Guaranteed

95.5% Pass Rate

CPA
Advanced Leval
Advanvced Auditing and Assurance August 2022
Suggested solutions

Advanvced Auditing and Assurance
Revision Kit

QUESTION 1(a)

Q The Basel Core Principles for Effective Banking Supervision, “Risk Management Processes” require that banks and banking groups must have comprehensive risk management processes, including Board and senior management oversight to identify, evaluate, monitor and control/mitigate all material risks and further to assess their overall capital adequacy in relation to their risk profile.

Required:

With reference to the above statements, discuss six components of an effective risk management programme for banks and similar institutions from an audit perspective.
A

Solution


Components of an effective risk management program for banks and similar institutions from an audit perspective:

➧ Risk Governance and Policies: The risk management program should have a well-defined governance structure, including clear roles and responsibilities for risk oversight. The audit perspective involves reviewing the adequacy and effectiveness of the risk management policies, procedures, and guidelines established by the Board and senior management to ensure they align with the institution's risk appetite and regulatory requirements.

➧ Risk Identification and Assessment: The risk management program should include robust processes for identifying and assessing all material risks faced by the institution. The audit perspective involves evaluating the risk identification processes, the accuracy of risk assessments, and the adequacy of the risk measurement methodologies.

➧ Risk Monitoring and Reporting: Effective risk management requires continuous monitoring of risks to promptly identify emerging risks or changes in risk levels. The audit perspective involves assessing the timeliness and accuracy of risk reporting, as well as the effectiveness of risk escalation procedures to senior management and the Board.

➧ Internal Controls and Mitigation Strategies: The risk management program should have adequate internal controls and risk mitigation strategies in place to manage identified risks effectively. The audit perspective involves evaluating the design and operating effectiveness of these controls and assessing their alignment with the risk management objectives.

➧ Capital Adequacy Assessment: Banks must assess their overall capital adequacy in relation to their risk profile to ensure they maintain sufficient capital to absorb potential losses. The audit perspective involves reviewing the institution's capital adequacy assessment processes, including stress testing and scenario analysis, to evaluate their effectiveness in ensuring capital sufficiency.

➧ Independent Validation and Assurance: Banks should have independent validation and assurance functions that assess the effectiveness of the risk management program. The audit perspective involves reviewing the independence, scope, and findings of these validation and assurance activities to provide an objective opinion on the risk management program's effectiveness.

More info

QUESTION 1(b)

Q Describe the specific responsibilities of the Board in overseeing an institution’s strategic risk management process.
A

Solution


Specific responsibilities of the Board in overseeing an institution's strategic risk management process:

➧ Setting Risk Appetite: The Board is responsible for defining and approving the institution's risk appetite, which includes the level of risk the organization is willing to take to achieve its strategic objectives. The Board should ensure that the risk appetite aligns with the institution's overall business strategy.

➧ Approving Risk Management Policies: The Board should review and approve risk management policies and ensure that they are consistent with the institution's risk appetite and regulatory requirements. This includes policies related to credit risk, market risk, operational risk, liquidity risk, and other material risks faced by the institution.

➧ Overseeing Risk Culture: The Board plays a crucial role in promoting a strong risk culture within the organization. This involves setting the tone at the top, emphasizing the importance of risk management throughout the institution, and ensuring that risk management practices are embedded in the organization's day-to-day activities.

➧ Monitoring Risk Exposures: The Board should receive regular and comprehensive risk reports from senior management, which provide insights into the institution's risk exposures and potential impact on the overall financial health. The Board must actively engage in discussions on risk trends, emerging risks, and risk mitigation strategies.

➧ Approving Major Risk Decisions: The Board should be involved in approving major risk-related decisions, such as significant new business initiatives, acquisitions, or divestitures. These decisions should be assessed for their alignment with the institution's risk appetite and strategic objectives.

➧ Engaging with Independent Auditors: The Board should interact with the institution's independent auditors and seek their insights on the effectiveness of the risk management process. The Board should address any significant audit findings and take appropriate actions to enhance risk management practices.

➧ Reviewing Capital Adequacy: The Board is responsible for regularly reviewing the institution's capital adequacy assessments and ensuring that adequate capital is maintained to support the risk profile. This involves assessing stress testing results and scenario analyses to evaluate the institution's resilience to adverse economic conditions.

➧ Ensuring Compliance and Reporting: The Board should ensure that the institution complies with relevant laws, regulations, and internal policies related to risk management. It is responsible for reporting risk-related matters to relevant regulatory authorities and stakeholders.

More info

QUESTION 2(a)

Q Radar Ltd. is a large private company that organises conferences, meetings and celebrations for other companies. The company was set up ten years ago by S and J who are the majority shareholders. The company employs over 300 staff in its 25 offices.

Your firm, XYZ CPA, where you are the Manager - Business Advisory, has been hired to provide internal audit services to Radar Ltd. In discussing with S, you discover that there is a small audit team headed by W, a recently qualified accountant. Before heading the internal audit, W was a junior finance manager in the company. Members of the internal audit team at Radar Ltd. would be redeployed to the finance department once XYZ CPA starts provision of the internal audit services.

S has briefed you of many instances where management policies were ignored. In addition, J has recently discovered a fraud in one office whereby an accounts manager was authorising payments of invoices received from fictitious suppliers, with the payment being channelled to the accounts manager’s personal bank account.

Required:

(i) Evaluate the benefits to Radar Ltd. from outsourcing its internal audit function.

(ii) Explain the potential impact on the external audit of Radar Ltd. if the internal audit function is outsourced.

(iii) Recommend procedures that could be used by XYZ CPA to quantify any financial loss suffered by Radar Ltd. due to the above fraud.

(iv) Compare responsibilities of external auditors and of management in relation to the prevention and detection of fraud.

(v) Assess two benefits and one limitation that may arise from setting up an audit committee in Radar Ltd.
A

Solution


(i) Benefits to Radar Ltd. from outsourcing its internal audit function:

➧ Independence and Objectivity: Outsourcing the internal audit function to an external firm like XYZ CPA ensures independence and objectivity in the audit process. External auditors are not influenced by internal politics or personal relationships, allowing them to provide unbiased assessments of the company's internal controls and risk management.

➧ Expertise and Resources: XYZ CPA, as a professional audit firm, brings a wealth of expertise and resources to the internal audit function. They have experience working with various clients in different industries, which enables them to provide valuable insights and best practices to improve Radar Ltd.'s operations.

➧ Cost-Effectiveness: Outsourcing the internal audit function can be cost-effective for Radar Ltd. Hiring an external firm eliminates the need to maintain an internal audit department with full-time staff and ongoing training expenses.

➧ Specialized Skills: External auditors often possess specialized skills and knowledge that might not be readily available within Radar Ltd.'s existing workforce. This can lead to better risk identification and enhanced fraud detection capabilities.

➧ Focus on Core Activities: By outsourcing internal audit services, Radar Ltd. can focus on its core business activities and strategic objectives. The internal audit function will be handled by professionals, allowing management to concentrate on day-to-day operations and business growth.

(ii) Potential impact on the external audit of Radar Ltd. if the internal audit function is outsourced:

➧ Reliance on Internal Audit Work: External auditors often rely on the work of internal auditors to gain assurance on the effectiveness of internal controls and to plan their audit procedures. If the internal audit function is outsourced, external auditors may need to perform additional testing and verification themselves, which could increase the scope and duration of the external audit.

➧ Assessment of Independence and Objectivity: External auditors need to assess the independence and objectivity of the internal audit function to determine the extent to which they can rely on the work performed. If the internal audit function is provided by XYZ CPA, the external auditors will need to evaluate the potential impact of any existing business relationships between XYZ CPA and Radar Ltd.

➧ Coordination and Communication: Effective coordination and communication between the external auditors and XYZ CPA (the outsourcing firm) will be crucial to ensure a comprehensive and efficient audit process. Close collaboration is essential to avoid duplication of efforts and ensure all audit objectives are adequately addressed.

(iii) Procedures that XYZ CPA could use to quantify any financial loss suffered by Radar Ltd. due to the above fraud:

➧ Forensic Examination: Conduct a forensic examination of the fraudulent transactions to trace the flow of funds and identify the extent of financial loss incurred by Radar Ltd. This may involve analyzing bank records, invoices, payment records, and other financial documents.

➧ Comparison Analysis: Perform a comparison analysis of transactions with fictitious suppliers against legitimate transactions to isolate the fraudulent ones. This will help quantify the specific amount of loss caused by the fraud.

➧ Interviews and Investigation: Interview relevant employees, including the accounts manager involved in the fraud, to gather information and evidence about the scheme. Conduct an investigation to uncover any accomplices or related fraudulent activities.

➧ Review of Internal Controls: Assess Radar Ltd.'s internal controls, particularly those related to payments and supplier management, to identify weaknesses that contributed to the fraud and assess the adequacy of preventive measures.

(iv) Responsibilities of external auditors and management in relation to the prevention and detection of fraud:

External Auditors:

➢ External auditors are responsible for conducting audits in accordance with auditing standards to provide reasonable assurance that the financial statements are free from material misstatement due to fraud or error.
➢ They are required to assess the risk of material misstatement due to fraud and design audit procedures to detect fraud.
➢ If external auditors discover any indications of fraud during their audit, they have a duty to communicate these findings to management and, in certain cases, to those charged with governance.

Management:

➢ Management is primarily responsible for the prevention and detection of fraud within the organization.
➢ They should establish and maintain a strong control environment, implement effective internal controls, and monitor compliance with policies and procedures to prevent and detect fraudulent activities.
➢ Management must promptly investigate any allegations or indications of fraud and take appropriate corrective actions.

(v) Benefits and limitation that may arise from setting up an audit committee in Radar Ltd.:

Benefits:

➧ Independent Oversight: The audit committee provides an independent oversight mechanism that enhances the credibility and integrity of the financial reporting process. It ensures that financial information is reviewed by a separate body, reducing the risk of undue influence or bias.

➧ Risk Management and Internal Controls: The audit committee helps to strengthen risk management and internal control systems within the company. It oversees the effectiveness of these controls, which contributes to better financial and operational risk management.

Limitation:

➧ Expertise and Time Commitment: The effectiveness of an audit committee depends on the expertise and commitment of its members. If the committee lacks sufficient knowledge or is overloaded with other responsibilities, its ability to provide meaningful oversight may be limited.

More info

QUESTION 2(b)

Q You are in charge of the audit of Sawala Ltd. and are planning the audit of financial statements for the year ended 31 December 2021. Sawala Ltd. has suffered decline in sales and profits in the last two years mainly due to loss of key customers. Many of Sawala Ltd.’s non-current assets are impaired in value and substantial receivables have been written off in the last six months.

Sawala Ltd’s. management have decided to restructure the business by reducing the manufacturing capacity by 75% and investing in new technology to make operations more efficient and widen the variety of components produced.

Sawala Ltd. has applied for a bank loan to finance the restructuring. Without the loan, Sawala Ltd. is unlikely to restructure successfully raising doubts on its ability to continue as a going concern.

Your firm has been asked to advise on forecasts and projections that the bank would need to decide on the finance requested. Management has also requested your firm to attend a meeting with the bank during which the forecasts would be discussed.

Required:

Advise on ethical and other implications to guide your firm on the request to provide advice on forecasts and attend the meeting with the bank.
A

Solution


➦ Providing advice on forecasts and attending a meeting with the bank as the auditor of Sawala Ltd. raises ethical and professional implications that need to be carefully considered.

The key implications are as follows:

(i) Independence and Objectivity: As the auditor, your firm must maintain independence and objectivity throughout the audit process. Providing advice on forecasts and projections to the bank could potentially compromise your independence and create the perception of a conflict of interest.

(ii) Confidentiality: The information shared with the auditor during the audit engagement is typically confidential and intended for the use of the company's management and stakeholders. Sharing this information with the bank may breach confidentiality unless there is explicit consent from Sawala Ltd.

(iii) Professional Skepticism: When evaluating forecasts and projections, auditors must exercise professional skepticism to critically assess the reasonableness and reliability of the information. Being involved in discussions with the bank could influence the auditor's objectivity and skepticism.

(iv) Scope of Work: The auditor's primary role is to express an opinion on the financial statements and provide assurance on their fairness and compliance with accounting standards. Providing advice on forecasts and attending a meeting with the bank extends beyond the traditional scope of an audit engagement.

(v) Expertise: Forecasting and financial projections involve specialized skills and expertise. If the audit team does not have the necessary expertise in this area, providing advice could lead to inaccurate or unreliable information.

Given these ethical and professional implications, your firm should consider the following actions:

➧ Independence and Objectivity: Avoid providing direct advice to the bank regarding forecasts. Instead, communicate to the bank that your firm's role is to express an opinion on the financial statements and that forecasts are the responsibility of Sawala Ltd.'s management and the bank's financial analysts.

➧ Confidentiality: Seek explicit permission from Sawala Ltd.'s management to share relevant information with the bank. Ensure that the information shared is limited to what is necessary for the bank's decision-making process and that sensitive information is appropriately protected.

➧ Professional Skepticism: Evaluate the forecasts and projections critically and independently, even if presented by management or the bank. Maintain professional skepticism and raise any concerns or discrepancies in the information provided.

➧ Scope of Work: Clarify the scope of your firm's engagement with the bank, explicitly stating that it does not include providing advice on forecasts. Avoid engaging in discussions that could compromise the independence and objectivity of the audit.

➧ Expertise: If your firm lacks expertise in forecasting and financial projections, consider involving external experts or referring the bank to reputable financial consultants who can provide the required advice.

More info

QUESTION 3(a)

Q Annlisa Keya is the financial controller of a leading church organisation in the country. Recently, the chief cashier in the church was suspended for misappropriating cash amounting to Sh.2 million over a period of six months.

The church’s Board of Deacons and the Finance Committee are of the view that though Annlisa Keya was not directly responsible for the loss, she failed by not discovering the fraud in time. They have recommended her suspension and possible dismissal. There are also worries that, because of the high cash volumes transacted in the church, the risk of errors and fraud in cash management is significant.

Annlisa has suggested to the Board of Deacons and Finance Committee to engage an independent auditor to carry out an investigation.

Your audit firm has been invited to a preparatory meeting of the Board of Deacons as the potential auditor for the assignment.

Required:

(i) Highlight the issues you would raise during this meeting regarding the entire investigation process.
(ii) Describe the essential principles that you must observe to conduct an effective investigation.
(iii) Recommend an effective internal control system for cash handled by the church.
A

Solution


(i) Issues to raise during the preparatory meeting regarding the investigation process:

➧ Scope of Investigation: Clarify the specific scope and objectives of the investigation. Understand the nature and extent of the alleged misappropriation and determine if any other related fraudulent activities need to be investigated.

➧ Independence and Objectivity: Emphasize the importance of the investigation being conducted independently and objectively. Ensure that the investigation team has no personal or financial interests in the outcome of the investigation.

➧ Access to Information and Witnesses: Discuss the need for full access to relevant documents, records, and witnesses during the investigation. Ensure cooperation from all parties involved and address any potential obstacles to obtaining necessary information.

➧ Confidentiality and Privacy: Discuss the importance of maintaining confidentiality during the investigation to protect the reputation and privacy of individuals involved. Stress the need to handle sensitive information securely.

➧ Timeliness: Address the need for a timely investigation to prevent any further loss or damage to the organization. Set clear timelines and milestones for the investigation process.

➧ Reporting and Communication: Discuss the format and frequency of reporting to the Board of Deacons and the Finance Committee. Agree on a clear communication plan to keep stakeholders informed about the progress of the investigation.

(ii) Essential principles to observe to conduct an effective investigation:

➧ Independence: The investigation team must be independent and free from any bias or conflicts of interest.

➧ Objectivity: The investigation team should approach the investigation with an objective mindset, without preconceived notions about the outcome.

➧ Confidentiality: Maintain strict confidentiality throughout the investigation to protect the integrity of the process and the privacy of individuals involved.

➧ Thoroughness: Conduct a thorough investigation, examining all relevant evidence, documents, and witnesses to ensure a comprehensive understanding of the situation.

➧ Timeliness: Complete the investigation in a timely manner to prevent further harm and provide prompt resolutions.

➧ Fairness: Treat all individuals involved with fairness and respect, providing them with an opportunity to present their side of the story.

➧ Compliance: Ensure that the investigation complies with all relevant laws, regulations, and internal policies.

(iii) Recommendation for an effective internal control system for cash handled by the church:

➧ Segregation of Duties: Implement a clear segregation of duties in cash handling processes to prevent a single individual from having control over all aspects of cash management.

➧ Dual Authorization: Require dual authorization for cash transactions above a certain threshold, ensuring that no single person can approve high-value transactions alone.

➧ Regular Reconciliations: Perform regular reconciliations between cash receipts and bank deposits to identify any discrepancies promptly.

➧ Physical Security Measures: Implement physical security measures such as safes, locked cash drawers, and surveillance cameras to protect cash from theft or unauthorized access.

➧ Periodic Audits: Conduct periodic internal audits of cash management processes to assess compliance with internal controls and identify any weaknesses or potential risks.

➧ Employee Training: Provide regular training to employees involved in cash handling to raise awareness of fraud risks and the importance of adhering to internal control procedures.

➧ Hotline for Reporting: Establish a confidential hotline or reporting mechanism for employees to report suspected fraudulent activities or concerns about cash management.

➧ Whistleblower Protection: Ensure that there are appropriate measures in place to protect whistleblowers who report suspected fraud or misconduct.

More info

QUESTION 3(b)

Q Describe the factors to be considered by an auditor in assessing the inherent risk in an organisation.
A

Solution


➦ Inherent risk is the risk of material misstatement in the financial statements before considering the effectiveness of internal controls. It represents the level of risk associated with specific accounts, transactions, or disclosures due to their nature or complexity. When assessing inherent risk, the auditor considers various factors that may affect the likelihood of material misstatements occurring. Here are the key factors to be considered by an auditor in assessing inherent risk in an organization:

➧ Nature of the Industry and Business: The industry in which the organization operates can significantly impact inherent risk. Certain industries, such as technology or pharmaceuticals, may have higher inherent risk due to rapidly changing market conditions or complex accounting standards.

➧ Complexity and Diversity of Transactions: Complex and diverse transactions, such as mergers and acquisitions, foreign currency transactions, or complex financial instruments, increase the likelihood of material misstatements.

➧ Financial Statement Components: Some financial statement components have a higher inherent risk, such as revenue recognition, inventory valuation, and estimates and provisions, due to the subjective judgment involved.

➧ Changes in Accounting Policies: If the organization has recently changed accounting policies or adopted new accounting standards, inherent risk may increase due to potential implementation challenges and uncertainties.

➧ Quality of Accounting Systems and Processes: Weaknesses in the organization's accounting systems and processes, such as lack of internal controls, insufficient segregation of duties, or inadequate IT controls, may lead to higher inherent risk.

➧ Management Integrity and Competence: The auditor evaluates the integrity and competence of management, as dishonest or incompetent management may intentionally or unintentionally create higher inherent risk.

➧ Financial Stability and Liquidity: An organization facing financial difficulties or liquidity constraints is more likely to have higher inherent risk as it may lead to aggressive accounting practices or inadequate disclosures.

➧ Regulatory Environment: The complexity and frequency of changes in the regulatory environment can impact inherent risk, especially in industries subject to strict regulations.

➧ Legal and Litigation Matters: Pending or potential legal claims or litigation can increase inherent risk, particularly if their outcomes are uncertain or significant.

➧ Related Party Transactions: Transactions with related parties can present higher inherent risk, as there may be a lack of arm's-length dealing or potential for self-interest.

➧ Geographical Operations: If the organization operates in multiple countries with different legal and regulatory environments, inherent risk may increase due to complexities in compliance and financial reporting.

➧ Management Override of Controls: The potential for management to override internal controls may increase inherent risk, especially if there is a lack of oversight or accountability.

More info

QUESTION 3(c)

Q Explain how audit files are archived and retrieved for a large organisation.
A

Solution


➧ Audit Trail Generation:

Whenever an auditable event occurs within the organization's systems or processes, an audit trail is generated. Audit trails are detailed records that capture relevant information about the event, such as the date and time of occurrence, the user responsible, the action taken, and any associated data or metadata.

➧ Centralized Logging and Storage:

To efficiently manage audit trails, most large organizations implement centralized logging and storage solutions. These solutions collect audit data from various sources and consolidate it into a central repository. This centralization ensures that all audit logs are in one location, making them easier to manage and search.

➧ File Format and Encryption:

Audit files are typically stored in a standardized format that ensures compatibility and ease of retrieval. Common formats include CSV (Comma-Separated Values), JSON (JavaScript Object Notation), or XML (Extensible Markup Language). Additionally, to protect the sensitive information within the audit logs, encryption is often applied to the files during storage.

➧ Retention Policies:

Organizations establish retention policies to determine how long audit files should be retained before they are eligible for archiving. Retention periods are usually based on legal requirements, industry regulations, or internal policies. For example, some data may need to be kept for a specific number of years for compliance purposes.

➧ Archiving Process:

When audit files reach the end of their retention period, they are marked for archiving. Archiving involves moving the files from the primary storage to secondary or long-term storage media. Organizations often use high-capacity and cost-effective storage solutions, such as tape backups or cloud-based archives, for long-term retention.

➧ Indexing and Metadata:

For easy retrieval, each archived audit file is indexed, and metadata is attached to it. Metadata includes relevant information about the file, such as its creation date, event type, associated user IDs, and any other pertinent details. Indexing enables faster searches when retrieving specific audit data.

➧ Access Control and Security:

Access to archived audit files is tightly controlled to ensure data security and prevent unauthorized access. Only authorized personnel with appropriate permissions should be able to retrieve and view these files. This access control is crucial, as audit logs often contain sensitive information that must be protected.

➧ Retrieval Process:

When required, authorized personnel can request the retrieval of specific audit files. They can do this through a designated system or application that manages access to archived data. The retrieval process may involve searching by relevant criteria, such as date range, user ID, event type, or keywords.

➧ Data Analysis and Reporting:

Once the required audit files are retrieved, they can be analyzed to gain insights into system activities, detect anomalies, and generate reports for compliance audits, incident investigations, or performance evaluations.

➧ Periodic Review and Monitoring:

Large organizations regularly review and monitor their audit file archiving process to ensure it remains effective, compliant with regulations, and aligned with evolving business needs.

More info

QUESTION 4(a)

Q Bandari Furniture Ltd. manufactures a wide range of domestic furniture. The main components of the furniture items are wood for the frames, foam filing for the cushions and fabric for the covering. The company’s annual turnover is Sh.700 million while its stock at the end of the year ended 31 December 2021 was Sh.400 million. You attended the stock take and you were happy with the accuracy of the exercise. The cost of raw materials and direct labour are calculated using the standard costing system while overheads are computed from the company’s financial accounting records as a percentage of direct labour cost.

Required:

(i) Describe the audit work that you would perform to check the standard cost per unit of a line of finished stock. Comment on how accurate this standard cost has to be.
(ii) Explain the work that you would perform to confirm that the variances are being determined correctly.
(iii) Comment on the overheads that you would include in the value of stock and those that you would not include, citing relevant examples.
(iv) State two variances that you would include and those that you would exclude when adjusting the value of stock from standard cost to actual cost.
A

Solution


(i) Checking Standard Cost per Unit of Finished Stock:

To verify the standard cost per unit of a line of finished stock, the auditor would perform the following audit procedures:

➧ Reviewing Standard Cost Calculation Methodology: The auditor would first examine the company's standard costing system and understand the methodology used to calculate the standard cost per unit. This would include analyzing the components of the standard cost, such as raw materials, direct labor, and overheads, and ensuring they are accurately accounted for.

➧ Inspecting Standard Cost Master File: The auditor would review the standard cost master file or database to check the accuracy and completeness of the standard costs assigned to each furniture item. This file should contain the standard costs for all components and processes involved in manufacturing the finished stock.

➧ Variance Analysis: The auditor would compare the actual costs incurred with the standard costs to identify any significant variances. Variances between the actual and standard costs may indicate potential issues in cost control or discrepancies in the standard costing system.

➧ Physical Verification: While this may not directly relate to standard cost per unit, the auditor would perform a physical verification of the finished stock to ensure that it matches the recorded quantities in the stock records.

➦ The accuracy of the standard cost per unit is crucial as it forms the basis for cost control, pricing decisions, and overall financial reporting. Any inaccuracies in the standard cost could lead to misstatements in the financial statements and affect the company's profitability and decision-making.

(ii) Confirmation of Variance Determination:

To confirm that variances are being determined correctly, the auditor would undertake the following audit procedures:

➧ Understanding Variance Calculation: The auditor would gain a comprehensive understanding of how variances are calculated within the organization. This includes examining the formulas and data sources used to compute variances for raw materials, direct labor, and overheads.

➧ Analyzing Variance Trends: The auditor would perform trend analysis to compare current year variances with previous years. Significant fluctuations in variances could indicate errors or inconsistencies in the variance calculation process.

➧ Testing Data Accuracy: The auditor would select a sample of production orders and trace the data used in variance calculations back to the underlying source documents, such as material requisitions, labor time sheets, and overhead allocation records. This helps ensure that the data used in variance calculations is accurate and reliable.

➧ Confirmation with Management: The auditor would hold discussions with management and those responsible for variance analysis to understand their process, controls, and any changes to the variance determination methodology.

(iii) Overheads Included and Excluded in the Value of Stock: Overheads that should be included in the value of stock are those that are directly attributable to the production of finished stock. Examples of such overheads include:

➢ Factory rent and utilities expenses directly related to the production area.
➢ Depreciation on machinery and equipment used in the production process. Factory supervisors' salaries and wages.
➢ Maintenance and repair expenses for production equipment.
➢ Overheads that should not be included in the value of stock are those that do not have a direct connection to the production of finished stock.


Examples of such overheads include:

Administrative overheads like office salaries, rent, and office supplies. Selling and distribution expenses. Research and development costs.

(iv) Variances Included and Excluded in Adjusting Stock Value:

➦ When adjusting the value of stock from standard cost to actual cost, the auditor would include certain variances and exclude others.

Typically, the following variances are included:

➧ Material Price Variance: This variance represents the difference between the standard cost of materials and the actual cost of materials used in production.

➧ Material Usage Variance: This variance represents the difference between the standard quantity of materials specified for production and the actual quantity of materials used.

➧ Labor Rate Variance: This variance reflects the difference between the standard labor rate and the actual labor rate paid.

➧ Labor Efficiency Variance: This variance represents the difference between the standard labor hours allowed for actual production and the actual labor hours worked.

The following variances are generally excluded from adjusting the stock value:

➧ Fixed Overhead Volume Variance: This variance arises due to changes in the level of activity and is often considered a production volume variance rather than a cost variance.

➧ Sales Volume Variance: This variance is related to the difference between the actual sales volume and the expected (budgeted) sales volume and does not directly impact the value of closing stock.

More info

QUESTION 4(b)

Q You are the auditor of Zambezi Ltd., a manufacturer of handcrafts. 40% of the sales are exported to a foreign country. You are about to commence the audit of the accounts for the year ended 31 October 2021. Account receivables are included in the statement of financial position at the year end net of Sh.3,000,000 debt provision (5%) at Sh.57 million. In the past audits, there has been a poor response to the trade receivables circularisation and a decision has been taken not to circularise or circulate them this year. In an attempt to reduce the exposure to the foreign currency, Zambezi Ltd. sells 50% of the foreign currency trade receivable forwards.

Required:

(i) Explain the substantive procedures that you would perform as an auditor to verify the accuracy of account receivables.
(ii) Describe the audit tests you would carry out in order to form an opinion on the doubtful debts provision and the action you would take if you concluded that it was materially misstated.
(iii) State what adjustment, if any, you would make to the foreign currency account receivables on the basis that they have all been recorded at the actual exchange rate ruling on the date of sale.
A

Solution


(i) Substantive Procedures for Verifying the Accuracy of Accounts Receivables:

As the auditor of Zambezi Ltd., to verify the accuracy of accounts receivables, you would perform the following substantive procedures:

➧ Aging Analysis: Perform an aging analysis of accounts receivables to categorize outstanding balances by the length of time they have been outstanding. This helps identify potential issues with collectability and highlights any significant overdue or doubtful accounts.

➧ Confirmations (alternative procedures): Since there has been a poor response to trade receivables circularisation, you would consider alternative procedures to obtain evidence of the existence and accuracy of accounts receivables. This may include obtaining confirmations from customers through email or other electronic means, reviewing subsequent cash receipts, or analyzing supporting documentation for transactions.

➧ Review of Sales Agreements and Invoices: Examine sales agreements and invoices to verify the accuracy of amounts billed to customers, ensuring that the transactions are properly recorded and supported.

➧ Reconciliation with General Ledger: Reconcile the total of individual customer balances in the accounts receivable subsidiary ledger with the corresponding general ledger balance to ensure accuracy and completeness.

➧ Credit Review: Perform a credit review of customers to assess their creditworthiness and the adequacy of credit limits granted.

➧ Analysis of Bad Debt History: Analyze historical bad debt write-offs to assess the adequacy of the current doubtful debts provision.

➧ Analytical Procedures: Apply analytical procedures to identify any unusual fluctuations or trends in accounts receivables balances and investigate the reasons behind them.

(ii) Audit Tests for Doubtful Debts Provision:

To form an opinion on the doubtful debts provision, the auditor would carry out the following audit tests:

➧ Assessment of Provision Adequacy: Evaluate the company's methodology for calculating the doubtful debts provision. Test the application of the 5% provision rate on the accounts receivables balances to ensure it is appropriate based on the historical bad debt experience and economic conditions.

➧ Review of Historical Bad Debt Experience: Examine the company's history of bad debts and compare it to the current provision to determine if any changes are necessary due to changes in customer risk or economic conditions.

➧ Confirmations (alternative procedures): Even though there is a decision not to circularise trade receivables this year, consider alternative procedures to obtain corroborative evidence for the recoverability of specific balances.

➧ Analysis of Specific Debts: Select a sample of significant accounts receivable balances and assess their collectability based on customer payment history and creditworthiness. Any indication of uncollectibility may require an adjustment to the doubtful debts provision.

➧ Review of Sales Returns and Allowances: Examine the company's records for sales returns and allowances to ensure they are adequately considered in the provision calculation.

➦ If the auditor concludes that the doubtful debts provision is materially misstated, they would communicate the finding to management and request appropriate adjustments to the financial statements. If management refuses to make the necessary adjustments and the misstatement is material and pervasive, the auditor would consider the impact on their opinion and possibly issue a qualified or adverse opinion on the financial statements.

(iii) Adjustment to Foreign Currency Accounts Receivables:

As 50% of the foreign currency trade receivables are sold forwards to reduce foreign currency exposure, the auditor would make an adjustment to the foreign currency accounts receivables. The adjustment would involve converting 50% of the foreign currency accounts receivables at the forward exchange rate used to hedge the foreign currency risk. This adjustment ensures that only the unhedged portion of the foreign currency accounts receivables is recorded at the actual exchange rate ruling on the date of sale, reflecting the economic exposure of the company to fluctuations in foreign currency rates.

More info

QUESTION 5(a)

Q Explain each of the following concepts, clearly indicating its impact on the work of auditors:

(i) Environmental audits.
(ii) Social reporting.
(iii) Audit disengagement.
(iv) Value for money audits.
A

Solution


(i) Environmental Audits:

➦ Environmental audits are assessments conducted to evaluate an organization's environmental performance, compliance with environmental regulations, and the effectiveness of its environmental management systems. These audits aim to identify areas where the organization can improve its environmental practices and reduce its environmental impact.

➧ Impact on Auditors:

For auditors, environmental audits may lead to changes in the scope and nature of their work. Auditors may need to assess whether the organization has appropriate systems in place to monitor and manage its environmental impacts. They may also need to review the organization's compliance with environmental laws and regulations, ensuring that any potential violations or non-compliance issues are appropriately reported. Conducting environmental audits may require auditors to collaborate with environmental experts or specialists to gain a comprehensive understanding of the organization's environmental practices and risks.

(ii) Social Reporting:

➦ Social reporting, also known as sustainability reporting or corporate social responsibility (CSR) reporting, involves disclosing an organization's social and ethical performance, including its efforts to address environmental, social, and governance (ESG) issues. This reporting provides stakeholders with information on the company's initiatives and impacts related to social and community welfare, employee well-being, human rights, diversity and inclusion, and philanthropic activities.

➧ Impact on Auditors:

For auditors, social reporting may necessitate the inclusion of assurance procedures on the information disclosed in sustainability reports. Auditors may be required to evaluate the completeness, accuracy, and reliability of the reported social performance metrics and activities. This involves verifying the underlying data, assessing the appropriateness of methodologies used to calculate social indicators, and validating the alignment of social reporting with recognized frameworks or standards (e.g., Global Reporting Initiative - GRI, Sustainability Accounting Standards Board - SASB).

(iii) Audit Disengagement:

➦ Audit disengagement refers to the termination of the auditor's engagement with a client before completing the audit engagement. This situation may arise due to various reasons, such as the client's refusal to provide necessary information, the auditor's inability to obtain sufficient and appropriate audit evidence, or concerns about management integrity or unethical practices.

➧ Impact on Auditors:

Audit disengagement is a significant decision that auditors take very seriously. It may have several implications for auditors, including the need to consider legal and professional responsibilities when deciding to disengage. When disengagement occurs, auditors typically have a responsibility to communicate the reasons for their decision to the client's management, audit committee, or board of directors. They may also need to consult with legal advisors to ensure they have fulfilled their obligations ethically and legally.

(iv) Value for Money Audits:

➦ Value for Money (VFM) audits are assessments conducted to evaluate whether an organization has achieved the best possible outcomes in terms of economy, efficiency, and effectiveness in the use of its resources. These audits go beyond financial considerations and analyze whether the organization's programs and activities have delivered intended results and benefits to stakeholders.

➧ Impact on Auditors:

For auditors, VFM audits require a broader perspective beyond financial statement auditing. They may need to assess the organization's performance metrics, the appropriateness of its resource allocation, and the effectiveness of its operational processes. VFM audits often involve benchmarking the organization's performance against industry standards or best practices to identify opportunities for improvement. By conducting VFM audits, auditors contribute to improving the overall efficiency and effectiveness of the organization's operations and help identify areas where resources can be better utilized to achieve desired outcomes.

More info

QUESTION 5(b)

Q Safari Company Limited is a manufacturing company that was established five years ago. The company has attained tremendous growth despite the stiff competition from other companies engaged in the manufacture of similar products. The company’s management is concerned with reducing the harm that may result from fines and the compensation in case of violation of the environmental laws and regulations. At the same time, to maintain its market share, the company intends to give support to the community through social responsibility activities.

Required:

You have been appointed to evaluate the environmental aspects and social support of the company. Describe the audit procedures that you would perform in order to advise accordingly.
A

Solution


Environmental Aspect Evaluation:

➧ Review of Environmental Policies and Procedures: Examine the company's environmental policies and procedures to understand its commitment to environmental sustainability and compliance with relevant laws and regulations.

➧ Site Visits and Observations: Conduct site visits to observe the manufacturing processes and identify potential environmental impacts. This includes assessing waste management practices, energy consumption, and any potential pollution sources.

➧ Review of Environmental Records and Reports: Analyze the company's environmental records and reports, such as emissions data, waste disposal records, and environmental impact assessments, to ensure compliance with regulatory requirements.

➧ Interviews with Key Personnel: Interview key personnel involved in environmental management to understand their roles, responsibilities, and awareness of environmental issues.

➧ Assessment of Environmental Risk Management: Evaluate the company's risk management practices related to environmental issues and identify areas where the company may be exposed to potential fines or penalties.

➧ Evaluation of Environmental Training Programs: Review the company's environmental training programs to assess if employees are adequately trained to handle environmental responsibilities and reduce environmental risks.

Social Support Evaluation:

➧ Review of Social Responsibility Policies: Examine the company's social responsibility policies and initiatives to understand its commitment to supporting the community.

➧ Assessment of Social Support Programs: Evaluate the effectiveness and impact of the company's social support programs. This includes analyzing the allocation of resources, measuring the outcomes, and determining how the programs align with the community's needs.

➧ Interviews with Community Members: Conduct interviews with members of the community to gather their feedback on the company's social support activities and assess their perceptions of the company's impact.

➧ Verification of Contributions: Verify the financial and non-financial contributions made by the company to community projects or charitable initiatives.

➧ Benchmarking Social Support Practices: Compare the company's social support practices with industry peers and best practices to identify opportunities for improvement.

➧ Review of Corporate Social Responsibility (CSR) Reports: Evaluate the company's CSR reports and disclosures to assess the transparency and completeness of the information provided.

➧ Assessment of Social Engagement: Evaluate the company's engagement with stakeholders, including community representatives and non-governmental organizations (NGOs), to understand the effectiveness of the company's social support initiatives.

More info

Comments on CPA past papers with answers:

New Unlock your potential with focused revision and soar towards success
Pass Kasneb Certification Exams Easily

Comments on:

CPA past papers with answers