FAU slow man set 2

1. Which of the following statement about an audit engagement letter is true?

Answer: It should refer to the applicable financial reporting framework.
2. Which of the following categories of risk can be controlled by the auditor?
Answer: 1. Sampling risk
2. detection risk
3. Which of the following statement about audit planning documentation is true?
Answer: The audit strategy guides the development of the audit plan.
4. In which of the following circumstance must an ACCA member disclose to a third party
confidential information acquired about client company?
Answer: where the auditor suspect that the company is engaged in money laundering activities.
5. The standard of audit working paper should help with which of the following?
Answer: 1. Meeting of the specific audit objective
2. Delegation of audit work
6. Which of the following is the most reliable audit evidence?
Answer: inspection by the audit of title deeds relating to reported building owned by the client
company.
7. Which of the following are information processing control?
Answer: -reconciliation of supplier statement
-sequential numbering of sale invoice.
8. The auditor Fig Co, which is a manufacturing company has noted an increase in total sales value
but a decrease in the company gross profit margin for 20x5, as a compared to the previous year.
Which of the following is consistent with, and adequately explain the decrease in the gross profit
margin?
Answer: During 20x5 the company had to pay higher prices when purchasing component.
9. Which of the following factor would be relevant to the external auditor assessment of the
competence of the internal audit function?
Answer: weather the internal audit function is adequately resource.
10. Which of the following control would have the primary objective of ensuring that hourly-paid
factor employee is the only paid for hour worked?
Answer: Review the authorization of time sheet by the factory supervisor.
11. In the context of the audit of the financial statement of a company which of the following are
analytical procedures?
Answer: 1. Comparing the monthly sale trend of the company with those of other companies in
the same business sector.
2. Calculating the average gross wage per employee of the company and comparing it to
the average for the previous years.
12. Which of the following application control is a control over the competences of data input?
Answer: Batch Total
13. Which of the following statement about written representation made by management to the
auditor are true?
Answer: 1. They include a statement that management has fulfill its responsibilities for the
preparation of the financial statement.
2. They confirm that all truncation has been recorded and are reflected in the financial
statement.
14. Which of the following is an example of how the auditor would use test data during an audit?
Answer: the processing data entered in to the client system to confirm that control is operating as
expected.
15. Which of the following statement about auditor’s liability is incorrect?
Answer: The shareholder of a company may successfully sue its auditor for breach of contract
16, Olive Co is a large electrical goods wholesaler. It is 1 July 20x5 and your firm will audit the
company's financial statements for the year ending 31 July 20X5. At the audit planning briefing,
your audit manager confirmed that Olive Co has well designed, strong internal control. He
emphasized that all elements of the company's control environment were particularly well
developed, especially that of the communication and enforcement of integrity and ethical
values.
Required
(a) Identify and explain THREE elements of the control environment of Olive Co, other than that
of the communication and enforcement of ethical values. (9 marks)
(b) (i) Explain the effect that well designed strong internal control in Olive Co should have on
your firm's assessment of the risk of material misstatement in the company's financial
statements. (3 marks)
(ii) Explain the impact that such strong internal control should have on the level of detection
risk and therefore the planned substantive procedures, when auditing Olive Co's financial
statements. (3 marks) (Total = 15 marks)
Answer:
16, a) Elements of the control environment Additional elements in Olive Co's control
environment would be as follows:
1) Commitment to competence. This refers to the consideration given by the directors of
Olive Co, to achieving appropriate levels of competence for all of employees, such that
tasks can be carried out effectively and efficiently.
2) Participation by those charged with the governance of Olive Co. This refers to the extent
that non - executive directors and other individuals, alongside the executive directors,
are involved in the governance of the company. Strong governance, incorporating
procedures which allow for day to day executive decisions to be scrutinized and
challenged by independent and experienced individuals, should lead to a stronger
control environment.
3) Management's philosophy and operating style. This refers to the characteristics of the
directors of Olive Co in the way they run the company's daily operations. For example,
their approach to managing business risks (cautious or cavalier?), and attitudes towards
financial reporting and accounting functions.
b) (i) Effect of strong internal control on assessment of risk of material misstatement:
The presence of strong internal control in Olive Co would influence the audit firm's assessment
of control risk when determining the level of risk of the existence of material misstatement in
the company's financial statements. There is a direct correlation between these risks in that the
lower the level of control risk, then the lower is the risk of material misstatement. Conversely,
the higher the level of control risk then the higher is the risk of material misstatement. Control
risk associated with the financial statements of Olive Co should be assessed as ‘’low’’.
(ii) Impact on planned substantive procedures:
The strong internal control should have a major impact on the level of detection risk that the
audit firm would be willing to accept in order to reduce audit risk to an acceptable level. Having
assessed the risk of material misstatement as low detection risk should be set at the level such
that : Audit risk = ( Risk of material misstatement x Detection risk ) As a consequence of the
strong internal control and lower level of control risk , a proportionately higher level of
detection risk should be set than would be , were control risk to be assessed higher . This higher
level of detection risk would mean that less extensive substantive procedures need to be
carried out in order to restrict exposure to audit risk to the prescribed level, than would be the
case if detection risk was low.
17, Pear Co is an established builders' merchant, and a new audit client of your firm. The next
financial statements of the company due for audit, will be those for the year ending 31 July
20x5 and the following information is relevant for the audit. The company operates from 14
sites around the country. 18 full - time staff are employed at each site together with varying
numbers of part - time and temporary employees. All sites comprise a shop and a yard with the
largest site also including the company's head office. During the year, each of the shops was
subjected to a major repair and refurbishment program. Each site sells timber, consumable
materials and general building products and very large stockpiles of sand are kept in each yard
to meet customer demand. Tools and equipment are also available both for sale and for short
term hire. Customers may collect goods themselves or they can make use of the company
delivery service. Pear Co owns a large volume of mobile plant and machinery to service its yard
and delivery operations. These include mechanical shovels, dumper trucks, lorries and vans.
Required
(a) Explain what is meant by inherent risk. (3 marks)
(b) Using the information provided, identify and explain THREE factors that would affect the
assessment of inherent risk associated with the financial statements of Pear Co for the year
ending 31 July 20X5. (12 marks) (Total = 15 marks)
Answer:
17, a) Inherent risk Inherent risk is the susceptibility of an assertion about a class of transaction,
account balance or disclosure to a misstatement that could be material, either individually or
when aggregated with other misstatements, before the consideration of any related internal
controls.
b) Inherent risk factors:
The following factors would affect the assessment of the inherent risks associated with the
audit of the financial statement of Pear Co:
(i) The company has incurred substantial costs on repair and refurbishment programs
at all 14 sites around the country. These costs would have a material effect on the
company's financial statements and initial concerns would centre on the
completeness and accuracy of recording including the correct classification of costs
between revenue (repair) and capital (improvement) expenditure in the financial
statements.
(ii) The company has extensive retail operations selling a wide range of products. The
nature and mix of sales at each site including the hiring of tools and equipment,
would lead to audit concern as to the possibility of unrecorded sales and the
incorrect categorization of sales in the company's accounting records.
 (iii) Inventory would represent a significant proportion of the company's assets and
there would be initial concern over this area of the company's financial statements.
Concerns would centre around the basis of the quantification and valuation of
inventory for inclusion in the company's statement of financial position. As regards
quantification, there may be particular concern as to the measurement of stockpiles
of sand and concerns about valuation may be found primarily on the values ascribed
to inventory lines and individual items of inventory held at each site. Owing to the
portability of inventory lines and open access to them, there would also be concern
as to the likelihood of loss or misappropriation of inventory.
18. a. Objectives of the internal control over purchases and trade payables
The objectives of the internal control that should be exercised are:
-To ensure that only necessary goods and services are purchased by Apple Co
-To ensure that all goods and services purchased are for the benefit of Apple Co
-To ensure that goods and services purchased are of sufficient quality
-To ensure that goods and services are purchased on a timely basis
-To ensure that goods and services are purchased on the best possible trading terms taking into
account price and due payment date
-To ensure that all purchase transactions are accurately and completely recorded in Apple Co's
accounting records
-To ensure that any disputes with suppliers are settled to the greatest benefit of Apple Co
b. Threats to independence
ACCA's Code of Ethics and Conduct recognizes that where an auditor carries out additional,
non-audit services for an audit client, in certain circumstances the firm's independence and
objectivity may be, or may be seen to be, compromised. If the audit firm designs and implements
the internal control system for Apple Co, by necessity, as part of the firm's audit procedures, the
system would need to be subsequently reviewed and evaluated. As such, the firm's independence
and objectivity with regard to the audit of Apple Co's financial statements would be open to a
self-review threat.

19. a. Obtaining an understanding of business operations

The matters that the audit firm may have considered when obtaining an understanding of the
business operations of Grape Co include:
(i) Nature of revenue sources, services and products. The company has several income
streams as detailed and the audit firm should have gained an understanding of the
extent to which the company relies on these as its principal source of revenue, the
sensitivity of each to market conditions, and the complexities involved in measuring
and recording income from each stream
(ii) Control of operational activities and reporting mechanisms. Grape Co owns six golf
clubs and there are various strategies the company could adopt to control the day to
day operations at each club and reporting for example autonomous operations and
reporting at each club or divisionalisation of operations and reporting.
(iii) The geographical spread of activities and administrative functions. Club locations are
spread throughout the country and in order to have a full appreciation of audit
 implications arising, the audit firm needs to know the location of each club, any
centralized administration activity and locations of inventory.
(iv) Employment arrangements including the existence of pension and other post-
employment benefits. Given the nature and geographical spread of the company's
activities, it is likely to have a significant number of employees with varying
contracts of employment and conditions of service. As such these will have material
financial implications for Grape Co and the audit firm should therefore be familiar
with them.
(v) Details of key suppliers to the company. It is very likely that Grape Co will trade with
many providers of goods and services - some of which may be key providers to the
company. The audit firm should be aware of the identity of the key providers in order
that it may address any implications resulting from sues arising with them.

b. Responding to offers of gifts from audit client

ACCA'S Code of Ethics and Conduct recognizes that accepting gifts (or hospitality) from
an audit client may create self-interest and familiarity threats. These threats cannot be
reduced by the application of any safeguard The Code therefore confirms that to avoid
these threats members of an audit team should only accept gifts or hospitality from an
audit client if they are of inconsequential and trivial value. Applying this principle to the
situation of Grape Co, the gift of free golf club membership is of significant value and
should be declined. The offer of free pens to the audit team appears to be of trivial and
clearly inconsequential value, therefore acceptance would not be in breach of the Code
and as such, may be accepted.

20. The three condition that must have existence for a third party to be successful in a claim
against an auditor are
DUTY OF CARE
The auditor must have a duty care, enforceable by law, to the third party. This would always be
the cse if there is a contract in place between the auditor and the third party, but a duty care
can be implied even in the absence of contract
NEGLIGENCE
In a situation where duty of care existed, the auditors must have been negligent in the
performance of that duty as judge by the professional standard in force at time
DAMAGE
When the auditor is deem to have been negligent, the third party must have suffered a
monetary loss as a direct consequence of negligence

21. (a) definition of term

Financial statement assertion are assertion made by management, explicit or otherwise that
are embodied in financial statement are use by the auditor to consider the different type of
potential misstatement that may occur
(b) identification and explanation of assertion – wage cost (any two of the following)
• Occurrence: the report cost $2.27Million relate to transaction that have occurred and
pertain to the company
• Completeness: the report cost $2.27 million are complete and there are no other wage
cost incurred during the accounting period
• Accuracy: the report cost $2.27 million accurately reflect the total wage cost of the
company for the accounting period
• Cut-off: the report cost $2.27 million relate only to the cost incurred for the accounting
period
• Classification : the report cost $2.27 million have been properly classified as wage cost
in financial statement
• Presentation: transaction and event pertaining to cost of $2.27 million are appropriately
aggregate or disaggregate and clearly describe and related disclosure are relevant and
understandable in the context of requirement of applicable financial reporting.
22. Question: An auditor wishes to select a sample of sale invoices for substantive testing
using systematic selection
a). explain the term systematic selection
b). identify two factors which would affect the sample size determined by the auditor.

Answer:
a). explanation of term: This is a sample method which the auditor selects items using
constant interval between selections. The first item may be selected on a random basis, and
thereafter the sampling interval is derived systematically, by for example, dividing the
population by the sample size to arrive at a constant interval for use.
b). two factors
- tolerate rate of misstatement
- expected rate of misstatement

23. Question:
a). identify the three possible types of modified opinion which may be expressed in an
audit’s report.
b). For any one of the types of modified opinion identified in (a), describe the circumstances
in which it should be expected.

Answer:
a). three types of modified opinion:
- a qualified opinion
- a disclaimer of opinion
- an adverse opinion
b). modified opinion-circumstances
Disclaimer of opinion: where the auditor is unable to obtain sufficient appropriate audit
evidence to conclude that the financial statements as a whole are free from material
misstatement, and where the effect of the subject matter on the financial statements is
material and pervasive.
Adverse opinion: where the auditor concludes that, based on the audit evidence
obtained, the financial statements as a whole are not free from material misstatement,
and where the effect of the subject matter on the financial statements is material and
pervasive.