports equipment retail outlets

The retail outlets are all located close to major towns and cities throughout Singapore. Each
outlet stocks a standard range of products which are supplied from a central warehouse
operated by Jog. Salaries for the core staff at the outlets are paid by Jog’s head office by
direct bank transfer. Each outlet is run on a day-to-day basis by a manager who is
responsible for hiring casual staff to cover peak periods. These casual staff members are
generally paid using cash from the till.

Jog received some bad publicity during the year following its inclusion in a television
documentary which revealed that one of its overseas sports shoe suppliers was making its
employees work long hours for very low wages. In an attempt to manage this adverse press
attention, Jog has now had to source these products from alternative suppliers based in
Singapore.

Fitness clubs
Jog’s 15 fitness clubs are all located directly above existing Jog retail outlets. Each club has its
own on-site manager and is operated independently of the adjacent retail outlet. Customers
of the fitness clubs pay by one of three methods: on a ‘pay per session’ basis over the fitness
club counter; by monthly direct debit paid into Jog’s head office bank account; or by annual
subscription to head office. Customers are then issued with a membership card which
enables them to gain access to the club. The company operates a bonus incentive scheme
for the managers at both its retail outlets and fitness clubs. The size of the bonus is linked to
the profitability of their individual operation.

Machine manufacture
During the year Jog started to manufacture its own running machines and rowing machines.
It sources the machine components from China and Taiwan. These components are
assembled in Singapore at Jog’s factory for sale both in Jog’s own stores under their own
'Jog' brand and also to independent sports shops under the 'Iron Champ‘ brand. The latter
accounts for approximately 80% of Jog’s total production of both running and rowing
machines. Sales to independent sports shops achieve a gross profit margin of 50%, whereas
sales to Jog’s own shops are made to that division at cost plus 10%.

Jog is invoiced by its overseas component suppliers in their respective local currency. The
components are sent by sea, which means that Jog’s typical lead time for components from
the placing of an order to delivery in Singapore is three months. Jog is required to pay its
suppliers 50% with order and 50% upon receipt of the components in Singapore.

Requirement
Identify which of the circumstances outlined above, should be taken into account when
planning the audit of Jog. Explain why these matters are important.