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CPA
Advanced Leval
Advanvced Auditing and Assurance May 2018
Suggested solutions

Advanvced Auditing and Assurance
Revision Kit

QUESTION 1(a)

Q (i) In the context of the above brief, discuss with practical examples how you would apply professional skepticism during an audit. Your response should include the following key audit processes:

• Performing risk assessment procedures.
• Obtaining audit evidence.
• Evaluating evidence.
• Forming the audit opinion.

(ii) Evaluate three possible challenges to your application of professional skepticism as discussed under (a) (i) above.
A

Solution


(i) In the context of the above brief, discuss with practical examples how you would apply professional skepticism during an audit. Your response should include the following key audit processes:

Performing risk assessment procedures:
➫ When seeking management explanations for large deviations from expectations, do not take the management assertion for it but instead gather corroborating audit evidence.

Obtaining audit evidence:
➫ Taking into account the sufficiency and dependability of audit evidence. If management refuses to offer requested written representations, reconsider the management's honesty and the oral representation.

Evaluating evidence:
➫ Examine audit evidence critically and keep an eye out for contradicting evidence that may call into question the adequacy and appropriateness of the evidence acquired.

Forming the audit opinion:
➫ Consider the overall sufficiency of evidence to support the audit opinion and if the financial statements as a whole represent a fair picture of underlying transactions and events.

(ii) Evaluate three possible challenges to your application of professional skepticism as discussed under (a) (i) above.

➫ Inherent pressure in the audit process, such as an incentive to maintain client relationships, which encourages low balling.

➫ Trust in management is especially prevalent in long-term client relationships.

➫ Lack of training and expertise, as auditors must be knowledgeable in critical areas.

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QUESTION 1(b)

Q Role of a forensic accountant in:

➢ Criminal investigations.
➢ Litigation support,
➢ Insurance claims.
A

Solution


Criminal Investigations
➫ By definition, "forensic" implies "fit for use in court," hence forensic accounting provides accounting analysis that can be used in legal proceedings. Accounting, auditing, and investigative abilities are used by forensic accountants to evaluate an individual's or business's finances. They are taught to think beyond the numbers and to deal with the business realities of a scenario.

Litigation support
➫ is the providing of accounting support in a subject involving existing or pending litigation. It is largely concerned with the quantification of economic damages, which implies that a typical litigation support assignment would entail assessing the economic loss or harm caused by a violation of contract. However, it also covers valuations, asset tracing, revenue recovery, accounting reconstruction, and financial analysis, to mention a few.Litigation assistance also collaborates closely with lawyers on issues such as contract disputes, insolvency litigation, insurance claims, royalty audits, shareholder disputes, and intellectual property claims.

Insurance claims
➫ The goal of forensic accounting in insurance claims is to calculate the economic loss in each case. Forensic accountants are independent, highly qualified accountants that evaluate damage and provide the most accurate cost account possible using a combination of historical data, present situations, and future predictions. (It's crucial to remember that forensic accountants aren't usually hired to determine responsibility; they're usually hired to assess damages.)

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QUESTION 2(a)

Q (i) Discuss the relationship between the concepts of "business risk" and "financial statements risk" in a company drawing references from the above scenario.

(ii) Evaluate four potential financial statements risks from the breach by Madawa Limited of County Government's planning regulations
A

Solution


(i) Relationship between the concepts of "business risk" and "financial statements risk" in a company

➦ A business risk is defined as a threat that could result in a company failing to accomplish an ongoing business goals. Business risks are challenges that the management of a business faces, and these problems should be identified and assessed for their potential impact on the business.

➦ Financial statement risk refers to the possibility that financial statements will be materially misstated prior to audit, it includes but not limited to components of the financial statement that may contain errors or purposeful misstatements in the published accounts of business.

➫ Madawa Limited faces the risk of lawsuit, which is a component of business risk, as well as the danger of understatement of contingent liabilities, which is a component of financial statement risk.

➫ Typically, there is a direct relationship between business risk and financial statement risk. In general, a business risk that is not addressed by management will have an influence on specific components of the financial statements, such as diminishing product demand.

➫ Auditors can utilize both business risk and financial statement risk concepts to identify areas of financial statements where material misstatement is likely to occur in order to establish mitigation plans to manage the risk.

(ii) Evaluate potential financial statements risks from the breach by Madawa Limited of County Government's planning regulations

1. Overstatement of PPE:
➫ The new premises are likely to be impared by the end of the year. The county administration has the authority to close the facility, and the press statement indicates that this will most likely happen before the end of the year.

2. Contigency
➫ Fines or penalties imposed by the county government- TIt is stated that the corporation has previously been sued, and that the county government may sue the company again. Procedures for contingent liabilities in conformity with IAS 37

3. Demolitions costs
➫ The county government may order that the building be demolished. If this demand is made before the end of the fiscal year, the corporation should make a provision for demolition expenditures.

4. Going concern
➫ The foregoing difficulties may cause the company to cease operations, and the potential failure to disclose these issues poses a financial statement risk.

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QUESTION 2(b)

Q Contrast the scope of due diligence investigations with that of an audit of financial statements.
A

Solution


Due diligence investigation Audit of financial statement
The scope of work is determined by the client The scope of work is determined by ISAS
Carried by accountants experienced in such assignment Carried by an independent auditor
Covers the last several years Typically covers the result for the year under audit


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QUESTION 3(a)

Q (i) During the interim audit

(ii) At the final audit visit.
A

Solution


(i) During the interim audit

➫ The records of the control systems are incorrect. The system's record should be updated to reflect the present condition.

➫ To extend substantive procedures after re-evaluating management's integrity and competency.

➫ Revisions should be made to the overall audit strategy, audit programs, and audit plans.

➫ Reorganize the staff by bringing in more experienced auditors to uncover new audit issues.

➫ Conduct a regular review of the work of junior audit staff. This should be done by a more senior member of the audit staff.

(ii) At the final audit visit.

➫ Examine the substance of management presentations to see if management is aware of their responsibility for adopting effective system controls.

➫ Examine the sustainability of the accounting policies used and whether there is any manipulation.

➫ Extend the scope of the analytical review techniques to identify any area where there may be a significant difference.

➫ Extend substantive procedures on internal control systems even further.

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QUESTION 3(b)

Q (i) Assess whether the undisclosed remuneration is material in the above context. Justify your conclusion. (4 marks)

(ii) Describe, indicating any other institutions that you will involve, the matters that you will consider and the actions that you will take to protect the interests of the company's shareholders and the integrity of your firm.
A

Solution


(i) Assess whether the undisclosed remuneration is material in the above context. Justify your conclusion.

➫ Matter can be classified as material based on the amount or quantity of the subject item.

➫ Given the nature of the managing director's position in the governing entity and the creation of financial statements, this matter is relevant.

➫ The integrity of the senior management is questionable. His reported salary is Kshs 36 Million while undisclosed remuneration is Ksh 12 Million which is 33% of the disclosed amount.This is clearly material.

➫ Although, when compared to a profit of Ksh 640 million, of which Ksh 12 million is merely 2%, the difference is significant and material, there is also an unclear circumstantial issue in terms of whether it is a loan to the director or an expense that must be disclosed.

(ii) Describe, indicating any other institutions that you will involve, the matters that you will consider and the actions that you will take to protect the interests of the company's shareholders and the integrity of your firm.

➫ Discuss with the managing director the consequences of his position for both the auditor and himself.

➫ Notify the audit committee and the entire board that you may intend to resign before the annual general meeting, together with a description of the reasons for your resignation.

➫ Notify the capital market authority of this circumstance.

➫ Inform the professional institute so that the institute is aware, and the managing director is unlikely to run another firm.

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QUESTION 4(a)

Q (i) Comment on the financial reporting implications of the above announcement.

(ii) Advise on anv titrther audit procedures you would perform in view ot•the additional information received

(iii) Recommend the action to take if the financial statements are not amended
A

Solution


(i) Comment on the financial reporting implications of the above announcement.

➦ According to IAS 10, Event After the Reporting Period, the announcement of a restructure after the reporting date is a non-adjusting event after the reporting date. This is due to the fact that the occurrence does not give evidence in regard to a state that existed at the end of the year.

Materiality calculation in respect of the potential cost of closure are as follows:

Based on revenue
4,000,000 / 200,000,000 = 0.02 × 100% = 2%

Based on profit
4,000,000 / 50,000,000 = 0.08 × 100% = 8%

Based on assets
4,000,000 / 1,000,000,000 = 0.004 × 100% = 0.4%

* As a result, this amount is relevant to the statement of comprehensive income. According to IAS 10, a note to the financial statements shall be made that identifies the nature of the occurrences and provides an estimate of the financial impact.

(ii) Advise on any further audit procedures you would perform in view of the additional information received

➫ Discuss the rationale for the restructuring with a senior management staff and examine minutes of board meetings where the plan was discussed to obtain an understanding of the cause for the restructuring.

➫ Examine any prospective financial statement remark that should reveal the non-adjusting event, offering a brief summary of the occurrence as well as an estimate of the financial impact.

➫ Verify the approval of the plan as well as the approval of the plan's announcement, which can be done by reviewing board minutes.

➫ Confirm the date the plan was authorized as well as the date of the announcement using supporting material such as the press release, letters addressed to employees, internal meetings with employees, and so on.

➫ Obtain a copy of the announcement and carefully read it for information, particularly a description of the exact nature of the restructuring, including the number of employees who will be affected.

➫ Analyse the Sh.4,000,000 possible cost of closure to the supporting documents, including a schedule outlining the number and grade of staff to be made redundant, which should be supported by payroll/contract information.

➫ Assess the planned restructuring in the context of the auditors' knowledge of the business, taking into account whether any additional costs are anticipated to be incurred.

(iii) Recommend the action to take if the financial statements are not amended

➫ There is an IAS 10 violation if no note is provided to the financial statements.In this example, there is insufficient disclosure in the notes to the financial statements identifying a major non-adjusting event that occurred after the reporting period date.

➫ According to ISA 701, where the auditor disagrees with management on the application of an IFRS and the disagreement is material to the financial statements, the auditor should provide a qualified or unfavourable opinion. Because the issue is material but not pervasive in the financial statements, a qualified "except for" view is appropriate.

➫ The audit report should include a paragraph explaining the cause for the qualification, identifying the IFRS violation and indicating the relevant financial amount. It would also be excellent practice for the auditor to emphasize that the IFRS violation has no impact on the project for the year and that the disagreement is exclusively related to inadequate disclosure in the notes to the financial statements.

➫ The auditor should ensure that individuals in charge of governance are aware of the situation and the potential ramifications for the audit report. This should provide the highest level of management (including executive and non-executive directors) with the opportunity to discuss the topic, taking into account the relevant facts of the disagreement and its implications.

➫ The auditors may opt to address this issue at the annual general meeting, where the circumstances that led to the qualified audit should be disclosed to the company's shareholders.

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QUESTION 4(b)

Q Discuss the auditor's consideration of materiality at the planning stage and the overall review stage of an audit.
A

Solution


Auditors normally Concider materiality both at planning Stage of the audit & at the overal Concluson stage for various reason.

➫ Materiality is paramount during planning because auditors must consider that mistakes that may be trieval may not effect major decisions during the audit and that much time should not be spent on them.

➫ Materiality is critical at the planning stage for auditors to decide the nature, timing, and scope of audit procedures to be carried out, as well as the areas to be given emphasis during audit evidence gathering.

➫ Auditors consider materiality in terms of any impact of errors and frauds and their magnitude in relation to the financial statement at the Overall Conclusion stage of the audit.

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QUESTION 5(a)

Q Explain three factors that you would consider in deciding on the extent to which you would rely on the work of the auditor of the subsidiary companies
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Solution


In deciding on the extent to which Primary auditors Can rely on the Work of secondary auditors, the following Maters should be taken into consideration

(i). The indipendence of the auditor

(ii). Past Working experience of the subsidiary auditor.

(iii). Professional Competence of the skills of the subsidiary auditor

(iv). Scope of audit work

(v). Availability of sufficient evidence

(vi). Accounting policies

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QUESTION 5(b)

Q Analyse three matters that you would consider in deciding whether you should qualify your audit report on the parent company given that the audit report on the financial statements of one or more of the subsidiary companies was qualified.
A

Solution


(1). No action should be taken if the matter is Material to the subsidiary but not Material in a group Context.

(2). If the matter is material to the subsidiary and likewise material in the Group Context, the group auditor will qualify the group, with the exception of group opinion.

(3). If the matter is material to the subsidiary and also material in a group context, and the Subsidiary's financial statements have not been audited by the principal auditor, a qualified opinion is issued, and no mention of the fact that the Subsidiary was audited by another firm should be made.

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QUESTION 5(c)

Q Your engagement team for the audit of- Douala Holdings Limited includes an audit senior and two relatively new audit assistants. One of the focus areas of the audit is the relatively high number of related pany transactions amotig the companies in the group. You wish to brief your team on the key audit considerations fòr related party transactions.

Summarise four matters for inclusion in your brief to the engagement team.
A

Solution


(i). Why related party transactions are considered as high audit risk area?
➫ The auditor will address issues of risky transactions.

(ii). When are parties considered to be related?
➫ The auditor will produce a list of related parties for the prior years.

(iii). Audit procedures to identify related parties
➫ The auditor will specify the methods that the team should follow in order to identify the related parties.

(iv). Evaluating the adequacy of the disclosures in the financial statement
➫ According to IFRS, related party transactions and balances must be fully disclosed. .

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