February 20, 2013

FINAL MOCK - SOLUTION

<<<3 HOURS & 15 MINUTES READING TIME>>>

Q1: Deficiencies in the Review Report The Report has not been addressed properly. Reference to the prior years audited financial statements in the first paragraph, is not required. A component of the financial statements i.e. Statement of Changes in Equity have not been identified in the first paragraph. Reference to the ISAs, in the first paragraph, is not required. The auditors review responsibilities should follow managements responsibilities in the first paragraph. There should be a statement in the second (scope) paragraph that the review was conducted in accordance with ISRE 2410. There should be a statement in the second (scope) paragraph that being a review engagement no audit opinion is being expressed on the financial statements. The words in accordance with approved Accounting Standard as applicable in Pakistan are missing from the conclusion paragraph. There should be a reference to material respect in the Conclusion paragraph. There should be no restriction on the distribution of the auditors review report as mentioned in the fourth paragraph. Over valuation of inventory should be reported as a qualification instead of emphasis of matter paragraph. Address of the Chartered Accountant needs to be given. The report should be dated.

Q2: a) The steps that I as an auditor would consider as part of the audit planning to ensure that all related party relationships and transactions are identified and disclosed in the financial statements are as follows: Obtaining an understanding of the controls, if any, that management has established to identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework. Inquiring of the management regarding: The identity of the entitys related parties, including changes from the prior period; The nature of relationships between the entity and these related parties; and Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the transactions. Inspecting the following documents for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed: Bank and legal confirmations Minutes of meetings of shareholders and of those charged with governance; and Any other records or documents as the auditor considers necessary (e.g. Register of members etc). Reviewing the extent and nature of business transacted with major customers, suppliers, borrowers and lenders for indications of previously undisclosed relationships. Reviewing the significant transactions outside the normal course of business, paying particular attention to the transaction recognized at or near end of the reporting period and inquire of management: The nature of these transactions Whether related parties are involved in these transactions Once related parties have been identified, the client should provide the details of transactions with such parties. I as auditor would ensure that these transactions are disclosed appropriately in the financial statements as per applicable financial reporting framework.

b) Fraud can be committed by management overriding controls using such techniques as: Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives. Inappropriately adjusting assumptions and changing judgments used to estimate account balances. Omitting, advancing or delaying recognition in F/S of events & transactions occurred during period. Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements. Engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity. Altering records and terms related to significant and unusual transactions.

Q3: a) Audit evidence is persuasive rather than conclusive because of the following reasons: The auditor gathers evidence on a test basis (the sample may or may not be representative). People make mistakes (both client and auditor). Documents could be forged (increasingly easy with digital technology) The clients personnel may not always tell the truth. b) If information to be used as audit evidence has been prepared using the work of a management's expert, auditor shall, to the extent necessary: (1) Evaluate the competence, capabilities and objectivity of that expert

Information regarding competence, capabilities and objectivity may come from a variety of sources, such as: Personal experience with previous work of that expert. Discussions with that expert. Discussions with others who are familiar with that expert's work. Knowledge of that expert's qualifications, membership of a professional body or industry association, license to practice, or other forms of external recognition. Published papers or books written by that expert. An auditor's expert (if any) used to assist the auditor in obtaining sufficient appropriate audit evidence with respect to information produced by the management's expert. (2) Obtain an understanding of the work of that expert; and

Aspects of the management's expert's field relevant to the auditor's understanding may include: Whether that expert's field has areas of specialty within it that are relevant to the audit. Whether any professional or other standards, and regulatory or legal requirements apply. What assumptions and methods are used by the management's expert, and whether they are generally accepted within that expert's field and appropriate for financial reporting purposes. The nature of internal and external data or information the management's expert uses. (3) Evaluate appropriateness of that expert's work as audit evidence for relevant assertion.

Considerations for such evaluation may include: The relevance and reasonableness of that expert's findings or conclusions, their consistency with other audit evidence, and whether they have been appropriately reflected in the financial statements; If that expert's work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods; and If that expert's work involves significant use of source data, the relevance, completeness, and accuracy of that source data.

Q4: a) Matters relevant to such evaluation include: Accuracy with which the expected results of substantive analytical procedures can be predicted. E.g. the auditor may expect greater consistency in comparing gross profit margins from one period to another than in comparing discretionary expenses, such as research or advertising Degree to which information can be disaggregated. E.g. substantive analytical procedures may be more effective when applied to financial information on individual sections of an operation or to financial statements of components of a diversified entity, than when applied to the financial statements of the entity as a whole Availability and reliability of the information (financial and non-financial). E.g. auditor may consider whether financial information (e.g. budgets or forecasts) and non-financial information (e.g. no of units produced or sold) is available to design substantive analytical procedures b) Reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Accordingly, the following are relevant when determining whether data is reliable for purposes of designing substantive analytical procedures: Source of the information available. E.g. information may be more reliable when it is obtained from independent sources outside the entity Comparability of information available. E.g. Broad industry data may need to be adjusted to become comparable to that of an entity that produces and sells specialized products. Nature and relevance of the information available. E.g. whether budgets are realistic (i.e. Prepared using expectations or are inflated to set high targets) Controls over the preparation of the information to ensure its completeness, accuracy and validity. E.g. controls over the preparation, review and maintenance of budgets.

Q5: a) IFAC undertakes following activities to serve public interest: Contributing to the development, adoption and implementation of high quality international standards and guidance. Contributing to the development of strong professional accountancy organizations and accounting firms, and to high quality practices by professional accountants Promoting the value of professional accountants worldwide Speaking out on public interest issues where the accountancy professions expertise is most relevant. b) Scope: An appraisal activity established or provided as a service to the entity. Its functions include, amongst other things, examining, evaluating and monitoring the adequacy and effectiveness of internal control.

Objectives Objectives of internal audit function are determined by management and where applicable those charged with Governance. Objectives of internal audit functions vary widely and depend on the size and structure of the entity and the requirements of entity. The activities of the internal audit function may include one or more of the following: Monitoring of internal control. Examination of financial and operating information. Review of operating activities. Review of compliance with laws and regulations. Risk management. Governance.

Q6: Deficiencies 1 The warehouse manager is planning to supervise the inventory count. Whilst he is familiar with the inventory, he has overall responsibility for the inventory and so is not independent. He may want to hide inefficiencies and any issues that arise so that his department is not criticised. There are ten teams of counters, each team having two members of staff. However, there is no clear division of responsibilities within the team. Therefore, both members of staff could count together rather than checking each others count; and errors in their count may not be identified. The internal audit teams are undertaking inventory counts rather than reviewing the controls and performing sample test counts. Their role should be focused on confirming the accuracy of the inventory counting procedures. Once areas are counted, the teams are not flagging the aisles as completed. Therefore there is the risk that some areas of the warehouse could be double counted or missed out. Inventory not listed on the sheets is to be entered onto separate sheets, which are not sequentially numbered. Therefore the supervisor will be unable to ensure the completeness of all inventory sheets. Recommendations An alternative supervisor who is not normally involved with the inventory, such as an internal audit manager, should supervise the inventory count. The warehouse manager and his team should not be involved in the count at all Each team should be informed that both members are required to count their assigned inventory separately. Therefore, one counts and the second member checks that the inventory has been counted correctly.

The internal audit counters should sample check the counting undertaken by the ten teams to provide an extra control over the completeness and accuracy of the count. All aisles should be flagged as completed, once the inventory has been counted. In addition, internal audit or the count supervisor should check at the end of the count that all 20 aisles have been flagged as completed. Each team should be given a blank sheet for entering any inventory count which is not on their sheets. This blank sheet should be sequentially numbered, any unused sheets should be returned at the end of the count, and the supervisor should check the sequence of all sheets at the end of the count. All inventory sheets should be signed by the relevant team upon completion of an aisle. When the sheets are returned, the supervisor should check that they have been signed.

The sheets are completed in ink and are sequentially numbered, however, there is no indication that they are signed by the counting team. Therefore if any issues arise with the counting in an aisle, it will be difficult to follow up as the identity of the counting team will not be known.

Some more points (only for guidance of students Questions requirement is only 6) Damaged goods are not being stored in a central area, and instead the counter is just noting on the inventory sheets the level of damage. However, it will be difficult for the finance team to decide on an appropriate level of write down if they are not able to see the damaged goods. In addition, if these goods are left in the aisles, they could be inadvertently sold to customers or moved to another aisle. Damaged goods should be clearly flagged by the counting teams and at the end of the count appropriate machinery should be used to move all damaged windows to a central location. This will avoid the risk of selling these goods. A senior member of the finance team should then inspect these goods to assess the level of any write down or allowance. It is not practical to stop all inventory movements as the production needs to continue. However, any raw materials required for 31 December should be estimated and put to one side. These will not be included as raw materials and instead will be work-inprogress. The goods which are manufactured on 31 December should be stored to one side, and at the end of the count should be counted once and included within finished goods. Any goods received from suppliers should be stored in one location and counted once at the end and included as part of raw materials. Goods to be despatched to customers should be kept to a minimum for the day of the count. A specialist should be utilised to assess both work-inprogress and the quantities of raw materials.

Wrestling Window Glass Co (Wrestling) undertakes continuous production and so there will be movements of goods during the count. Inventory records could be under/overstated if goods are missed or double counted due to movements in the warehouse.

The warehouse manager is to assess the level of work-in-progress and raw materials. In the past, a specialist has undertaken this role. It is unlikely that the warehouse manager has the experience to assess the level of work-in-progress as this is something that the factory manager would be more familiar with. In addition, whilst the warehouse manager is familiar with the raw materials, if he makes a mistake in assessing the quantities then inventory could be materially misstated.

With regards to the warehouse manager, he could estimate the raw materials and the specialist could check it. This would give an indication as to whether he is able to accurately assess the quantities for subsequent inventory counts.

Q7: Part (a) Financial Statements requires amendment or not Receivables Provides evidence of conditions at the year end Receivable to be adjusted via write down or provision Lawsuit Provides evidence of present obligation at the year end Provision required and not contingent liability disclosures Part (b) Audit Procedures Part (c) Impact on audit report if issue remain unresolved

Review correspondence with customer Discuss with management Review post year-end period for cash receipts

Amount is immaterial so, No Modification

Discuss with company lawyer Review correspondence with supplier Discuss with management and obtain written representation

Qualified Opinion

Warehouse Provides evidence of conditions that arose subsequent to the year end No adjustment required, possible disclosure of any uninsured sums

Discuss with management whether sufficient levels of inventory to continue operating Obtain written representation that going concern status appropriate Obtain schedule of damaged inventory and review reasonableness Review correspondence with insurance firm to assess levels of uninsured goods

If the inventory at Bass is material, then Qualified Opinion and if it is Pervasive, then Adverse Opinion due to non disclosure

Q8: a) An auditor's internal expert is subject to the quality control policies and procedures of that firm (as per ISQC 1 or similar national requirements. Auditor's internal expert may be from a network firm which may share common quality control policies and procedures with the auditor's firm. Engagement teams are entitled to rely on the firm's system of quality control, unless information provided by the firm or other parties suggests otherwise. Extent of that reliance will vary with the circumstances, and may affect the nature, timing and extent of the auditor's procedures with respect to such matters as: Competence and capabilities Through recruitment and training programs. Objectivity. Auditor's internal experts are subject to relevant ethical requirements, including independence. Evaluation of the adequacy of the expert's work E.g. firm's training programs may provide internal experts with an appropriate understanding of relationship of their expertise with audit process. Reliance on such training and other firm processes may affect nature, timing and extent of the auditor's procedures to evaluate the adequacy of expert's work. Adherence to regulatory and legal requirements, through monitoring processes. Agreement with the expert. Such reliance does not reduce the auditor's responsibility to meet the requirements of this ISA. b) Acceptance and continuance of Client Relationship The engagement partner shall be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed, and shall determine that conclusions reached in this regard are appropriate. Following information assists engagement partner in determining whether the conclusions reached regarding the acceptance and continuance of client relationships and audit engagements are appropriate: The integrity of principal owners, key management and those charged with governance of the entity; Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and resources; Whether the firm and the engagement team can comply with relevant ethical requirements; and Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship. If the engagement partner obtains information that, if available earlier, would have caused the firm to decline the audit engagement, the engagement partner shall communicate that information promptly to the firm, so that the firm and the engagement partner can take the necessary action.

Engagement Quality Control Review For audits of listed entities and other selected audit engagements, engagement partner shall: a) Determine that an engagement quality control reviewer has been appointed; b) Discuss significant matters arising during the audit engagement, including those identified during the engagement quality control review, with the engagement quality control reviewer; and c) Not date the auditor's report until the completion of the engagement quality control review.

Q9: a) A complex group structure, especially where there are frequent acquisitions, disposals or reorganizations. Poor corporate governance structures, including decision-making processes, that are not transparent. Components operating in foreign jurisdictions may be exposed to factors such as unusual government intervention in trade and fiscal policy, and restrictions on currency and dividend movements; and fluctuations in exchange rates. Unusual related party relationships and transactions. Prior occurrences of intra-group account balances that did not balance or reconcile on consolidation. The existence of complex transactions that are accounted for in more than one component. Components' application of accounting policies that differ from those applied to the group financial statements. Components with different financial year-ends, which may be utilized to manipulate the timing of transactions. Prior occurrences of unauthorized or incomplete consolidation adjustments. Aggressive tax planning within the group, or large cash transactions with entities in tax havens. Frequent changes of auditors engaged to audit the financial statements of components. b) Large, unusual or non-recurring transactions. Circumstances where errors are difficult to define, anticipate or predict. In changing circumstances that require a control response outside the scope of an existing control. In monitoring the effectiveness of automated controls. c) The objective of an audit is to express an opinion on the financial statements, whether the financial statement give a true and fair view, and are presented fairly, in all material aspects, in accordance with the applicable financial reporting framework. d) In the context of audit opinion, reasonable assurance is a high, but not an absolute level of assurance. The auditor, in order to give audit opinion, has to obtain sufficient and appropriate audit evidence so as to conclusions on which to base his audit opinion. It also implies that the Audit risk will be reduced to an acceptably low level, but not to zero.

Best of Luck