CMA January 2024 Examination Solutions

Solution:

The correct answer is (a) Reasonable assurance and limited assurance. The International Framework for Assurance Engagements (IFAE) identifies two levels of assurance: reasonable assurance and limited assurance. Reasonable assurance is a high, but not absolute, level of assurance. Limited assurance is a moderate level of assurance. Both are expressed in a positive or negative form, respectively.

Solution:

The correct answer is (b) The entity's board of directors. Management, under the oversight of the board of directors, is responsible for the preparation and fair presentation of the financial statements, including the adequacy of disclosures, in accordance with the applicable financial reporting framework. The auditor's responsibility is to express an opinion on whether the financial statements, as a whole, are free from material misstatements, including inadequate disclosures.

Solution:

The correct answer is (d) Determine whether the client's financial reports are fairly stated. The primary objective of an audit is to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. While detecting fraud is a consideration, it's not the primary objective. The auditor provides an opinion on the financial statements as a whole, not a certification of individual transactions.

Solution:

The correct answer is (a) The management. Internal auditors are employees of the company and are appointed by management to provide an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. This is in contrast to an external auditor who is appointed by the shareholders in a general meeting.

Solution:

The correct answer is (b) Internal control system. While both internal and external auditors are concerned with internal controls, the scope of an internal auditor's work is much broader. The internal auditor's primary focus is on the effectiveness and efficiency of the internal control system, which includes the entire range of a company's operations, not just its financial reporting. The independent auditor's primary concern with internal controls is their impact on the financial reporting process.

Solution:

The correct answer is (b) Internal check. Internal check is a part of the internal control system. It is a system of assigning duties to employees in such a way that the work of one employee is automatically checked by another employee. This is a key control in preventing and detecting errors and fraud. Internal control is a broader term, and internal audit is a separate function performed by internal auditors.

Solution:

The correct answer is (b) Examination of vouchers to check authenticity of records. Vouching is an audit procedure in which the auditor examines the vouchers, such as invoices, receipts, and bank statements, to verify the authenticity and accuracy of the transactions recorded in the books of accounts. This is a crucial step in obtaining sufficient and appropriate audit evidence.

Solution:

The correct answer is (d) none of these. Undervaluation of stock, or any other asset, is a misstatement that can be caused by either an error or fraud. It is not a technical error, as that refers to errors in calculation. It is not a compensatory error, as it is a single misstatement, and it is not an error of principle, as it does not violate an accounting principle. The undervaluation of stock is a misstatement that can lead to an incorrect presentation of the financial statements.

Solution:

The correct answer is (d) General Meeting. A company auditor is appointed by the shareholders in a general meeting and can only be removed by the shareholders in a general meeting. This is a key principle of auditor independence, as it ensures that the auditor is not subject to the influence of management or individual directors.

Solution:

The correct answer is (c) Examining the physical existence & valuation of assets. Verification is a broad audit procedure that involves confirming the existence, ownership, and valuation of assets and liabilities. This includes not only the physical existence of assets but also their valuation, ownership, and disclosure in the financial statements.

Solution:

False. Auditors issue a **disclaimer of opinion** when there is a **limitation of scope** that is pervasive to the financial statements. When there is a **disagreement with management** on matters that are pervasive to the financial statements, the auditor issues an **adverse opinion**. The type of modified opinion depends on whether the issue is a disagreement or a limitation of scope, and whether it is material and pervasive.

Solution:

True. The statement is correct. Auditor independence is a fundamental principle of auditing and is mandatory before accepting an audit engagement. The auditor must be independent in mind and appearance to be able to form an objective opinion on the financial statements.

Solution:

False. A qualified audit report indicates that the financial statements are **not** free from misstatements, but the misstatements are not pervasive. A qualified opinion is issued when the auditor concludes that the financial statements are materially misstated but not pervasively, or when the auditor is unable to obtain sufficient appropriate audit evidence but the possible effects on the financial statements are material but not pervasive. An unqualified opinion is issued when the financial statements are free from misstatements.

Solution:

True. The statement is correct. As per ISA 560, "Subsequent Events," the auditor is required to perform audit procedures to obtain sufficient and appropriate audit evidence that all events that occurred 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 and appropriately treated.

Solution:

True. The statement is correct. An auditor is required to perform some substantive procedures in all audit engagements, even if the auditor assesses the risk of material misstatement as low. This is because there is always some risk that the internal controls may not be operating as effectively as they were assessed, and the auditor must obtain sufficient and appropriate audit evidence to support their opinion.

Solution:

The correct matches are as follows:

• (1) Judgements about materiality are based on -> (d) surrounding circumstances, including the size and nature of the misstatement. Materiality is a matter of professional judgment and is based on the size and nature of the misstatement and the surrounding circumstances.
• (2) Auditors issue adverse audit opinion when -> (g) misstatements in the financial statements are pervasive. An adverse opinion is issued when the auditor concludes that the financial statements are materially and pervasively misstated.
• (3) Internal controls are designed for -> (a) preventing errors occurring in financial information or detecting and correcting them. The primary objective of internal controls is to prevent and detect errors and fraud in the financial statements.
• (4) A significant risk is a risk which -> (b) requires special audit consideration due to its high probability and high magnitude. A significant risk is a risk of material misstatement that requires special consideration by the auditor due to its nature and potential impact.
• (5) A financial interest in an assurance client -> (c) may create a self-interest threat. A financial interest in a client can create a self-interest threat, as the auditor's objectivity could be compromised by the financial interest.

Solution:

The objectives of internal controls over sales order processing and the extent to which Nokia Ltd achieves them are:

• **Authorization:** All sales orders should be properly authorized. Nokia Ltd achieves this by having the computer check for sufficient inventories and that the customer's credit limit is not exceeded. Orders that exceed the credit limit are referred to the credit controller for approval.
• **Accuracy:** All sales orders should be accurately recorded. Nokia Ltd achieves this by having the order details read back to the customer for confirmation.
• **Completeness:** All sales orders should be completely recorded. Nokia Ltd achieves this by automatically assigning a sequential order number to each order and having the warehouse supervisor check the sequence of packing notes for completeness.
• **Cut-off:** All sales orders should be recorded in the correct accounting period. Nokia Ltd achieves this by checking the despatches at the gatehouse to ensure that they are accompanied by the appropriate documentation.

Solution:

Here are the deficiencies in Nokia Ltd's internal control system and the corresponding recommendations:

• **Deficiency 1: Lack of review of credit limits.**
  • **Consequence:** This could lead to a customer's credit limit being increased without proper authorization, which could result in a bad debt.
  • **Recommendation:** The company should have a formal process for reviewing and updating credit limits. A report of all credit limit changes should be generated and reviewed by a senior manager.
• **Deficiency 2: Lack of segregation of duties.**
  • **Consequence:** The credit controller can both authorize credit limit changes and enter them into the system. This could lead to fraud, as the credit controller could increase a customer's credit limit without proper authorization.
  • **Recommendation:** The company should segregate the duties of authorizing credit limit changes and entering them into the system. The authorization should be done by a senior manager who is independent of the credit controller.
• **Deficiency 3: Lack of independent verification.**
  • **Consequence:** The warehouse supervisor can confirm packing and also notify of any shortfalls. This could lead to fraud, as the warehouse supervisor could intentionally understate the number of goods dispatched and then sell the goods on the side.
  • **Recommendation:** The company should have a person independent of the warehouse supervisor to perform a count of the goods and to check for any shortfalls.
• **Deficiency 4: Lack of controls over new customers.**
  • **Consequence:** New customer accounts are set up based on the oral authority of the chief accountant. This could lead to a customer account being set up without proper authorization, which could result in a bad debt.
  • **Recommendation:** The company should have a formal process for setting up new customer accounts, which should include a written authorization from a senior manager.

Solution:

The auditor should perform the following substantive procedures to obtain sufficient and appropriate audit evidence in relation to Gooseberry Co's research and development expenditure:

• **Recalculation:** Recalculate the amortization of the intangible assets and ensure that it is correctly calculated over the useful life of the assets.
• **Vouching:** Vouch the development costs to the underlying documentation, such as invoices and payroll records.
• **IAS 38:** Verify that the costs meet the criteria for capitalization as per IAS 38, "Intangible Assets."
• **Management inquiry:** Discuss with management the nature of the development projects and the reasons for their capitalization.

Solution:

The auditor should perform the following substantive procedures to obtain sufficient and appropriate audit evidence in relation to the matters identified regarding depreciation of property, plant and equipment:

• **Recalculation:** Recalculate the depreciation charge for the year and ensure that it is correctly calculated based on the new useful lives, residual values, depreciation rates, and methods.
• **Management inquiry:** Discuss with management the reasons for the change in the depreciation policy.
• **IAS 16:** Verify that the change in depreciation policy is in line with the requirements of IAS 16, "Property, Plant and Equipment."
• **Disclosure:** Ensure that the change in depreciation policy is adequately disclosed in the notes to the financial statements.

Solution:

The auditor should perform the following substantive procedures to obtain sufficient and appropriate audit evidence in relation to the directors' bonuses:

• **Recalculation:** Recalculate the bonus amount based on the net assets, excluding intangible assets, and ensure that it is correctly calculated.
• **Vouching:** Vouch the bonus payment to the underlying documentation, such as the board resolution.
• **Service contracts:** Review the directors' service contracts to confirm that they are entitled to a bonus.
• **Disclosure:** Ensure that the bonus is adequately disclosed in the notes to the financial statements, as per local legislation.

Solution:

The capitalization of the development costs, which do not meet the criteria for capitalization as per IAS 38, is a material misstatement. The finance director's confidence that the project will meet the criteria for capitalization in 20X6 is not a valid reason for not making an adjustment in the current year. The auditor must consider the misstatement to be material. Since the misstatement is not pervasive to the financial statements as a whole, the auditor should issue a **qualified opinion**. The auditor's report will include a "Basis for Qualified Opinion" section explaining the misstatement and the reasons for the qualified opinion.

Solution:

The audit risks for MetroLife Pharmaceuticals Limited (MPL) are:

• **Going concern:** The company has lost its sales by 11% and is facing serious competition, which could indicate a going concern problem.
• **Sales promotion & incentive expenses:** The increase in sales promotion and incentive expenses could be a sign of a decline in sales and could be misstated.
• **Non-current assets:** The replaced machineries are still recognized in the financial statements at written down value, which could lead to an overstatement of non-current assets.
• **Segregation of duties:** The departmental heads are making asset purchases without central control, which is a lack of segregation of duties.
• **Inventory valuation:** The valuation of inventory is a key audit risk, as it is a significant item on the balance sheet.

Solution:

The audit procedures to be performed in response to the audit risks are:

• **Going concern:** Review the company's cash flow forecast and discuss with management their plans to address the decline in sales.
• **Sales promotion & incentive expenses:** Vouch a sample of the sales promotion and incentive expenses to the underlying documentation, such as invoices and receipts.
• **Non-current assets:** Perform a physical verification of the non-current assets and ensure that the replaced machineries are derecognized from the financial statements.
• **Segregation of duties:** Document the internal controls over the purchase of assets and assess their effectiveness.
• **Inventory valuation:** Perform a physical verification of the inventory and ensure that it is valued at the lower of cost and net realizable value.

Solution:

The audit evidence to be collected is:

• **Cash flow forecast:** The company's cash flow forecast and management's plans to address the decline in sales.
• **Sales promotion & incentive expenses:** Invoices, receipts, and other documentation for sales promotion and incentive expenses.
• **Non-current assets:** Physical verification reports, non-current asset register, and documentation for the derecognition of replaced machineries.
• **Internal controls:** Documentation of the internal controls over the purchase of assets.
• **Inventory valuation:** Physical verification reports, inventory records, and documentation for the valuation of inventory.

Solution:

To: The Management of Diamond Ceramics Limited

From: Engagement Manager, Rrl & Co. Chartered Accountants

Date: [Date]

Subject: Letter to Management on Audit Procedures

Dear Sir/Madam,

This letter is in response to your concerns regarding the sufficiency and appropriateness of the audit procedures performed for the physical verification of inventory and non-current assets.

As part of our audit, we performed a physical verification of inventory and non-current assets on a random sample basis. The sample size was determined based on our professional judgment and the assessed risk of material misstatement. We performed our procedures in accordance with the Bangladesh Standards on Auditing (BSAs) and obtained sufficient and appropriate audit evidence to support our conclusion.

While we performed our procedures with professional skepticism and due care, the auditor's responsibility is not to perform a complete physical verification of all inventory and non-current assets. The auditor's responsibility is to express an opinion on whether the financial statements are free from material misstatements.

The auditor's procedures are designed to provide reasonable assurance, not absolute assurance, that the financial statements are free from material misstatements. Therefore, the auditor's opinion may not detect all misstatements, including fraud.

We are ready to discuss this matter with you further.

Sincerely,

Engagement Manager

Rrl & Co. Chartered Accountants

Solution:

The auditor should perform the following additional procedures after being aware of the theft of inventory and non-current assets:

• **Inquiry of management:** Inquire of management about the nature and extent of the theft and the action taken.
• **Internal controls:** Assess the internal controls over the physical security of inventory and non-current assets and the segregation of duties.
• **Audit report:** Assess the impact of the theft on the audit report. If the theft is material, the auditor should issue a qualified or adverse opinion.
• **Fraud:** Consider whether the theft is an indicator of fraud and whether the auditor's responsibility for fraud has been met.

Solution:

The auditor should perform the following procedures regarding the overdraft account and the guaranty:

• **Bank confirmation:** Obtain a bank confirmation to confirm the terms and conditions of the overdraft account and the guaranty.
• **Management inquiry:** Inquire of management about the reasons for the non-disclosure of the overdraft account and the guaranty.
• **Legal counsel:** Obtain a written representation from the legal counsel about the likelihood of a claim under the guaranty.
• **Disclosure:** Assess whether the overdraft account and the guaranty are required to be disclosed in the financial statements as per IAS 10, "Events After the Reporting Period," and IAS 37, "Provisions, Contingent Liabilities, and Contingent Assets."