Professional Stage Audit & Assurance June 2011

EXAMINERS MARK PLAN COMMENTARY

The marking plans set out below were those used to mark these questions. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication. More
marks were available than could be awarded for each requirement. The available marks for each part of the
question are shown after the commentary to each question. This allowed credit to be given for a variety of valid
points which were made by candidates
General comments
It was pleasing to note that the improvement in time management identified in recent sessions was
sustained. There were notably fewer unfinished last answers and answers to the short-form questions
(SFQs) appeared less rushed. However, a significant number of candidates are still failing to take
advantage of the facility to present the short-form answers in note form, with some candidates answers
extending over a page in length. A small number of candidates failed to follow the instruction to answer
each short-form question on a separate page and to submit the short-form questions in numerical
order.

SFQ 1
Erica may continue
in order to maintain audit quality
ES 3 permits when substantial change in the business
provided:
- only for additional period of up to two years/no longer than 7 years in total
- expanded review of work undertaken by Engagement QC Reviewer
- fact and reasons disclosed to shareholders as early as practicable
If company not prepared to make such disclosures, should not accept
Answers to this question were mixed. A significant number of candidates attained full marks, as they were
aware of the new provision in ES3 Long Association with the Audit Engagement, but an equally significant
number of candidates were unaware of the relevant provisions and therefore scored no marks on this
question. A significant number of candidates did not answer the question and, instead, discussed the
ethical threats presented by the situation described in the scenario.
Maximum marks
Total available

2
3

SFQ 2
The primary responsibility for the prevention and detection of fraud rests with management
External auditor is responsible for obtaining reasonable assurance that the financial statements are free
from material misstatement
The amount involved is not material
It represents 0.12% of revenue and 2% of profit before tax
Audit involves sampling
Fraud is often concealed or involves collusion making it difficult to detect
This question was well answered with many candidates attaining full marks. The points most commonly
overlooked were in relation to audits being conducted on a sample basis and the fact that fraud is often
concealed or involves collusion.
Maximum marks

Total available

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SFQ 3
Analytical procedures
Comparisons with
- previous corresponding six months
- month by month
- industry sector data
- budget/forecast
Relationships between figures/changes in ratios
Use of proofs in total
Obtain plausible explanations for significant movements
Limitations
A good knowledge of the business is required to understand results
Consistency of results may conceal an error
May be a tendency to carry out procedures mechanically, without appropriate professional scepticism
Requires an experienced member of staff to be done properly
Reliable data may not be available
Lack of comparability if business is growing/changing
This question was generally well answered with most candidates providing a number of methods of how
analytical procedures could be used when reviewing interim financial information as well as a number of
limitations of such procedures. Weaker candidates failed to answer the question and, instead, wrote in
general terms about how analytical procedures might be used at the various stages of an audit. A number
of candidates wasted time writing about the level of assurance that would be provided by a review of
interim financial information this was outside the scope of the requirement and did not score any marks.
Maximum marks
Total available

4
6

SFQ 4
All boxes to be uniquely numbered
Register of numbers and to whom distributed/where located
Provision of means of securing boxes to counters (eg chains)
Sealing of boxes so that opening prior to collection by entity is apparent
Regular collection of boxes from retail outlets and restaurants by trusted persons
Dual control (ie 2 people) over opening and counting of cash donated
Immediate recording of amounts in boxes
Prompt banking of cash
Independent reconciliation of amount recorded with bank records
This question was very well answered with many candidates achieving either three or four marks. The
most significant shortcoming related to recommendations not appropriate to the scenario. A common
example was the recommendation to install CCTV to monitor the collecting boxes. A number of candidates
confused segregation of duties with dual control. Many candidates failed to observe the instruction to limit
their response to four procedures and wasted time listing more than four. Marks were not awarded
beyond the first four procedures listed.
Maximum marks

Total available

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SFQ 5
May be window dressing/cut off error
May be material misstatements in financial statements if:
- excluded from inventory
- included in sales and receivables
- goods are faulty/no provision for cost below NRV
May be indicative of:
- need for further provisions re additional returns/items in inventory
- lack of management integrity/unreliable management representations
Answers to this question were mixed. Most candidates explained the potential window dressing or cut-off
issue and were able to identify at least one area of the financial statements that would be impacted.
However, candidates were often unable to extend their discussion to the further implications such as doubts
over management integrity and the possible indication that there may be additional returns unaccounted for.
Maximum marks
Total available

2
3

SFQ 6
Consequences
Assets recorded in the register may not exist or may have been stolen
Assets in existence, acquisitions or disposals may not be recorded
Incorrect capital allowances may be claimed
Assets may be fully written down but still in use and consequently undervalued
Assets may be impaired or no longer in use and consequently overvalued
Depreciation charges on assets may be inappropriate
Resulting in misstatements in the financial statements
Recommendations
Regular/monthly/quarterly reconciliation of register and assets
- physical to register to ensure completeness of recording
- register to physical to ensure existence and in good condition
Reconciliation to be performed independent of custodian
Differences to be reported and investigated
Train staff on how to carry out procedures
Monitoring of procedures to ensure checks undertaken
Answers to this question were disappointing. Most candidates identified some of the potential
consequences of not undertaking periodic comparisons of the plant and equipment register with physical
assets, such as assets no longer existing or unrecorded acquisitions. However, candidates
recommendations tended to be vague such as carry out reconciliations. Furthermore, many strayed
beyond recommendations relating to the lack of comparison of register and physical assets and discussed
other controls relating to tangible non-current assets, such as controls over ordering. A minority of
candidates confused plant and equipment with inventory.
Maximum marks

Total available

10

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Question 7

Total marks: 40

General comments
Although answers to this question attained the lowest overall average mark on the written test questions,
there were some very good answers. In general, candidates provided good answers to part (a) but there
were mixed answers to parts (b) and (c).
Part (a)
Justify why revenue, purchases and payables, inventory and e-commerce development costs have
been identified as areas of audit risk and, for each item, describe the procedures that should be
included in the audit plan in order to address those risks.
Revenue

Revenue

Justification
There is a risk of understatement if cash from
outlet sales is misappropriated and not recorded
as a sale. However, the risk of overstatement is
greater due to the significant increase of 11.9%
which is out of line with movements in purchases
and inventory days. This may be caused by:
deliberate overstatement due to the
bonus which is linked to profit;
failure to deduct post year-end returns
which relate to pre year-end sales;
the unreliability of the new on-line system
and failure to deduct duplicate sales; and
inappropriate revenue recognition policies
for on-line sales (e.g. on order instead of
despatch).

Audit procedures
Review gross profit margins on an outlet by outlet
basis to identify any which are out of line with
expectation.
Review the results of the periodic inventory
counts to identify any shortfalls between physical
inventory and records, which may indicate
unrecorded sales.
Trace goods returned records/credit notes to
adjustments to revenue figure.
Evaluate and test the system of control over cash
sales and on-line sales.
Discuss the reason for the increase in revenue
with management and obtain a breakdown of
revenue on outlet by outlet and on-line bases to
identify movements out of line with expectation.

Purchase and trade payables

Purchase and trade payables

Justification
Foreign suppliers are paid in their local currency,
which may result in translation errors due to
calculation errors or use of inappropriate
exchange rates.

Audit procedures
Evaluate and test controls over recording of
invoices and payments to suppliers.
Reperform a sample of foreign currency
translations, checking the rates to a reliable
external source.
Trace a sample of goods received records to
invoices recorded in the purchases and payables
records.
Inspect invoices/payments after date to see if
they relate to the year under review.
Reconcile suppliers statements with the balances
on the payables ledger or, if necessary,
undertake direct confirmation of balances.
Inspect suppliers invoices/contracts to ascertain
whether there has been any change in suppliers
terms of trading.

Payables days have fallen from 39.4 to 35.3 days,

which may indicate that payables are understated
due to unrecorded invoices and/or deliberate
understatement due to the profit-related bonus.

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Inventory

Inventory

Justification
Inventory days have increased from 61.8 to 64.9
days and may indicate overstatement. This may be
caused by:
unreliable inventory records if adjustments
for differences identified during the periodic
counting are not accurately reflected in the
records;
translation errors in respect of inventory
purchased from overseas suppliers;
slow-moving items due to end of shelf
life/out of fashion/damaged;
a failure to account for returns in the
relevant accounting period;
a failure to write down damaged goods that
have been returned; and/or
the deliberate overstatement of inventory
due to the profit-related bonus

Audit procedures
Evaluate and test controls exercised over the
inventory system and the periodic counting
procedures (e.g. segregation of duties,
counting in pairs, noting damaged items).
Review results of the clients counting
procedures, in particular, evaluate the level of
discrepancies and consider the implications for
the reliability of the EPOS system.
Attend an inventory count during the year and
undertake test counts involving two way
counting.
Trace a sample of goods returned records to
inventory records.
Review the aged inventory report to identify
slow-moving items and discuss provision with
management.
Inspect the inventory valuation listing and
selling prices after the year end to identify
items which may have an NRV below cost.
Test a sample of items to suppliers invoices to
check cost is correctly recorded.

Website development costs

Website development costs

Justification
Costs may have been misstated due to:
the inclusion of incorrect material and labour
costs and inappropriate items such as training
or scrapped costs;
the misclassification of tangible and intangible
elements; and/or
deliberate overstatement due to the profitrelated bonus.
Depreciation and amortisation may have been
calculated over inappropriate useful lives.
There is potential impairment if the internet business
does not prove to be profitable.

Audit procedures
Obtain a schedule of costs capitalised and
review items to ensure they are capital in
nature.
Vouch amounts to contracts with/invoices from
suppliers.
Vouch labour costs to payroll details and time
sheets.
Ensure scrapped costs have been expensed.
Discuss the basis for useful life with
management and reperform depreciation and
amortisation calculations.
Inspect post year-end management accounts
to ensure internet sales are holding up.

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This part of the question was very well answered in respect of revenue and purchases and trade payables.
However, inventory and e-commerce development costs were generally not well answered. As noted in
previous examiners commentaries, those candidates who worked methodically through the question
justifying why each item had been identified as a key area of audit risk and then describing procedures to
address that risk scored particularly well. Almost all candidates followed the examiners guidance to use a
columnar format to layout their answers. On the whole, candidates performed better on the justification of
the risks identified in the question than on the procedures to be performed to address the risks. The
procedures were often too vague or unrelated to the justification of the audit risk. A minority of candidates
failed to appreciate the importance of using analytical procedures as a risk assessment tool and lost the
marks available for performing such procedures.
Revenue
Most candidates were able to provide a number of reasons to justify why revenue was an area of audit risk
and provide some relevant audit procedures. The audit procedures most commonly overlooked were the
review of revenue and margins on an outlet by outlet basis to identify any results that were out of line with
expectation and the review of results of the periodic inventory counts to identify shortfalls between physical
inventory and records.
Purchases and trade payables
Almost all candidates were able to justify why purchases and trade payables was an area of audit risk. The
audit procedures most commonly overlooked were the evaluation and testing of controls over the purchase
and payments system and the tracing of goods received records to invoices posted in the purchase and
payables accounts.
Inventory
Stronger candidates identified slow-moving and damaged goods and the failure to correctly account for
returns as justifications for the audit risk and were able to describe relevant audit procedures. However
many candidates provided weak answers to justify why inventory had been identified as a key audit risk and
consequently were unable to describe any associated audit procedures. A large number of candidates
failed to appreciate the significance of the perpetual inventory records in both the valuation of inventory and
the identification of aged inventory. There was a general lack of appreciation of the importance of checking
the reliability of the records and ensuring that the results of inventory counts were reflected in those
records. These candidates were therefore unable to describe any audit procedures that would adequately
test the reliability of the records, for example the need to attend an inventory count during the year to
evaluate controls over the counting procedures and perform two-way test counting. Some candidates
incorrectly cited the need for auditors to organise their own inventory count at the year end or demanded
that the client undertake such a count. A number of candidates incorrectly calculated inventory days using
revenue instead of purchases. As noted by examiners in previous commentaries, a number of candidates
lost marks by being too vague. For example, many candidates cited check inventory is stated at the lower
of cost and NRV but failed to explain how they would do this or attend inventory count but failed to explain
what they would do at the count.
E-commerce development costs
Most candidates were able to score some marks by identifying that e-commerce development costs may
have been misstated and that capitalised costs needed to be reviewed to ensure that they were capital in
nature. A significant minority of candidates ignored the requirement to justify why e-commerce development
costs in the statement of financial position had been identified as an audit risk but justified why
weaknesses in the e-commerce system were an audit risk. Consequently these candidates failed to identify
any associated audit procedures. Almost all candidates overlooked the fact that there is a potential
impairment if the on-line business does not prove to be profitable.
Maximum marks

24

Total available

51

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Part (b)
Identify and explain the threats to objectivity and state how your firm should respond to those
threats in respect of the boards requests for the provision of services regarding:
(i)
the internal audit function; and
(ii)
the recruitment and remuneration package of the finance director.
Internal audit function
Threats
A self-review threat arises as the external auditor will have to re-evaluate the work of the internal audit
function and may be reluctant to identify shortcomings or rely too heavily on the work.
A management threat arises if the internal audit function is required to make judgements or take decisions
that are the responsibility of management.
A self-interest threat arises if the firm becomes over-dependent on the fees from Brandsco and fear of
losing the fees impairs the external auditors objectivity.
Response
The firm may accept the internal audit engagement if the following safeguards are in place:
- there is informed management (i.e. management is capable of making decisions);
- the work is performed by partners and staff who have no involvement in the external audit;
- the work is properly and effectively assessed by the external audit team;
- responsibilities do not include the taking of decisions as to the scope and nature of the services to be
provided and the design of internal controls or implementing changes thereto;
- respective responsibilities are set out in an engagement letter; and
- an engagement quality control review is undertaken.
However, the engagement should be refused if it is reasonably foreseeable that the external auditor would
place significant reliance on the work of the internal audit function.
The firm should ensure that the total fees from Brandsco do not exceed 15% of the annual fee income of
the firm. Where fees are between 10% and 15% of the annual fee income, the matter should be disclosed
to those charged with governance and the ethics partner and an external quality control review should be
arranged.
Appointment of finance director and advice on remuneration package
Threats
A familiarity threat arises as the audit team may be reluctant to criticise the information or explanations
provided by the finance director.
A management threat arises if the directors expect the firm to be involved in the appointment of the finance
director. The firm may become too closely aligned with the views and interests of management.
Response
Appointment of finance director
The firm should not provide recruitment services to an audit client that would involve taking responsibility for
the appointment of any director. As Brandsco is not listed, ES 5 Non-audit Services Provided to Audited
Entities (ES 5) does not expressly prohibit recruitment services. If the directors are considered to be
informed management, which they appear to be in this case, the service can be provided in less formal
ways such as the provision of salary surveys and advice on a candidates financial competence.
Remuneration package
ES 5 prohibits the provision of services to an audit client that would involve the audit firm advising on the
quantum of remuneration package or the measurement criteria because the familiarity threat is too high.
Consequently this service should be refused.

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Answers to this part of the question were mixed. In respect of the internal audit services, the majority of
candidates identified the self-review threat. However, a significant number failed to identify the
management and self-interest threats and consequently failed to attain marks available for those threats
and the safeguards in relation to those threats. Those who identified the self-review threat often correctly
identified the safeguard of separate teams. However, many of those stated, incorrectly, that information
barriers should be in place between the two teams. These candidates failed to appreciate that
confidentiality was not an issue and that there should be discussions between the internal and external
auditors. Part (ii) regarding the recruitment and remuneration package of the finance director was not well
answered. Of those who did correctly identify the management and familiarity threats, few were able to
state how they could be mitigated. Disappointingly, a large number of candidates overlooked completely the
remuneration package of the finance director in their answer and so lost marks. There was some (but less
than in previous sessions) evidence of the scattergun approach where some candidates just listed all the
possible threats to independence without linking them to the circumstances in the question no mark was
awarded unless the threat could be linked to the circumstances in the question.
Maximum marks

10

Total available

25

Part (c)
Describe the matters to be included in your firms engagement letter for the examination of the
profit and cash flow forecasts in respect of:
(i)
the directors responsibilities; and
(ii) the purpose and scope of your firms work.
The matters to be included in the letter of engagement are as follows:
Directors responsibilities
The directors are responsible for:
the preparation and presentation of the forecasts, including the identification and disclosure of the
assumptions on which the forecasts are based;
providing the reporting accountant with all relevant information and source data used in developing the
assumptions; and
providing written representations on the intended use of the forecasts, the completeness of significant
assumptions and acknowledgement of their responsibility for the forecasts.
Purpose and scope of work
The assurance firm is responsible for:
examining (not auditing) the profit and cash flow forecasts for the period specified by the directors for
the purpose of supporting the application for funding;
considering the reasonableness of the assumptions and providing limited assurance as to whether the
assumptions provide a reasonable basis for the forecasts. This will be expressed negatively in the form
of nothing has come to our attention, which causes us to believe that these assumptions do not
provide a reasonable basis for the forecast; and
providing an opinion as to whether the forecasts are properly prepared on the basis of the stated
assumptions.
A statement as to whether the engagement is to be conducted in accordance with the provisions of ISAE
3400, The Examination of Prospective Financial Information.

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Although there were some very good answers to this part of the question, many answers were
disappointing. Weaker candidates strayed beyond the requirement and provided matters to be included in
engagement letters generally including the basis of fees, restrictions of circulation of the report and
limitation of liability, none of which scored any marks. Many candidates were unaware of the scope of the
work undertaken when examining profit and cash flow forecasts. A significant number of candidates failed
to appreciate the role of assumptions in the preparation of forecasts and their impact on both the directors
and the assurance firms responsibilities. In respect of directors responsibilities, a number of candidates
strayed beyond the requirement and wasted time writing at length about their responsibilities regarding the
financial statements, the prevention and detection of fraud and error and the implementation and
maintenance of internal controls. In respect of the assurance firms responsibilities, a significant number of
candidates cited, incorrectly, that the forecasts should give a true and fair view. The majority of candidates
correctly stated that the level of assurance would be limited and expressed negatively. However, few
candidates stated that an opinion would be expressed on whether the forecasts were properly prepared on
the basis of the assumptions.
Maximum marks

Total available

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Question 8

Total marks: 20

General comments
Answers to this question attained the highest overall average mark on the written test questions. This was
generally due to very strong answers on part (a) as answers to part (b) were generally disappointing.
Part (a)
Identify and explain the matters that should be considered by your firm in deciding whether to
accept appointment as external auditor to Traveluxe. Your answer should include any preliminary
audit risks identified from the information provided.
Matters to be considered
Reason for the change in auditor
Whether there has been a disagreement between the retiring auditor and the management of Traveluxe, as
it may indicate that management lacks integrity and the firm may not wish to be associated with such a
client because of the adverse impact on its reputation.
Adequacy of resources
Whether the firm has:
- experience in the industry sector and, if so, whether the firm has sufficient resources for separate teams
if the firm acts for a competitor;
- the ability to cover the Irish subsidiary as the firm does not have an office in Ireland; and
- the ability to cope with a popular year end (i.e. December) and to complete the audit within three
months as required by the client.
Source of funds introduced by Alison Stableford
Whether the funds are from a legitimate source to ensure compliance with Money Laundering Regulations.
Outsourced payroll
Whether the service organisation will grant access to its records and whether the service organisations
auditors produce a report on internal controls. Otherwise there may be a limitation on scope.
Extended liability
Whether the firm owes a duty of care to Traveluxes bank, thereby exposing the firm to potential claims for
damages if Traveluxe defaults on its loan repayments.
Audit risk analysis
New client
A lack of knowledge and understanding of the business may result in failure to identify events and
transactions, which impact on the financial statements and, in addition, opening balances may be misstated.
Bank reviewing the financial statements
There is a risk of management bias in order to comply with any covenants attached to the loan. In addition,
detection risk is higher due to the time pressure involved in having to complete the audit within three
months.
Regulated industry
Failure of Traveluxe to comply with industry regulations may result in fines which may not be provided for or
disclosed as a contingent liability in the financial statements.
Going concern
A number of factors point to the potential failure of Traveluxe and in particular:
- the government contracts are renewable so there is no guarantee of future revenue streams;
- if Traveluxe fails to comply with laws and regulations, its operating licence may be withdrawn; and
- if Traveluxe fails to comply with any terms and conditions of the bank loan, the facility may be recalled.
Acquisition of Roaches Coaches
The parent company will be preparing consolidated financial statements for the first time and may lack
proficiency in their preparation. This increases risk of error with respect to consolidation adjustments such
as goodwill. The risk of misstatement is compounded by the fact that the Euro is the local currency, which
may result in translation errors. There may be an impairment issue regarding the investment in the parent
companys financial statements arising from the state of the Irish economy.
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This part of the question was very well answered. The majority of candidates were able to provide a wide
range of matters to be considered in deciding whether to accept appointment as external auditor and audit
risks. Weaker candidates just listed general points without linking them to the scenario. For example, some
candidates correctly identified resources as an issue but did not link it into geographical coverage or a tight
deadline. A significant number laboured professional clearance, failing to appreciate that topic was more
relevant to part (b). Many candidates wasted time discussing the fee dependency threat, failing to
appreciate that this was unlikely to be the case for a firm with 15 offices throughout England and Wales.
Although the majority identified that the preparation of consolidated financial statements for the first time
increased the risk of error, few considered the potential for impairment of the investment in the parents
financial statements. Weaker candidates failed to appreciate that it was the clients proficiency that was in
doubt and instead wondered, incorrectly, whether the audit firm had the ability to deal with consolidated
financial statements. A minority wasted time listing procedures to be carried out this was outside the
scope of the requirement and no marks were awarded for such points.
Maximum marks

14

Total available

25

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Part (b)
State the responsibilities of the outgoing firm of external auditors relating to the change of
appointment as set out in the ICAEW Code of Ethics. Give reasons for each of the responsibilities.
Note: You are not required to refer to the Companies Act 2006 provisions in respect of a change of
external auditor.
Obtain authority from the company to discuss Traveluxes affairs with the incoming auditor. This authority is
required to comply with the fundamental principle of confidentiality. If the client refuses to grant permission to
discuss the clients affairs, this should be reported to the incoming auditor to alert him that the client may be
hiding information.
Answer promptly any communication from the incoming auditor about the clients affairs. A prompt response
will avoid the perception of lack of professionalism and assist in a smooth changeover. Record in writing any
discussions with the incoming auditor to provide evidence if questioned in the future.
Confirm whether there are any matters which the incoming auditor ought to know, explaining them
meaningfully (honestly and unambiguously) or confirm there are no such matters. Matters to be disclosed
may include:
- unlawful acts by the client,
- unpaid fees,
- differences of opinion.
This ensures that the incoming auditor is in full possession of the facts and can make an informed decision.
If the existing auditor has made one or more suspicious activity reports relating to money laundering or
terrorism, the existing auditor should not disclose that fact to avoid the offence of tipping off.
Transfer promptly all books and records belonging to the company so that the company can comply with
statutory requirements regarding adequate accounting records.
Answers to this part of the question were very disappointing as the majority of candidates failed to follow the
instruction in the requirement to ignore the Companies Act 2006 provisions. Consequently, they wasted time
citing points for which there were no marks. The points most commonly identified in respect of the ICAEW
Code of Ethics, were those relating to professional clearance and returning books and records to the
company. In general, coverage of responsibilities was better than reasons underlying those responsibilities.
For example, although many cited the matters that could be disclosed to the prospective auditor, few stated
that it was to assist the auditor to make an informed decision. The points most commonly overlooked were
those relating to the recording of discussions with the prospective auditor and the importance of not
disclosing suspicious activity reports.
Maximum marks
Total available

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Question 9

Total marks: 20

General comments
Answers to this question attained the second highest average mark on the written test questions. It was
pleasing to note an improvement in the standard of answers relating to modified audit reports.
Part (a)
Explain and distinguish between the following three types of modified audit opinions:
(i)
qualified opinion;
(ii) adverse opinion; and
(iii) disclaimer of opinion.
Qualified opinion
A qualified opinion is expressed when there is a misstatement (i.e. a disagreement) or the auditor is unable
to obtain sufficient appropriate audit evidence, (i.e. a limitation on scope) and that the misstatement is/could
be material but not pervasive. The opinion is expressed as except for the financial statements give a
true and fair view.
Adverse opinion
An adverse opinion is expressed when misstatements are (a disagreement is) material and pervasive. It is
expressed as the financial statements do not give a true and fair view.
Disclaimer of opinion
A disclaimer of opinion is expressed when the auditor is unable to obtain sufficient appropriate evidence (i.e.
a limitation on scope) and the possible effects of undetected misstatements, if any, are material and
pervasive. It is also expressed when, in extremely rare circumstances, there are multiple uncertainties. The
wording used is
we do not express an opinion on the financial statements (or we are unable to form an opinion as to
whether the financial statements give a true and fair view.)
A qualified opinion is expressed when the issues are confined to specific elements, accounts or items of the
financial statements. An adverse opinion or a disclaimer of opinion is expressed when:
- many items in the financial statements are affected:
- if confined to specific elements, the issues represent or could represent a substantial proportion of the
financial statements; or
- in relation to disclosures, are fundamental to the users understanding of the financial statements.
This part of the question was generally well answered as the vast majority of candidates provided plausible
explanations of the different types of modified opinions. The most common omission was a failure to
distinguish between material without being pervasive and material and pervasive. Furthermore, candidates
often lost marks by failing to cite the wording used in the opinion, for example, except for in respect of a
qualified opinion. A number of candidates stated, incorrectly, that adverse opinion and disclaimer of opinion
were qualified opinions. A minority of candidates confused qualified opinions with emphasis of matter
paragraphs. Few candidates mentioned that a disclaimer of opinion can be expressed when there are
multiple uncertainties.
Maximum marks

Total available

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Part (b)
For each of the situations outlined:
(i)
state, with reasons, the actions you would take; and
(ii)
discuss the implications for the audit reports on the financial statements of Par and Fairway
and describe the effects, if any, on each audit report.
Par plc
Actions/reasons
Discuss the matter with management as the loss of a major customer gives rise to going concern issues.
Discussions should focus on managements contingency plans such as replacement contracts.
Review managements assessment of the companys ability to continue as a going concern this should
include an examination of profit and cash flow forecasts.
Implication for the audit report
If there is uncertainty about the going concern status of the company and management is willing to fully
disclose the circumstances, the report but not the opinion, should be modified. An emphasis of matter
paragraph should be included after the opinion paragraph, highlighting the issue and drawing users attention
to the note in the financial statements. There should be a specific statement in the emphasis of matter
paragraph that the opinion is not qualified/modified.
If management refuses to disclose the uncertainty, the opinion should be modified due to
misstatement/disagreement. The modification should be a qualified opinion if the issue is considered material
but not pervasive or an adverse opinion if considered material and pervasive. A paragraph, explaining the
issue should be included above the opinion.
If the company is not considered to be a going concern, the financial statements should be prepared on the
break-up basis. If the basis is fully explained in notes to the financial statements, the opinion is not modified
but the auditor may modify the report with an emphasis of matter paragraph.
If the financial statements are prepared on an inappropriate basis, many items in the financial statements will
be materially misstated. This would be pervasive requiring an adverse opinion stating that the financial
statements do not give true and fair view.
Fairway Ltd
Actions/reasons
The amount should be noted on the schedule of individually immaterial errors and the directors should be
informed of the matter. The subsequent sale is an adjusting subsequent event, providing additional evidence
of the value of the work in progress at the year end. The work in progress should be valued at net realisable
value (NRV), because it is lower than cost. However, the difference between the cost and NRV is 50,000
and is not material as it is only 2% of profit before tax and 0.25% of total assets.
Implications for the audit report
Even if the directors refuse to amend the financial statements, there will be no modification to the audit report
in respect of this matter alone. However, it must be considered with other individually immaterial items, in
case they are material when aggregated.

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Par
The majority of candidates identified that there was a going concern issue and, consequently, the importance
of discussing contingency plans with management. Those candidates who identified that there were a
number of different possible outcomes scored high marks. However, weaker candidates did not distinguish
between an uncertainty about the going concern and whether the company was definitely going to cease to
trade (i.e. not a going concern). In addition, many lost marks by failing to identify that the implication for the
audit report depended on whether or not the directors were willing to disclose the situation in the notes to the
financial statements. This was particularly so when candidates were dealing with the break-up basis of
preparation of the financial statements.
Fairway
The majority of candidates correctly identified that the situation represented an adjusting subsequent event
and that work in progress should be included at its net realisable value (NRV) because it was lower than cost.
However, there was a considerable misunderstanding in relation to materiality. Many candidates failed to
appreciate that it was the difference between the cost of the work in progress included in the financial
statements and the NRV that should be considered. Instead, they considered the materiality of the work in
progress figure and consequently concluded that the amount was material when in fact the difference
between cost and NRV was not material. As a result, these candidates reached the wrong conclusion in
respect of the implication for the audit report.
Maximum marks

14

Total available

22

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