Question 1: Multiple Choice Questions
Problem Statement: If an auditor determines that there is substantial doubt about an entity's ability to continue as a going concern, they should:
a) Withdraw from the engagement
b) Issue an adverse opinion
c) Modify the audit report with an emphasis of matter paragraph
d) Express a standard unmodified opinion
e) All the above
Solution:
The correct answer is (c) Modify the audit report with an emphasis of matter paragraph. 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 opinion and include a separate section with the heading "Material Uncertainty Related to Going Concern" to highlight the issue. If the disclosure is inadequate, a qualified or adverse opinion would be appropriate.
Problem Statement: An auditor is required to communicate key audit matters (KAMs) in the audit report when:
a) The auditor expresses an adverse opinion
b) The audit is conducted under the PCAOB standards
c) The audit is conducted for a listed entity
d) There is a fraud risk identified
e) None of the above
Solution:
The correct answer is (c) The audit is conducted for a listed entity. As per International Auditing Standard (ISA) 701, the auditor is required to communicate Key Audit Matters (KAMs) in the audit report of a listed entity. For other entities, the communication of KAMs is voluntary unless required by law or regulation.
Problem Statement: Which of the following statements regarding audit sampling is correct?
a) A larger sample size always leads to more accurate audit results
b) Statistical and non-statistical sampling provide the same level of assurance
c) Sampling risk is eliminated when an auditor examines all items in a population
d) The purpose of audit sampling is to draw conclusions about an entire population based on a subset of items
e) All above
Solution:
The correct answer is (d) The purpose of audit sampling is to draw conclusions about an entire population based on a subset of items. Audit sampling, as per ISA 530, is the application of audit procedures to less than 100% of items within a population of audit relevance such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population.
Problem Statement: A "going concern" assumption implies that:
a) The company has plans to expand its operations.
b) The financial statements are prepared using a liquidation basis
c) The company is expected to continue operating in the foreseeable future
d) The company is facing significant financial distress
e) All above
Solution:
The correct answer is (c) The company is expected to continue operating in the foreseeable future. The going concern assumption is a fundamental principle of accounting which assumes that a business will continue to operate for an indefinite period of time and will be able to realize its assets and discharge its liabilities in the normal course of business.
Problem Statement: Which of the following assertions is most directly tested when an auditor performs a confirmation of accounts receivable balances?
a) Completeness
b) Valuation
c) Existence
d) Rights and obligations
e) None of the above
Solution:
The correct answer is (c) Existence. A confirmation of accounts receivable provides strong evidence that the recorded balances actually exist. By receiving a direct response from the customer, the auditor gets reliable external evidence that the debt is valid.
Problem Statement: The auditor's report should be dated as of:
a) The last day of fieldwork
b) The date the audit report is signed by the auditor
c) The date the financial statements are prepared
d) The date when the auditor has obtained sufficient appropriate audit evidence
e) All above
Solution:
The correct answer is (b) The date the audit report is signed by the auditor. The date of the auditor's report is the date the auditor signs the report. This signifies that the auditor has completed all necessary audit procedures and has obtained sufficient appropriate audit evidence to form an opinion on the financial statements.
Problem Statement: Which of the following audit opinions suggests that the financial statements are materially misstated but not pervasive?
a) Qualified opinion
b) Adverse opinion
c) Unmodified opinion
d) Disclaimer of opinion
e) None of the above
Solution:
The correct answer is (a) Qualified opinion. A qualified opinion is issued when the auditor concludes that the financial statements are materially misstated, but the effects of the misstatement are not pervasive to the financial statements. An adverse opinion is issued when the misstatement is both material and pervasive.
Problem Statement: The responsibility for ensuring that financial statements are free from material misstatements rests with:
a) The auditor
b) The company's management
c) The internal audit team
d) The shareholders
e) None of the above
Solution:
The correct answer is (b) The company's management. The primary responsibility for the preparation of financial statements and ensuring that they are free from material misstatements rests with the company's management and those charged with governance. The auditor's role is to express an opinion on those financial statements.
Problem Statement: Which of the following is an example of detective control?
a) Physical locks on inventory storage
b) Segregation of duties
c) Monthly bank reconciliations
d) Pre-approval of purchase orders
e) All the above
Solution:
The correct answer is (c) Monthly bank reconciliations. Detective controls are designed to find errors or irregularities that may have occurred. Bank reconciliations are a classic example of this as they help detect discrepancies between the company's records and the bank's records after the transactions have taken place. Physical locks and pre-approvals are preventive controls, and segregation of duties is a control activity designed to prevent fraud.
Problem Statement: Which of the following is a limitation of internal control?
a) Internal control prevents all frauds
b) Human errors and management override can affect internal control effectiveness
c) Internal control replaces the need for external audits
d) Internal control ensures absolute accuracy
e) None of the above
Solution:
The correct answer is (b) Human errors and management override can affect internal control effectiveness. Internal controls, no matter how well-designed, can be circumvented due to human errors, collusion among employees, or override by management. Controls provide reasonable, not absolute, assurance that the financial statements are free of material misstatements.
Question 2: Modified True/False
Problem Statement: The audit engagement partner will not review all working papers on the audit file before issuing an opinion.
Solution:
True. The engagement partner is responsible for the overall audit, but it is not practical for them to review every single working paper on the file. They typically review the key working papers and significant issues to ensure that the audit has been performed in accordance with professional standards and that the audit opinion is supported by the evidence obtained.
Problem Statement: The client has demonstrated a lack of professional skepticism.
Solution:
False. Professional skepticism is a mindset and attitude of the **auditor**, not the client. It involves a questioning mind and a critical assessment of audit evidence. The client is not expected to demonstrate professional skepticism, but rather to provide accurate and complete information.
Problem Statement: The familiarity threat occurs where the professional adopts a stance arguing for or against client's point of view.
Solution:
False. The situation described is the **advocacy threat**, not the familiarity threat. The familiarity threat arises when, due to a long or close relationship with a client, an auditor becomes too sympathetic to their interests. The advocacy threat is about actively promoting a client's position to the point where the auditor's objectivity is compromised.
Problem Statement: The auditor has an active responsibility to carry out subsequent events procedures between the date of the financial statements and the date of the auditor's report.
Solution:
True. As per ISA 560 (Subsequent Events), the auditor has an active and specific responsibility to perform audit procedures to obtain sufficient appropriate audit evidence about subsequent events that occur between the date of the financial statements and the date of the auditor's report. These procedures are designed to identify events that may require adjustment or disclosure in the financial statements.
Problem Statement: If the client refuses the existing auditor permission to communicate with the prospective audit, the prospective auditor should decline the appointment.
Solution:
True. The prospective auditor must communicate with the existing auditor to gather information about the client and the reasons for the change in auditors. If the client refuses to give permission for this communication, it is a significant red flag that could indicate a potential issue with the client. Therefore, the prospective auditor should, as a matter of professional skepticism, decline the engagement.
Question 3: Matching
Problem Statement: Match the items of column A with the most suitable items of column B. Match only one item of column A with one item of column B. Write your answer on the answer script.
| Column A | Column B |
|---|---|
| (1) Management threat arise when the audit firm under take work- | (a) Indication of withdrawal of financial support by creditors. |
| (2) In case of trust threat- | (b) Either satisfied with the sufficiency or appropriateness of the evidence that obtained. |
| (3) For managing the conflict- | (c) None of these. |
| (4) A possible symptom of going concern problem as per IAS 570 is- | (d) that involves making judgement and taking decision. |
| (5) the modified opinion is given when the auditor is. | (e) Not indication of withdrawal of financial support by creditors. |
| (f) Sufficient disclosure should be made to the clients or potential clients. | |
| (g) The professional skepticism is impaired. | |
| (h) Bank statements obtained from the client by the auditor. | |
| (i) The auditor is very much unsatisfied. |
Solution:
The correct matches are as follows:
- (1) Management threat arise when the audit firm under take work- -> (d) that involves making judgement and taking decision. A management threat occurs when the auditor takes on a role that is the responsibility of management, such as making decisions.
- (2) In case of trust threat- -> (g) The professional skepticism is impaired. The trust threat is not a standard term in professional ethics, but it relates to the auditor's objectivity being compromised by a lack of professional skepticism.
- (3) For managing the conflict- -> (f) Sufficient disclosure should be made to the clients or potential clients. To manage a conflict of interest, the auditor should disclose the conflict to the client and, if necessary, take other safeguards.
- (4) A possible symptom of going concern problem as per IAS 570 is- -> (a) Indication of withdrawal of financial support by creditors. The withdrawal of financial support is a key indicator of a going concern problem.
- (5) the modified opinion is given when the auditor is. -> (i) The auditor is very much unsatisfied. A modified opinion is issued when the auditor concludes that the financial statements are materially misstated or when they are unable to obtain sufficient appropriate audit evidence.
Question 4: Substantive Procedures & Auditor's Report
Problem Statement: Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence In relation to Encore Co's vehicle additions and disposals.
Solution:
The auditor should perform the following substantive procedures for vehicle additions and disposals:
- **Additions:**
- Verify the cost of new vehicles by inspecting the purchase invoices and payment records.
- Trace the new vehicles to the non-current asset register and physically inspect them.
- Recalculate the depreciation for the new vehicles.
- **Disposals:**
- Agree the disposal proceeds to the sales documentation.
- Recalculate the profit or loss on disposal, ensuring the carrying amount is correctly removed from the non-current asset register.
- Verify that the cash consideration was received.
Problem Statement: Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the VALUATION of Encore Co's trade receivables.
Solution:
The auditor should perform the following substantive procedures for the valuation of trade receivables:
- **Aging Analysis:** Obtain and review the aged trade receivables listing and discuss any long-outstanding balances with management.
- **Allowance for credit losses:** Assess the adequacy of the allowance for credit losses by reviewing post-year-end cash receipts and discussing the collectability of old debts with management.
- **Credit Terms:** Compare the credit controller's credit terms with those of the company's policy to identify any inconsistencies.
- **Review of correspondence:** Review correspondence with customers to identify any disputes or complaints that may suggest that the receivables are not recoverable.
- **Confirmation:** Consider sending confirmation requests to a sample of customers to confirm the balances.
Problem Statement: Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence In relation to the potential breach of transport regulations by Encore Co.
Solution:
The auditor should perform the following substantive procedures regarding the potential breach of transport regulations:
- **Inquiry:** Inquire of management and those charged with governance about the nature of the complaint, the progress of the investigation, and the likelihood of a fine.
- **Legal Confirmation:** Obtain a confirmation letter from the company's lawyers regarding the likelihood of the company being found guilty and the estimated amount of the fine.
- **Review of correspondence:** Review any correspondence with the transport authority and the former employee.
- **Disclosure:** Assess whether the company has made an appropriate provision or disclosure in the financial statements as required by relevant accounting standards.
Problem Statement: It is now 26 August 20X5 and the auditor's report for Encore Co is being finalized. On 12 August 20X5, the transport authority announced that it was taking legal action against Encore Co in respect of 17 breaches of the regulations. Encore Go's lawyers have advised that it is probable Encore Co will be found guilty of all of the breaches. Encore Co's directors have informed you that no provision will be made in respect of this matter, as the decision by the authority to take legal action was made after the year end, but they have agreed to disclose the issue in the notes to the financial statements.
Solution:
The legal action taken by the transport authority is a **non-adjusting subsequent event** as the event that triggered the legal action (the breaches) occurred during the year, but the announcement and the probability of a fine were confirmed after the year-end. As per International Accounting Standard (IAS) 10, such events should be disclosed in the notes to the financial statements.
The directors' decision not to make a provision for the fine is incorrect, as a provision should be made when there is a present obligation as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. In this case, the legal advice suggests it is probable the company will be found guilty, so a provision should be made. The disclosure in the notes is also not sufficient if a provision is required.
The impact on the auditor's report will be as follows: The financial statements contain a material misstatement (the lack of a provision for the fine) which is not pervasive. Therefore, the auditor should issue a **qualified opinion** with an "Emphasis of Matter" paragraph explaining the reason for the qualification. The auditor should also include a "Basis for Qualified Opinion" section in their report.
Question 5: Professional Ethics & Going Concern
Problem Statement: You have recently come across the following professional issues: 1) During the audit of a listed company on which you were involved, you overheard the finance director on the telephone to a family friend requesting him to buy shares on his behalf, prior to an announcement about a new product which you know is likely to increase the share price significantly. The finance director is a chartered accountant. 2) During a night out at the pub following your exams one of your fellow students told you in strictest confidence that he had tampered with his degree certificate on his computer to improve the classification. He explained that he had done this to satisfy the minimum requirements to secure a job at his firm, one of your main rivals. He boasted about how easy it was with new computer technology currently available. 3) One of the audit clients you recently worked on was so impressed with your courtesy towards his staff members that he wanted to make you a gift of tickets to the World Cup football final, along with an overnight stay in a hotel.
Solution:
Here are the problems and the actions to be taken for each situation:
- **Insider Trading:** The finance director is engaging in insider trading, which is illegal and unethical. The information about the new product is price-sensitive and not yet public.
- **Action:** You must report this to the senior audit partner immediately. The firm must then take appropriate action, which may include reporting the finance director to the relevant regulatory bodies, such as the BSEC.
- **Misrepresentation and Fraud:** Your fellow student has committed fraud by altering a legal document to secure a job. This is a serious ethical breach and a criminal offense.
- **Action:** You have a professional duty to report this. You should inform your firm's ethics partner. The firm should then consider its professional obligation to report the matter to the student's employer.
- **Gift and Hospitality:** Accepting a gift of significant value from an audit client could create a self-interest threat or a familiarity threat to your objectivity and independence.
- **Action:** You should politely decline the gift and explain the firm's policy on gifts and hospitality. You should also inform the senior audit partner about the offer, as this may be considered a key matter for the audit file.
Problem Statement: You have recently been appointed auditor of Supachill Ltd and are planning the audit for the year ending 31 December 20X5. You have obtained the following background information about the company: The company prepares chilled foods and sells them to supermarkets under its own brand name and that of a national supermarket chain, with which it has a one-year renewable contract. At present this contract represents 45% of revenue. The company is currently negotiating a substantial contract with another supermarket chain, but is reluctant to agree to the prices and 60 days' credit facility demanded. On 1 January 20X5 the managing director, who was previously involved in property development, acquired all the shares in Supachill Ltd from Omega Ltd, a conglomerate, which was rationalizing its operations. Immediately following the acquisition Supachill Ltd had net assets of CU2 million, after taking account of low interest loans of CU5 million from Omega Ltd. These loans are secured on the freehold property of the company and are repayable in equal quarterly instalments over a five- year period until 31 December 20X9. Day-to-day working capital is funded by an overdraft facility of CU1.5 million, secured by a fixed and floating charge on the other assets of the company. This facility is to be reviewed by the bank early in 20X6 after the audited accounts are available. The original business plan envisaged the acquisition of an adjacent factory to enable the company to double its output, but this expansion has been postponed. The managing director has explained that there will be a delay in preparing the draft accounts as the finance director has left and has yet to be replaced. The accountant is assisted in the day-to-day accounting function by temporary staff. There is a projected loss for the year but forecasts indicate a return to profitability in the next financial year.
Solution:
The auditor needs to perform the following procedures to assess the going concern status of Supachill Ltd:
- **Review of Cash Flow Forecasts:** Obtain and review the company's cash flow forecasts to assess its ability to meet its financial obligations, especially the quarterly loan repayments to Omega Ltd and the overdraft facility.
- **Review of Key Contracts:** Review the contract with the national supermarket chain and assess the likelihood of its renewal. Also, assess the status of the new contract negotiations and the potential impact of the credit facility on cash flows.
- **Discussions with Management:** Discuss with the managing director the reasons for the projected loss and the plans to return to profitability. Discuss the plans for replacing the finance director and the impact of the temporary staff on the financial reporting process.
- **Review of Loan Agreements:** Review the loan agreement with Omega Ltd and the overdraft facility with the bank to understand the terms and conditions and the security provided.
- **Subsequent Events:** Inquire about any events that occurred after the year-end that may affect the going concern assumption, such as the bank's review of the overdraft facility.
Question 6: Internal Control Deficiencies & Risks
Problem Statement: You are currently undertaking an assurance engagement for Mouse and Ratty Ltd, a large firm of PR consultants in Leeds. During the work, you have found a number of issues on which you need to report. These can be summarized as follows: You have found a total of Tk.18,000 of unauthorized expenditure on IT equipment. Any IT expenditure in excess of Tk.150 has to be authorized by a director. The IT expenditure for the year is 65% in excess of the budget. There does not appear to have been an investment project which was not budgeted for. There seems to be little reason for the rise. Large sums for travelling expenses are not being authorized when in excess of nightly limits set. Four executives spent a total of Tk. 25,000 in excess of nightly limits throughout the year. When examining work in progress, it became clear that there were sums which have been there for more than six months without being billed. This total is Tk.56,000. There appears to be no explanation for this. When overtime forms are submitted, any amount of more than three hours per month needs to be authorized. This is rarely done. The company paid out Tk. 180,000 in unauthorized overtime. There are no controls over non-chargeable times. The proportion of non-chargeable time for individual executives varies from 5% to 34%. Required: Identify the internal control deficiencies arising from the above
Solution:
The internal control deficiencies are:
- Lack of authorization for IT expenditure in excess of budget.
- Lack of authorization for travel expenses that exceed nightly limits.
- Lack of follow-up on long-outstanding work in progress that has not been billed.
- Lack of authorization for overtime hours.
- Lack of control over non-chargeable time.
Problem Statement: The risks to which each identified deficiency exposes the company
Solution:
The risks to which each deficiency exposes the company are:
- **Unauthorized IT expenditure:** This could lead to a significant overspend on IT, which may not be in line with the company's budget or strategic objectives. It also suggests a lack of financial discipline.
- **Unauthorized travel expenses:** This could lead to excessive and unnecessary travel expenses, which could reduce the company's profitability. It also indicates a lack of control over key expenses.
- **Unbilled work in progress:** This could lead to a significant loss of revenue for the company. The company may be performing work for which it is not billing, or the work may be of poor quality and therefore not billable.
- **Unauthorized overtime:** This could lead to a significant overspend on labor costs. The overtime may not be necessary, or it may be due to a lack of productivity.
- **Lack of control over non-chargeable time:** This could lead to a significant loss of revenue. The company may be paying employees for time that is not being used for client work, which is a waste of resources.
Problem Statement: Actions that the company should take to mitigate those risks.
Solution:
The company should take the following actions to mitigate the risks:
- **Authorization of expenditure:** The company should strictly enforce its policy on authorizing all IT expenditure in excess of the budget.
- **Authorization of expenses:** All travel expenses that exceed the nightly limits must be authorized by a senior manager or a director.
- **Billing of work in progress:** The company should implement a system to track all work in progress and ensure that it is billed on a timely basis.
- **Authorization of overtime:** All overtime hours must be authorized by a manager or supervisor before they are worked.
- **Tracking of non-chargeable time:** The company should implement a system to track all non-chargeable time and investigate the reasons for the high proportion of such time.
Question 7: Auditor's Report & Audit Opinion
Problem Statement: The physical inventory count sheets for one of the depots were lost before they were made available to you, and you have not been able to confirm the inventory quantities and values for this depot by alternative methods. The directors have valued this part of the inventory at Tk. 75,000 and this figure is included in the overall inventory valuation of Tk. 640,000.
Solution:
This is a limitation on the scope of the audit. The auditor is unable to obtain sufficient appropriate audit evidence about the inventory's existence and valuation. Since the amount (Tk. 75,000) is material (11.7% of total inventory) but not pervasive to the financial statements as a whole, the auditor should issue a **qualified opinion** with a "Basis for Qualified Opinion" section explaining the limitation. A disclaimer of opinion would be appropriate if the amount was both material and pervasive.
Problem Statement: Included in trade receivables, which total Tk. 580,000, is a debt amounting to Tk. 45,000 from a customer which went into liquidation on 15 June 2021. You have ascertained from the liquidator that your client is unlikely to receive a distribution. The statement of comprehensive income for the year shows a pre-tax profit of Tk. 100,000 but the directors are not prepared to provide for this debt.
Solution:
This is a **material misstatement** in the financial statements. The customer's liquidation provides strong evidence that the debt is uncollectible, and therefore a provision should be made as a subsequent event that provides evidence of conditions that existed at the year-end. The directors' refusal to provide for the debt of Tk. 45,000, which is material (45% of pre-tax profit), is a material misstatement. However, the effect is not pervasive. The auditor should issue a **qualified opinion** with a "Basis for Qualified Opinion" section explaining the misstatement. An adverse opinion would be appropriate if the misstatement was pervasive.
Problem Statement: The financial statements of Builders Merchants do not contain a statement of cash flows.
Solution:
The omission of a statement of cash flows is a material misstatement. Since Builders Merchants is a listed company, the statement of cash flows is a fundamental component of the financial statements required by accounting standards. The omission is not just material but also **pervasive** to the financial statements as a whole. Therefore, the auditor should issue an **adverse opinion**, as the financial statements do not present a true and fair view in accordance with the applicable financial reporting framework.
Problem Statement: A substantial claim has been lodged against the company by a major customer. The matter is fully explained in the notes to the accounts, but no provision has been made for legal costs or compensation payable as it is not possible to determine with reasonable accuracy the amounts, if any, which may become payable. The directors have received legal advice which appears to be reliable in indicating that the claim can be successfully defended.
Solution:
This issue relates to a contingent liability. Based on the legal advice received, the directors believe the claim can be successfully defended, which means the likelihood of an outflow of resources is not probable. Therefore, a provision is not required. The disclosure in the notes to the accounts is appropriate as it informs the users of the financial statements about the potential liability. The auditor should agree with the directors' treatment and issue a standard **unmodified opinion**, as there is no material misstatement. An "Emphasis of Matter" paragraph could be included to draw attention to the matter if it is considered fundamental to the users' understanding of the financial statements.