CMA January 2025 Examination Solutions

Solution:

The correct answer is (c) Financial statement assertion level. According to ISA 315, "Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment," control risk should be assessed at the assertion level for classes of transactions, account balances, and disclosures. This allows the auditor to link the assessed risk to the specific audit procedures performed.

Solution:

The correct answer is (a) Cash balance. Analytical procedures involve comparing data to identify relationships and trends. While they can be used for cash, other audit procedures such as bank confirmations and reconciliations are typically more effective and are therefore the primary procedures used for cash. For investments, bills receivables, and debtors, analytical procedures are often used to test the reasonableness of the balances.

Solution:

The correct answer is (d) Speak as a member of company. A retiring auditor has the right to make a written representation, have it circulated to members, and be heard at the general meeting where their removal is considered. However, they do not have the right to speak as a member of the company, as they are not a shareholder.

Solution:

The correct answer is (b) Unqualified opinion with reference to notes to the accounts. As per ISA 570, "Going Concern," when the auditor concludes that a material uncertainty exists related to going concern but the financial statements adequately describe the uncertainty, they should express an unmodified (unqualified) opinion and include a separate section with the heading "Material Uncertainty Related to Going Concern" to highlight the issue. This paragraph will refer to the notes in the financial statements that provide the detailed disclosure.

Solution:

The correct answer is (a) Breach of confidentiality. Auditors have a professional and legal obligation to maintain the confidentiality of client information. A breach of this duty can lead to legal action, disciplinary proceedings by professional bodies, and damage to the auditor's reputation. Lack of attention to audit procedures and non-compliance with tax regulations are also liabilities, but a breach of confidentiality is a direct legal liability that auditors can face.

Solution:

The correct answer is (d) Over Valuation of assets. Window dressing is the practice of manipulating a company's financial statements to make its performance or financial position appear better than it actually is. This can be done by overvaluing assets, understating liabilities, or accelerating revenues.

Solution:

The correct answer is (b) Impersonal ledger. An impersonal ledger contains nominal accounts, which are used to record income, expenses, gains, and losses. A personal ledger contains accounts of individuals or organizations with whom the business has a relationship, such as debtors and creditors.

Solution:

The correct answer is (b) There are no unrecorded liabilities. By examining a supplier's statement, the auditor can compare the balance shown in the statement with the balance recorded in the client's books. If the supplier's balance is higher than the client's, it may indicate that the client has failed to record a liability. This procedure is a key test for the completeness assertion of liabilities.

Solution:

The correct answer is (d) Sale of scrap. The sale of scrap is a by-product of the production process. To vouch for the sale of scrap, the auditor would need to examine the cost records to determine the value of the scrap produced and whether the sale proceeds are reasonable. This is an important step in ensuring that all income has been recorded and that the revenue is fairly valued.

Solution:

The correct answer is (d) Introductory, scope and opinion paragraph. A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence and the possible effects on the financial statements are both material and pervasive. In such cases, the auditor must modify the introductory, scope, and opinion paragraphs to reflect the inability to form an opinion. They will state that they were unable to perform certain procedures and therefore cannot express an opinion on the financial statements.

Solution:

False. The auditor may rely on the work of a management's expert if the auditor is satisfied with the expert's competence, capabilities, and objectivity. This reliance is guided by ISA 500, "Audit Evidence," and ISA 620, "Using the Work of an Auditor's Expert." The auditor, however, must always maintain professional skepticism and evaluate the expert's work for its appropriateness as audit evidence.

Solution:

True. As per IAS 24, "Related Party Disclosures," management is responsible for identifying and disclosing related parties and related party transactions. The auditor's role is to obtain sufficient appropriate audit evidence about whether the related party relationships and transactions have been appropriately identified, accounted for, and disclosed in the financial statements.

Solution:

False. Analytical procedures require a significant amount of professional judgment and a deep understanding of the client's business and industry. Therefore, while audit juniors may perform some basic analytical procedures, the overall planning and review of these procedures should be carried out by a more senior member of the audit team, such as the audit manager or partner.

Solution:

True. This is a crucial audit procedure for assessing the going concern assumption. A company's inability to manage its cash flows, as evidenced by a high utilization of its bank overdraft and a consistent proximity to its limit, can be a significant indicator of a going concern problem. The auditor must, therefore, review the bank statements and discuss with management how the company plans to manage its liquidity in the foreseeable future.

Solution:

False. The auditor's responsibility is to plan and perform the audit to obtain reasonable assurance that the financial statements are free from material misstatements, whether due to fraud or error. The auditor should follow the procedures in ISA 240, "The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements," which focuses specifically on the auditor's responsibility for fraud. The ISA does not provide a "reasonable exception," but rather a framework for addressing the risk of fraud.

Solution:

The correct matches are as follows:

• (1) To understand the client, auditor need to have a good understanding any laws & regulation -> (d) which have an impact on its operation. The auditor must understand the legal and regulatory framework of the client's business to assess its impact on the financial statements.
• (2) As per ISA-315, the auditor -> (e) Identifying and assessing the risk of material misstatement. ISA 315 requires the auditor to identify and assess the risks of material misstatement through an understanding of the entity and its environment.
• (3) A significant risk is a risk of material misstatement that -> (a) Is the auditor's judgement requires special consideration. A significant risk is a risk that requires special consideration from the auditor due to its nature and potential impact.
• (4) The auditor with removal if a qualified audit report is produced -> (c) Is intimidation threat. An intimidation threat can arise when a client threatens to remove the auditor if they issue a modified opinion.
• (5) Business risk is the risk of inherent to the company in its operations -> (g) It includes risk at all label of the business. Business risk is the risk that a company will be unable to meet its objectives, and it includes risks at all levels of the business.

Solution:

Scenario 1: Bakers Co

The threats to objectivity in this scenario are:

• **Familiarity Threat:** The firm has been auditing Bakers Co for 17 years. This long-standing relationship could lead to the auditors becoming too trusting or sympathetic to management, compromising their professional skepticism.
• **Self-Interest Threat:** The fee from the new consultancy work, combined with the existing audit fee, could represent a significant portion of the firm's income. This financial dependency could influence the auditor's judgment and create a self-interest threat.
• **Management Threat:** The new consultancy work could involve making decisions or taking on a role that is the responsibility of management, such as designing or implementing a new financial system. This would create a management threat, as the auditor would be auditing their own work.

The safeguards that could be implemented are:

• **Independent review:** The audit of Bakers Co should be subject to an independent review by a partner who is not involved in the audit.
• **Fee negotiation:** A senior partner who is not involved in the audit should negotiate the fee for the consultancy work to ensure that the fee does not create a self-interest threat.
• **Resigning from the audit:** If the fee from both the audit and the consultancy work is too high, the firm should consider resigning from the audit to maintain its independence.

Scenario 2: Murphy Manufacturing Co

The threats to objectivity in this scenario are:

• **Self-Review Threat:** If Peter is appointed as an internal auditor, he would be responsible for auditing the control systems that he helped to design and implement. This would create a self-review threat, as he would be auditing his own work.
• **Familiarity Threat:** Peter's close relationship with the purchasing department, especially with his immediate supervisor, could compromise his objectivity as an internal auditor.

The safeguards that could be implemented are:

• **Rotation of duties:** Peter should not be assigned to audit the purchasing department for a period of time to avoid a self-review threat.
• **Independent review:** The work of the internal audit team should be subject to an independent review by a senior manager or an external auditor to ensure that the work is objective and free from bias.

Solution:

The five threats to ethics are:

1. **Self-Interest Threat:** This threat arises when an auditor has a financial or other interest that could improperly influence their judgment or behavior.
   • **Example:** An auditor owns shares in the company they are auditing.
2. **Self-Review Threat:** This threat arises when an auditor audits their own work or the work of a colleague who is closely related.
   • **Example:** A member of the audit team also prepares the financial statements of the client.
3. **Advocacy Threat:** This threat arises when an auditor promotes a client's position to the point where their objectivity is compromised.
   • **Example:** An auditor represents a client in a legal dispute with a third party.
4. **Familiarity Threat:** This threat arises when an auditor becomes too familiar with a client due to a long-standing relationship. This could lead to a lack of professional skepticism.
   • **Example:** A senior audit partner has been auditing the same client for 10 years.
5. **Intimidation Threat:** This threat arises when an auditor is intimidated or threatened by a client, which could prevent them from acting objectively.
   • **Example:** A client threatens to fire the auditor if they do not issue an unmodified audit report.

Solution:

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. It is the risk that the auditor will fail to detect a material misstatement in the financial statements.

The components of audit risk are:

• **Inherent Risk:** The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.
• **Control Risk:** The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that 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.
• **Detection Risk:** 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.

Solution:

Here are six audit risks for Aquamarine Co and the corresponding auditor's responses:

Audit risk	Auditor's response
There is a risk that the valuation of work in progress (WIP) is misstated due to continuous production.	Attend the year-end inventory count and observe the work in progress to assess the stage of completion. Test the cost of raw materials and labor by vouching them to the purchase invoices and payroll records.
There is a risk that the new plant and machinery purchased in April may not be correctly recognized or depreciated.	Verify the purchase invoice for the new plant and machinery. Trace the addition to the non-current asset register and recalculate the depreciation. Ensure that the part of the plant that has not been delivered is not recognized as a non-current asset.
The patent may be overvalued as it has a limited life of five years. There is a risk that the amortization is not correctly calculated.	Verify the cost of the patent by inspecting the purchase agreement. Recalculate the amortization of the patent over its five-year life and ensure that the valuation is reasonable.
The significant increase in receivables may not be recoverable, leading to a risk of misstatement of the trade receivables balance.	Obtain an aged receivables listing and discuss any long-outstanding balances with management. Review post-year-end cash receipts and assess the adequacy of the allowance for credit losses.
The decision to make 65 employees redundant could lead to a provision for redundancy costs, which if not correctly accounted for, could misstate the financial statements.	Discuss with management the timing of the announcement and the planned redundancy costs. Ensure that a provision is made only if the company has a present obligation as a result of a past event.
The revaluation of land and buildings is a significant change in accounting policy. There is a risk that the revaluation is not performed by a competent professional.	Verify that the revaluation has been performed by a professional valuer. Review the valuation report to ensure that it is reasonable. Recalculate the revaluation surplus and ensure that the new values are correctly reflected in the financial statements.

Solution:

Amethyst & Co should consider the following additional factors in relation to Aquamarine Co's use of a payroll service organization:

• **System and Organization Control (SOC) Report:** The auditor should obtain and review the SOC report of the service organization to understand the internal controls over the payroll function.
• **Communication with the Service Organization:** The auditor should communicate with the service organization to confirm the information about the payroll function.
• **Impact on Internal Controls:** The auditor should assess how the outsourcing of the payroll function has affected Aquamarine Co's internal controls.

Solution:

The limitations of internal control include:

• **Human Error:** Mistakes can be made due to carelessness, distraction, or misunderstanding.
• **Management Override:** Management can override internal controls for their own benefit or to manipulate financial statements.
• **Collusion:** Two or more employees can collude to circumvent internal controls.
• **Cost/Benefit:** The cost of implementing an internal control should not exceed the benefits that are expected to be derived from it.

Solution:

Here are eight deficiencies in Pomeranian Co's internal control system and the corresponding recommendations:

Control deficiency	Control recommendation
The sales director sets the credit limit. This is a lack of segregation of duties.	The credit limit should be set by a person who is independent of the sales department, such as a credit manager.
Credit limits are only changed when a customer requests an increase, which could lead to credit risk.	The credit limits should be regularly reviewed and updated based on a customer's creditworthiness.
Copies of GDNs are sent to the finance department on a weekly basis, which could lead to a delay in billing.	Copies of GDNs should be sent to the finance department on a daily basis to ensure that billing is done on a timely basis.
The credit controller is on maternity leave and no one has taken over her duties, which could lead to a lack of collection of receivables.	A temporary credit controller should be appointed to take over the duties of the credit controller.
The reconciliation of trade receivables is only reviewed by the financial controller if there are any unreconciled differences.	The financial controller should review all reconciliations, even if there are no unreconciled differences.
The internal audit department only completes the physical comparison of assets at two sites per year, which is not sufficient.	The internal audit department should increase the frequency of the physical comparison of assets to ensure that all assets are accounted for.
The warehouse managers are responsible for supervising inventory counts at their sites, which is a lack of segregation of duties.	The inventory counts should be supervised by a person who is independent of the warehouse manager, such as a member of the internal audit department.
The basis of the standard costs was reviewed two years ago, which may not be a reliable basis for the valuation of inventory.	The standard costs should be reviewed and updated on an annual basis to ensure that the valuation of inventory is accurate.

Solution:

The materiality level of Tk. 10,000 used in 2016 will likely **not** be appropriate for the current year's audit. Materiality is determined by the size and nature of an item and is assessed based on the financial statements as a whole. A company's financial performance and financial position can change from one year to the next, which can affect the level of materiality.

In this case, the company's total assets and total liabilities have significantly decreased from 2016 to 2017. As materiality is often calculated as a percentage of a benchmark, such as total assets, the materiality level should be re-evaluated for the current year's audit. Using a lower materiality level would mean that the auditor would need to perform more extensive audit procedures to obtain sufficient appropriate audit evidence, which would increase the cost and time of the audit. Therefore, the auditor should re-assess the materiality level for the current year's audit to ensure that it is appropriate.

Solution:

The factors that influence materiality are:

• **Size:** The size of an item can be a factor in determining its materiality. For example, a Tk. 1,000,000 misstatement in a company with Tk. 10,000,000 of revenue is material, while the same amount in a company with Tk. 1,000,000,000 of revenue may not be.
• **Nature:** The nature of an item can also be a factor. For example, a misstatement in the salaries of senior management may be considered more material than a similar misstatement in the salaries of junior employees.
• **Benchmark:** The materiality level is often calculated as a percentage of a benchmark, such as total assets, revenue, or profit before tax. The choice of benchmark depends on the nature of the company and the needs of the users of the financial statements.

Solution:

Based on the statement of financial position, the auditor should concentrate on the following areas:

• **Inventory:** The value of inventory has decreased significantly from Tk. 179,000 in 2016 to Tk. 52,000 in 2017. This could be due to a number of reasons, such as a decline in sales or an obsolescence of inventory. The auditor should concentrate on the valuation of inventory and perform substantive procedures to ensure that it is not overstated.
• **Receivables:** The value of receivables has also decreased significantly from Tk. 136,000 in 2016 to Tk. 78,000 in 2017. This could be due to a number of reasons, such as a change in credit policy or an inability to collect debts. The auditor should concentrate on the valuation of receivables and perform substantive procedures to ensure that the allowance for credit losses is adequate.
• **Provision:** A provision of Tk. 20,000 has been made for warranty. The auditor should concentrate on the valuation of the provision and perform substantive procedures to ensure that it is reasonable. The auditor should also review the warranty claims made during the year and assess the adequacy of the provision.
• **Going Concern:** The company's total assets have decreased significantly, and it has a negative reserve. This suggests that there may be a going concern problem. The auditor should concentrate on the going concern assumption and perform substantive procedures to ensure that the financial statements are prepared on a going concern basis.