IIT ADACC Chapter 8 Assessment Booklet: Finance and Auditing

This document presents the solutions to the ADACC Chapter 8 assessment, focusing on audit and reporting on financial systems and records. The assessment includes short answer questions addressing various aspects of auditing, such as the application of different international standards (ISAs, ISREs, ISAEs, ISRSs) to specific engagements, limitations of providing absolute assurance, identification of inherent and control risks within a company, and the assessment of audit risk related to customer groups. The solutions also delve into the analysis of financial ratios, the importance and practical application of materiality, the use of generalized audit software, and the rationale behind using non-statistical sampling. The document aims to provide comprehensive answers to the assessment questions, demonstrating an understanding of key auditing concepts and principles.

Advanced Diploma
of Accounting
Student
Assessment Booklet
Name:
Date:
Manual Version Number:
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ADACC – Chapter 8
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Short Answer Question 1:
Which types of international standard (ISAs, ISREs, ISAEs or ISRSs) apply to the
following type of engagement?
a) An audit of a client’s internal controls
b) Providing an opinion on whether historical financial statements have
been prepared in accordance with an identified financial reporting
framework
c) Providing an opinion on whether the corporate governance
arrangements in a company comply with a specific corporate
governance code
d) Preparing a tax return for a client.
a) For engagement of an auditor for an audit of a client’s internal
controls, the International Standards on Auditing (ISAs) are
applicable.
b) International Standards on Review Engagement (ISREs) is
applicable for engagement of an auditor for providing an
opinion on whether historical financial statements have been
prepared in accordance with an identified financial reporting
framework.
c) International Service Organisation Assurance Standards (ISAEs)
is applicable for engagement of an auditor providing an opinion
on whether historical financial statements have been prepared
in accordance with an identified financial reporting framework.
d) International Standards on Related Services (ISRSs) is
applicable for engagement for preparing a tax return for a
client.
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Short Answer Question 2:
Why is it not possible to provide absolute assurance with an assurance
engagement such as an annual audit?
Auditors are engaged for examining the correctness and trueness of the
information provided in the financial statement of an organisation and
making an opinion about the true and fair view of the financial
statement of the organisation. It means, the auditor provides and
assurance about the compliance of various standards in accounting and
reporting financial information of the organisation. Auditors are engaged
for a specified period of time and it is impossible to check all the
financial transactions from its initiation to the completion. Therefore,
they have to check the accounting and reporting of financial information
on a sample basis. An auditor cannot provide an absolute assurance as
the applications of testing and sampling makes the ability of the auditor
to detect material misstatement. Some other factors such as limitation
of the internal control systems, persuasive audit evidences and the
validity of the audit evidence also responsible for making the ability of
the auditor to restrict in providing an absolute assurance.
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Short Answer Question 3:
Identify the levels of inherent and control risk in the following company. On the
basis of the limited information available, state for each type of risk whether you
think it is high, medium or low.
Building Blocks Company is a construction company. The company builds
residential buildings in a number of towns and cities. The manager of the
business has worked his way up the company and believes that he really
understands how to make profits in this industry. He employs cheap labour by
using his knowledge of where casual labour meet and look for work. He also
utilises his knowledge and is able to take short-cuts from what he calls overly-
prudent health and safety bureaucratic regulations. He has been successful and
the company is generally profit-making but has had problems recently with a
group of workers who he had to dismiss due to theft of expensive building
materials.
In the given case study, the company is a construction company which
builds up buildings in various cities and towns. The managers of the
company is having a fair knowledge and experience in managing such
type of a business. With such an experience he manages to hire cheap
labours and to make profit there from.
Construction businesses are labour intensive in nature, without labours
the construction of buildings is not possible. Hence, they have to hire an
employ massive number of labours. It is difficult for a manager to
understand the mental perception and characteristics of all the labours.
Hence, theft of materials by the labours is an inherent risk for the
business.
On the other hand, it is the duty of the supervisors and managers to
ensure efficient management of the labours to increase the productivity
of labours and to detect mismanagement and theft of materials by the
labours. Hence, it is the internal control risk to ensure efficient
management and utilisation of labour force and detection of theft of
materials by the labours.
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Short Answer Question 4:
The auditor is aware from knowledge of the industry that a major customer of an
audit client is in financial difficulty and may be unable to pay a significant
amount that it owes to the client. Explain how the auditor should make an
assessment of this risk.
Customer groups of an organisation also subject to audit risk and it must
be assessed properly. Risk associated with the customer group of the
organisation includes, the default risk of non-payment of dues in time.
To assess such risk, an auditor first need to ensure that the transactions
with the customers as recorded in the financial books of accounts are
true and correct. It must be checked and evaluated that the amount of
accounts receivables reported in the financial statement is correct. In
doing so, the auditor can select a sample of customer group and check
transactions completely to make a conclusion about the true and
correctness of the reported figures. As in such type of an industry, it is
common that the customer fails to pay dues, the percentage or the
industry average should be used for making a conclusion on the
reported amount of uncollectible debts for the company.
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Short Answer Question 5:
An auditor finds from analytical procedures that there has been an increase in
the average inventory turnover period from 50 days in the previous year to
nearly 70 days in the current year. There has also been a reduction in the ratio of
total payroll costs to the number of employees.
What might these changes in ratios indicate?
Inventory turnover ratio indicates the inventory conversion cycle from
cash to inventory and again to cash. In another words it can be said
that, inventory turnover expresses the degree of inventory holding as a
proportion to the turnover of the company. High inventory turnover in
days means the company is holding higher amount of inventory and the
inventory conversion cycle is high. Therefore, changing inventory
turnover from 50 days to 70 days the company is holding more
inventory and the conversion cycle has been increased. It implies the
company is having more capital blockage in the inventory.
Reduction in total payroll cost to the number of employees, either
means increase in number of employees or a decrease in the total
payroll costs. Hence, in the given case study, the decrease in total
payroll cost to number of employees ration indicates that the company
has become efficient in utilisation of the labour forces of the company.
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Short Answer Question 6:
Explain why materiality is important but difficult to apply in practice.
Materiality for financial statements can be described as the presentation
of actual facts and figures or the actual financial results and financial
performance of the company. Therefore, to ensure that the financial
statements are free from material misstatements the materiality is
important. Different users uses and interprets the financial statements
in different ways and sense, also the needs for financial information of
different stakeholders are varying, that is why it is difficult to apply
materiality in practice.
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Short Answer Question 7:
How can generalised audit software be used to assist in performing substantive
procedures during an audit?
Generalised audit software helps and auditor to find audit risks involved
in various areas of financial accounting and reporting. Substantive
procedures is a process of ensuring the true and correctness of a fact or
figure reported in the financial statement. The substantive procedure
includes, checking of evaluation inspection, completeness, existence
and its disclosure in the financial statement. Therefore, automated
generalised audit software can help an auditor to check the existence,
completeness, its evaluation and disclosure in the financial statement as
and when a significant risk is suspected with a financial transaction.
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Short Answer Question 8:
Given that non-statistical sampling is less rigorous than statistical sampling, why
would an auditor use non-statistical sampling?
In auditing and checking the trueness and correctness of the financial
information reported in the financial statement, transactions are
selected on a sample basis and checked to make a conclusion about the
whole financial transactions. An unbiased sampling may help in better
understanding the population of the data. Hence, in selecting
transactions for auditing, non-statistical sampling methods are used. It
also help in focusing more on the more suspected areas of financial
accounting.
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Short Answer Question 9:
a) ASA 300.10 discusses how auditors might plan the timing and direction of
audit resources such as team members. Why is it important to make such
plans?
b) What responsibilities do auditors have in relation to detecting events after
the audit report has been signed?
a) For execution of the audit work successfully, the audit plan is
important. Plan of allocation of resources and engagement of
team members in various works as per their expertise is also
important for successful completion of an audit.
b) It is the responsibility to ensure that the no part of the report
which has been signed by the auditor is edited and
misrepresented in the annual report of the company.
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Short Answer Question 10:
Recent corporate collapses have brought a heightened focus on the ability of
auditors to detect earnings management practices. What is earnings
management? Provide examples.
Earnings management is the process of showing positive views on the
revenue generation of the company. Hence, earnings management
practices are intended for attracting investors, but in reality, the
company might not have that much efficient financial position as shown
by the earnings management practice. Hence, it may mislead the
investor and decision makers and may lead to corporate collapse.
Example of an earnings management is showing high profitability and
profit growth of the company.
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Short Answer Question 11:
List 3 taxable transactions according to financial legislation.
a) Sale of taxable goods or provision of taxable services for a
consideration.
b) Payment of salaries and wages.
c) Interest paid or received for finances in connection to the
business.
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Case Study Information
Client: Swann Ltd.
You are the partner responsible for per forming a quality control review on the
audit of Swann Ltd. Y ou are currently reviewing the audit working papers and
draft audit report on the financial statements of Swann Ltd for the year ended
30, June 2014. The draft financial statements recognise revenue of $8·5
million, profit before tax of $1million, and total assets of $175 million.
During the year Swann Ltd.’s factory was extended by the self-construction of a
new processing area, at a total cost of $5 million. Included in the costs
capitalised are borrowing costs of $100,000, incurred during the six-month
period of construction. A loan of $4 million carrying an interest rate of 5%
was taken out in respect of the construction on 1, September 2013, when
construction started. The new processing area was ready for use on 1, April
2013, and began to be used on 1, June 2014. Its estimated useful life is 15
years.
Client: Coot Ltd.
You are also responsible for the audit of Coot Ltd, and you are currently
reviewing the working papers of the audit for the year ended 30 June 2014. In
the working papers dealing with payroll, the audit junior has commented
as follows: ‘Several new employees have been added to the company ’s payroll
during the year, with combined payments of $125,000 being made to them.
There does not appear to be any authorisation for these additions. When I
questioned the payroll supervisor who made the amendments, she said
that no authorisation was needed because the new employees are only
working for the company on a temporary basis. However, when discussing
staffing levels with management, it was stated that no new employees have
been taken on this year. Other than the tests of controls planned, no other
audit work has been per formed.’
Client: Kobain Ltd.
You are also responsible for the audit of Kobain Ltd, a new audit client of your
firm, with a financial year ended 30 June 2014. Kobain Ltd’s draft financial
statements recognise total assets of $55 million, and profit before tax of $15
million. The audit is nearing completion and you are reviewing the audit files.
Kobain Ltd designs and creates high-value items of jewellery. Approximately half
of the jewellery is sold in K obain Ltd’s own retail outlets. The other half is sold
by external vendors under a consignment stock arrangement, the terms of
which specify that Kobain Ltd. retains the ability to change the selling price of
the jewellery, and that the vendor is required to return any unsold jewellery
after a period of nine months. When the vendor sells an item of jewellery to a
customer, legal title passes from Kobain Ltd. to the customer.
On delivery of the jewellery to the external vendors, Kobain Ltd recognises
revenue and derecognises inventory. At 30 June 2014, jewellery at cost price
of $3 million is held at external vendors. Revenue of $4 million has been
recognised in respect of this jewellery.
Case Study Question 1:
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Swann Ltd - Comment on the audit matters that should be considered in respect
of your file review of non-current assets
In the engagement of the auditor of the Swann Ltd, the auditor is
responsible for a quality control related matters. Hence, the auditor is
required to focus more on the quality control related issue and not on
the issues related with the non-current assets and its capitalisation.
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Case Study Question 2:
Swann Ltd - List the evidence you would expect to find regarding the new
processing area.
As the auditor is engaged for the review of quality control aspect of the
new processing area, the auditor will collect the certifications from the
engineers and respective authorities certifying the completeness and
fitness of the new area and its security and safety measures.
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Case Study Question 3:
Coot Ltd - In relation to the audit of Coot Ltd.’s payroll: Explain the meaning of
the term ‘professional scepticism’
Professional scepticism means that the auditor will always have a doubt
about the trueness or correctness of an event as disclosed in the
financial records and financial statements. Therefore, in the audit
process of the Coot Ltd, the auditor should have a view initially that the
approval of adding new employees is unauthorised and payments made
to them is also unauthorised. Based on that doubt the auditor will collect
evidences to nullify such doubts and to achieve at a conclusion about its
trueness and correctness.
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Case Study Question 4:
Coot Ltd - In relation to the audit of Coot Ltd.’s payroll: Recommend any further
actions that should be taken by the auditor in order of importance.
In the audit of the Coot Ltd, it is the responsibility of the auditor to check
the attendance and payments of salaries and wages as per the
attendance. He also need to check and evaluate the amount paid to the
employees as salaries and wages as per the company rules and
respective labour laws. It is also an important duty of the auditor to
check whether the activities of the company related to the employees
are complying with the existing labour laws and any other Act prevailing
in the country in relation to the employees and labours.
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Case Study Question 5:
Kobain Ltd - Comment on the audit matters that should be considered in respect
of the consignment stock arrangement.
As in this stage the auditor is reviewing the overall audit papers and the
audit is nearing to the completion, the auditor should look into all such
matters which remained unaddressed as well as the matters already
highlighted. Hence, the auditor should consider checking the process of
revenue recognition for consignment sales as an audit matter in the
given casestudy.
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Case Study Question 6:
Kobain Ltd - Explain the audit evidence you should expect to find in your file
review in respect of the consignment stock arrangement.
In respect of the consignment stock as held with the customers, to
evaluate it and to check its correctness, goods despatch note or the
provisional invoices made at the time of dispatching such goods need to
be collected as an audit evidence. On the other hand to recognise stock
and profit on such sales, the cost related information or the purchase
invoices also needs to be collected as the audit evidence.
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