Question 1: Multiple Choice Questions
Problem Statement: For a retail business with a large volume of transactions, which of the following audit techniques is the MOST appropriate for addressing emerging risk?
a) Use of computer-assisted audit techniques
b) Quarterly risk assessments
c) Sampling of transaction logs
d) Continuous auditing
e) Integrate Auditing
Solution:
The correct answer is (d) Continuous auditing. Continuous auditing is the most appropriate technique for a business with a large volume of transactions because it allows the auditor to monitor the control environment and transactions in real-time. This provides a timely detection of emerging risks and allows the auditor to take immediate action. The other options are also useful but do not provide the same level of timely detection of emerging risks as continuous auditing.
Problem Statement: The decisions and actions of an auditor are MOST likely to affect which of the following types of risk?
a) Inherent
b) Detection
c) Control
d) Business
e) Sample
Solution:
The correct answer is (b) Detection. Detection risk is the risk that the auditor's procedures will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements. The auditor's decisions and actions, such as the nature, timing, and extent of audit procedures, directly affect the level of detection risk. The other risks are either inherent to the business or are part of the client's internal control system, and are therefore outside the auditor's direct control.
Problem Statement: Which of the following is the MOST critical step when planning an IS audit?
a) Review findings from prior audits
b) Executive management's approval of the audit plan
c) Review information security policies and procedures
d) Perform a risk assessment
e) None of the above
Solution:
The correct answer is (d) Perform a risk assessment. A risk assessment is the most critical step in planning an IS audit. It helps the auditor to identify the most significant risks to the information systems and to focus the audit procedures on those risks. The other options are also important, but they are part of the risk assessment and planning process.
Problem Statement: Which of the following sampling methods is MOST useful when testing for compliance?
a) Attribute sampling
b) Variable sampling
c) Stratified mean-per-unit sampling
d) Difference estimation sampling
e) Unstratified mean per unit
Solution:
The correct answer is (a) Attribute sampling. Attribute sampling is a statistical sampling method used to test for compliance with internal controls. It is used to estimate the rate of occurrence of an attribute, such as the number of invoices that were not approved before payment. The other options are variable sampling methods that are used to estimate a monetary amount or a monetary misstatement, which are more appropriate for substantive testing.
Problem Statement: Which of the following would normally be the MOST reliable evidence for an auditor?
a) A confirmation letter received from a third party verifying an account balance
b) Assurance from management
c) Trend data obtained from Internet sources
d) Ratio analysis developed by the auditor from reports supplied by line management
e) An internally generated computer accounting report
Solution:
The correct answer is (a) A confirmation letter received from a third party verifying an account balance. Evidence is more reliable when it is obtained from an independent source outside the entity. A confirmation letter from a third party, such as a bank or a customer, is considered highly reliable as it is obtained directly from an external source. The other options are either internally generated or are less reliable as they are subject to management's influence or are from a less reliable source.
Problem Statement: When selecting audit procedures, an auditor should use professional judgment to ensure that:
a) Sufficient evidence will be collected
b) Significant deficiencies will be corrected within a reasonable period
c) All material weaknesses will be identified
d) Audit costs will be kept at a minimum level
e) Sufficient audit staff has been engaged
Solution:
The correct answer is (a) Sufficient evidence will be collected. The auditor's professional judgment is used to design and perform audit procedures to obtain sufficient and appropriate audit evidence. The objective is to obtain reasonable assurance that the financial statements are free from material misstatement. While the other options are desirable, they are not the primary objective of using professional judgment in selecting audit procedures.
Problem Statement: The final decision to include a material finding in an audit report should be made by the:
a) audit committee
b) Management
c) Engagement Partner
d) Review Partner
e) Board of Director
Solution:
The correct answer is (c) Engagement Partner. The engagement partner is ultimately responsible for the audit engagement and for the audit report. The engagement partner makes the final decision on the content of the audit report, including whether to include a material finding. The other options are also involved in the audit process, but the final decision rests with the engagement partner.
Problem Statement: After initial review, an auditor has reasons to believe that fraud may be present. The auditor should:
a) Expand activities to determine whether an investigation is warranted
b) Report the matter to the audit committee
c) Report the possibility of fraud to management
d) Consult with external legal counsel to determine the course of action to be taken
e) Report the matter in the management letter
Solution:
The correct answer is (a) Expand activities to determine whether an investigation is warranted. As per BSA 240, "The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements," when an auditor has reasons to believe that fraud may be present, they should expand their procedures to determine whether an investigation is warranted. This is a crucial step in the auditor's responsibility to consider fraud in an audit.
Problem Statement: An auditor uses computer-assisted audit techniques (CAATs) to collect and analyze data. Which of the following attributes of evidence is MOST affected by using CAATs?
a) Usefulness
b) Reliability
c) Relevance
d) Adequacy
e) Readiness
Solution:
The correct answer is (b) Reliability. CAATs can be used to test a larger population of data, which can increase the reliability of the audit evidence. For example, the auditor can use CAATs to test all sales transactions in a year, rather than just a sample, which can provide a higher level of assurance about the accuracy and completeness of the sales transactions. The other attributes are also affected, but reliability is the most affected.
Problem Statement: An auditee disagrees with an audit finding. Which of the following is the BEST course of action for the auditor to take?
a) Discuss the finding with the auditor’s manager
b) Retest the control to confirm the finding
c) Elevate the risk associated with the control
d) Discuss the finding with the auditee's manager
e) Remove the findings from the report
Solution:
The correct answer is (d) Discuss the finding with the auditee's manager. When an auditee disagrees with an audit finding, the auditor should discuss the finding with the auditee's manager to gain a better understanding of the issue and to resolve the disagreement. If the disagreement cannot be resolved, the auditor should document the disagreement and the reasons for it in the audit working papers. The auditor should not remove the finding from the report, as that would be a violation of professional ethics.
Question 2: Modified True/False
Problem Statement: Process Work ensures the effectiveness of controls related to interest calculation for an accounting system.
Solution:
False. **Process work** is an internal control activity that ensures the effectiveness of controls related to interest calculation for an accounting system. The statement as written is confusing, so the correct statement is that a process work is an internal control activity.
Problem Statement: Board of Directors appoint the statutory auditor in Board Meeting.
Solution:
False. The **shareholders** appoint the statutory auditor in a **General Meeting**. The board of directors may appoint the first auditor or fill a casual vacancy, but the shareholders have the ultimate authority to appoint and remove the auditor.
Problem Statement: Audit Charter govern the authority and responsibilities of internal audit function.
Solution:
True. The statement is correct. An audit charter is a formal document that defines the internal audit activity's purpose, authority, and responsibility. It establishes the internal audit activity's position within the organization and authorizes access to records, personnel, and physical properties relevant to the performance of engagements.
Problem Statement: Auditor are responsible for identifying fraud in Financial Statements.
Solution:
False. The auditor's primary responsibility is to obtain reasonable assurance that the financial statements as a whole are free from material misstatement, whether caused by fraud or error. The responsibility for identifying fraud rests with management and those charged with governance. While the auditor has a responsibility to consider fraud in an audit, it is not their primary responsibility to identify fraud.
Problem Statement: Working papers support auditor’s opinion regarding underlying financial Statements.
Solution:
True. The statement is correct. Working papers are the records kept by the auditor of the procedures performed, the evidence obtained, and the conclusions reached. They provide the principal support for the auditor's opinion on the financial statements and are a key part of the audit process.
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. Follow the example given below in proving your answer.
| Column A | Column B |
|---|---|
| 1. stewardship | (a) means that a company’s directors safeguard the company’s assets and manage them on behalf of shareholders |
| 2. Familiarity threat | (b) means the auditor is too personally close to or familiar with employees, officers, or directors of the client company |
| 3. Audit documentation | (c) Means to collect required sufficient and appropriate audit evidence (as per BSA 230) |
| 4. Error | (d) an unintentional misstatement in financial statements, including the omission of an amount or a disclosure |
| 5. Directors’ responsibility | (e) disclosing with reasonable accuracy at any time the financial position of the company |
| (f) examine individual transactions so that the auditor may certify as to their validity | |
| (g) determine whether the client’s financial reports are fairly stated |
Solution:
The correct matches are as follows:
- 1. stewardship -> (a) means that a company’s directors safeguard the company’s assets and manage them on behalf of shareholders.
- 2. Familiarity threat -> (b) means the auditor is too personally close to or familiar with employees, officers, or directors of the client company.
- 3. Audit documentation -> (c) Means to collect required sufficient and appropriate audit evidence (as per BSA 230).
- 4. Error -> (d) an unintentional misstatement in financial statements, including the omission of an amount or a disclosure.
- 5. Directors’ responsibility -> (e) disclosing with reasonable accuracy at any time the financial position of the company.
Question 4: Internal Audit and Planning
Problem Statement: Outline the factors that need to be taken into account by an external auditor when evaluating an internal audit function and its work.
Solution:
An external auditor should evaluate the following factors when assessing an internal audit function:
- **Objectivity and independence:** The internal audit function should be independent of the activities it audits. The external auditor should assess the reporting lines of the internal audit function and whether it is free from management's influence.
- **Technical competence:** The internal audit staff should have the necessary skills and qualifications to perform their work. The external auditor should assess the qualifications and experience of the internal audit staff.
- **Due professional care:** The internal audit function should perform its work with due professional care. The external auditor should review the internal audit working papers and reports to assess the quality of their work.
- **Communication:** There should be a good working relationship between the internal and external auditors. The external auditor should communicate with the internal auditor and discuss the audit plan and findings.
Problem Statement: Identify, with reasons, from the situation outlined above, circumstances that should be taken into account when planning the external audit of Holly.
Solution:
The following circumstances should be taken into account when planning the external audit of Holly:
- **Internal audit function:** The internal audit department is new and staffed with long-serving finance staff. This creates a risk that the internal audit function may not be independent and objective. The external auditor should not rely on the work of the internal audit function until a thorough evaluation is performed.
- **Local sourcing of goods and services:** The shop managers are responsible for sourcing goods and services locally and for taking on casual staff. This creates a risk that there is a lack of control over these expenses and that they may be misstated. The external auditor should perform more extensive substantive procedures on these expenses.
- **Shop manager bonus incentives:** The shop managers have bonus incentives linked to the annual profit of their shop. This creates a risk that the shop managers may manipulate the financial statements to increase their bonuses. The external auditor should perform more extensive substantive procedures on the revenue and expenses of the shops.
- **High street coffee shops:** The company operates a chain of 50 high street coffee shops in Dhaka and 20 in the rest of Bangladesh. This creates a risk that the company's financial statements may be misstated due to the geographic spread of the company's operations. The external auditor should consider the need for a physical verification of the assets of the shops.
Question 5: Contingent Liability & Public Interest Entity
Problem Statement: Define contingent liability and describe necessary disclosure requirements underlying contingent liability.
Solution:
A **contingent liability** is a potential obligation of a company that may or may not arise in the future, depending on the outcome of a future event. It is a liability that is not yet a definite obligation but may become one in the future.
The disclosure requirements for a contingent liability are governed by IAS 37, "Provisions, Contingent Liabilities and Contingent Assets." A company should disclose a contingent liability unless the possibility of an outflow of resources embodying economic benefits is remote.
The disclosure should include a brief description of the nature of the contingent liability, an estimate of its financial effect, an indication of the uncertainties relating to the amount or timing of any outflow, and the possibility of any reimbursement.
Problem Statement: Write down the determinants of PIE as per latest FRC notifications.
Solution:
As per the latest FRC notifications, the determinants of a Public Interest Entity (PIE) are companies or entities that:
- **Are listed:** Companies that have their securities listed on a stock exchange.
- **Are regulated:** Entities such as banks, financial institutions, and insurance companies that are subject to the supervision of a regulatory body.
- **Have a large number of shareholders or stakeholders:** Companies with a large number of shareholders or stakeholders are also considered PIEs.
- **Have a significant impact on the economy:** Entities that have a significant impact on the economy, such as state-owned enterprises, are also considered PIEs.
Problem Statement: Prepare notes for a planning meeting with the audit engagement partner which: (i) Identify, from the circumstances particular to Extensions Ltd. as described above that should be taken into consideration when planning the audit with necessary explanation. (ii) Describe the extent to which the work performed by the internal auditor may affect your planning, and the factors that could limit the use you may wish to make of his work.
Solution:
(i) Planning Considerations for Extensions Ltd.
- **Business and industry:** The company's business has expanded from mobile set sales to a wide range of mobile accessories, food, drinks, and household products. This creates a risk that the company's financial statements may be misstated due to the complex nature of the business.
- **Internal controls:** The company has a centralized point-of-sale system, which is a key control. However, there is a risk that the system may not be operating effectively.
- **Inventory:** The company has a wide range of inventory, which could create a risk of misstatement. The auditor should consider the need for a physical verification of the inventory.
- **Internal audit:** The company has an internal auditor who is responsible for monitoring and testing the internal controls. This could allow the external auditor to rely on the work of the internal auditor.
(ii) Use of Internal Auditor's Work
The work of the internal auditor may affect our planning in the following ways:
- **Reliance on work:** We may be able to rely on the work of the internal auditor in our audit, which could reduce the amount of substantive testing we need to perform.
- **Coordination:** We should coordinate our work with the internal auditor to avoid duplication of effort.
The factors that could limit the use we may wish to make of his work are:
- **Objectivity and independence:** The internal auditor's objectivity and independence may be compromised if he is not independent of the activities he audits.
- **Technical competence:** The internal auditor's technical competence may be a concern if he does not have the necessary skills and qualifications.
- **Due professional care:** The internal auditor's work may not be performed with due professional care, which could limit our reliance on his work.
Question 6: Audit Tendering, Threats, and Planning
Problem Statement: Discuss the appropriateness of the suggestion by Shelly Combe to propose a low fee for the external audit.
Solution:
The suggestion by Shelly Combe to propose a low fee for the external audit is inappropriate. Offering a low fee to win the audit engagement and then expecting to recover the lost revenue from non-audit services creates a **self-interest threat** to the firm's independence. This could compromise the firm's objectivity and professional skepticism. The fee for the audit should be based on the time and effort required to perform the audit, not on the prospect of winning other non-audit services. The auditor should not allow the prospect of winning non-audit services to influence their professional judgment.
Problem Statement: Identify, with reasons, the matters to be considered and procedures to be performed by your firm when considering whether to tender for the external audit engagement of Duckling for the year ending 30 September 2012.
Solution:
The following matters should be considered when deciding whether to tender for the audit engagement of Duckling:
- **Integrity of management:** The firm should assess the integrity of management by making inquiries of the previous auditors and third parties.
- **Technical competence:** The firm should assess whether it has the necessary skills and resources to perform the audit. The accounting records are maintained by Vladimir's son who has no other accounting experience, which could create a risk of material misstatement.
- **Related party transactions:** Snuggly Ltd is a major supplier of fabrics to Duckling and Vladimir is the majority shareholder of Snuggly. This creates a risk of material misstatement due to related party transactions. The auditor should perform extensive substantive procedures on these transactions.
- **New client:** This is a new client, and the auditor will need to perform a thorough risk assessment. The auditor should also consider the need for a physical verification of the assets of the company.
Problem Statement: Identify, with reasons, the matters specific to the examination of and report on Duckling’s profit and cash flow forecasts, that your firm should include in the letter of engagement where it invited to perform this service.
Solution:
The following matters should be included in the letter of engagement for the examination of and report on Duckling’s profit and cash flow forecasts:
- **Scope of engagement:** The letter should clearly state the scope of the engagement, which is to examine and report on the profit and cash flow forecasts for the three years ending 30 September 2015.
- **Management's responsibility:** The letter should state that management is responsible for the preparation and fair presentation of the forecasts.
- **Auditor's responsibility:** The letter should state that the auditor's responsibility is to express an opinion on whether the forecasts are prepared in accordance with the applicable financial reporting framework.
- **Limitation of engagement:** The letter should state that the engagement is not an audit and that the auditor's opinion is not a guarantee of the future results of the company.
Problem Statement: Assuming that your firm has been appointed as external auditor, identify and explain the potential threats to your firm’s objectivity and independence that may arise if it also provides the tax planning and compliance services.
Solution:
The following threats to the firm’s objectivity and independence may arise if it also provides tax planning and compliance services:
- **Self-review threat:** The firm would be auditing its own work, which could compromise its objectivity. The firm would be unable to provide an independent opinion on the tax provision and deferred tax liability in the financial statements.
- **Advocacy threat:** The firm would be advocating for the client in its tax planning, which could compromise its objectivity. The firm would be unable to provide an independent opinion on the tax provision and deferred tax liability in the financial statements.
- **Management threat:** The firm would be involved in the management of the client, which could compromise its independence. The firm would be unable to provide an independent opinion on the financial statements.
- **Familiarity threat:** The firm would be too familiar with the client, which could compromise its independence. The firm would be unable to provide an independent opinion on the financial statements.
Question 7: Auditor's Report & Misstatements
Problem Statement: Comment on the issues raised in the extract from the draft auditor’s report for the year ended 31 March 2022. (Note: You are NOT required to re-draft the extracts from the auditor’s report.)
Solution:
The draft auditor’s report has several issues:
- **Basis for opinion:** The auditor should not mention "International Standards on Auditing (ISAs)" as the basis for their opinion. They should mention "Bangladesh Standards on Auditing (BSAs)" as the applicable standards in Bangladesh.
- **Opinion:** The auditor should not give a positive assurance that the financial statements present a "true and fair view." They should give a reasonable assurance that the financial statements are "free from material misstatements."
- **Going concern:** The auditor has identified a material uncertainty regarding going concern, but the financial statements do not make any reference to it. This is a material misstatement due to non-disclosure. The auditor should issue a **qualified** or **adverse opinion** depending on the pervasiveness of the misstatement. The auditor should also include a "Basis for Opinion" section to explain the reason for the modified opinion.
- **Other information:** The auditor should not disclose the issue as "Other Information." The issue is a material misstatement in the financial statements and should be addressed in the "Basis for Opinion" section. The auditor's opinion on the financial statements is a statement of whether they are free from material misstatements, and not a statement of whether they are true and fair.
Problem Statement: Write up only necessary paragraphs as extracts to the complete audit report where signs/indications of qualifications remain visible (you may keep other paragraph titles blank).
Solution:
Basis for Qualified Opinion
The company has not made a provision for the entire amount of doubtful receivables, which is a material misstatement. As per IAS 37, "Provisions, Contingent Liabilities, and Contingent Assets," a company should make a provision for a liability when it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. The directors' refusal to make the provision is a violation of IAS 37.
Qualified Opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion section of our report, the financial statements present fairly, in all material respects, the financial position of Ambuja Cement Ltd as at 31 December 2019, and of its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards.