CAF 8 Volume 1

KnS School of Business Studies
CA CAF- 8 Audit & Assurance

Summary Notes by SK
Index of Handouts
S. No. Description Page No.
1. CA CAF 8 Audit Syllabus 3
2. Analysis of Theoretical & Practical Questions 12
3. CA CAF 8 Result Analysis of ICAP 13
4. Broad categories of CAF 8 14
5. Snapshot of an External Audit Process 15
6. Audit Cycle 16
7. ICAP CA CAF 8 Past paper (Spring 2023) 17
8. ICAP CA CAF 8 Past paper (Autumn 2022) 20
9. ICAP CA CAF 8 Past paper Solution (Autumn 2022) 23
10. Sequence to study CAF 8 Audit & Assurance 30
11. Basics Concepts of Audit & Assurance # Part 1

32
12. Introduction to Auditing
33
13. Inherent Limitations of an External Audit
34
14. Basic Concepts # Part 2
36
15. CAF 8 Past Papers (Basic Concepts)
50
16. Few More Practice Questions
57
17. ISA 500 - Audit Evidence
62
18. ISA 230 - Working Papers
80
19. ISA 320 - Materiality
91
20. ISA 300 - Planning an Audit
105
Page 1 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Summary Notes by SK
ISA 315 - Audit Risk (Theoretical Part) 120
21.
22. ISA 315 - Audit Risk (Practical Part) 126
23. Audit Risk plus Accounting Ratios 154
24. (ISA 300 + 315) - Understanding the Entity 181
25. Internal Audit Department 192
26. ISA 610 - Using the Work of Internal Auditors 208
27. ISA 620 - Using the Work of an Expert 217
28. Internal Control 225
29. Internal control of a Small Company 231
30. Documentation of accounting and internal control system 235
31. Audit Report 253
 ISA 700 - Audit Report
32. ISA 701 - Key Audit Matters 308
33. ISA 560 - Subsequent Events 319
34. ISA 570 - Going Concern 342

Summary Notes by SK
CAF-8 Audit and Assurance Syllabus
Competency
Apply knowledge of general concepts, principles, skills and techniques of auditing and
selected International Standards on Auditing, Assurance and Ethics.
Syllabus Teaching
GRID Weightage
Ref. hours
A Audit Framework, Regulations and professional ethics 25-30 15-25
B Planning and Risk Assessment 20-25 15-20
C Audit Evidence and Internal Controls 50-55 45-55
D Conclusion and Reporting 15-20 10-15
Total 110-130 100
Key Examinable Technical Competencies

Syllabus Proficiency Testing
Ref. Learning Outcomes Level Level
A. Audit Framework, Regulations and professional
ethics
a Basic Concepts
1. Describe briefly the history, vision, mission,
objectives and functions of the international
auditing and assurance standards board
(IAASB).
2. Discuss the types, scope and inherent
limitations of an External Audit. P1 T1
3. Discuss the concepts of true and fair view,
professional skepticism, professional judgment,
accountability and stewardship.
4. Discuss the responsibility of management, those
charged with governance and external auditors
in relation to financial statements.
b Concept of assurance and non-assurance
engagements
1. Discuss the types and levels of the assurance
engagement.
2. Discuss briefly the non-assurance engagements P1 T1
related to Preparing Accounting Records and
Financial Statements, Valuation Services and
Recruitment Services.

Summary Notes by SK
Ref. Learning Outcomes Level Level
c Agreeing the terms of Audit Engagements
1. Discuss the concept, importance and the contents
of Engagement Letter.
P1 T1
2. Discuss factors to be considered in the case of
recurring audits.
3. Discuss Preconditions for an audit and Course of
action in the case when preconditions are not present.
d Quality Control Procedures
1. Explain the overall objectives and importance of
quality control procedures in conducting an audit.
2. Explain briefly the quality control procedures for P1 T1
acceptance and continuance of client relationship
and engagement, engagement performance and
monitoring.
e Appointment, removal and qualification of auditors
1. Discuss the requirements related to appointment, P2 T2
removal, fee, qualification and disqualification of
auditors.
2. Discuss the objectives, rights and duties of external P1 T1
auditors in relation to the Financial Statement.
f Code of Ethics
1. Discuss fundamental principles and threats to P2 T2
Independence and Objectivity.
2. Discuss the circumstances that cause threats and
explain the safeguards to offset threats to compliance
with the fundamental principles and threats to
independence and objectivity.
3. Explain the matters to be considered by an audit
firm in the following circumstances:
 Client acceptance
 Engagement acceptance
B Planning and Risk Assessment

a Planning an Audit
1. Discuss the importance of planning an audit and the
content of an audit strategy and detailed audit plan.
P1 T1
2. Discuss preliminary engagement activities.

Summary Notes by SK
Learning Outcomes
Ref. Level Level
3. Discuss additional considerations in initial audit
engagements.
4. Discuss briefly the concept of interim and final audit
and list the audit procedures that can be performed
by the external auditor at the interim and final stage
of an audit.
b Audit Documentation
1. Discuss the importance of audit documentation
including custody, ownership, confidentiality and
retention. P1 T1
2. Discuss types of working papers (Permanent and
current), including automated and standardized
working papers.
3. Discuss factors to be considered in determining the
form and content of audit documentation.
c Risk identification and Assessment
1. Define audit risk and its components.
2. Explain audit risk from the given scenario and the
auditor’s response to the risk identified.
3. Explain why auditors obtain an understanding of
the entity and its environment.
4. Explain the matters about which the auditor will P2 T2
obtain an understanding of the entity and its
environment.
5. Explain how the auditor will obtain an
understanding of the entity and its environment.
6. Explain the purpose of risk assessment procedures
at the planning stage of an audit.
7. Discuss documentation.
d Materiality in planning and performing an Audit
1. Explain the concepts of materiality, qualitative
materiality, revision in materiality, performance
materiality.
P2 T2
2. Explain how materiality is calculated.
3. Explain the application of materiality on audit.
4. Discuss documentation of materiality.
e Fraud and Error
1. Define fraud and error and discuss their differences. P2 T2

Summary Notes by SK
Learning Outcomes
Ref. Level Level
2. Discuss types of Fraud.
3. Discuss the responsibility of Management, those
charged with governance and external auditor with
respect to fraud.
4. Discuss risk assessment procedures with respect to
fraud by the External Auditor.
5. Discuss response to the assessed risk of material
misstatement due to fraud (at the financial statement
level).
6. Identify fraud risk factors and circumstances that
indicatethe possibility of fraud in simple scenarios.
C Audit evidence and Internal Controls
a Audit Evidence
1. Define audit evidence and discuss methods to
obtain audit evidence.
2. Discuss the concept of Sufficient and appropriate
audit evidence. P1 T1
3. Explain types of audit procedures.
4. Define financial statement assertions.
b External Confirmation
1. Define external confirmation, types, methods and
significance of external confirmation.
2. Discuss planning and design of External
Confirmation.
3. Discuss the course of action in the case of reply from
P2 T2
third parties (both in the case of positive and
negative confirmations).
4. Discuss the course of action if management refuses
to allow the auditor to send confirmation.
5. Discuss the concept of exception and procedures to
be performed in the case of an exception.
c Analytical procedures
1. Explain analytical procedures and their various types. P2 T2
2. Discuss factors to be considered when using
analytical procedures as substantive procedures.
3. Discuss the importance of analytical procedures at
the planning stage and when forming an overall
conclusion / at the end of the audit.
4. Interpret accounting ratios along with audit risk.

Summary Notes by SK
Learning Outcomes
Ref. Level Level
d Audit Sampling
1. Explain audit sampling and its purpose.

2. Explain the concept of 100% testing and selection
technique including factors to be considered in this
regard.
3. Discuss methods of sampling (Statistical and non-
statistical).
4. Explain the concept of sampling risk and non-
sampling risk. P1 T1
5. Explain the concept of Stratification.
6. Discuss the concept of misstatement and rate of
deviation including expected and tolerated.
7. State the audit procedures to be performed on the
selected sample.
8. Discuss the concept of projecting misstatement and
evaluating the results of audit sampling.
e Subsequent Events
1. Explain requirements related to subsequent events
and the auditor’s responses.
2. Describe the auditor’s responsibility in respect of
the following situations:
- Events occurring between the date of the
financial statements and the date of the auditor’s P2 T2
report.
- Facts that become known to the auditor after the
date of the auditor’s report but before the date the
financial statements are issued.
- Facts that become known to the auditor after the
financialstatements have been issued.
f Going Concern
1. Discuss the concept of going concern assumption.
2. Discuss the responsibility of management and
external auditors with respect to going concern.
3. Explain potential indicators that an entity is not a
going concern. P2 T2
4. Discuss the procedures to be applied in performing
going concern reviews and additional procedures
when events or conditions are identified.
5. Explain the impact on the audit report in the case
of going concern.

Summary Notes by SK
Learning Outcomes
Ref. Level Level
g Written Representation
1. Explain written representation.
2. Discuss the course of action when there is a doubt as
to the reliability of written representation.
3. Discuss the course of action in the event when
management does not provide the requested written P2 T2
representation.
4. Explain the impact on the audit report in the case
there is a doubt about the reliability of written
representation and when such is not provided by
the management.
h Substantive Procedures
1. Explain the audit procedures to verify:
- Profit and loss items (Sales, Purchases, payroll
expense, Bad debt expense)
- Balance Sheet Items (Cash in hand, Cash at
Bank, Tangible and Intangible Fixed Assets,
Debtors, Trade Payables, Inventory, Long term
P2 T2
loan, Various types of provisions)
- litigation and claims
- segment information
2. Explain the audit procedures for relevant and
specific financial statement assertions.
i Internal Control and Test of Controls
1. Explain internal control and its components. P2 T2
2. Discuss the objectives and limitation of an
accounting and internal control system.
3. Discuss how the internal control system is
documented through various methods.
4. Discuss the concept of Walkthrough Test and the
difference between Walk through Test and Test of
Controls.
5. Discuss internal controls of a small company/entity.
6. Explain the risk, controls and test of controls to be
performed on major transition cycles (Sales system,
purchase system, inventory system, bank and cash
system, payroll system and revenue and capital
expenditure system).

Summary Notes by SK
Learning Outcomes
Ref. Level Level
j Using the work of others
1. Discuss the concepts and functions of the
internal audit department.
2. Explain the difference b/w the external audit and
internal audit.
3. Explain how the work of internal auditors is
evaluated and direct assistance of internal auditors is
used.
P2 T2
4. Explain areas where an auditor’s expert can be used
by the external auditor.
5. Explain factors to evaluate the competence,
capability and objectivity of the auditor’s expert.
6. Explain how the adequacy of the auditor’s expert’s
work can be evaluated.
7. Explain how reference to the Auditor’s expert is
made in theauditors’ report.
k Related Party
1. Describe the term related party using simple
examples.
2. Discuss how related party transactions can give rise
to the risk of material misstatement using simple
examples. P2 T2
3. Describe the audit procedures including risk
assessment procedures and related activities to
obtain information relevant to identifying the
related party relationships and transactions
including responses to the assessed risk of material
misstatement.
l Computer Assisted Audit Techniques and General &
Applicable IT Controls
1 Explain the concept of Computer Assisted Audit
Techniques, Test Data and Audit Software and
their advantages and disadvantages. P2 T2
2 Describe general I.T controls and Application I.T
controls.
D Conclusions and Reporting
a External Audit Report

1. Discuss the concept of unmodified and modified P1 T2
opinions.

Summary Notes by SK
Learning Outcomes
Ref. Level Level
2. Discuss the contents of an audit report.
3. Discuss additional reporting responsibilities.
4. Discuss the format and content of key audit matters
(KAM), emphasis of matter paragraph (EOMP) and
other matter paragraph (OMP).
5. Discuss the relationship of KAM with other content of
audit report.
6. Discuss circumstances where EOMP and OMP
are/may be necessary.
7. Discuss the relationship of EOMP and OMP with
other content of audit report.
8. Discuss the impact on the audit report via various types

of opinions in scenario-based questions. P2 T2
b Engagement to Review Financial Statements

1. Discuss the concept and scope of a review engagement.
2. Explain Difference b/w audit and review engagement.
P1 T1
3. Discuss the procedures to be performed by the
practitioner in the case of a review engagement.
Specific Examinable Knowledge Reference
ISA 200: Overall objectives of the Independent Auditor and the conduct of an audit in
1
accordance with International Standards on Auditing
2 ISA 210: Agreeing the terms of audit engagement
3 ISA 220: Quality Control for an audit of financial statements
4 ISA 230: Audit documentation
ISA 240: The auditor’s responsibilities relating to fraud in an audit of financial
5
statements (including appendix 1 and 3)
6 ISA 300: Planning an audit of financial statements
ISA 315(revised): identifying and assessing the risk of material misstatement through
7
understanding the entity and its environment
8 ISA 320: Materiality in planning and performing an audit
9 ISA 330: The auditor’s response to assessed risks
10 ISA 500: Audit evidence
11 ISA 501: Audit evidence-specific considerations for selected items
12 ISA 505: External confirmations
13 ISA 520: Analytical procedures

Summary Notes by SK
14 ISA 530: Audit Sampling
15 ISA 560: Subsequent Events
16 ISA 570: (Revised) Going Concern
17 ISA 580: Written representations
18 ISA 610(revised 2013): Using the work of internal auditors
19 ISA 620: Using the work of an auditor’s expert
20 ISA 700(revised): Forming an opinion and reporting on Financial statements
21 ISA 701: Communicating Key audit matters in the Independent auditor’s report
22 ISA 705 (revised): modifications to the opinion in the independent auditor’s report
ISA 706 (revised): emphasis of matter paragraphs and other matter paragraphs in
23
the independent auditor’s report
24 ISRE 2400: Engagements to review historical financial statements
25 Companies Act 2017 (Sections 246 to 251)
ICAP Code of Ethics for Chartered Accountants revised 2019 (Sections 100-120, 320 and
26
330)

Summary Notes by SK
Analysis of Theoretical & Practical Questions in the CAF 8 Exam
(Previously CAF 9)
S. No. Attempt Theoretical Questions Practical Questions
1 March 2016 62 38
2 September 2016 72 28
3 March 2017 49 51
5 March 2018 38 62
7 March 2019 61 39
9 March 2020 25 75
10 September 2020 39 61
11 March 2021 36 64
12 September 2021 28 72
13 March 2022 43 57

Summary Notes by SK
CAF 8 Result Analysis of ICAP (13 Attempts)
S. No. Attempt Result Analysis
1 September 2016 55%
2 March 2017 36%
4 March 2018 29%
6 March 2019 21%
7 September 2019 25 %
8 March 2020 41 %
10 March 2021 42 %
12 March 2022 33%

Summary Notes by SK
Broad categories of CAF 8
Basic Concepts of Audit
Materiality & Audit Report
Subsequent Events, Going Concern and Management Representation
Materiality, Fraud and Risk Assessment
Internal Controls and Test of Controls
Audit Evidence and Substantive Procedures
Code of Ethics / ICAP Ethical guidelines / Co. Law sections
I.T and Other small areas
HOW TO STUDY CA CAF 8

Summary Notes by SK
Snapshot of an External Audit Process
Inherent Limitation of an Audit
Management External Scope of an Audit Few

A Basic
& TWCG U Auditors Professional Judgment Concepts
D Of
I Professional Skepticism External
T Audit
Levels & Types of Assurance
True & Fair View
Responsibilities
1. Running of the company 1. Conducting an audit of financial statements

2. Implementation of internal controls 2. Expressing an opinion on financial statements
3. Preparation of financial statements 3. Giving recommendation on internal controls to management

Summary Notes by SK
Audit Cycle
2020 2021
B/S Date Date of Report
Dec 31st, 2020 Feb 20th, 2021 AGM Date April 05th, 2021
Financial Year JAN FEB MARCH APRIL
1 2 3

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Sequence to study CAF 8 Audit & Assurance
S. No. Description
1. Basic concepts of an audit
2. Audit Evidence (ISA 500)
3. Working Papers (ISA 230)
4. Materiality (ISA 320)
5. Audit Report (ISA700,701,705 & 706)
6. Subsequent Events (ISA 560)
7. Going concern (ISA 570)
8. Planning an Audit (ISA 300)
9. Audit Risk (ISA 315)
10. - Theoretical area
10 a) - Practical area
10 b) Audit Risk (Not for Profit Organization - NPO)
11. Understanding the entity & its environment (ISA 315)
12. Internal Audit Function / Department
13. Using the work of Internal Auditors (ISA 610)
14. Using the work of an Expert (ISA 620)
15. Test of controls (TOCs)
16. Substantive Procedures

Summary Notes by SK
17 (a) - F/S Assertions
17 (b) - Debtors plus ISA 505 (External confirmation)
17 (c) - Cash in hand and cash at bank
17 (d) - Fixed Assets (tangible and Intangible assets)
17 (e) - Trade payables and provisions
17 (f) - Operating expenses, Sales and Purchases
17 (g) - Inventory / closing stock
18. Analytical Procedures (ISA 520)
19. Management representation (ISA 580)
20. Related Parties (ISA 550)
21. Fraud and Error (ISA 240)
22. Sampling (ISA 530)
23. Engagement Letter (ISA 210)
24. Interim and final audit
25. Other small areas (e.g. Internal Control & its components)
26. Review Engagement (ISRE 2400)
27. Code of Ethics / ICAP code of conduct
28. Company Law sections
29. I.T (C.A.A.T)
30. Revision and past papers practice (Topic wise)

Summary Notes by SK
Basics Concepts of Audit & Assurance # Part 1

1. Concept of an external audit
2. Concept of an external audit (4 steps of an audit)
3. Scope of an external audit
4. Objective of an external audit
5. Assurance firm and assurance client
6. Audit team hierarchy (structure within an audit firm)
7. Audit Cycle (Class diagram)
8. Concept of professional judgment
9. Concept of professional skepticism
10. Concept of Inherent Limitations of an audit
11. Concept of an assurance engagement
i. Types of Assurance
ii. Levels of Assurance
iii. Contents/Elements of an Assurance Engagement.
12. Responsibility of Management & those charged with Governance.
13. Responsibility of an External auditor
14. Concept of true & fair view in the Audit report
15. Concept of an Internal Control
16. Concept of management letter (M.L)
17. Concept of accountability, stewardship & agency
18. Concept of an external audit report
19. Concept and Diff b/w statutory & non-statutory audit
20. Difference between an external & internal audit.
21. Rights (Powers) and Duties of an External auditor.

Summary Notes by SK
Introduction to Auditing
1.
2. An External Auditor examines/audits the F/S of the company and expresses an independent audit
opinion on those accounts in the form of an Audit Report at the end of an Audit which is addressed to
its Shareholders/Members. (ISA700,701,705 &706)
3. An External auditor complies with the code of ethics (Ethical guidelines) for professional
accountants/auditors issued by International Federation of Accountants (IFAC).
4. An External auditor conducts an audit in accordance with the International Standards of Auditing
(ISA) which determines the scope of an external audit.
5. An External auditor examines/conducts an audit of F/S prepared by the management of the company.
(Finance dept.) and approved by its Board of Directors (B.O.D)
6. An External Auditor can NEVER express an Absolute Level of Assurance in an audit engagement
because there are Inherent Limitations of an audit e.g.
i. The use of testing techniques (Audit is done on a sample basis i.e. (we don’t check every single item
in the F/S) (ISA 530)
ii. The inherent limitations of an Audit & Accounting and Internal control system
operating at the client (e.g. Human errors & collusion between employees via Fraud etc.)
Student Notings

Summary Notes by SK
Inherent Limitations of an External Audit
Absolute level of assurance can NEVER be expressed in an External Audit because of inherent limitations
of an audit that affect the auditor’s ability to detect Material Misstatements in the financial statements.
It can also be said that the auditors can never certify that the accounts are correct, they can only express a
reasonable assurance on the financial statements of the company.
Reasonable assurance is a concept that there are no material misstatements in the financial statements taken
as a whole.
What is Reasonable Assurance……?
These Inherent Limitations of an AUDIT are as follows:
1. External Auditors conduct examination on a test basis i.e. they work on a sample basis and do not check
everything in the F/S. (Sampling to be discussed Later in ISA 530)
2. The fact that most of the audit evidence is persuasive rather than conclusive. (audit evidence sometimes
indicates what is probable, i.e. it’s not certain, ……………because most of the times evidence is based on
estimates and judgments & intentions i.e. External Auditors evaluate the reasonableness of estimates
made by the Management e.g.
i. Provision for doubtful debts

ii. Provision for obsolete stock
iii. Provision for court case / lawsuit
iv. Provision for warranty
3. Audit Report has its own limitation because of its technical language/wordings and standard format (ISA
700 Revised).
There are Inherent Limitations of an Accounting and Internal Control System operating at the Client:
Examples are:
 Management override of Internal Controls What is Internal Control...?

 Human error (typing mistakes).
 Cost/benefit trade off (where it’s not cost feasible to implement controls)
 Practice of fraud and intentional misrepresentation by the management is also an Inherent Limitation for the
Audit. ( to be discussed in ISA 240 )
Because of factors described above, an External audit is NOT a guarantee that the financial statements are
free from material misstatements, i.e. an absolute assurance is not attainable.

Summary Notes by SK
Further an audit opinion does not assure the future viability of the entity nor the efficiency or effectiveness
with which management has conducted the affairs of the entity.
Other Limitations of an Audit
Student Noting

Summary Notes by SK
BASIC CONCEPTS # Part 2

1. Scope of an external Audit
2. Overall Objectives of an External Auditor
3. Professional Judgment
4. Professional Skepticism
5. True and Fair View
6. Management’s Responsibility
7. Internal Control
8. Standard Audit Report (ISA 700)
9. Management Letter (M.L)
10. Concept of accountability, stewardship and agency
11. Assurance engagements

Summary Notes by SK
1.Scope of an External Audit
Scope of an external audit is determined by the auditor having regard of the following:
1. ISA (International Standards of Auditing)
2. I.F.R.S and I.A.S
3. Local Laws (Companies Act 2017) &
4. Scope defined by
(4-a) Professional bodies like ICAP & ACCA
(4-b) Terms of an audit engagement as per ISA 210
Scope of an Audit covers:

a) Only financial statements and not the whole annual report.
b) Scope of an Audit does not assure the efficiency and effectiveness of management and those charged
with governance.
c) Audit does not assure the future viability of the entity.
d) Audit opinion does not cover an opinion on the Internal Controls of the audit client, however,
external auditor considers internal controls in order to design audit procedure to determine the audit
risk, to express and opinion on the financial statement of the company.
e) Audit covers additional matters only if local laws and regulations require the auditor to do so.
f) Performing audit procedures to obtain sufficient appropriate audit evidence (S.A.A.E) to verify
financial statements
g) Evaluating the appropriateness of accounting policies and the reasonableness of accounting
estimates made by management
Questions to be asked:
1.
2.
3.
2.Objectives of an External Auditor

 To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatements, whether due to fraud or error, thereby enabling the auditor to express an opinion on
whether the financial statements have been prepared, in all material respects, in accordance with an
applicable financial reporting framework (e.g. IFRS and IASs) and relevant LAWS (Companies Act
2017)
 To report on the financial statements to the shareholders as required by the ISAs, in accordance with
the auditor’s findings during the audit.

Summary Notes by SK
3.Professional Judgment
Meaning and importance
An external auditor must take informed decision about the course of action to be followed by him on the
basis of relevant training, knowledge and experience and keeping in view the guidance provided by auditing
and accounting (IFRS) standards. Professional judgment must be exercised throughout the audit and must
be appropriately documented.
Areas / matters where Professional Judgement is used by the External Auditor are:
1.
2.
3.
4.
5.
Question to be asked
1.
2.
3.

Summary Notes by SK
4.Professional Skepticism
Meaning and Importance
Professional skepticism includes being alert to, for:

 Audit evidence that contradicts another audit evidence obtained during the audit.
 Information that brings into question the reliability of documents and responses to inquiries to be
used as audit evidence.
 Conditions that may indicate possible fraud.
Maintaining professional skepticism throughout the audit is important to reduce the risk of
 Overlooking unusual circumstances. And
 Using inappropriate assumptions.
The auditor cannot be expected to disregard past experience of the honesty and integrity of the entity’s
management and TCWG.
Nevertheless, the auditor in the current year must maintain professional skepticism and should not be
satisfied with less-than Persuasive audit evidence when obtaining reasonable assurance.
1
5.True and Fair View

In the audit report, the auditor states whether ‘in his opinion and to the best of his information and
according to the explanation given to him, the accounts are give a true and fair view or not………
TRUE: Information is factual and conforms to reality, not false and is free from error, in addition the
information conforms to required standards and law (IFRS/ IAS and companies act 2017). The accounts

Summary Notes by SK
have been correctly extracted from the books and records (e.g. Journal Ledger and Trial Balances) and have
proper supporting documents.
This implies that the financial statements are based upon facts and realities; they are not false or erroneous.
FAIR:
Information is free from discrimination and bias (there should NOT be separate accounting treatments for
the same transaction & events) and
The financial statements should reflect the commercial substance of the company’s underlying transactions
(E.g. treatment of finance Lease as per IFRS 16 (IAS 17) and recording of revenue as per IFRS 15….)
Class Example
1.
2.
6.Management Responsibilities
1. Managing the business so as to achieve company objectives.
2. Making key business strategies.
3. Assessing business risks to those objectives being achieved.
4. Safeguarding the company’s assets.
5. Keeping proper accounting records.
6. Preparing company financial statements.
7. Ensuring the company complies with applicable laws and regulations
It is NOT the responsibility of the auditors of a company to do any of the above.

Summary Notes by SK
7.Internal Control
1.
2.
3.
General Examples of Internal Control

Summary Notes by SK
8. External Audit Report (ISA 700 REVISED)
Here we are given the understanding of the main source of communication between the auditors and the
shareholders which is nothing but the Audit Report which is also known as the Audit Deliverable given to
the shareholders & the stakeholders at the end of the audit. It’s not only the main source of communication
but also a very condensed form of communication and carries an important message from the auditor to the
shareholders and the stakeholders. Its normally addressed to the shareholders and signed by the engagement
partner in the name of the audit firm or personal name of the partner, as the case may be.
There are o2 Types of audit opinions 1. Unmodified Opinion 2. Modified Opinion (to be discussed in detail
in future)
Standard Audit Report

INDEPENDENT AUDITOR'S REPORT (As per ISA 700 Revised)
To the Shareholders of Company [or Other Appropriate Addressee]
Report on the Audit of the Financial Statements

Opinion
We have audited the financial statements of ABC Company (the Company), which comprise the statement
of financial position as at December 31, 2OX1, and the statement of comprehensive income, statement of
changes in equity and statement of cash flows for the year then ended, and notes to the financial statements,
including a summary of significant accounting policies.
_______________
In our opinion, the accompanying financial statements present fairly, in all material respects, (or
give a true and fair view) of the financial position of the Company as at December 31, 20X1, and
(of) its financial performance and its cash flows for the year then ended in accordance with international
Financial Reporting Standards (IFRS).
Basis for Opinion para (________________________________)

We conducted our audit in accordance with international Standards on Auditing (ISAs). Our responsibilities
under those standards are further described in the Auditors Responsibilities for the Audit of the Financial
Statements section of our report. We are independent of the Company in accordance with Code of Ethics
for Professional Accountants (IESBA Code) together with the ethical requirements that are relevant to our
audit of the financial statements, and we have fulfilled our other ethical responsibilities in accordance with
these requirements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our opinion.

Summary Notes by SK
Key Audit Matters (ISA 701) ------Significant Matters for the current period
Key audit matters are those matters that, in our professional judgment, were of most significance in our
audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion
thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with ISA 701, which applies to audits of the financial
statements of listed entities.]
Other Information (ISA 720) * Not in CAF 8 Syllabus

Management is responsible for the other information. The other information comprises the [information included in the X
report, but does not include the financial statements and our auditor’s report thereon.]
Our opinion on the financial statements does not cover the other information and we do not express any form of assurance
conclusion thereon.
In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing
so, consider whether the other information is materially inconsistent with the financial statements or our knowledge
obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we
conclude that there is a material misstatement of this other information; we are required to report that fact. We have
nothing to report in this regard.
Responsibilities of Management and Those Charged with Governance for the Financial
Statements
Management is responsible for the preparation and fair presentation of the financial statements in
accordance with IFRS and for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether due to fraud or error.
______________________
In preparing the financial statements, management is responsible for assessing the Company’s ability to
continue as a going concern, disclosing, as applicable, matters related to going concern and using the going
concern basis of accounting unless management either intends to liquidate the Company or to cease
operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company’s financial reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our
opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in
accordance with ISAs will always detect a material misstatement when it exists.
Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate,
they could reasonably be expected to influence the economic decisions of users taken on the basis of these
financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional
skepticism throughout the audit. We also:

Summary Notes by SK
 Identify and assess the risks of material misstatement of the financial statements, whether due to fraud
or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that
is sufficient and appropriate to provide a basis for our opinion.
The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting
from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the
override of internal control.
 Obtain an understanding of internal control relevant to the audit in order to design audit procedures
that are appropriate in the circumstances, but NOT for the purpose of expressing an opinion on
the effectiveness of the Company’s internal control.
 Evaluate the appropriateness of accounting policies used and the reasonableness of accounting
estimates and related disclosures made by management.
__________________________________
 Conclude on the appropriateness of management’s use of the going concern basis of accounting and,
based on the audit evidence obtained, whether a material uncertainty exists related to events or
conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If
we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report
to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify
our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s
report. However, future events or conditions may cause the Company to cease to continue as a going
concern.
 Evaluate the overall presentation, structure and content of the financial statements, including the
disclosures, and whether the financial statements represent the underlying transactions and events in a
manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned scope
and timing of the audit and significant audit findings, including any significant deficiencies in internal
control that we identify during our audit.
___________________________
We also provide those charged with governance with a statement that we have complied with relevant
ethical requirements regarding independence, and to communicate with them all relationships and other
matters that may reasonably be thought to bear on our independence, and where applicable, related
safeguards.
_________________________
From the matters communicated with those charged with governance, we determine those matters that were
of most significance in the audit of the financial statements of the current period and are therefore the key
audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public-
disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should
not be communicated in our report because the adverse consequences of doing so would reasonably be
expected to outweigh the public interest benefits of such communication.

Summary Notes by SK
Report on Other Legal and Regulatory Requirements
______________________________________
[The form and content of this section of the auditor’s report would vary depending on the nature of the
auditor's other reporting responsibilities prescribed by local law or local auditing standards (if any)
Name of Engagement Partner
Signature in the name of the audit firm, the personal name of the auditor, or both, as appropriate
Auditor Address
Date of Audit Report ___________
9.Management Letter (Management Report / Internal control weakness letter)

Management letter (M.L.) is usually provided to the directors / TCWG covering internal control
weaknesses identified by External Auditor during the audit, after the completion of the External Audit.
These recommendations are a by-product of External Audit and are considered to be a value-added service
for the audit client.
Key point to remember here is that.
In Management Letter we do not express an opinion on the internal controls of an audit client, we only
notify those materials weaknesses that auditor considers of such importance that must be brought to
management/ TCWG's attention.
Therefore, these weaknesses identified are not a complete list of such items and may include more of such
control weaknesses in actual. M.L can be given at both interim and final stage of an audit.
10. Concept of accountability, stewardship and agency
An audit of a company’s account is needed because in companies, the owners of the business are often not
the same persons as the individuals who manage and control that business
 The shareholders own the company.

 The company in managed and controlled by its directors.
The directors have a stewardship role. They look after the assets of the company and manage them on
behalf of the shareholders. As the shareholders have bought shares in the co. (investment made), they
expect a return from their investment (in the form of dividend and capital gain) and as the Directors are
acting as agents and managing their investment, they are in a position to effect that return.
The relationship between the shareholders and Board of Directors is also an application of general legal
principle of agency, where Agent has a legal duty to act in the best interest of the principal and should be
accountable to principal for everything that he does as an agent.
Second concept of Agency
The External Auditors are also considered to be the agents of the shareholders acting on their behalf i.e.
conducting audit of the financial statements and expressing an independent audit opinion.
It’s a basic legal requirement of all agency and principal relationships that the agent should act in the best
interest of the principal, which in this case is that the auditors must perform their audit work as per the
scope of ISA and express an opinion on the F/S to the shareholders based on the audit procedures
performed.

Summary Notes by SK
11.ASSURANCE ENGAGEMENTS
Expected Questions on Assurance Engagements
Audit AUDIT RELATED SERVICES

Assurance Engagements
Natures of
Audit Review Agreed upon Compilation
services/
Engagement Engagement Procedures Engagement
Assignment
High, but not

Types of No
an absolute Moderate
Assurance Assurance is
Assurance Assurance is No Assurance is
provided by expressed in
(i.e. expressed on expressed
the External this
Reasonable the F/S
Auditor assignment
assurance)
Report Audit Report Review Report Factual Collection,

provided by expressing a expressing a Finding of classification &
the Auditor & Positive Level Negative Level procedures, is summarization of
level of of assurance of assurance reported by the accounting
assurance the information
practitioner prepared by the
client
E.g’s include
preparation of
financial statement
Bank Recons, Sale
Tax Returns and
various reports via
F/S etc.

Summary Notes by SK
Audit
In an audit engagement, the auditor provides a high, but not absolute, level of assurance that the information
subject to audit (F/S) is free of material misstatement. This is expressed positively in the audit report as
positive assurance
Review ____________________
In a review engagement, the auditor provides a moderate level of assurance (which is less than Reasonable
Assurance) that the information subject to review (F/S) is free from material misstatement. This is expressed
in the form of negative assurance.
Agreed Upon Procedures ________________________

For agreed upon procedures ,as the auditor simply provides a report of the factual findings
(based on the assignment),no assurance is expressed.Instead users of the report assess for themselves the
procedures and findings reported by the auditor and draw their conclusions from the auditors work .( Mostly
these reports are not shared with General Public )
Compilation Engagement _____________________ (its called Accountancy Assignment)

In a compilation engagement ,although the users ( company management ) of the compiled information
derive some benefit from the accountants involvement, no assurance is expressed in the report instead the
objective of the assignment is to collect,classify and summarize the financial information.
1. Meaning of ASSURANCE from an AUDIT perspective
Definition of an Assurance Engagement:

‘It means an engagement in which a practitioner expresses a conclusion designed to enhance the degree of
confidence of the intended users (different stake holders) other than the responsible party (the company itself) about
the outcome of the evaluation or measurement of a subject matter (Financial Statements) against suitable criteria
(e.g. IFRS or any other Reporting Framework.)’
The outcome of the evaluation or measurement of a subject matter is the information that results from applying
the criteria to the subject matter (____) e.g.:
 Checking/ verifying accounting treatments, measurements, presentations and disclosures as per the
International Financial Reporting Standards (e.g. IFRS)

Summary Notes by SK
Remember it’s the subject matter (F/S) information about which the practitioner (External Auditor) gathers
sufficient evidence to provide a reasonable basis for expressing a conclusion in an assurance report.
Absolute Level of Assurance is
2. TYPES OF ASSURANCE ENGAGEMENT
NEVER possible……….!
Under this framework, there are two types of assurance engagements a practitioner is permitted to perform:
 Reasonable assurance engagement &
 Limited assurance engagement.
Why Absolute Assurance CANNOT be given by the External auditor……………? IMP
REASONABLE ASSURANCE ENGAGEMENT:
Definition
The objective of a reasonable assurance engagement is a reduction in assurance engagement risk to an
acceptable level ……to form the basis for a positive form of expression of the Practitioners (External Auditors)
conclusion in the audit report.
(Common example is an External Audit in which Positive Assurance is expressed in the audit report by the
external auditor)
MODERATE (LIMITED) ASSURANCE ENGAGEMENT:
The objective of a limited assurance engagement is a reduction in assurance engagement risk to a level that is
acceptable in the circumstances of the engagement, but where the risk is greater than for a reasonable assurance
engagement, as the basis to form a negative assurance.
(Common example is a Review Engagement of the F/S for the interim period)
3. Levels of Assurance:
 Positive Level of Assurance ( to be discussed via Audit Report )

 Negative Level of Assurance (to be discussed via Review Report)
Positive (reasonable) Assurance:
If a lot of detailed work is performed on the subject matter, the assurance provider can conclude whether or not
the subject matter has been properly prepared.
Positive assurance is a HIGH level of assurance so a high level of reliance can be placed upon it. Positive
assurance however is not a 100% guarantee. (Rem! _________________________________)
An example of positive assurance is given in the statutory audit report on F/S. In their conclusion auditors say
‘in our opinion the financial statements give (or do not give) a true and fair view of the state of the
company’s affairs’.

Summary Notes by SK
Negative (Moderate) Assurance:
If a smaller amount of work is performed on the subject matter then the assurance provider may only be able to
confirm that ‘nothing has come to light to suggest errors or problems exist’. In other words, there may be
inaccuracies/problems; however, the assurance provider did not come across them! This is a much lower level
of assurance and is known as negative assurance. Obviously less reliance should be placed on negative
assurance
4. Elements / _________of an Assurance Engagement: (REST)
Three party relationships (intended user, Responsible party and practitioner)

Subject matter
Suitable criteria
Evidence
Assurance Report
An assurance engagement performed by a practitioner will consist of the following elements:
(a) Three party relationship. The three parties are the intended user (__________________), the responsible
party and the practitioner (______________).
(b) Subject matter. This is the data to be evaluated by the Auditor that has been prepared by the responsible
party. It mostly includes Financial Statements being audited (includes complete set of account)
(c) Suitable criteria. The subject matter is evaluated or measured against criteria in order to reach an Opinion
on the F/S (i.e. IFRS / IAS and other Prevailing local Laws)
__________________________________________________________________________________
__________________________________________________________________________________
(d) Evidence. Sufficient and appropriate audit evidence (ISA 500) needs to be gathered by the external auditor
to support the required level of assurance to express an audit opinion on the F/S via audit report
(e) Assurance report. A written report containing the practitioner's/ auditor’s opinion is issued to the Intended
users (mostly the shareholders), at the end of the audit in an appropriate format depending upon the nature of
assurance engagement. (i.e. Audit report or review report)

Summary Notes by SK
ACCA F8 & CA CAF 8 Practice Questions on Basic Concepts
S. No. Questions Attempt Marks
1 Q.6 (b) ICAP March 2017 6 marks
2 Q.6 (e) ICAP March 2016 3 marks
3 Q.1 ICAP March 2013 8 marks
4 Q.33 (a + b) ACCA 3 + 3 marks
5 Q.9 (c) ICAP Sep 2020 4 marks
6 Q.1 (g) ICAP Sep 2015 3 marks
7 Q.1 ICAP Sep 2017 5 marks
8 Q.1 ICAP Sep 2018 8 marks
9 Q.1 ICAEW (Final) 4 marks

Summary Notes by SK
ICAP March 2017 (6 marks)
Question 6 (b)
Discuss the concepts of stewardship and accountability in the context of a limited company and fair
presentation (true and fair view) in relation to the financial statements.
Answer b:
Stewardship:
The directors have a stewardship role. They look after the assets of the company and manage them on behalf of
the shareholders.
Accountability:
As agent of the shareholders, the board of directors is accountable to the shareholders. The directors show their
accountability to the shareholders by preparing annual financial statements and presenting them to the
shareholders for discussion and approval.
Fair presentation:
Although the phrase ‘true and fair view’ has no legal definition, the term ‘true’ implies free from error, and
‘fair’ implies that there is no undue bias in the financial statements or the way in which they have been
presented.
In preparing the financial statements, a large amount of judgment is exercised by the directors. Similarly,
judgment is exercised by the auditor in reaching his opinion. The phrases ‘true and fair view’ and ‘present
fairly’ indicate that a judgment is being given that the financial statements can be relied upon and have been
properly prepared in accordance with an appropriate financial reporting framework.
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Question 6 e
Briefly discuss the concept of ‘Professional skepticism.
Answer e:
Professional Skepticism:
It refers to an attitude that includes a questioning mind, being alert to conditions which may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence.
However, it does not mean that the auditors should disbelieve everything they are told, but they should view
what they are told with a skeptical attitude, and consider whether it appears reasonable and whether it conflicts
with any other evidence.
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Summary Notes by SK

Question 1
Briefly describe the meaning of Professional judgment. Explain its important in the context of an audit and
identify the key decisions/ areas where an auditor may need to apply Professional Judgment.
Answer 1:
Professional Judgment:
It means making informed decisions by a professional accountant about the courses of actions that are
appropriate in the circumstances during an audit engagement, in the context of auditing, accounting and ethical
standards and by applying the relevant training, knowledge and experience.
Why Professional Judgment is necessary:

Professional judgment is essential to the proper conduct of an audit. This is because interpretation of relevant
ethical requirement and the ISAs and the informed decision required throughout the audit cannot be made
without the application of relevant knowledge and experience to the facts and circumstances.
Professional judgment is necessary in particular when taking decisions about:
 Materiality and audit risk

 The nature, timing and extent of audit procedures used to meet the requirements of ISAs and gather
audit evidence.
 Evaluating whether sufficient appropriate audit evidence has been obtained to achieve the objectives of
the auditor.
 The evaluation of management's judgments in applying the entity's applicable financial reporting
framework and accounting policies.
 The drawing of conclusions based on the audit evidence obtained, from the example assessing the
reasonableness of the estimates made by the management in preparing the financial statements.
--------------------------------------------------------------------------------------------------------------------------------------
ACCA F8 (3 +3 marks)
Risk and professional scepticism’
Auditors are required to plan and perform an audit with professional skepticism, to exercise professional
judgment and to comply with ethical standards.
Required:
a. Explain what is meant by ‘professional skepticism’ and why it is so important that the auditor maintains
professional skepticism throughout the audit. (3 marks)
b. Define ‘professional judgment’ and describe two areas where professional judgment is applied when
planning an audit of financial statements. (3 marks)
Answer 33:
a. Professional skepticism
Professional skepticism is an attitude that includes having a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and subjecting audit evidence to a critical assessment
rather than just taking it at face value.

Summary Notes by SK
It is important that professional skepticism is maintained throughout the audit to reduce the risks of
overlooking unusual transactions, of over-generalizing when drawing conclusions, and of using inappropriate
assumptions in determining the nature, timing and extent of audit procedures and evaluating the results of
them.
Professional skepticism is necessary to the critical assessment of audit evidence. This includes questioning
contradictory audit evidence and the reliability of documents and responses from management and those
charged with governance.
b. Professional judgment
Professional judgment is the application of relevant training, knowledge and experience in making informed
decisions about the appropriate courses of action in the circumstances of the audit engagement. The auditor
must exercise professional judgment when planning an audit of financial statements.
Professional judgment will be required in many areas when planning. For example, the determination of
materiality for the financial statements as a whole and performance materiality levels will require professional
judgment.
Professional judgment will also be required when deciding on the nature, timing and extent of audit
procedures.
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ICAP September 2020 (4 marks)

Question 9 (c)
Briefly explain any four elements of an assurance engagement.
Answer c:
An assurance engagement performed by a practitioner consist of the following elements:
(i) Three party relationships: An assurance engagement is a three-party relationship consist of

practitioner, responsible party and intended users.
(ii) Subject matter: This is the data such as the financial statements that have been prepared by the
responsible party for the practitioner to evaluate.
(iii)Evidence: Information used by the practitioner in arriving at the conclusion on which

their opinion is based. This must be sufficient and appropriate.
(iv) Assurance Report: The report containing the practitioner's opinion. This is issued to the intended
user(s) following the collection of evidence.
------------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
ICAP September 2015 (3 marks)

Question 1 (g)
Briefly explain with examples, the different levels of assurance that can be provided to an assurance.
Answer g:
Reasonable Assurance:
A high (but not absolute) level of assurance provided by the practitioners conclusion expressed in a positive
form. The reasonable assurance is usually expressed in case of statutory audits.
Limited Assurance:
A moderate level of assurance provided by the practitioners conclusion expressed in a negative form. The
negative form of assurance is usually expressed in case of review engagement.
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ICAP Sept 2017 (5 marks)

Question 1
In response to an audit engagement letter sent to Roof Limited (RL), Mr. Aziz Aslam, the new chief executive
of RL has requested your firm to provide absolute assurance in the audit report.
Required:
Draft an appropriate reply mentioning any four reasons why the above request cannot be complied with.
Answer:
To CEO, APL.
An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the
auditor’s ability to detect material misstatements. These limitations arise because of the following:
(i) The use of testing/sampling techniques;

(ii) The limitations that exist in any accounting and internal controls system (for example, the possibility
of collusion);
(iii) The fact that most audit evidence is persuasive rather than conclusive; and
(iv) The work undertaken by the auditor to form an opinion is permeated by judgment.
Further, other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (for example, transactions between related parties).
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Summary Notes by SK

Question 1
A friend of yours has invested in the shares of Ascender Limited. On receiving the company’s annual report,
he made the following comments:
“The auditor has expressed an unqualified opinion. Since the auditor must have arrived at his opinion after
testing majority of the transactions, therefore the financial statements are correct in all respects. Since no
control deficiencies and fraudulent conduct had been reported by the auditor, I can safely invest further
amount of money in the company because there is no risk that I will lose my money due to fraudulent
conduct of management or misrepresentations in the financial statements.”
Required:
Write a letter to your friend to remove his misconceptions related to the audit of financial statements including
brief explanation of your point of view.
Answer:
To: ABC
Dated: 4 September 2018
Subject: Explanation of Misstatement Related to Audit
I received your comments on the audit report of Ascender Limited and want to clarify that:
The auditor, because of inherent limitation of audit, cannot reduce audit risk to zero. Therefore, auditor
provides a reasonable assurance but not absolute assurance that financial statements are free from material
misstatement.
In order to provide reasonable assurance, auditor plans and performs audit procedures based on the concept of
materiality and assessment of audit risk. Auditor does not aim to examine all or the majority of transactions.
Based on professional judgment about the effectiveness of the selection, auditor applies audit procedures using
100% selection, specific selection or audit sampling. Thus, selective examination of specific items does not
provide audit evidence about the whole population and conclusion drawn from a sample may be different if
the entire population were subject to the same procedure.
The management is responsible for the internal controls for the preparation of financial statements and auditor
is responsible to obtain understanding of the same in order to design audit procedures. Auditor is not required
to express opinion on effectiveness of internal controls.
Furthermore, the auditor is responsible to provide reasonable assurance not the absolute assurance that
financial statements as a whole are free from material misstatement, whether caused by fraud or error. As
stated above, the principle of materiality will also be applied here in case of misstatement due to fraud. The
objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness of the view
presented by the financial statements. Its objective is not the prevention or detection of fraud.
The objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness of the
view presented by the financial statements. Its objective is not the prevention or detection of fraud.

Summary Notes by SK
Moreover, there is a possibility that despite all due care, the auditor is unable to detect a fraud especially those
involving management override of controls.
I hope above explanations would enhance your understanding regarding auditor’s roles and responsibilities in
the audit of financial statements.
Yours faithfully,
XYZ
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ICAEW (4 marks)
Question 1
You are the engagement partner responsible for the audit of ABC Company for the year ended June 30, 2018.
You have provided the report to the shareholder on 30 September, 2018.
An error has recently been discovered in covered in ABC Co by the ABC Co by the Managing Director.
During investigation it was discovered that error was present in the financial statements for the year ended
June 30, 2018.
Managing Director of ABC Co. has written to the company's auditors stating auditors report in which it was
mention that these financial statements have been prepared in accordance with IFRS.
Managing Director is requesting an explanation from the Engagement Partner as to how they could have
missed it.
What points should the auditors make in response to the managing director?
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Summary Notes by SK
Few More Practice Questions

1. What are the advantages of an audit to an organization? (03)
(ICAP, CAF 08 Level - Spring 2004 Q.#1b)
2. Discuss the concepts of stewardship and accountability in the context of a limited company.
(ICAP, CAF 08 Level - Spring 2017, Q.#6b) (04)
3. List down the basic elements of an assurance engagement. (03)

(ICAP, CAF 08 Level - Spring 2003, Q.#1b)
4. Explain the meaning of "assurance" and give two examples of types of assurance which can be provided,
distinguishing between the two in terms of the level of assurance offered by each of them.
(ICAP's Official Question Bank for CAF 08 - Q. # 173a)
5. (a) What is meant by reasonable assurance? (02)

(b) Why an auditor cannot provide an absolute assurance as a result of audit? Explain. (03)
(ICAP, CAF 08 Level - Autumn 2004, Q.#1bc)
6. Distinguish between absolute and reasonable assurance. Identify the type of assurance that is expected in
an audit of the financial statements, clearly outlining the reasons to justify your point of view.
(ICAP, CAF 08 Level - Spring 2009, Q.#4) (08)
7. Describe THREE limitations of external audits. (03)

(ACCA, Fundamentals Level F8 - December 2012)
8. What is the difference between an "assurance engagement" and an "audit engagement"? (01)
(ICAP, CAF 08 Level - Spring 2003, Q.#1c)
9. AG Company approached the Mini-Finance Bank to extend their overdraft limit in order to finance a
new project. The bank asked the company to provide cash flow projections and assurance over those
projections.
Required:
Explain the type of assurance engagement that will be undertaken by the auditor in the above scenario
and form of such assurance. Also explain why such type of assurance is appropriate for cash flow
projections. (03)
(ICMA Pakistan - Fall 2016)
10. Give any two examples about the uncertainty relating to the financial statements being audited
by you. (02)
(ICAP, CAF 08 Level - Autumn 2004, Q.#2a)
11. What parts of a company's annual report are covered by an audit report? (02)
(ICAEW Professional Stage – September 2006)
12. Briefly highlight the management's responsibilities relating to the financial statements? (04)
(ICAP, CAF 08 Level - Autumn 2009, Q. # 1a)

Summary Notes by SK
13. Discuss as to who is responsible to prepare financial statements. (02)
(ICAP, CAF 08 Level - Spring 2002, Q. # 3b)
14. What is the primary/overall objective of an audit? (03)

(ICAP, CAF 08 Level - Autumn 2001, Q. # 3a)
15. The purpose of an external audit and its role are not well understood. You have been asked to write
some material for inclusion in your firm's training materials dealing with these issues in the audit of
large companies.
Required:
Draft an explanation dealing with the purpose of an external audit and its role in the audit of large
companies, for the inclusion in your firm's training materials.
(ICAP's Question Bank for CAF 08 - Q. # 8a)
16. You are the audit manager of Rake Enterprises, a limited liability company. The company's annual
revenue is over Rs 100 million.
Required:
Compare the responsibilities of the directors and auditors regarding the published financial statements of
Rake Enterprises.
(ACCA, Fundamentals Level F8 - June 2005)
17. During the act team planning meeting, a member of the audit team passed a comment that based on past
experience with the client, he was confident that the management of the client was honest and there was
no issue as regards management integrity or risk of fraud in the Company. The audit manager
responded that the auditor should always maintain an attitude of professional skepticism throughout the
audit.
Required:
Briefly describe Audi Skepticism and elaborate on the response of the audit manager (04)
(ICAP, CAF 08 Level - Autumn 2009, Q. 1b)
18. An auditor is required to maintain an attitude of 'Professional Skepticism' while conducting an audit of
Financial Statements
Describe by giving TWO appropriate examples, the term Professional Skepticism. (04)
(PIPFA - Summer 2015)

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 500 – ‘Audit Evidence’

Summary Notes by SK
Expected questions on Audit Evidence – ISA 500

1. Define audit evidence and what are the 02 MAIN types of audit
evidence / methods to obtain audit evidence?
2. Briefly explain the financial statements assertions for balance sheet,

profit & loss and P&D?
3. List and explain the audit procedures to obtain audit evidence?
4. What procedures / techniques are performed by an external auditor to

obtain Audit evidence?
5. What are the factors that influence the reliability of audit evidence?
6. What are the factors that influence the auditor’s judgment concerning
the sufficiency of Audit evidence obtained?
7. Explain the term “Sufficient and Appropriate Audit Evidence”?
8. Explain the concept of Relevance in the context of ISA 500 along with
examples.
9. Direct and Indirect questions along with substantive procedures (to be

discussed later)

Summary Notes by SK
Concept of Audit Evidence (ISA 500)
Definition of Audit Evidence:
Audit evidence is all the information used/gathered by the External auditor in arriving at the
conclusions on which the audit opinion is based, and includes information contained in the accounting
records (G.L, Trial balance and other records) underlying the financial statements.
Audit evidence, which is cumulative in nature, includes audit evidence obtained from audit procedures
performed during the course of the audit and may include audit evidence obtained from other sources
such as previous years audit working papers (ISA 230) of the same audit client.
Audit evidence in simple words can be defined as any piece of information which assists the auditor to
reach a conclusion on the truth and fairness of the financial statements of the company.
Audit evidence is obtained from: (might include information other than below mentioned list)
 Documents / supporting documents such as purchase orders, payment and receipt vouchers,
invoices, receipts, employee time sheets, customer orders, letters, bank statements, contracts and
other legal documents (Memorandum , Articles etc )
 Entries in accounting records. ( Journal Entries )
 Entries / postings in Cash Book, Profit and Loss account, Balance Sheet etc.
 Answers/Replies from management to questions raised by the auditor.
 Information or confirmations received from external parties such as debtors, creditors, banks,
legal advisors, tax consultants and other stake holders.
 Computations produced by the client or by the auditor himself, for example depreciation
calculations, reconciliations, computations of accruals and prepayments etc.
 Evidence gained from the auditors physical counting of stock at the balance sheet data (stock
counting of Raw Material / W.I.P / Finished Goods)
Important thing to note:

Audit evidence requires that the auditor obtains Sufficient Appropriate Audit Evidence to be able to
draw reasonable conclusions on which to base the audit opinion.
Sufficient and Appropriate Audit Evidence

Summary Notes by SK
Sufficient Appropriate Audit Evidence ……… IMP
Sufficiency relates to the QUANTITY of audit evidence and appropriateness relates to the QUALITY of Audit
Evidence which includes BOTH Relevance AND Reliability of evidence.
Appropriateness = Quality
Relevance Reliability
Appropriateness is the measure of quality of audit evidence which has 2 elements: Relevance and
Reliability.
RELEVANCE
(To be discussed Later after substantive procedures)
Factors which influence the sufficiency and appropriateness of audit evidence (both quantity and
quality factors covered)
1. The assessment of audit risk involved.( more risk = more evidence required )
2. The nature of the accounting and internal control systems. ( Weak Controls = More
evidence required)
3. The materiality of the item involved.(E.g. Stock ,fixed assets and debtors are
material items in the F/S)
4. The auditor’s past and current knowledge and experience of the business.
5. The source and reliability of the information available (from 3rd parties or M.I.S of
the company )
6. Size of the organization (a small company is less likely to have as tight control as a large
organization) = more evidence
7. The sampling method that the auditor will use to obtain the audit evidence because the chosen
method will also affect the size of the audit sample.
Reliability Factors…….. ( IMP )
1. Evidence is more reliable when it is obtained from independent sources outside the
entity.(i.e. 3rd party confirmations )
2. Evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective (e.g. Evidence obtained from Unilever, Siemens).
3. Written evidence (documented) is more reliable than verbal evidence
4. Evidence obtained directly by E. Auditors is more reliable.
5. Original documents are more reliable than photocopies etc
Quantity of audit evidence is effected by the auditors assessment of risk i.e. The higher the risk the more
the evidence will be gathered, similarly the higher the quality ,the less may be required ,obtaining more
audit evidence ,however may not compensate for its poor quality.
(Professional judgment is exercised by the External Auditor)

Summary Notes by SK
There are 02 methods to obtain audit evidence or say that Audit evidence can be gathered by the
following two methods:
Test of control (T.O.C): ( To be covered while studying TOC Topic)

Tests performed to obtain evidence about the operating effectiveness of controls in preventing, detecting
and correcting material misstatements.TOC should be designed to check that the control procedures/
S.O.P are being applied and that the objectives are being achieved. Test of control includes two things:
 Design: Design test means to ensure that the system is properly designed i.e. proper accounting
system is designed or in place or that proper internal controls are designed to ensure that
material misstatements will be detected.
 Operation: This test means to check that whether the controls were operating effectively throughout
the period or not
Substantive Procedures S.P (also called Detailed Testing / Verification of F/S)
These tests are to obtain audit evidence to detect material misstatements in the financial statements.
Definition of S.P:
Substantive procedures (or substantive tests) are procedures performed by the auditor to detect material
misstatement (either via fraud or error) at the assertion level.
Assertion Level
P&L, B/S and P&D items.
They are generally of two types:
 Substantive Analytical procedures (ratio analysis and comparison analysis from last year to the
current year ) to be discussed in detail in ISA 520
 Other substantive procedures (Tests of Details) such as tests of detail of transactions and balances
e.g.
(Verification of documents such as purchase orders, invoices, receipts, employee time sheets, customer
orders, letters, bank statements, contracts and other legal documents, review of minutes of director
meetings and other committees)

Summary Notes by SK
Audit Procedures
1. Inspection of Assets:
By inspection of assets we mean that External Auditor verifies/ inspects the Inventory (Raw Material
/ W.I.P / Finished Goods) and tangible assets of the Company. External Auditor also verifies /
counts cash in hand at the Balance Sheet date.
Normally External Auditor physically counts the inventory / Fixed Assets and cash in hand at the end
of Financial Year (Balance Sheet Date)
2. Inspection of Records:
By inspection of records we mean verifying or inspecting the following documents of the Audit client.
1. Invoices
2. Purchase Orders
3. Bank Reconciliations
4. General Ledger
5. Good Receive Note (GRN)
6. Bank Statements
7. Cash book
8. Supplier statements
9. Delivery Challan etc.
3. Inquiry:
By inquiry we mean verifying / obtaining information from client personally e.g. obtaining
information from senior Management (e.g. GM finance, Internal Auditor, CEO, CFO & other
relevant personnel), as the External Auditor thinks appropriate.
This inquiry can be done from people outside the organization e.g. external lawyer / consultants &
other experts.
4. Re-performance:
By re-performance we mean performing the procedures / calculation by External Auditor’s own
methodologies (E.g. re-performing the calculation of depreciation & amortization & re-performing the
Provision for doubtful debt for the year).
5. Re-calculation:
By re-calculation we mean simply re-calculation / rechecking the calculations done by the client e.g.
re-checking the totaling of depreciation & amortization and re-calculating the total of bank
reconciliation.
6. Observation:
In this procedure, External Auditor simply observes a process being performed by others (E.g.
Observing the inventory counting process and cash counting process and observing the process of
inspection of inventory on arrival in the factory.
7. External Confirmation: (To be discussed in detail in ISA 505)
External confirmation is a procedure by which an external auditor verifies a respective
balance or transaction or terms of an agreement, directly from a 3RDparty
e.g. (Dispatching confirmation directly to a debtor, creditor or a Bank)

Summary Notes by SK
This procedure provides more reliable audit evidence to the external auditor.
There are various types of 3rd party confirmations and commonly 2 methods of external confirmation.
(Positive and Negative method)
Examples of third-party confirmations

1) Debtor confirmation Please
2) Creditor confirmation Learn…!
3) Tax confirmation
4) Lawyer confirmation
5) Loan confirmation
6) Third party stock confirmation
7) Bank confirmation
8) Any other third-party confirmation to verify the terms & conditions of an agreement / contract.
8. Analytical Procedures:
Definition and explanation will be covered when covering ISA 520 separately
Examples of Analytical Procedures:
1. Comparison from last year’s numbers

2. All kinds of ratio analysis
3. Comparison of actual numbers with budgets/Forecasts.
4. Comparison of actual numbers with predicted / expected amounts (this is called predictive test)
5. Comparison of Financial information with Financial information
6. Comparison of Non-Financial with Financial information.
7. Comparison with industry norms (similar industry).
8. Comparison with overall economic growth of the country.
(for that particular sector or industry)

Summary Notes by SK
FINANCIAL STATEMENT ASSERTIONS (to be covered Later)
Assertions used by the auditor fall into the following categories:
(Now REVISED as per ISA 315)
 Assertions about classes of transactions and events for the period under audit (P&L
Assertions)
1. Occurrence: transactions and events that have been recorded have occurred and pertain to the entity.
(Sales and Purchases occurred during the year)
2. Completeness: all transactions and events that should have been recorded have been recorded. (1000
Transactions in a year-----all should be recorded in the F/S)
3. Accuracy: amounts relating to recorded transactions and events have been recorded appropriately.
(Amounts are recorded with correct amounts)
4. Cutoff: transactions and events have been recorded in the correct accounting period. (20016 Sales are
recorded in 2016 and not 2017)
5. Classification: transactions and events have been recorded in the proper accounts i.e. Correct
General ledger (Classification of sales btw various products)

Summary Notes by SK
 Assertions about account balances at the period end (B/S Assertions)
1. Existence: Assets, liabilities and equity interests exist at the B/S date.
2. Rights and obligations: the entity holds or controls the right to asset, and liabilities are the
obligations of the entity. (Cash exists and Debtors are genuine and company has the right to receive
these ...)
3. Completeness: all assets, liabilities and equity interests that should have been recorded have been
completely recorded.
4. Valuation and Allocation: Assets, liabilities and equity interests are included in the financial
statements at appropriate carrying amounts. i.e. Are correctly valued.
 Assertions about Presentation and Disclosure:
1. Occurrence and Rights & Obligations: disclosed events, transactions and other matters have
occurred and pertain to the entity.
2. Completeness: all disclosures that should have been included in the financial statements have been
included.
3. Classification and Understandability: financial information is appropriately presented and

described and disclosures are clearly expressed.
4. Accuracy and Valuation: Financial and other information are disclosed fairly and at appropriate
amounts.

Summary Notes by SK
ACCA F8 & CA CAF 8 Practice Questions on

Audit Evidence
S. No. Attempt Marks
ACCA
1 Q.2 Mar/June 2016 10 marks
2 Q.6 a Sep/Dec 2015 4 marks
3 Q.71 June 2007 4 marks
4 Q.2 b Dec 2013 3 marks
5 Q.58 Dec 2009 4 marks
ICAP
7 Q.8 a March 2022 5 marks
8 Q.7 Sept 2010 4 marks

Summary Notes by SK
ACCA F8 March/June 2016 (10 marks)
Question 2
i. Describe FIVE types of procedures for obtaining audit evidence; and
ii. For each type of procedure, describe an example relevant to the audit of BANK balances.
(to be covered after Substantive Procedures)
Note: The total marks will be split equally between each part.
Answer 2:
Procedures to obtain evidence and an audit test relevant to bank balances
1. Inspection
Inspection involves examining records or documents, whether internal or external, in paper form,
electronic form, or other media, or a physical examination of an asset.
Inspect the bank reconciliation for any outstanding lodgments and agree to the pre year-end cash
book, post year-end bank statement and also to paying-in-book pre year end.
2. Observation
Observations consist of looking at a process or procedure being performed by others.
Observe the process for the opening of mail and logging of any cheques received from customers to
ensure adequate segregation of duties.
3. Analytical procedures
Analytical procedures consist of evaluations of financial information through analysis of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass
such investigation as is necessary of identified fluctuations or relationships which are inconsistent
with other relevant information or which differ from expected values by a significant amount.
Review the year-end bank balance against prior year to identify any significant fluctuations as these
could be evidence of window dressing and discuss with management.
4. Inquiry
Inquiry consists of seeking information from knowledgeable persons, both financial and non-
financial, within the entity or outside the entity.
Inquire of management as to whether the company has opened/closed any bank accounts during
the period.
5. Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records.
Recalculation may be performed manually or electronically.
Recalculate the additions in the year-end cash book to confirm accuracy of the amount.
6. External confirmation
An external confirmation represents audit evidence obtained by the auditor as a direct written
response to the auditor from a third party, in paper form, electronic form or by other medium.
Obtain a standard bank confirmation from each bank the company has undertaken banking
transactions with during the year.

Summary Notes by SK
7. Re-performance
Re-performance involves the auditor’s independent executive of procedures or controls which were
originally performed as part of the entity’s internal control.
Re-perform the year-bank reconciliation to ensure the process was undertaken accurately.
Tutorial note: Marks will be awarded for any other relevant bank balance tests.
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ACCA F8 September/December 2015 (4 marks)
Question 6 (a)
Explain FOUR factors which influence the reliability of audit evidence.
Answer 6 (a):
Reliability of audit evidence
The following factors or generalizations can be made when assessing the reliability of audit evidence:
 The reliability of audit evidence is increased when it is obtained from independent sources outside the
entity.
 The reliability of audit evidence which is generated internally is increased when the related controls
imposed by the entity, including those over its preparation and maintenance, are effective.
 Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained
indirectly or by inference.
 Audit evidence in documentary form, whether paper, electronic or other medium, is more reliable
than evidence obtained orally.
 Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles, the reliability of which may depend on the controls over their preparation
and maintenance.
----------------------------------------------------------------------------------------------------------------------
ACCA F8 June 2007 (4 marks)

71 Metcalf
ISA 500 Audit evidence states that the auditors objective 'is to design and perform audit procedures in
such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the auditor's opinion'.
Required
a. Describe the factors which will influence the auditor's judgement concerning the sufficiency of audit
evidence obtained
Answer 71:
a. Factors concerning the sufficiency of audit evidence
(Plz learn from my Handout of ISA 500)
Source of evidence

Summary Notes by SK
The auditor will be concerned about the source of the evidence, that is, whether it is generated by the
entity being audited or by a third party or if it is auditor-generated evidence.
Materiality of the amount

More audit evidence would be required when examining more material balances, and the lower the
level of materiality set
Inherent and control risks

The higher these risks are, the more audit evidence will be required in order to provide assurance over
figures in the financial statements.
Accounting and control systems

Depending on whether the systems in place are reliable or not, this will influence the amount of audit
evidence required to support various audit assertions.
--------------------------------------------------------------------------------------------------------------------
ACCA F8 December 2013 (3 marks)

Question 2 (b)
ISA 500 Audit Evidence requires auditors to obtain sufficient and appropriate audit evidence.
Appropriateness is a measure of the quality of audit evidence, that is, its relevance and its reliability.
Required:
Identity and explain THREE factors which influence the reliability of audit evidence
Answer 2 (b):
Reliability of audit evidence
The following factors or generalizations can be made when assessing the reliability of audit resources:
 The reliability of audit evidence is increased when it is obtained from independent sources outside the
entity.
 The reliability of audit evidence which is generated internally is increased when the related controls,
including those over its preparation and maintenance, imposed by the entity are effective.
 Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly
or by inference.
 Audit evidence in documentary form, whether paper, electronic or other medium, is more reliable
than evidence obtained orally.
 Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies facsimiles, the reliability of which may depend on the controls over their preparation and
maintenance.
--------------------------------------------------------------------------------------------------------------------
a. ISA 500 Audit Evidence requires audit evidence to be reliable.
Required:
List FOUR factors that influence the reliability of audit evidence

Summary Notes by SK
Answer:
a. Reliability of audit evidence
Reliability is influenced by source and the nature of the information, including the controls over its
preparation and maintenance. Four specific factors that influence reliability are:
 Audit Evidence from external sources is more reliable than that obtained from the entity’s records
because it is from an Independent source.
 Evidence obtained directly by auditors is more reliable than that obtained indirectly
 Evidence in form of documents (paper or electronic) or written representations reliable than more
reliable than oral representations can be retracted.
 Original documents are more reliable than photocopies or facsimiles, which can easily be altered by
the client.
--------------------------------------------------------------------------------------------------------------------
Question 3:
a. The auditor has a responsibility to design audit procedures to obtain sufficient and appropriate evidence.
There are various audit procedures for obtaining evidence. such as external confirmation.
Required:
Apart from external confirmation:
(i) State and explain FIVE procedures for obtaining audit evidence:
(ii) For each procedure, describe an example relevant to the audit of purchases and other expenses.
(To be covered after Substantive Procedures)

Answer 3a:
Procedures to obtain evidence and an audit test relevant to purchases and other expenses:
Inspection
Inspection involves examining records or documents, whether internal or external, in paper form,
electronic form, or other media, or a physical examination of an asset.
 Inspect a sample of purchase invoices and agree the amount is included correctly within the purchase
ledger.
 Inspect purchase orders for evidence of authorisation by a responsible official.
Observation
Observation consists of looking at a process or procedure being performed by others.
 Observe the process for logging purchase invoices into the system to ensure that all invoices are
entered completely and accurately.
 Observe the goods received department to assess whether goods received are checked against purchase
orders and reviewed for adequate quality.
Analytical procedures
Analytical procedures consist of evaluations of financial information through analysis of plausible
relationships among both financial and non-financial data. Analytical procedures also encompass such
investigation as is necessary of identified fluctuations or relationships that are inconsistent with other
relevant information or that differ from expected values by a significant amount.

Summary Notes by SK
 Calculate the operating profit margin/overhead ratio and compare it to last year and budget and
investigate any significant differences.
 Review monthly other expenses to identify any significant fluctuations and discuss with management.
Inquiry
Inquiry consists of seeking information of knowledgeable persons, both financial and non-financial, within
the entity or outside the entity.
 Discuss with management whether there have been any changes in the key suppliers used and
compare this to the purchase ledger to assess completeness and accuracy of purchases.
 Inquire of department heads the process they follow in authorising orders to ensure that it follows the
specified company authorisation process.
Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may
be performed manually or electronically.
 Recalculate the accuracy of a sample of purchase invoices.
 Recalculate the prepayments and accruals charged at the year end to ensure the accuracy of the other
expenses.
Reperformance
Reperformance involves the auditor's independent execution of procedures or controls that were originally
performed as part of the entity's internal control.
 Reperform the purchase ledger control account reconciliation to ensure accuracy.
 Select a sample of purchase orders and match them to the goods received notes and purchase invoices
to ensure completeness of the purchase cycle.
Tutorial note: Marks will be awarded for any other relevant purchases and expenses tests.
Top Tips: Only four factors were needed other valid factors would be:
 Evidence created in the normal course of business is more reliable than evidence created specifically for the audit
 Original evidence from the entity’s record is more reliable when the related control system operates effectively.
--------------------------------------------------------------------------------------------------------------------
Question 7
Explain the term “Sufficient and Appropriate Audit Evidence.”
Answer:
The sufficiency and appropriateness of audit evidence are interrelated.
(i) Sufficiency is the measure of the quantity of audit evidence.

(ii) The quantity of an audit evidence needed is affected by the auditor's assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also
by the quality of such audit evidence (the higher the quality, the less may be required).
(iii)Appropriateness is the measure of the quantity of audit evidence; that is, it is relevance and its
reliability in providing support of the conclusions on which the auditor’s opinion is based.

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 230 – ‘Working Papers / Audit

Documentation’

Summary Notes by SK
Expected questions on Working Papers / Audit
Documentation
1. Define working papers & explain the benefits / objectives of working
papers / audit documentation?
2. List the advantages of working papers / audit documentation?
3. Explain permanent audit file & list the contents of a permanent audit
file?
4. List the features / _______________/______________ of a good
working paper?
5. List the contents of working paper file / audit documentation?
6. Explain the factors that may affect the form & content of working
papers?
7. Explain the term standardized & automated working papers? Explain
with examples.
8. Briefly explain current audit file & list the contents of a current audit
file?
9. Briefly explain the difference between permanent & temporary
working papers with examples?
10. Identify and explain errors in the above working paper extract?
11. Assembly of working papers
.
.
12. List the advantages of automated working papers?

Summary Notes by SK
Class Lecture Noting

Summary Notes by SK
Audit Documentation / Audit Working Papers (ISA 230)
The auditor should document matters on a timely basis matters which are important in providing audit
evidence to enable the auditor to express an independent audit opinion on the financial statements.
“Documentation means the working papers prepared by and retained by the External auditor in
connection with the performance of the audit. Working papers may be in the form of data stored on
paper or on electronic media.”
Nature of Working Papers
Advantages/Objectives of Audit working papers:
1. Assist in the planning of the audit. (ISA 300)

2. Assist in the performance of the audit.
3. Assist in the timely supervision and review of the audit by the manager and partner.
(they verify all work done i.e. review audit evidence gathered during the audit)
4. Helps to maintain a complete & detailed record of the audit evidence gathered during the audit
process to support the auditor’s opinion. (by performing CAIRO ) ISA 500
5. Helps for future reference in the upcoming years and to protect the auditors as evidence in the case of
any legal action.
6. Enabling the audit team to be accountable for its work
7. It enables quality control reviews (both Internal and External )
8. Retaining a record of matters of continuing significance to future audits
Working papers should be prepared…..

 On a timely basis,
 should be such detailed and complete enough so that it is useful for another auditor in the next year
(Other audit team from the same audit firm) that has no previous experience with the audit or the
audit of such an organization,
 to provide understanding of the work performed during the audit.
 To drive conclusions drawn from the audit procedures performed
(Remember: It’s the professional judgment of the Auditor to decide what to include and what not to
include in the working papers…!)
Note: Working papers not to include documents that have been superseded/ replaced by new and
corrected working papers + W. Ps are not a substitute for oral explanations by the client (though they
provide clarification)
Form and content of working papers: Please Learn!
Are affected by matters such as:

1. Nature of the engagement. (Audit or Compilation Engagement)
2. Nature, size & complexity of the business. (the bigger the co. the more w.papers )
3. Complexity of the entities internal control. (more complex – more w.papers)

Summary Notes by SK
4. Nature of audit procedures to be performed
5. The extent of judgement involved in performing the audit work.
6. Significance of audit evidence obtained (more working papers are required for testing material
balances)
7. Specific audit methodology and technology used in the course of the audit. (use of checklists by
the auditors and other automated tools / C.A.A.T reducing the audit documentation in a smart
manner)
8. The identified risk of material misstatement (more is the risk more is the work)
9. Nature and extent of exceptions identified (more exceptions identified = more w. papers)
Contents of Working Papers: (Imp ) Please Learn!
 Information obtained during the audit for understanding the entity and its environment
(___________)
 Information and documentation of the internal control system of the audit client.
 Extracts or copies of important legal document
(___________________________________________________________)
 Documentation for making audit strategy
 Determination of materiality level (cutoff for testing transactions– chapter 6)
 Analysis of significant transactions & balances. (e.g. Inventory and Receivables) and key ratios
 Substantive procedures performed during the audit __________
 Engagement letter for the year ( )
 Management letter (or Management Report)
 3rd party confirmations dispatched during the audit (Debtors / creditors etc and their replies)
 Key agreements and contracts. ( ________________________________)
 Important calculations like depreciation, amortization etc
 Copies of financial statements (Draft and Final accounts)
 Auditor’s report for the current year
 Written representations received from the audit client. ________
Working papers should clearly identify the following: (also called Features of Working Papers)
 Name of the client Please Learn!

 Year end (B/S Date)
 Subject (Account head of B/S or P&L)
 Objective of the work done (F/S Assertion)
 Who performed the work & date (Audit Junior/Senior)
 Who reviewed the work & date (Audit Manager and the Partner )
 Identification of audit procedures carried out (e.g. Inspection of assets etc.)
 Any issues identified
 Conclusion / key points of the work performed (was the audit evidence obtained, satisfactory or not)
 Audit ticks (identifying the procedures performed)
 Working paper reference (C 23/64)

Summary Notes by SK
E.g.: of Audit Ticks used on the working papers….
T-casting checked
TT-cross casting checked
G.L-verified from G.L
C - Confirmation dispatched
¢ - calculation checked & P – Physically observed (Any tick can be used by the auditor)
In the case of recurring audits, some working paper files may be classified as ‘permanent ‘audit files which
contain information of continuing importance and are updated with the new information every year.
(after every audit)
Others are classified as ‘current’ audit files which contain information relating primarily to the audit of
that particular period ( period of audit ), which means that all audit evidence and documentation done
for that particular year is filed in the current audit file.(Current audit files are maintained every year for
each client)
Plz Learn ..!
Examples of Permanent working papers
Example of Current / Temporary Working Papers

Summary Notes by SK
Other Sources of Information
Annual Report, Management Reports, Budgets and Forecasts, Organization charts, list of company
employees, list of company warehouses and stores, Last year working papers and Trade journals.
Retention and Confidentiality of working papers
Audit working papers are the property of External auditors and should therefore be properly retained for
the number of years by them as per the local requirements or the audit firms practice.
(ISA recommends min 5 Yrs --- from the date of report) (Local laws states: 10 yrs.)
Similarly, the responsibility of the confidentiality of the audit working papers is also of the External
auditors. However, certain working papers may be given (copies) to the audit client, at their request, but
these are not a substitute of clients working papers/accounting records.
--------------------------------------------------------------------------------------------------------------------------------
Assembly of Working Paper File
The auditor is required to assemble the final audit file(s) on a timely basis AFTER the date of the
auditor’s report. This usually excludes drafts of working papers or financial statements, or notes that are
incomplete. After the assembly of the final audit file has been completed, the auditor must not delete or
discard audit documentation before the end of its retention period.
Changes to document can be made if
 Changes are deemed necessary
 There are exceptional circumstances in which auditor has to perform new or additional procedures or
reaches new conclusion
If it does become necessary to MODIFY existing or add new documentation after this stage, the auditor
to document:
 when and by whom the modifications were made

 the reasons for making them.
If exceptional circumstances arise AFTER the date of the audit report, such that the auditor:
 has to perform new or additional procedures, or
 reaches new conclusions

Summary Notes by SK
the auditor is required to DOCUMENT:
 the circumstances
 the new or additional procedures performed, audit evidence obtained, conclusions reached and their
effect on the auditor’s report, and
 when & by whom the resulting changes to audit documentation were made & who reviewed them
----------------------------------------------------------------------------------------------------------------------------
Automated and Standardized working papers
Automated working paper packages have been developed which can make the documentation of audit
work much easier. They make preparation of working papers, lead schedules more easy.
Automated W. papers =either prepared via Microsoft Office tools (Ms. Word and Excel) or any Audit
Software (to be discussed in C.A.A.T)
Advantages of Automated Working Papers

 The risk of errors is reduced.
 The working papers will be neater and easier to review by seniors
 The time saved will be substantial as adjustments in the F/S can be made easily to all working papers
via accounting software or Ms Excel.
 Standards working paper forms/formats do not have to be carried to audit locations.
 Audit working papers can be transmitted for review via email
Standardized working papers

The use of standardized working papers may improve the efficiency of audit work but they can be
dangerous because they may lead to mechanical approach i.e. Audit team might work without using their
professional judgment during the audit……
 Stnd Confirmations (Debtor confirmation, creditor confirmation etc )
 Stnd Checklists and Questionnaires
 Stnd Audit Programs (List of audit procedures)
 Stnd stock count sheet and cash count sheet.

Summary Notes by SK
CA CAF 8 Practice Questions on
Working Papers
1 Q. 2 c March 2021 3 marks
2 Q. 3 a & b Sept 2016 6 marks
3 Q.3 March 2015 7 marks

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 320 – ‘Materiality’

Summary Notes by SK
Expected Questions on ISA 320 (Materiality)

Summary Notes by SK
Concept of Materiality (ISA – 320)
Definition
‘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’
OR
“Information is material if its omission or misstatement could influence the economic decisions of
users (shareholders & stakeholders) taken on the basis of the financial statements, materiality also
depends on the size of the item or error judged in the particular circumstances (depends upon
professional judgement)”
Judgments about materiality are made in the light of surrounding circumstances and are affected by the
size or nature of a misstatement or a combination of both
EXPLANATION
The assessments of what is material is ultimately a matter of the auditor’s professional judgment, and is
affected by the auditor’s perception of the financial information needs of users and the perceived level of
risk; the higher the risk, the lower will be the level of overall materiality.
(IMP)
In assessing materiality, the auditor to consider that a number of errors each with a small value may, when aggregated,
may amount to a material misstatement.
The assessment of what is material is ultimately is a matter of auditors professional judgement and is affected by the
auditors perception of the financial information needs of users of the financial statement
PERFORMANCE MATERIALITY
When establishing the overall Audit Strategy (in chapter # 3 ISA 300), the auditor shall determine
materiality for the F/S as a whole (called Planning materiality –P.M).If in the specific circumstances of
the entity, there is one or more particular classes of transaction, account balances for which misstatements
of lesser amounts than materiality for the financial statements as a whole….. are expected to influence the
users of the F/S……. than External auditor shall also calculate Performance Materiality.
The auditor will set performance materiality, which is LOWER than materiality for the financial
statements as a whole. Performance materiality is defined……. as the amount less than materiality for the
financial statements as a whole. Performance materiality is normally set at a lower level than overall
materiality and is used for testing individual transactions, account balances and disclosures.
As per ISA 320 ‘MATERILITY is often calculated using benchmarks such as 5% of PBT or 1% of gross revenue, these
are starting points for the auditor to calculate materiality.
(Performance Materiality or Tolerable Error –T.E --- is normally 50% of planning materiality).
Benchmarks (Variable) for calculating Planning Materiality……..

Summary Notes by SK
Basic Example for Audit Students
E.g Planning Materiality is calculated as follows:
(0.5% of Sales / Revenue,
This is Planning materiality ------------------or say materiality for F/S as a whole
(Suppose its 500 K)
For testing particular class of transactions (P&L Items), account balances (B/S Items), we further
calculate Tolerable error (Performance Materiality) which is normally 50% of planning materiality ---------
in our example it will be 250K)
Balance Sheet as on Dec 31,2017
E.g. Debtors – 650 K (exceeds T.E—will be tested) ____________________________
Inventory –150 K (below T.E – will not be tested) ___________________________
IMP
However, note that, even if an item is below performance materiality, auditor may still perform audit
procedures by performing analytical procedures + Inquiry from the audit client.
Remember: The levels of materiality may be revised during the course of the audit and this may result in
further audit procedures (CAIRO) being performed by the auditor.
Relationship between Audit Risk and level of Materiality …. IMP

Choice of Benchmark / Variable
It is a matter of professional judgment for the External Auditor to decide the benchmark
Following factors are considered when identifying an appropriate benchmark:

 Nature of entity (e.g. if profit oriented, materiality will be based on net profit but if not-for-profit,
materiality will be based on total assets/expenses)
 Which items are focused by shareholders (e.g. for banks… users focus on total assets otherwise its
PBT)
 Volatility of benchmark / variable (the less volatile, the better it is for an external auditor
Choice of percentage:
It’s a matter of professional judgment and it depends on:
 Risk ………(the higher the risk, the lower shall be the percentage )
 Benchmark / variable (the higher the benchmark …. the lower should be the percentage)
TYPES OF MATERIALITY
 QUANTITATIVE MATERIALITY
Planning and
Performance Materiality
 QUALITITATIVE MATERIALITY (Other than Numbers)
QUALITATIVE MATERIALITY
These qualitative factors are:
 NATURE OF THE ITEM INVOLVED:
Many items in financial statements are by their nature subject to a high degree of subjectivity OR are
material to the users of the F/S such as Provision for warranty / Lawsuit, Legal and Professional
Charges, Auditors remuneration, Bad debts expense etc.

Summary Notes by SK
 IMPACT OF THE ITEM INVOLVED:
Errors which may not be material in number may have a major impact on the financial statements
understanding for the shareholders / users OR in the near future to come.
E.g. would be inadequate or improper description of an accounting policy when it is likely that user
of the financial statement would be misled by that description. And
Failure to disclose a lawsuit against the company by its customers when it is likely that the consequent
imposition of penalty will significantly impair operating capability and will raise going concern issue
for the company in the near future….
 CONCEPTUAL ERROR:
Typically, a conceptual error is one where the amount is incorrectly treated even though the amount is
correct. For example, a non-current asset purchased has been written off to profit and loss completely in
the year of purchase rather than being Capitalized and then depreciated over its useful life
Similarly….. treating finance lease as operating lease and vice versa and the amount is immaterial in
the context of F/S as a whole …
Other Examples of Qualitative Misstatements…….
IMP
Why the External Auditor does needs to consider Materiality??
External Auditor needs to consider the level of materiality at the following stages / phases of an audit:
a) At the PLANNING STAGE (to be linked with ISA 300)

b) While PERFORMING the audit procedures (checking items > materiality threshold)
c) At the END of the Audit / Reporting Stage (Reaching an appropriate audit opinion)
a) At the Planning Stage / Risk assessment stage (ISA 300)

In deciding where audit attention will be more focused, the auditor will plan to spend more audit time
(perform more substantive procedures) on areas which are material and are more risky in the F/S.
b) During the Audit:

Auditor will focus more attention on material transactions and account balances and will perform more
audit procedures to obtain S.A.A.E in respect of those balances and will be more cautious for
misstatements that exceed materiality threshold.
c) At the end of the audit / When reaching an audit opinion:

Auditors will need to assess and evaluate the impact of material misstatements identified, on the
F/S taken as a whole and thereby on the truth and fairness of the financial statements in order to
issue an appropriate audit report to the shareholders.

Summary Notes by SK
Explanation
The auditor needs to consider whether the aggregate of uncorrected misstatements is material, if the
auditor concludes that the aggregate is material, the auditor needs to consider reducing the risk by
extending the audit procedures and requesting management to adjust the financial statements. (E.g. total
of uncorrected misstatements exceed Planning materiality………. this is material now and auditor should
propose adjustments in the F/S to the Management and mgmt. must make adjustment to the F/S)
WHAT IF MANAGEMENT REFUSES TO ADJUST THE FINANCIAL STATEMENTS …?
If management refuses to adjust the financial statements and the results of extended audit procedures DO
NOT enable the auditor to conclude…… that the aggregate of uncorrected misstatements is not material
(I.e its material...! ), than the auditor should consider the appropriate modification to the audit OPINION…
i.e. (Impact on the Audit Report) (TO BE DISCUSSED LATER …….)
Documentation by the External Auditor with respect to Materiality

(ISA 230)
The following matters to be documented:
 Basis for calculation of planning materiality;

 Basis for calculation of performance materiality;
 Basis for deciding variable/ benchmark and percentage.
 Revision of both P.M and Performance materiality, if any, along with its reasoning.
Can the External Auditor Revise the Planning and Performance Materiality during the audit?

Summary Notes by SK
Student Notings

Summary Notes by SK
ACCA F8 & CA CAF 8 Practice Questions on
Materiality
ACCA
1 Q. 17 a March / June 2019 4 marks
2 Q. 3 a June 2013 5 marks
3 Q. 2 b June 2010 5 marks
ICAP
4 Q.2 b March 2021 4 marks
5 Q. 2 b Sept 2020 7 marks
6 Q. 3 a March 2020 6 marks
8 Q. 7 a Sept 2017 2 marks
9 Q. 7 a & b March 2016 7 marks
10 Q. 6 Sept 2014 5 marks
11 Q. 5 March 2010 11 marks

Summary Notes by SK
ACCA F8 March / June 2019 (4 marks)
Question 17a
Define and explain materiality and performance materiality.
Answer:
a. Materiality and performance materiality
Materiality and performance materiality are dealt with under ISA 320 Materiality in Planning and
Performing an Audit. Auditors need to establish the materiality level for the financial statements as a
whole, as well as assess performance materiality levels, which are lower than the overall materiality for the
financial statements as a whole.
Materiality
Materiality is defined in ISA 320 as follows: ‘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.
If the financial statements include a material misstatement, then they will not present fairly (give a true
and fair view) the position, performance and cash flows of the entity.
A misstatement may be considered material due to its size (quantitative) and/or due to its nature
(qualitative) or a combination of both. The quantitative nature of a misstatement refers to its relative size.
A misstatement which is material due to its nature refers to an amount which might be low in value but
due to its prominence and relevance could influence the user’s decision, for example, directors’
transactions.
As per ISA 320, materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of
total revenue or total assets. These values are useful as a starting point for assessing materiality, however,
the assessment of what is material is ultimately a matter of the auditor’s professional judgement. It is
affected by the auditor’s perception of the financial information, the needs of the users of the financial
statements and the perceived level of risk; the higher the risk, the lower the level of overall materiality.
In assessing materiality, the auditor must consider that a number of errors each with a low value may,
when aggregated, amount to a material misstatement.
Performance materiality
Performance materiality is defined in ISA 320 as follows: ‘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.
Hence performance materiality is set at a level lower than overall materiality for the financial statements
as a whole. It is used for testing individual transactions, account balances and disclosures. The aim of
performance materiality is to reduce the risk that the total of all of the errors in balances, transactions
and disclosures exceeds overall materiality
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Question 3a
Explain the concepts of materiality and performance materiality in accordance with ISA 320
Materiality in Planning and Performing an Audit.

Summary Notes by SK
Answer:
Materiality and performance materiality

Materiality and performance materiality are dealt with under ISA 320 Materiality in Planning and
Performing an Audit. Auditors need to establish the materiality level for the financial statements as a
whole, as well as assess performance materiality levels, which are lower than the overall materiality.
Materiality is defined in ISA 320 as follows:
‘Misstatements, including omissions, are considered to be material if they, individually or in the

the financial statements.’
In assessing the level of materiality, there are a number of areas that should be considered. First the
auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both. The quantity of the misstatement refers to the relative size of it and the quality
refers to an amount that might be low in value but due to its prominence could influence the user’s
decision, for example, directors’ transactions.
As per ISA 320, materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of
total revenue or total expenses. These values are useful as a starting point for assessing materiality.
The assessment of what is material is ultimately a matter of the auditor’s professional judgement, and it is
affected by the auditor’s perception of the financial information needs of users of the financial statements
and the perceived level of risk; the higher the risk, the lower the level of overall materiality.
In assessing materiality, the auditor must consider that a number of errors each with a low value may,
when aggregated, amount to a material misstatement.
In calculating materiality, the auditor should also set the performance materiality level.
Performance materiality is normally set at a level lower than overall materiality. It is used for testing
individual transactions, account balances and disclosures. The aim of performance materiality is to
reduce the risk that the total of errors in balances, transactions and disclosures does not in total exceed
overall materiality.
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Question 2b
ISA 320 Materiality in Planning and Performing an Audit provides guidance on the concept of materiality in
planning and performing an audit.
Required:
Define materiality and determine how the level of materiality is assessed.
Answer
Materiality is defined as follows:
‘Misstatements, including omissions, are considered to be material if they, individually or in the
the financial statements.’

Summary Notes by SK
In assessing the level of materiality there are a number of areas that should be considered. Firstly, the
auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both. The quantity of the misstatement refers to the relative size of it and the quality refers
to an amount that might be low in value but due to its prominence could influence the user’s decision, for
example, directors’ transactions.
In assessing materiality the auditor must consider that a number of errors each with a low value may when
aggregated amount to a material misstatement.
The assessment of what is material is ultimately a matter of the auditors’ professional judgement, and it is
affected by the auditor’s perception of the financial information needs of users of the financial statements.
In calculating materiality the auditor should also consider setting the performance materiality level. This is
the amount set by the auditor, it is below materiality, and is used for the particular classes of transactions,
account balances and disclosures.
As per ISA 320 materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of
gross revenue. These values are useful as a starting point for assessing materiality.
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Question 5
a) Sajjad is the audit senior on the audit of Hameed Limited (HL). Upon his manager's instruction Sajjad
had determined the acceptable materiality level to be Rs. 10 million at the initial planning stage. However,
at the time of evaluating the results of audit procedures carried out at the interim stage, he has reduced the
materiality level to Rs. 7.5 million.
Required:
i. Identify the possible causes which motivated Sajjad to reduce the materiality level. (02)
ii. Discuss the impact of reduction in the materiality level on audit risk and the audit procedures to be
performed. (05)
b) During the course of an audit, both quantitative as well as qualitative misstatements need to be
considered. Give four examples of qualitative misstatements. (04)
Answer:
i. Sajjad may have decided to change the level of materiality because of any of the following causes:
 a change in circumstances; or
 a change in the auditor's knowledge as a result of performing audit procedures.
ii. There is an inverse relationship between materiality and the level of audit risk. This relationship is
considered by an auditor in determining the nature, timing and extent of audit procedures.
Mr. Sajjad reduced the materiality level which resulted in increase in audit risk. Therefore, in order
to compensate the effect of increased audit risk, he should either.
 reduce the assessed risk of material misstatement, where this is possible by carrying out extended or
additional tests of control; or

Summary Notes by SK
 reduce the detection risk by modifying the nature, timing and extent of planned substantive
procedures.
b) Examples of qualitative misstatements would include the following:

(i) Inadequate or improper description of an accounting policy when it is likely that a user of the
financial statements would be misled by the description.
(ii) Failure to disclose the breach of regulatory requirements when it is likely that the consequent
imposition of regulatory restrictions will significantly impair operating capability.
(iii) Non-disclosure of directors personal expenses, charged to the company even if they are insignificant
(iv) Non-disclosure of failure to meet debt covenant requirements.
(v) Illegal payments which may not be material but if revealed may have severe repercussions.
Class Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 300 – ‘Audit Strategy and Audit

Plan’

Summary Notes by SK
Audit Strategy and Audit Plan
Expected questions on Audit Strategy and Audit Plan
1. Define Audit Strategy & detailed Audit Plan?
2. What are the advantages / purpose /importance of planning an Audit? / Audit
Planning?
3. List and briefly explain the preliminary engagement activities to be performed by the
Auditor prior to the commencement of the audit?
4. List the contents of an overall Audit Strategy?
5. What are the matters to be considered by the Auditor while making an Audit Strategy?
6. What are the matters to be included in a detailed Audit Plan? OR
7. List the contents of the detailed Audit Plan?
8. List the contents / Matters to be included in an / of an Audit Strategy & provide
relevant example for the given case? (Scenario based Question) ……….. Most Imp!
9. Explain the difference/ tabulate the Difference between Audit Strategy and Audit
Plan?
10. Explain the additional considerations to be considered by the auditor in the case of an INITIAL audit?
--------------------------------------------------------------------------------------------------------------------------------
Planning an Audit – ISA 300
ISA 300 requires the auditor to: (Overall Objectives of ISA 300)
1. Involve the whole engagement team in planning the audit

2. Establish an understanding of the terms of the engagement required by ISA 210 (Ch 2)
3. Establish an overall strategy for the audit that sets the scope, timing and direction of
the audit and that guides the development of the audit plan
4. Develop an audit plan which includes a description of planned risk assessment procedures and
planned further audit procedures (CAIRO)
5. Document the overall audit strategy & the audit plan, including any significant changes made during
the audit.
Introduction to Planning:
The auditor should plan an audit so that the engagement will be performed in an effective manner.
Planning an audit involves establishing the overall audit strategy for the engagement and developing an
audit plan.
Planning involves the engagement partner and other key members of the engagement team to benefit from
their experience and insight (understanding) and to enhance the effectiveness and efficiency of the
planning process.
Advantages / Benefits of Planning/Need for Planning
1. It ensures that appropriate attention is devoted to important areas of the audit

(E.g______________________________________________________________ etc.)
2. It ensures that potential problems are identified (Misstatement in _____________)
3. It ensures that such problems (Audit and accounting issues) are resolved on a timely basis.
4. It ensures that audit engagement is properly organized and managed.
5. Planning also assists in the proper assignment of work to engagement team members.

Summary Notes by SK
6. Planning facilitates the direction, supervision of engagement team members and review of their work.
(managers review the work done by the audit team)
7. Proper utilization of assistants. ( ______________________________)
Attitude of Professional skepticism to be exercised during Planning and performing an Audit
When planning and performing an audit, the auditor should adopt an attitude of professional skepticism.
Professional skepticism is:
“An attitude that includes a questioning mind, being alert to conditions which may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence”.
(Please refer to P.S handout studied earlier)
Involvement of Key Engagement Team Members

ISA 300 requires the engagement partner and other key members of the engagement team to be involved
in planning the audit, including participating in the discussion among engagement team members.
Depending on the size of client, complexity and any other relevant factors, this may involve the
engagement partner and other key members of the engagement team.
Preliminary Engagement Activities - IMP
The auditor shall undertake the following activities at the beginning of each audit engagement:
1. Perform procedures required by ISA 220 (Quality Control) regarding the continuance of the client
relationship and the specific audit engagement. This will consider whether the auditor:
 has competency & capability to perform the engagement including time and
resources, to do so;
has considered the integrity of the client, and does not have information that would
lead it to conclude that the client lacks integrity.
2. Evaluate compliance with relevant ethical requirements, including independence, in accordance with
ISA 220 & Code of Ethics
 This will involve confirming that the auditor remains compliant with ethical
requirements from beginning till the end of the audit and apply safeguards where
necessary. (to be covered in Ch. 14)
 The engagement partner will need to provide the firm with relevant information about
the client engagement plus any ethical requirements on the firm.
3. Establish an understanding of the terms of the engagement, as required by ISA 210
(already covered in chapter 2).
For continuing audit engagements (Recurring Audits), such initial procedures often occur shortly after the
completion of the previous audit.
Student Notings

Summary Notes by SK
Planning Activities……. (Main heading)
The overall Audit Strategy
The auditor should establish the overall audit strategy for the audit. The overall audit strategy sets the
scope, timing and direction of the audit and guides the development of a more detailed audit plan.
Contents of the overall audit strategy / Consideration in Establishing the Overall Audit
Strategy / Matters to be included within the Audit strategy document
Learn 3 points from each
heading
1. Main Characteristics of the Engagement
The audit strategy should consider the main characteristics of the engagement which defines its scope.
1. Understanding the entity and its environment (Banking / Trading or Manufacturing Industry) / The
nature of business
2. The applicable financial reporting framework (relevant Int. Accounting standards or any other acc.
stands) on which the F/S to be audited has been prepared.
3. The availability of key client personnel & internal auditors (if any)
4. The expected audit coverage. (Sample coverage)
5. Use of Experts eg Lawyers and service organizations (e.g. Payroll services are outsourced)
6. Whether C.A.A.T will be used and its effect on audit procedures
2. Reporting Objectives, timing of the audit and nature of communications

The objective here is to plan the timings of the and the nature of communications required for e.g.:
1. Communications with 3rd parties (e.g. Debtors / creditors etc.)

2. Ascertaining the reporting objectives of the engagement and the timing of the audit (timetable for
audit) and deadlines to be met. (e.g. Completion of Audit and Delivery of Audit Report)
3. Meetings and discussion with those TCWG to discuss significant audit issues arising.
4. When audit meetings will take place and when their work will be reviewed.
3. Significant factors during the Audit

Factors to be considered which in the auditor’s professional judgement are significant, for e.g.:
1. Determination of appropriate materiality levels.eg Calc. of Planning and Performance materiality (ISA
320)
2. The need to maintain professional skepticism in gathering and evaluating audit evidence.
3. The need to maintain professional judgement in gathering and evaluating audit evidence.
4. Identification of material components / significant items in B/S and P&L (E.g. Debtors & Inventory)
4.Preliminary engagement activities and knowledge gained on other engagements

It should consider the results of preliminary audit planning activities and other knowledge gained on other
engagements for e.g.:
1. Significant changes in the financial reporting framework

2. Whether audit will be conducted via TOCs or substantive procedures
3. Conclusions on the effectiveness of internal controls based on earlier testing.
4. Significant business (changes in I.T or Business processes) and industry developments
(E.g. New regulations or new material or new practices etc.)

Summary Notes by SK
5.Nature, timing and extent of resources
1. How AUDIT resources are managed, directed and supervised.
2. Selection of audit engagement team and assignment of audit work to experienced team members
where there may be higher risks of material misstatement.
3. Total man hours required for the job and setting up the audit budget. (e.g. 1000 hours)
Once the overall audit strategy has been established, the auditor is able to start the development of a
more detailed audit plan to address the various matters identified in the overall audit strategy.
Although the auditor ordinarily establishes the overall audit strategy before developing the detailed audit
plan, the two planning activities are not necessarily discrete (distinct) or sequential process but are closely
inter related.
Exam Focused Points
The Audit Plan: (to be linked with T.O.C and S. P’s)
The auditor will take the overall audit strategy and convert it into a more detailed audit plan. The plan
includes the nature, timing and extent of audit procedures to be performed by engagement team members
in order to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level.
Contents of a Detailed Audit Plan

1. Description of planned risk assessment procedures – as per ISA 315
2. Description of Audit procedures / Audit tests to verify Profit & loss and Balance sheet and P& D
items assertions
3. Other planned procedures as per ISAs (e.g. ISA 560 Subsequent Events & ISA 570 Going Concern
etc.)
Examples:
 A timetable of planned audit work.
 Details of the allocation of work to audit team members.
 Audit procedures for B/S and P&L (e.g. inventory, receivables, cash etc.)
 Materiality for the financial statements as a whole and performance materiality
The audit plan is MORE detailed than the overall audit strategy and includes audit procedures
(application of Tests of Controls and Substantive Procedures) to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an
ACCEPTABLY LOW LEVEL.

Summary Notes by SK
Additional considerations in initial audit engagements – IMP
The purpose and objective of planning the audit are the SAME whether the audit is an initial or recurring
engagement. However, for an INITIAL audit (ISA 510), the auditor may need to expand the planning
activities because the auditor does not ordinarily have the previous experience with the entity.
For an initial audit engagement, ADDITIONAL matters the auditor may consider in planning the
audit include the following:
1. Unless prohibited by law or regulation, arrangements to be made with the previous auditor, for
example, to review the previous auditor’s working papers;
2. Any major issues (including the application of IAS/IFRS/ISA) discussed with management in
connection with the initial selection as auditor, the communication of these matters to those charged
with governance and how these matters affect the overall audit strategy and audit plan;
3. The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening
balances;( closing balances of last year) – ISA 510
4. Other procedures required by the firm’s system of quality control (ISA 220) for initial audit
engagements (for example, the firm’s system of quality control may require the involvement of another
partner/senior individual to review the overall audit strategy prior to commencing significant audit
procedures or to review reports prior to their issuance).
Exam Focused Points
Documentation in the case of ISA 300

 Audit Strategy
 Audit Plan &
 Any significant changes made during the audit engagement to the overall strategy or the detailed audit
plan along with reasons for it.

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
CA CAF 8 & ACCA F8 Practice Questions on
Planning an Audit
ICAP
1 Q. 2 (b) March 2021 4 marks
ACCA
4 Q.18 (a) Sept / Dec 2017 4 marks
5 Q.1 (a) Dec 2014 5 marks
6 Q.1 (c) Dec 2013 4 marks
7 Q.17 (b) Sept/Dec 2017 3 marks
8 Q. 2 (a) June 2012 4 marks

Summary Notes by SK
Question 18 (a)
ISA 300 planning an Audit of Financial Statements provides guidance to assist auditors in planning an
audit.
Required:
Explain the benefits of audit planning
Answer 18:
c. Benefits of audit planning
Audit planning is addressed by ISA 300 Planning and Audit of Financial Statements. It states that
adequate benefits the audit of financial statements in several days:
 Help the auditor to devote appropriate attention to important area of the audit.
 Helping the auditor to identify and resolve potential problems on a timely basis.
 Helping the auditor of to properly to 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 to respond to anticipated risks and the proper assignment of work to them.
 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 1 (a)
ISA 300 Planning an Audit of Financial Statements provides guidance to auditors. Planning an audit
involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate
planning benefits the audit of financial statements in several ways.
Required:
Explain the importance of audit planning.
Answer 1 (a):
Importance of audit planning
 It helps the auditor to devote appropriate attention to important areas of the audit.
 It helps the auditor to identify and resolve potential problems on a timely basis.
 It helps the auditor to properly organize and manage the audit engagement so that it is performed in
an effective and efficient manner.
 It assists in the selection of engagement team members with appropriate levels of capabilities and
competence to respond to anticipated risks and the proper assignment to work to them.
 It facilitates the direction and supervision of engagement team members and the review of their work.
 It assists, where applicable, in the coordination of work done by experts.
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Summary Notes by SK
Question 1 (c)
Minty Cola Co (Minty) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks
and its year end is 31 December 2013. You are the audit manager of Parsley & Co and are currently
planning the audit of Minty. You attended the planning meeting with the engagement partner and
finance director last week and recorded the minutes from the meeting shown below. You are reviewing
these as part of the process of preparing the audit strategy.
Minutes of planning meeting for Minty
Minty's trading results have been strong this year and the company is forecasting revenue of $85 million,
which is an increase from the previous year. The company has invested significantly in the cola and fizzy
drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing
and replacing a significant amount of the machinery used in the production process.
As the level of production has increased, the company has expanded the number of warehouses it uses to
store inventory. It now utilises 15 warehouses; some are owned by Minty and some are rented from third
parties. There will be inventory counts taking place at all 15 of these sites at the year end.
A new accounting general ledger has been introduced at the beginning of the year, with the old and new
system being run in parallel for a period of two months.
As a result of the increase in revenue, Minty has recently recruited a new credit controller to chase
outstanding receivables. The finance director thinks it is not necessary to continue to maintain an
allowance for receivables and so has released the opening allowance of $1.5 million.
In addition, Minty has incurred expenditure of $4.5 million on developing a new brand of fizzy soft
drinks. The company started this process in January 2013 and is close to launching their new product into
the market place.
The finance director stated that there was a problem in November in the mixing of raw materials within
the production process which resulted in a large batch of cola products tasting different. A number of
these products were sold; however, due to complaints by customers about the flavour, no further sales of
these goods have been made. No adjustment has been made to the valuation of the damaged Inventory,
which will still be held at cost of $1 million at the year end.
As in previous years, the management of Minty is due to be paid a significant annual bonus based on the
value year-end total assets.
Required:
c) Identity the main areas, other than audit risks, that should be included with the audit strategy
document for Minty Cola Co; and for each area provide an example relevant to the audit.
Answer 1 (c):
Audit strategy document
The audit strategy sets out the scope, timing and direction of the audit and helps the development of the
audit plan. It should consider the following main areas.

Summary Notes by SK
It should identify the main characteristics of the engagement which define its scope. For Minty it should
consider the following:
 Whether the financial information to be audited has been prepared in accordance with IFRS.
 To what extent audit evidence obtained in previous audits for Minty will be utilized.
 Whether computer-assisted audit techniques will be used and the effect of IT on audit procedures.
 The availability of key personnel at Minty. It should ascertain the reporting objectives of the
engagement to plan the timing of the audit and the nature of the communications required, such as:
 The audit timetable for reporting and whether there will be an interim as well as final audit.
 Organization of meetings with Minty's management to discuss any audit issues arising.
 Location of the 15 inventory counts.
 Any discussions with management regarding the reports to be issued.
 The timings of the audit team meetings and review of work performed.
 If there are any expected communications with third parties.
The strategy should consider the factors that, in the auditor's professional judgment, are significant in
directing Minty's audit team's efforts, such as:
 The determination of materiality for the audit.
 The need to maintain a questioning mind and to exercise professional skepticism in gathering and
evaluating audit evidence
It should consider the results of preliminary audit planning activities and, where applicable, whether
knowledge gained on other engagements for Minty is relevant, such as:
 Results of previous audits and the results of any tests over the effectiveness of internal controls.
 Evidence of management's commitment to the design, implementation and maintenance of sound
internal control.
 Volume of transactions, which may determine whether it is more efficient for the audit team to rely on
internal control.
 Significant business developments effecting Minty, such as the change in accounting system and the
significant expenditure on an overhaul of the factory.
The audit strategy should ascertain the nature, timing and extent of resources necessary to perform the
audit, such as:
 The selection of the audit team with experience of this type of industry.
 Assignment of audit work to the team members,
 Setting the audit budget. Tutorial note: The answer is longer than required for four marks but
represents a teaching aid
--------------------------------------------------------------------------------------------------------------------

Question 17 (b)
You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer Construction
Co, for the year ending 30 September 20X7. The company specializes in property construction and
providing ongoing annual maintenance services for properties previously constructed. Forecast profit
before tax is $13.8m and total assets are expected to be $22.3m, both of which are higher than for the year
ended 30 September 20X6.

Summary Notes by SK
You are required to produce the audit strategy document. The audit manager has met with Prancer
Construction Co’s finance director and has provided you with the following notes, a copy of the August
management accounts and the prior year financial statements.
p
Meeting notes
The prior year financial statements recognize work in progress of $1.8m, which was comprised of
property construction in progress as well as ongoing maintenance services for finished properties. The
August 20X7 management accounts recognize $2.1m inventory of completed properties compared to a
balance of $1.4m in September 20X6. A full year-end inventory count will be undertaken on 30
September at all of the 11 building sites where construction is in progress. There is not sufficient audit
team resource to attend all inventory counts.
In line with industry practice, Prancer Construction Co offers its customer a five-year building warranty,
which covers any construction defects. Costumers are not required to pay any additional fees to obtain
the warranty. The finance director anticipates the provision will be lower than last year as the company
has improved its building practices and therefore the quality of the finished property.
Customers who wish to purchase a property are required to place an order and pay a 5% nonrefundable
deposit prior to the completion of the building. When the building is complete, customers pay a further
92.5%, with the final 2.5% due to be paid six months later. The finance director has informed you that
although an allowance for receivables has historically been maintained, it is anticipated that this can be
significantly reduced.
Information from management accounts

Prancer Construction Co’s prior year financial statements and August 20X7 management accounts
contain a material overdraft balance. The finance director has confirmed that there are minimum profit
and net assets covenants attached to the overdraft.
A review of the management accounts shows the payables period was 56 days for August 20X7,
compared to 87 days for September 20X6. The finance director anticipates that the September 20X7
payables days will be even lower than those in August 20X7.
Required:
b) 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. (3 marks)
Answer 17 (b)
Areas to be included in the audit strategy document
The audit strategy sets out the scope, timing and director of the audit and helps the development of the
audit plan. ISA 300 Planning an Audit of Financial Statements sets out areas which should be considered
and documented as part of the audit strategy document and are as follows:
Main characteristics of the engagement

The audit strategy should consider the main characteristics of the engagement, which define its
scope. For Prancer Construction Co, the following are examples of things which should be
included:
 Whether the financial information to be audited has been prepared in accordance with the relevant
financial reporting framework.
 Whether computer-assisted audit techniques will be used and the effect of IT on audit procedures.
 The availability of key personal at Prancer Construction Co.

Summary Notes by SK
Reporting objectives, timing and nature of communication
It should ascertain the reporting objectives of the engagement to plan the timing of the audit and the
nature of the communications required, such as:
 The audit timetable for reporting including the timing of interim and final stages.
 Organization of meetings with Prancer Construction Co’s management to discuss any audit issues
arising.
 Any discussions with management regarding the reports to be issued.
 The timing of the audit team meetings and review of work performed.
Significant factors affecting the audit

The strategy should consider the factors which, in the auditor’s professional judgment, are significant in
directing Prancer Construction Co’s audit team’s efforts, such as:
 The determination of materiality for the audit.
 The need to main a questioning mind and to exercise professional skepticism in gathering and
evaluating audit evidence.
Preliminary engagement activities and knowledge from previous engagements

It should consider the results of preliminary audit planning activities and, where applicable, where
knowledge gained on other engagements for Prancer Construction Co is relevant, such as:
 Results of any tests over the effectiveness of internal controls.
 Evidence of management’s commitment to the design, implementation and
maintenance of sound internal controls.
 Volume of transactions, which may determine whether it is more efficient for the audit team to rely on
internal controls.
 Significant business developments affecting Prancer Construction Co, such as the improvement in
building practices and construction quality.
Nature, timing and extent of resources

The audit strategy should ascertain the nature, timing and extent of resources necessary to perform the
audit, such as:
 The selection of the audit team with experience of this type of industry.
 Assignment of audit work to the team members. - Setting the audit budget.
---------------------------------------------------------------------------------------------------------
Question 2 (a)
ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in planning an
audit.
Required:
Explain the benefits of audit planning.
Answer 2 (a)
Benefits of audit planning
Audit planning is addressed by ISA 300 Planning an Audit of Financial Statements. It states that
adequate planning benefits the audit of financial statements in several ways:
 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.

Summary Notes by SK
 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 to respond to anticipated risks and the proper assignment of work to them.
 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

Summary Notes by SK
Student Notings

Summary Notes by SK
Audit Risk – ISA 315

‘Theoretical Part’

Summary Notes by SK Summary Diagram
Audit Risk ISA 315 Audit Risk (A.R) = Risk of Material Misstatement ( R.O.M.M) * Detection Risk (D.R)
Audit Risk
Audit Risk is the risk that an At the Financial Statement Level At the Assertion Level
external auditor may give a wrong Risk at the F/S Level refers
opinion on the refer Handout # 2
to the risk of M.M that 1. Inherent Risk
financial statements. i.e. It’s the
pervasively effects F/S
risk that an auditor expresses an
incorrect / wrong Audit opinion as a whole and potentially 2. Control Risks
when the financial statements are affects many assertions in the F/S Detection Risk has further 02 Components
materially misstated.
Pls Note: It’s the RISK that has an overall They are NOT related to the external audit Sampling Risks
It does not mean Auditor's own impact on the F/S… and they both exist independently of the
Business risk or the business risk
that is unrelated to the financial
Audit i.e Non -Sampling Risks
statements of the company. Egs from Handout .2 They exist prior to the External Audit ……
Also Note: (They are not in the control of the
Audit risk can never be zero External auditors)
because of inherent limitations of External auditors can ONLY assess
an audit.
Inherent and
The objective of an External
Control Risks
Auditor is to reduce the Audit risk
to an acceptably low level which
depends upon the Professional
judgement of the external auditor.

Summary Notes by SK
ISA 315 Audit Risk - H.O # 2
RISK AT THE FINANCIAL STATEMENT and AT THE ASSERTION LEVEL
Risk at the F/S Level

It relates to the risks of material misstatement that pervasively affects F/S taken as a whole & potentially
affect many assertions of the F/S.
i.e. It’s the risk that has an impact on the financial statement overall.
Examples of RISK at the F/S Level:

1. Management override of controls.
2. Risk of fraud (ISA 240)
3. Deficient control environment (e.g. Weak corporate Governance)
4. Managements lack of competence.
5. Management integrity. (Management cannot be trusted)
6. Conditions & reliability of entity’s record.
7. Declining economics conditions. (or changing Industry conditions)
8. Going Concern Risk. (ISA 570)
Response of RISK at the F/S Level by the External Auditor
(To be covered while studying ISA 240 Fraud & Error)
These include:
1. Emphasizing to the audit team the need to maintain and exercise an attitude of professional
skepticism during the audit.
2. Assigning more experienced audit staff at the client.
3. Increased supervision of audit staff
4. The use of experts (E.g. Lawyers, Environmental Experts, Tax experts etc.)
5. Incorporating more unpredictability into the audit procedures
Explanation:
Incorporating an element of unpredictability in the audit procedures to be performed is important as
individuals within entity who are familiar with the audit procedures normally performed on engagements
may be more able to conceal fraudulent financial reporting.
This can be achieved by, for example.
Performing substantive procedures on selected account balances assertions not otherwise tested due to
their materiality or risk.
(Example: verification of Rent expense or Short-term loan or Marketing expenses.)
 Adjusting the timings of audit procedures from that otherwise expected
(Example: Dispatching debtor and creditors confirmation before the balance sheet date or counting
stock before the B/S date)
 Using different sampling methods.
(Using statistical sampling Method rather than Non-statistical method or using random method
rather than haphazard method)
 Performing audit procedures at different locations or at locations on an unannounced basis.

Summary Notes by SK
 (Counting inventory in stores / warehouses on locations not counted previously or informing the audit
client on the very last moment or counting physical cash on different branches for the current year
audit)
 Changing the nature, timing and extent of audit procedures (to be discussed in future)
INHERENT RISK
Inherent risk is the risk that items in the F/S may be misstated as a result of their inherent characteristics/
feature.
When inherent risk is high, this means that there is a high risk of misstatement of an item in the financial
statements. (P& L, B/S or P&D)
Inherent Risk is the susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement which could be material, either individually or when aggregated with other
misstatements, before consideration of any related controls.
Examples of Inherent risk (I.R):
1. Complex calculation of provisions (+ Accounts involving high degree of estimations
e.g. Provisions made under IAS 37)
2. Technological developments based on Industry having significant
variations.
( )
3. Declining industry resulting in reduced sales & Debtors. (tough competition)
4. Theft & misappropriation of portable assets (e.g. Cash and portable inventory)
5. Pending litigations against the company.
6. The nature of the entity and the industry in which it operates.
E.g. 1: A company in the cement industry operates in a volatile and high-risk environment, and
items in its financial statements are more likely to be misstated than items in the financial
statements of companies in a more low-risk environment, such as a service industry.
CONTROL RISK (C.R)
Control Risk is the risk that a misstatement which could occur in assertion about a class of
transaction, account balance or disclosures and which could be material, either individually or
when aggregated with other misstatements, will not be prevented, or detected and corrected, on
a timely basis by the entity’s internal control.’
Examples of Control Risk (C.R):
1. Possibility of human errors/mistakes. (wrong punching of sales invoices)
2. Collusion between employees. (employees conducting fraud together)
3. Management override of controls.
4. Inadequate/inappropriate SOP’s/Deficiencies in Internal Controls.
5. Non-Routine transactions. (Procuring assets on Leasing)
6. Lack of Qualified & inexperienced Staff.
7. Changes in Key Personnel (E.g. CFO, Senior Manager Finance etc).
8. Changes in I.T Environment (Change of software).
The initial assumption should be that control risk is very high, and that existing internal controls are
insufficient to prevent the risk of material misstatement.

Summary Notes by SK
DETECTION RISK (D.R)
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 which exists and which could be material,
either individually or when aggregated with other misstatements. (Detection risk is affected by
sampling and non-sampling risks.)
The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low
level will not detect a misstatement that exists and that could be material, either individually or
when aggregated with other misstatements.
Detection risk is the risk that the EXTERNAL AUDITOR’s procedures will fail to detect a
MATERIAL misstatement in a transaction or in an account balance
Detection risk can be lowered by carrying out more tests/ procedures in the audit. For example,
to reduce the detection risk from 10% to 5%, the auditor should carry out more tests. (MORE
PROCEDURES)
In other words, the detection risk can be managed by the auditor in order to control the overall
audit risk. Inherent risk and Control risk CANNOT be controlled by the external auditor
Examples of Detection Risk (D.R)

1. First year of audit
2. No past Audit experience of the audit client
3. Integrity of Management (We cannot trust the Management representations /statements)
4. Unreliable data and information (The Information System of the client is not reliable)
D.R can be INCREASED by OR say Factors that increase D.R:

1. Inadequate planning by the External Auditor
2. Inappropriate assignment of personnel to the engagement team
3. Failure in applying professional skepticism during the Audit
4. Inadequate supervision and review
5. Incorrect sampling techniques (ISA 530)
6. Inappropriate/incorrect sample size
D.R is the risk that audit procedures performed by the External Auditor will fail to detect
material misstatement. It relates to the inability of the auditor to examine all evidence. Audit
Evidence is usually persuasive rather than conclusive (covered in Basic concepts) therefore
some D.R will always exist, allowing the external auditor to seek/express reasonable level of
assurance.
Conclusion:
The auditor’s inherent and control risk assessment influences the extent of substantive
procedures required to reduce the D.R and thereby reducing the audit risk to an acceptably low
level. D.R however, can only be reduced and not eliminated, because of the inherent limitations
of an audit. Accordingly, some D.R will always exist.

Summary Notes by SK
Student Notings

Summary Notes by SK
Audit Risk – ISA 315

‘Practical Part’

Summary Notes by SK
Audit Risks kay cheetay Points …. 

(Practical Points that affect Audit Risks)
1. Incurred revenue & capital expenditure during the year OR increase in capital expenditure during the
year. OR question says X amount of expenditure has been capitalized during the year.
2. Increase in subsequent expenditure during the year.

RISKS: There is a risk of incorrect classification between revenue and capital expenditure as per IAS
16, resulting in both P.P.E and profit being overstated OR understated.
As per IAS 16 …. only purchase price plus directly attributable costs are part of the cost of the asset.
(Other future costs e.g. servicing and maintenance costs are amortized over the period accordingly)
________________________________________________________________________
3. Increase in research & development cost (IAS 38)/Expenditure on Brands incurred during the year
e.g. Costs capitalized as development costs.
RISKS: There is a risk of incorrect classification between research and development expenditure as
per IAS 38, resulting in both I.A and profit being over stated and understated.
In case, question ONLY mentions that cost has been capitalized as development costs than in that
case ……. There is a risk of overstatement of Intangible asset and overstatement of profit.
4. Various provisions made during the year e.g. Provision for lawsuit / warranty or restructuring
RISK: There is a risk that because of wrong estimates and judgement (both Intentional and
unintentional), provision could be both undervalued or overvalued in the F/S.
5. There are pending cases against the company OR new cases filed on the Co. during the year OR
The sector in which the company operates is highly regulated / Fines Penalties might be imposed on
the organization.
RISK: There is a risk of completeness of provisions or inadequate or no disclosure in the F/S as per
IAS 37.
(If it is probable that company will make a payment, a provision is required. If the payment is
possible rather than probable, a contingent liability disclosure would be necessary.
Both drafting’s are correct:

a) There is a risk over the completeness of any provisions or contingent liabilities.) or
b) There is a risk of provision being over / under valued and risk of inadequate or no
disclosure in the F/S as per IAS 37.
6. Imposition of new laws & regulations on the company

RISK: There is a risk of penalty not being recorded in the F/S resulting in profit being overstated OR
Risk of liabilities being understated OR risk of incorrect disclosures in the F/S.
7. Inadequate Internal controls/SOP’s / or lack of controls in Sales or Purchase department

RISK: There is a risk of controls not being operating effectively leading to overall
ROMM in the F/S or sales and debtors & purchases and payables being overstated or understated

Summary Notes by SK
8. During the year employees were made redundant e.g. Branch office was closed (Part of restructuring)
RISK: There is a risk that because of wrong estimates the provision could be both overvalued or
undervalued. (OR SAY …There is a risk of completeness of Provision in the F/S.)
9. Bank Loan obtained for 5 / 10 years

RISK: There is a risk of incorrect classification between current and long-term portion of long-term
loan & risk of incorrect disclosure of security provided against bank loan in the F/S.
10. Bank Loan increased as compared to last year.

RISK: There should be additional interest costs therefore there is a risk that this has been omitted from
profit and loss a/c leading to understated finance costs and overstated profit.
11. Bank loan has loan covenants attached, plus the company is facing cash flow problems or faces
liquidity issues.
RISK: There is a risk that if these loan covenants (profit or assets targets) are breached and the loan
becomes repayable immediately than the company will face going concern risk. (ISA 570)
In addition, there is a risk of manipulation of profits and net assets to ensure that bank covenants are
met.
12. Interest / Finance cost increased during the year because of increase in bank loan.
RISK: There is a risk that interest costs will be understated to manipulate profits especially if there are
profit based bonuses for senior management.
13. Introduction of new accounting software during the period and run in parallel during the year
RISK: There is risk of data being lost & balances being misstated if they have not been transferred
completely and accurately, therefore there is a risk of overall R.O.M.M in the F/S.
14. Senior management joins the organization with different prior experience (CFO has joined a BANK
who was previously CFO in a pharmaceutical company)
RISK: There is a risk that there will be overall errors in making judgements and estimates leading to
overall R.O.M.M in the F/S
15. Hiring of unqualified /incompetent / inexperienced staff in the finance department

RISK: There is an inherent as well as control risk that there will be overall R.O.M.M in the F/S.
16. Revaluation of assets during the year (treatment of IAS 16)

RISK: There is a risk that if the treatment of revaluation is not done as per IAS 16 than both PPE and
profits will be over or under-stated.
17. New product has been manufactured by the company but it won’t be allowed to be sold by the
company or its expected that a new law will be imposed which will stop the sales of the product.
RISK: There is risk of going concern for the company plus if stock is not written
down than profit and inventory will be overstated.
18. Top Management/Senior Management from the finance dept. has left the Company very close to the
balance sheet date.
RISK: There is an inherent risk of increased work load for the finance team resulting in control risks
(C.R) for the auditor leading to misstatements in the F/S.

Summary Notes by SK
Alternative Drafting
There is an inherent risk of increased work load for the finance team resulting in control risks (C.R) as
there will be errors within the accounting records by the over -worked finance team and there is no
supervision from senior mgmt.
IMP
19. Default of major customer/receivable during the year OR
20. Receivables balance is increasing over the years as compared to last year or collection in days has
increased as compared to last year.
RISK: There is a risk that if receivables are not recoverable and adequate provisioning is not done
than debtors will be overvalued.
---------------------------------------------------------------------------------------------------------------------------
21. Out of court settlement with the customers / suppliers (before or after the B/S date)
RISK: There is a risk that resulting provision or liability will be over or under valued. (also termed as
completeness of provisions and disclosures)
22. Excess inventory & fixed assets in the warehouse.

RISK: There is a risk of Increased theft & misappropriation of assets resulting in loss of sundry income
leading to profit being understated.
23. First year of audit or it’s a new audit client

RISK: There is a risk of not detecting the errors in the F/S being the first year resulting in detection
risk (D.R) for the external auditor.
(As the team is not familiar with transactions and balances, there will be an increased detection risk on
the audit.)
24. Proper disclosures as per I.F.R.S or local laws are required in the F/S
RISK: There is a risk of incorrect or inadequate disclosures in the F/S.
25. Sales related bonus / incentive being offered to employees.

RISK: There is a risk of sales and debtors being overstated in the F/S by inaccurate sales cutoff.
26. Subsequent fraud discovered by senior management after leaving the organization.
RISK: There is a risk that if previous fraud is not adjusted, than F/S will be materially
misstated. (or say overall R.O.M.M in the F/S will increase)
Alternative: There is a risk that if the impact of the fraud has not been quantified and corrected in the
statement of profit or loss or any other frauds have not been uncovered, the financial statements could
be misstated.
27. Risk of improper/ incorrect classification between current and non-current assets, current and non-
current liabilities.
28. Disposal of fixed assets during the year

RISK: There is a risk of wrong calculation of profit on disposal leading to profit being over and
understated.

Summary Notes by SK
29. Abnormal gain / loss on disposal of fixed assets during the year.
RISK: There is a risk of unreasonable depreciation policy (accounting estimate) leading to both P.P.E
and profit being under or overstated.
30. The company has both owned & rented assets.
RISK: There is risk that if rented assets are classified as owned assets than assets will be overvalued
and profit will be overstated.
31. Sudden conversion of accumulated losses into profits in the current year.
RISK: There is a risk of admin expenses being understated and profits being overstated.
32. Management bonus is linked on the total assets of the company. (IMP)
RISK: There is a risk that management will manipulate assets of the company via estimates and
provisions and this will lead to assets being overvalued in order to increase their personnel bonus.
33. Management bonus is linked on the profits of the company (IMP)

RISK: There is a risk that management will manipulate profits of the company via estimates and
provisions and this will lead to profits being overstated in order to increase their personnel bonus.
34. Sudden decrease in Admin expenses without any change in company’s operations.
RISK: There is a risk of profit being overstated.
35. Company has Intangible assets under IAS 38 (Patent, license, Franchise etc.)
RISK: There is a risk that if treatment is not done as per IAS 38 than both Intangible assets and profits
could be over/under stated.
INVENTORY
36. Assets/Inventory ordered/procured with no certainty that they will be received at the yearend or not.
RISK: There is a risk of inaccurate cutoff leading to stock/purchases and payables both being
overstated at the B/S date.
OR there is a risk that if inventory / fixed assets are recorded before they physically exist than both
inventory / fixed assets and payables will be over-stated in the F/S.
IMP
37. There are various locations / stores for inventory counting at the B/S date and company / client
management is willing to get 100 per % stock counted at the B/S date.
Please note :100% verification of inventory at all locations is not always practically possible for the
external auditor.
RISK: There is a risk that auditor will not be able to obtain S.A.A.E over the existence and
completeness of inventory locations not visited by the auditor at the B/S date.
38. Company values its inventory at the lower of cost and net realizable value. Cost includes both
production and general overheads.
RISK: If general overheads are included in inventory cost, then this will result in inventory being
over-valued.

Summary Notes by SK
39. Inventory is destroyed by fire / flood BEFORE the B/S Date
RISK: There is a risk that inventory is damaged and not valued as per IAS 2 resulting in closing stock
being overvalued.
40. The company is planning to undertake the full year-end inventory count after the B/S date and then
adjust for inventory movements from the year end.
RISK: If the adjustments are not completed accurately, then the year-end inventory could be under or
over-valued.
41. Stock returned after / or before the B/S date being damaged or expired or product recalled by the
company. (inventory was at the B/S date)
RISK: There is a risk that if inventory is not valued as per IAS 2 then closing stock would be
overvalued plus refunds will need to be made to the customers and sales will have to be reversed,
which if not done, then revenue will be overstated and liabilities will be understated.
42. Closing stock balance has increased as compared to last year. (or turnover in days have increased)
RISK: There is a risk that stock is old fashioned / or out of demand and not being sold resulting in its
NRV being lower than cost and if not adjusted as per IAS 2, will result in closing stock being
overvalued.
43. In the case of W.I.P, expert service must be obtained

RISK: There is a risk of W.I.P being under or overvalued.
(The level of work in progress needs to be assessed at the year end. Assessing the percentage of
completion for partially constructed inventory can be very subjective, and an expert should undertake
this. If the percentage of completion is not calculated correctly, the inventory valuation may be under
or over-valued.
44. Useful life of assets or depreciation rates have been reassessed or reviewed by the management during
the year.
RISK: There is a risk that this has been done to manipulate the profits or to achieve some kind of
profit targets resulting in profit and PPE being overstated.
45. Contingent assets as per IAS 37 should only be recorded when virtually certain.
RISK: There is a risk that assets are not virtually certain and are recorded as assets resulting in assets
being overvalued in the F/S.
To comply with IAS 37 contingent assets should not be recognized until the receipt is virtually
certain. If recorded there is a risk of assets and profits being over-stated.
46. The client is requesting to complete the audit early quickly than last year.
RISK: This will result in detection risk for the external auditor plus there will be less time for the
finance team to prepare the financial statements leading to an inherent risk that F/S will me be
materially misstated.
47. Bank reconciliations are not made on timely basis.
RISK: There is a risk that differences will not be reconciled resulting in the risk of bank balances
being over /under valued.
48. Physical stock is not reconciled with General ledger or book records.
RISK: There is a risk that closing stock could be over/under valued.

Summary Notes by SK
49. If physical cash is not reconciled with General ledger (Cash Book cash column)
RISK: There is a risk that cash balance would be over / under valued.
50. New technology has been introduced by the company because of which old & existing P & M have
been impaired.
RISK: There is a risk that if impairment treatment is not done as per IAS 36 than both P & M and
profits will be overstated.
51. Sales ledger and creditors ledger were closed 10 days after the B/S date
RISK: There is a risk of incorrect cutoff in both sales and purchases leading to over / under sales and
debtors as well as purchases and payables.
52. No supplier statement or purchase ledger control account reconciliations have been performed during
the period.
RISK: There is an increased risk of errors within trade payables and the year-end payables balance
may be under or over-valued.
53. A patent / franchise has been purchased by the company for X no of years and if the management has
expensed the full amount in the current year P&L than…..
RISK: There is a risk that as the sum has been fully expensed and not treated in accordance with IAS
38 than both intangible assets and profits are understated.
(In accordance with IAS 38 Intangible Assets, this should have been included as an intangible asset
and amortized over its useful life accordingly )
54. The company has raised new finance / equity through issuing of shares at a premium. This needs to be
treated correctly, with adequate disclosures made and proper allocation between share capital and
share premium in the B/S.
RISK: If this is not done, then there is a risk that accounts may be misstated due to a lack of disclosure
as well as share capital and share premium will be misstated.
55. During the year, company outsourced its ABC department / function to an external service
organization / service provider.
RISK: A detection risk arises as to whether sufficient and appropriate evidence is available at the audit
client to verify the completeness and accuracy of controls over that ABC function / transactions and
balances at the year-end.
56. Because of market competition, selling price has been reduced OR abnormal discounts are given to
customers.
RISK: There is a risk of inventory being over-valued / risk of revenue being over-stated / risk of profit
being over-stated.
57. Raw material is imported from other country

RISK: There is a risk of Risk of Trade payables / trade creditors may be under / overvalued and
exchange gains and losses may also be over – under stated.

Summary Notes by SK
Few Accounting standards to be covered for Audit Risk Topic….
IAS 2,16,10,36,37,38 and IFRS 15

*Accounting Ratios and Audit Risks to be covered separately
Indicators for Risk of GOING CONCERN
Indicators of FRAUD RISK

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ACCA F8 Practice Questions on Audit Risk
S. No. Question Attempt Marks
1 Q.1 b (Minty Co) ACCA Dec 2013 12 marks

2 Q.3 (Recorder Co) ACCA June 2014 10 marks
3 Q.2 (Seagull & Co) ACCA Dec 2014 10 marks
4 Q.18 (Chania & Co) ACCA Sept 2016 12 marks
5 Q.17 c (Cupid & Co) ACCA Sept/ Dec 2017 14 marks
6 Q.17 b (Daffodil & Co) ACCA Mar/ June 2019 14 marks
CA CAF 8 Practice Questions on Audit Risk
1
2
3
4
5

Summary Notes by SK
Audit Risk Practice Questions

Question 1
Minty Cola Co (Minty) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks
and its year end is 31 December 2013. You are the audit manager of Parsley & Co and are currently
planning the audit of Minty.
You attended the planning meeting with the engagement partner and finance director last week and
recorded the minutes from the meeting shown below. You are reviewing these as part of the process of
preparing the audit strategy.
Minutes of planning meeting for Minty

Minty’s trading results have been strong this year and the company is forecasting revenue of $85 million,
which is an increase from the previous year. The company has invested significantly in the cola and fizzy
drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing
and replacing a significant amount of the machinery used in the production process.
As the level of production has increased, the company has expanded the number of warehouses it uses to
store inventory. It now utilizes 15 warehouses; some are owned by Minty and some are rented from third
parties. There will be inventory counts taking place at all 15 of these sites at the year end.
A new accounting general ledger has been introduced at the beginning of the year, with the old and new
systems being run in parallel for a period of two months.
As a result of the increase in revenue, Minty has recently recruited a new credit controller to chase
outstanding receivables. The finance director thinks it is not necessary to continue to maintain an
allowance for receivables and so has released the opening allowance of $1.5 million.
In addition, Minty has incurred expenditure of $4.5 million on developing a new brand of fizzy soft
drinks. The company started this process in January 2013 and is close to launching their new product into
the market place.
The finance director stated that there was a problem in November in the mixing of raw materials within
the production process which resulted in a large batch of cola products tasting different. A number of these
products were sold; however, due to complaints by customers about the flavor, no further sales of these
goods have been made. No adjustment has been made to the valuation of the damaged inventory, which
will still be held at cost of $1 million at the year end.
As in previous years, the management of Minty is due to be paid a significant annual bonus based on the
value of year-end total assets.
Required:
b) Using the minutes provided, identify and describe SIX audit risks, and explain the
auditor’s response to each risk, in planning the audit of Minty Cola Co. (12 marks)

Summary Notes by SK
Answer:
(b) Audit risks and responses
Audit risk Auditor response

Minty has incurred $5m on updating, repairing The auditor should review a breakdown of these
and replacing a significant amount of the costs to ascertain the split of capital and revenue
production process machinery. expenditure, and further testing should be
If this expenditure is of a capital nature, it should undertaken to ensure that the classification in the
be capitalised as part of property, plant and financial statements is correct.
equipment (PPE) in line with IAS 16 Property,
Plant and Equipment. However, if it relates
more to repairs, then it should be expensed to
the statement of profit or loss (income
statement). If the expenditure is not correctly
classified, profit and PPE could be under or
overstated
At the year end there will be inventory counts The auditor should assess which of the inventory
undertaken in all 15 warehouses. sites they will attend the counts for. This will be any
with material inventory or which have a history of
It is unlikely that the auditor will be able to significant errors.
attend all 15 inventory counts and therefore they
need to ensure that they obtain sufficient For those not visited, the auditor will need to review
evidence over the inventory counting controls, the level of exceptions noted during the count and
and completeness and existence of inventory for discuss with management any issues which arose
any warehouses not visited. during the count.
Inventory is stored within 15 warehouses; some The auditor should review supporting
are owned by Minty and some rented from third documentation for all warehouses included within
parties. Only warehouses owned by Minty PPE to confirm ownership by Minty and to ensure
should be included within PPE. There is a risk of non-current assets are not overstated
overstatement of PPE and understatement of
rental expenses if Minty has capitalised all 15
warehouses
A new accounting general ledger system has The auditor should undertake detailed testing to
been introduced at the beginning of the year and confirm that all opening balances have been
the old system was run in parallel for two correctly recorded in the new general ledger system.
months.
There is a risk of opening balances being They should document and test the new system.
misstated and loss of data if they have not been They should review any management reports run
transferred from the old system correctly. In comparing the old and new system during the
addition, the new general ledger system will parallel run to identify any issues with the processing
require documenting and the controls over this of accounting information.
will need to be tested.
The finance director of Minty has decided to Extended post year-end cash receipts testing and a
release the opening provision of $1·5 million for review of the aged receivables ledger to be
allowance for receivables as he feels it is performed to assess valuation and the need for an
unnecessary. There is a risk that receivables will allowance for receivables.
be overvalued, as despite having a credit

Summary Notes by SK
controller, some balances will be irrecoverable
and so will be overstated if not provided against.
In addition, due to the damaged inventory there
is an increased risk of customers refusing to
make payments in full.
Minty has incurred expenditure of $4·5 million Obtain a breakdown of the expenditure and
on developing a new brand of fizzy drink. This undertake testing to determine whether the costs
expenditure is research and development under relate to the research or development stage. Discuss
IAS 38 Intangible Assets. The standard requires the accounting treatment with the finance director
research costs to be expensed and development and ensure it is in accordance with IAS 38.
costs to be capitalised as an intangible asset.
If Minty has incorrectly classified research costs
as development expenditure, there is a risk the
intangible asset could be overstated and expenses
understated.
A large batch of cola products has been damaged Detailed cost and net realisable value testing to be
in the production process and will be in performed to assess how much the inventory
inventory at the year end. No adjustment has requires writing down by
been made by management.
The valuation of inventory as per IAS 2

Inventories should be at the lower of cost and net
realisable value. Hence it is likely that this
inventory is overvalued.
Due to the damaged cola products, a number of Review the breakdown of sales of damaged goods,
customers have complained. It is likely that for and ensure that they have been accurately removed
any of the damaged goods sold, Minty will need from revenue.
to refund these customers.
Revenue is possibly overstated if the sales returns
are not completely and accurately recorded.
The management of Minty receives a significant Throughout the audit the team will need to be alert
annual bonus based on the value of year-end to this risk. They will need to maintain professional
total assets. There is a risk that management skepticism and carefully review judgmental
might feel under pressure to overstate the value decisions and compare treatment against prior years.
of assets through the judgments taken or through
the use of releasing provisions.
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Summary Notes by SK
Question 3
Recorder Communications Co (Recorder) is a large mobile phone company which operates a network of
stores in countries across Europe. The company’s year-end is 30 June 2014. You are the audit senior of
Piano & Co. Record is a new client and you are currently planning the audit with the audit manager.
You have been provided with the following planning notes from the audit partner following his meeting
with the finance director.
Recorder purchases goods from a supplier in South Asia and these goods are shipped to the company’s
central warehouse. The goods are usually in transit for two weeks and the company correctly records the
goods when received. Recorder does not undertake a year-end inventory count, but carries out monthly
continuous (perpetual) inventory counts and any errors identified are adjusted in the inventory system for
that month.
During the year the company introduced a bonus based on sales for its sales persons. The bonus target
was based on increasing the number of customers signing up for 24-month phone line contracts. This has
been successful and revenue has increased by 15%, especially in the last few months of the year. The level
of receivables is considerable higher than last year and there are concerns about the creditworthiness of
some customers.
Recorder has a policy of revaluing its land and buildings and this year has updated the valuations of all
land and buildings.
During the year the directors have each been paid a significant bonus, and they have included this within
wages and salaries. Separate disclosure of the bonus is required by local legislation.
Required:
a) Describe FIVE audit risks, and explain the auditor’s response to each risk, in planning the audit of
Recorder Communications Co. (10 marks)
Answer:
Audit risks and responses
Audit risks Audit responses

Recorder Communications Co (Recorder) is a Piano & Co should ensure they have a suitably
new client for Piano & Co. As the team is not so experienced team. Also, adequate time should be
familiar with the accounting policies, allocated for team members to obtain an
transactions and balances of Recorder, there will understanding of the company and the risks of
be an increased detection risk on the audit. material misstatement.
Recorder purchases their goods from South Asia The audit team should undertake detailed cut-off
and the goods are in transit for two weeks. At the testing of goods in transit from the suppliers in South
year end there is a risk that the cut-off of Asia to ensure that the cut-off is complete and
inventory, purchases and payables may not be accurate.
accurate. The company correctly accounts for
goods when they receive them. Therefore at the
year-end only goods which have been received

Summary Notes by SK
into the warehouse should be included in the
inventory balance and a respective payables
balance recognised.
The company undertakes continuous (perpetual) The completeness of the continuous (perpetual)
inventory counts at its central warehouse. Under inventory counts should be reviewed. In addition, the
such a system all inventory must be counted at level of adjustments made to inventory should be
least once a year with adjustments made to the considered to assess whether reliance on the
inventory records. inventory records at the year end will be acceptable.
Inventory could be under or overstated if the
continuous (perpetual) inventory counts are not
complete and the inventory records accurately
updated for adjustments.
A sales-related bonus scheme has been Increased sales cut-off testing will be performed along
introduced in the year; this may lead to sales cut- with a review of any post year-end cancellations of
off errors with employees aiming to maximise contracts as they may indicate cut-off errors.
their current year bonus.
Receivables are considerably higher than the Extended post year-end cash receipts testing and a
prior year and there are concerns about the review of the aged receivables ledger to be performed
creditworthiness of some customers. to assess valuation. Also consider the adequacy of
any allowance for receivables.
There is a risk that some receivables may be
overvalued as they are not recoverable.
In addition, receivables could be overstated as a External confirmation of receivables to confirm that
result of the bonus scheme; some of the customers exist and represent valid amounts due.
customers signed up for contracts may not
actually exist.
Recorder has a policy of revaluing its land and Discuss with management the process adopted for
buildings and these valuations have been undertaking the valuation, including whether the
updated during the year. whole class of assets was revalued and if the
Property, plant and equipment could be under or valuation was undertaken by an expert. This process
overvalued if the recent valuation has not been should be reviewed for compliance with IAS 16.
carried out in accordance with IAS 16 Property, Review the disclosures of the revaluation in the
Plant and Equipment and adequate disclosures financial statement for compliance with ISA 16.
may not have been made in the financial
statements.
The directors have each been paid a significant Discuss this matter with management and review the
bonus and separate disclosure of this in the disclosure in the financial statements to ensure
financial statements is required by local compliance with local legislation.
legislation.
The directors’ remuneration disclosure will not
be complete and accurate if the bonus paid is not
disclosed in accordance with the relevant local
legislation.
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Summary Notes by SK
Question 2
You are the audit supervisor of Seagull & Co and are currently planning the audit of your existing client,
Eagle Heating Co (Eagle), for the year ending 31 December 2014. Eagle manufactures and sells heating
and plumbing equipment to a number of home improvement stores across the country.
Eagle has experienced increased competition and as a result, in order to maintain its current levels of sales,
it has decreased the selling price of its products significantly since September 2014. The finance director
has informed your audit manager that he expects increased inventory levels at the year end. He also
notified your manager that one of Eagle’s key customers has been experiencing financial difficulties.
Therefore, Eagle has agreed that the customer can take a six-month payment break, after which payments
will continue as normal. The finance director does not believe that any allowance is required against this
receivable.
In October 2014 the financial controller of Eagle was dismissed. He had been employed by the company
for over 20 years, and he has threatened to sue the company for unfair dismissal. The role of financial
controller has not yet been filled and so his tasks have been shared between the existing finance
department team. In addition, the purchase ledger supervisor left in August and a replacement has been
appointed in the last week. However, for this period no supplier statement reconciliations or purchase
ledger control account reconciliations were performed.
You have undertaken a preliminary analytical review of the draft year to date statement of profit or loss,
and you are surprised to see a significant fall in administration expenses.
Required:
Explain FIVE audit risks, and the auditor’s response to each risk, in planning the audit of Eagle
Heating Co.
Answer:
Audit risks and responses
Audit risk Auditors response
Eagle Heating Co (Eagle) has decreased the selling The auditor should undertake detailed cost and
price of products significantly since September 2014 NRV testing to assess whether inventory is
and there are increased levels of inventory expected overvalued and requires write down.
at the year end.
It is possible that the selling price may have fallen

so that the net realisable value (NRV) of inventory is
below cost. IAS 2 Inventory requires inventory to
be stated at the lower of cost and NRV. Hence it is
possible that inventory is overvalued
A key customer of Eagle has been experiencing If the six-months payment break has now ended,
financial difficulties and Eagle has agreed a six- review after date cash receipts for this customer to
month payment break; however, the finance assess whether any payments have been made.
director does not believe an allowance is required.
Discuss with the finance director why he feels an
allowance is not required. Review whether any
If the customer is experiencing difficulties, there is general allowance for uncollectable accounts is

Summary Notes by SK
an increased risk that the receivable is not sufficient to cover the amount of this receivable.
recoverable and hence is overvalued.
In light of the increased competition, reduction in The auditor should undertake detailed going
selling price and financial difficulties of a key concern testing. They should review the cash flow
customer, there is an increased risk that Eagle is forecast for the foreseeable future to assess
facing going concern difficulties. whether the going concern basis is appropriate or
whether additional going concern disclosures are
required in the financial statements.
The financial controller of Eagle was dismissed in The audit team should write to the company’s
October and is threatening to sue the company for lawyers to enquire of the existence and likelihood
unfair dismissal. of success of any claim from the former financial
controller.
If it is probable that Eagle will make payment to the
financial controller, a provision for unfair dismissal
is required. If the payment is possible rather than
probable, a contingent liability disclosure would be
necessary. If Eagle has not done this, there is a risk
over the completeness of any provisions or
contingent liabilities.
The financial controller has been dismissed and his The team should remain alert throughout the audit
tasks have been allocated between the finance for additional errors within the finance
department team, this has increased their workload. department.
This increases the inherent and control risk within

Eagle as errors may have been made within the In addition, discuss with the finance director
accounting records by the overworked finance team whether he will be able to provide the team with
members and there is no one working in a assistance for any audit issues as there is no
supervisory capacity financial controller available.
The purchase ledger supervisor left in August and The audit team should increase their testing on
no reconciliations of supplier statements and trade payables at the year end, with a particular
purchase ledger control account have been focus on completeness of payables. A detailed
performed. There is an increased risk of errors review of the year-end purchase ledger control
within trade payables and the year-end payable may account reconciliation should be performed with a
be under or overstated. focus on any unusual reconciling items.
Preliminary analytical review of the draft statement Update the analytical review with the full year
of profit or loss has identified a significant fall in
results and if significant fluctuations on prior year
administration expenses. remain, discuss these with management. Obtain
supporting evidence to verify management
Administration expenses tend to be fixed costs and explanations.
hence would be unlikely to fluctuate significantly
with changes in sales volumes. Hence there is a risk
that administration expenses are understated
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Summary Notes by SK
ACCA F8 September 2016 (12 marks)
Question 18
You are an audit supervisor of Chania & Co and are planning the audit of your client, Sitia Sparkle Co
which manufactures cleaning products. Its year end was 31 July 20X6 and the draft profit before tax is
$33·6 million. You are supervising a large audit team for the first time and will have specific responsibility
for supervising and reviewing the work of the audit assistants in your team.
Sitia Sparkle Co purchases most of its raw materials from suppliers in Africa and these goods are shipped
directly to the company’s warehouse and the goods are usually in transit for up to three weeks. The
company has incurred $1·3 million of expenditure on developing a new range of cleaning products which
are due to be launched into the market place in November 20X6. In September 20X5, Sitia Sparkle Co
also invested $0·9 million in a complex piece of plant and machinery as part of the development process.
The full amount has been capitalised and this cost includes the purchase price, installation costs and
training costs.
This year, the bonus scheme for senior management and directors has been changed so that rather than
focusing on profits, it is instead based on the value of year-end total assets. In previous years an allowance
for receivables, made up of specific balances, which equaled almost 1% of trade receivables was
maintained. However, the finance director feels that this is excessive and unnecessary and has therefore
not included it for 20X6 and has credited the opening balance to the profit or loss account.
A new general ledger system was introduced in May 20X6; the finance director has stated that the data
was transferred and the old and new systems were run in parallel until the end of August 20X6. As a result
of the additional workload on the finance team, a number of control account reconciliations were not
completed as at 31 July 20X6, including the bank reconciliation. The finance director is comfortable with
this as these reconciliations were completed successfully for both June and August 20X6. In addition, the
year-end close down of the purchase ledger was undertaken on 8 August 20X6.
Required:
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of
Sitia Sparkle Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.
(12 marks)
Answer:
(b) Audit risk and auditors responses

Audit risk Auditor’s response
Sitia Sparkle Co purchases their goods from The audit team should undertake detailed cut-off
suppliers in Africa and the goods are in transit testing of purchases of goods at the year end and
for up to three weeks. At the year end, there is a the sample of GRNs from before and after the year
risk that the cut-off of inventory, purchases and end relating to goods from suppliers in Africa
payables may not be accurate and may be should be increased to ensure that cut-off is
under/overstated complete and accurate.
Sitia Sparkle Co has incurred expenditure of Obtain a breakdown of the expenditure and verify
$1·3 million in developing a new range of that it relates to the development of the new
cleaning products. This expenditure is classed as products. Undertake testing to determine whether
research and development under IAS 38 the costs relate to the research or development

Summary Notes by SK
Intangible Assets. The standard requires research stage. Discuss the accounting treatment with the
costs to be expensed to profit or loss and finance director and ensure it is in accordance with
development costs to be capitalised as an IAS 38.
intangible asset.
If the company has incorrectly classified
research costs as development expenditure, there
is a risk the intangible asset could be overstated
and expenses understated. In addition, as the
senior management bonus is based on year-end
asset values, this increases this risk further as
management may have a reason to overstate
assets at the year end.
In September 20X5, the company invested $0·9 Obtain a breakdown of the $0·9 million
million in a complex piece of plant and expenditure and undertake testing to confirm the
machinery. The costs include purchase price, level of training costs which have been included
installation and training costs. As per IAS 16 within non-current assets. Discuss the accounting
Property, Plant and Equipment, the cost of an treatment with the finance director and the level of
asset incudes its purchase price and directly any necessary adjustment to ensure treatment is in
attributable costs only. accordance with IAS 16.
Training costs are not permitted under IAS 16 to

be capitalised as part of the cost and therefore
plant and machinery and profits are overstated.
The bonus scheme for senior management and Throughout the audit, the team will need to be
directors of Sitia Sparkle Co has been changed; it alert to this risk and maintain professional
is now based on the value of year-end total scepticism.
assets.
Detailed review and testing on judgemental
There is a risk that management might be decisions, including treatment of provisions, and
motivated to overstate the value of assets compare treatment against prior years. Any
through the judgements taken or through the use manual journal adjustments affecting assets should
of releasing provisions or capitalisation policy be tested in detail.
In addition, a written representation should be

obtained from management confirming the basis
of any significant judgements.
The finance director of Sitia Sparkle Co believes Review and test the controls surrounding how
that an allowance for receivables is excessive Sitia Sparkle Co identifies receivables balances
and unnecessary and therefore has not provided which may require a provision to ensure that they
for it at the year end and has credited the are operating effectively in the current year.
opening balance to profit or loss.
There is a risk that receivables will be Discuss with the finance director the rationale for
overvalued; some balances may be irrecoverable not maintaining an allowance for receivables and
and so will be overstated if not provided for. releasing the opening provision.
In addition, releasing the allowance for Extended post year-end cash receipts testing and a
receivables will increase asset values and hence review of the aged receivables ledger to be
the senior management bonus which increases performed to assess valuation and the need for an
the risk further. allowance for receivables.
A new general ledger system was introduced in The auditor should undertake detailed testing to

Summary Notes by SK
May 20X6 and the old and new systems were confirm that all of the balances at the transfer date
run in parallel until August 20X6. have been correctly recorded in the new general
ledger system.
There is a risk of the balances in May being The auditor should document and test the new
misstated and loss of data if they have not been system. They should review any management
transferred from the old system completely and reports run comparing the old and new system
accurately. If this is not done, this could result in during the parallel run to identify any issues with
the auditor not identifying a significant control the processing of accounting information.
risk.
In addition, the new general ledger system will
require documenting and the controls over this
will need to be tested.
A number of reconciliations, including the bank Discuss this issue with the finance director and
reconciliation, were not performed at the year request that the July control account
end, however, they were undertaken in June and reconciliations are undertaken. All reconciling
August. items should be tested in detail and agreed to
supporting documentation.
Control account reconciliations provide comfort
that accounting records are being maintained
completely and accurately. At the year end, it is
important to confirm that balances including
bank balances are not under or overstated. This
is an example of a control procedure being
overridden by management and raises concerns
over the overall emphasis placed on internal
control.
The purchase ledger of Sitia Sparkle Co was The audit team should undertake testing of
closed down on 8 August, rather than at the year transactions posted to the purchase ledger between
end 31 July. 1 and 8 August to identify whether any
There is a risk that the cut-off may be incorrect transactions relating to the 20X7 year end have
with purchases and payables over or been included or any 20X6 balances removed.
understated.
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ACCA F8 September / December 2017 (14 marks)
Question 17 (c)
You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer Construction
Co, for the year ending 30 September 20X7. The company specializes in property construction and
providing ongoing annual maintenance services for properties previously constructed. Forecast profit
before tax is $13·8m and total assets are expected to be $22·3m, both of which are higher than for the year
ended 30 September 20X6.
You are required to produce the audit strategy document. The audit manager has met with Prancer
Construction Co’s finance director and has provided you with the following notes, a copy of the August
management accounts and the prior year financial statements.
Meeting notes
The prior year financial statements recognize work in progress of $1·8m, which was comprised of property
construction in progress as well as ongoing maintenance services for finished properties. The August 20X7

Summary Notes by SK
management accounts recognize $2·1m inventory of completed properties compared to a balance of $1·4m
in September 20X6. A full year-end inventory count will be undertaken on 30 September at all of the 11
building sites where construction is in progress. There is not sufficient audit team resource to attend all
inventory counts.
In line with industry practice, Prancer Construction Co offers its customers a five-year building warranty,
which covers any construction defects. Customers are not required to pay any additional fees to obtain
the warranty. The finance director anticipates this provision will be lower than last year as the company
has improved its building practices and therefore the quality of the finished properties.
Customers who wish to purchase a property are required to place an order and pay a 5% non-refundable
deposit prior to the completion of the building. When the building is complete, customers pay a further
92·5%, with the final 2·5% due to be paid six months later. The finance director has informed you that
although an allowance for receivables has historically been maintained, it is anticipated that this can be
significantly reduced.
Information from management accounts

Prancer Construction Co’s prior year financial statements and August 20X7 management accounts
contain a material overdraft balance. The finance director has confirmed that there are minimum profit
and net assets covenants attached to the overdraft.
A review of the management accounts shows the payables period was 56 days for August 20X7,
compared to 87 days for September 20X6. The finance director anticipates that the September 20X7
payables days will be even lower than those in August 20X7.
Required:
c. Using all the information provided describe SEVEN audit risks, and explain the auditor’s
response to each risk, in planning the audit of Prancer Construction Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively.
(14 marks)
Answer:
Audit Risk & Audit responses
Audit Risk Audit responses
Prancer Construction Co is a new client for Cupid & Co should ensure they have a suitably
Cupid & Co. As the team is not familiar with the experienced team. In addition, adequate time should
accounting policies, transactions and balances of be allocated for team members to obtain an
the company, there will be an increased detection understanding of the company and the risks of
risk on the audit. material misstatement including a detailed team
briefing to cover the key areas of risk.
Prancer Construction Co is likely to have a material The auditor should discuss with management the
level of work in progress at the year end, being process they will undertake to assess the percentage
construction work in progress as well as ongoing completion (or work in progress at the year end.
maintenance services, as Prancer Construction Co This process should be reviewed by the auditor while
has annual contracts for many of the buildings attending the year-end inventory counts.
constructed.
The level of work in progress will need to be assessed In addition, consideration should be given as to whether
at the year end. Assessing the percentage completion an independent expert is required to value the work in

Summary Notes by SK
for partially constructed buildings is likely to be progress or if a management expert has been used. If the
quite subjective, and the team should consider if they work of an expert is to be used, then the audit team will
have the required expertise to undertake this. If the need to assess the competence, capabilities and
percentage completion is not correctly calculated, objectivity of the expert.
the inventory valuation may be under or overstated.
The August 20X7 management accounts contain Detailed cost and net realisable value (NRV) testing to be
$2.1 million of completed properties; this balance performed at the year end and the aged inventory
was $1.4 million in September 20X6. report to be reviewed to assess whether inventory
The increase in inventory may be due to an requires to be written down.
increased level of pre year-end orders. Alternatively, it
may be that Prancer Construction Co is struggling to
sell completed properties, which may indicate that
they are overvalued. IAS 2 Inventories requires that
inventory should be stated at the lower of cost and
NRV.
At the year end there will be inventory counts The auditor should assess for which of the building
undertaken at all 11 of the building sites in progress. sites they will attend the counts. This will be those
with the most material inventory or which according
It is unlikely that the auditor will be able to attend all to management have the most significant risk of
of these inventory counts, increasing detection risk, misstatement.
and therefore they need to ensure that they obtain
sufficient evidence over the inventory counting For those not visited, the auditor will need to review
controls and completeness and existence of the level of expectations noted during the count and
inventory for any sites not visited. discuss with management have the most significant
risk of misstatement.
Prancer Construction Co offers its customers a Discuss with management the basis of the provision
building warranty of five years, which covers any calculation, and compare this to the level of post
construction defects. A warranty provision will be year-end claims, if any, made by customers. In
required under IAS 37 Provisions, Contingent particular, discuss the rationale behind reducing the
Liabilities and Contingent Assets. Calculating level of provision this year.
warranty provisions requires judgement as it is an
uncertain amount. Compare the prior year provision with the actual
level of claims in the year, to assess the
The finance director anticipates this provision will reasonableness of the judgements made by
be lower than last year as the company has management
improved its building practices and the quality of
its finished properties. However, there is a risk that
this provision could be understated, especially in
light of the overdraft covenant relating to a
minimum level of net assets and is being used as a
mechanism to manipulate profit and asset levels.
Customers who wish to purchase a property are Discuss with management the treatment of deposits
required to place an order and a 5% non- received in advance, to ensure it is appropriate.
refundable deposit prior to the completion of the
building. During the final audit, undertake increased testing
over the cut-off of revenue and completeness of
These deposits should not be recognised as deferred income
revenue in the statement of profit or loss until the

Summary Notes by SK
performance obligations as per the contracts have
been satisfied, which is likely to be when the
building is finished and the sale process is
complete. Instead, they should be recognised as
deferred income within current liabilities.
Management may have incorrectly treated the

deferred income as revenue, resulting in overstated
revenue and understated liabilities.
An allowance for receivables has historically been Review and test the controls surrounding how the
maintained, but it is anticipated that this will be finance director identifies old or potentially
reduced. irrecoverable receivables balances and credit
control to ensure that they are operating effectively.
There is a risk that receivables will be overvalued;
some balances may not be recoverable and so will Discuss with the director the rationale for reducing
be overstated if not provided for. the allowance for receivables.
In addition, reducing the allowance for receivables Extended post year-end cash receipts testing and a
will increase asset values and would improve the review of the aged receivables ledger to be
covenant compliance, which increases the performed to assess valuation and the need for an
manipulation risk further. allowance for receivables.
Prancer Construction Co has a material overdraft Review the covenant calculations prepared by the
which has minimum profit and net assets company at the year end and identify whether any
covenants attached to it. If these covenants were to defaults have occurred; if so, determine the effect
be breached, the overdraft balance would become on the company.
instantly repayable.
The team should maintain their professional
If the company does not have sufficient cash to scepticism and be alert to the risk that profit and/or
meet this repayment, then there could be going net assets have been overstated to ensure
concern implications. compliance with the covenants.
In addition, there is a risk of manipulation of profit
and net assets to ensure that covenants are met.
Preliminary analytical review of the August The audit team should increase their testing on
management accounts shows payable days of 56 trade payables at the year end, with a particular
for August 20X7, compared to 87 days for focus on completeness of payables. A payables
September 20X6. It is anticipated that the year-end circularisation or review of supplier statement
payable days will be even lower. reconciliations should be undertaken.
The forecast profit is higher than last year,

indicating an increase in trade, also the company’s
cash position has continued to deteriorate and
therefore, it is unusual for payable days to have
decreased.
There is an increased risk of errors within trade
payables and the year-end payables may be
understated.

Summary Notes by SK
Question 17 (b)
You are an audit supervisor of Daffodil & Co and are planning the audit of Peony Co for the year ending
31 May 20X9. The company is a food retailer with a large network of stores across the country and four
warehouses. The company has been a client of your firm for several years and the forecast profit before
tax is $28·9m. The audit manager has
attended a planning meeting with the finance director and has provided you with the following notes of
the meeting.
Planning meeting notes

Peony Co has an internal audit (IA) department which undertakes controls testing across the network of
stores. Each store is visited at least once every 18 months. The audit manager has discussed with the
finance director that the external audit team may rely on the controls testing which is undertaken by IA.
During the meeting, the finance director provided some forecast financial information.
During the meeting, the finance director provided some forecast financial information. Revenue for the
year is expected to increase by 3% as compared to 20X8; the gross margin is expected to increase from
56% to 60%; and the operating margin is predicted to decrease from 21% to 18%.
Peony Co values inventory in line with industry practice, which is to use selling price less average profit
margin. The directors consider this to be a close approximation to cost.
The company does not undertake a full year-end inventory count and instead undertakes monthly
perpetual inventory counts, each of which covers one-twelfth of all lines in stores and the warehouses. As
part of the interim audit which
was completed in January, an audit junior attended a perpetual inventory count at one of the warehouses
and noted that there were a large number of exceptions where the inventory records showed a higher
quantity than the physical inventory which was present in the warehouse. When discussing these
exceptions with the financial controller, the audit junior was informed that this had been a recurring
issue.
During the year, IA performed a review of the non-current assets physically present in around one-third
of the company’s stores. A number of assets which had not been fully depreciated were identified as
obsolete by this review
The company launched a significant TV advertising campaign in January 20X9 in order to increase
revenue. The directors have indicated that at the year end a current asset of $0·7m will be recognised, as
they believe that the advertisements will help to boost future sales in the next 12 months. The last
advertisement will be shown on TV in early May 20X9.
Peony Co decided to outsource its payroll function to an external service organisation. This service
organisation handles all elements of the payroll cycle and sends monthly reports to Peony Co which
detail wages and salaries and statutory obligations. Peony Co maintained its own payroll records until 31
December 20X8, at which point the records were transferred to the service organisation.
Peony Co is planning to expand the company by opening three new stores during July 20X9 and in order
to finance this, in March 20X9 the company obtained a $3m bank loan. This is repayable in arrears over
five years in quarterly instalments. In preparation for the expansion, the company is looking to streamline

Summary Notes by SK
operations in the warehouses and is planning to make approximately 60 employees redundant after the
year end. No decision has been made as to when this will be announced, but it is likely to be in May 20X9.
Answer:
Audit risk Auditor’s response
The external audit team may place reliance on the The external audit team should meet with IA staff,
controls testing work undertaken by the IA read their reports and review their files relating to
department. store visits to ascertain the nature of the work
undertaken.
If reliance is placed on irrelevant or poorly
performed testing, then the external audit team may Before using the work of IA, the audit team will
form an incorrect conclusion on the strength of the need to evaluate and perform audit procedures on
internal controls at Peony Co. This could result in the entirety of the work which they plan to use, in
them performing insufficient levels of substantive order to determine its adequacy for the purposes of
testing, thereby increasing detection risk. the audit. In addition, the team will need to re-
perform some of the testing carried out by IA to
assess its adequacy.
Forecast ratios from the finance director show that The classification of costs between cost of sales
the gross margin is expected to increase from 56% and operating expenses should be reviewed in
to 60% and the operating margin is expected to comparison to the prior year and any
decrease from 21% to 18%. inconsistencies investigated.
This movement in gross margin is significant and

inconsistent with the fall in operating margin. There
is a risk that costs may have been omitted or
included in operating expenses rather than cost of
sales. Misclassification of expenses would result in
understatement of cost of sales and overstatement
of operating expenses.
Peony Co's inventory valuation policy is selling Testing should be undertaken to confirm cost and
price less average profit margin, as this is industry NRV of inventory and that on a line-by-line basis
practice. Inventory should be valued at the lower of the goods are valued correctly.
cost and net realisable value (NRV).
In addition, valuation testing should focus on
IAS 2 Inventories allows this as a cost calculation comparing the cost of inventory to the selling price
method as long as it is a close approximation to less margin for a
cost. If this is not the case, then inventory could be sample of items to confirm whether this method is
under or overvalued. actually a close approximation to cost.
The company utilises a perpetual inventory system The timetable of the perpetual inventory counts
at its warehouse rather than a full year-end count. should be reviewed and the controls over the
Under such a system, all inventory must be counted counts and adjustments to records should be
at least once a year with adjustments made to the tested.
inventory records on a timely basis. Inventory could
be under or overstated if the perpetual inventory In addition, the level of adjustments made to
counts are not all completed, such that some inventory should be considered to assess their
inventory lines are not counted in the year. significance. This should be discussed with
management as soon as possible as it may not be
possible to place reliance on the inventory records

Summary Notes by SK
During the interim audit, it was noted that there at the year end, which could result in the
were significant exceptions with the inventory requirement for a full year-end inventory count.
records being higher than the inventory in the
warehouse. As the year-end quantities will be based
on the records, this is likely to result in overstated
inventory.
A number of assets which had not been fully Discuss the depreciation policy for non-current
depreciated were identified as being obsolete. assets with the finance director and assess its
reasonableness. Enquire of the finance director if
This is an indication that the company's the obsolete assets have been written off. If so,
depreciation policy of non-current assets may not review the adjustment for completeness.
be appropriate, as depreciation in the past appears
to have been understated
Peony Co is planning to include a current asset of $ Discuss with management the rationale for
7.0 m, which relates to advertising costs incurred including the advertising as a current asset.
and adverts shown on TV before the year end. Request evidence to support the assessment of
probable future cash flows, and review for
The costs were incurred and adverts shown in the reasonableness.
year ending 20X9 and there is no basis for including
them as a current asset at the year end. The costs Review supporting documentation for the
should be recognised in operating expenses in the advertisements to confirm that all were shown
current year financial statements. before the 20X9 year end.
If these costs are not expensed, current assets and Request that management remove the current
profits will be overstated. asset and record the amount as an expense in the
statement of profit or loss.
During the year, Peony Co outsourced its payroll Discuss with management the extent of records
function to an external service organisation. A maintained at Peony Co for the period since
detection risk arises as to whether sufficient and January 20X9 and any monitoring of controls
appropriate evidence is available at Peony Co to which has been undertaken by management over
confirm the completeness and accuracy of controls payroll.
over the payroll cycle and liabilities at the year end.
Consideration should be given to contacting the
service organisation's auditor to confirm the level
of controls in place, a type 1 or type 2 report could
be requested.
The payroll function was transferred to the service Discuss with management the transfer process
organisation from 1 January 20X9, which is five undertaken and any controls which were put in
months prior to the year end. If any errors occurred place to ensure the completeness and accuracy of
during the transfer process, these could result in the data.
wages and salaries being under/overstated.
Where possible, undertake tests of controls to
confirm the effectiveness of the transfer controls.
In addition, perform substantive testing on the
transfer of information from the old to the new
system.
A $3m loan was obtained in March 20X9. This Re-perform the company's calculations to confirm
finance needs to be accounted for correctly, with that the split of the loan note is correct between

Summary Notes by SK
adequate disclosure made. The loan needs to be non-current and current liabilities and that total
allocated between non-current and current financing proceeds of $3m were received.
liabilities. Failure to classify the loan correctly
could result in misclassified liabilities In addition, the disclosures for this loan note
should be reviewed in detail to ensure compliance
with relevant accounting standards.
Peony Co is planning to make approximately 60 Discuss with management the status of the
employees redundant after the year end. redundancy announcement; if before the year end,
review supporting documentation to confirm the
The timing of this announcement has not been timing. In addition, review the
confirmed; if it is announced to the staff before the basis of and recalculate the redundancy provision.
year end, then under IAS 37 Provisions, Contingent
liabilities and Contingent Assets, a redundancy
provision will be required at the year end as a
constructive obligation will have been created.
Failure to provide or to provide an appropriate
amount will result in an understatement of
provisions and expenses.
--------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
‘Audit Risk plus Accounting Ratios’

Summary Notes by SK
Audit Risk plus Accounting Ratios
This explanation is for the questions where audit risks is examined along with an extract of P&L and B/S
(in this case key accounting ratios are calculated and audit risk is explained from the same along with
other information given in the question)
1.Debtors / Receivables
Average debtors
Debtors Turn Over = * 365
Credit sales
Comment:
If debtor’s turn over in days has increased as compared to last year and no adequate provision for doubtful
debts has been made than there is a risk that company will be recording debtors that are not recoverable
i.e. There is a risk that debtors have been overvalued in the F/S.
(or say increased Risk of Recoverability of receivables)
(Also refer to the information given in the question e.g. management has increased the credit terms for
their customers…this information will NOW be linked with the debtors turn over in days calculated from
the question)
2.Inventory / Closing stock
Average F goods
Inventory Turn Over = * 365
Cost of goods sold
Comment:
If inventory turnover in days has increased as compared to last year than there is a risk that stock is
becoming obsolete or out of fashion/ or slow moving ….leading to the risk that its NRV will be lower than
its cost & if not valued as per IAS 2 correctly, than closing stock will be overvalued in the F/S
(Also refer to the information given in the question e.g. Closing stock has increased as compared to last
year…this information will NOW be linked with the inventory turnover in days calculated from the
question)
3.Interest Cover
P.B.I.T (in times)
Interest cover =
interest charges
Comment:
If bank covenant is breached & penalty is imposed by the bank than there is a Risk of penalty not being
recorded in the F/S leading to risk of profit being overstated and in the case of contingent liability
(lawsuit filed by the bank) there is a risk of incorrect/inadequate or no disclosure in the F/S.
4.Cash flow + Liquidity risks
Current assets Quick assets

Inventory Turn Over = Current Liabilities & Quick Ratio =
Current Labilities

Summary Notes by SK
FIRST calculate current and quick ratio for both years, in case these ratios have gone negative or declined
as compared to last year THAN also compare the cash and bank balance from last year, incase this balance
has gone down (decreased from last year) or converted into bank O.D balance PLUS….also
…Calculate creditors turn over in days and if number of days have increased as compared to last year i.e
increased from 60 to 80 days, this further indicates that company is facing cashflow problems and is not
able to pay its creditors on a timely basis / due dates.
NOTE:
In case sales, gross profit and operating margin has also declined as compared to last year than this
decline can also be added here as point to refer to cashflow and liquidity problems.
HOW TO DRAFT AUDIT RISK POINT

Negative or declined liquidity ratios along with negative or declined cash & bank balance plus increased
creditors turn over in days indicates cash flow and potential liquidity problems for the company leading to
the risk of Going concern difficulties for the company. (i.e. Going concern assumption might now NOT be
valid or appropriate)
NOTE: (Also refer to any further information given in the scenario / question)
5.Sales / Revenue and Cost of Sales comparison

Compare Revenue and cost of sales of both years and then comment
If revenue has increased by large % and cost of sales has decreased or increased by a lower percentage
…than there is a Risk that revenue has been overstated or cost of sales has been understated in the F/S.
6.Gross Profit margin and Operating margin
Compare gross profit margin and operating margin for both years and then comment
If GP margin has increased by large % and operating margin has decreased as compared to last year or
O.M margin has increased by a lower percentage …there is a Risk that cost of sales has been understated
and admin expenses have been overstated or there is a risk of reclassification of expenses btw cost of
sales and admin expenses / operating expenses. understated.
7.Creditors turnover
(Creditors / Trade Payables )
Creditors Turn Over = *365
Comment:
If creditors number of days has decreased as compared to last year and in comparison, sales has increased
in the current year as compared to last year than there is a risk that creditors / trade payables have been
undervalued in the F/S.

Summary Notes by SK
ACCA F8 & CA CAF 8 Practice Questions

on Audit Risk & Ratio

ACCA
1 Q3 c Dec 2010 (covered with Audit Risk & Ratio) 15 marks
3 Q.5 a June 2012 3 marks
4 Q.3 b June 2013 15 marks
5 Q.5c Sept/ Dec 2015 3 marks
6 Q.16 Sept/ Dec 2018 3+ 3+ 16 marks
ICAP
8 Q.6a March 2009 18 marks

Summary Notes by SK
Question 3c
You are the audit senior of White & Co and are planning the audit of Redsmith Co for the year
ended 30 September 2010. The company produces printers and has been a client of your firm for two years;
your audit manager has already had a planning meeting with the finance director. He has provided you
with the following notes of his meeting and financial statement extracts.
Redsmith’s management were disappointed with the 2009 results and so in 2010 undertook a number of
strategies to improve the trading results. This included the introduction of a generous sales-related bonus
scheme for their salesmen and a high profile advertising campaign. In addition, as market conditions are
difficult for their customers, they have extended the credit period given to them.
The finance director of Redsmith has reviewed the inventory valuation policy and has included additional
overheads incurred this year as he considers them to be production related. He is happy with the 2010
results and feels that they are a good reflection of the improved trading levels.
Financial statement extracts for year ended 30 September
DRAFT ACTUAL
2010 2009
$m $m
Revenue 23.0 18.0
Cost of Sales (11.0) (10.0)
Gross profit 12.0 8.0
Operating expenses (7.5) (4.0)
Profit before interest and taxation 4.5 4.0
Inventory 2.1 1.6
Receivables 4.5 3.0
Cash — 2.3
Trade payables 1.6 1.2
Overdraft 0.9
Required:
Using the information above:
i. Calculate FIVE ratios, for BOTH years, which would assist the audit senior in planning the audit; and
(5 marks)
ii. From a review of the above information and the ratios calculated, explain the audit risks that arise and
describe the appropriate response to these risks. (10 marks)

Summary Notes by SK
Answer 3c:
Five ratios for 2010 and 2009 to assist in planning
Ratio 2010 2009
Gross margin (gross profit/revenue x 100%) 52.2% 44.4%
Operating margin (PBIT/revenue x 100%) 19.6% 22.2%
Inventory days ([inventory/COS] x365) 70 days 58 days
Receivable days ([receivables/revenue] x 365) 71 days 61 days
Current ratio (Current assets/current liabilities) 2.6 5.8
Top tips: Other ratios you may have used include payable days (53 in 2010, 44 in 2009), the quick ratio (1.8
in 2010, 4.4 in 2009), inventory turnover (5.2 in 2010, 6.3 in 2009) and
operating expenses as a percentage of revenue (33% in 2010, 22% in 2009).
i. Audit risks and responses

Audit risks Responses
Redsmith's management may be biased in financial The audit team must be alert to the increased risk
statement areas involving judgement because 2009 of bias and focus on financial statement estimates
results were disappointing. They may use that require management to exercise judgement.
accounting estimates to artificially improve Careful review must be undertaken of any such
presented results. area.
The introduction of a sales related bonus. scheme Increase the sample sizes for any substantive sales
may incentivise employees to push post year-end cut off testing and extend the time period from
sales back into the current year, overstating which the sample is selected.
revenue for 2010.
Receivables balances may not be recoverable given A review of aged receivable balances should be
that receivable days have increased by 10 days and carried out and there will be an increased focus on
credit periods for recoverability through extended post
customers have increased. year end cash receipts testing.
The current ratio decreases by 55%, lack of cash (an Increased emphasis on a detailed going concern
overdraft in 2010) and sales increase indicates review. Discussions with management as to the
potential liquidity problems due to overtrading, ability of Redsmith to continue as a going concern
which could impact on the company's ability to and careful attention paid to the post year end
continue as a going concern. period.
Inventory could be overvalued as a result of the new Review the inventory calculations to identify the
policy to include more overheads in inventory. This overheads included and ensure they are valid
is consistent with the 10 day increase in inventory production overheads. Discuss the reasons for
days. including them with the finance
director.
Top tips: Five well explained risks and responses would have been sufficient here, bit you may have
also come up with the following:
Costs of sales may have been omitted or Cost of sales and operating expenses to be
incorrectly included as operating expenses. This compared to prior year and expectations on a line
may be the reason for gross margin increasing by by line basis to identify any instances of change in
7.8% but operating margin classification of expenses.
decreasing by 2.6%.
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Summary Notes by SK
Question 79
a. With reference to ISA 520 Analytical Procedures and ISA 315 Identifying and assessing the risks of material
misstatement through understanding the entity and its environment explain
i. what is meant by the term ‘analytical procedures’; (2 marks)
ii. the different types of analytical procedures available to the auditor; and (3 marks)
iii. the situations in the audit when analytical procedures can be used. (3 marks)
Zak Co sells garden sheds and furniture from 15 retail outlets. Sales are made to individuals, with income
being in the form of cash and debit cards. All items purchased are delivered to the customer using Zak’s own
delivery vans; most sheds are too big for individuals to transport in their own motor vehicles. The directors
of Zak indicate that the company has had a difficult year, but are pleased to present some acceptable
results to the members.
The statements of profit or loss for the last two financial years are shown below:
Statement of profit or loss

31 march 31march
2008 2007
Income statement $’000 $’000
revenue 7,482 6364
cost of sales (3,520) (4,253)
Gross Profit 3,962 2,111
Operating expenses (1235) (1320)
Administration (981) (689)
Selling and distribution (101) (105)
Interest payable 145
Investment income 1790 (3)
Profit / (loss) before tax
Financial statement extract 253 (950)
Cash and bank
Required:
a. As part of your risk assessment procedures for Zak Co, identify and provide a possible explanation for
unusual changes in the statement of profit or loss. (9 marks)
Confirmation of the end of year bank balances is an important audit procedure.
Answer 79:
a. Analytical procedures
i. Analytical procedures consist of the analysis of significant ratios and trends including the resulting
investigations of fluctuations and relationships that are inconsistent with other relevant information
or which deviate from predictable amounts.

Summary Notes by SK
ii. Types of analytical procedures
 The consideration of comparisons with similar information for prior periods, anticipated results of the
client from budgets or forecasts, predictions prepared by the auditor, and industry information
 Analytical procedures between elements of financial information that are expected to conform to a
predicted pattern based on the client’s experience, such as the relationship of gross profit to sales
 Analytical procedures between financial information and relevant non-financial information, such as
the relationship of payroll costs to the number of employees.
iii. Use of analytical procedures
Analytical procedures can be used at all stages of the audit, and must be used at:
 The planning stage in accordance with ISA 315 identifying and assessing the risks of material misstatement
through understanding the entity and its environment and;
 The final review stage in accordance with ISA 520 Analytical procedures.
During the audit planning stage, analytical procedures are used as a risk assessment procedure to obtain an
understanding of the entity and its environment and to help determine the nature, timing and extent of
audit procedures.
Analytical procedures can be used as substantive audit procedures during audit fieldwork when their use
can be more effective or efficient than tests of details in reducing the risk of material misstatement at the
assertion level to an acceptably low level.
Analytical procedures must be used at the final review stage of the audit where they assist the auditor in
forming an overall conclusion as to whether the accounts are consistent with his understanding of the entity
Zak Co
Revenue
Although the directors have indicated that the company has had a difficult year, revenue has increased
from the previous year by 18%. The auditors need to establish the reason for this increase as it does not
correlate with the directors’ comments.
Cost of sales
Cost of sales has fallen by 17% in comparison to the previous year- this is strange given that revenue has
increased, as one would expect cost of sales to similarly increase. The reason for this decrease needs to be
ascertained. It could be as a result of closing inventory being undervalued.
Gross profit
Gross profit has increased dramatically by 88% in comparison to the previous year. The reason for this
needs to be examined, given that revenue has increased but cost of sales has decreased.
Administration costs
Administration costs have fallen slightly by 6%. This appears unusual given that revenue has increased
from the previous year, as one would expect the increased revenue to lead to increased administration
costs. Expenditure in this area may be understated perhaps as a result of incorrect cut-off being applied.

Summary Notes by SK
Selling and distribution costs
Selling and distribution costs have increased significantly by 42%. An increase is expected given that
revenue has also increased, however the increase is not comparable. There may have been a misallocation
between administration and selling and distribution costs – again this will need to be investigated
thoroughly.
Interest payable
It is surprising that Zak has a reasonable cash surplus this year but still continues to pay a similar level of
interest. The interest payable may be overstated and the reasons for interest payments not decreasing
despite the absence of the large overdrawn balance seen last year must be established. One explanation for
this might be a cash injection immediately prior to the year end.

Question 5a
Explain the three stages of an audit when analytical procedures can be used by the audit.
Answer 5 a:
Analytical procedures
Analytical procedures can be used at all stages of an audit; however, ISA 315 Identifying and assessing the risks of
material misstatement through understanding the entity and its environment and ISA 520 Analytical procedures identify
three particular stages.
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.
Substantive procedures can either be tests of detail or substantive analytical procedures.
At the final review stage, the auditor must design and perform analytical procedures that assist him when
forming an overall conclusion as to whether the financial statements are consistent with the auditor’s
understanding of the entity.
--------------------------------------------------------------------------------------------
Question 3b
You are the audit senior of Rhino & Co and you are planning the audit of Kangaroo Construction Co
(Kangaroo) for the year ended 31 March 2013. Kangaroo specializes in building houses and provides a
five-year building warranty to its customers. Your audit manager has held a planning meeting with the
finance director. He has provided you with the following notes of his meeting and financial statement
extracts:
Kangaroo has had a difficult year; house prices have fallen and, as a result, revenue has dropped. In order
to address this, management has offered significantly extended credit terms to their customers. However,
demand has fallen such that there are still some completed houses in inventory where the selling price may
be below cost. During the year, whilst calculating depreciation, the directors extended the useful lives of
plant and machinery from three years to five years. This reduced the annual depreciation charge.

Summary Notes by SK
The directors need to meet a target profit before interest and taxation of $0•5 million in order to be paid
their annual bonus. In addition, to try and improve profits, Kangaroo changed their main material
supplier to a cheaper alternative. This has resulted in some customers claiming on their building
warranties for extensive repairs. To help with operating cash flow, the directors borrowed $1 million from
the bank during the year. This is due for repayment at the end of 2013.
Financial statement extracts for year ended 31 March

DRAFT DRAFT
2013 2012
$m $m
Revenue 12.5 15.0
Cost of sales (7.0) (8.0)
_____ _____
Gross profit 5.5 7.0

Operating expenses (5.0) (5.1)
_____ _____
Profit before interest and taxation 0.5 1.9

_____ _____
Inventory 1.9 1.4

Receivables 3.1 2.0
Cash 0.8 1.9
Trade payables 1.6 1.2
Loan 1.0 _____
Required:
Using the information above:
i. Calculate FIVE ratios, for BOTH years, which would assist the audit senior in planning the audit;
and (5 marks)
ii. Using the information provided and the ratios calculated, identify and describe FIVE audit risks
and explain the auditor’s response to each risk in planning the audit of Kangaroo Construction
Co. (10 marks)

Summary Notes by SK
Answer 3b:
iii..Ratios
Ratios to assist the audit supervisor in planning the audit:
2013 2012
gross margin 5.5/12.5 = 44% 7/15 = 46.7%
operating margin 0·5/12·5 = 4% 1·9/15 = 12·7%
inventory days 1·9/7 * 365 = 99 days 1·4/8 * 365 = 64 days
inventory turnover 7/1·9 = 3·7 8/1·4 = 5·7
receivable days 3·1/12·5 * 365 = 91 days 2·0/15 * 365 = 49 days
payable days 1·6/7 * 365 = 83 days 1·2/8 * 365 = 55 days
current ratio 5·8/2·6 = 2·2 5·3/1·2 = 4·4
quick ratio (5·8 – 1·9)/2·6 = 1·5 (5·3 – 1·4)/1·2 = 3·3
iii. audit risks and responses
audit risk audit response
Receivable days have increased from 49 to 91 days Extended post year-end cash receipts testing
and management has significantly extended the and a review of the aged receivables ledger to
credit terms given to customers. This leads to an be performed to assess valuation.
increased risk of recoverability of receivables as they
may be overvalued.
Due to the fall in demand for kangaroo construction Detailed cost and net realisable value testing to
co’s (kangaroo) houses, there are some houses be performed and the aged inventory report to
where the selling price may be below cost. IAS 2 be reviewed to assess whether inventory
inventories requires that inventory should be stated requires writing down.
at the lower of cost and NRV.
In addition, inventory days have increased from 64
to 99 days and inventory turnover has fallen from
5·7 in 2012 to 3·7 in the current year. There is a risk
that inventory is overvalued.
The directors have extended the useful lives of Discuss with the directors the rationale for
plant and machinery from three to five years, extending the useful lives. also, the five year
resulting in the depreciation charge reducing. life should be compared to how often these
Under IAS 16 property, plant and equipment, assets are replaced, as this provides evidence of
useful lives are to be reviewed annually, and if asset the useful life of assets.
lives have genuinely increased, then this change is
reasonable. However, there is a risk that this

Summary Notes by SK
reduction has occurred in order to achieve profit
targets. If this is the case, then plant and machinery
is overvalued and profit overstated.
The directors need to reach a profit level of $0·5 Throughout the audit, the team will need to be
million in order to receive their annual bonus. alert to this risk and maintain professional
There is a risk that they might feel under pressure scepticism. They will need to carefully review
to manipulate the results through the judgements judgemental decisions and compare treatment
taken or through the use of provisions. against prior years. In addition, a written
representation should be obtained from
management confirming the basis of any
significant judgements.
Due to a change in material supplier, the quality of Review the level of the warranty provision in
products used has deteriorated and this has led to light of the increased level of claims to confirm
customers claiming on their five-year building completeness of the provision.
warranty. If the overall number of people claiming
on the warranty is likely to increase, then the
warranty provision should possibly be higher. If the
directors have not increased the level of the
provision, then there is a risk the provision is
understated.
Kangaroo has borrowed $1·0m from the bank via a During the audit, the team would need to check
short-term loan. this loan needs to be repaid in that the $1·0m loan finance was received. In
2013and so should be disclosed as a current addition, the disclosures for this loan should be
liability. reviewed in detail to ensure compliance with
relevant accounting standards and legislation.
In addition, kangaroo may have given the bank a The loan correspondence should be reviewed to
charge over its assets as security for the loan. there ascertain whether any security has been given,
is a risk that the disclosure of any security given is and this bank should be circularised as part of
not complete. the bank confirmation process.
The current and quick ratios have decreased from Detailed going concern testing to be performed
4·4 to 2·2 and 3·3 to 1·5 respectively. In addition, during the audit and discussed with the directors
the cash balances have decreased over the year, to ensure that the going concern basis is
there is a fall in demand and kangaroo have taken reasonable. The team should discuss with the
out a short-term loan of $1 million, which needs to directors how the short-term loan of $1·0 million
be repaid in 2013. Although all ratios are above the will be repaid later in2013.
minimum levels, this is still a significant decrease
and along with the fall in both operating and gross
profit margins, as well as the significant increase in
payable days could be evidence of going concern
difficulties.
------------------------------------------------------------------------------------------

Summary Notes by SK
ACCA F8 September/ December 2015 (03 marks)
Question 5 c
You are an audit senior of Scarlet & Co and are in the process of reviewing the systems testing completed
on the payroll cycle of Bronze Industries Co (Bronze), as well as preparing the audit programmes for the
final audit.
Bronze operate several chemical processing factories across the country, it manufactures 24 hours a day,
seven days a week and employees work a standard shift of eight hours and are paid for hours worked at
an hourly rate. Factory employees are paid weekly, with approximately 80% being paid by bank transfer
and 20% in cash; the different payment methods are due to employee preferences and Bronze has no
plans to change these methods. The administration and sales teams are paid monthly by bank transfer.
Factory staff are each issued a sequentially numbered clock card which details their employee number
and name. Employees swipe their cards at the beginning and end of the eight-hour shift and this process
is not supervised. During the shift employees are entitled to a 30-minute paid break and employees do not
need to clock out to access the dining area. Clock card data links into the payroll system, which
automatically calculates gross and net pay along with any statutory deductions. The payroll supervisor
for each payment run checks on a sample basis some of these calculations to ensure the system is
operating effectively.
Bronze has a human resources department which is responsible for setting up new permanent employees
and leavers. Appointments of temporary staff are made by factory production supervisors. Occasionally
overtime is required of factory staff, usually to fill gaps caused by staff holidays. Overtime reports which
detail the amount of overtime worked are sent out quarterly by the payroll department to production
supervisors for their review.
To encourage staff to attend work on time for all shifts Bronze pays a discretionary bonus every six
months to factory staff; the production supervisors determine the amounts to be paid. This is
communicated in writing by the production supervisors to the payroll department and the bonus is input
by a clerk into the system.
For employees paid by bank transfer, the payroll manager reviews the list of the payments and agrees to
the payroll records prior to authorising the bank payment. If any changes are required, the payroll
manager amends the records. For employees paid in cash, the pay packets are prepared in the payroll
department and a clerk distributes them to employees; as she knows most of these individuals, she does
not require proof of identity.
Required:
a) Identify and explain FIVE internal control STRENGTHS in Bronze Industries Co’s payroll system.
(5 marks)
b) Identify and explain SIX internal control DEFICIENCIES in Bronze Industries Co’s payroll system and
provide a RECOMMENDATION to address each of these deficiencies.
(12 marks)
c) Describe substantive ANALYTICAL PROCEDURES you should perform to confirm Bronze Industries
Co’s payroll expense. (3 marks)

Summary Notes by SK
Answer 5:
c. Substantive analytical procedures to confirm payroll expense
 Compare the total payroll expense to the prior year and investigate any significant differences.
 Review monthly payroll charges, compare this to the prior year and budgets and discuss with
management any significant variances.
 Compare overtime pay as a percentage of factory normal hours pay to investigate whether it is at a
similar level to the prior year and within an acceptable range. Investigate any significant
differences.
 Perform a proof in total of total wages and salaries, incorporating joiners and leavers and any pay
increase.
 Compare this to the actual wages and salaries in the financial statements and investigate any
significant differences.
------------------------------------------------------------------------------------------
(Covered in Audit Risk plus Ratios Topic)
ACCA F8September/ December 2018 (3+ 3+ 16 marks)

Question 16 (a+ b+ c)
You are an audit supervisor of Earl & Co and are planning the audit of Darjeeling Co for the year ending
30 September 20X8. The company develops and manufactures specialist paint products and has been a
client of your firm for several years. The audit manager has attended a planning meeting with the finance
director and has provided you with the following notes of the meeting and financial statement extracts.
You have been asked by the audit manager to undertake preliminary analytical procedures using the
financial statement extracts.
Planning meeting notes

During the year Darjeeling Co has spent $0·9m, which is included within intangible assets, on the
development of new product lines, some of which are in the early stages of their development cycle.
Additionally, as the company is looking to expand production, during the year it purchased and installed a
new manufacturing line. All costs, incurred in the purchase and installation of that asset, have been
included within property, plant and equipment. These capitalised costs include the purchase price of
$2·2m, installation costs of $0·4m and a five-year servicing and maintenance plan costing $0·5m. In order
to finance the development projects and the new manufacturing line, the company borrowed $4m from the
bank which is to be repaid in installments over eight years and has an interest rate of 5%. Developing new
products and expanding production is important as the company intends to undertake a stock exchange
listing in the next 12 months.
The company started a number of initiatives during the year in order to boost revenue. It offered extended
credit terms to its customers on the condition that their sales order quantities were increased. In addition,
Darjeeling Co made an announcement in October 20X7 of its ‘price promise’: that it would match the
prices of any competitor for similar products purchased. Customers who are able to prove that they could
purchase the products cheaper elsewhere are asked to claim the difference from Darjeeling Co, within one
month of the date of purchase of goods, via its website. The company intends to include a refund liability
of $0·25m, which is based on the monthly level of claims to date, in the draft financial statements.

Summary Notes by SK
The finance director informed the audit manager that a problem arose in June 20X8 in relation to the
mixing of materials within the production process for one particular product line. A number of these faulty
paint products had already been sold and the issue was identified following a number of complaints from
customers about the paint consistency being incorrect. As a precaution, further sales have been stopped
and a product recall has been initiated for any of these specific paint products sold since June.
Management is investigating whether the paint consistency of the faulty products can be rectified and
subsequently sold.
Financial statement extracts for year ending 30 September.

Forecast Actual
20X8 20X7
$’000 $’000
Revenue 19,850 16,990
Cost of sales (12,440) (10,800)
Gross profit 7,410 6,190
---------- ----------
Inventory 1,850 1,330
Trade receivables 2,750 1,780
Bank (810) 560
Trade payables 1,970 1,190
Required:
a. Explain why analytical procedures are used during THREE stages of an audit. (3 marks)
b. Calculate THREE ratios, for BOTH years, which would assist you in planning the audit of
Darjeeling Co. (3 marks)
c. Using the information provided and the ratios calculated, describe EIGHT audit risks and explain
the auditor’s response to each risk in planning the audit of Darjeeling Co.
Note: Prepare your answer using two columns headed Audit risk and Auditor’s response
respectively. (16 marks)
Answer:
a. Analytical procedures
Analytical procedures can be used at all stages of an audit; however, ISA 315 identify three particular
stages.
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.
Substantive procedures can either be tests of detail or substantive analytical procedures.
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.

Summary Notes by SK
a. Ratios
Ratios to assist the audit supervisor in planning the audit:
20X8 20X7
Gross margin 7,410/19,850 = 37.3% 6,190/16,990 = 36.4%
Inventory holding period 1,850/12,440 * 365 = 54 days 1,330/10,800 * 365 = 45 days
OR
Inventory turnover 12,440/1,850 = 6.7 10,800/1,330 = 8.1
Receivables collection period 2,750/19,850 * 365 = 51 days 1,780/16,990 * 365 = 38 days
Payables payment period 1,970/12,440 * 365 = 58 days 1,190/10,800 * 365 = 40 days

Current ratio 4,600/(1,970 + 810) = 1.65 3,670/1,190 = 3.08
Quick ratio 2,750/(1,970 + 810) = 0.99 (3,670 - 1,330)/1,190 = 1.97
b. Audit risks and auditor’s response
Audit risks Auditor’s response

During the year, Darjeeling Co has spent $0·9m Obtain a breakdown of the expenditure and verify
on developing new product lines, some of which that it relates to the development of the new
are in the early stages of their development cycle. products. Review expenditure documentation to
This expenditure is classed as research and determine whether the costs relate to the research or
development under IAS® 38 development stage.
Intangible Assets. The standard requires research Discuss the accounting treatment with the finance
costs to director and ensure it
be expensed to profit or loss and only is in accordance with IAS 38.
development costs to be capitalised as an
intangible asset.
The company has included all of this expenditure

as an intangible asset. If research costs have been
incorrectly classified as development expenditure,
there is a risk that intangible assets could be
overstated and expenses understated.
Darjeeling Co purchased and installed a new Review the purchase documentation for the new
manufacturing line. The costs include purchase manufacturing line to confirm the exact cost of the
price ($2·2m), installation costs ($0·4m) and a five- servicing and that it does relate to a five-year period.
year servicing and maintenance plan ($0·5m).
Discuss the accounting treatment with the finance
As per IAS 16 Property, Plant and Equipment, the director and the level of any necessary adjustment
cost of an asset includes its purchase price and to ensure treatment is in accordance with IAS 16.
directly attributable costs only. IAS 16 does not
allow servicing and maintenance costs to be

Summary Notes by SK
capitalised as part of the cost of a non-current
asset, as they are not directly related to the cost of
bringing the asset to its working condition.
The servicing costs relate to a five-year period and

so should be charged to profit or loss over this
time. The upfront payment represents a
prepayment for five years; as the services are
received, the relevant proportion of the cost
should be charged to profit or loss. If the service
for 20X8 has been carried out, then $0·1m
($0·5m/5)
should be charged to profit or loss. Therefore
property,
plant and equipment (PPE) and profits are
overstated and prepayments are understated.
The company has borrowed $4m from the bank During the audit, the team would need to confirm
via an eight-year loan. This loan needs to be that the $4 million loan finance was received. In
correctly split between current and non-current addition, the split between current and non-current
liabilities in order to ensure correct disclosure liabilities and the disclosures for this loan should be
reviewed in detail to ensure compliance with
relevant accounting standards and local legislation.
Details of security should be agreed to the bank

confirmation letter.
As the level of debt has increased, there should be The finance costs should be recalculated and any
additional finance costs as the loan has an interest increase agreed to the loan documentation for
rate of 5%. There is a risk that this has been confirmation of the 5% interest rate. Interest
omitted from the statement of profit or loss payments should be agreed to the cash book and
leading to understated finance bank statements to confirm the amount was paid
costs and overstated profit. and is not therefore a year-end payable.
Darjeeling Co intends to undertake a stock Earl & Co should ensure that there is a suitably
exchange listing in the next 12 months. experienced audit team. Also, adequate time should
be allocated for team members to obtain an
In order to maximise the success of the potential understanding of the company and the significant
listing, Darjeeling Co will need to present risks of overstatement of revenue, profits and assets,
financial statements which show the best possible including attendance at an audit team briefing.
position and performance.
The team needs to maintain professional scepticism
The directors therefore have an incentive to and be alert to the increased risk of manipulation.
manipulate the financial statements, by
overstating revenue, profits and Significant estimates and judgements should be
assets. carefully
reviewed in light of the misstatement risk.
The receivables collection period has increased Review and test the controls surrounding how
from 38 to 51 days and management has extended Darjeeling Co identifies receivables balances which
the credit terms given to customers on the may not be recoverable and procedures around
condition that sales order quantities were credit control to ensure that they are operating
increased. The increase in receivable days could effectively.

Summary Notes by SK
be solely due to these increased credit terms. Extended post year-end cash receipts testing and a
However, it could also be due to an increased risk review of the aged receivables ledger to be
over recoverability of receivables as they may be performed to assess valuation. Also consider the
overvalued and expenses understated. adequacy of any allowance for
receivables
This year the company made a ‘price promise’ to Discuss with management the basis of the refund
match the price of its competitors for similar liability of $0·25m and obtain supporting
products. Customers are able to claim the documentation to confirm the reasonableness of the
difference from the company for one month after assumptions and calculations
the date of purchase of goods.
The company should account for the price

promise in accordance with IFRS® 15 Revenue
from Contracts with Customers. As the company
may be required to provide a refund, the
anticipated refund amount should not be initially
recognised as revenue but instead as a refund
liability until the one-month price promise period
has ended.
This is a highly subjective area, with many

judgements required with regards to the level of
likely refund due. As this is a new liability, the
directors may not have correctly accounted for
this sum resulting in overstated revenue,
under/overstated profits and liabilities.
Darjeeling Co has stopped further sales of one of Review the list of sales of the paint product made
its pain products and a product recall has been between June and the date of the recall, agree that
initiated for any goods sold since June. the sales have been removed from revenue and the
This product recall will result in Darjeeling Co inventory included. If the refunds have not been
paying refunds to customers. The sales will need paid before the year end, review the draft financial
to be removed from the 20X8 financial statements statements to confirm that it is included within
and a refund liability current liabilities.
recognised. Also inventory will need to be
reinstated, albeit at a possibly written down value.
Failing to account for this correctly could result in
overstated revenue, understated liabilities and
misstated inventory
The company is holding a number of damaged Discuss with the finance director whether any write
paintproducts in inventory and overall the downs will be made to this product, and what, if
inventory holding period has increased from 45 any, modifications will be required to rectify the
days to 54 days. quality of the product. Testing should be undertaken
to confirm cost and NRV of the affected paint
Due to the issue with the paint consistency, the products held in inventory and that on a line by line
quality of these products is questionable and basis the goods are valued correctly.
management is
investigating whether these products can be
rectified. There is a risk that this inventory may be
overvalued as its net realisable value may be

Summary Notes by SK
below cost.
Revenue has increased by 16·8% in the year; and During the audit a detailed breakdown of sales will
the gross margin has increased slightly from 36·4% be obtained, discussed with management and tested
to 37·3%. This is a significant increase in revenue in order to understand the sales increase. Also
and, along with the increase in gross margin, may increased cut-off testing should be undertaken to
be related to the increased credit period and price verify that revenue is recorded in the right period
promise promotion or could be due to an and is not overstated.
overstatement of revenue.
The payables payment period has increased from Detailed going concern testing to be performed
40 to 58 days. The current ratio has decreased during the audit, including the review of cash flow
from 3·08 to 1·65. forecasts and the
underlying assumptions. These should be discussed
The quick ratio has also decreased from 1·97 to with management to ensure that the going concern
0·99. basis is
reasonable.
In addition, the bank balance has moved from
$0·56m to an overdraft of $0·81m.
These are all indicators that the company could be

experiencing a reduction in its cash flow which
could result in going concern difficulties or
uncertainties. These
uncertainties may not be adequately disclosed in
the financial statements.
------------------------------------------------------------------------------------------
ICAP CAF 8 Sept 2010 (8 marks)
Question 3
The analytical procedures which are carried out near the end of the audit usually assist the auditor in
forming an overall conclusion on the financial statements.
Required:
a. State the objectives which an auditor expects to achieve while applying analytical at the end of an audit
(04 marks)
b. Discuss the course of action an auditor should adopt when results of analytical procedures identify
inconsistent relationships or differ from expected values by significant amounts.
(04 marks)
Answer 3:
a. The auditor should apply analytical procedures at or near the end of the audit in order to
i. Form an overall conclusion as to whether the financial statements as a whole are consistent with
the auditor's understanding of the entity.
ii. Corroborate the conclusions formed through other procedures performed during the audit of
individual components or elements of the financial statements.

Summary Notes by SK
iii. Identify previously unrecognized risk of material misstatement. In such circumstances, the auditor
may:
 revise the auditor's assessment of the risk of material misstatement; and
 modify the further planned audit procedures accordingly.
b) When analytical procedures identify significant fluctuations or relationships, the auditor shall
investigate such differences. Fluctuations can be investigated in the following manner:
i. Inquiring of management and obtaining appropriate audit evidence relevant to management

responses. These audit evidence may be obtained by taking into account:
 the auditor’s understanding of the entity and its environment; and
 with other audit evidence obtained during the course of the audit
ii. Performing other audit procedures when:

 management is unable to provide an explanation, or
 the explanation together with the audit evidence obtained is not considered adequate.
------------------------------------------------------------------------------------------
ICAP CAF March 2009 (18 marks)

Question 6
a. Analytical procedures are an important part of the audit process and a tool which the auditor uses
during the various phases of an audit.
Required:
a. Describe the nature and purpose of analytical procedures used during an audit
(06 marks)
i. Describe the factors that the auditor needs to consider while designing and performing analytical
procedures as substantive procedures. (04 marks)
ii. Describe the objectives which an auditor expects to achieve while applying analytical procedures at
the overall review stage of an audit. (04 marks)
b. Representations by management are considered as audit evidence.

Describe the basic elements of a management representation letter. (04 marks)

Summary Notes by SK
Business Risk – Something Extra 
Business Risk
Business risks are the factors that could prevent or hinder the achievement of organizational goals and
objectives. It is the risk inherent to the company in its operations. (i.e every company faces business risks)
IMPORTANT POINT
When required to identify or highlight Business risk in a question, plz do not think of urself as an external
auditor, instead think as DIRECTOR or C.E.O of the company.
As part of B.O.D / senior management you should understand and be aware that the company faces a lot
of risks and these risks could be from both internal and external factors.
Examples of business risks include:
1. Loss of customers or
2. Decrease in sales
3. Increase in production costs
4. Cash-flow problems
5. Decline in product demand or
6. Increase in market competition or
7. New competitor
8. Litigations and claims (Non-compliance with laws and regulations) or
9. Penalties being imposed as a result of Non-compliance
10. Technological obsolescence
11. Heavy investments required (e.g. High Tech or Pharma industry where there is constant need of
research)
12. Decrease in profitability (via reduces sales price or decline in margins)
13. Political and economic instability
14. Inadequate financing
15. Risk of fraud
16. Risk of theft and misappropriation
17. Loss of major supplier
18. Loss of key employees
19. Trade union strikes etc.
PLEASE NOTE (BUSINESS RISKS ARE BROADLY CATEGORIZED INTO 3 CATEGORIES: 1)

Financial Risks 2) Operational Risks 3) Compliance Risks
----------------------------------------------------------------------------------------------------------

Summary Notes by SK
CAF 9 March 2020
Question 1
6. Business Risks
7. Audit Risks
Business Risk Risk at the assertion level / Audit Risks

DPL has to comply with very strict regulations Liabilities may be understated relating to undisclosed
and any non-compliance would result in penalties.
heavy fines.
A contingent liability may not be disclosed in the
financial relating to any legal action taken by the
regulator against DPL.
DPL's competitor has introduced a new Since DPL is selling Drug-A at lower margin, its
product which has caused DPL to reduce it inventory might need to be recorded at lower of cost or
selling price. NRV which if not done may lead to risk inventory
being over-valued
Since DPL is a listed entity and the revenues are

decreasing, DPL may overstate its revenue or
understate its expenses.
If the revenues keep on decreasing DPL's property,

plant and equipment may need to be tested for
impairment as there is a risk that both profits and PPE
could be over-stated.
DPL has to continuously carry on research If the criteria for development cost (or intangible asset)
projects. has not been met research cost might be
inappropriately recorded as development cost
Due to significant imports of raw material DPL There is a risk that trade payables may not be
is exposed to foreign currency risk because of translated using the correct exchange rate and may be
the fluctuation in exchange rates. under-valued.
Exchange gains and losses may not be calculated
correctly and profits may be
over stated.

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
Exam Focused Points

Summary Notes by SK
ISA 315 (Revised)

‘Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity
and Its Environment’

Summary Notes by SK
Expected Questions … (ISA 300 + 315)
1. Explain the reasons for an external auditor to obtain understanding of the audit client before
the start of the audit.
2. Explain/ discuss the purpose of risk assessment procedures performed by the external auditor
at the planning stage of the audit.
3. What are the sources/ HOW will the external auditor obtain evidence for risk assessment
procedures.
4. Identify sources of information relevant to obtaining / gaining understanding of the audit

client AND describe how this information will be used by the auditor.
5. Explain the procedures to obtain understanding of the entity & its environment as per ISA
315 at the risk assessment stage.
6. Describe the term significant audit risk and list few examples.
7. Explain the importance of risk assessment at the planning stage of an audit.
8. Explain the term Audit Risk and briefly explain its components.
9. Define Inherent and control risk and list few examples.
10. Explain how detection risk can be controlled / reduced by the external auditor.
11. Scenario based question on audit risk …………(Most Imp)
 Describe / explain (05) audit risks from the given scenario and explain the
auditor’s response to each risk in planning the audit of ABC & co.
 From the given scenario / points, categorize between Inherent, control and
Detection risk
 From the given points / information, classify inherent, control and detection
risk between high and low risk

Summary Notes by SK
Planning an Audit = Audit Strategy + Detailed Audit Plan
Audit Strategy includes ……………….……
1) Understanding the Entity and its Environment (ISA 315)

2) Assessing the Risk of Material Misstatement (R.O.M.M)
Detailed Audit Plan includes ……
3) Responding to the Assesses Risk of Material Misstatement (R.O.M.M)
1. Understanding the Entity and its Environment (ISA 315)

The objective of the auditor under ISA 315 is to identify and assess the risks of misstatement,
whether due to fraud or error, through understanding the entity and its environment, including its
internal controls.
3 MAIN questions to be asked in this regard are:
 WHY (why obtain the understanding of the entity and its environment?)
 WHAT (what are the matters to be considered when obtaining the understanding of the entity)
 HOW (what procedures are to be performed by the auditor to obtain understanding of the entity
and its environment)
WHY….? Please Learn
1. To identify and assess the risks of material misstatement at the financial statement level
2. To identify and assess the risks of material misstatement at the Assertion level
3. To enable the auditor to design and perform further audit procedures in response to risk at the F/S
level
4. To enable the auditor to design and perform further audit procedures in response to risk at the
assertion level.
5. To exercise audit judgment when setting Planning and performance materiality while making audit
strategy.
WHAT………………………….? Please Learn

This will involve the Auditor taking understanding of the following:
1. the industry in which the entity operates
2. the nature and competence of its management
3. the entity’s internal control system (further discussion in chapter 9)
4. Its current financial performance (Profitability and Ratio Analysis etc.)
5. Reporting requirements and deadlines (As per local laws)
6. Any recent developments. (New Product launched by the audit client etc.)

Summary Notes by SK
7. Relevant industry, regulatory and other external factors, including the applicable financial reporting
framework. (___________________________)
8. The nature of the entity, including its operations, ownership and management structures.
9. The entity’s selection and application of accounting policies, including whether they are appropriate
for its business and consistent with the industry norms.
10. The entity’s objectives and strategies and those related business risks that may result in risks of
material misstatement.
11. The measurement and review of the entity’s financial performance.
(_____________________________________)
When the auditor draws on knowledge, he has gained from previous audits of the audit client, it is
important that he takes into account any significant changes in circumstances and general economic
environment. (auditor must update his previous knowledge)
HOW / Sources of Information............................... Please Learn

(Procedures to be performed by the External auditor)
1. Inquiry / discussion from management (From Directors, Internal Auditors & other officers
within the Entity)
2. Discussion with last year / previous auditors.
3. Analytical procedures (Comparison from last year….. to be covered in ISA 520)
4. Last year’s Management letter / other reports to management
5. Inspection of S.O.P’s and Internal Control Manuals / procedural manuals
6. Knowledge obtained from last year audit
7. Review of B.O.D minutes / other committee minutes. (e.g. Audit Committee)
8. Discussion within the audit team (Managers & Partners guiding the audit team)
9. Information obtained from other engagements performed at the client
e.g. Agreed Upon Procedures and Accountancy assignments etc.)
10. Reviewing last years working paper file.
11. Review prior years F/S.
12. Trade industry journals / trade magazines / Press releases
13. Client website
14. Annual report of the audit Client
15. Financial statements of competitors.
16. Budgets and management accounts.

Summary Notes by SK
2) ASSESSING THE RISK OF MATERIAL MISSTATEMENT (R.O.M.M)
When the auditor has obtained an understanding of the entity, he shall assess the risks of material
misstatement in the financial statements, also identifying significant risks, if any.
The auditor is required to identify and assess the risks of material misstatement at both the financial
statement and at the assertion level. (____________________________)
The financial statement level refers to risks which are pervasive to the financial statements as a whole and
which potentially affects many assertions. (For examples refer H.O # 2)
The risk at the assertion level refers to specific risks in P&L, B/S and presentation and disclosure items in
the notes to the accounts. Risk at this level has 02 types. INHERENT RISK and CONTROL RISK. (For
examples refer H.O # 2)
IMPORTANCE OF RISK ASSESSMENT /
-------------------------------------------------------------------------------------------------------------------------------------------
SIGNIFICANT RISK
The auditor should look for factors that could be significant in the F/S and to which particular attention
should be given by the audit team.
In addition, the auditor may also be aware that the client company has a poor track record in collecting
trade receivables. This knowledge of the business might make the auditor reach the conclusion that the
audit should give particular attention to the verification of trade receivables.
Significant risks are COMPLEX or UNUSUAL transactions that may indicate fraud, or other special
risks and these require special audit consideration. As part of the risk assessment procedures, the
auditor shall determine whether any of the risks are significant risks in the F/S.

Summary Notes by SK
The following factors indicate that a risk might be significant: Please Learn
1) Risk of fraud (ISA 240)
2) Its relationship with recent accounting or other developments
3) The degree of subjectivity in the financial information (E.g. Provision for Lawsuit)
4) It is an unusual transaction in the F/S (eg. Lease accounting)
5) It is a significant transaction with related party (e.g. Transactions with Parent or subsidiary
companies)
6) The complexity of the transaction (eg Calc of Borrowing costs)
The auditor will then focus his work more on balances in the financial statement where he considers there
is significant risk of material misstatement. High risk/significant material items will be audited in detail,
and low risk items will receive less attention.
i.e. (More time on High risky & material items and less time on low risky and immaterial items)
3) RESPONDING TO THE ASSESSED RISK OF MATERIAL MISSTATEMENT

The objective in this regard is to gather adequate appropriate audit evidence about assessed risks of
material misstatement, by designing and putting in place appropriate responses to the assessed risks.
 Response at the F/S Level (will be covered in the topic of Fraud- ISA 240)
 Response at the Assertion Level ------------------By Performing Test of controls,

Substantive Procedures or a combination of both.
From here we move towards the topics of ………………….T.O.C. s and S.P’s

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Summary Notes by SK
ACCA F8 Practice Questions on
ISA 315 (Understanding the entity)

1 Question 2 c ACCA Sept /Dec 2015 5 marks
2 Question 3 a ACCA Dec 2012 5 marks
3 Question 45 ACCA South 4 marks
4 Question 50 ACCA Serenity 6 marks

Summary Notes by SK
Question 2 (c)
ISA 210 Agreeing the Terms of Audit Engagements requires auditors to agree the terms of an engagement
with those charged with governance and formalise these in an engagement letter.
c. Your audit firm has just won a new audit client, Milky Way Technologies Co (Milky Way), and you
have been asked by the audit engagement partner to gain an understanding about the new client as
part of the planning process.
Required:
Identify FIVE sources of information relevant to gaining an understanding of Milky Way Technologies
Co and describe how this information will be used by the auditor.
Answer:
c) Understanding an entity
Prior year financial statements: Provides information in relation to the size of Milky Way Technologies
Co (Milky Way) as well as the key accounting policies, disclosure notes and whether the audit opinion
was modified or not.
Discussions with the previous auditors/access to their files: Provides information on key issues
identified during the prior year audit as well as the audit approach adopted.
Prior year report to management: If this can be obtained from the previous auditors or from
management, it can provide information on the internal control deficiencies noted last year. If these have
not been rectified by management, then they could arise in the current year audit as well and may impact
the audit approach.
Milky Way’s accounting systems notes/procedural manuals: Provides information on how each of the
key accounting systems operates and this will be used to identify areas of potential control risk and help
determine the audit approach.
Discussions with management: Provides information in relation to the business, any important issues
which have arisen or changes to accounting policies from the prior year.
Review of board minutes: Provides an overview of key issues which have arisen during the year and how
those charged with governance have addressed them.
Current year budgets and management accounts: Provides relevant financial information for the year to
date. It will help the auditor during the planning stage for preliminary analytical review and risk
identification.
Milky Way’s website: Recent press releases from the company may provide background on the business
during the year as this will help in identifying the key audit risks.
Financial statements of competitors: This will provide information about Milky Way’s competitors, in
relation to their financial results and their accounting policies. This will be important in assessing Milky
Way’s performance in the year and also when undertaking the going concern review.
----------------------------------------------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
ACCA F8 Dec 2012 (5 marks)
Question 3 (a)
Required:
List FIVE sources of information that would be of use in gaining an understanding of Sunflower
Stores Ltd, and for each source describe what you would expect to obtain.
Answer:
Source of information Information expect to obtain
Prior year audit file Identification of issues that arose in the prior year audit and
how these were resolved. Also, whether any points brought
forward were noted for consideration for this year’s audit.
Prior year financial statements Provides information in relation to the size of the entity as well
as the key accounting policies and disclosure notes.
Accounting systems notes Provides information on how each of the key accounting
systems operates.
Discussions with management Provides information in relation to any important issues which
have arisen or changes to the company during the year.
Current year budgets and management Provides relevant financial information for the year to date.
Accounts of sunflower stores co Will help the auditor to identify whether sunflower has
changed materially since last year. In addition, this will be
useful for preliminary analytical review and risk identification.
Permanent audit file Provides information in relation to matters of continuing
importance for the company and the audit team, such as
statutory books
Information or important agreements.
Sunflower’s website Recent press releases from the company may provide
background on changes to the business during the year as this
could lead to additional audit risks
Prior year report to management Provides information on the internal control deficiencies noted
in the prior year; if these have not been rectified by
management then they could arise in the current year audit as
well.
Financial statements of competitors This will provide information about sunflower’s competitors, in
relation to their financial results and their accounting policies.
This will be important in assessing sunflower’s performance in
the year and also when undertaking the going concern review.
------------------------------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
ACCA F8 Questions
45 South (4 marks)
ISA 315 Identifying and assessing the risks of material misstatement through understanding the entity and
its environment requires auditors to obtain an understanding of the entity and its environment, including
its internal control.
Required
a) Explain why obtaining an understanding of the entity and its environment is important for the auditor.
(4 marks)
Answer:
a) Importance of understanding the entity and its environment
Understanding the entity and its environment (including the entity's internal control), is important to
the auditor because it allows the auditor to:
 Identify and assess the risks of material misstatement, whether due to fraud or error, at both the
assertion and the financial statement level.
 Assess the reliance that can be placed on internal control
 Design and perform further audit procedures in response to the assessed risks such that detection
and audit risk can be reduced to an acceptable level.
 Establish a frame of reference for exercising audit judgement, for example, when setting audit
materiality.
------------------------------------------------------------------------------------------------------------------------------------------
50 Serenity ( ACCA F8) (6 marks)
(a) ISA 315 Identifying and assessing the risks of material misstatement through understanding the entity
and its environment requires the auditor to perform risk assessment procedures which include
obtaining an understanding of the entity and its environment, including its internal control.
Required
1) Explain the purpose of risk assessment procedures. (3 marks)
2) Outline the sources of audit evidence the auditor can use as part of risk assessment procedures.
(3 marks)
Answer:
i. Risk assessment procedures are performed at the planning stage of an audit to obtain an understanding
of the entity being audited and to identify any areas of concern which could result in material
misstatements in the financial statements. They allow the auditor to assess the nature, timing and
extent of audit procedures to be performed.
ii. Sources of audit evidence that can be used as part of risk assessment procedures.
 Inquiries of management
 Prior year financial statements
 Current year management accounts and budgets
 Analytical procedures
 Observation and inspection

Summary Notes by SK
Student Notings

Summary Notes by SK
‘Internal Audit Department’

Summary Notes by SK
Summary Diagram - Internal Audit Department
Benefits of Internal Audit Dept.
Limitations and Independence of

Internal Audit Dept
Internal Audit Assignments
Internal Audit Report
/Functions
Outsourcing of Internal Audit Dept
Factors to be considered before

establishing an internal audit dept.
Comparision of External and

internal audit dept
1 2 3 4 5 6
other
Value for
operational Fraud Best Value Risk Assignments /
Money Audit
Audit Investigation Audit Management tasks /
(VFM)
functions
Preparation of F/S
Stock and Cash counts
Fixed Assets counts
Performing Service Audits
Compliance & Legal Audits
Application or Procedures on
C.C.G
Any other special assignment
Summary Notes by SK
The Internal Audit Department
Definition
“Internal auditing means an appraisal activity established within an entity as a service to the entity. It examines,
evaluates and reports to the management on the adequacy and effectiveness of the systems in place. (By system
we mean any department, any process or any business unit of theorganization / company).
 Finance
 Human Resource
 Marketing
 Procurement
 Treasury department etc.
In short, internal auditors are ensuring compliance / adherence to established company policies (S.O.P) for
various departments and functions. Internal audit is currently going through a significant change and is being
evolved gradually as the business risks for the organizations are constantly changing.
One of the key reasons is because of the importance in Code of Corporate governance as it laysgreat stress on
establishing an Internal Audit department in the company.
Reporting Line:
Internal Audit Function reports to Audit committee (comprising mostly of Independent Non- Executive
Directors- NEDs) which is part of board of directors (B.O.D)
Within the department. Internal auditors report to the Chief Internal Auditor.
Benefits of Internal Audit Department
1. Improvements in financial controls of the entity

2. Improvements in non-financial controls within the entity
3. Improvements in compliance with key laws and regulations
4. Improvements and suggestions in the economy, efficiency and effectiveness of theoperations of
the company.
5. It enhances the reputation of the entity for sound corporate governance and increases shareholders
confidence.
6. If internal audit department is effective than their work can be relied upon by the externalauditors.
Scope/ Assignments of an internal audit department

1. Performing operational audits of various functions like Human Resource, Procurement dept. etc. and
monitoring internal controls (verifying established Policies and Procedures of the company) ... Also called
review of operational and financial controls.
2. Performing Value for Money Audits which includes the review of the economy, efficiency and
effectiveness of various operations.
3. Regulatory compliance (adhering to applicable laws and regulations like health and safety and
environmental laws)
4. Performing Best Value Audits.

Summary Notes by SK
5. Peforming special Fraud Investigations.
6. Performing risk management.
7. Other assignments / functions
(Various OTHER functions and assignments can be performed on the instructions of Those Charged
with Governance (Refer summary diagram)
Comparison btw External and Internal auditor OR (External or internalaudit dept.)
There are a number of fundamental differences between the two audit roles. These are summarizedin the following
table
External Auditor Internal Auditor
Scope of work To express an opinion on the truth and To examine systems andcontrols and
fairness of the annual financial statements. assess risks in order to make
recommendations to
The external auditor will therefore carry management / TCWG for
out whatever work he deems necessary to improvements.
reach that opinion
The internal auditor’s work
programme / internal audit
assignments are mostly decided by head
of audit with the oversight of Audit
committee / TCWG.
Qualification to act Set out by law and regulation. This ensures No statutory requirements —
that the external auditor is independent of management select a suitably
the entity and qualified to act. (in Pakistan competent person to act as internal
only CA can signthe audit report) auditor. It is therefore possible that
the internal auditor may not be as
competent as the external auditor,
depending on management’s
recruitment criteria.
Appointed by The shareholders in the AGM of The Management.
the company. In order to ensure as much
independence as possible the internal
auditors must therefore be appointed
by audit committee / TCWG
Duties set out by Statue Scope of internal auditors is
Rights and duties of an external auditor are determined with the oversight of audit
given by law / statute. committee and TCWG.
Eg in Companies Act That document is called
Terms of reference (TOR)
Report to The shareholders via auditreport Audit committee / TCWG via

Internal audit report.

Summary Notes by SK
Independence and limitations of the internal auditors
External auditors should be and must be see independent of the company they audit. However internal
auditors cannot achieve the same degree of independence as that achieved of the external auditor. Full-time
internal auditors are employed by the entity who rely on the entity for their job and salary and other benefits.
Various measures can be taken to try to protect the independence of the internal auditors
Factors to be considered in this respect are:
Reporting lines.
The chief internal auditor may report to the audit committee and not to the finance director or the chief
accountant.
Deciding the scope of internal audit work.

The scope of work carried out by the internal auditors should not be decided by the finance director or line
management responsible for the operations that might be subjected to audit. The scope should be decided by
the chief internal auditor or by the audit committee.
Rotation of internal audit staff.

Internal auditors should not be allowed to become too familiar with the operations that they audit or the
management responsible for them. To reduce this, internal auditors should be rotated regularly, say every
two to three or five years.
Appointment of the chief internal auditor.

The chief internal auditor should not be appointed by a senior executive who may have some self- interest in
wishing to appoint a ‘yes man’ who will not ‘cause trouble’. Instead, the audit committee should be responsible
for appointing a new chief internal auditor and that must also be approved by the board of directors.
Conflict of Interests /Designing internal controls.

The internal auditors should not be responsible for the design of internal controls / SOPs within the entity. If
they did, they would be required to audit their own work creating self- review threat, which is unacceptable.
Weaknesses and limitations of an Internal audit Department
1. Not a regulatory department (Not required by law unless Listed co. in Pakistan)
2. No prescribed qualification for working as an Internal auditor.
3. No benchmarks / standardization (I.A dept varies from company to company)
4. Cost of setting up an internal audit dept. can be very high.
5. Independence of internal auditors. ( Not Like external auditors who are totally independent of the
company)
Value For Money Audits (VFM Audit)

Not-for-profit organizations and the public sector organizations (Govt. sector) are currently under tremendous
pressure to justify each of their actions in terms of economy, efficiency and effectiveness. Achieving value
for money is a symbol of good governance for such organizations.
(E.gs of N.P.O are Selani Welfare Trust and Edhi Foundation — Public Sector Org e.g
Government Colleges and Govt. Hospitals)

Summary Notes by SK
The absence of a profit measure requires an alternative focus in a not-for-profit organization. The principle of
value for money implies that efforts must be made to ensure available funds are spent in the, provision of
services in a way that maximizes the benefit to the user of the services / customers.
The value for money principle focuses on three E’s namely, Economy, Efficiency and Effectiveness inany activity/
function of the organization.
Economy
Implies the principle of prudence i.e. the least possible cost should be incurred to fulfill any need or say that
resource cost to be kept at minimum or lowest. Attaining the resources/ material at the lowest cost. (Getting 2
products at Rs 1000 & Rs 950. economy is achieved by purchasing at Rs 950)
Efficiency
Implies the maximization of output input ratio i.e. the output per unit of input should be maximized.
An efficient operation produces maximum output for a given set of input (resources required) or requires
minimum input for a given level of output.
E.g. One Teacher and 150 students & One Teacher and 50 students
Effectiveness
Organization objectives have been achieved.
(E.g. Spending on College, spending on Food Etc.)
Example
Purchasing less expensive raw material (economy) may help maximize the number of units that may be
obtained for a given sum of money (efficiency). This may be at conflict with the desired objective of high
standard of performance for finished goods. (Effectiveness).
IMP
Internal auditors will evaluate these factors for any given business system (function / dept. / Operation)
or product/ service of the company.
V.F.M will be judged by comparison with best systems / products / services and other alternativesavailable.
Limitations of Value For Money:
1.
2.
3.

Summary Notes by SK
Fraud Investigations / Special Fraud Assignment
The Primarily Responsibility for establishing & maintaining control in the organization rests with Board of
Directors or say those charged with Governance similarly they are responsible for the prevention and
detection of fraud and error in the organization.
In this respect, internal auditors are responsible for ASSISTING/ HELPING the B.O.D in the
deterrence of fraud/ or prevention and detection of fraud and error, by performing special investigations
and evaluating the adequacy and effectiveness of the internal control system in place.
Remember it’s the directors (TCWG) who are wholly responsible for the prevention and detection of fraud
and error in the company.
When assessing the risk of fraud, internal auditors should determine few factors
 Are Realistic organizational goals and objectives are set by the management…………
 Are their Policies and Procedures to monitor activities and safeguard company assets….
While the internal auditors verify transactions of various operations (called operational audits) they cannot
conduct detailed audit of every transaction (they also work on a sample basis just like external auditors).
Accordingly, the internal auditor CANNOT achieve/ or give an Absolute Assurance that non-
compliance or irregularities do not exist.
(Remember Inherent Limitations are there....and they cannot be eliminated !)
Internal Auditor’s Role in Preventing and detecting Fraud & Error
1. Internal Auditor can conduct investigation of any department/function where there is slightest
risk of fraud. (after consent and approval from management)
2. Internal Auditor assess the adequacy & effectiveness of internal controls of the concernedfunction/
department.
3. Internal auditors can help directors/ senior management identify areas where fraud risks exists by
regular reviews of various operational functions.
4. Internal auditors can help management to develop controls to mitigate against fraud risks.
5. Internal Auditors must be alert for any fraud risk indicators (E.g. Unauthorized/
unapproved transactions, No supporting documents, purchasing from other than
approved vendors, no timely Bank & stock reconciliations, no signatures obtained on
delivery notes from customers, unexplained prices for new customers, Unauthorized
hiring of key employees in the finance department, abnormal credit terms etc.
Reporting of Fraud
 When an internal auditor suspect’s wrong doing, the appropriate authorities within the organization
should be informed (i.e. Chief Internal Auditor, Audit Committee and C.E.O)
 When the incidence of significant fraud has been established after fraud investigation (supporting
evidence has been gathered), senior management and the board should be notified immediately.
A written report might be issued at the conclusion of the investigation phase and might be submitted to
legal. counsel (in-house legal dept.) or for any subsequent police investigation, whererelevant.

Summary Notes by SK
Risk Management
1. The I/A dept assists the Audit/Risk committee in identifying the areas of high risk
2. The I/A dept may suggest controls to manage the risks that are identified
3. The I/A dept may conduct regular procedures to determine any changes in the key risks of the
company
4. The I/A dept may conduct regular procedures to ensure that controls created in relation to key risks
identified are operating effectively or not.
Best Value Audit
The best value audit is aimed at improving the effectiveness, efficiency and economy of the various
business functions / operations under review. This can be achieved by reviewing the functions under
review and by recommending improvements.
Internal auditors evaluate the current system and methods/services provided by the companies and then
recommend mgmt. (by recommending new strategies and methodologies) how to achieve best value be it
any department or any product or service of the company)
The most important ingredients of a best value review are explained with the ' 4 Cs'. These four C's are
Challenge, Compare, Consult and Compete.
1. Challenge
Identifies the need of the service and the way it is provided. An entity should discontinue providing
a service if the reason why the service is provided cannot be identified satisfactorily
2. Compare
Compares the attributes of the services provided with those provided by similar organization.
Comparison paves the way for improvements.
3. Consult
Suggests consulting with service users / customers in order to know whether or not the services
provided meet the needs of the consumers.
4. Compete
Encourages fair competition so as to achieve efficient and effective services.
The element of competition enables and paves the way to achieve best value audit.
Outsourcing the Internal Audit Department ( READ ONLY)

Rather than having a permanent internal audit presence some organizations have chosen to outsource the
function (acquiring/purchasing the service from a 3rd party/ External Service Provider) such that they
would ‘buy in’ necessary skills as they needed from an external service provider.
Background behind outsourcing is the fact that often companies CAN’T AFFORD to have certain
departments/ functions on a permanent basis e.g.
Cafeteria, Human Resource, repair Maintenance, Internal audit and Payroll functions etc. (mostly those
functions are outsourced that are NOT CORE departments / functions of the organization)
Advantages of outsourcing an Internal Audit Department

1. Internal Auditors do not need to be permanently recruited/ hired. (Full time ee’s are not required) thus
resulting in saving of monthly fixed costs.
2. Outsourcer provides specialist services (they are experts for their work)
3. Outsourcer provides immediate services to the company. (hiring time is saved)

Summary Notes by SK
4. Outsourcer provides access to new techniques/ methodologies without the need for additional
investment or in-house development etc.)
5. Less management time is required on permanent internal audit dept. (e.g. Annual appraisals,
training and development
6. Outsourcing service can be acquired for a short period of time.
Disadvantages of outsourcing an Internal Audit Department

1. There is a threat to Independence & Objectivity if the outsourced internal audit service is provided by
the company’s external auditors.
2. Outsourcing may be expensive for the company as service is being acquired from a professional
service company. (Big 4 firms are expensive)
3. The outsourced firm may not be flexible when problems arise, since they do not have a permanent
presence in the company. (Time Constraints are there)
4. Standard of service may not be up to the standards of the company. (difficult to understand the
requirements of the management)
5. There is a risk of lack of knowledge, proper understanding of the organization objectives and its
culture.
6. Loss of development of in-house skills by the company (by not a permanent I.A.D)
7. Company staff may oppose outsourcing if it results in existing staff being made redundant(losing jobs)
8. There will be lack of loyalty and dedication of external staff for the company.
Assessing the need for an internal Audit department / or say

Factors to be considered before establishing an internal audit department (IMP)
The size and complexity of the business.
The number of employees in an organization or changes in the business structure.
Are the benefits of having an internal audit department more than the cost of forming an internal audit
department.
Changes in key risks that the organization faces.

Frequent errors occurring in the exiting accounting and internal control system.
An increased number of unexplained or unacceptable events
(e.g. Large number of inventories gone missing, or various frauds being highlighted etc.)
Internal Audit Report ( READ ONLY)

As there are no formal reporting requirements for internal auditors therefore the report may take any
format.
Internal auditors produce reports for directors and management as a result of various operational audits
and other assignments performed.
performed. These reports are internal to the organization and are unlikely to be shared with third
parties other than the external auditors.

Summary Notes by SK
Step 1 - Produce Draft Report
First the internal auditors produce a draft internal audit report which is discussed by the relevantmanagement.
Step 2 - Exit meetings
The people at this meeting are likely to include both operational staff from internal audit dept. operational
staff of the department and managers of the relevant dept. along with the manager of the internal audit dept.
The objectives of this meeting are to:
 Discuss the findings and associated recommendations

 Provide management with the opportunity to give their views on, and ask for clarification of, the
observations and recommendations allowing any misunderstandings to be resolved.
 Agree on possible solutions to the problems the internal audit assignment has identified.
Step 3 - Final Report
Depending on the organization, the final report may take the form of a written report or a PowerPoint
presentation.
Standard report format would include the following elements:
 TERMS OF REFERENCE
 EXECUTIVE SUMMARY
 BODY OF THE REPORT (more elaborative)
 APPENDIX / ANNEXURES (if required)
Step 4 - Distribution of the final report
The full report should be provided to those people who can take corrective action on the issues raised in
the report. Summary reports should be provided to B.O.D and Audit committee. Communication may
also go to external auditors and others who are affected by, or interested in, the results.
Step 5 - Releasing the Report
If the report is to be released to parties outside the organization, the risks of doing so should be assessed.
Approval to release should be gained from senior management & legal counsel.
Step 6 - Management Response
After the issuance of the final report, management (CEO and Heads of Departments) will be given the
opportunity to provide their formal response to the internal audit report.

Summary Notes by SK
CA CAF 8 & ACCA F8 Practice Questions
on Internal Audit Department
ICAP
1 Q.5 b ICAP March 2020 7 marks
2 Q.1 e ICAP Sept 2015 2 marks
ACCA
3 Q.16 c ACCA March / June 2018 5 marks
4 Q.4 b c d ACCA June 2013 10 marks
5 Q. 3 c ACCA Dec 2012 5 marks

Summary Notes by SK
Question 16 c
The finance director is interested in establishing an internal audit department (IAD). In the company she
previously worked for the IAD carried out inventory counts, however, as this is not relevant for Raspberry Co,
she has asked for guidance on what other assignments an IADcould be asked to perform.
Required:
Describe assignments the internal audit department of Raspberry Co could carry out.
Answer 16 c:
Assignments for internal audit department (IAD)
Value for money review – The IAD could be asked to assess whether Raspberry Co is obtaining value for
money in areas such as capital 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. There is likely to
be a significant level of PPE and the asset register must be kept up to date to ensure continuous production. If
significant negative differences occur, this may be due to theft or fraud.
Regulatory compliance – Raspberry Co produces electricity and operates a power station, hence it will be
subject to a large number of laws and regulations such as health and safety and environmental legislation. The
IAD could help to monitor compliance with these regulations.
IT system reviews – Raspberry Co is likely to have a relatively complex computer system linking production
data to head office. The IAD could be asked to perform a review over the computer environment and controls.
Cash controls – Raspberry Co’s internal auditors could undertake controls testing over cash payments. 70% of
employees are paid in cash rather than bank transfer, therefore on a weekly basis cash held is likely to be
significant, therefore the cash controls in payroll should be tested to reduce the level of errors.
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.
-------------------------------------------------------------------------------------------------------
Question 4 b c d
Bush-Baby Hotels Ltd operates a chain of 18 hotels located across the country. Each hotel has bedrooms, a
restaurant and leisure club facilities. Most visitors to the restaurant and leisure club are hotel guests; however, these
facilities are open to the public as well. Hotel guests generally charge any costs to their room but other visitors must

Summary Notes by SK
make payment directly to the hotel staff.
During the year, senior management noticed an increased level of cash discrepancies and inventory
discrepancies, and they suspect that some employees have been stealing cash and goods from the hotels. They
are keen to prevent this from reoccurring and are considering establishing an internal audit department to
undertake a fraud investigation.
Required:
(b) Explain how the new internal audit department of Bush-Baby Hotels Ltd could assist the
directors in preventing and detecting fraud and error. (3 marks)
(c) Describe the limitations of Bush-Baby Hotels Ltd establishing and maintaining an internal
audit department. (2 marks)
The directors would like the internal audit department to have as broad a role as possible, as this will make the
decision to recruit an internal audit department more cost effective.
Required:
(d) Describe additional functions, other than fraud investigations, the directors of Bush-Baby Hotels Ltd could
ask the internal audit department to undertake. (5 marks)
----------------------------------------------------------------------------------------------------------
Answer 4 b c d:
b. Preventing and detecting fraud and error
The directors of Bush-Baby Hotels Co (Bush-Baby) are responsible for the prevention and detection of fraud
and error. However, the new internal audit department can help the directors by assessing the main areas of
fraud risk, assessing the adequacy and effectiveness of control systems and helping to develop controls to
mitigate key risks.
Having developed the controls, they can undertake regular reviews of compliance by each hotel of these
controls. Where non-compliance is identified, they can instigate further training if necessary or report
suspected frauds to senior management.
Where fraud is suspected, the internal audit department can undertake a detailed fraud investigation to
identify who is involved, likely sums stolen and gather evidence for any subsequent police investigation.
In addition, the presence of an internal audit department can itself act as a fraud deterrent, as the risk of being
discovered means individuals are less likely to undertake fraudulent activities.
c. Limitations of establishing and maintaining an internal audit department

The internal auditors of Bush-Baby will be employees of the company and so this can impair their
independence, as they may not report issues to those charged with governance for fear of losing their job.
Although some internal auditors are professionally qualified, there is no requirement to be qualified, as there
is for external auditors. Hence, there may be gaps in the experience and technical knowledge of the internal
audit department.
The cost of establishing an internal audit department can be significant; hence prior to recruiting a team, the
management of Bush-Baby should consider carefully the roles the team can perform and whether this will

Summary Notes by SK
generate sufficient value for money.
As Bush-Baby has not previously had any form of internal audit, there may be some resistance from
employees of the company. They may be uncomfortable with the idea of their work being reviewed,
especially if the first role of the department is to undertake fraud investigations.
d) Additional functions for Bush-Baby’s internal audit department
Monitoring asset levels

The internal audit department could undertake inventory counts at the restaurants of the 18 hotels. There is likely
to be a significant level of goods held at each hotel. Internal audit could count actual levels of goods held and
compare them to the hotels’ records. If consistent negative differences occur for a hotel, then this may be an early
indicator of fraud. If positive differences are highlighted, then it could be because employees have not been
adequately trained on how to record inventory.
Cash controls at hotels

Bush-Baby’s internal auditors could undertake controls testing over cash receipts and cash counts. It is likely
that cash at each hotel will be significant as there would be cash at the reception, restaurant and leisure club.
Each hotel should have tight controls over the cash receipts process. These controls should be tested at each
location as well as performance of acash count to reduce the level of errors.
Customer satisfaction levels

In order to improve the overall guest experience in the hotel, members of the internal audit department could
undertake ‘mystery guest’ reviews, where they enter the hotel as a guest, stay the night, eat and drink in the
restaurant and visit the leisure club. They then rate the overall hotel experience. This is fed back to each hotel to
improve customer service and can provide the basis for further training, if necessary.
Overall review of financial/operational controls

The department could undertake reviews of controls at head office, as well as individual hotels and make
recommendations to management over such areas as the purchasing process as well as the payroll cycle.
IT system reviews
Bush-Baby is likely to have a relatively complex computer system linking all of the tills in the hotels to head
office. The internal audit department could be asked to perform a review over the computer environment and
controls.
Value for money review

The internal audit department could be asked to assess whether Bush-Baby is obtaining value for money in areas
such as capital expenditure.
Regulatory compliance
Bush-Baby’s operations include leisure clubs, restaurants and hotel rooms. There will be various laws and
regulations such as health and safety, food hygiene and fire prevention that impact Bush-Baby. The internal
audit department could help to monitor compliance with these regulations.
-------------------------------------------------------------------------------------------------------

Summary Notes by SK
Question 3 c
The finance director of Sunflower Stores Ltd is considering establishing an internal audit department.
Required:
Describe the factors the finance director should consider before establishing an internal audit department.
Answer 3 c:
Internal audit department

Prior to establishing an internal audit (IA) department, the finance director of Sunflower should
consider the following:
1. The costs of establishing an IA department will be significant, therefore prior to

committing to these costs and management time, a cost benefit analysis should be performed.
2. The size and complexity of Sunflower should be considered. The larger, more complex and diverse a
company is, then the greater the need for an IA department. At Sunflower there are 25 supermarkets
and a head office and therefore it would seem that the company is diverse enough to gain benefit from
an IA department.
3. The role of any IA department should be considered. The finance director should consider what tasks
he would envisage IA performing. He should consider whether he wishes them to undertake inventory
counts at the stores, or whether he would want them to undertake such roles as internal controls
reviews.
4. Having identified the role of any IA department, the finance director should consider whether there are
existing managers or employees who could perform these tasks, therefore reducing the need to
establish a separate IA department.
5. The finance director should assess the current control environment and determine whether there are
departments or stores with a history of control deficiencies. If this is the case, then it increases the
need for an IA department.
6. If the possibility of fraud is high, then the greater the need for an IA department to act as both a
deterrent and also to possibly undertake fraud investigations. As Sunflower operates 25 food
supermarkets, it will have a significant risk of fraud of both inventory and cash.

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 610 (Revised) – ‘Using the Work of

Internal Auditors’

Summary Notes by SK
Introduction to ISA 610 (Revised)

Scope of ISA 610 includes:
 using the work of the internal audit function in obtaining audit evidence; and
 using internal auditors to provide direct assistance under the direction, supervision and review of
the external auditor.
To determine whether the internal auditor’s work is adequate for his purposes, the external auditoris required to
evaluate the internal audit function and its procedures. A decision can then be taken as to whether the work of
the internal auditors can be used as part of the evidence or not.
The table below summarizes the criteria against which the internal audit function will be assessed.
(GENERAL CRITERIA)
If any of the above factors are lacking than external auditor shall not use the work of the internal audit
function.
Evaluating internal auditors’ work
Criteria Comment
Objectivity  What is the status of the internal audit
function within theentity?
 To whom does it report? Does it have
access to those chargedwith governance?
 Is it free of any conflicting
responsibilities (e.g. any operational
responsibilities)?
Technical Competence  Are there any restrictions placed on
the internal audit function / or their
scope?
 Are internal auditors members of

relevant professionalbodies?
 Do they have adequate technical training
and proficiency?
 Are there established policies for hiring and
training internalauditors?
 Do the internal auditors possess the
required knowledge offinancial reporting?
 Is the work of internal audit properly
planned, supervised, reviewed and
documented?
 Does the I.A function have appropriate
quality control procedures, audit

Summary Notes by SK
manuals, work programs (list of
procedures to be performed) and other
relevant documents?
Systematic anddisciplined approach  Is the work of internal audit properly
planned, supervised, reviewed and
documented?
 Does the I.A function have appropriate
quality control procedures, audit
manuals, work programs (list of
procedures to be performed) and other
relevant documents?
Examples of work of the internal audit function that can be used by the external auditor include:
 Testing of the operating effectiveness of controls;

 Substantive procedures involving limited judgment;
 Observation of inventory counts;
 Tracing transactions through the information system relevant to financial reporting;
 Testing of compliance with regulatory requirements;
Using the work of internal auditors (SPECIFIC CRITERIA)
In addition to the general assessment of the internal audit function, ISA 610 also requires the external
auditor to evaluate each specific piece of work performed by internal audit dept. before itis used as external
audit evidence for the external auditor.
The external auditor is required to evaluate whether:
1. the work was properly planned, performed, supervised, reviewed and documented;
2. sufficient, appropriate evidence was obtained to enable auditors to draw reasonable
conclusions;
3. appropriate conclusions were reached, consistent with any reports prepared;
4. any exceptions or unusual matters were properly resolved.
5. making inquiries of appropriate individuals within the internal audit function;
6. observing procedures performed by internal audit;
7. reviewing the internal audit function’s work program and working papers;
8. reperforming a sample of the internal audit function’s procedures
Communication with those charged with governance (TCWG)
ISA 610 requires the external auditor to communicate the planned use of the work of the internal audit function
to those charged with governance for their understanding of the proposed audit approach.

Summary Notes by SK
Using the Direct assistance of Internal Auditors
Direct assistance is defined as the use of internal auditors to perform audit proceduresunder the direction, supervision and review of
the external auditor.
Considering the use of internal auditors to provide direct assistance
If the external auditor plans to use internal auditors to provide direct assistance on the audit (and is not
prohibited from doing so by law or regulation) they must evaluate the existence and significance of threats to
objectivity and the level of competence of the internal auditors who will be providing such assistance.
Internal auditors may not provide direct assistance if:
 there are significant threats to the objectivity of the internal auditor; or

 Lacks sufficient competence to perform the proposed work.
And should NOT BE involved in making significant amount of judgment in:
 planning and performing audit procedures; and

 evaluating the audit evidence gathered.
When determining the nature and extent of direct assistance work to be assigned to internal audit,the external
auditor shall consider:
 the amount of judgment involved;
 the assessed risk of material misstatement;
 the existence of threats to the objectivity and level of competence of the internal auditors;
ISA 610 precludes the use of internal audit to perform direct assistance in procedures that:
 involve making significant judgments in the audit;
 relate to higher assessed risks of material misstatement where the judgment required in performing the
relevant audit procedures is more;
 relate to work with which the internal auditors have been involved and which has already been, or
will be, reported to management or
 relate to decisions the external auditor makes regarding the internal audit function and the use of its
work or direct assistance.
The external auditor shall direct, supervise and review the work performed by internal auditors on the
engagement. In doing so:
The direction, supervision and review by the external auditor of the work performed by the internal auditors
must be sufficient in order for the external auditor to be satisfied that the internal auditors have obtained
sufficient appropriate audit evidence to support the conclusions based on that work.
Plz NOTE:
The ultimate responsibility of the external audit is of the external auditor who will be signing the audit
report after the completion of the audit.

Summary Notes by SK
Prior to using internal auditors to provide direct assistance:
The external auditor shall:

 Obtain written agreement from an authorized representative of the entity that the internal auditors will
be allowed to follow the E.A instructions, and that the entity will not intervene in the work and
 Obtain written agreement to keep all matters confidential as instructed by the E.A and inform them of
any threat to their objectivity.
Documentation by the External Auditor (IMP)
1. The existence and significance of threats to the objectivity of the internal auditors, and the level of
competence of internal auditors.
2. The basis for the decision regarding the nature and extent of the work performed by the internal
auditors;
3. Who reviewed the work performed and the date and extent of that review in accordance withISA 230;
4. The written agreements obtained from an authorized representative of the entity (may be CEO, CFO
or Head of Internal audit dept ) and the internal auditors; and
5. The working papers prepared by the internal auditors who provided direct assistance.

Summary Notes by SK
ISA 610 - Using the work of Internal Auditors
Areas to be Covered in - ISA 610 Action Plan
1 Evaluating Internal Auditors Work (General Criteria) Learn

2 Using the specific work of Internal Auditors (Specific Criteria) Learn
3 Direct assistance of Internal Auditors Read
4 Areas where direct assistance should not be taken by the internal Learn
Auditors
5 Documentation by the External Auditors Learn

Summary Notes by SK
CA CAF 8 Practice Questions on ISA 610
1 Q. 9 d Sept 2021 4 marks
2 Q.7 b March 2019 4 marks
4 Q6 March 2016 4 marks

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 620 – ‘Using the Work of

An Auditor’s Expert’

Summary Notes by SK
Using the Work of An Auditor’s Expert - ISA 620

DEFINITIONS
1. Auditor’s expert – An individual or organization possessing expertise in a field other than accounting
or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient
appropriate audit evidence.
An auditor’s expert may be either an auditor’s internal expert (who is a partner or staff, including
temporary staff, of the auditor’s firm), or an auditor’s external expert.
2. Management’s expert – An individual or organization possessing expertise in a field other than

accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the
EXAMPLES / AREAS / SITUATIONS WHERE EXPERTS ARE

USED BY THEAUDITOR (IMP)
1. Valuation of land & buildings, plant & machinery or any specialized stock)
2. Valuation of intangible assets.
3. Estimations of oil & gas reserves.
4. Valuation of environmental liabilities.
5. Interpretation of contracts and various laws.
6. Analysis of complex tax issues.
FACTORS TO CONSIDER WHETHER OR NOT TO USE AN EXPERT

(Whether to use the work of an expert or not)
1. Whether management has used a management’s expert in preparing the financial statements. The
nature and significance of the matter, including its complexity.
2. The risks of material misstatement in the matter.
3. The expected nature of procedures to respond to identified risks, including the auditor’s knowledge of
and experience with the work of experts in relation to such matters;
4. The availability of alternative sources of audit evidence.

Summary Notes by SK
TERMS OF AGREEMENT WITH THE AUDITORS EXPERT (IMP)
1. Nature, scope and objectives of the expert’s work
2. The respective responsibilities of the expert and the external auditor
3. The form of the expert’s report ( )
4. Confidentiality requirements for the expert
ASSESSING THE OVERALL WORK OF AN EXPERT ( 04 Points)

The auditor shall:
1. Assess the competence, capabilities and objectivity of the expert
FACTORS TO ASSESS THE COMPETENCE, CAPABILITIES AND

OBJECTIVITY OF AN EXPERT… (IMP)
a) Personal experience with previous work of that expert.
b) Discussions with that expert.
c) Discussions with other auditors or others who are familiar with that expert’s work.
d) Knowledge of that expert’s qualifications, membership of a professional body or industry association,
license to practice, or other forms of external recognition.
e) Published papers or books written by that expert.
f) The audit firm’s quality control policies and procedures
Objectivity of an Expert
 The expert must not be in any type of employment with the audit client.
 The external auditor must not be dependent or related in any form on the audit client
e.g. (He has obtained a loan from the client or is a family relative of the audit client.)
2. Obtain an understanding of the expert’s field of expertise to allow the auditor to determinethe scope of his
work.
3. Obtain an understanding of the expert’s field of expertise to allow the auditor to evaluate the adequacy
of his work.

Summary Notes by SK
4. Evaluate the adequacy of the expert’s work, including the:
a) relevance and reasonableness of the expert’s conclusions
b) consistency of those conclusions with other audit evidence
c) relevance and reasonableness of significant assumptions and methods used
d) relevance, completeness and accuracy of source data.
Note: Generally, the auditor is assessing whether the expert’s work constitutes sufficient and appropriate audit
evidence for the audit.
PROCEDURES TO BE DONE IF WORK OF EXPERT IS NOT ADEQUATE
1. The auditor shall agree with the expert on the extent of further audit procedures to beperformed.
2. The auditor shall perform additional audit procedures.
3. Hire another expert
THE AUDITOR’S RESPONSIBILITY FOR THE AUDIT OPINION
The auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the
auditor’s use of the work of an auditor’s expert.
REFERENCE TO THE AUDITOR’S EXPERT IN THE AUDITOR’S
REPORT
The auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an unmodified
opinion (unless required by law to do so)
If such reference is required by law, the auditor shall indicate in the auditor’s report that the reference does
not reduce the auditor’s responsibility for the auditor’s opinion.
If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such reference is
relevant to an understanding of a modification and in this case experts name will be mentioned in the
modification para with the approval of the expert. (If consent not given,obtain legal advice)
EXAM FOCUS POINT

1) Separate question can be asked on the above ISA.
2) Can also be examined along with the topic of inventory and fixed assets. (in the question of Substantive
Procedure)
3) Can also be examined along with the topic of Audit Report.

Summary Notes by SK
Using the Work of An Auditor’s Expert - ISA 620
Areas to be Covered in - ISA 620 Action Plan
1 Examples / situations where an auditors expert may be used by the E.A Learn
2 Terms / contents of an agreement with an expert Learn
3 Factors to assess the competence, capability and objectivity of an expert Learn
4 Evaluating the adequacy of an Experts work Learn
5 Reference to the work of an Expert in the auditors report Read

Summary Notes by SK
CA CAF 8 Practice Questions on ISA 620
2 Q.5 a March 2020 6 marks
3 Q.7 c September 2017 2 marks

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
‘Internal Control’

Summary Notes by SK
*(This topic to be covered after Test of Controls)
INTERNAL CONTROL
Definition of Internal Control:
An internal control system includes the policies, processes and other aspects of a company that,taken together:
….Facilitates its effective and efficient operation by enabling it to respond appropriately to significant business, operational,
financial, compliance and other risks to achieving the company’s objectives. This includes the safeguarding of assets from
inappropriate use or from loss and fraud, and ensuring that liabilities are identified and managed.
….Internal control is the PROCESS designed and affected by those charged with governance, management and other
personnel, to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial
reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations ...designed and
implemented to address identified business risks that threaten the achievement of any of these objectives.”
Internal control objectives ……………….
1. The orderly and efficient conduct of the business

2. Adherence to internal policies / S.O.P
3. The safeguarding of assets (Co. Assets)
4. The prevention of fraud and error
5. The accuracy and completeness of the accounting records
6. The timely preparation of reliable financial information
Limitations of an Internal Control: OR Why Internal Controls may be ineffective?
Internal control, no matter how well designed and operated, can provide an entity with only about achieving the entity
objectives. The likelihood of achievement is affected by limitations inherent to internal control, these include:
1. Human Errors ( .)
2. Human Judgment ( )
3. Collusion between employees ( )
4. Cost/Benefit Feasibility or
5. Management override of controls
6. Incompetent staff / mgmt. ( )
Components of internal control: (TCM)
1. The Control Environment

2. h
The Entities Risk Assessment Process
3. e
The Information System
4. Control Activities
5. Monitoring
C of Controls
o
n
Page 226 of 370 Prepared
t by M. Sajid Kapadia (ACA, FCCA, APFA)
r
o
Summary Notes by SK
1. The Control Environment:
The auditor should obtain an understanding of the control environment. The control environment includes
the governance and management functions and the attitudes, awareness and actions of TCWG
concerning the entity’s internal control and its importance in the entity.
The control environment sets the tone of an organization, influencing the control consciousness of its people. It
is the foundation for an effective internal control, resulting in overall internal controls in the organization.
The control environment includes the following elements OR say that control environment can beevaluated by
the following factors
Please Learn
Factors for understanding of the control environment are:
Control Environment
Communication and Essential elements which influence the effectiveness of thedesign,
enforcement of integrityand implementation and monitoring of controls.
ethical values ( Eg by Mission and Vision statements of Co.in the annualreports etc)
Commitment tocompetence Management’s consideration of the competence levels for

the particular jobs and how these can be further enhanced.
(Hiring and training the best resource)
Participation by those charged Attributes of those charged with governance such as:
with governance  Extent of involvement
 Appropriateness of actions and interactions with internaland
external auditors
(Involvement of CEO in all Internal control enforcement
sessions and seminars etc.)
Management’s philosophy and  Approach to taking and managing business risks

operatingstyle  Attitudes and actions towards financial reporting
(selecting prudent acc. Policies)
(Is mgmt. Risk seeker or risk averse?)
Organizational structure The framework, within which an entity’s activities for achieving its
objectives are planned, executed, controlled andreviewed.
(Tall structure or flat structure)
Assignment of authorityand How authority and responsibility for operating activities areassigned and
responsibility how reporting and authorization hierarchies are established.
(there must be proper segregation of duties and proper
delegation to assistants)

Summary Notes by SK
Human resource policiesand Recruitment, orientation, training, evaluation, counseling, promoting and
practices compensation of ee’s and remedial actions,ifany. (HR dept. must be very
strong as it plays a very prominent role in developing quality staff for
the
organization)
Methods to determine Control environment:

 Inquiries from management (e.g. From Departmental heads)
 Observing Processes
 Inspection of documents (SOPs , Written code of conduct etc. )
2. The Entities Risk Assessment Process:
In order to design controls that will effectively prevent and detect errors within a system, directors must fully
understand the risks that threaten the system in the first place.
If TCWG do not understand that cash is at high risk of being stolen or being misappropriated, they will not
implement controls such as timely banking, cash reconciliations plus timely bank reconciliations etc.
For financial reporting purposes, the entity's risk assessment process includes how management identifies
business risks relevant to the preparation of F/S in accordance with the entity's applicable FRF. It estimates
their significance, assesses the likelihood of their occurrence, and decides upon actions to respond to and
manage them and the results thereof.
Risks in the F/S can arise or change due to circumstances such as:
 New personnel (New CFO or Director Finance)

 New information systems (Oracle or SAP implemented during the year)
 Rapid growth (Sales Growth by 30 % from Last Year)
 New technology introduced (new method / new formula)
 New products launched (New Civic Model)
 New accounting pronouncements OR new Laws and Regulations (e.g. new IFRS)
3. The Information System:

The auditor is required to consider the information system (M.I.S) relevant to financial reporting system
operating at the client, and should consider what internal controls are there on the Information system
being operated at the client.
Auditor to obtain to understanding of the below mentioned areas:
 The procedure by which business transactions are processed

 The process for preparing F/S including estimates ( eg Provision forLawsuit)
 Controls on adjustments / recurring and non-recurring entries (Customerclaims etc)
 The processes used in the preparation of the financial statements
 How these transactions and other events relevant to the financial reportingprocess are
‘captured’ by the entity

Summary Notes by SK
4. Control Activities also called
The control activities / procedures are those policies and procedures (more detailed day to day operating
procedures) in addition to the control environment which are established to achieve the entities specific/
general objectives.
Please Learn - IMP
They are the application of internal controls.
Examples of control activities
Approval and control of documents Transactions should be approved by an authorized person. For
example, overtime hours should be approved by departmental
managers. Budgets should be approved by B.O.D ….
Controls over computerized Includes General AND Application Controls ( page 97 onwards)
applications
Maintaining the arithmetical For example, checking to see if individual invoices have been added
accuracy of records up correctly and Calculations done accurately (done viaMs Excel
or any accounting software)
Maintaining and reviewing control Control accounts bring together transactions in individual ledgers.
accounts and trial balances Trial balances bring together unusual transactions forthe
organization as a whole. Preparing these can highlight unusual
transactions or account balances.
Reconciliations Reconciliations involve comparison of a specific balance in the
accounting records with what another source says the balance
should be, for example, bank reconciliation. Differences
between the two figures should only be reconciling items.
Comparing the results of cash, For example, in physical count of petty cash, the balance shown in
security and inventory counts with the cash book/ petty cash book (G.L) should be the same as the
accounting records amount held. ( Physical Cash)
Comparing internal data with For example, comparing records of goods dispatched ( )
external sources of information to customers with customers’ acknowledgment of goods that have
been received. Or comparing G.R.N with suppliers invoice
Limiting physical access to assets Only authorized personnel should have access to certain assets
and records (particularly valuable or portable ones) e.g. ensuring that the
inventory stores are properly locked and only authorized store
personnel are allowed access.
Performance Reviews Examples Include:
 Comparing actual performance against budget
 Comparing actual performance against forecast
Comparing actual performance against prior period performance
 Variance analysis and other control reporting for mgmnt

Summary Notes by SK
Segregation of Duties Segregation of duties means dividing the work to be done
between two or more individuals, so that the work done by one
individual acts as a check and balance on the work of the others.
This reduces the risk of error or fraud.
Plan B – (CAR-CAPS)
Comparison Controls Comparisons are a very powerful control. Imagine we budgeted to spend
$ 1m on capital expenditure this year but the actual spend was $2rn.
This could suggest a number of issues:
 perhaps the 'actual' figure is wrong;
 perhaps the budgeting process is inadequate;
 perhaps there was no authorization for the extra $ 1m.
Authorisation An appropriate person should approve transactions. For example,
employee expense claims should be approved by a department manager to
ensure no fraudulent expenses are being claimed.
Reconciliations A bank reconciliation can help to pick up errors between postings in the
cash book and the bank statement
Computer Controls Controls over access to computer systems, such as passwords, can help to
prevent unauthorised access to books and records.
Arithmetical Controls Checking to see if balances have been added up correctly or
if number sequences are complete to detect missing transactions.
Physical Controls Physical controls such as CCTV, safes and locks can help to prevent theft
and unauthorised access.
Segregation of Duties Allocating tasks within an accounting system to different employees
reduces the risk of fraud and makes the detection of errors more likely.
Concept of Segregation of Duties
If several individuals are involved in the completion of an overall task, this increases the likelihood that errors
will be detected when they are made. It is more difficult for a person to commit fraud, when there is proper
segregation of duties.
5. Monitoring of Controls:
Monitoring of controls is a process to assess the effectiveness of internal control’s performance over time, it
involves assessing controls, on a timely basis and taking necessary corrective actions modified for any changes in
conditions. Management accomplishes monitoring of controls through either ongoing activities or separate
evaluations.
Companies are monitoring these internal controls by the help of Internal Audit Function
(ISA 610)

Summary Notes by SK
‘Internal control of a Small

Company’

Summary Notes by SK
Small Company and its Internal Control
1. General definition of a Small Company

2. Features/characteristics of a Small Company.
3. Problems of a small Company for an External Auditor
i. Problems of internal control in a small company &
ii. Difficulty to obtain audit evidence and the impact on audit approach in the case of a small
company.
A small entity is an enterprise in which:

 There is concentration of ownership and management with a small number of individuals (often
a single individual or Group of Individuals)
 One or more of the following characteristics are also found:
 Few sources of income and uncomplicated activities (Simple Trading of Few Commodities like Sole
proprietorship)
 Unsophisticated record keeping (Receipts and payments a/c only)
 Limited internal controls
 Straightforward or uncomplicated transactions
 Few lines of business / few products
 Few personnel / employees.
General Features of a Small Company:

1. These are mostly managed by a single individual i.e. denominated by a single member e.g. (Naheed Super
Store, Agha s Super store, Arif Habib Investments, Jahangir Siddiqui Groupetc.)
2. They have weak internal controls. (Can’t afford lot of staff members)
3. There is no segregation of duties. (as its not cost feasible)
4. There is lack of experienced and qualified staff. (Cannot hire ACCAs and CAs)
5. There is lack of evidence as less documentation and records are maintained. (Fewer Books of accounts)
6. There are mostly chances of management override of controls. (as Mgmt. is closely involvedat all times)
7. In the audit of small companies, the emphasis of auditor is more towards verification of financial
numbers rather than testing of controls.
8. Auditor independence is impaired in the audits of small companies as auditor also performs some
accountancy work for the client as small companies expect external auditors to provide professional advice
and guidance on various matters including accountancy matters.

Summary Notes by SK
Internal control problems in a small Company
1. Most internal controls / SOPs are not practicable for small companies however, important internal
control in a small co. is the close involvement of directors/ owners in day to day controls. This close
involvement may, however, result in management override of controls which may result in some
control weakness.
2. Auditors, auditing small companies face problem of insufficient evidence with respect to both Test of
Controls and Substantive procedures i.e. In the case of TOC’s there is little evidence that whether
control is operating effectively or not.
3. Small companies should focus on setting good ethical behavior & integrity values to strengthen internal
controls so that external auditor can place reliance on the same during the audit.
4. Where managers of small company are not the owners, in this case risk for an external auditor further
increases because of weak control environment.
5. Small companies do however, have some primary internal controls like management’s sole authority on
sales, purchases and payments, controls on cash and fixed assets……leading to correct balances in the
balance sheet.
6. If these controls can be relied upon, than the extent of substantive procedures on P&L and B/S might
decrease thereby reducing the audit risk to an acceptably low level.
Problems of Internal Controls for small entities

Many control activities that are found in a large company may be inappropriate for a small entity because
they are too costly or impractical to apply.
Segregation of duties is an obvious example of this. It is difficult to segregate duties in a small company
with only a few employees. The same individual has to carry out a variety of different tasks.
Often, control systems in small entities are based on a high level of involvement by the directors or owners.
Authorisations of the owner-manager personally authorising many transactions, mighttherefore be a key feature
of control systems. The active involvement of an owner-manager might mitigate risks arising from a lack of
segregation of duties.
However, because of active involvement of the owner-manager the attitudes and actions of that person will
be key to the auditor’s risk assessment. There is unlikely to be a written code of conduct so a culture of
integrity and ethical behaviour will be important.
The following problems may arise when internal control systems rely excessively on the involvement of
TOP/senior management.
 There may be a lack of evidence as to how systems are supposed to operate. The auditor willneed to
rely more on enquiry than on review / inspection of documentation.
 There may be lack of evidence of controls being actually operated. (How does the auditorknow that the
controls exist and are being applied?).
 Management may override internal controls.
 Management may lack the necessary expertise. (Lack of qualification or experience)
 There is unlikely to be any independent person within the management team as there wouldbe
within BOD of a large entity.

Summary Notes by SK
Audit Approach
When auditing a small entity, the auditor needs to understand and evaluate whatever controls are in
operation. It is likely …………. that a lower level of reliance will be placed on controls in a smaller entity,
and that a large sample size of ........................................... substantive testing will therefore be required
to reduce the audit risk to an acceptably low level.
(__________________________________________________________________________________)
Conclusion

Summary Notes by SK
‘Documentation of an accounting and

internal control system’

Summary Notes by SK
Documentation of accounting and internal control systems of the AUDIT
CLIENT.
The auditors must keep a record of the client's accounting and internal control system which must be updated
each year. This can be documented through the use of narrative notes, flowcharts, questionnaires or
checklists.
There are several techniques for recording the internal control system as follows:
• Narrative notes
• Questionnaires
• Flowcharts
• Checklists
Narrative notes
The purpose of narrative notes is to describe and explain the accounting & internal control system e.g. Sales and
Purchase system.
Narrative notes
Advantages Disadvantages
They are relatively simple to record and can Describing something in narrative notes can be a
facilitate understanding to all. lot more time consuming.
They can be used for any They are awkward

Acc. system due to the method’s flexibility. to update if written manually.
Flowcharts
Flowcharts can take many forms, but in general are graphic illustrations of the physical flow of information
through the accounting system. This can sometimes help the auditor to identify weakness in controls more
easily than by reading narrative notes.
Flowcharts have certain advantages and disadvantages.
Advantages
Can be prepared quickly.
Flow Charts are fairly easy to follow and to review.
They generally ensure that the system is recorded in its entirety i.e. completely.
Disadvantages
They are ONLY most suitable for describing standard systems.
Major amendment is difficult without redrawing.
Time can sometimes be wasted by charting areas that are of no audit significance.

Summary Notes by SK
An example of flowchart is as follows:
Internal Control Questionnaires (ICQs)

In respect of questionnaires, there are 02 types:
 Internal Control Questionnaires (ICQs) are used to ask whether controls exist which meet
specificcontrol objectives.
 Internal Control Evaluation Questionnaires (ICEQs) are used to determine whether there are
controls which prevent or detect specified errors /omissions / Frauds.
They comprise a list of questions designed to determine whether desirable controls are present or not.
Questionnaires are answered by stating a 'YES' or 'NO' and a 'NO' answer indicates a deficiency in the
internal control system.
An example I.C.Q in PURCHASE CYCLE………
Are PURCHASES made from only authorized suppliers?

Are Purchase Orders made and approved?
YES/NO/Comments or Remarks
Internal Control Evaluation Questionnaires (ICEQs)

The characteristic of ICEQs is that they concentrate on the significant frauds, errors or omissions thatcould occur
at each phase / step of the appropriate cycle and see if controls are operating or not.
Main Control Qs
Is Sales Invoice made at the time of shipment of GOODS ?......................... e.g. of ICQ
a) Is there segregation of duties when making sales invoices?
b) Are invoices sequentially pre-numbered?
c) Are invoices checked for Quantity? ICEQ
d) Are invoices checked for authorized
prices? Advantages and disadvantages
of ICQs and ICEQs
ICQs and ICEQs
Adv. Dis-adv.
If drafted thoroughly, they can ensure all They can be drafted vaguely, hence misunderstood and
controls are considered important controls not identified

Summary Notes by SK
They are quick to prepare They may contain a large number of irrelevant controls
They are easy to use and control They may not include unusual controls, which are
nevertheless effective in particular circumstances
Checklists
Checklists may be used instead of questionnaires to evaluate the internal control system. The difference is that,
instead of asking questions, statements are made to ‘mark off’ and tick boxes are used to indicate where the
statement holds true.
For example a checklist may state ‘GOODS are examined on arrival as to quantity and quality’ which would be
ticked (√) if this control does actually occur, or crossed if not. (Simply checking that whether statement holds true
or not!)
(Checklists share many of the same advantages and disadvantages of IQCs and ICEQs.)
(*Please cover this, after covering the concept of walkthrough test) Question:
Explain the steps the external auditor should take to confirm the accuracy of flowcharts / documentation in the
working paper file.
Steps to confirm Prior year system notes & Flowcharts and other documentation
of Internal control system
1. Obtain system notes/documentation form last year working paper fileand ensure they are complete.
2. Review prior year M.L to identify the recommendation that were made last year as this may result in
changes on the system notes / control documentation for the current year.
3. Obtain system documentation/system flowchart from the management to identify any changes made
in last 12 months.
4. Interview the client staff/ management to determine that either any controls / S.O.P’s have change during
the last year.
5. Perform walk-through tests by tracing a single transaction throughout that system to ensure and verify that
system notes/ documentation is accurate.
During the walk-through test, confirms that notes/ documentation reflects the current S.O.P in place.

Summary Notes by SK

Summary Notes by SK
ACCA F8 & CA CAF 8 Practice Questions
on Internal Control and IC. Documentation

ACCA
1 Q. 16 b Sept/Dec 2017 5 marks
2 Q. 18 a March/June 2017 4 marks
4 Q. 2 a June 2015 5 marks
5 Q. 3 a Dec 2013 6 marks
6 Documenting Internal Controls (June 2011) 10 marks
7 ICQs and ICEQs 10 marks
ICAP
9 Q. 1 c Sept 2016 3 marks

Summary Notes by SK
ACCA F8 Sept / Dec 2017 (5 marks)

Question 16 b
You are an audit supervisor of Halley & Co and you are reviewing the documentation describing Comet
Publishing Co’s purchases and payables system in preparation for the interim and final audit for the year ending 30
September 20X7. The company is a retailer of books and has ten stores and a central warehouse, which holds the
majority of the company’s inventory.
Your firm has audited Comet Publishing Co for a number of years and as such, audit documentation is available
from the previous year’s file, including internal control flowcharts and detailed purchases and payables system notes.
As far as you are aware, Comet Publishing Co’s system of internal control has not changed in the last year. The
audit manager is keen for the team to utilise existing systems documentation in order to ensure audit efficiency. An
extract from the existing systems notes is provided below.
Extract of purchases and payables system

Store managers are responsible for ordering books for their shop. It is not currently possible for store managers to
request books from any of the other nine stores. Customers who wish to order books,which are not in stock at the
branch visited, are told to contact the other stores directly or visit the company website. As the inventory levels
fall in a store, the store manager raises a purchase requisition form, which is sent to the central warehouse. If
there is insufficient inventory held, a supplier requisition form is completed and sent to the purchase order clerk,
Oliver Dancer, for processing. He sends any orders above $1,000 for authorisation from the purchasing director.
Receipts of goods from suppliers are processed by the warehouse team, who agree the delivery to the purchase order,
checking quantity and quality of goods and complete a sequentially numbered goods received note (GRN). The
GRNs are sent to the accounts department every two weeks for processing.
On receipt of the purchase invoice from the supplier, an accounts clerk matches it to the GRN. Theinvoice is then
sent to the purchase ordering clerk, Oliver, who processes it for payment. The finance director is given the total
amount of the payments list, which she authorises and then processes the bank payments. Due to staff shortages in the
accounts department, supplier statement reconciliations are no longer performed.
Answer 16 b:
Steps to confirm prior year flowcharts and system notes

 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 forinvestigation 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.

Summary Notes by SK
 Interview client staff to ascertain whether systems and controls have changed including the stores and warehouse
to ensure that the flowcharts and notes produced last year is correct.
 Perform walk-through tests by tracing a sample of transactions through the purchases and payables system to
ensure that the flowcharts and systems notes contained on the audit file are accurate.
 During the walk-through tests, confirm the systems notes and flowcharts accurately reflect the control procedures
which are in place and can be used to identify controls for testing.
------------------------------------------------------------------------------------------
ACCA F8 Mar June 2017 (4 marks)
Question 18 a:
a. ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment requires auditors to obtain an understanding of control activities relevant to the audit.
Control activities are the policies and procedures which help ensure that management directives arecarried out.
Required:
Describe FOUR different types of control activities and, for each type, provide an example control a
company may implement.
Answer 18 a:
Control activities
 Segregation of duties – assignment of roles or responsibilities to ensure the tasks of authorising and
recording transactions and maintaining custody of assets are carried out by different people, thereby
reducing the risk of fraud and error occurring. For example, the purchase ledger clerk recording
invoices onto the purchase ledger, and the finance director authorising the payment of those purchase
invoices.
 Information processing – controls including application and general IT controls, which ensure the
completeness, accuracy and authorisation of information being processed. For example, use of batch
control totals when entering transactions into the system.
 Authorisation – approval of transactions by a suitably responsible official to ensure transactions are

genuine. For example, authorisation by a responsible official of all purchase orders.
 Physical controls – restricting access to physical assets as well as computer programs and data files,
thereby reducing the risk of theft. For example, cash being stored in a safe which only a limited
number of employees are able to access.
 Performance reviews – comparison or review of the performance of the business by looking at areas
such as budget versus actual results. For example, the review by department heads of monthly results
of actual trading to budget and prior year, with analysis of variances.
------------------------------------------------------------------------------------------

Summary Notes by SK
ACCA F8 Sept 2016 (6 marks)
Question 16 a
Heraklion Co is a manufacturer of footballs and is a new audit client for your firm. You are an audit supervisor
of Spinalonga & Co and are currently preparing for the forthcoming interim and final audit for the year ending
31 October 20X6. You are required to document and assess the sales system, recommend control improvements
to deal with a specific fraud issue as well as undertake substantive testing of revenue.
Sales ordering, goods despatched and invoicing
Heraklion Co sells footballs to a range of large and small sports equipment retailers in several countries. Sales
are made through a network of sales staff employed by Heraklion Co, but new customer leads are generated
through a third party company. Sales staff are responsible for assessing new customers’ creditworthiness and
proposing a credit limit which is then authorised by the sales director. The sales staff have monthly sales targets
and are able to use their discretion in granting sales discounts up to a maximum of 10%. They then record any
discount granted in the customer master data file.
The sales staff visit customer sites personally and orders are completed using a two-part pre-printed order form.
One copy is left with the customer and the other copy is retained by the sales person. The sales order number is
based on the sales person’s own identification (ID) number.
The company markets itself on being able to despatch all orders within three working days. Once the order is
taken, the sales person emails the finance department and warehouse despatch team with the customer ID and
the sales order details and from this a pick list is generated. Sequentially numbered goods despatched notes are
completed and filed in the warehouse.
Sequentially numbered invoices are generated using the pick lists for quantities and the customer master data
file for prices. Standard credit terms for customers are 30 days and on a monthly basis sales invoices which are
over 90 days outstanding are notified to the relevant sales person to chase payment directly with the customer.
Required:
Describe TWO methods for documenting the sales system, and for each explain ONE advantage and ONE
disadvantage of using this method.
Answer 16 a:
a. Documenting the sales system
There are several methods which can be used to document the sales system.
Narrative notes
Narrative notes consist of a written description of the system; they would detail what occurs in thesystem at
each stage and would include any controls which operate at each stage.
Advantages of this method include:
 They are simple to record; after discussion with staff members, these discussions are easily written up
as notes.
 They can facilitate understanding by all members of the audit team, especially more junior members
who might find alternative methods too complex.

Summary Notes by SK
Disadvantages of this method include:
 Narrative notes may prove to be too cumbersome, especially if the system is complex or heavily
automated.
 This method can make it more difficult to identify missing internal controls as the notes record the
detail but do not identify control exceptions clearly.
Questionnaires
Internal control questionnaires (ICQs) or internal control evaluation questionnaires (ICEQs) contain a list of
questions; ICQs are used to assess whether controls exist whereas ICEQs assess the effectiveness of the
controls in place.
 Questionnaires are quick to prepare, which means they are a timely method for recording the
system.
 They ensure that all controls present within the system are considered and recorded; hence
missing controls or deficiencies are clearly highlighted by the audit team.

 It can be easy for the staff members to overstate the level of the controls present as they are asked a
series of questions relating to potential controls.
 A standard list of questions may miss out unusual or more bespoke controls used by thecompany.
Flowcharts
Flowcharts are a graphic illustration of the internal control system for the sales system. Lines usually
demonstrate the sequence of events and standard symbols are used to signify controls or documents.
 It is easy to view the system in its entirety as it is all presented together in one diagram.
 Due to the use of standard symbols for controls, it can be effective in identifying missing
controls.
 They can sometimes be difficult to amend, as any amendments may require the whole
flowchart to be redrawn.
 There is still the need for narrative notes to accompany the flowchart and hence it can be a time-
consuming method.
Note: Full marks will be awarded for describing TWO methods for documenting the sales system and
explaining ONE advantage and ONE disadvantage for each method.
------------------------------------------------------------------------------------------

Summary Notes by SK
Question 2 a
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity andIts Environment
describes the five components of an entity’s internal control.
Required:
Identify and briefly explain the FIVE components of an entity’s internal control.
Answer 2 a:
a. Internal control components
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and
Its Environment considers the components of an entity’s internal control. It identifies the following components:
Control environment
The 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 internal control and its
importance in the entity. The control environment sets the tone of an organisation, influencing the control
consciousness of its people.
The control environment has many elements such as communication and enforcement of integrity and ethical
values, commitment to competence, participation of those charged with governance, management’s philosophy
and operating style, organisational structure, assignment of authority and responsibility and human resource
policies and practices.
Entity’s risk assessment process

For financial reporting purposes, the entity’s risk assessment process includes how management identifies business
risks relevant to the preparation of financial statements in accordance with the entity’s applicable financial reporting
framework. It estimates their significance, assesses the likelihood of their occurrence, and decides upon actions
to respond to and manage them and the results thereof.
Information system
The information system relevant to financial reporting objectives, which includes the accounting system, consists of
the procedures and records designed and established to initiate, record, process, and report entity transactions (as well
as events and conditions) and to maintain accountability forthe related assets, liabilities, and equity.
Control activities relevant to the audit
Control activities are the policies and procedures which help ensure that management directives are carried out.
Control activities, whether within information technology or manual systems, have various objectives and are
applied at various organisational and functional levels.
Monitoring of controls
Monitoring of controls is a process to assess the effectiveness of internal control performance over time. It involves
assessing the effectiveness of controls on a timely basis and taking necessary remedial actions. Management
accomplishes the monitoring of controls through ongoing activities, separate evaluations, or a combination of the
two. Ongoing monitoring activities are often built into the normal recurring activities of an entity and include
regular management and supervisory activities.

Summary Notes by SK
Question 3 a
You are a member of the recently formed internal audit department of Oregano Ltd (Oregano). The company
manufactures tinned fruit and vegetables which are supplied to large and small food retailers. Management and
those charged with governance of Oregano have concerns about the effectiveness of their sales and despatch
system and have asked internal audit to document and review the system.
Sales and despatch system

Sales orders are mainly placed through Oregano’s website but some are made via telephone. Online orders are
automatically checked against inventory records for availability; telephone orders, however, are checked
manually by order clerks after the call. A follow-up call is usually made to customers if there is insufficient
inventory. When taking telephone orders, clerks note down the details on plain paper and afterwards they
complete a three part pre-printed order form. These order forms are not sequentially numbered and are sent
manually to both despatch and the accounts department.
As the company is expanding, customers are able to place online orders which will exceed their agreed credit
limit by 10%. Online orders are automatically forwarded to the despatch and accounts department.
A daily pick list is printed by the despatch department and this is used by the warehouse team to despatch
goods. The goods are accompanied by a despatch note and all customers are required to sign a copy of this. On
return, the signed despatch notes are given to the warehouse team to file.
The sales quantities are entered from the despatch notes and the authorised sales prices are generated by the invoicing
system. If a discount has been given, this has to be manually entered by the sales clerk onto the invoice. Due to
the expansion of the company, and as there is a large number of sale invoices, extra accounts staff have been
asked to help out temporarily with producing the sales invoices. Normally it is only two sales clerks who
produce the sales invoices.
Required:
(a) Describe TWO methods for documenting the sales and despatch system; and for each explain an advantage
and a disadvantage of using this method.
Answer 3 a:
a. Documenting the sales and despatch system

There are several methods which can be used by the internal audit department of Oregano Ltd (Oregano)
to document their system.
Narrative notes
Narrative notes consist of a written description of the system; it would detail what occurs in the system at
each stage and would include any controls which operate at each stage.
 They are simple to record; after discussion with staff members of Oregano, these discussions
are easily written up as notes.
 They can facilitate understanding by all members of the internal audit team, especially more
junior members who might find alternative methods too complex.

Summary Notes by SK
 Narrative notes may prove to be too cumbersome, especially if the sales and distribution system is
complex.
 This method can make it more difficult to identify missing internal controls as the notes record the
detail but do not identify control exceptions clearly.
Questionnaires
Internal control questionnaires (100) or internal control evaluation questionnaires (ICEQ) contain a list of
questions; ICes are used to assess whether controls exist whereas ICEQs test the effectivenessof the controls.

 Questionnaires are quick to prepare, which means they are a timely method for recording the
system.
 They ensure that all controls present within the system are considered and recorded; hence
missing controls or deficiencies are clearly highlighted by the internal audit team.

 It can be easy for the staff members of Oregano to overstate the level of the controls present as they are
asked a series of questions relating to potential controls.
 A standard list of questions may miss out unusual controls of Oregano.
-------------------------------------------------------------------------------------
Flowcharts
Flowcharts are a graphic illustration of the internal control system for the sales and despatch system. Lines usually
demonstrate the sequence of events and standard symbols are used to signify controlsor documents.

 It is easy to view the sales system in its entirety as it is all presented together in one diagram.
 Due to the use of standard symbols (or controls, they are easy to spot as are any missing controls.

 They can sometimes be difficult to amend, as any amendments may require the whole flowchart to be
redrawn.
 There is still the need for narrative notes to accompany the flowchart and hence it can be a time consuming
method.
Note: Full marks will be awarded for describing TWO methods for documenting the sales and despatch
system and explaining ONE advantage and ONE disadvantage for each method.
---------------------------------------------------------------------------------------------------------------------------------

57 Documenting Internal Control
a. Auditors are required to document their understanding of the client's internal controls. There are various options
available for recording the internal control system. Two of these options are narrative notes and internal control
questionnaires.

Summary Notes by SK
Required:
Describe the advantages and disadvantages to the auditor of narrative notes and internal control questionnaires as
methods for documenting the system. (6 marks)
b. ISA 315 requires auditors to obtain an understanding of control activities relevant to the audit.
Control activities are the policies and procedures which help ensure that management directives are carried out;
and which are designed to prevent and detect fraud and error occurring. An example of a control activity is
maintained of a control account.
Required:
Apart from maintained of a control account, explain four control activities a company may undertake to
prevent and detect fraud and error. (4 marks)
Answer 3 a:
a. Narrative notes
They are relatively simple to record and can facilitate Describing something in narrative notes can be a
understanding by all audit team members. lot more time consuming than, say,
representing it as a simple flowchart,
particularly where the system follows a logical flow.
They can be used for any system due to the They are awkward to update if written manually
methods’ flexibility.
Editing in future years can be relatively easy if they are It can be difficult to identify missing internal
computerised. controls because notes record the detail of
systems but may not identify control exceptions
clearly.
Internal control questionnaires

The principal disadvantage is that they can be
drafted vaguely, hence misunderstood and important
controls not identified.
They are quick to prepare. They any contain a large number of irrelevant
controls.
They are easy to use and control. They may not include unusual controls, which are
nevertheless effective in particular circumstances.
(Note. Only six valid points were needed to obtain full marks.)

Summary Notes by SK
Control activities includes:
Approval and control of documents Transactions should be approved by an
appropriate person (e.g. overtime should be
approved by departmental managers)
Checking the arithmetical accuracy records For example, checking to see if individualinvoices
have been added up correctly.
Reconciliations Reconciliations involve comparison of a specific
balance in the accounting records with whatanother
source says the balance should be, for example, a
bank reconciliation. Differences between the two
figures should only be reconciling items.
Segregation of duties Allocation of roles and responsibilities to two or more

different person such that the risk of an individual
being able to perpetrate fraud id
reduced.
Comparing internal data with external sources of For example, comparing records of goods dispatched
information to customers with customers' acknowledgement of
goods that have been
received
Limiting physical access to assets and records Only authorized personnel should have access to
certain assets (particularly valuables or portable ones)
e.g. ensuring that the inventory stores locked are
unless store personnel are there.
Controls over information processing Computer controls are put in place including general
IT controls. These cover a range of applications and
support the overall IT environment and application
controls, which can be manual or automated controls
and which operate on a cycle/business process level.
Performance reviews A comparison or review of the performance of

the business is carried out by looking at areas such as
budget v actual result.
-----------------------------------------------------------------------------------------------
61 ICQs and ICEQs (ACCA F8) (10 marks)
ISA 315 Identifying and assessing the risks of material misstatement through understanding the entity and its environment
details the auditor's responsibilities in relation to an entity's system of internal controls.

Summary Notes by SK
Required:
a. Explain the auditor's responsibilities in relation to an entity's system of internal controls. (3)
b. Other than internal control questionnaires and internal control evaluation questionnaires state
two methods which an auditor may use to document an entity's internal controls. (1)
c. Explain what is meant by 'internal control questionnaires' and 'internal control evaluation
questionnaires’. For each type of questionnaire, give one example of a question that might be
included in respect of the purchases cycle (6)
Answer 61:
a. The auditor should obtain an understanding of internal controls relevant to the audit. They should:
 Obtain an understanding of the entity and the risks it is exposed to
 Ascertain the nature of the entity's internal control system and assess the Impact of this on the
level of audit risk
Decide whether the internal control system is sufficient to gather audit evidence through testsof
control with reduced substantive testing or whether full substantive testing is required
 Report any significant deficiencies in internal control to those charged with governance
b. Narrative notes and flow charts.
c. Internal Control Questionnaires (ICQs)

IQCs are used to ask whether controls exist which meet specific control objectives. They comprise a list of
questions designed to determine whether desirable controls are present, and are formulated so that there is
one to cover each of the major transaction cycles.
An ICQ is therefore designed to help evaluate the system as well as to record it. One of the most effective
ways of designing the questionnaire is to phrase the questions so that all the answers can be given as 'YES' or
'NO' and a 'NO’ answer indicates a deficiency in the system.
For example, one question in respect of the purchases cycle might be 'Are purchase invoices matched and
compared to goods received notes before being passed for payment?'
Internal Control Evaluation Questionnaires (ICEQs)
ICEQs have a different focus from ICQs and are concerned with assessing whether specific errors (or frauds)
are possible, rather than establishing whether certain desirable controls are present. This is achieved by
reducing the control criteria for each transaction stream down to a handful of key questions (or control
questions).
The characteristic of these questions is that they concentrate on the significant errors or omissions that could
occur at each phase of the appropriate cycle if controls are weak (deficient).
For example, one of the questions in the purchases cycle might be ‘Is there reasonable assurance that goods or
services could not receive without a lability being recorded’?

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 700 - ‘Audit Report’

Summary Notes by SK

Summary Notes by SK
Audit Report- CA CAF 8 Past Papers Index
S. No. Attempt Question Marks
1 Sep-22 Q/s marks
2 Mar-22 Q/s marks
3 Sep-21 Q/s 3 18 marks
4 Mar-21 Q/s 6 18 marks
6 Mar-20 Q/s 3 b 08 marks
10 Mar-18 Q/s 4a 12 marks
15 Mar-14 Q/s 8 (ii,iii,iv) 7 marks
17 Sep-11 Q/s 8 b + c 14 marks
18 Mar-11 Q/s 8 a & b (iii) 7 marks

Summary Notes by SK
Expected Questions on ‘Audit Report’
1. List & briefly explain the contents of an external audit report as per ISA 700
(Revised).
2. List the contents of an audit report and also explain the reasons for such para in
the audit report/ appropriateness of such statements in the audit report.
3. Explain the term modified opinion as per ISA 705.
4. Briefly explain the types of modifications.
5. Explain the term unmodified opinion and also draft an opinion paragraph for
such an opinion.
6. Briefly list the contents of an auditor’s responsibility para
as per ISA 700.
7. Identify & explain the errors in the given extracts of an audit report.( few imp
paras )
8. Define / briefly explain the term pervasive & explain with examples.
9. Briefly explain the conditions of an E.O.M para & also list the example of
situations under which an E.O.M para can be given by the Auditor.
10. List the contents of an E.O.M para / Features of an E.O.M para.
11. Briefly explain the conditions of an O.M para & also list the example of
situations under which an O.M para can be given by the Auditor.
12. Briefly list the contents of a basis for modification paragraph.
13. List the changes in the audit report as per ISA 705 in the case
of a disclaimer of opinion.
14. Define KAM & list the factors to be considered by the
auditor to place KAM para in the audit report.
15. List the contents of KAM para as per ISA 701.
16. Scenario based question (V. Imp)
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________

Summary Notes by SK
Example of an Unmodified Opinion
To the Shareholders of Company
Opinion
We have audited the financial statements of ABC Company (the Company), which comprise the statement of
financial position as at December 31, 2OX1, and the statement of comprehensive income, statement of
changes in equity and statement of cash flows for the year then ended, and notes to the financial statements,
(2nd Para – This is opinion on the F/S)

In our opinion, the accompanying financial statements present fairly, in all material respects, (or
give a true and fair view) of the financial position of the Company as at December 31, 20X1, and
(of) its financial performance and its cash flows for the year then ended in accordance with international
Financial Reporting Standards (IFRS).
Basis for Opinion para (This is standard para)

We conducted our audit in accordance with international Standards on Auditing (ISAs). Our responsibilities
under those standards are further described in the Auditors Responsibilities for the Audit of the Financial
Statements section of our report. We are independent of the Company in accordance with Code of Ethics for
Professional Accountants (IESBA Code) together with the ethical requirements that are relevant to our audit
of the financial statements, and we have fulfilled our other ethical responsibilities in accordance with these
requirements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our opinion.
Key Audit Matters (ISA 701) ------Significant Matters for the current period
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit
of the financial statements of the current period. These matters
thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with ISA 701, which applies to audits of the financial
statements of listed entities.]

Summary Notes by SK
Other Information (ISA 720) ………..( Not examined in CAF 9 Syllabus)……..xxx……
Responsibilities of Management and Those Charged with Governance for the
Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in accordance
with IFRS and for such internal control as management determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error.
(To be covered in ISA 570)

In preparing the financial statements, management is responsible for assessing the Company’s ability to
continue as a going concern, disclosing, as applicable, matters related to going concern and using the going
concern basis of accounting unless management either intends to liquidate the Company or to cease
operations, or has no realistic alternative but to do so.
Auditor’s Responsibilities for the Audit of the Financial Statements (Most Important
para)
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our
opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in
accordance with ISAs will always detect a material misstatement when it exists.
financial statements. (Concept of Materiality)
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional
skepticism throughout the audit. We also:
1. Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or
error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is
sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material
misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve
collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
that are appropriate in the circumstances, but NOT for the purpose of expressing an opinion on
the effectiveness of the Company’s internal control.
estimates and related disclosures made by management.
(To be covered under ISA 570)

 Conclude on the appropriateness of management’s use of the going concern basis of accounting and,
conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If
we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report
Summary Notes by SK
to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify
our opinion.
Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report.
However, future events or conditions may cause the Company to cease to continue as a going concern.
manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned scope and
timing of the audit and significant audit findings, including any significant deficiencies in internal control that
we identify during our audit. (Refers to M.L)
(in the case of Listed company)
We also provide those charged with governance with a statement that we have complied with relevant ethical
requirements regarding independence, and to communicate with them
all relationships and other matters that may reasonably be thought to bear on our independence, and where
applicable, related safeguards.
(in the case of Listed company)

From the matters communicated with those charged with governance, we determine those matters that were of
most significance in the audit of the financial statements of the current period and are therefore the key audit
matters. We describe these matters in our auditor’s report unless law or regulation precludes public-disclosure
about the matter or when, in extremely rare circumstances, we determine that a matter should not be
communicated in our report because the adverse consequences of doing so would reasonably be expected to
outweigh the public interest benefits of such communication.
Report on Other Legal & Regulatory Requirements

(This para depends upon the local law of the respective country)
[The form and content of this section of the auditor’s report would vary depending on the nature of the
auditor's other reporting responsibilities prescribed by local law or national auditing standards.]
Name of Engagement Partner
Auditors Signature
(The report can be signed in the name of the audit firm OR in the personal name of the sole partner, as the
case may be.)
Auditors Address
Date of Audit Report (D.O.R)

Summary Notes by SK
Shortcut to Remember contents
Exam Focused Points

Summary Notes by SK
Contents of an Audit Report (ISA 700 Revised)
Explanation
The auditor’s report must have a title that clearly indicates that it is the
Title of the Report report of the independent auditor. This signifies that the auditor has met
all the ethical requirements concerning independence and therefore
distinguishes the auditor’s report from other reports.
Addressee The address will be determined by the law or regulation, but is likely to
be the shareholders or those charged with governance.
Opinion paragraph The opinion paragraph must identify the entity being audited, state that
the financial statement have been audited, identify the title of each
statement that comprises the F/S being audited refer to the summary of
significant accounting policies and other explanatory notes, and specify
the notes, and specify date or period covered by each statement
comprises the financial statements
If the auditor expresses an unmodified opinion on financial, the opinion

shall use one of the following equivalent phrases
 The financial statements present fairly, in all material respects,

OR give a true and fair view of …. In accordance with [the
applicable financial reporting framework eg IFRS].
Basis for opinion Para The basis for opinion paragraph must state that the audit was
conducted in accordance with ISAs, and refer to the Auditor’s
responsibilities for the audit of the financial statements’ section which
describes the auditor’s responsibilities under the ISAs.
The Auditor must also state that they are independent of audited
entity, in accordance with the relevant ethical requirements relating to
the audit.
Finally, the auditor must state that they believe the audit evidence
obtained is sufficient, and appropriate to provide a basis for the audit
opinion.
Key audit matters (ISA 701) For the audit of listed entities, or where required by law or regulation,
the auditor should include Key audit matters section. This section
describes the matters that, in the auditor’s professional, judgment, are
most significant to the audit of the current period.
Other information For the audit of listed entities or any other entity where the auditor has
(ISA 720) obtained other information, another information section should be
included in the auditor’s report. This section should include
 A statement that management is responsible for the other
information

Summary Notes by SK
 A statement that the auditor’s opinion does not cover the other
information
 A description of auditor’s responsibilities for reading

considering and reporting on other information, and
 Where other information has been obtained, either a auditor has

nothing to report, or a description of any uncorrected material
misstatement.
Responsibilities for the Financial This part of the report describes the responsibilities of those who are
statements responsible for the preparation of the financial statements. This section
(Mgmt. and TCWG) should describe management’s responsibilities including the following
 The preparation of financial statement in accordance with the

applicable financial reporting framework;
 The implementation of such internal control as are necessary to

enables the preparation of the financial statements that are free
from material misstatement, whether due to error or fraud.
 The assessment of the entity’s ability to continue as a going

concern, the appropriateness of the going concern basis of
accounting and adequacy of its disclosures;
Auditor's responsibilities for the  The auditor’s objectives are to obtain reasonable assurance
audit of financial statements whether the financial statements as a whole are free from
material misstatement, and to issue an auditor’s report that
includes the auditor’s opinion; and
 Reasonable assurance is a high level of assurance, but is not a
guarantee that an audit conducted in accordance with the ISAs
will always detect a material misstatement when it exists.
The report must also:

 Explain that misstatements can arise from fraud or error
 Describe the meaning of materiality
 Explain that the auditor exercises professional judgment and
maintains professional skepticism throughout the audit
 Describe the auditor’s responsibilities in an audit.
If the auditor is required by law to report on any other matters, this

Other reporting responsibilities must be done in an additional paragraph titled ‘Report on the other
legal and regulatory requirements or otherwise as appropriate’.

Summary Notes by SK
Name of the engagement partner The name of engagement partner should be identified in the Audit
report.
The report must contain the auditor’s signature, whether this is the
Auditor’s signature auditor’s own name or the audit firm’s name.
Auditor’s Address The location where the auditor practices must be mentioned.
Date of the report (D.O.R) The report must be dated no earlier than the date on which the auditor
has obtained sufficient appropriate audit evidence on which to base the
auditor’s opinion.
Types of Audit Opinions

1. Unmodified Opinion
This opinion is expressed when there is no Material misstatement and there is no inability to obtain
sufficient appropriate audit evidence by the External auditor.
2. Modified Opinion (Covered under ISA 705)

When the audit opinion is not in the original form i.e. other than unmodified opinion.
There are three types of modified opinions.
 Qualified opinion
 Adverse opinion
 Disclaimer of opinion
Core elements of an Audit Report (as per ISA 700 Revised)
Shortcut is TOK-BRAND (there are 13 contents)
(Already covered in previous handout)
When auditor MODIFY’s the AUDIT opinion…….
The ISA 705 states that the auditor shall modify the opinion in the auditor’s report when:
 The auditor concludes that, based on the audit evidence obtained, the financial statements
as a whole are not free from material misstatement; or
 The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement.

Summary Notes by SK
Modified Opinions:
Qualified Opinion, Adverse Opinion and a
Disclaimer of Opinion
Concept of Pervasive:
Definition
A term used, in the context of misstatements, to describe the effects on the financial statements of
misstatements or the possible effects on the financial statements of misstatements, if any, that are undetected
due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial statements
are those that, in the auditor’s judgment:
1. Are not confined to specific elements, accounts or items of the financial statements;
(Misstatements are multiple and are in various heads of both P&L and B/S and multiple elements could
not be verified)
2. If so confined, represent or could represent a substantial proportion of the financial statements; or
(One misstatement is 30% of profit before tax or say that Inventory could not be verified amounting to 45
% of total assets.)
3. In relation to disclosures, are fundamental to users’ understanding of the financial statements.
(A disclosure that if not given or not adequate could seriously mislead the shareholders and stake holders e.g.
No disclosure in the case of going concern as per ISA 570)
PERVASIVENESS………………………………………………. (bohat ala !!!)
Pervasiveness is a matter that confuses many candidates as; once again, it is a matter that requires professional
judgment. In this case the judgment is whether the matter is isolated to specific components of the financial
statements, or whether the matter pervades many elements of the financial statements, rendering them
unreliable as a whole.
The bottom line is that ….IF the auditor believes that the financial statements may be relied upon in some
part for decision making then the matter is material and not pervasive. If, however, they believe the
financial statements should NOT be relied upon at all for making decisions then the matter is
PERVASIVE.

Summary Notes by SK
Qualified Opinion:
When there is ……
Material Misstatement = Material but not Pervasive

OR Auditor is Unable to obtain S.A.A.E = Material but not Pervasive
Drafting of QUALIFIED OPINION
In the case of Material Misstatement…………….
Because of TREATMENT
In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion section of our
report, the accompanying financial statements give a true and fair view of the financial position of the
Company as at December 31, 20Xl, and (of) its financial performance and its cash flows for the year then
ended in accordance with International Financial Reporting Standards (IFRSs).
Because of DISCLOSURE
In our opinion, except for the incomplete disclosure of the matter described in the Basis for Qualified Opinion
section of our report, the accompanying financial statements give a true and fair view of the financial position
of the Company as at December 31, 20Xl, and (of) its financial performance and its cash flows for the year
then ended in accordance with International Financial Reporting Standards (IFRSs).
In the case of Inability to obtain S.A.A.E
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion
section of our report, the accompanying financial statements give a true and fair view of the financial position
of the company as at December 31, 20Xl, and (of) its financial performance and its consolidated cash flows
for the year then ended in accordance with International Financial Reporting Standards (IFRSs).
Adverse Opinion
When there are Material Misstatements individually or in the aggregate and are both Material &Pervasive to
the financial statements taken as a whole.

Summary Notes by SK
Because of TREATMENT
In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section
of our report the accompanying financial statements DO NOT GIVE a TRUE and FAIR view of the
financial position of the company as at December 31 20X1, and (of) its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting Standards (IF'RSs).
Because of DISCLOSURE………(where NO disclosure is given in the F/S)
In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion
section of our report the accompanying financial statements DO NOT GIVE a TRUE and FAIR of the
financial position of the company as at December 31 20X1, and (of) its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting Standards (IF'RSs).
Adverse opinion
An adverse opinion is expressed when the auditor, having obtained sufficient appropriate audit evidence,
concludes that misstatements are both material and pervasive to the financial statements. The table below
gives on example of why an adverse opinion might be expressed for each of the three possible reasons for
misstatements being determined as pervasive.
Reason deemed pervasive Explanation
Misstatements are NOT confined to specific No depreciation has been provided on plant and equipment,
elements accounts or items in the financial a receivable balance consisting half of total receivable and
statements has not been provided and trade payable have been
significantly understated.
All misstatements are material and these balances are
significant on the statement of financial position (SOFP)
Misstatements are not confined to specific A house building company has included all the houses it has
elements accounts or items in the financial constructed in the year as non-current assets rather than
statements and represent a substantial inventory. The value of these houses constitutes 90% of the
portion of the financial statements. total assets value on the SOFP.
Misstatements related to disclosures which There is a material uncertainty in respect of going concern
are fundamental to users understanding of the which has not been adequately disclosed.
financial statements
Auditor is Unable to obtain S.A.A.E on which to base the audit opinion AND the matter is Material AND
Pervasive
ISA 705 states that the auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on
the financial statements of undetected misstatements, if any, could be both material and pervasive.

Summary Notes by SK
We do not express an opinion on the accompanying financial statements of Company. Because of the
significance of the matters described in the basis for Disclaimer of Opinion section of our report, we have
not been able to obtain sufficient appropriate audit evidence provide a basis for an audit opinion on the
EXCEPTION
ISA 705 states that the auditor shall disclaim an opinion when, in extremely rare circumstances involving
multiple uncertainties, the auditor concludes that, notwithstanding having obtained sufficient appropriate
audit evidence regarding each of the individual uncertainties, it is not possible to form an opinion on the
financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on
IMPORTANT…Changes in the Audit Report in the case of Disclaimer of Opinion
1.
2.
3.
4.
5.
6.
7.
8.
9.

Summary Notes by SK
IMPORTANT……………Audit Report Infrastructure

Summary Notes by SK
Report Structure in the case of ……………….. MODIFICATION IMP
Headings for OPINION PARA plus its IMP wordings
Qualified opinion……. In our opinion Except for ……………………………………..

Qualified opinion…….. In our opinion Except for the POSSIBLE EFFECT…………
Adverse opinion……… In our opinion because of the significance……………………
Disclaimer of Opinion…Because of the significance of the matter……………………
BASIS FOR MODIFICATION PARA…………. Contents!
In case of M.M due to disclosures

There may be an inadequate disclosure OR No Disclosure in the F/S.
In the case of inadequate Disclosures

The external auditor to explain in the basis para that inadequacy of disclosure in the F/S
If there is a M.M that relates to non-disclosure the auditor shall:
 Discuss the matter with top mgmt.

 Describe the nature of omitted information in basis for modification para.
 If practically possible, include the omitted disclosure in the basis for modified opinion para (UNLESS
prohibited by law /regulation.)
Disclosing the omitted information in the basis for modification paragraph would not be practicable if:
 The disclosures have not been prepared by management or the disclosures are otherwise not readily available
to the auditor; or
 In the auditor’s judgment, the disclosures would be unduly voluminous in relation to the auditor’s report.

Summary Notes by SK
Inability to obtain sufficient appropriate audit evidence
Inability to obtain S.A.A.E (also called Limitation of Scope)
(1) Circumstances BEYOND the control of the entity:

Force majeure events (fire, floods, storms etc.)
Assets have been taken over / seized by Govt.
Accounting records have been seized by Govt. authorities
(2) Circumstances relating to the NATURE OR TIMING of the Auditor’s work:

Timing: Auditors appointment was such that they could NOT verify the stock
counting or other counting of assets at the B/S date.
Nature: Substantive Procedures cannot be performed because of system automation and the results of TOCs
are not effective. (This is covered after TOC and S.P)
(3) Limitations imposed by management:

(In this case, external auditor is being prevented by management to perform the desired Audit procedures.
E.g.:
Not allowing the dispatch of debtor / creditor confirmation,
Preventing the counting of stock at yearend,
Preventing from meeting with persons whom auditors think appropriate for the
purpose of audit
Not providing the required Purchase Orders and sales invoices etc.

Summary Notes by SK
IMP
If alternative/further audit procedures can be performed by the External Auditor, this will NOT constitute an
inability to obtain sufficient appropriate audit evidence.
Material Misstatement………….3 Things
Difference between the amount, classification presentation or disclosure of an item which is reported in
financial statements and what was required to be reported in accordance with AFRF.
Accordingly, a material misstatement of the financial statements may arise in relation to:
a) The appropriateness of the selected accounting policies;

b) The application (Treatment) of the selected accounting policies; or
c) The appropriateness or adequacy of disclosures in the FS.
Communication with those charged with governance ( READ ONLY)

ISA 705 states that when the auditor expects to modify the opinion in the auditor’s report, the auditor shall
communicate with those charged with governance the circumstances that led to the expected modification and
the proposed wording of the modification.
This enables:
The auditor to give notice to them of the intended modification(s) and the reasons (or circumstances) for the
modification(s); and provide
TCWG an opportunity, where appropriate, to provide the auditor with further information and explanations in
respect of the matter(s) giving rise to the expected modification(s).
Emphasis of Matter Paragraph (E.O.M) + Other Matter Para (O.M) (ISA 706 Revised)
E.O.M= Matter is FUNDAMENTAL to the

User’s understanding +
The matter has already been presented &
disclosed in the financial statements
Further Conditions:
There is no Material Misstatement &
Inability to obtain sufficient appropriate audit evidence

Summary Notes by SK
IMP POINTS
1. E.O.M will not be given for a matter that has already been discussed in KAM para.
2. E.O.M will not be given for a matter that has already been discussed in Basis for
Modification para.
3. E.O.M will not be given for a matter that has already been discussed in Other matter para.
4.
Few circumstances / Examples of E.O.M: ………………… (Please Learn…!)
1. An uncertainty relating to the future outcome of exceptional litigation

or regulatory action.
2. Early application of new IFRS/IAS that has a MATERIAL effect on the financial statements.
3. Major catastrophe that has had or continues to have a significant effect on the entity’s financial position
4. Any Other case as the external auditor may think appropriate in the
circumstances.
E.O.M required by standard
ISA 560
ISA 570
Contents of an E.O.M Paragraph (also called features of an E.O.M para) (Please Learn…!)
1. It highlights a matter affecting the financial statements.

2. It highlights a matter already disclosed in the notes to the financial statements.
3. The Para must clearly refer to the note in the financial statements that more extensively discusses the
matter highlighted.
4. The E.O.M Para is inserted immediately before / after the KAM Para.
(with the Heading of E.O.M)
5. The Para must clearly mention that our opinion is not MODIFIED in respect of this matter.

Summary Notes by SK
EXAMPLE of an E.O.M PARA…
EXAM HINT FOR E.O.M

Summary Notes by SK
DRFATING OF E.O.M Para in the EXAM
Exam Focused Points

Summary Notes by SK
Other Matter Paragraph
If the auditor considers it necessary to communicate matters not presented or disclosed in the financial
statements that in the auditor’s judgment is RELEVANT to;
I. the user’s understanding of the audit;

II. the auditor’s responsibility or
III. auditor’s report,
The auditor shall do so by adding paragraph in the auditor’s report called “Other Matter Paragraph” provided
such communication is not prohibited by law or regulation.
(It refers to a matter other than those presented or disclosed in the financial statements)
Important Points:
Examples / Circumstances when OTHER MATTER Para is given in the Audit Report…………
1. If prior period financial statements were NOT audited.
2. If prior period financial statements were audited by a predecessor auditor (date of report + opinion
expressed to be mentioned in the other matter para)
Example of Other Matter para

Summary Notes by SK
3. Relevant to Users Understanding of the Audit
In rare circumstances auditor could not withdraw (because of legal requirements) even though the effect of
inability to obtain SAAE (due to management-imposed limitation) was material and pervasive, auditor
may consider to include an OTHER MATTER Para describing the reason for not withdrawing from the
engagement.
4. Relevant to Users' Understanding of the Auditor's Responsibilities or the Auditor's Report:
Law or regulation or local practices in a jurisdiction may require or permit the auditor to elaborate on
matters that provide further explanation of the auditor's responsibilities in the audit of the F/S or of the
auditor's report thereon.
5. Restriction on distribution or use of the auditor's report:
When the financial statements are prepared for a specific purpose or for specific users, the auditor may
consider it necessary to include an Other Matter paragraph, stating that the auditor's report is intended
solely for the intended/ specific users, and should not be distributed to or used by other parties / users.
ICAP Past Papers for E.O.M and O.M Paragraph
S. No Attempt Marks

Summary Notes by SK
Illustration 1 - Qualified Opinion due to a Material Misstatement of the Financial Statements
INDENPENDENT AUDITOR 'S REPORT
To the Shareholders of ABC Company [or Other Appropriate Addressee]
Report on the Audit of the Financial statements
Qualified Opinion
We have audited the financial statements of ABC Company (the Company) which comprise the statement of
financial position as at December 31, 20X1 and the statement of comprehensive income, statement of changes
in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a
summary of significant accounting policies.
report, the accompanying financial statements present fairly in all material respects, (or give a true and fair view
of) the financial position of the Company as at December 31, 20Xl, and (of) its financial performance and its
cash flows for the year then ended in accordance with International Financial Reporting Standard (IFRSs).
Basis for Qualified Opinion ( Reason Para )

The Company's inventories are carried in the statement of financial position at xxx. Management has not
stated the inventories at the lower of cost and net realizable value but has stated them solely at cost, which
constitutes a departure from IFRSs. The Company's records indicate that, had management stated the
inventories at the lower of cost and net realizable value, an amount of xxx would have been required to write
the inventories down to their net realizable value. Accordingly, cost of sales would have been increased by
xxx, and income tax, net income and shareholders' equity would have been reduced by xxx, xxx and xx, x
respectively.
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities
under those standards are further described in the Auditor's Responsibilities for the Audit of the Financial Statements
section of our report. We are independent of the Company in accordance with the ethical requirements that are
relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical
responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is
sufficient and appropriate to provide a basis for our qualified opinion.
Other Information
Key Audit Matters (ISA 701)

of the financial statements of the current period. These matters were addressed in the context of our audit of
the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate
opinion on these matters. In addition to the matter described in the Basis for Qualified Opinion section we have
detern1ined the matters described below to be the key audit matters to be communicated in our report.
{Description of each key audit matter in accordance with ISA 701.}

Summary Notes by SK
Illustration 2 — Adverse opinion due to a Material Misstatement of consolidated financial
statements
INDEPENDENT AUDITOR' S REPORT
Report on the Audit of the Consolidated Financial Statements
Adverse Opinion
We have audited the consolidated financial statements of ABC Company and its subsidiaries (the
Group), which comprise the consolidated statement of financial position as at December 31, 20X1 and the
consolidated statement of comprehensive income consolidated statement of changes in equity and
consolidated statement of cash flows for the year then ended and notes to the consolidated financial statements
In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section of
our report the accompanying consolidated financial statements do not give a true and fair view of the financial
position of the Group as at December 31, 20Xl and (of) its consolidated financial performance and its
consolidated cash flows for the year then ended in accordance with International Financial Reporting
Standard (IFRSs).
Basis for Adverse Opinion

As explained in Note X, the Group has not consolidated subsidiary XYZ Company that the Group acquired
during 20X1 because it has not yet been able to determine the fair values of certain of the subsidiary's material
assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis. Under
IFRSs, the Company should have consolidated this subsidiary and accounted for the acquisition based on
provisional amounts. Had XYZ Company been consolidated, many elements in the accompanying
consolidated financial statements would have been materially affected. The effects on the consolidated
financial statements of the failure to consolidate have not been determined.
under those standards are further described in the Auditor's Responsibilities for the Audit of the Consolidated
Financial Statements section of our report. We are independent of the Group in accordance with the ethical
requirements that are relevant to our audit of the consolidated financial statements in [jurisdiction], and we
have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our adverse opinion.
Key Audit Matters

Except for the matter described in the Basis for Adverse Opinion section, we have determined that there are no
other key audit matters to communicate in our report.

Summary Notes by SK
Illustration 3 — Qualified Opinion due to the Auditor's Inability to Obtain Sufficient Audit
Evidence Regarding a Foreign Associate
INDEPENDENT AUDITOR'S REPORT
Report on the Audit of the Consolidated Financial Statements'
Qualified Opinion
We have audited the consolidated financial statements of ABC Company and its subsidiaries (the Group),
which comprise the consolidated statement of financial position as at December 31, 20X1, and the
consolidated statement of comprehensive income, consolidated statement of changes in equity and
consolidated statement of cash flows for the year then ended, and notes to the consolidated financial
statements, including a summary of significant accounting policies.
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion section
of our report, the accompanying consolidated financial statements present fairly, in all material respects, (or
give a true and fair view of) the financial position of the Group as at December 31, 20X1, and (of) its
consolidated financial performance and its consolidated cash flows for the year then ended in accordance with
International Financial Reporting Standards (IFRSs).
Basis for Qualified Opinion

The Group's investment in XYZ Company, a foreign associate acquired during the year and accounted for by
the equity method, is carried at xxx on the consolidated statement of financial position as at December 31,
20X1, and ABC's share of XYZ's net income of xxx is included in ABC's income for the year then ended. We
were unable to obtain sufficient appropriate audit evidence about the carrying amount of ABC's investment in
XYZ as at December 31, 20X1 and ABC's share of XYZ's net income for the year because we were denied
access to the financial information, management, and the auditors of XYZ. Consequently, we were unable to
determine whether any adjustments to these amounts were necessary.
under those standards are further described in the Auditor's Responsibilities for the Audit of the Consolidated
Financial Statements section of our report. We are independent of the Group in accordance with the ethical
requirements that are relevant to our audit of the consolidated financial statements in [jurisdiction], and we
have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.
Key Audi Matters

of the consolidated financial statements of the current period. These matters were addressed in the context of
our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do
not provide a separate opinion on these matters. In addition to the matter described in the Basis for Qualified
Opinion section, we have determined the matters described below to be the key audit matters to be
communicated in our report.
[Description of each key audit matter in accordance with ISA 701.]

Summary Notes by SK
Illustration 4 — Disclaimer of Opinion due to the Auditor's Inability to Obtain Sufficient Appropriate
Audit Evidence about Multiple Elements of the Financial Statements
Report on the Audit of the Financial Statements"
We were engaged to audit the financial statements of ABC Company (the Company), which comprise the
statement of financial position as at December 31, 20X1, and the statement of comprehensive income,
statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial
statements, including a summary of significant accounting policies.
We do not express an opinion on the accompanying financial statements of the Company.

Because of the significance of the matters described in the Basis for Disclaimer of Opinion section
of our report, we have not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion on these financial statements.
Basis for Disclaimer of Opinion

We were not appointed as auditors of the Company until after December 31, 20X1 and thus did not observe
the counting of physical inventories at the beginning and end of the year. We were unable to satisfy ourselves
by alternative means concerning the inventory quantities held at December 31, 20X0 and 20X1, which are
stated in the statements of financial position at xxx and xxx, respectively. In addition, the introduction of a
new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts
receivable. As of the date of our report, management was still in the process of rectifying the system
deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts
receivable included in the statement of financial position at a total amount of xxx as at December 31, 20X1. As
a result of these matters, we were unable to determine whether any adjustments might have been found
necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making
up the statement of comprehensive income, statement of changes in equity and statement of cash flows.
Responsibilities of Management and Those Charged with Governance for the Financial Statements
[Reporting in accordance with ISA 700 (Revised) — see Illustration 1 in ISA 700 (Revised).]
Auditor's Responsibilities for the Audit of the Financial Statements

Our responsibility is to conduct an audit of the Company's financial statements in accordance with
International Standards on Auditing and to issue an auditor's report. However, because of the matters
described in the Basis for Disclaimer of Opinion section of our report, we were not able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion on these financial statements.
We are independent of the Company in accordance with the ethical requirements that are relevant to our audit
of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in
accordance with these requirements.

Summary Notes by SK
Example of E.O.M + O.M
Illustration 5

To the Shareholders of ABC Company

Opinion
We have auditing the financial statements of ABC company (the Company),…………

In our opinion the accompanying financial statements give a true & fair view of the financial position of
the Company as at December 31, 20X1, and (of) its financial performance and its cash flows for the year then
ended in accordance with International Financial Reporting Standards (IFRSs).
Basis for Opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our Responsibilities
under those standards are further described in the Auditor Responsibilities for the Audit of the Financial Statements
section of our report…………………………………………
Emphasis of Matter
We draw attention to Note X of the financial statements, which describes the effects of a fire in the
company's production facilities. Our opinion is not modified in respect of this matter.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most significance in
our audit of the financial statements of the current period. These matters were addressed in the
context of our audit of the financial statements as a whole, and in forming our opinion thereon, and
we do not provide a separate opinion on these matters.
(Description of each key audit matter in accordance with ISA 701)
Other Matter
The financial statements of ABC Company for the year ended December 31, 20X0, and were audited
by another auditor who expressed an modified opinion on those statement on March 31, 20X1.
Other Information
same
Responsibilities of Management and Those Charged with Governance for the Financial Statements
same
Auditor Responsibilities for the Audit of the Financial Statements
same
Summary Notes by SK
Report on Other Legal and Regularity Requirements
same
Rest contents are same.

Illustration 6
(Example where both Modification plus E.O.M is given in the Audit Report)
Qualified Opinion
We have audited the financial statements of ABC company (the Company)……………
report, the accompanying financial statements present fairly, in all material respect, (or give a true & fair view of )
the financial position of the Company as at December 31, 20X1, and (of) its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs).
Basis for Qualified Opinion

The company's short-term marketable securities are carried in the statement of financial position at xxx.
Management has not marked these securities to market but has instead stated them at cost, which constitutes a
departure from IFRSs. The Company's record indicate that had Management marked the marketable securities
to market, the Company would have recognized an unrealized loss of xxx in the statement of comprehensive
income for the year. The carrying amount of securities in the financial position would have been reduced by
the same amount at December 31, 20X1, and income tax, net income and shareholders' equity would have
been reduced by xxx, xxx and xxx respectively.
We conducted …… (stnd Para)
Emphasis of Matter - Effects of a Fire
We draw attention to Note X of the financial statements, which describes the effects of a fire in the Company's
production facilities. Our opinion is not modified in respect of this matter.
Rest contents are same.

Summary Notes by SK
Placement of K.A.M, E.O.M & Other Matter Paragraph
As per ISA As per Local Law report
1. Report on Financial Statement 1. Report on the Audit of F/S
( 1st Heading)
2. Opinion
E.O.M K.A.M 3. Basis for opinion
K.A.M E.O.M 4. KAM
(effects of fire lawsuit etc.)
O.M O.M 5. Other information

6. Responsibilities of management
2. Report in other legal & regulatory 7. Responsibilities of external Auditor.
requirement. (2nd Heading)
Will be inserted as a Sub-Heading 8. Report on other legal & regulatory
requirement. (Given as per local laws)
Other matter a)
b)
3. In case it pertains to the whole AUDIT c)
report than no sub heading ….. rather there
will be a 3rd main heading in the audit report
Other matter d)
Other Matter (It is placed after report para.)
E.O.M
As per ISA As per Local Law
E.O.M KAM Opinion
KAM E.O.M Basis of opinion
Sep Para as per ..Going Concern
E.O.M Before KAM
KAM
(In case of local law report E.O.M will always be
placed before KAM.)

Summary Notes by SK
ACCA F8 Practice Questions on Audit Report

3 Q.18 Sept / Dec 2020 5 marks

6 Q.18 March / June 2018 5 marks
(*ALL answers are of ACCA Examiner)

Question 5 c Extracted.
The following additional issues have arisen during the course of the audit of Minnie Co. Profit before tax is
$10m.
(i) Depreciation has been calculated on the total of land and buildings. In previous years it has only been
charged on buildings. Total depreciation is $2·5m and the element charged to land only is $0·7m.
(4 marks)
(ii) Minnie Co’s computerised wages program is backed up daily, however for a period of two months the
wages records and the back-ups have been corrupted, and therefore cannot be accessed. Wages and salaries for
these two months are $1·1m. (4 marks)
(iii) Minnie Co’s main competitor has filed a lawsuit for $5m against them alleging a breach of copyright; this
case is ongoing and will not be resolved prior to the audit report being signed. The matter is correctly disclosed
as a contingent liability. (4 marks)
Required: Discuss each of these issues and describe the impact on the audit report if the above issues remain
unresolved.
Note: The mark allocation is shown against each of the three issues above. Audit report extracts are NOT
required. (12 marks)

Summary Notes by SK
Answer: (The solution is as per ACCA Examiner)
c) (i) Depreciation on land and buildings
Depreciation has been provided on the land element of property, plant and equipment and this is contrary to
IAS 16 Property, Plant and Equipment, as depreciation should only be charged on buildings.
The error is material as it represents 7% of profit before tax (0·7m/10m) and hence management should
remove this from the financial statements.
If management refuse to amend this error then the audit report will need to be modified. As management has
not complied with IAS 16 and the error is material but not pervasive then a qualified opinion would be
necessary.
A basis for qualified opinion paragraph would need to be included explaining the material misstatement in
relation to the provision of depreciation on land and the effect on the financial statements. The opinion
paragraph would be qualified ‘except for’ – due to material misstatement.
(ii) Wages program

Minnie Co’s wages program has been corrupted leading to a loss of payroll data for a period of two months.
The auditors should attempt to verify payroll in an alternative manner. If they are unable to do this then
payroll for the whole year would not have been verified.
Wages and salaries for the two month period represents 11% of profit before tax (1·1m/10m) and therefore is a
material balance for which audit evidence has not been available.
The auditors will need to modify the audit report as they are unable to obtain sufficient appropriate evidence in
relation to a material, but not pervasive, element of wages and salaries and therefore a qualified opinion will be
required.
A basis for qualified opinion paragraph will be required to explain the limitation in relation to the lack of
evidence over two months of payroll records. The opinion paragraph will be qualified ‘except for the possible
effect’ – due to insufficient appropriate audit evidence.
(iii) Lawsuit
The company is being sued by a competitor for breach of copyright. This matter has been correctly disclosed in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
The lawsuit is for $5m which represents 50% of profit before tax (5·0m/10m) and hence is a material matter.
This is an important matter which needs to be brought to the attention of the users.
An emphasis of matter paragraph would need to be included in the audit report, in that the matter is
appropriately disclosed but is fundamental to the users’ understanding of the financial statements; this will not
affect the audit opinion which will be unmodified in relation to this matter.
An emphasis of matter paragraph should be inserted after the opinion paragraph, the paragraph would
explain clearly about the lawsuit and cross references to where in the financial statements the disclosure of this
contingent liability can be found.
--------------------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
Question 3
You are the audit manager of Chestnut & Co and are reviewing the key issues identified in the files of two
audit clients.
Palm Industries Co (Palm)
Palm’s year end was 31 March 2015 and the draft financial statements show revenue of $28·2 million,
receivables of $5·6 million and profit before tax of $4·8 million. The fieldwork stage for this audit has been
completed.
A customer of Palm owed an amount of $350,000 at the year end. Testing of receivables in April highlighted
that no amounts had been paid to Palm from this customer as they were disputing the quality of certain goods
received from Palm. The finance director is confident the issue will be resolved and no allowance for
receivables was made with regards to this balance.
Ash Trading Co (Ash)
Ash is a new client of Chestnut & Co, its year end was 31 January 2015 and the firm was only appointed
auditors in February 2015, as the previous auditors were suddenly unable to undertake the audit. The
fieldwork stage for this audit is currently ongoing.
The inventory count at Ash’s warehouse was undertaken on 31 January 2015 and was overseen by the
company’s internal audit department. Neither Chestnut & Co nor the previous auditors attended the count.
Detailed inventory records were maintained but it was not possible to undertake another full inventory count
subsequent to the year end.
The draft financial statements show a profit before tax of $2·4 million, revenue of $10·1 million and inventory
of $510,000.
Required:
For each of the two issues:
i. Discuss the issue, including an assessment of whether it is material;
ii. Recommend ONE procedure the audit team should undertake to try to resolve the issue; and
iii. Describe the impact on the audit report if the issue remains UNRESOLVED.
Notes:
The total marks will be split equally between each of the two issues.
Audit report extracts are NOT required.
Answer: (The solution is as per ACCA)
Palm Industries Co (Palm)

(i) A customer of Palm’s owing $350,000 at the year-end has not made any post year-end payments as they are
disputing the quality of goods received. No allowance for receivables has been made against this balance. As
the balance is being disputed, there is a risk of incorrect valuation as some or all of the receivable balance is
overstated, as it may not be paid.
This $350,000 receivable balance represents 1·2% (0·35/28·2m) of revenue, 6·3% (0·35/5·6m) of receivables
and 7·3% (0·35/4·8m) of profit before tax; hence this is a material issue.
Summary Notes by SK
A procedure to adopt includes:

 Review whether any payments have subsequently been made by this customer since the audit
fieldwork was completed.
 Discuss with management whether the issue of quality of goods sold to the customer has been
resolved, or whether it is still in dispute.
 Review the latest customer correspondence with regards to an assessment of the likelihood of the
customer making payment.
(ii) If management refuses to provide against this receivable, the audit report will need to be modified. As
receivables are overstated and the error is material but not pervasive a qualified opinion would be necessary.
A basis for qualified opinion paragraph would be needed and would include an explanation of the material
misstatement in relation to the valuation of receivables and the effect on the financial statements. The opinion
paragraph would be qualified ‘except for’.
Ash Trading Co (Ash)

Chestnut & Co was only appointed as auditors subsequent to Ash’s year end and hence did not attend the
year-end inventory count. Therefore, they have not been able to gather sufficient and appropriate audit
evidence with regards to the completeness and existence of inventory.
Inventory is a material amount as it represents 21·3% (0·51/2·4m) of profit before tax and 5% (0·51/10·1m) of
revenue; hence this is a material issue.
(ii) A procedure to adopt includes:

 Review the internal audit reports of the inventory count to identify the level of adjustments to the
records to assess the reasonableness of relying on the inventory records.
 Undertake a sample check of inventory in the warehouse and compare to the inventory records and
then from inventory records to the warehouse, to assess the reasonableness of the inventory records
maintained by Ash.
The auditors will need to modify the audit report as they are unable to obtain sufficient appropriate evidence in
relation to inventory which is a material but not pervasive balance. Therefore, a qualified opinion will be
required.
A basis for qualified opinion paragraph will be required to explain the limitation in relation to the lack of
evidence over inventory. The opinion paragraph will be qualified ‘except for the POSSIBLE Effects’.
------------------------------------------------------------------------------------------

Summary Notes by SK
Question 18
It is 1 July 20X5. You are an audit manager of Sagittarii & Co and you are in charge of two final audits which
are due to commence shortly. Vega Vista Co and Canopus Co are both existing clients with a financial year
ended 31 March 20X5. Vega Vista Co is a not-for-profit charitable organization which raises funds for
disadvantaged families and the draft financial statements show revenue of $0.8m. Canopus Co manufactures
paint products in seven factories across the country and the draft financial statements show total equity and
liabilities of $11.6m.
Canopus Co
Restructuring provision
Canopus Co recently announced plans to fundamentally restructure its production processes due to a change
in the focus of the company's operations. It has included a $2.1m restructuring provision in the draft financial
statements. The restructure involves a refurbishment of the factories, the purchase of new plant and equipment
and retraining of existing staff. These plans were finally agreed at a board meeting in March 20X5 and
announced to shareholders and employees just before the year end.
Requirements:
During the audit of Canopus Co's restructuring provision, the audit team discovered that $270,000 of costs
included did not meet the criteria for inclusion as per IAS 37 Provisions, Contingent Liabilities and Contingent
Assets. The finance director has suggested that no adjustment is made in the 20X5 financial statements as the
provision is a matter of judgment and the provision has been deemed reasonable by the board.
d) Discuss the issue and describe the impact on the auditor's report, if any, should this issue remain
unresolved. (5 marks)
Answer:
Impact on Auditor's report
The restructuring provision of $2.1 million includes $270,000 of costs which do not meet the criteria for
inclusion as per IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Hence by including this
amount the provision and expenses for this year are overstated and profits understated.
The error is material as it represents 2.3% of total equity and liabilities/total assets (0.27m/11.6m) and hence
the finance director should adjust the financial statements by removing this cost from the provision and instead
expensing it to profit or loss as it is incurred. The argument that the provision is judgmental and has been
deemed reasonable by the board is not valid. IAS 37 has strict criteria for what can and cannot be included
within a restructuring provision. For example, training costs for existing staff must be specifically excluded.
If the finance director refuses to amend this error the audit opinion will be modified due to a material
misstatement. As management has not complied with IAS 37 and the error is material but not pervasive, a
qualified opinion would be appropriate.

Summary Notes by SK
A basis for qualified opinion paragraph would be included after the opinion paragraph and would explain the
material misstatement in relation to the incorrect treatment of the restructuring provision and the effect on the
financial statements. The opinion paragraph would be qualified 'except for'.
------------------------------------------------------------------------------------------
Question 6
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:
Research and development

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 amortised on a
straight line basis over five years.
Required:
c. 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 capitalisation. The finance director does not
intend to change the accounting treatment adopted as she considers this an immaterial amount.
Required:
Discuss the issue and describe the impact on the audit report, if any, if the issue remains unresolved.
(4 marks)
Answer 6c:
Audit reports
One of the projects Andromeda has developed in the year does not meet the recognition criteria under IAS 38
Intangible Assets for capitalisation but has been included within intangible assets. This is contrary to IAS 38,
as if the criteria are not met, then this project is research expenditure and should be expensed to profit or loss
rather than capitalised.
The error is material as it represents 11·8% of profit before tax (0·98m/8·3m) and hence management should
adjust the financial statements by removing this project from intangible assets and charging it to profit or loss
instead. The finance director’s argument that the balance is immaterial is not correct.
If management refuses to amend this error, then the audit report will need to be modified. As management has
not complied with IAS 38 and the error is material but not pervasive, then a qualified opinion would be
necessary.
A basis for qualified opinion paragraph would be needed and would explain the material misstatement in
relation to the incorrect treatment of research and development and the effect on the financial statements. The
opinion paragraph would be qualified ‘except for’.
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Summary Notes by SK
ACCA F8 Sept/Dec 2017 (5 marks)
Question 18
Dashing Co manufactures women’s clothing and its year end was 31 July 20X7. You are an audit supervisor
of Jaunty & Co and the year-end audit for Dashing Co is due to commence shortly.
The draft financial statements recognise profit before tax of $2·6m and total assets of $18m. You have been
given responsibility for auditing receivables, which is a material balance, and as part of the audit approach, a
positive receivables circularisation is to be undertaken.
At the planning meeting, the finance director of Dashing Co informed the audit engagement partner that the
company was closing one of its smaller production sites and as a result, a number of employees would be
made redundant. A redundancy provision of $110,000 is included in the draft financial statements.
Required:
A few months have now passed and the audit team is performing the audit fieldwork including the audit
procedures which you recommended over the redundancy provision. The team has calculated that the
necessary provision should amount to $305,000. The finance director is not willing to adjust the draft financial
statements.
Required:
d) Discuss the issue and describe the impact on the auditor’s report, if any, should this issue remain
unresolved (5 marks)
Answer:
Impact on auditor’s report
The company has included a redundancy provision of $110,000 in the draft financial statements, however,
audit fieldwork testing has confirmed that the provision should actually be $305,000. The provision is
understated and profit before tax overstated if the finance director does not amend the financial statements.
The provision included is $110,000, it should be $305,000 hence an adjustment of $195,000 is required which
represents 7·5% of profit before tax (195/2,600) or 1·1% of total assets (195/18,000) and hence is a material
matter.
If management does not adjust the redundancy provision, the auditor’s report will need to be modified. As
provisions are understated and profit overstated, there is a material misstatement, which is not pervasive.
Therefore, a qualified opinion would be necessary, stating that the opinion is qualified ‘except for’. A basis for
qualified opinion paragraph would also need to be included subsequent to the opinion paragraph. This would
explain the material misstatement in relation to the redundancy provision and the effect on the financial
statements.
------------------------------------------------------------------------------------------
Question 18
You are an audit manager of Cranberry & Co and you are currently responsible for the audit of Gooseberry
Co, a company which develops and manufactures health and beauty products and distributes these to

Summary Notes by SK
wholesale customers. Its draft profit before tax is $6·4m and total assets are $37·2m for the financial year ended
31 January 20X8. The final audit is due to commence shortly and the following matters have been brought to
your attention:
Research and development

Gooseberry Co spent $1·9m in the current year developing nine new health and beauty products, all of which
are at different stages of development. Once they meet the recognition criteria under IAS® 38 Intangible
Assets for development expenditure, Gooseberry Co includes the costs incurred within intangible assets. Once
production commences, the intangible assets are amortised on a straight line basis over three years.
Management believes that this amortisation policy is a reasonable approximation of the assets’ useful lives, as
in this industry there is constant demand for innovative new products.
During the audit, the team discovers that the intangible assets balance includes $440,000 related to one of the
nine new health and beauty products development projects, which does not meet the criteria for capitalisation.
As this project is ongoing, the finance director has suggested that no adjustment is made in the 20X8 financial
statements. She is confident that the project will meet the criteria for capitalisation in 20X9.
Required:
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this issue remain
unresolved. (5 marks)
Answer:
Impact on auditor’s report
One of the new health and beauty products Gooseberry Co has developed in the year does not meet the
recognition criteria under IAS 38 Intangible Assets for capitalisation but has been included within intangible
assets. This is contrary to IAS 38, as if the criteria are not met, then this project is research expenditure and
should be expensed to the statement of profit or loss rather than capitalised.
The error is material as it represents 6·9% of profit before tax (0·44m/6·4m) and 1·2% of net assets
(0·44m/37·2m) and hence management should adjust the financial statements by removing this amount from
intangible assets and charging it to the statement of profit or loss instead. IAS 38 requires costs to date to be
expensed; if the project meets the recognition criteria in 20X9, then only from that point can any new costs
incurred be capitalised. Any costs already expensed cannot be written back to assets.
If management refuses to amend this error, then the auditor’s opinion will need to be modified. As
management has not complied with IAS 38 and the error is material but not pervasive, then a qualified
opinion would be necessary.
A basis for qualified opinion paragraph would be needed after the opinion paragraph and would explain the
material misstatement in relation to the incorrect treatment of research and development and the effect on the
financial statements. The opinion paragraph would be qualified ‘except for’.
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Summary Notes by SK
Audit Report Exam Focused Points

Summary Notes by SK

Summary Notes by SK

Summary Notes by SK

Summary Notes by SK

Summary Notes by SK
DRAFTING OF THE AUDIT REPORT ANSWER
1) Explanation of the Issue / Matter
2) Calculation of Materiality
3) Audit Procedures / Audit Tests
4) Impact on the Audit Report / Audit Opinion

Summary Notes by SK
Exam Focused lecture on Audit Report (ISA 705, ISA 320 and
ISA 450)
Case 1:
Case 2:
Case 3:

Summary Notes by SK
Additional concept for CAF 8 students……………… 
Year Ended Sept 30,20x8

Profit before Tax 131.4 m
Uncorrected misstatements
Your review also includes an assessment of uncorrected misstatements. These have been recorded by the audit
team as follows:
$000
1 Interest payable omitted in error 1,942
2 Additional allowance for receivables required 9,189
3 Error in sales invoice processing resulting in understatement of sales 8,541
4 Write off in respect of faulty goods 2,900
Faulty goods
The adjustment for faulty goods listed as an uncorrected misstatement above relates to an entire batch of
shoes, which was produced on 12 September 20X8. The audit work concluded that the cost of this inventory
exceeded its net realisable value by $2·9m. The directors dispute the audit team’s figures and believe that the
realisable value of the inventory still exceeds its cost.
1. Which of the uncorrected misstatements numbered (1), (2) and (3) by the audit team MUST be adjusted for
if the auditor is to issue an unmodified audit opinion?
A. Misstatements 2 and 3 only

B. Misstatements 1 and 3 only
C. Misstatements 1, 2 and 3
D. Misstatement 2 only
2. All adjustments required by the auditors have been made to the financial statements with the exception of
adjustment (4) relating to the faulty goods.
Which of the following correctly describes the effect of this matter on the auditor’s report?
A. Unmodified opinion with no further disclosure
B. Unmodified opinion with disclosure in an emphasis of matter paragraph
C. Qualified opinion due to material misstatement
D. Qualified opinion due to inability to obtain sufficient appropriate audit evidence

Summary Notes by SK
Recap of ISA 450 with reference to ISA 580
Extract from ISA 450

Written Representations
The auditor shall request a written representation from management and, where appropriate, those charged
with governance whether they believe the effects of uncorrected misstatements are immaterial, individually
and in aggregate, to the financial statements as a whole.
A summary of such items shall be included in or attached to the written representation.
Written Representations
Because the preparation of the financial statements requires management to adjust the financial statements to
correct material misstatements, the auditor is required to request them to provide a written representation
about uncorrected misstatements.
In some circumstances, management and, where appropriate, those charged with governance may not believe
that certain uncorrected misstatements are misstatements.
For that reason, they may want to add to their written representation words such as: "We do not agree that
items ... and ... constitute misstatements because [description of reasons]."
Obtaining this representation does not, however, relieve the auditor of the need to form a conclusion on the
effect of uncorrected misstatements.
When the question of Audit Report mentions Planning Materiality (Variable for determining the materiality)
than the following wordings to be added in the solution / answer:

Summary Notes by SK
Recap of Important Exam Focused points again ………!
Point 1
EXAM SCENARIO
CASE 1 – Planning Materiality is given
CASE 2 – Profit before tax is given
CASE 3 – Loss before Taxation / Revenue is given
Point 2
The question might not mention a material misstatement OR a disagreement with management
nor might mention that there is an inability to obtain SAAE…………
What to do...?
Point 3
When to mention KAM (ISA 701) in the solution / drafting

Summary Notes by SK
Location of the description of the auditor’s responsibilities for the
audit of the financial statements
The description of the auditor's responsibilities for the audit of the financial statements required by ISA 700
shall be included; (Please refer standard Audit Report)
1. Within the body of the auditor's report; (Already covered)

2. Within an appendix to the auditor's report, in which case the auditor's report shall
include a reference to the location of the appendix; or
3. By a specific reference within the auditor's report to the location of such a
description on a website of an appropriate authority, where law, regulation or
national auditing standards expressly permit the auditor to do so.
2) Location in an appendix
ISA permits the auditor to include the statements regarding the auditor's responsibilities for the audit of the
financial statements in an appendix to the auditor's report, provided that appropriate reference is made within
the body of the auditor's report to the location of the appendix.
The following is an illustration of how such a reference to an appendix could be made in the auditor's report:

……(Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes
our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted
in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise
from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be
expected to influence the economic decisions of users taken on the basis of these financial statements….)
A further description of our responsibilities for the audit of the financial statements is included in appendix X
of this auditor's report.
This description, which is located at [indicate page number or other specific reference to the location of the
description], forms part of our auditor's report.
3) Reference to a website of an appropriate authority
ISA explains that the auditor may refer to a description of the auditor's responsibilities located on a website of
an appropriate authority, only if expressly permitted by law, regulation or national auditing standards.
An appropriate authority could be a national auditing standard setter, regulator, or an audit oversight body.
Such organizations are well placed to ensure the accuracy, completeness and continued availability of the
standardized information. It would not be appropriate for the auditor to maintain such a website.
The following is an illustration of how such a reference to a website could be made in the auditor's report:

Summary Notes by SK
…….(Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes
our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted
in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise
from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be
expected to influence the economic decisions of users taken on the basis of these financial statements……)
A further description of our responsibilities for the audit of the financial statements is located at [Organization's]
website at: [website address]. This description forms part of our auditor's report.
Name of the engagement Partner
The name of the engagement partner shall be included in the auditor's report on the F/S of listed entities
unless, in rare circumstances, such disclosure is reasonably expected to lead to a significant personal security
threat. In the rare circumstances that the auditor intends not to include the name of the engagement partner in
the auditor's report, the auditor shall discuss this intention with those charged with governance to inform the
auditor's assessment of the likelihood and severity of a significant personal security threat.
In case of Disclosure
If disclosure is NOT given than wordings will be:

“In our opinion except for the non-disclosure of the matter described in the basis for qualified opinion section
of our report the accounts are giving a true and fair view….”.
If disclosure is not INADEQUATE
“In our opinion except for the incomplete disclosure of the matter described in the basis for qualified section
of our report the accounts are giving a true and fair view…..”.
Issue is Material AND Pervasive

ADVERSE OPINION
In case of Disclosure
If disclosure is NOT given than wordings will be:
“In our opinion because of the omission of the information mentioned in the Basis for……in the accounts do
not give a true and fair view”.
If disclosure is NOT ADEQUATE & the issue is MATERIAL & PERVASIVE

“In our opinion because of incomplete disclosure of the information referred / mentioned in the Basis for
………… accounts do not give a true and fair view”.
(In case of treatment …. “In our opinion, because of the significance of the matter discussed in the Basis for
…………the FS do not give a true and Fair view.”)

Summary Notes by SK
In case of Accounting Policy
Material but not pervasive - Qualified Opinion
The opinion paragraph will be as follows:
“In our opinion except for the affects of the matter described in the Basis for …. Financial statements give a
true and fair view”.
OR
“In our opinion except for the affects of the incorrect accounting policy as described in the Basis for ….
Financial statements give a true and fair view”.
In this case a basis for qualified opinion paragraph will be inserted immediately after the opinion paragraph
mentioning the reason for qualification.
Material and Pervasive – Adverse Opinion
The opinion paragraph will be as follows:
“In our opinion, because of the significance of the matter discussed in the Basis for …………the F/S do not
give a true and Fair view.”
OR
“In our opinion, because of the significance of the incorrect accounting policy as discussed in the Basis for
…………the F/S do not give a true and Fair view.”
In this case a basis for adverse opinion paragraph will be inserted immediately after the opinion paragraph
mentioning the reason for qualification.

Summary Notes by SK
Expectations Gap…..IMP
‘Expectations gap‘, is defined as the difference between the apparent public perception (Shareholders and
stakeholders) about the responsibilities of external auditors on one hand and the legal and professional
responsibilities of external auditor on the other hand.( As per ISAs and Companies Act 2017)
The question is ….. how can we make the unmodified auditor's report/ opinion clear and so transparent and
understandable to the users / shareholders ….that this expectation GAP reduces to a reasonable extent .( it can
never be reduced)
What are these Expectation Gaps?

a. Misunderstandings as to the nature of audited financial statements, for example that:
 The statement of financial position provides a fair valuation of the reporting entity.(few items in the
F/S are recorded at cost)
 The amounts in the financial statements are stated precisely i.e they are accurate.
 (there are estimates and judgements involved like provisions and fair value estimates)
 The audited financial statements give a guarantee that the entity concerned will continue to
exist for the foreseeable future.
(Auditors never express a guarantee on the F/S neither they give a guarantee about the company’s future or its
continuity)
b. Misunderstanding as to the type and extent of work undertaken by the External auditors.
External auditors express an opinion on the financial statements only & not the internal controls of the audit
client plus we only verify material balances during theaudit and lastly, the audit is done on a sample basis (test
basis) as per ISA 530.
c. Misunderstanding about the level of assurance provided by External auditors, for example.
These misunderstandings are:
An unmodified audit opinion means that no frauds have occurred during the audit period.
(The objective of an external audit is to expresses an opinion on the financial statements of the company and not the
prevention and detection of fraud, as it is the responsibility of management & TCWG. Adding further, an
unmodified opinion is not a guarantee that no frauds exist in financial statements
The auditors provide an absolute level of assurance that the figures in the financial statements are correct (ignoring
the concept of materiality and the limitations of estimates and various assumptions).
Clarification:
External auditor provides reasonable level of assurance which is a high but not an absolute level of assurance because
there are inherent limitations of an audit. For example: 100 % testing is not done as the external auditor use sampling
techniqueto conduct the audit plus in few cases audit evidence is persuasive rather than conclusive.

Summary Notes by SK
Student Notings

Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 701 – ‘Key Audit Matters (KAM)’

Summary Notes by SK
Expected Questions on KAM
1. Briefly explain the concept of KAM and list examples of matters that can be included or
placed in KAM para as per ISA 701.
2. Determine the matters to be considered to place a matter as KAM in the audit report.
3. Explain the factors to be considered in determining whether a matter will be placed in
KAM para.
4. Importance / purpose of KAM in the audit report.
5. Highlight errors in the standard KAM para.
6. Placement of KAM in the audit report. (Drafting of KAM)
7. Scenario based question along with the audit report
Auditor shall communicate key audit matters in the auditor's report for audits of
 Listed entities
 Entities other than listed entities, if required by law
 Other entities decided by the auditor using his professional judgment, including those that
may be of significant public interest,
Purpose and Importance of KAM in the Audit report

Communicating key audit matters provides additional information to intended users of the financial
statements to assist them in understanding those matters that, in the auditor's professional judgment, were of
most significance in the audit of the financial statements of the current period.
KEY Word for KAM

Most significant matters for the CURRENT period that are selected from the matters
communicated with TCWG.
1. The auditor to perform the following: (READ ONLY)
a. Determine the matters which should be described as KAMs
b. Communicate - the KAM to TCWG
c. Communicate - KAM in the Audit Report.
d. Maintain proper documentation as per ISA 230

Summary Notes by SK
2. Features of KAM (IMP)

a. Matters that were communicated to Board Audit Committee or other BOD members during the audit
b. Matters that required significant attention ( ______________________________________)
c. Matters of most significance in audit. (e.g.: Provision for Law suit)
d. High ROMM
e. Issue pertains to current period only
f. KAM pertains to FS
IMP
3. KAM is NOT ………………………(very very important)

 A substitute for disclosures on the financial statements (AFRF)
 A substitute for a modified opinion (ISA 705)
 A substitute for reporting a material uncertainty related to GC (ISA 570)
 A separate opinion on individual matters (ISA 700 – other reporting resp.)
 An implication that matter has not been resolved by the auditor.
(i.e. its solved / resolved by the External Auditor)
4. Types / Examples of matters reported by different auditors as KAM

 Property valuation and impairment
 CAPEX ( Capital expenditure)
 Goodwill impairment
 Inventory valuation

Summary Notes by SK
 Revenue recognition ( IMP)
 Change in accounting policy
 Claims & litigation ( eg. provisions)
 Taxation (deferred and current)
 Management override of controls or internal control deficiency impacting FS
5. Why KAM in the Audit REPORT………..

(Explain how the auditor determines that whether a matter will be placed as KAM or not)
 High ROMM
 Significantly subjective or Judgmental issues / amounts
 Uncertainty of matter
 Complex issue
 Areas where an expert is required or any consultation is required
 Assessed Significant Risks that required significant audit attention/
 Significant transactions and events affecting the audit
 Change in audit approach during the audit as a result of an unexpected audit evidence
 The severity of control deficiency identified.
 Whether several separate issues interacted, eg if a long-term contract had repercussions in several areas
(revenue recognition, litigation or contingencies)
 Any misstatements related to the matter, and the nature and materiality of the misstatements.
 The importance of the matter to intended users' understanding, including materiality.


Descriptions of individual Key Audit Matters in the Audit Report - IMP

(Contents of KAM Para in the Audit report)
 Include a reference to the related disclosure(s), if any, in the financial statements;
 State that why the matter was considered to be one of most significance in the audit; and
 Specify how the matter was addressed in the audit
o A brief overview of procedures performed;
o An indication of the outcome of the auditor's procedures; or
o Key observations with respect to the matter, (if any)
Communication with those charged with governance

Communication with those charged with governance enables them to be made aware of the key audit matters
that the auditor intends to communicate in the auditor’s report, and provides them with an opportunity to
obtain further clarification where necessary.
The auditor shall communicate with them:
 Those matters the auditor has determined to be the key audit matters; or
 The auditor’s determination that there are no key audit matters to communicate in the auditor’s report.

Summary Notes by SK
Placement of KAM in the Audit report

In the case of Listed company + KAM (Listed co)
(Unmodified opinion)
Key Audit Matters are those matters that, in our professional judgment, were of the significance in our audit of
the financial statements of the current period. These matters were addressed in the context of our audit of the
financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion
on these matters.
[Description of each key audit matter in accordance with ISA 701, which applies to audit of
the financial statements of listed entities….]
In the case of Modification of opinion (Qualified or Adverse opinion) + KAM

(Listed co)
Key Audit Matters
Key Audit Matters are those matters that, in our professional judgment, were of the significance in our audit of
the financial statements of the current period. These matters were addressed in the context of our audit of the
financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion
on these matters. IN ADDITION to the matter described in the Basis for Qualified Opinion section we
have determined the matters described below to be the key audit matter to be communicated in our
report.
(Reference to the modification of opinion is given in the audit report)
[Description of each key audit matter in accordance with ISA 701, which applies to audit of the financial
statements of listed entities….]
In the case of Modification of opinion (Qualified or Adverse opinion) + No KAM (Listed co )

Key Audit Matters
Except for the matter described in the Basis For Adverse Opinion section…… WE have determined that
there are no other key audit matters to communicate in our report.
In the case of Listed company + No KAM

Key Audit Matters
We have determined that there are NO Key audit matters to communicate in our report.
In the case of Un-Listed company + KAM .(same as Above)

In the case of Un-Listed company + No KAM
No heading of KAM Para in the audit report
In the case of Disclaimer of Opinion
No KAM Para in the audit report

Summary Notes by SK
Exam HINTS for KAM

Summary Notes by SK
Test Question

To the Shareholders of Company
--------------------------------------------------------------------------------------------------------------------------------------
Key Audit Matters (ISA 701)
Key audit matters are those matters that, in our professional judgment, were most important in our audit of the
financial statements of the current and prior period. These matters
thereon, and we provide a separate opinion on these matters.
Responsibilities of Management and Those Charged with Governance for

the Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in accordance
relevant framework and for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain maximum assurance about whether the financial statements as a whole are free
from ALL misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our
opinion. Reasonable assurance is a high level of assurance, and is a guarantee that an audit conducted in
accordance with ISAs will always detect ALL material misstatement when it exists.
As part of an audit in accordance with ISAs, we exercise materiality throughout the audit. We also:
 Identify and assess the risks of material misstatement of the financial statements, whether due to fraud
or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that
is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material
misstatement resulting
from fraud is almost equal to the one resulting from error, as fraud may involve collusion, forgery,
intentional omissions, misrepresentations, or the override of internal control.

Summary Notes by SK
that are appropriate in the circumstances, and also for the purpose of expressing an opinion on the
effectiveness of the Company’s internal control.
estimates and related disclosures made by external auditor
 Conclude on the appropriateness of external auditors use of the going concern basis of accounting and,
conditions that may cast significant doubt on the Company’s ability to continue as a going concern.
If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s
report to the related disclosures in the financial statements or, if such disclosures are inadequate, to
modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our
auditor’s report. However, future events or conditions may cause the Company to cease to continue as
a going concern.
manner that achieves a reasonable presentation.

Summary Notes by SK
Few points of differentiation in the audit report as per Local Law
Opinion Paragraph
As per Local laws the first paragraph to state that "we state that we have obtained all the information &
explanations which to the best of our knowledge & belief were necessary for the purposes of the audit.
In the second paragraph of the opinion paragraph the wording as follows to be inserted that F/S confirm with
the accounting and reporting standards as per applicable in Pakistan and give the information required by the
Companies Act, 2017, in the manner so required and respectively give a true and fair view of the state of the
Company's affair as at 30th June 2018 and of the profit, comprehensive income, the change in equity and its
cash flows for the year then ended.
Basis for Opinion Paragraph

Basis for Opinion Paragraph to mention that audit has been conducted in accordance with ISA as applicable in
Pakistan.
This paragraph will also mention regarding Code of Ethics for professional accountants as adopted by ICAP.
KAM
A per local laws KAM is presented in column format where, on the left side Key Audit Matter is explained &
on the right side, how the auditor has addressed the matter during the audit (audit procedures are performed),
is/are explained.
Responsibility of management & Board of Directors
This paragraph to mention the accounts are prepared as per reporting standards as applicable in Pakistan & the
requirements of Companies Act, 2017.
Report on other legal & regulatory requirements

As per local law, in this paragraph four opinion are given as follows:
 First opinion is on proper books of accounts.
 Second opinion pertains to preparation of account in confirmatory with Companies Act, 2017 and
further in agreement with the book of account & returns.
 The third opinion is on investments made, expenditure incurred & guarantees extended during the
year.
 The fourth opinion is on Zakat deductible at source under the Zakat & Usher ordinance.
E.O.M and O.M Para

As per local laws EOM is given after the Basis for Opinion Paragraph & before KAM para & other matter para
is given after the opinions on local laws and before the name of the engagement partner.
(Please refer local law audit reports to verify the above differences)

Summary Notes by SK
CA CAF 8 Practice Questions on Audit Report


Summary Notes by SK
Student Notings

Summary Notes by SK
ISA 560 - ‘Subsequent Events’

Summary Notes by SK

Summary Notes by SK
Expected Questions on ‘Subsequent Events’ ISA 560
Q1. Explain the objectives of an External Auditor with respect to

ISA 560 / subsequent events?
Q2. Explain the term subsequent events as per ISA 560 and
briefly discuss the events that it deals with?
Q3. Explain the Audit procedures/ Audit Tests that will be

performed by the External Auditor to ensure that events
occurring between the date of F/S (B/S Date) and date of
Audit Report are identified and accounted for?
Q4. Explain the External Auditor’s responsibility with respect to

facts that are known to the Auditor after the date of the Audit
Report but before the date the F/S are issued?
Q5. Explain the External Auditor responsibility with respect to

facts which become known to the Auditor after the F/S have
been issued?
Q6. Scenario based question? (Most Imp!)
 Explain whether the F/S need amendment or not / Evaluate the

need for amendment in the F/S
 List/ Explain the audit procedures the auditor needs to perform in
this regard / Suggest the auditors course of Action AND
 Discuss the impact on the Audit Report/Audit Opinion
(Should the issue remain unresolved)

Summary Notes by SK
SUMMARY OF ISA 560
ISA 560 provides guidance to auditors in this area. The objectives of the auditor are:
 To obtain sufficient appropriate audit evidence about whether events occurring between the date of
the financial statements and the date of the auditor’s report that need adjustment or disclosure in the
financial statements are properly reflected in the financial statements
 To respond appropriately to facts that become known to the auditor after the date of the auditors’
report which may have caused the auditor to amend the auditor’s report if they were known to the
auditor at the date of the report
---------------------------------------------------------------------------------------
Subsequent Events are events occurring between the period-end (B/S Date) and the date of the
auditor’s report and also include facts discovered after the auditor’s report has been issued. Auditors
shall consider the effect of such events on the financial statements and on their audit opinion.
IAS 10 – Recap...
ISA 10 Events after the reporting period deals with the treatment in the financial statements of events, both
favourable and unfavourable, occurring after the period-end. There are two types of event defined by
IAS 10:
 Those that provide evidence of conditions that existed at the year-end date (adjusting
events)
 Those that are indicative of conditions that arose after the year-end date (non-adjusting
events)
General Procedures / General responsibility

Auditors have a responsibility to review subsequent events before they sign the auditor’s report, and may
have to take action if they become aware of subsequent events between the date they sign the auditor’s
report and the date the financial statements are issued.
Events occurring UP TO the date of the auditor's report

The auditor shall perform procedures designed to obtain sufficient appropriate audit evidence that all events up
to the date of the auditor's report that may require adjustment of, or disclosure in, the financial statements have
been identified and adjusted and disclosed accordingly.
These procedures should be applied to any matters / events examined during the audit which may be sensitive to
change after the B/S date.
Lecture Example:
______________________________________________________________________________________
ISA 560 lists procedures to identify subsequent events which may require adjustment or disclosure. They should
be performed near the auditors' report.

Summary Notes by SK
GENERAL AUDIT PROCEDURES TO TEST SUBSEQUENT EVENTS
Inquiries of management
 Status of items involving subjective judgment (like provisions involving estimates)
 Status of items accounted for using inconclusive data at the B/S date ( based on info at the B/S
date )
Whether there have been any:
 Sales or destruction of assets
 Developments involving risk areas, provisions and contingencies
 Unusual accounting adjustments
 Major events (e.g. going concern problems)
 Litigations or claims
Other Procedures
 Review management procedures for identifying subsequent events to ensure that such
 events are identified on a timely basis.
 Read minutes of B.O.D /other committee meetings and enquire about unusual items.
 Review latest available interim financial statements. (First quarterly F/S)
 Obtain evidence concerning any litigation/ lawsuit from the company's lawyers.
 Obtain written representation that all events occurring subsequent to the period-end which need
adjustment or disclosure have been adjusted or disclosed. (TO BE COVERED IN ISA 580)
Facts discovered AFTER the date of the auditor’s but BEFORE the financial statements are
issued
The financial statements are the management’s responsibility. They should therefore inform the auditors
of any material subsequent events between the date of the auditor’ report and the date of the financial
statements are issued. The auditor does not have any obligation to perform procedures, or make enquiries
regarding the financial statements, after the date of the report.
However, if the auditor becomes aware of a fact that, had it been known to the auditor at the date of the
auditor’s report, may have caused the auditor to amend the auditor’s report, the auditor shall:
 Discuss the matter with management and those charged with governance.
 Determine whether the financial statements need amendment.
 If amendment is required, inquire how management intends to address the matter in the financial
statements.
If amendment is required to the financial statements and management makes the necessary
changes, the auditor must carry out a number of procedures:
 Undertake any necessary audit procedures on the changes made.
 Extend audit procedures for identifying subsequent events that may require adjustment of or
disclosure in the financial statements to the date of the new auditor’ report.
 Provide a new auditor’s report on the amended financial statements.
If management does not amend the financial statements:
Summary Notes by SK
 If the auditor’s report has not yet been provided to the entity, the auditor shall modify the opinion
and then provide the auditor’s report.
 If the auditor’s report has already been provided to the entity, the auditor shall notify management
and those charged with governance not to issue the financial statements before the amendments are
made……………………… but if the financial statements are issued anyway, the auditor shall take
action to seek to prevent reliance on the auditor’s report.( Seek legal advice)
Facts discovered AFTER the financial statements have been issued

Auditor have no obligations to perform procedures or make enquiries regarding the financial statements
after they have been issued.
However if the auditor becomes aware of a fact that…………… had it been known to the auditor at the
date of the auditor’s report………….. may have caused the auditor to amend the auditor’s report, the
auditor shall:
 Discuss the matter with management and those charged with governance.
 Determine whether the financial statements need amendment.
 If amendment is required, inquire how management intends to address the matter in the financial
statements.
If management amends the financial statements, the auditor shall carry out any necessary procedures on
the amendment and review the steps taken by management to ensure that anyone in receipt of the
previously issued financial statements is informed.
The auditor shall also issue a new or amended auditor’s report, which will include an explanatory
paragraph known as emphasis of matter paragraph (E.O.M) that refers to a note in the financial
statements that discusses the reason for the amendment. Audit procedures will be extended up to the date
of the new report.
If management does not take the necessary steps to ensure that anyone in receipt of the previously issued
F/S is informed of the situation and does not amend the F/S where necessary, the auditor shall notify
management and those charged with governance that the auditor will seek to prevent future reliance on
the auditor’s report. If management still does not act, the auditor shall take appropriate action to seek to
prevent reliance on the auditor’s report. (Seek legal advice).

Summary Notes by SK
Subsequent Events (ISA 560) - Practical Cases for

Scenario Based Questions (V.IMP)
1. Debtors/Receivables
1a)
B/s Date D.O.R

Dec 31 ,2017
1b) Exception to the above Case
Student Notings

Summary Notes by SK
2. Lawsuit/Court Case filed by the Customer or Supplier
(i) Court Case Filed ……………..BEFORE the B/s Date
ia) Case Pending till the Date of Report…………….
ib) Case Finalized before the Date of Report………..
(ii) Court Case Filed.............................. AFTER the B/s Date
ii a) Case Pending till the Date of Report
ii b) Case Finalized before the Date of Report………..

Summary Notes by SK
3. Out of Court Settlement Case (Extension of 2nd Case)
Matter is resolved mutually between the parties outside the court.
Assumption: _______________
3a) Provision recorded in the F/S at the B/s Date

(Provision recorded at an estimated amount)
3b) Contingent liability disclosed in the F/S at the B/s Date

Summary Notes by SK
4. Damage of Inventory / Stock or Fixed Assets

Due to Natural Disaster after the B/s. Date
(eg: Fire, Flood, Earthquake)
(____________________________________)
4a) 100 % Insurance Coverage……
4b) No Insurance Coverage…..
4b) Partial Insurance Coverage……

Summary Notes by SK
5. Return of Stock / Inventory after the B/S Date…
5a) Sale of stock after the B/S Date that is damaged or obsolete
5b) Sale of tailored or specialized stock / inventory for a specific customer after the B/S date
(will be covered in the end)

Summary Notes by SK
Audit Procedures / Audit Tests for the Question of Subsequent Events

Cheetah-pun…...!
For Scenario based QS’s…..
Lawsuit / court case- Substantive Procedures

 Review / Inspect documentation/correspondence of the case / legal action.
 Review customer correspondence to consider the likelihood of any payment (in the case of
receipts)
 Discuss the matter with management and those charged with Governance:
 Whether the amount will be paid or not
 Whether disclosure is required in the F/S or
 An adjustment is required in the F/S
 Obtain lawyer confirmation (Lawyer Report) to obtain their point of view/opinion.
 Discuss the matter with lawyer to confirm their point of view on the matter / issue.
 Review correspondence with the supplier/ vendor to confirm the amount they are willing to
accept. (in the case of out of court settlement )
Debtors / A/c Receivables - Substantive Procedures

 Verify subsequent receipts / post balance sheet receipts from the customers
 Discuss with mgmt. / TCWG why they think an adjustment is not required in the F/S
 Review customer correspondence to assess whether there is any likelihood of payment or not.
Fire/Flood / explosion Substantive Procedures

 Obtain a schedule of damaged P.P.E/Inventory & agree its net book value to the non-current
register to confirm its value of affected assets.
 Verify breakdown of Inventory records & P.P.E records to determine / ascertain the level of the
inventory/ P.P.E at the time of fire / flood.
 Inspect / review any correspondence from insurance company confirming the amount of claim,
likely payments and current status of investigation via surveyor’s report to determine / assess the
extent of any uninsured amounts because it’s the uninsured amount which if material is required
to be disclosed in the financial statements.
 Obtain analysis of Inventory/Assets damaged and compare with Average Inventory/Fixed
Assets in the warehouse/Stores to see the reasonableness of amount claimed by management.
 Discuss with T.C.W.G as to the disclosure of this non-adjusting event in the financial statement.
 Discuss the matter with management & those charged with Governance as to the continuity of
business & validity of going concern assumption.
Inventory – sale after the B/S date

 Obtain schedule showing the inventory and agree to supporting documents that it was produced
prior to B/S date (otherwise it would not require a write down at year end.)
 Verify the calculation of scrap value /NRV & agree the amount/ value to the supporting
documents.

Summary Notes by SK
 Discuss the matter with TCWG as to the treatment of IAS 2 & whether adjustment will be made
or not in the F/S.
 Obtain Management representation with respect to the validity of going concern Assumption.
 Review B.O.D minutes to assess whether this event was the only event / case for defective
inventory ( as there might be other events like this)
 Inquire from mgmt. that whether the company has sufficient stock to continue business in the
short term or not.
Other points / Other Procedures

Summary Notes by SK
ACCA F8 Practice Questions on
Subsequent Events
1 Q.5 Dec 2011 20 marks
2 Q.5 b June 2013 12 marks
3 Q.18 d March / June 2019 6 marks

Subsequent Events

Summary Notes by SK
Subsequent Events Exam Focused Points

Summary Notes by SK
Subsequent Events Exam Focused Points

Summary Notes by SK
Question 5
a) Describe the auditor's responsibility for subsequent events occurring between:
i. The year-end date and the date auditor report is signed; and
ii. The date the auditor's report is signed and the date the financial statement are issued.
(5 marks)
b) Humphries Co operates a chain of food wholesalers across the country and its year end was 30
September 2011. The final audit is nearly complete and it is proposed that the financial statements and
audit report will be signed on 13 December. Revenue for the year is $78 million and profit before
taxation is $7.5 million. The following events have occurred subsequent to the year end.
Receivable
A customer of Humphries Co has been experiencing cash flow problems and its year-end balance is $0.3
million. The company has just become aware that its customer is experiencing significant going concern
difficulties. Humphries believe that as the company has been trading for many years, they will receive
some, if not full, payment from the customer; hence they have not adjusted the receivable balance.
Lawsuit
A key supplier of Humphries Co is suing them for breach of contract. The lawsuit was filed prior to the
year end, and the sum claimed by them is $1 million. This has been disclosed as a contingent liability in
the notes to the financial statements; however correspondence has just arrived from the supplier indicating
that they are willing to settle the case for a payment by Humphries Co of $0.6 million. It is likely that the
company will agree to this.
Warehouse
Humphries Co has three warehouses; following extensive rain on 20 November significant rain and river
water flooded the warehouse located in Bass. All of the inventory was damaged and has been disposed of.
The insurance company has already been contacted. No amendments or disclosures have been made in
Required:
For each of the three events above:
i. Discuss whether the financial statements require amendment;
ii. Describe audit procedures that should be performed in order to form a conclusion on the
amendment;
iii. Explain the impact on the audit report should the issue remain unresolved.
(15 marks)
Note: The total marks will be split equally between each event. (20 marks)

Summary Notes by SK
Answer:
a) ISA 560 Subsequent events responsibilities

Period between the year-end date and the date the auditor’s report is signed
The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all
events occurring between the date of the financial statements and the date of the auditor’s report that
require adjustment of, or disclosure in, the financial statements have been identified.
The auditor is not, however, expected to perform additional audit procedures on matters to which
previously applied audit procedures have provided satisfactory conclusions.
Period between the date the auditor’s report is signed and the date the financial statements are issued
The auditor has no obligation to perform any audit procedures regarding the financial statements after the
date of the auditor’s report.
However, if a fact becomes known to the auditor that, had it been known to the auditor at the date of the
auditor’s report, may have caused him to amend the auditor’s report, the auditor shall discuss the matter
with management, determine whether the financial statements need amendment and, if so, inquire how
management intends to address the matter in the financial statements.
If management amends the financial statements, the auditor shall carry out the necessary audit
procedures, extend the subsequent events testing to the date of the new auditor’s report and provide a new
auditor’s report on the amended financial statements.
b) Humphries Co
Receivable
A customer, owing $0.3 million at the year end, is experiencing significant going concern difficulties. This
information was received after the year end but provides further evidence of the recoverability of the
receivable balance at the year end.
Under IAS 10 Events after the Reporting Period, if the customer is experiencing cash flow difficulties just
a few months after the year end, then it is highly unlikely that the $0.3m was recoverable as at 30
September.
The receivables balance is overstated and consideration should be given to adjusting this balance, if
material, through the use of an allowance for receivables or by being written off.
The following audit procedures should be applied to form a conclusion as to the level of the adjustment:
 The correspondence with the customer should be reviewed to assess whether there is any
likelihood of payment.
 Discuss with management as to why they feel an adjustment is not required.
 Review the post year-end period to see if any payments have been received from the customer.
The receivable of $0.3 million is not material as it represents 4% of profit (0.3/7.5) and 0.4% of revenue
(0.3/78) and therefore, although overstated, it does not require adjustment. As the error is immaterial then
no amendment is required to the audit opinion.
(However, the $0.3m should be noted in the summary of unadjusted errors.) to be covered in the topic of ISA 580

Summary Notes by SK
Lawsuit
A key supplier is suing Humphries Co for $1 million; the company has made contingent liability
disclosures. However, subsequent to the year end the supplier agreed to settle at $0.6 million and it is
likely the company will agree. Although the settlement was agreed after the year end, it provides further
evidence that the company had a present obligation as at 30 September.
The financial statements should be adjusted with the contingent liability disclosures being removed
and instead a provision of $0.6 million being recorded.
The following audit procedures should be applied to form a conclusion as to the level of the adjustment:
 The auditor should contact the company’s lawyers to ask their view as to whether the settlement is
probable and whether $0.6 million is the likely amount.
 Review the correspondence with the supplier to confirm that the amount they are willing to accept
is in fact $0.6 million.
 Discuss with management as to whether it is probable that they will pay this sum and obtain a
written representation confirming this.
The sum being claimed is $1 million but the probable payment is $0.6 million, this is material as it
represents 8% of profit (0.6/7.5) and hence management should provide for this amount.
If management refuse to provide then the audit report will need to be modified. As management has not
complied with IAS 37) Provisions, Contingent Liabilities and Contingent Assets) and the error is material
but not pervasive then a qualified opinion would be necessary.
A basis for qualified opinion paragraph would be required and would need to include a paragraph
explaining the material misstatement in relation to the lack of a provision and the effect on the financial
statements. The opinion paragraph would be qualified ‘except for’.
Warehouse
The warehouse in Bass has been subject to a flood in late November, the entire inventory has been
disposed of and the company has insurance in place. This event occurred after the year end and the flood
would not have been in existence at 30 September, and hence this event indicates a non-adjusting event.
The financial statements should not be adjusted; however, if the impact of any uninsured losses are
material, then a disclosure of the nature of the event and any estimates of the financial impact may be
required. If the amount is not material then it may not be necessary to include any disclosures.
The following audit procedures should be applied to form a conclusion as to the extent of any disclosures:
 Discuss the matter with the directors, checking whether the company has sufficient inventory to
continue trading in the short term.
 Obtain a written representation confirming that the company’s going concern status is not
impacted.
 Obtain a schedule showing the inventory destroyed and compare this to the average inventory in
the other two warehouses to see if the amount claimed to be damaged is reasonable.
 Review any correspondence from the insurers, confirming the amount of the insurance claim to
assess the extent of any uninsured amounts.
The amount of damaged inventory is likely to be material; however, the company has insurance and so it
is only the uninsured level of inventory which should possibly be disclosed.
If disclosures are not required, because the uninsured loss is immaterial, then there will be no reporting
implications for the audit report.

Summary Notes by SK
If disclosure of this subsequent event is required and management refuse to make these disclosures, then
the audit report will need to be modified with a qualified ‘except for’ opinion.
(Please refer Audit Report lecture for the drafting of opinion para wordings)
(If the impact of the uninsured level of inventory is such that the company’s going concern status is
impacted, consideration should be given to modifying the audit report opinion. This would involve
including an emphasis of matter paragraph drawing attention to the possible risk in relation to going
concern. (will now be Updated as per revised ISA 570)

Question 5 (b)
Panda Co manufactures chemicals and has a factory and four offsite storage locations for finished goods.
Panda Co’s year end was 30 April 2013. The final audit is almost complete and the financial statements
and audit report are due to be signed next week. Revenue for the year is $55 million and profit before
taxation is $5.6 million.
The following two events have occurred subsequent to the year end. No amendments or disclosures have
been made in the financial statements.
Event 1 – Defective chemicals

Panda Co undertakes extensive quality control checks prior to dispatch of any chemicals. Testing on 3
May 2013 found that a batch of chemicals produced in April was defective. The cost of this batch was
$0.85 million. In its current condition it can be sold at a scrap value of $0.1 million. The costs of correcting
the defect are too significant for Panda Co’s management to consider this an alternative option.
Event 2 – Explosion
An explosion occurred at the smallest of the four offsite storage locations on 4th May 2013. This resulted
in some damage to inventory and property, plant and equipment. Panda Co’s management have
investigated the cause of the explosion and believe that they are unlikely to be able to claim on their
insurance. Management of Panda Co has estimated that the value of damaged inventory and property,
plant and equipment was $0.9 million and it now has no scrap value.
Required:
For each of the two events above:
i. Explain whether the financial statements require amendment; and

ii. Describe audit procedures that should be performed in order to form a conclusion on any required
amendment.
Note: The total marks will be split equally between each event. (12 marks)
(c) The directors do not wish to make any amendments or disclosures to the financial statements for the
explosion (event 2)
Required:
Explain the impact on the audit report should this issue remain unresolved (3 marks)
(15 marks)

Summary Notes by SK
Answer:
Subsequent events
Event 1 – Defective chemicals
Panda Co’s (Panda) quality control procedures have identified that inventory with a cost of $0·85 million
is defective; the scrap value of this inventory is $0·1 million. This information was obtained after the year
end but provides further evidence of the net realisable value of inventory at the year end and hence is an
adjusting event.
IAS 2 Inventories requires that inventory is valued at the lower of cost and net realisable value. The
inventory of $0·85 million must be written down to its net realisable value of $0·1 million. The write down
of $0·75 million (0·85 – 0·1) is material as it represents 13·4% (0·75/5·6) of profit before tax and 1·4%
(0·75/55) of revenue. Hence, the directors should amend the financial statements by writing down the
inventory to $0·1 million.
The following audit procedures should be applied to form a conclusion on the adjustment:
 Review the board minutes/quality control reports to assess whether this event was the only case
of defective inventory as there could potentially be other inventory which requires writing down.
 Discuss the matter with the directors, checking whether the company has sufficient inventory to
continue trading in the short term.
 Obtain a written representation confirming that the company’s going concern status is not
impacted.
 Obtain a schedule showing the defective inventory and agree to supporting production
documentation that it was produced prior to 30 April, as otherwise it would not require a write
down at the year end.
 Discuss with management how they have assessed the scrap value of $0·1 million and agree this
amount to any supporting documentation to confirm the value.
Event 2 – Explosion
An explosion has occurred in one of the offsite storage locations and property, plant and equipment and
inventory valued at $0·9 million have been damaged and now have no scrap value. The directors do not
believe they are likely to be able to claim insurance for the damaged assets. This event occurred after the
year end and the explosion would not have been in existence at 30 April, and hence this event indicates a
non-adjusting event.
The damaged assets of $0·9 million are material as they represent 16·1% (0·9/5·6) of profit before tax and
1·6% (0·9/55) of revenue. As a material non-adjusting event, the assets should not be written down to
zero; however, the directors should consider including a disclosure note detailing the explosion and the
value of assets impacted.
The following audit procedures should be applied to form a conclusion on any amendment:
 Obtain a schedule showing the damaged property, plant and equipment and agree the net book value
to the non-current assets register to confirm what the value of damaged assets was.

Summary Notes by SK
 Obtain the latest inventory records for this storage location to ascertain the likely level of inventory at
the time of the explosion.
 Discuss with the directors whether they will disclose the effect of the explosion in the financial
statements.
 Discuss with the directors why they do not believe that they are able to claim on their insurance; if a
claim was to be made, then only uninsured losses would require disclosure, and this may be an
immaterial amount.
c) Audit report
The explosion is a non-adjusting post year-end event and the level of damaged assets are material. Hence a
disclosure note should be included in the 2013 financial statements and the write down of assets would be
included in the 2014 financial statements.
If the directors refuse to make the subsequent event disclosures, then the financial statements are
materially misstated and as the lack of disclosure is material but not pervasive, the audit report will be
modified and a qualified opinion will be necessary.
A basis for qualified opinion paragraph would need to be included before the opinion paragraph. This
would explain the misstatement in relation to the lack of subsequent events disclosure and the effect on the
financial statements. The opinion paragraph would be qualified ‘except for'.
----------------------------------------------------------------------------------------------------------------------------------------------------------
Question 18 (d)
Hyacinth Co develops and manufactures computer components and its year end was 31 December 20X8.
The company has a large factory, and two warehouses, one of which is off-site. You are an audit
supervisor of Tulip & Co and the final audit is due to commence shortly. Draft financial statements show
total assets of $23·2m and profit before tax of $6·4m. The following three matters have been brought to
your attention:
The audit is now almost complete and the auditor’s report is due to be signed shortly. The following
matter has been brought to your attention:
On 3 February 20X9, a flood occurred at the off-site warehouse. This resulted in some damage to
inventory and property, plant and equipment. However, there have been no significant delays to customer
deliveries or complaints from customers. Hyacinth Co’s management has investigated the cause of the
flooding and believes that the company is unlikely to be able to claim on its insurance. The finance
director of Hyacinth Co has estimated that the value of damaged inventory and property, plant and
equipment was $0·7m and that it now has no scrap value.
Required:
i. Explain whether the 20X8 financial statements of Hyacinth Co require amendment in relation
to the flood; and
ii. Describe audit procedures which should be performed in order to form a conclusion on any
required amendment. Note: The total marks will be split equally between each part.

Summary Notes by SK
Answer:
Subsequent event
A flood has occurred at the off-site warehouse and property, plant and equipment and inventory valued at
$0·7 million have been damaged and now have no scrap value. The directors do not believe they are likely
to be able to claim on the company’s insurance for the damaged assets. This event occurred after the
reporting period and is not an event which provides evidence of a condition at the year end and so this is a
non-adjusting event.
The damaged assets of $0·7 million are material as they represent 10·9% ($0·7m/$6·4m) of profit before
tax and 3·0% ($0·7m/$23·2m) of total assets. As a material non-adjusting event, the assets do not need to
be written down to zero in this 25 financial year. However, the directors should consider including a
disclosure note detailing the flood and the value of assets impacted.
The following audit procedures should be applied to form a conclusion on any amendment:
 Obtain a schedule showing the damaged property, plant and equipment and agree the net book value
to the non-current assets register to confirm the total value of affected assets.
 Obtain a schedule of the water damaged inventory, visit the off-site warehouse and physically inspect
the impacted inventory. Confirm the quantity of goods present in the warehouse to the schedule; agree
the original cost to pre year-end production costs.
 Review the condition of other PPE and inventory to confirm all damaged assets identified.
 Review the damaged property, plant and equipment and inventory and discuss with management the
basis for the zero scrap value assessment.
 Discuss with management why they do not believe that they are able to claim on their insurance; if a
claim were to be made, then only uninsured losses would require disclosure, and this may be an
immaterial amount.
 Discuss with management whether they will disclose the effect of the flood, as a non-adjusting event,
in the year-end financial statements.

Summary Notes by SK
ISA 570 – ‘Going Concern’

Summary Notes by SK
Expected Questions on Going Concern (ISA 570 – Revised)
1. Define Going Concern assumption?

2. Explain 4 / 5/ 6 potential indicators that company is not a
going concern
3. List and explain the going concern indicators?
4. Differentiate/Explain/Discuss between Management &
External Auditor responsibilities for Going Concern
assumption?
5. Briefly explain the auditor’s responsibility for reporting on
going concern to the directors / TCWG?
6. What are the reporting responsibilities of an external auditor
with respect to Going Concern?
7. Scenario Based Questions? ….IMP
 List and explain the Indicators of Going Concern
 Describe the audit procedures / audit tests to be performed
by the external Auditor to assess that whether the company
is Going Concern or not.
 Explain the impact on the audit report / opinion
(________________________________________________________________)

Summary Notes by SK
Going Concern Assumption
Definition
Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable future.
General purpose F/S are prepared on a going concern basis, unless management either intends to liquidate the
entity or to cease operations, or has no realistic alternative but to do so and when Going concern assumption is valid
than assets and liabilities are recorded on the basis that the entity will be able to realize its assets and discharge its
liabilities in the normal course of business.
Responsibilities of Management
Because general purpose F/S are prepared on a going concern basis, the going concern assumption is a
fundamental principle in the preparation of F/S. Therefore managements responsibility for the presentation
and preparation of the F/S also includes responsibility to assess the entity’s ability to continue as a going
concern even if there is no explicit requirement to do so in the framework.
If mgmt. becomes aware of facts that cast doubt upon the entity’s ability to continue as going concern than
Mgmt. must disclose those uncertainties in the F/S.
If mgmt. concludes that G.C assumption is not appropriate than F/S will be prepared on breakup value basis
but this fact must be disclosed in the F/S for the shareholder / users
Period of Assessment…… (Evaluating Management Assessment)
The auditor to inquire and perform procedures to identify events or conditions that may cast significant doubt
on Going concern assumption for a period of twelve months from the balance sheet date or a longer period if
the applicable F.R.F / law or regulation specifies / or conditions require.
(Period beyond 12 months can be inquired by the E.A)
Responsibilities of External Auditor …IMP
The auditor must remain alert throughout the period for conditions that may cast doubt on the entity’s ability
to continue as a going concern. The auditor’s responsibility is to obtain sufficient appropriate audit evidence
about the appropriateness of management’s use of the going concern assumption in the preparation and
presentation of the financial statements for the year and to conclude that whether there is a material
uncertainty about the entity’s ability to continue as a going concern.
The potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater
for future events or conditions that may cause an entity to cease to continue as a going concern. The auditor
cannot predict such future events or conditions.
Accordingly, the absence of any reference to going concern uncertainty in an auditor’s report cannot be
viewed as a guarantee as to the entity’s ability to continue as a going concern
(In short, Auditor must be alert throughout the audit for doubts on GC ..! + evaluate management’s
assessment of the entity’s ability to continue as a going concern Note: this assessment will be for a minimum
period of 12 months)
Summary Notes by SK
Going concern indicators (3 types)
Financial IMP…!
Operating
Others
Mitigating Factors (very Imp when deciding to modify the audit report)
The significance of such events or conditions often can be mitigated by other factors. For example, the effect of
an entity being unable to make its normal debt repayments may be counter-balanced by management’s plans
to maintain adequate cash flows by alternative means, such as by disposing of assets, or obtaining additional
capital.
Audit Procedures When Events or Conditions Are Identified
Specific Audit procedures to be performed as follows: (Please learn these…..!!) (IMP)
1. Obtain company’s cashflow forecast and review the cash inflows and cash outflows and also the
reasonableness of their assumptions and also discuss unfavorable findings with management.
2. Review post year end management accounts to assess if they are in line with cashflow and other forecasts.
3. Reading the terms of loan agreements and determining whether any have been breached.
4. Discuss with director finance regarding increase in sales or whether new customers have been obtained.
(new sales lead )
5. Review the company’s post year end sales order book to assess and determine if the levels of trade/sales
are likely to increase.
6. Review post year end (subsequent) B.O.D minutes and minutes of other relevant committees to identify
other issues which might indicate other risks of going concern.
7. Inquiring of the entity’s legal counsel regarding the existence of litigation and claims.
(eg Claims from Suppliers and Customers)
8. Enquire from company lawyers with respect to proposed change in any law / legislation which might
make company product obsolete in the near future.
9. Confirming the existence of arrangements to provide financial support from related and third parties and
assessing their financial ability.
10. Evaluating plans to deal with un-fulfilled customer orders. (Orders that are pending yet )
11. Performing audit procedures regarding subsequent events to identify those that affect the entity’s ability to
continue as a going concern.
12. Confirming the existence, terms and conditions of borrowing facilities from Banks. (eg Loan Agreements
or correspondence)
13. Obtaining and reviewing reports of any regulatory actions. (for any penalties being imposed by regulatory
bodies )
14. Assessing the genuineness for any planned disposals of assets. (e.g. Vacant Building or Land to confirm
the mitigating factor)
15. Obtaining written / management representation confirming the B.O.Ds view that company is a going
concern. (to be linked and covered in ISA 580)

Summary Notes by SK
OR Obtain Management representation for future plans & their feasibility.
EXAM FOCUS POINT
1. Theoretical question can be asked for the above procedures.

2. In the case of scenario-based question, above procedures will have to be linked with the given
scenario in the exam.
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Going Concern Indicators ……………………………MOST IMP

Events or conditions that may cast doubt about the going concern assumption (potential indicators that an
entity is not a going concern).
 Financial Indicators  Net liability or net current liability position

 Fixed-term borrowings approaching maturity without prospects
of renewal or repayment
 Indications of withdrawal of financial support by creditors
 Negative operating cash flows (historical or prospective i.e
future Cash flows)
 Adverse key financial ratios or decreased as compared to last
year)
 Substantial operating losses or significant deterioration in the
value of assets used to generate cash flows
 Arrears or discontinuance of dividends
 Inability to pay creditors on due dates
 Inability to comply with terms of loan agreements
__________________________________________
 Change from credit to cash-on-delivery transactions with
suppliers
 Inability to obtain financing for essential new product
development or other essential investments
__________________________________________
 Operating Indicators  Management intentions to liquidate or cease operations

 Loss of key management without replacement
___________________________________________
 Loss of a major market, key customers, license, or principal
suppliers (Supplier has ceased trading)
___________________________________________
 Labour difficulties ( eg Trade Union Strikes)
 Shortage of important supplies
__________________________________________
 Emergence of a highly successful competitor
( E.g. Pizza Max and 14TH Street for Pizza Hut)

Summary Notes by SK
 Other Indicators  Non-compliance with laws and regulations
 Pending legal or regulatory proceedings against the entity that
may, if successful, result in claims that the entity is unlikely to
be able to satisfy
__________________________________________
 Changes in laws/regulations/government policy expected to
adversely affect the entity
_________________________________________
 Uninsured or underinsured catastrophes
_________________________________________
Other Going concern indicators
Audit conclusions & reporting – Going Concern
Scenario Impact on auditor’s report

1. Going concern assumption is appropriate Unmodified opinion PLUS Separate Para
but a material uncertainty exists …which Section headed ‘Material Uncertainty Related to
is adequately disclosed Going Concern’
2. Going concern assumption is appropriate Qualified or adverse opinion (i.e. modified opinion)
but a material uncertainty exists …which
is NOT adequately disclosed in the F/S
3. Use of going concern assumption is Adverse opinion (i.e. modified opinion)
inappropriate in the F/S
4. Management is unwilling to make or Qualified or disclaimer of opinion (i.e. modified opinion)
extend its assessment with respect to Because of Lack of S.A.A.E
going concern…
Case 1: Going concern assumption is appropriate BUT a material uncertainty exists which is adequately
disclosed in the F/S………….
In this situation, the opinion on the financial statements will be unmodified but the auditor's report will include
a separate para headed ‘Material Uncertainty Related to Going Concern’
The report is standard/unmodified, except for this new paragraph, placed immediately after the ‘Basis for
Opinion Para’…

Summary Notes by SK
Material Uncertainty Related to Going Concern………(Heading of the pargraph)

We draw attention to Note 6 in the financial statements, which indicates that the Company incurred a net loss
of ZZZ during the year ended December 31, 2OX1 and, as of that date, the Company's current liabilities
exceeded its total assets by YYY. As stated in Note 6, these events or conditions, along with other matters as
set forth in Note 6, indicate that a material uncertainty exists that may cast significant doubt on the Company’s
ability to continue as a going concern.
Our opinion is not modified in respect of this matter.
Case 1(a): Going concern assumption is appropriate BUT a material uncertainty Exists which is NOT
adequately disclosed in the F/S….
In this situation, as inadequate disclosure has been made of the material uncertainty, the auditor’s opinion will
be modified - either a qualified or adverse opinion will be issued depending on the magnitude of the
uncertainty.
An extract from the auditor's report where a qualified opinion is issued is provided by the ISA follows.
Qualified Opinion
In our opinion, except for the incomplete disclosure of the information referred to in the Basis for Qualified
Opinion paragraph, the financial statements present fairly, in all material respects (or ‘give a true and fair view
of’) the financial position of the Company as at December 31, 20X0, and of its financial performance and its
cash flows for the year then ended in accordance with international Financial Reporting Standards (IFRSs).
Basis for Qualiﬁed Opinion
The Company's financing arrangements expire and amounts outstanding are payable on 19 March 20X1. The
Company has been unable to conclude re-negotiations or obtain replacement-financing. This situation indicates
that a material uncertainty exists that may cast significant doubt on the Company's ability to continue as a
going concern. The financial statements do not fully disclose this matter.
Case 1(b): Going concern assumption is appropriate but a material uncertainty Exists which is not
adequately disclosed in the F/S….( Impact is Material and Pervasive )
Adverse Opinion
In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion section
of our report, the accompanying financial statements do not present fairly (or do not give a true and fair
view of), the financial position of the Company as at Dec………….
Basis for Adverse Opinion

Summary Notes by SK
The Company’s financing arrangements expired and the amount outstanding was payable on December 31,
20X1. The Company has been unable to conclude re-negotiations or obtain replacement financing and is
considering filing for bankruptcy. This situation indicates that a material uncertainty exists that may cast
significant doubt on the Company's ability to continue as a going concern. The financial statements do not
adequately disclose this fact.
Case 3: Management unwilling to make or extend its assessment
In some circumstances, the auditor may ask management to make or extend its assessment. If management
does not do this, a qualified opinion or a disclaimer of opinion may be appropriate, because it may not
be possible for the auditor to obtain sufficient appropriate audit evidence regarding the use of the going
concern assumption in the preparation of the financial statements.
Exam Focus point

1. Both theoretical and practical / scenario-based question can be asked on the Audit report with
respect to going concern.
2. Please remember audit report cheetay points in the case of impact of going concern on the
audit report.
Communicating to those charged with governance (Responsibility Towards Directors)
The auditor shall communicate with those charged with governance, events or conditions that may cast doubt
on the entity's ability to continue as a going concern. This will include:
 Whether the events or conditions constitute a material uncertainty

 Whether the use of the going concern assumption is appropriate in the preparation and presentation of
the financial statements
 The adequacy of related disclosures
 Implications on the audit report
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Summary Notes by SK

Summary Notes by SK
Exam Focused Points for CA CAF 8 Students

Summary Notes by SK
Exam Focused Points for CA CAF 8 Students

Summary Notes by SK
ACCA F8 Practice Questions on Going Concern

Going Concern

Summary Notes by SK
Going Concern Exam Focused Points

Summary Notes by SK
Going Concern Exam Focused Points

Summary Notes by SK
Question 5
You are the audit manager of Kiwi & Co and you have been provided with financial statements extracts
and the following information about your client, Strawberry Kitchen Designs Ltd (Strawberry), who is a
kitchen manufacturer. The company’s year end is 30 April 2012.
Strawberry has recently been experiencing trading difficulties, as its major customer who owes £0·6m to
Strawberry has ceased trading, and it is unlikely any of this will be received. However, the balance is
included within the financial statements extracts below. The sales director has recently left Strawberry and
has yet to be replaced.
The monthly cash flow has shown a net cash outflow for the last two months of the financial year and is
forecast as negative for the forthcoming financial year. As a result of this, the company has been slow in
paying its suppliers and some are threatening legal action to recover the sums owing.
Due to its financial difficulties, Strawberry missed a loan repayment and, as a result of this breach in the
loan covenants, the bank has asked that the loan of £4·8m be repaid in full within six months. The
directors have decided that in order to conserve cash, no final dividend will be paid in 2012.
Financial statements extracts for year ended 30 April:

DRAFT ACTUAL
2012 2011
Current Assets $m $m
Inventory 3.4 1.6
Receivables 1.4 2.2
Cash - 1.2
Current Liabilities 1·9 0·9

Trade payables 0·8 -
Overdraft 4·8 0·2
Required
b) Explain the potential indicators that Strawberry Kitchen Designs Ltd is not a going concern.
(6 marks)
c) Describe the audit procedures that you should perform in assessing whether or not the company is a
going concern. (6 marks)
d) Having performed the going concern audit procedures, you have serious concerns in relation to the
going concern status of Strawberry. The finance director has informed you that as the cash flow issues
are short term he does not propose to make any amendments to the financial statements.
Required:
i. State Kiwi & Co’s responsibility for reporting on going concern to the directors of Strawberry
Kitchen Designs Ltd; and (2 marks)
ii. If the directors refuse to amend the financial statements, describe the impact on the audit
report. (3 marks)
(17 marks)
Answer:
Summary Notes by SK
b) Going concern indicators
i. A major customer of Strawberry Kitchen Designs Ltd (Strawberry) has ceased trading owing them
£0·6m. This will result in a significant loss of future revenues and profit, and unless this customer
can be replaced then there will be a reduction of future cash flows.
ii. The sales director has recently left the company and has yet to be replaced. Loss of a key director
will impact on the company’s sales, as Strawberry has already lost a major customer, then without
an experienced sales director to generate new sales the company will face significantly reduced
sales and cash flows.
iii. Strawberry is experiencing negative monthly cash flows and this is expected to continue. If the
company continues to have cash outflows then it will increase its overdraft further and will start to
run out of available cash.
iv. The company has been late paying some of its suppliers. If suppliers are being paid late then they
may refuse to supply Strawberry with goods or impose ‘cash on delivery’ terms which will disrupt
service or sales to customers.
v. A number of the suppliers are threatening legal action. If this occurs then Strawberry will have
legal costs on top of the amounts owed already and this will further increase the pressure on cash
flows. In addition, other suppliers may hear about the legal action and, as a result, stop supplying
goods to Strawberry.
vi. Strawberry has missed a loan repayment which is a breach in the loan covenant and hence the
loan of £4·8m is now all repayable. The company only has six months to raise £4·8m; as it
currently stands they do not have this level of cash available and unless they are able to raise
alternative finance or sell non-current assets, it is difficult to see how they will be able to raise this
amount.
vii. In order to conserve cash Strawberry has decided not to pay a final dividend for 2012. This may
result in shareholders losing faith in the company and they may attempt to sell their shares; in
addition, they are highly unlikely to invest further equity, and Strawberry urgently needs to raise
finance to repay their loans.
viii. The current ratio has significantly declined from 4·55 (1·6 + 2·2 + 1·2/0·9 + 0·2) in 2011 to 0·64
(3·4 + 1·4/1·9 + 0·8 + 4·8) in 2012. The current ratio is showing that the current assets are not
sufficient to pay the current liabilities. This is another indication of the worsening liquidity
position of the company, which has mainly occurred due to the loan becoming repayable.
c) Going concern procedures

1. Obtain the company’s cash flow forecast and review the cash in and out flows. Assess the
assumptions for reasonableness and discuss the findings with management to understand if the
company will have sufficient cash flows.
2. Perform a sensitivity analysis on the cash flows to understand the margin of safety the company
has in terms of its net cash in/out flow.
3. Discuss with the finance director whether the sales director has yet been replaced and whether any
new customers have been obtained to replace the one lost.
4. Review the company’s post year-end sales and order book to assess if the levels of trade are likely
to increase and if the revenue figures in the cash flow forecast are reasonable.
5. Review the loan agreement and recalculate the covenant which has been breached. Confirm the
timing and amount of the loan repayment.
6. Review any agreements with the bank to determine whether any other covenants have been
breached, especially in relation to the overdraft.
Summary Notes by SK
7. Discuss with the directors whether they have contacted any alternative banks for finance to assess
whether they have any other means of repaying the loan of £4·8m.
8. Review any correspondence with shareholders to assess whether any of these are likely to increase
their equity investment in the company.
9. Review post year-end correspondence with suppliers to identify if any others have threatened legal
action or refused to supply goods.
10. Enquire of the lawyers of Strawberry as to the existence of any additional litigation and request
their assessment of the likely amounts payable to the suppliers.
11. Perform audit tests in relation to subsequent events to identify any items that might indicate or
mitigate the risk of going concern not being appropriate.
12. Review the post year-end board minutes to identify any other issues that might indicate further
financial difficulties for the company.
13. Review post year-end management accounts to assess if in line with cash flow forecast.
14. Consider whether the going concern basis is appropriate for the preparation of the financial
statements.
15. Obtain a written representation confirming the director’s view that Strawberry is a going concern.
(d) i. Reporting in relation to going concern to the directors of Strawberry Kitchen

Designs Ltd
Kiwi & Co has a responsibility to report to the directors in relation to any events or conditions
which may cast doubt on Strawberry’s ability to continue as a going concern. These include:
 Whether the events or conditions constitute a material uncertainty;
 Whether the use of the going concern assumption is appropriate in the preparation of the financial
statements; and
 The adequacy of related disclosures in the financial statements.
(ii) Audit report

The directors do not wish to make any amendments to the financial statements. However, if we believe that
Strawberry is not a going concern then the audit report will need to be modified. An adverse opinion will
be required regardless of whether or not the financial statements include disclosure of the inappropriateness
of management’s use of the going concern assumption as the financial statements are materially misstated,
and the misstatements are material and pervasive to the financial statements.
The basis for adverse opinion paragraph will require an explanation that the use of the going concern basis
is inappropriate. The opinion paragraph will state that the financial statements do not give a true
and fair view ………..

Question 5
Clarinet Co (Clarinet) is a computer hardware specialist and has been trading for over five years. The
company is funded partly through overdrafts and loans and also by several large shareholders; the year
end is 30 April 2014.
Clarinet has experienced significant growth in previous years; however, in the current year a new
competitor, Drums Design Co (Drums), has entered the market and through competitive pricing has
gained considerable market share from Clarinet. One of Clarinet’s larger customers has stopped trading
Summary Notes by SK
with them and has moved its business to Drums. In addition, a number of Clarinet’s specialist developers
have left the company and joined Drums. Clarinet has found it difficult to replace these employees due to
the level of their skills and knowledge. Clarinet has just received notification that its main supplier who
provides the company with specialist electrical equipment has ceased to trade.
Clarinet is looking to develop new products to differentiate itself from the rest of its competitors. It has
approached its shareholders to finance this development; however, they declined to invest further in
Clarinet. Clarinet’s loan is long term and it has met all repayments on time. The overdraft has increased
significantly over the year and the directors have informed you that the overdraft facility is due for renewal
next month, and they are confident it will be renewed.
The directors have produced a cash flow forecast which shows a significantly worsening position over the
coming 12 months. They are confident with the new products being developed, and in light of their
trading history of significant growth, believe it is unnecessary to make any disclosures in the financial
statements regarding going concern.
At the year end, Clarinet received notification from one of its customers that the hardware installed by
Clarinet for the customers’ online ordering system has not been operating correctly. As a result, the
customer has lost significant revenue and has informed Clarinet that they intend to take legal action
against them for loss of earnings. Clarinet has investigated the problem post year end and discovered that
other work-in-progress is similarly affected and inventory should be written down. The finance director
believes that as this misstatement was identified after the year end, it can be amended in the 2015 financial
statements.
Required:
a) Describe the procedures the auditors of Clarinet Co should undertake in relation to the uncorrected inventory
misstatement identified above. (4 marks)
b) Explain SIX potential indicators that Clarinet Co is not a going concern. (6 marks)
c) Describe the audit procedures which you should perform in assessing whether or not Clarinet Co is
a going concern. (6 marks)
The auditors have been informed that Clarinet’s bankers will not make a decision on the overdraft facility
until after the audit report is completed. The directors have now agreed to include some going concern
disclosures.
Required:
d) Describe the impact on the audit report of Clarinet Co if the auditor believes the company is a
going concern but that this is subject to a material uncertainty. (4 marks)
Answer:
a. Procedures to undertake in relation to the uncorrected misstatement
 The extent of the potential misstatement should be considered and therefore a large sample of
inventory items should be tested to identify the possible size of the misstatement.
 The potential misstatement should be discussed with Clarinet Co’s management in order to
understand why these inventory differences are occurring.
 The misstatement should be compared to materiality to assess if the error is material individually.
 If not, then it should be added to other errors noted during the audit to assess if in aggregate the
uncorrected errors are now material.

Summary Notes by SK
 If material, the auditors should ask the directors to adjust the inventory balances to correct the
misstatements identified in the 2014 year end.
 Request a written representation from the directors about the uncorrected misstatements including
the inventory errors.
 Consider the implication for the audit report if the inventory errors are material and the directors
refuse to make adjustments.
b) Going concern indicators
A new competitor, Drums Design Co (Drums), has entered the market and gained considerable market
share from Clarinet through competitive pricing. There is a risk that if Clarinet continues to lose market
share this will impact on future cash flows. In addition, there may be pressure on Clarinet to drop their
prices in order to compete, which will impact profits and cash flows.
A significant customer has stopped trading with Clarinet and moved its business to Drums. This could
result in a significant loss of future revenues and profit, and unless this customer can be replaced, there
will be a reduction of future cash flows.
A number of Clarinet’s specialist developers have left the company and joined Drums and the company
has found it difficult to replace these employees due to their experience and skills. The company is looking
to develop new products and in order to do this, it needs sufficiently trained staff. If it cannot recruit
enough staff, then it could hold up the product development and stop the company from increasing
revenue.
Clarinet’s main supplier who provides specialist equipment has just stopped trading. If the equipment is
highly specialized, there is a risk that Clarinet may not be able to obtain these products from other
suppliers which would impact on their ability to trade. More likely, there are other suppliers available but
they may be more expensive which will increase the outflows of Clarinet and worsen the cash flow
forecast.
Clarinet needs to raise finance to develop new products in order to gain market share; they approached
their shareholders for further finance but they declined to invest further. If Clarinet is unable to obtain
suitable finance, then it may be that the shareholders deem Clarinet to be too risky to invest in further.
They may be concerned that Clarinet will not be able to offer them a suitable return on their investment,
suggesting cash flow problems. In addition, if Clarinet cannot obtain alternative finance, then it will not be
able to develop the products it needs to.
Clarinet’s overdraft has grown significantly during the year. If the bank does not renew the overdraft and
the company is unable to obtain alternative finance, then it may not be able to continue to trade.
Clarinet’s cash flow forecast shows a significantly worsening position for the coming 12 months. If the
company continues to have cash outflows, then it will increase its overdraft further and will start to run
out of available cash.
One of Clarinet’s customers is planning to sue the company for loss of revenue due to hardware being
installed by Clarinet in the customer’s online ordering system not operating correctly. If the customer is
successful, then Clarinet may have to pay a significant settlement which will put further pressure on cash
flows. In addition, it is unlikely that this customer will continue to trade with Clarinet and if the problems
become known to other customers, this may lead to a further loss of revenue and cash flows as well as
impact on Clarinet’s reputation.
c) Going concern procedures
 Obtain the company’s cash flow forecast and review the cash in and outflows. Assess the assumptions
for reasonableness and discuss the findings with management to understand if the company will have
sufficient cash flows.
 Perform a sensitivity analysis on the cash flows to understand the margin of safety the company has
in terms of its net cash in/outflow.

Summary Notes by SK
 Discuss with the finance director whether any new customers have been obtained to replace the one
lost.
 Review the company’s post year-end sales and order book to assess if the levels of trade are likely to
increase in light of the increased competition from Drum and if the revenue figures in the cash flow
forecast are reasonable.
 Discuss with the directors whether replacement specialist developers have been recruited to replace
those lost to Drum.
 Review any agreements with the bank to determine whether any covenants have been breached,
especially in relation to the overdraft.
 Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.
 Review the correspondence with shareholders to assess whether any of these are likely to reconsider
increasing their investment in the company.
 Discuss with the directors whether they have contacted any banks for finance to help with the new
product development.
 Enquire of the lawyers of Clarinet as to the existence of any additional litigation and request their
assessment of the likelihood of Clarinet having to make payment to their customer who intends to sue
for loss of revenue.
 Perform audit tests in relation to subsequent events to identify any items which might indicate or
 Review the post year-end board minutes to identify any other issues which might indicate further
 Review post year-end management accounts to assess if in line with cash flow forecast.
 Obtain a written representation confirming the directors’ view that Clarinet is a going concern.
d) Audit report
The directors of Clarinet have agreed to make going concern disclosures; however, the impact on the audit
report will be dependent on the adequacy of these disclosures. If the disclosures are adequate, then the
audit report will be modified by adding a separate paragraph headed ‘Material uncertainty related to
Going concern’.
The paragraph will state that the audit opinion is not modified, indicate that there is a material uncertainty
and will cross reference to the disclosure note in the F/S made by management. It would be included
immediately after the Basis for opinion paragraph.
If the disclosures made by management are not adequate, the audit opinion will need to be modified as
there is a material misstatement. Depending on the materiality of the issue, this will be either qualified or
an adverse opinion.
A paragraph describing the matter giving rise to the modification will be included just AFTER the opinion
paragraph and this will clearly identify the lack of disclosure over the going concern uncertainty. The
opinion paragraph will be amended to state ‘Except for’ or the financial statements do not give a true and
fair view
--------------------------------------------------------------------------------------------------------------------
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Summary Notes by SK
Test Questions-Going Concern
Test Question # 1 (2 marks)

a) Define the going concern assumption
Medimade Co is an established pharmaceutical company that has for many years generated 90% of its
revenue through the sale of two specific cold and flu remedies. Medimade has lately seen a real growth in
the level of competition that it faces in its market and demand for its products has significantly declined. To
make matters worse, in the past the company has not invested sufficiently in new product development and
so has been trying to remedy this by recruiting suitably trained scientific staff, but this has proved more
difficult than anticipated.
In addition to recruiting staff the company also needed to invest $2m in plant and machinery. The
company wanted to borrow this sum but was unable to agree suitable terms with the bank; therefore it used
its overdraft facility, which carried a higher interest rate.
Consequently, some of Medimade’s suppliers have been paid much later than usual and hence some of
them have withdrawn credit terms meaning the company must pay cash on delivery. As a result of the
above the company’s overdraft balance has grown substantially.
The directors have produced a cash flow forecast and this shows a significantly worsening position over the
coming 12 months.
The directors have informed you that the bank overdraft facility is due for renewal next month, but they are
confident that it will be renewed.
They also strongly believe that the new products which are being developed will be ready to market soon
and hence trading levels will improve and therefore that the company is a going concern. Therefore, they
do not intend to make any disclosures in the accounts regarding going concern.
Required:
a) Identify potential indicators that the company is not a going concern and describe why these could
impact upon ability if the company to continue trading on a going concern basis. (6 marks)
b) Explain the audit procedures that the auditor of Medimade should perform in assessing whether or
not the company is a going concern. (6 marks)
c) The auditors have been informed that Medimade’s bankers will not make a decision on the overdraft
facility until after the audit report is completed. The directors have now agreed to include going
concern disclosures.
Required:
Describe the impact on the audit report of Medimade if the auditor believes the company is a going
concern but a material uncertainty exists. (6 marks)
(Total 20 marks)
-------------------------------------------------------------------------------------------------------------------------------

Summary Notes by SK
Mercury Motoring Co (Mercury) specializes in manufacturing engine parts for motor cars and the
company has a diverse customer base but seven significant customers. The company’s year-end was 30
September 2015.
During the year, a number of the company’s significant customers have experienced a fall in sales, and
consequently they have purchased fewer items from Mercury. As a result, Mercury has paid a number of
its suppliers later than usual and some of them have withdrawn credit terms meaning the company must
pay cash on delivery. One of Mercury’s main suppliers is threatening legal action to recover the sums
owing. As a result of the increased level of payables, the company’s current ratio has fallen below 1 to 0·9
for the first time.
Mercury has produced a cash flow forecast to 30 June 2016 and this shows net cash outflows until May
2016. Mercury has a loan of $2·3 million which is due for repayment in full by 30 September 2016.
The finance director has just informed the audit manager that there is a possible change in legislation
which will result in one of Mercury’s top product lines becoming obsolete as it will not comply with the
proposed law. The prepared cash flow forecasts do not reflect this possible event.
Required:
a) Explain FIVE potential indicators that Mercury Motoring Co is NOT a going concern.
(5 marks)
b) Describe the audit procedures which you should perform in assessing whether or not Mercury
Motoring Co is a going concern. (5 marks)
(10 marks)
-------------------------------------------------------------------------------------------------------------------------------

You are a partner in a firm of chartered accountants. Following independent matters are under your
consideration:
i. The draft financial statements of Elrond Pakistan Limited (EPL) for the year ended 31 January 2021
include inventory of Rs. 26 million that was purchased on 1 January 2021 for fulfilling a large
specialized order of a foreign customer. Due to sudden imposition of import restriction in the foreign
country, the customer cancelled the order on 28 January 2021. The draft financial statements show
that EPL’s profit before tax is Rs. 130 million.
ii. During the audit of Stellar Limited (SL), the management informed the audit team that its largest
customer, Ether Limited (EL) has recently notified that it will not renew its contract with SL, which
is due to expire on 30 June 2021. Sales from EL constitutes 70% of the total revenue. The
management has further informed that they are in negotiation with EL and are hopeful to retain the
customer
Required:
For each of the above independent matters:
a) state the audit procedures which may be performed by your audit team. (8 marks)
b) discuss with reasons, the implication(s) on the audit report. (10 marks)

Summary Notes by SK
Solution of Test Questions-Going Concern

Answer # 1
a) The going concern assumption means that management believes the company will continue in business
for the foreseeable future. Foreseeable future is not defined in ISA 570 Going Concern. However, under
IAS 1 Presentation of Financial Statements, this period is a minimum of 12 months after the year end.
IAS 1 Presentation of Financial Statements requires that management automatically prepare financial
statements on a going concern basis unless they believe that the company will soon cease trading.
b)
Indicator Why could impact going concern
Medimade has seen a significant decline in If the company is not able to increase demand for its
demand for its products. products then it will struggle to generate sufficient
operating cash flows leading to going concern
difficulties.
Medimade generates 90% of its revenue As the market is very competitive and Medimade
through sales of just two products, and this has only two products then it is very dependent on
market has now become very competitive. these and must ensure that it makes sufficient sales
as otherwise it may face difficulties in meeting all
expenses.
Lack of investment in future product As current products reach the end of their life-cycle
development they will bring in diminishing cash flows. Without
new products to generate future income operating
cash flows will be strained.
The company is struggling to recruit suitably The company has decided that it needs to develop
trained scientific staff to develop new products. new products, however, this is a highly specialised
area and therefore it needs sufficiently trained staff.
If it cannot recruit enough staff then it could hold up
the product development and stop the company from
increasing revenue.
Medimade was unable to obtain suitable If Medimade was unable to obtain finance for its
funding for its $2m investment in plant and investment, then this could indicate that the banks
machinery. deem the company to be too risky to lend money to.
They may be concerned that Medimade is unable to
meet its loan payments, suggesting cash flow
problems.
Some trade payables have been paid much Failing to make payments to suppliers on time could
later than their due dates. ultimately lead to some of them refusing to supply
Medimade. Therefore the company may need to find
alternative suppliers and they could be more
expensive which will decrease operating cash flows
and profits.
Some suppliers have withdrawn credit terms As Medimade must now make cash on delivery,
from Medimade resulting in cash on delivery then it puts additional pressure on the company’s
payments. overdraft, which has already grown substantially.
This is because the company has to pay for goods in
advance but it may not receive cash from its
receivables for some time later.
The overdraft facility has increased Medimade’s overdraft has grown significantly and it
Summary Notes by SK
substantially and is due for renewal next is heavily dependent on it to pay its expenses. If the
month. bank does not renew the overdraft and the company
is unable to obtain alternative finance then it may
not be able to continue to trade.
The cash flow forecast has shown a The future cash outflows are greater than the inflows
significantly worsening position. and this position is worsening rather than improving
. If Medimade cannot start to reverse this position,
then it may have difficulties in funding it operating
activities.
c) .
 Obtain the company’s cash flow forecast and review the cash in and out flows. Assess the
assumptions for reasonableness and discuss the findings with management to understand if the
company will have sufficient cash flows.
 Perform a sensitive analysis on the cash flows to understand the margin of safety the company has in
terms of its net cash in/out flow.
 Review any current agreements with the bank to determine whether any key ratios have been
breached.
 Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.
 Discuss with the directors whether they have contacted any alternative banks for finance or whether
they have any other means of repaying the bank overdraft.
 Review the company’s post year end sales and order book to assess if the levels of trade are likely to
increase and if the revenue figures in the cash flow forecast are reasonable.
 Review post year end correspondence with suppliers to identify if any further restrictions in credit
have arisen, and if so ensure that the cash flow forecast reflects an immediate payment for trade
payables.
 Inquire of the lawyers of Medimade as to the existence of litigation and claims, if any exist then
consider their materiality and impact on the going concern basis.
 Perform audit tests in relation to subsequent events to identify any items that might indicate or
 Review the post year end board minutes to identify any other issues that might indicate financial
difficulties for the company.
 Review post year end management accounts to assess if in line with cash flow forecast.
 Consider whether any additional disclosures as required by FRS 101 (Revised) Presentation of
Financial Statements in relation to material uncertainties over going concern should be made in the
 Obtain a written representation confirming the director’s view that Medimade is a going concern.

Summary Notes by SK
d) The directors of Medimade have agreed to make going concern disclosures, however, the impact on the
audit report will be dependent on the adequacy of these disclosures. If the disclosures are adequate, then
the audit report will be unmodified.
However, an emphasis of matter paragraph would be required.
This will state that the audit report is not modified, identify that there is a material uncertainty and will
cross reference to the disclosure note made by management, this paragraph would be included after the
opinion paragraph.
If the disclosures made by management are not adequate the audit report will need to be modified. A
material misstatement modification will be required, depending on the materiality of the issue this will be
either qualified or an adverse opinion.
A paragraph describing the matter giving rise to the modification will be included just before the opinion
paragraph and this will clearly identify the going concern uncertainty. The opinion paragraph will be
amended to state ‘except for’ or the accounts are not fairly presented.
-------------------------------------------------------------------------------------------------------------------------------
Answer # 2:
a) Going concern indicators
During the year a number of Mercury’s significant customers have experienced a fall in sales, hence they
have purchased fewer items from Mercury. There is a risk that if Mercury’s customers continue to reduce
the level of their purchases, this will reduce Mercury’s sales and future cash flows. In addition, Mercury
may need to reduce their prices in order to boost sales volumes, which will impact profits and cash flows.
Mercury has paid some of its suppliers later than usual and hence some of them have withdrawn credit
terms meaning the company must pay cash on delivery. This puts additional pressure on the company’s
cash flow. This is because the company has to pay for goods in advance but it may not receive cash from
its receivables until sometime later.
One of Mercury’s main suppliers is threatening legal action to recover the sums owing. If this occurs, then
Mercury will have legal costs in addition to the amounts already owed and this will further increase the
pressure on cash flows. In addition, other suppliers may hear about the legal action and, as a result, stop
supplying goods to the company.
The company’s current ratio has fallen below 1 to 0·9 for the first time. The current ratio is showing that
the current assets are not sufficient to pay the current liabilities. This is another indication of the
worsening liquidity position of the company.
Mercury has produced a cash flow forecast to 30 June 2016 and this shows net cash outflows until May
2016. If the company continues to have cash outflows, then it will put further pressure on the company’s
cash flows and there is the risk that it will start to run out of available cash.
Mercury has a significant loan which is due for repayment in full by 30 September 2016. The company
only has nine months to raise the $2·3 million and with falling levels of sales and negative cash flows
forecast until May 2016, it is difficult to see how they will be able to raise alternative finance to pay this
amount.
Mercury is facing a possible change in legislation which will result in one of its top product lines becoming
obsolete. Whilst this is only a possible change in the law, if it does come into force then the inventory for
this product may have to be scrapped, resulting in a large write off and possible reduced sales, profit and
cash flows.

Summary Notes by SK
b) Going concern procedures
 Discuss with management the basis for their going concern review and request that Mercury’s
management extend their cash flow forecast by three months to 30 September 2016.
 Review this extended cash flow forecast and review the cash in and outflows. Assess the assumptions
for reasonableness and discuss the findings with management to understand if the company will have
sufficient cash to meet its liabilities as they fall due.
 Perform a sensitivity analysis on the cash flows to understand the margin of safety the company has
in terms of its net cash in/outflow.
 Discuss with the finance director whether the level of sales from its existing customers has increased
or if any new customers have been obtained.
 Review the company’s post year-end sales and order book to assess if the levels of trade are likely to
increase and if the revenue figures in the cash flow forecast are reasonable.
 Discuss with the directors whether they have contacted any banks for finance to assess whether they
have any other means of repaying the loan of $2·3m due in September 2016.
 Review post year-end correspondence with suppliers to identify if any others have threatened legal
action or refused to supply goods.
 Evaluate management’s plans for future actions, including their contingency plans in relation to
ongoing financing and plans for generating revenue, and consider the feasibility of these plans.
 Enquire of the lawyers of Mercury as to the existence of any additional litigation and request their
assessment of the likely amounts payable to the supplier.
 Enquire of the lawyers as to their view with regards to the proposed change in legislation, which may
render a key product line obsolete. In particular, their view of the likelihood of it actually becoming
law within the period to 30 September 2016.
 Perform audit tests in relation to subsequent events to identify any items which might indicate or
 Review the post year-end board minutes to identify any other issues which might indicate further
 Review post year-end management accounts to assess if in line with cash flow forecast.
 Obtain a written representation confirming the directors’ view that Mercury is a going concern.
-------------------------------------------------------------------------------------------------------------------------------
Answer # 3:
(a) Audit procedures:
 Inquire from the management that whether any contract was made with the foreign customer.
 Review the contract to identify as to whether any recovery can be made from the customer for
exiting/breaching the contract.
 Inquire from the management that since the inventory was for specific use, could it be put to some
other use.
 Inquire from the management that whether they have carried out any exercise to determine the NRV
of this inventory.
 Assess the managements working of NRV for accuracy.
(b) Reporting implication:

The value of the inventory recorded by management is 20% of profit before tax and therefore material
but not pervasive as its effect restricted to one account head of the financial statements.
If the management records the NRV adjustment then a clean opinion would be issued. However, the
auditor may consider including it as a key audit matter.

Summary Notes by SK
If the auditor considers that no major adjustment is required in the inventory value and the
management has not recorded that adjustment, then the auditor will combine it with other
misstatements to assess whether the combined effect is material.
If the auditor considers that major adjustment is required in the inventory value and the management
has not recorded that adjustment, then the auditor expressed a qualified opinion. The auditor needs to
include a basis for qualified opinion, explaining the reasons for qualifying the opinion.
(a) Audit procedures:

 Discuss with the management that whether they have carried out a going concern assessment.
 Discuss with management that whether there are any contingency plan(s) in place for the loss of
this contract.
 Review the negotiations with EL regarding the contract renewal being carried out.
 Inquire the management that whether any new customer has been identified subsequently.
 Review the minutes of board of directors meeting to identify the course of action to be adopted by
the management.
 Review the projected cash flow and profit and loss forecast prepared by the management in light
of this event.
 Review subsequent financial statements of EL to obtain evidence regarding the going concern
assumption.
 Obtain management representation regarding the fact that EL have sufficient resources/support
from sponsors to continue as a going concern.
(b) Reporting implication:

If there is uncertainty about the going concern status of the company and management is willing to
fully disclose the circumstances, a paragraph headed Material Uncertainty Related to Going Concern
should be included, highlighting the issue and drawing users’ attention to the note in the financial
statements. There should be a specific statement that the opinion is not modified.
If management refuses to disclose the uncertainty, the opinion should be modified due to
misstatement/disagreement. The modification should be a qualified opinion if the issue is considered
material but not pervasive or an adverse opinion if considered material and pervasive.
If the entity’s going concern is not valid and the financial statements are prepared on an inappropriate
basis and consequently many items in the financial statements will be materially misstated. This
would be pervasive requiring an adverse opinion stating that the financial statements do not give true
and fair view.
If the management is unwilling to make or extend its assessment a disclaimer of opinion would be
given.

Summary Notes by SK
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Summary Notes by SK
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KnS School of Business Studies

CA CAF- 8 Audit & Assurance

S. No. Description Page No.

1. CA CAF 8 Audit Syllabus 3

2. Analysis of Theoretical & Practical Questions 12

3. CA CAF 8 Result Analysis of ICAP 13

4. Broad categories of CAF 8 14

5. Snapshot of an External Audit Process 15

7. ICAP CA CAF 8 Past paper (Spring 2023) 17

8. ICAP CA CAF 8 Past paper (Autumn 2022) 20

9. ICAP CA CAF 8 Past paper Solution (Autumn 2022) 23

10. Sequence to study CAF 8 Audit & Assurance 30

11. Basics Concepts of Audit & Assurance # Part 1

Page 1 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

23. Audit Risk plus Accounting Ratios 154

24. (ISA 300 + 315) - Understanding the Entity 181

25. Internal Audit Department 192

26. ISA 610 - Using the Work of Internal Auditors 208

27. ISA 620 - Using the Work of an Expert 217

28. Internal Control 225

29. Internal control of a Small Company 231

30. Documentation of accounting and internal control system 235

31. Audit Report 253

 ISA 700 - Audit Report

 ISA 701 - Audit Report

 ISA 705 - Audit Report

 ISA 706 - Audit Report

32. ISA 701 - Key Audit Matters 308

33. ISA 560 - Subsequent Events 319

34. ISA 570 - Going Concern 342

Page 2 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Key Examinable Technical Competencies

Page 3 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

B Planning and Risk Assessment

Page 4 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Page 5 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Page 6 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

1. Explain audit sampling and its purpose.

Page 7 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Page 8 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

a External Audit Report

Page 9 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

8. Discuss the impact on the audit report via various types

b Engagement to Review Financial Statements

Specific Examinable Knowledge Reference

Page 10 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

Page 11 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

S. No. Attempt Theoretical Questions Practical Questions

Page 12 of 370 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

S. No. Attempt Result Analysis

1 September 2016 55%

2 March 2017 36%

3 September 2017 15%

4 March 2018 29%

5 September 2018 55%

6 March 2019 21%

9 September 2020 27%

11 September 2021 35%

12 March 2022 33%

13 September 2022 34%