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APTFinancialConsultants

AUDIT AND ASSURANCE SERVICES REVIEW KIT, NOVEMBER, 2008

COMPILEDREVIEWQUESTION&ANSWERSFOR
NOVEMBER,2008SESSION
1. Thefollowingquestionsandanswershavebeencompliedfromvarioussources
includingbooksandotherprofessionalexams.Theyareaimedatincreasing
confidencefortheCPAcandidatesandshouldnotbeusedasasubstitutefor
syllabuscoverage.
2. For purpose of printing, it is advisable to print two pages in one in order to save
stationery.
3. Speculation is not a good practice in professional exams. The following set of
questionsarejustforguidanceasyouapproachtheexams,pleaseensuresyllabus
coveragetoguaranteeforyourpassing.TAKEYOURSYLLABUSBOOKATLEASTONE
MONTHBEFORETHEEXAMANDTICKGENUINELYYOURLEVELOFUNDERSTANDING
ONEACHSUBJECTMATTER
Makesureyouhavereadtheexaminationguidesupplementedwiththispaper.
Thereare200questionsandanswersinthispaper.

QUESTION1
YouhavebeenaskedtocarryoutaninvestigationbythemanagementofViziboCo.Oneofthe
companys subsidiaries, Endeleza Engineering Co, has been making losses for the past year.
Vizibos management is concerned about the accuracy of Endeleza Engineerings most recent
quartersmanagementaccounts.
Thesummarizedincomestatementsforthelastthreequartersareasfollows:

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Vizibos management board believes that the high material consumption as a percentage of
revenueforthequarterto30June2006isduetooneormoreofthefollowingfactors:
(1)undercountingorundervaluationofclosinginventory;
(2)Excessiveconsumptionorwastageofmaterials;
(3)materialbeingstolenbyemployeesorotherindividuals.
EndelezaEngineeringhasasmallnumberoflargecustomersandmanufacturesitsproductsto
eachcustomersspecification.
Thesellingpriceoftheproductisdeterminedby:
(1)estimatingthecostofmaterials;
(2)estimatingthelabourcost;
(3)addingamarkuptocoveroverheadsandprovideanormalprofit.
The estimated costs are not compared with actual costs. Although it is possible to analyse
purchaseinvoicesformaterialsbetweencustomersordersthisanalysishasnotbeendone.
A physical inventory count is carried out at the end of each quarter. Items of inventory are
entered on stocksheets and valued manually. The company does not maintain perpetual
inventory records and a full physical count is to be carried out at the financial year end, 30
September2006.
Thedirectlabourcostincludedintheinventoryvaluationissmallandshouldbeassumedtobe
constantattheendofeachquarter.Historically,thecostofmaterialsconsumedhasbeenabout
70%ofrevenue.
Themanagementaccountsto31March2006aretobeassumedtobecorrect.
Required:
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(a) Define forensic auditing and describe its application to fraud investigations. (5
marks)
(b) Identify and describe the matters that you should consider and the procedures you
shouldcarryoutinordertoplananinvestigationofEndelezaEngineeringCoslosses.(10
marks)
(c)(i)Explainthemattersyoushouldconsidertodeterminewhetherclosinginventoryat
30June2006isundervalued;and
(ii) Describe the tests you should plan to perform to quantify the amount of any
undervaluation.(8marks)
(d) (i) Identify and explain the possible reasons for the apparent high materials
consumptioninthequarterended30June2006;and
(ii) Describe the tests you should plan to perform to determine whether materials
consumption,asshowninthemanagementaccounts,iscorrect.(7marks)
(e)
Explain the role of support letters (also called comfort letters) as evidence in
theauditoffinancialstatements.

SUGGESTEDSOLUTION
(a)Forensicauditing
Definition
The process of gathering, analysing and reporting on data, in a predefined context, for the
purpose of finding facts and/or evidence in the context of financial/legal disputes and/or
irregularitiesandgivingpreventativeadviceinthisarea.
Tutorialnote:Creditwillbeawardedforanydefinitionthatcoversthekeycomponents:Anaudit
isanExamination(e.goffinancialstatements)andforensicmeansusedinconnectionwithcourts
oflaw.Forensicauditingmaybedefinedasapplyingauditingskillstosituationsthathavelegal
consequences.
Applicationtofraudinvestigation
Asafraudisanexampleofanirregularity,afraudinvestigationisjustoneofmanyapplications
of forensic auditing, where evidence about a suspected fraud is gathered that could be
presentedinacourtoflaw.Thepredefinedobjectiveofafraudauditis:
toproveordisprovethesuspicions;and,ifproven,
toidentifythepersonsinvolved;
toprovideevidenceforappropriateaction,possiblycriminalproceedings.
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Aswellasbeingreactive,forensicauditingcanbeproactivebybeingpreventative.Thatis,the
techniquesofforensicauditingcanbeusedtoidentifyrisksoffraudwithaviewtomanaging
thoseriskstoanAcceptablelevel.
(b)Priortocommencementoftheinvestigation
Tutorialnote:Thephrasemattersandproceduresisusedtoencouragecandidatestothink
morewidelythanjustconsiderationsorjustactions.Apossiblestructureforthisanswercouldbe
undertwoseparateheadings:mattersandprocedures.However,manymatterscouldbephrased
asprocedures(andviceversa).Forexample,amatterwouldbe
thetermsofreferenceandtheproceduretoobtainandclarifytheTOR.Candidatesshouldnote
that a tabular/columnar answer is NOT appropriate as any attempt to match matters and
proceduresislikelytoresultinrepetitionofthesamepoint(differentlyphrased).
DiscusstheassignmentwithVizibosmanagementtodeterminethepurpose,natureandscope
of the investigation. In particular, discuss whether any irregularity (theft/fraud) is suspected
and,ifso,whetherevidencegatheredwillbeused:
incriminalproceedings;
insupportofaninsuranceclaim.
Obtainclarificationoftermsofreference(TOR)inwritingfromVizibosmanagement.
TheTORshouldgivetheinvestigatingteamfullaccesstoanyaspectofEndelezaEngineerings
operationsrelevanttotheirinvestigation.
Investigationwillinvolveconsiderationof:
possibleunderstatementofinventoryvalueat30June2006;
highmaterialconsumptionforthequarterended30June2006.
Determine the level of experience of staff required for the investigation and the number of
staffofeachgrade.
The availability of suitable staff may affect the proposed start of the investigation.
Alternatively,thetimingofother
assignmentsmayhavetoberescheduledtoallowthisinvestigationtobestartedimmediately.
Vizibos management will presumably want the investigation completed before the next
inventorycount(at30September 2006)toknowifthefindings haveany implicationsforthe
conductofthecountandthedeterminationofyearendinventory.
Theinvestigationmayhavebeencommissionedtogivecredencetotheperiodendsaccounts.
Theinvestigationmaythereforebeofthenatureofalimitedaudit.

Produce a budget of expected hours, grades of staff and costs. Agree the anticipated
investigativefeewithVizibosmanagement.
Thedepthoftheinvestigationwilldependonmatterssuchas:
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theextentofrelianceexpectedtobeplacedontheinvestigationreport;
whetherthereportisforVizibosinternaluseonlyorisitlikelytobecirculatedtobankers
and/orshareholders.
Thetypeofassurance(egnegative,reasonable)islikelytohaveabearingon:
anycaveatsinthereport;
thelevelofrisk/potentialliabilityforanyerrorsinconclusionsgiveninthefinalreport;
thelevelofnecessarydetailedtestingrequired(evenifanauditisnotrequested).
An engagement letter must be drafted and Vizibos management must agree to its terms in
writingbeforeanyinvestigativeworkcanbegin.Theletterofengagementshouldinclude:
detailsofworktobecarriedout;
likelytimescale;
basisofdeterminingfee;
thereliancethatcanbeplacedonthefinalreportandresultsoftheinvestigation;
theextentofresponsibilitiesagreed;
anyindemnityagreed;
theinformationtobesuppliedasabasisfortheinvestigation;and
anyareasspecificallyexcluded.
Assesstheappropriatenessofanexclusionclause;forexample:CONFIDENTIALthisreport
has been prepared for the private use of Vizibo only and on condition that it must not be
disclosedtoanyotherpersonwithoutthewrittenconsentofthepreparingaccountant.
(c)(i)Inventoryundervaluationmatterstoconsider
Physicalinventorycount
Inventory will be undervalued at 30 June 2006 if all inventory is not counted. The
investigation should consider the adequacy of quarterly physical count procedures. For
example,whetherornot:
allitemsaremarkedwhencounted;
managementcarriesouttestchecks;
stocksheetsareprenumberedandpreparedinink;
acompletesetofstocksheetsisavailablecoveringallcategoriesofinventory;
EndelezaEngineeringsmanagementusesthestocksheetstoproducetheinventoryvalue.
Tutorialnote:Inventorywillnotbeundervaluedifitdoesnotexist(egbecauseithasbeenstolen).
Theftwouldbereflectedinhigherthannormalmaterialsconsumption(see(d)).
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Cutoff
Inventorywillbeundervaluedat30June2006if:
anygoodssetasideforsaleinJulywereexcludedfromthecount;
aliabilitywasrecognisedat30June2006forgoodsthatwereexcludedfrominventory(egin
transitfromthesupplier);
production did not cease during the physical count and raw materials being transferred
betweenwarehouseandproductionwereomittedfrominventory.
Scrapmaterials
Inventorywillbeundervaluedifanyscrapfrommaterialsusedinproductionthathasavalue
(egbecauseitcanberecycled)isexcluded.Inventorymaybeundervaluedcomparedwiththe
previous quarterifthereis any changein Endelezasscrap/wastagepolicy (egifpreviously it
wasvaluedininventorybutnowitisexcluded).
Ifproductionproblemsincreasedwastageinthelastperiodthiswouldaccountforthelower
valueofinventoryandhighermaterialsconsumption.
(ii)Teststoquantifytheamountofanyundervaluation
Tutorial note: Any tests directed at quantifying an overstatement and/or instead of
understatementwillnotbeawardedcredit.
Physicalcount
Inspectthewarehouse/factoryareastoidentifyhighvalueinventoryitemsandconfirmtheir
inclusiononthestocksheetsat30June2006(orotherwisevouchtoadeliverynoteraisedafter
thatdate).
Recast all additions and recalculate all extensions on the stocksheets to confirm that there
havebeennoomissions,transpositionerrorsorothercomputationaldiscrepanciesthatwould
accountforanundervaluation.
Cutoff
Ascertainthelastdeliverynotesanddespatchnotesrecordedpriortocountingandtraceto
purchase/salesinvoicestoconfirmthatanaccuratecutoffhasbeenappliedindeterminingthe
resultsforthequarterto30June2006andtheinventorybalanceatthatdate.
TraceanylargevaluepurchasesinJunetothe30Junestocksheets.Ifnotonthestocksheets
inquireofmanagementwhethertheyareincludedinproduction(orsold).Verifybytracingto
productionrecords,goodsdespatchnotes,etc.
Analyticalprocedures
Comparelargevolume/highvalueitemsonstocksheetsat31Marchwiththoseat30Juneto
identifyanythatmighthavebeenomitted(orsubstantiallydecreased).Inquireofmanagement
ifanyitemssoidentifiedhavebeencompletelyusedinproduction(butnotreplaced),scrapped
or excluded from the count (eg if obsolete). Any inventory excluded should be counted and
quantified.
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Compare inventory categories for 30 June against previous quarters. Inventory value at 30
June is 10% less than at 31 March, though revenue is 28% higher. An increase in inventory
mighthavebeenexpectedtosupportincreasedrevenueifthereisageneralincreaseintrading
activity. (Alternatively, a decrease in inventory may reflect a difficulty in obtaining
supplies/maintaininginventorylevelsifdemandhasincreased).
Scrapmaterials
Make inquiries of Endeleza Engineerings warehouse and production officials regarding the
companysscrap/wastagepolicyandanyrecordsthatarekept.
Reviewproductionrecordsonamonthonmonthbasisanddiscusswiththefactorymanager
whetheranyproductionproblemshaveincreasedwastageinthequarterto30June2006.
Pricingtest
Raw materials select a sample of high value items from the 31 March 2006 inventory
valuation and confirm that any unit price reductions as shown by the 30 June 2006 valuation
are appropriate (eg vouch lower unit price to recent purchase invoices or write down to net
realizablevalue).
WIPandfinishedgoodsagreeasampleofunitpricestocostingrecords(egbatchcostings).
Recalculateunitpricesonasamplebasisandvouchmakeuptoinvoices/payrollrecords,etc.
(d)(i)Highmaterialsconsumptionmatterstoconsider
Tutorialnote:Materialsconsumptionhasincreasedfrom70%ofrevenueto78%.Therecouldbe
valid business reasons for this (eg there could be an abnormally high level of wastage) or
accountingerrorsthatresultinoverstatementofmaterials.
Cutoff
Rawmaterialpurchases:Materialsconsumptionwillbeoverstatedifgoodsdeliveredafterthe
quarterendhavebeenincluded(incorrectly)inpurchasesto30June2006althoughexcluded
(correctly)fromtheJunecount.
Revenue: Materialsconsumption willbeoverstatedas a percentage ofrevenue if revenue is
understated(egifgoodssoldbefore30June2006arerecordedinthenextquarter).
Losses
Materialsconsumptionwillbehigherthannormalifthereis anabnormallyhighlevelofraw
materials scrapped or wasted during the production process. This could be due to inferior
qualityrawmaterialsortechnicalproblemswiththemanufacturingprocess.
Materials consumption will also be overstated if raw materials recorded as being used in
productionarestolen.
Obsoleteorredundantinventory
Materialsconsumptionwillappearhigherifinventoryat30June2006islower.Forexample,if
slowmoving,

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damagedorobsoleteinventoryidentifiedatthecountwasexcludedorwrittendown(although
includedinthepreviousquartersinventoryvaluation).
Individualcontracts
Materials consumption will be higher if the increase in revenue is attributable to a small
numberoflargecontractsforwhichsubstantialdiscountshavebeennegotiated.
Materialsconsumptionwillbehigherifthecostofmaterialsoncustomersspecificationshas
beenunderestimatedinthedeterminationofsellingprices.
Purchasing
Materials consumed will increase if Endeleza Engineering has changed to a more expensive
supplierinthequarterto30June2006.
(ii)Highmaterialsconsumptiontests
Cutoff
Purchases: Select a sample of invoices included in purchases to 30 June 2006 and match to
goodsreceivednotestoconfirmreceiptat30June2006andhenceinclusionininventoryatthat
date.
Revenue: Inspect despatch notes raised on or shortly before 30 June 2006 and trace goods
soldtoinvoicesraisedonorbefore30June2006.
Scrap
Inquireofproduction/factoryandwarehouseofficialsthereasonsforscrapandwastageand
hownormallevelsaredetermined.
Inspect records of materials wastage and confirm the authorisation for scrapping materials
and/orreissuing
replacementmaterialstotheproductionprocess.
Physically inspect scrap, if any, to confirm that its condition renders it unsuitable for
manufacture(andhenceconfirmitsexclusionfrominventoryat30June2006).
Reviewcreditnotesreceivedafter30June2006toidentifymaterialsreturned(egofinferior
quality).
Obsoleteorredundantinventory
Inspect the stocksheets at 30 June 2006 for goods identified as obsolete, damaged, etc and
comparewiththelevel(andvalue)ofthesameitemsidentifiedatthepreviousquarterscount.
Individualcontracts
Compare discounts given on new contracts with normal discount levels and confirm the
authorityofthepersonapprovingdiscounts.
Calculate actual material cost as a percentage of revenue on individual major contracts and
comparewiththe70%benchmark.
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Testsofcontrols
Purchases:Inspectgoodsreceivednotestoconfirmthatrawmaterialsarebeingcheckedfor
qualityandquantityuponreceipt.Inspectinvoicesrecordedtoconfirmthatgoodshavebeen
received(asevidencedbyagoodsreceivednote).
Reviewgoodsreturnsrecordedonprenumberedgoodsreturnnotesandconfirmmatchedto
subsequentcreditnotesreceived.
Observegatecontrolsandotherphysicalsecurityoverinventoryandreviewthesegregation
ofdutiesthatseektopreventordetecttheftofinventory.
Sales: Review goods despatch notes and confirm matching to sales invoices that have been
raisedpromptlyandrecordedonatimelybasis.
Salesreturns:Reviewcreditnotesforauthorisationandmatchingtogoodsreturnsnotes.

(e)

Supportletters

Tutorial note: Although there are different types and uses of such letters (eg for registering a
prospectus),theonlyreferencetothemisinthecontextofgroupaudits.
Consolidated financial statements are prepared on a going concern basis when a group, as a
singleentity,isconsideredtobeagoingconcern.However,thegoingconcernbasismayonlybe
appropriateforcertainseparatelegalentities(egsubsidiaries)becausetheparentundertaking
(orafellowsubsidiary)isableandwillingtoprovidesupport.Manybanksroutinelyrequirea
letter of reassurance from a parent company stating that the parent would financially or
otherwisesupportasubsidiarywithcashfloworotheroperationalproblems.
Asauditevidence:
Formalconfirmationofthesupportwillbesoughtintheformofaletterofsupportorcomfort
letter confirming the parent companys intention to keep the subsidiary in operational
existence(orotherwisemeetitsobligationsastheyfalldue).
Theletterofsupportshouldnormallybeapprovedbyaboardminuteoftheparentcompany
(orbyanindividualwithauthoritygrantedbyaboardminute).
The ability of the parent to support the company should also be confirmed, for example, by
examiningthegroupscashflowforecast.
Theperiodofsupportmaybelimited(egtooneyearfromthedateoftheletteroruntilthe
dateofdisposalofthe
subsidiary). Sufficient other evidence concerning the appropriateness of the going concern
assumptionmustthereforebeobtainedwherealaterrepaymentofmaterialdebtsisforeseen.
The fact of support and the period to which it is restricted should be noted in the financial
statementsofthesubsidiary.

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QUESTION2
You are the manager responsible for four audit clients of Zilipendwa & Co, a firm of Certified
PublicAccountants.Theyearendineachcaseis30June2006.
You are currently reviewing the audit working paper files and the audit seniors
recommendationsfortheauditorsreports.Detailsareasfollows:
(a)MatandaCoisasubsidiaryofChumbaCo.Seriousgoingconcernproblemshavebeennoted
duringthisyearsaudit.
Matanda will be unable to trade for the foreseeable future unless it continues to receive
financialsupportfromtheparentcompany.Matandahasreceivedaletterofsupport(comfort
letter)fromChumbaCo.
The audit senior has suggested that, due to the seriousness of the situation, the audit opinion
mustatleastbequalifiedexceptfor.(5marks)
(b) Lorenze Co has changed its accounting policy for goodwill during the year from
amortisation over its estimated useful life to annual impairment testing. No disclosure of this
changehasbeengiveninthefinancialstatements.
Thecarryingamountof goodwillinthebalancesheet asat30 June 2006isthesame asat30
June2005asmanagementsimpairmenttestshowthatitisnotimpaired.
The auditsenior hasconcludedthat aqualification is not required but suggests thatattention
canbedrawntothechangebywayofanemphasisofmatterparagraph.(6marks)
(c)ThedirectorsreportofAbruptCostatesthatinvestmentpropertyrentalformsamajorpart
ofrevenue.However,anotetothefinancialstatementsshowsthatpropertyrentalrepresents
only16%oftotalrevenuefortheyear.Theauditseniorissatisfiedthattherevenuefiguresare
correct.
Theauditseniorhasnotedthatanunqualifiedopinionshouldbegivenastheauditopiniondoes
notextendtothedirectorsreport.(4marks)
(d)AuditworkontheafterdatebanktransactionsofJingleCohasidentifiedatransferofcash
from Bell Co. The audit senior assigned to the audit of Jingle has documented that Jingles
financedirectorexplainedthatBellcommencedtradingon7July2006,afterbeingsetupasa
whollyownedforeignsubsidiaryofJingle.
The auditsenior has noted that althoughno otherevidence has been obtained an unmodified
opinion is appropriate because the matter does not impact on the current years financial
statements.(5marks)
Required:
For each situation, comment on the suitability or otherwise of the audit seniors
proposalsfortheauditorsreports.Whereyoudisagree,indicatewhatauditmodification
(ifany)shouldbegiveninstead.
Note:Themarkallocationisshownagainsteachofthefourissues.(20marks)

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QUESTION3
(a) Commentontheneedforethical guidancefor accountants on money laundering.(5
marks)
(b)YouareseniormanagerinDezo&Co,afirmofCertifiedPublicAccountants.Recently,you
have been assigned specific responsibility for undertaking annual reviews of existing clients.
Thefollowingsituationshaveariseninconnectionwiththreeclients:
(i)DezowasappointedauditorandtaxadvisortoKoraColastyearandhasrecentlyissuedan
unmodified opinion on the financial statements for the year ended 31 March 2006. To your
surprise, the tax authority has just launched an investigation into the affairs of Kora on
suspicionofunderdeclaringincome.(7marks)
(ii)ThechiefexecutiveofXalamCo,anexporterofspecialistequipment,hasaskedforadviceon
the accounting treatment and disclosure of payments being made for security consultancy
services. The payments, which aim to ensure that consignments are not impounded in the
destination country of a major customer, may be material to the financial statements for the
year ending 31 December 2006. Xalam does not treat these payments as tax deductible. (4
marks)
(iii) Your firm has provided financial advice to the Pholey family for many years and this has
sometimesinvolvedyourfirmincarryingouttransactionsontheirbehalf.Theeldestson,Esau,
is to take up a position as a senior government official to a foreign country next month. (4
marks)
Required:
Identifyandcommentontheethicalandotherprofessionalissuesraisedbyeachofthese
mattersandstatewhataction,ifany,Dezo&Coshouldnowtake.(15marks)
Note:Themarkallocationisshownagainsteachofthethreesituations.
(20marks)

SUGGESTEDSOLUTIONFORQN2AND3
Zilipendwa&Co
(a)MatandaCo
If a letter of support had not been received, then a qualified opinion on the grounds of
disagreement (about the appropriateness of the going concern presumption) would be
required.Asthematterislikelytobepervasiveanadverseopinionwouldbeappropriate(ISA
570GoingConcern).

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However, the company has received a letter of support from its parent company to the effect
that it willenable Matanda to continue trading.If thisevidence(togetherwith otherevidence
such as managements representations) is considered to be sufficient to support the
appropriateness of the going concern presumption, a qualified opinion will not be necessary
provided that the support is adequately disclosed in a note to the financial statements. If the
evidenceissufficient,butthedisclosureinadequate,anexceptforopinionwouldberequired.
If the letter of support does not provide sufficient evidence (eg if there are doubts about
Chumbasabilitytoprovidetherequiredfinance),thesignificantuncertaintyarisingshouldbe
disclosedinanemphasisofmatterparagraphintheauditorsreport.
Thiswouldnotresultinaqualifiedopinion(unlessthedisclosurerelatingtoitwereconsidered
inadequate).
Conclusion
Theauditseniorsproposalisunsuitable.Theauditorsreportshouldbeunmodified(assuming
thatDisclosuresareadequate).
(b)LorenzeCo
Inordertoshowfairpresentation,inallmaterialrespects,thefinancialstatementsofanentity
should contain not only accurate figures, but also sufficient disclosure in relation to those
figures in order to allow the user to understand them. As required by IAS 1 Presentation of
FinancialStatements,itemsshouldbetreatedonaconsistentbasisfromyeartoyear.Ifthisis
notthecase,thenanychange,togetherwiththefinancialimpactofthischange,willneedtobe
disclosedinanotetothefinancialstatements.
Failure to disclose the reasons for change in policy (ie to comply with IFRS 3 Business
Combinations) and its effects (eg the lack of annual amortisation) means that the financial
statementsdonotcomplywithIAS8 AccountingPolicies,ChangesinAccountingEstimatesand
Errors.Aqualifiedopinionisthereforerequiredonthegroundsofdisagreementondisclosure
(IAS1andIAS8).Assumingthemattertobematerial(butclearlynotpervasive),anexceptfor
opinionshouldbeexpressed.
The main purpose of an emphasis of matter paragraph is to describe a matter of significant
uncertaintywhichhasbeentakenintoaccountinformingtheauditopinionitdoesnotqualify
that opinion. Such a paragraph highlights a note in the financial statements that more
extensivelydiscussesthematter.Anemphasisofmatterparagraphcannotthereforebeusedto
makegoodalackofdisclosure.
IFRS 3 also requires disclosure of a reconciliation of the carrying amount of goodwill at the
beginningandendoftheyear.Thisshouldshownomovementfortheyearended30June2006.
Conclusion
Theauditseniorsproposalisunsuitable.Unlessallaspectsofthechange(includingreasonand
effect)areadequatelydisclosedanexceptforqualification willberequiredonthegroundsof
disagreement.
(c)AbruptCo
Theauditopinionstateswhetherthefinancialstatements:
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arepresentedfairly,inallmaterialrespects(orgiveatrueandfairview)inaccordancewith
thefinancialreportingframework;and
complywithstatutoryrequirements(whereappropriate).
The directors report is not a part of financial statements prepared under International
FinancialReportingStandards(IFRS).
However, auditors have a professional responsibility to read other information in documents
containingauditedfinancialstatements(egthedirectorsreportinanannualreport)toidentify
material inconsistencies with the audited financial statements (or material misstatements of
fact).
A material inconsistency exists when other information contradicts information contained in
theauditedfinancialstatements.
Clearly,majorisinconsistentwith1.6%.
Iftheinconsistencyisresolved(egbecausethedirectorsreportiscorrectedtostate...major
partofotherincome...)anunmodifiedauditorsreportwillbegiven.
If the inconsistency is not resolved, the audit opinion on the financial statements cannot be
qualified (because the inconsistency is in the directors report). In this case, an emphasis of
matter paragraph may be used to report on this matter that does not affect the financial
statements (ISA 700 The Independent Auditors Report on a Complete Set of General Purpose
FinancialStatements).
Conclusion
Anunqualifiedopiniononthefinancialstatementsisappropriate.If,however,theinconsistency
is not resolved, it should be reported in a separate emphasis of matter paragraph, after the
opinionparagraph.
(d)JingleCo
Thecashtransferisanonadjustingpostbalancesheetevent.ItindicatesthatBellwastrading
afterthebalancesheetdate.
However,thatdoesnotprecludeBellhavingcommencedtradingbeforetheyearend.
The finance directors oral representation is wholly insufficient evidence with regard to the
existence (or otherwise) of Bell at 30 June 2006. If it existed at the balance sheet date its
financialstatementsshouldhavebeenconsolidated(unlessimmaterial).
The lack of evidence that might reasonably be expected to be available (eg legal papers,
registrationpayments,etc)suggestsalimitationonthescopeoftheaudit.Ifsuchevidencehas
been sought but not obtained then the limitation is imposed by the entity (rather than by
circumstances).
Whilstthetransactionitselfmaybeimmaterial,theinformationconcerningtheexistenceofBell
may be material to users and should therefore be disclosed (as a nonadjusting event). The
absence of such disclosure, if the auditor considered necessary, would result in a qualified
exceptfor,opinion.
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Tutorialnote: Anymatterthatisconsideredsufficientlymaterialtobeworthyofdisclosureasa
nonadjustingeventmustresultinsuchaqualifiedopinionifthedisclosureisnotmade.
If Bell existed at the balance sheet date and had material assets and liabilities then its non
consolidationwouldhaveapervasiveeffect.Thiswouldwarrantanadverseopinion.
Also,thenatureofthelimitation(beingimposedbytheentity)couldhaveapervasiveeffectif
the auditor is suspicious that other auditevidence hasbeen withheld.In thiscase theauditor
shoulddisclaimanopinion.
Conclusion
Additionalevidenceisrequiredtosupportanunqualifiedopinion.Ifthiswerenotforthcoming
adisclaimermaybeappropriate.

QUESTION3
(a)Needforethicalguidance
Accountants(firmsandindividuals)workinginacountrythatcriminalisesmoneylaundering
arerequiredtocomplywithantimoneylaunderinglegislationandfailuretodosocanleadto
severepenalties.Guidanceisneededbecause:
legalrequirementsareonerous;
moneylaunderingiswidelydefined;and
accountantsmayotherwisebeused,unwittingly,tolaundercriminalfunds.
Accountants need ethical guidance on matters where there is conflict between legal
responsibilities and professional responsibilities. In particular, professional accountants are
boundbyadutyofconfidentialitytotheirclients.Guidanceisneededtoexplain:
how statutory provisions give protection against criminal action for members in respect of
theirconfidentialityrequirements;
whenclientconfidentialityoverrideprovisionsareavailable.
Furtherguidanceisneededtoexplaintheinteractionbetweenaccountantsresponsibilitiesto
reportmoneylaunderingoffencesandotherreportingresponsibilities,forexample:
reportingtoregulators;
auditorsreportsonfinancialstatements(ISA700);
reportstothosechargedwithgovernance(ISA260);
reportingmisconductbymembersofthesamebody.
Professionalaccountantsarerequiredtocommunicatewitheachotherwhenthereisachange
inprofessionalappointment

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(ie professional etiquette). Additional ethical guidance is needed on how to respond to a


clearance letter where a report of suspicion has been made (or is being contemplated) in
respectoftheclientinquestion.
Tutorialnote:Althoughthetermprofessionalclearanceiswidelyused,rememberthatthereisno
clearancethattheincumbentaccountantcangiveorwithhold.
Ethicalguidanceisneededtomakeaccountantsworkingincountriesthatdonotcriminalise
money laundering aware of how antimoney laundering legislation may nevertheless affect
them. Such accountants may commit an offence if, for example, they conduct limited
assignments or have meetings in a country having antimoney laundering legislation (eg UK,
Ireland,Singapore,AustraliaandtheUnitedStates).
(b)Annualreviewsofexistingclients
(i)Taxinvestigation
Koraisarelativelynewclient.Beforeacceptingtheassignment(s)Dezoshouldhavecarried
out customer due diligence (CDD). Dezo should therefore have a sufficient knowledge and
understandingofKoratobeawareofanysuspicionsthatthetaxauthoritymighthave.
Astheinvestigationhascomeasasurpriseitispossiblethat,forexample:
thetaxauthoritiessuspicionsareunfounded;
Dezohasfailedtorecognisesuspiciouscircumstances.
Tutorialnote:Ineithercase,Dezoshouldnowreviewrelevantprocedures.
Dezoshouldreviewanycommunicationfromthepredecessorauditorobtainedinresponseto
its professional inquiry (for any professional reasons why the appointment should not be
accepted).
Aqualitycontrolfornewauditsisthattheauditopinionshouldbesubjecttoasecondpartner
reviewbeforeitisissued.Itshouldbeconsiderednowwhetherornotsuchareviewtookplace.
If it did, then it should be sufficiently well documented to evidence that the review was
thoroughandnotamereformality.
Criminalpropertyincludestheproceedsoftaxevasion.IfKoraisfoundtobeguiltyofunder
declaringincomethatisamoneylaunderingoffence.
Dezos reputational risk will be increased if implicated because it knew (or ought to have
known)aboutKorasactivities.
(Dezo may also be liable if found to have been negligent in failing to detect any material
misstatementarisinginthe31March2006financialstatements.)
Korasauditworkingpaperfilesandtaxreturnsshouldbereviewedforanysuspicionoffraud
being committed by Kora or error overlooked by Dezo. Tax advisory work should have been
undertakenand/orreviewedbyamanager/partnernotinvolvedintheauditwork.
Astaxadvisor,Dezocouldsoonbemakingdisclosuresofmisstatementstothetaxauthorities
onbehalfofKora.DezoshouldencourageKoratomakenecessarydisclosurevoluntarily.

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If Dezo finds reasonable grounds to know or suspect that potential disclosures to the tax
authorities relate to criminal conduct, then a suspicious transaction report (STR) should be
madetothepoliceforce
Tutorialnote:Thoughnotthemainissuecreditwillbeawardedforotherethicalissuessuchasthe
potentialselfinterest/selfreviewthreatarisingfromtheprovisionofotherservices.
(ii)Adviceonpayments
Ascomparedwith(i)thereisnoobvioustaxissue.Xalamis notoverstatingexpenditurefor
taxpurposes.
Dezo should consider its knowledge of import duties, etc in the destination country before
recommendingacourseofactiontoXalam.
The payments being made for security consultancy services may amount to a bribe.
Corruptionandbribery(andextortion)aredesignatedcategoriesofmoneylaunderingoffence
under The Forty Recommendations of the Financial Action Task Force on Money Laundering
(FATF).
Ifthisisabribe:
Xalam clearly benefits from the payments as it receives income from the contract with the
majorcustomer.Thisiscriminalpropertyandpossessionofitisamoneylaunderingoffence
Dezo should consider the seriousness of the disclosure made by the chief executive in the
contextofdomesticlaw.
Dezomaybeguiltyofamoneylaunderingoffenceifthematterisnotreported.Ifareportto
theFIUisconsiderednecessaryDezoshouldencourageXalamto makevoluntarydisclosure.If
Xalamdoesnot,Dezowillnotbeinbreachofclientconfidentialityforreportingknowledgeofa
suspicioustransaction.
Tutorialnote:Makingareporttakesprecedenceoverclientconfidentiality.
(iii)Financialadvisor
Customerduediligence(CDD)andrecordkeepingmeasuresapplytodesignatednonfinancial
businessesandprofessions(suchasDezo)whopreparefororcarryoutcertaintransactionson
behalfoftheirclients.
Esau is a politically exposed person (PEP ie an individual who is to be entrusted with
prominentpublicfunctionsinaforeigncountry).
DezosbusinessrelationshipswithPholeythereforeinvolvereputationalriskssimilartothose
withEsau.InadditiontoperformingnormalduediligencemeasuresDezoshould:
haveriskmanagementsystemstohavedeterminedthatEsauisaPEP;
obtainseniorpartnerapprovalformaintainingbusinessrelationshipswithsuchcustomers;
takereasonablemeasurestoestablishthesourceofwealthandsourceoffunds;
conductenhancedongoingmonitoringofthebusinessrelationship.
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DezocanchoosetodeclinetoactforPholeyand/orEsau(ifasked).
Ifthebusinessrelationshipistobecontinuedseniorpartnerapprovalshouldbeobtainedfor
anytransactionscarriedoutonPholeysbehalfinfuture.
Tutorialnote:ThePholeyfamilyisnotdescribedasanauditclientthereforenofamiliaritythreat
arisesinrelationtoan
audit(thefamilymaynothaveanyinvolvementinentitiesrequiringanaudit).

QUESTION4
YouhavebeenpresentedwiththefollowingdraftfinancialinformationaboutMTAKUJA,avery
successfulcompanythatdevelopsandlicensesspecialistcomputersoftwareandhardware.Its
noncurrentassetsmainlyconsistofproperty,computerhardwareandinvestments,andthere
have been additions to these during the year. The company is experiencing increasing
competition from rival companies, most of which specialize in hardware or software, but not
both.Thereispressuretoadvertiseandtocutprices.
You are the audit manager. You are planning the audit and are conducting a preliminary
analytical review and associated risk analysis for this client for the year ended 31 May 2004.
Youhavebeenprovidedwithasummarizeddraftincomestatementwhichhasbeenproduced
very quickly and certain accounting ratios and percentages. You have been informed that the
company accounts for research and development costs in accordance with IAS 38 Intangible
Assets.

INCOMESTATEMENT
Yearended31May

2003

2002

TZS000,000

TZS000,000

Revenue

15,206

13,524

Costofsales

3,009

3,007

GrossProfit

12,197

10,517

Distributioncosts

3,006

1,996

Administrativeexpenses

994

1,768

Sellingexpenses

3,002

274

Profitfromoperations

5,195

6,479

Netinterestreceivable

995

395

Profitbeforetax

6,190

6,874

Incometaxexpense

3,104

1,452

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Netprofit

3,086

5,422

Retainedprofits

1,617

3,983

Dividendspaid

1,469

1,439

Earningspershare

043

104

Grossmargin

080

078

Distributioncosts

020

015

Administrativeexpenses

007

013

Sellingexpenses

020

002

Operatingprofit

034

048

Accounting
percentages

ratios

and

Performance ratios include the


following
Expenses as a percentage of
revenue

Required:
(a) Using the information above, comment briefly on the performance of the company for the
twoyears.(8marks)
(b)Useyouranswertopart(a)toidentifytheareasthataresubjecttoincreasedauditriskand
describethefurtherauditworkyouwouldperforminresponsetothoserisks.(12marks)
(c) Explain the auditors responsibilities for the appropriateness of the going concern
assumptionasabasisforthepreparationoffinancialstatements.

QUESTION4SUGGESTEDSOLUTION
1(a)Performance
(i) The company has increased its revenues by 12% and its gross profit by 16% which in a
competitive market is very good (if not entirely credible) however, increased operating
expenseshaveresultedinareductioninoperatingprofitsof20%.
(ii) The gross margin is very high; this is not abnormal in this sector, especially for software
(althoughthemarginishighforhardware),butitmayalsobetheresultoferrors,becausethe
informationhasbeenproducedveryquickly.Thisisalsotrueoftheotherfigures.
(iii)Totalexpensesasapercentageofrevenuehaveincreasedsubstantiallywiththeresultthat
operatingprofitasapercentageofrevenuehasreducedbyaroundathird.
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(iv)Theincreaseinthesellingexpensesasapercentageofrevenuemayreflecttheneedforthe
companytospendmoreonadvertising.
(v)Theincreaseinthedistributioncostsasapercentageofrevenuemayreflectinefficienciesin
themethodofdistributioninanindustrythatseparatesthesefunctions.
(vi)Theadministrativeexpensesasapercentageofrevenuehavehalvedalthoughtheydonot
representasignificantamountinabsoluteterms.
(vii) The reduction in operating profits has been partially offset by increased net interest
receivablebutprofitbeforetaxisstilldown10%.
(viii) The reduction in profit before tax and the increased tax charge have resulted in a
reductioninprofitaftertaxofover40%.
(ix)Totaldividendshavebeenincreased,despitethelowerprofits.
(x) The reduction in earnings per share is partly due to the reduction in profits but there is
insufficientinformationtostatewhetheritisalsoattributabletoanincreaseinthenumberof
shares,althoughthisseemslikely.

(b)Higherriskareasandauditprocedures
Grossmarginandoperatingexpenses
(i) I would obtain a detailed schedule of revenue and cost of sales showing the opening and
closinginventoryfiguresforbothsoftwareandhardwareandIwouldperformadetailedreview
ofchangeson,say,amonthly,quarterlyandhalfyearlybasis.
(ii) I would ascertain the accounting policies for revenue recognition for both software and
hardware and ensure that they were in accordance with relevant International Accounting
Standards.Iwouldthentesttheapplicationofthesepolicies toindividualtransactions.IAS38
IntangibleAssetsrequiresthatcertaindevelopmentcostsbecapitalizedinthebalancesheetand
thatresearchcostsandcoststhatdonotmeetthecriteriaforcapitalizationbeexpensed.
(iii)Iwould seektoestablishwhyallthreecategoriesof operatingexpenseshave changed so
dramatically,byenquiryandbyobtainingascheduleofoperatingexpensesandabreakdownof
thecostofsalesfigure.
(iv) I would perform detailed analytical procedures on operating expenses and cost of
sales/grossmargins,onaquarterlyandmonthlybasisandIwouldalsoperformdetailedtesting
oftransactionsintheseareasinordertoensurethatmisclassificationshavenotoccurred.
(v)Auditevidenceprovidedbybalancesheetworkontheinventoryfigures(suchasanalytical
proceduresperformedontheinventorylevelsandattendanceattheinventorycount)willalso
provideevidenceinrelationtocostofsales.
(vi) It is possible that some reclassifications or even errors have been made some costs
appearingasoperatingexpensesmightproperlybelongincostofsales.Itcertainlyseemsodd
thatwhilstsaleshaveincreasedby12%,thecostofsalesfigurehashardlyincreasedatall.The
reductioninadministrativeexpensesshouldalsobeinvestigated.
(vii)Iwouldobtainschedulesrelatingtononcurrentassetsandestablishtheextenttowhich
thesehadcontributedtoanincreaseindepreciationcosts.Iwouldenquireastothenatureof
theadditionsandtheirpurpose.Additionalnoncurrent

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assetswouldalsobeexpectedtocontributetorevenues.Ifthechangeintheearningspershare
figureis(partly)a resultofanewissueofshares,itmaybethatthecashgeneratedhasbeen
usedforinvestmentinnoncurrentassets.
(viii) Because of the possibility of errors, I would increase my sample sizes during tests of
controlsovertherecording,processingandpostingoftransactionsthatarepostedtorevenue,
costofsalesandoperatingexpenseaccounts.
(ix)Iwouldperformdetailedsubstantivetestingonsamplesoftransactionsintheseareasfrom
sourcedocumentation(suchaslicensingdocumentation,payrollrecords,purchaseinvoicesfor
components etc.) through to the daybooks, ledgers, and schedules supporting the income
statement(forcompleteness),andviceversa.
(x)Theextentofsubstantiveprocedureswilldependontheextenttowhichcontrolsareshown
to be effective and I would be particularly careful to follow up any errors discovered in both
tests of controls and substantive testing. I would also pay particular attention to any
unauthorized,substantialorlateadjustments.
Interestreceivable
(xi)Iwouldaskforabreakdownof,andexplanationfor,theincreaseinnetinterestreceivable.I
wouldperformfurtheranalyticalproceduresontheinterestcostsandincomeandensurethat
theseareinlinewithcurrentinterestratesandthetypesofinvestmentsheldbythecompany.
Taxation
(xii)Itseemsstrangethatthetaxfigurehasincreasedsodramatically.Iwouldaskforcopiesof
the tax calculations for detailed review, and to corroborate explanations provided by
management.
Dividendsandearningspershare
(xiii)Iwouldenquireastowhydividendshadincreased,despitethelowerprofits,andestablish
whether this trend can be maintained in the face of falling profits. I would also enquire as to
whetherthecompanyhasanyplanstorestructureinlinewithtrendsintheindustry,whatthe
company intends to do about the competition, and whether there is any possibility of a take
over.
(xiv)Iwouldestablishwhethertherehadbeenanyshareissueduringtheyearthathadaffected
the calculation of the earnings per share and, if there had been, what was the purpose of the
shareissue.

(c)Auditorsresponsibilitiesappropriatenessofgoingconcernassumption
Tutorialnote:Thisisonlya5markrequirementandcommentscontributingtoanexplanationof
directorsresponsibilitiesinsteadof,oraswellas,auditorsresponsibilitieswillnotearnmarks.
Theauditorshouldconsider:
the appropriateness of managements use of the going concern assumption (a fundamental
principle in the preparation of the financial statements) when planning and performing audit
proceduresandinevaluatingtheresultsthereof;and
whethereventsorconditionsmaycastsignificantdoubtontheentitysabilitytocontinueasa
goingconcern(andstayalerttoevidenceofsucheventsorconditions).

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In particular the auditor should evaluate managements assessment of the appropriateness of


thegoingconcernassumptionforaperiodofatleast12months.
Whentherearesignificantdoubtsabouttheappropriatenessoftheassumption,managements
plansforfutureactionsshouldbereviewed.Sufficientevidenceshouldbegatheredtoconfirm
ordispel whetheror not materialuncertainty exists. Thismay necessitate theperformanceof
additional specific audit procedures (e.g. the examination of cash flows and prospective
financialinformation).
Written management representations should be sought confirming managements plans and
futureactions.
Where the going concern is appropriate but a material uncertainty exists the auditor must
assess the adequacy of managements disclosure (of events/conditions and managements
plans)inthefinancialstatements.Ifdisclosureis:
adequate, the audit opinion should be unqualified opinion with an emphasis of matter
paragraph;
inadequate,theauditorshouldexpressaqualifiedoradverseopinion(asappropriate).
Iftheassumptionisjudgedinappropriatetheauditorshouldexpressanadverseopinionifthe
financial statements have been drawn up on a going concern basis (irrespective of any
disclosuremade).

QUESTION5
(a) There is a growing demand in both the public and private sectors for professional
accountants to provide assurance on a variety of subject matter by expressing a conclusion
regardingitsqualityorcontext.
Required:
Discuss this statement in the context of IFACs first International Standard on Assurance
Engagements.
(b) Knowledge of the business is crucial to determining the most effective and efficient audit
strategyforanentityusingtheInternetforelectroniccommerce.Anyauditorneedstohavean
indepthunderstandingoftherelatedrisksandthesecuritymeasurestominimisethem.
Required:
Discusstheimpactofecommerceontheauditprocess.

(b) You are the audit manager of MAJALIWA Co, a private limited liability company. You are
currently reviewing two matters that have been left for your attention on the audit working
paperfilefortheyearended30September2005:
(i) MAJALIWA holds an extensive range of inventory and keeps perpetual inventory records.
There was no full physical inventory count at 30 September 2005 as a system of continuous
stockcheckingisoperatedbywarehousepersonnelunderthesupervisionofaninternalaudit
department.
A major systems failure in October 2005 caused the perpetual inventory records to be
corruptedbeforetheyearendinventorypositionwasdetermined.Asdatarecoveryprocedures
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were found to be inadequate, MAJALIWA is reconstructing the yearend quantities through a


physical count and rollback. The reconstruction exercise is expected to be completed in
January2006.(6marks)
(ii)AuditworkonafterdatebanktransactionsidentifiedatransferofcashfromMIPANGOCo.
TheauditseniorhasdocumentedthatthefinancedirectorexplainedthatMIPANGOcommenced
tradingon7October2005,after
being set upas a whollyowned foreignsubsidiaryof MAJALIWA. No other evidence has been
obtained.(4marks)
Required:
Identifyandcommentontheimplicationsoftheabovemattersfortheauditorsreportonthe
financial statements of MAJALIWA Co for the year ended 30 September 2005 and, where
appropriate,theyearending30September2006.
(c) Describe the principal audit procedures to be carried out on the opening balances of the
financialstatements
(d)Explaintheauditorsresponsibilitiesforotherinformationindocumentscontainingaudited
financialstatements

SUGGESTEDSOLUTIONQUESTION5
(a)

Providingassurance

Tutorial note: A simple discuss question should not be approached as .write everything I know
about this topic. Candidates will be expected to address the key words and phrases in the
statementinalogicalorder.
The statutory audit of historical financial statements is an example of a traditional assurance
servicewhichhasbeenprovidedbyauditorsformanyyears.Factorswhichhavecontributedto
agrowingdemandfordifferentassuranceservicesbyaccountantsinclude:
.businessexpansion(e.g.throughacquisitionsandmergers)andglobalization;
.developmentsininformationtechnologyandcommunicationnetworks;
.greateraccountabilityofcorporatemanagers;
.theaccountingprofessiontakingtheopportunitytoprovidenonauditservices.
In the public sector, assurance is increasingly sought on information concerning the
performanceofnationaldepartmentsandeducationproviders(Intheprivatesector,thereisan
increasing demand for large companies to assess the quality of their management and
communications systems, whilst consumers demand assurance that ecommerce ensures data
integrityandconfidentiality.
Professionalaccountantsbringindependencetoassuranceservicesbecausetheyareboundto
adheretoanethicalcode(e.g.IFACsCodeofEthicsforProfessionalAccountants.ortheNBAAs
.Rules of Professional Conduct.). Such codes require that other fundamental principles,
including integrity, professional competence, due care and confidentiality, be observed. The
term.professionalaccountant.includes.auditor.
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The objective of an assurance engagement is to enhance the credibility of information (by


evaluatingthesubjectmatteragainst
suitable criteria and to expressing a conclusion that conveys a degree of confidence to the
intendedusers).
Thus,assuranceservicesimprovethequalityorcontextofinformationfordecisionmakersto
use. Quality concerns the relevance and reliability of information which is interrelated with
sufficiency (a measure of quantity). Context concerns the format in which information is
presented.

Typesofassuranceservicesinclude:
. Risk assessments . evaluating whether an entity has appropriate systems to manage its
businessrisks;
.Performancemeasurement.assessingthequalityofperformancemeasurementsystemsasa
basisfordeterminingwhethertheorganisation.sgoalsandobjectivesareachieved;
. Information systems . providing assurance that the entity.s information systems provide
relevantandreliableinformationfor
financialandoperatingdecisions;
.Ecommerce.evaluatingwhetheranentity.swebsiteconformstotheprinciplesandcriteriafor
businesstoconsumerelectroniccommerce.
Subjectmatter,whichmaybeasatapointintimeorforaperiodoftime,mustbeidentifiable
andinaformwhichallowsevidencetobegathered.Forexample:
.Data(e.g.prospectivefinancialinformation);
.Systems(e.g.internalcontrols);
.Behaviour(e.g.corporategovernance).
An engagement which seeks to provide a .high. (but not absolute) level of assurance (e.g. an
audit)isconcludedbytheexpressionof
an opinion on whether the subject matter (e.g. financial statements) conform, in all material
respects, to suitable criteria (e.g. financial statement assertions). This is called .positive
assurance.
However, an engagement may seek to provide only a .moderate. level of assurance either
because the professional accountant.s procedures are less extensive than for an audit (e.g. a
reviewengagement)orbecausethesubjectmatterislessreliable(e.g.
prospectivefinancialinformation).Theconclusionisexpressedina.negative.form(i.e.thatno
informationcametolighttosuggestthatthesubjectmatterdidnotconformwithstatedcriteria
orassertions).
Additionalpoints
. The profession has been slow to respond to the growing demand because of the associated
increaseinexposuretoprofessionalliability.
.ISA100hasbeenissuednotjusttoestablishstandardsandprovideguidancebuttoactasa
frameworkforthedevelopmentbytheIAPCofspecificstandardsonassuranceengagement.
(b)Tutorialnotes
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(1) Impact in the requirement means what effect (if any) this is reinforced by differences in
focusinthequote.
(2) In its widest sense the term audit process encompasses the stages of engagement/client
acceptance, planning, testing/evidence, evaluation and reporting thus the one line of the
requirementprovidesaframeworkforastructured
answer.
(3) The quote provides further context and clues for a discussion related risks and security
measures.
ElectronicCommerceUsingtheInternetorOtherPublicNetworks(EffectontheAuditofFinancial
Statements).
GiventhescopeofthisQcandidatesshouldneitherbesurprisednordeterredbythelengthofthis
answer!
Engagement/clientacceptance
Anauditormustbecompetenttoaccept/continueanengagementfortheauditofthefinancial
statementsofanentityengagedinecommerce.Inparticulartheauditormusthavethemeans
toassesstheentityssecurityinfrastructure(anaspectofthecontrol
environment),evaluateinternalcontrolsandcarryoutdetailedsubstantiveprocedures.
Knowledgeofthebusiness
The auditors knowledge of the business is fundamental to assessing the significance of e
commerce to the entitys business activities and any impact on audit risk. For example, the
auditorshouldconsiderwhethersecurityissueshavebeenaddressedandthewayinwhich:
_ ecommerce links to the entitys operating system e.g. many ecommerce systems on the
Internet (online shop fronts) are not yet linked with the entitys accounting (back office)
systems;
_Internettransactionsarecapturedandtransferredtotheentitysaccountingrecords.Thismay
affect:
thecompletenessandaccuracyoftransactionrecording;
thetimingofrevenuerecognition;
recognitionandrecordingofdisputedtransactions.
TheauditorrequiresappropriateITskillsandInternetknowledgeto:
understandthetechnologyused;
assesstheITskillsofentitypersonnel;
adoptathroughthecomputerauditapproach(seelater).
Specifically,theauditorofanentityinvolvedinecommerceneedstounderstand:
thewiderangeofrisksthatexists(e.g.relatinghacking,lackofauthenticationoftransactions,
transmissionfailures,lossoftrust,theftofcustomeridentity,etc);andthesystemsreliability
andpreventativeanddetectioncontrols.
Materiality
The auditor is unlikely to use traditional benchmarks to establish a materiality threshold
because:
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materialityisnotbasedsolelyonquantitativemeasures;
qualitative factors may include the assessment of a systems reliability (where it is as yet
unproven);
theimpactofsignificantrisks(seebelow)arisingcannotbequantifiedinfinancialterms;
theremaybenoperformancetrackrecord.
Tutorial note: A profitbased materiality threshold is likely to be inappropriate for a dot.com
company.

Riskassessment
The auditor considers ecommerce business risks in so far as they may impact on audit risk
including:
risks arising from relationships with ecommerce trading partners this concerns the
authenticityofcustomers/suppliesandtheintegrityoftransactions;
risks related to the recording and processing of ecommerce transactions e.g. if an
unidentifiedindividualcaninitiatea
transaction,orthereisalossofvisibleevidence(audittrail);
pervasiveecommercesecurityrisks(includingviruses,hackingandothercomputercrimes)
whichimpactonthecontrolenvironment;
denialofservicei.e.overloadingthesystemwithspooforderstobringdownthesystem;
fraudriskswhichareincreasedbytheanonymityofcustomers(similarlymoneylaundering);
risksofsystemfailuresorcrasheswhichrestrictaccessandresultinlossofdata;
enhancedgoingconcernriskofcompaniesinvolvedinInternetactivitygenerallyanddot.com
companiesinparticular.
The way in which an entity uses IT for ecom, including the entitys assessment of risk and
acceptable risk levels in the IT systems, is significant to the security, completeness and
reliabilityofthefinancialinformationproduced,andthereforeaffectstheauditorsassessment
ofinherentandcontrolrisk.
Dot.Comentities
Particularrisksrelatingtodot.comentitiesinclude:
theabsenceofatraditionalassetbase;
thetreatmentofcostsincurredinsettingupaninfrastructure;
theneedforongoinginvestmentinwebtechnology;
cash flow forecasts and business plans based on subjective judgments without any proven
basis;
lackofcashflowswhenbusinesstakesoff(i.e.overtrading);
generatingintangiblessuchasbrandvalueandcustomerservicequality;
marketpressurestoachieveexpectations;

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value added through ecommerce resulting in a market capitalisation which is significantly


(sometimesphenomenally!)higher
thanthebookvalueoftheunderlyingnetassets.
Tutorialnote: Themarketcapitalisationofdot.comentitiesmaybebasedonarevenuemultiple
wheretheentityisjustamiddleman
effectivelytakingacommission on the sale,but showing thatcommission asrevenue lesscost of
sale.
Formanydot.combusinesses(likeAmazon.com),thegreatestimpactofecommerceisonthe
salessystem.Riskareaswillinclude:
validityofcustomersandothers;
creditworthinessandcreditcardtransactions;
despatchingofproducts.
Goingconcern
When ecommerce businesses report significant losses in their startup phase, the
appropriateness of the going concern assumption (which underlies the preparation of the
financialstatements)shouldbeassessed.Theauditorshouldconsider:
theextenttowhichthelossesareduetononrecurringtransactionsandevents;
cashflowandbreakevenforecasts;
theentitysbusinessplans(e.g.tofurtherextendoperatingactivitiese.g.intowarehousing
anddistribution);
whetherfinancialarrangementsareadequatetoensuretheviabilityofcontinuedoperations.
Controls
Internalcontrolsseektoensurethattransactionsareauthorisedandcorrectly(i.e.completely
andaccurately)recordedandthat
assetsaresafeguarded.Thenatureofecommercetransactionsdemandsthatcontrolsaremore
sophisticatedandextensive(e.g.
encompassingdataprivacy).
Securitymeasuresaimedatensuringtransactionintegrityinclude:
encryptioni.e.scramblingintocodewhichcanonlybedecryptedwiththerightkey;
hashvaluesi.e.atotaloffieldstocheckthatnumericalvaluesinatransactionhavenotbeen
tamperedwith;
digitalsignaturesverifythattransactionhasbeensentbyanauthoriseduser;
68digitpasswordsofalphanumericcombination;
biometricsi.e.physicalattributes(e.g.thumbprints,voicerecognition,retinascans);
transaction certificatestypicallyobtained by aconsumer and presented electronicallyto a
supplierwhochecksitsvalidity
withtheproviderofthecertificationservice.
Systemsfailures
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Systems failures (both at the entity and for outsourced functions) can affect the entitys
reputationandresultinapotentiallossof
customers, with a significant impact on profit. The auditor considers the entitys contingency
andbusinesscontinuityplans.
Evidence
In contrast to traditional businesses which focus on controls relating to each stage of
transactionrecording,systemcontrolsfor
ecommercefocusontransactionexecution(e.g.fulfillingacustomerorder).Theauditormust
obtainevidenceofboththedesign
andoperationofcontrolsrelatingtotransactionexecutiontoensurethat:
fictitiousormultipleidentitiesareidentified(i.e.authenticcustomer);
customersbrowsingandthoseplacingordersaredistinguished;
inputisvalidatedandduplicationoromissionoftransactionsisprevented;
termsoftradearedeterminedatthesametimetheorderisprocessed(thismayrequirethat
paymentiscollectedwhenan
orderisplaced);
causes of transaction failures (e.g. credit card authorisation failure and breaks in
communication)areaddressed;
incompleteprocessingisprevented(e.g.byrejectingtheorder).
Itishighlyunlikelythataroundthecomputerapproachwillbeappropriateasbothinputof
transactions and processing are electronic. Even though physical goods may be dispatched
(thoughnotalwayse.g.softwaresuppliers)thereistypicallyless
conventional external audit evidence and the traditional audit paper trail is virtually
eliminated(e.g.onlinecustomerordersandconfirmationthereof)
Audittrailsincludingaccessandtransactionlogsmaydeteranddetectunauthorisedusersand
roguetransactions.Althoughentitiesmaynothaveautomaticaccesstotheseandotherunusual
activitylogs,servicelevelagreementswiththeISP(InternetServiceProvider)mayprovidefor
themtoberetrievedondemandforauditpurposes.
Electronicrecordscanbemoreeasilydestroyedoralteredthanmorerobustphysicalrecords
(withoutleavingevidenceofsuchdestructionoralteration).Thereforetheauditormustassess
whether security of information policies and security controls are adequate to prevent
unauthorised access or changes to the financial records. Particular consideration should be
givento:
the controls incorporated in system design to ensure data integrity (e.g. record integrity
checks,electronicdatestampsusing
digitalsignatures,versioncontrolofelectronicevidence,etc);
controlsoverthedatainterface(betweenfrontandbackofficesystems);
controlsoverrealtimerequirements(e.g.toprovideabufferbetweentransactionsprocessed
ontheInternetandexistingoperatingsystems);
theaccessibility,integrityandretentionofecomrecords.
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Computerassistedaudittechniques
Fileinterrogationsoftware(whichaccessedtheentitysdataandmasterfiles)maybeusedto
examine all (rather than a sample of) items in a population. Files on online systems may be
interrogatedusinginteractiveenquirysoftware.
Analyticalprocedures
Analyticalproceduresmustbe used at theplanning andoverall review stages. However,their
use as substantive analytical procedures may be limited as traditional relationships (e.g.
betweentransactionandaccountbalances)maynolongerbeappropriate.
A significant factor in the use of analytical procedures is the extent of disintermediation (i.e.
direct connection of producers and consumers to eliminate such middlemen as wholesalers,
distributorsandretailers).Thismayaffect,forexample:
levelsofinventoryheld(ifany);
thenatureofcustomeraccounts(e.g.individualsratherthanretailorwholesale).
Also,thecomparabilityofbalanceswithpriorperiodsmaybeaffectedbythereliabilityofthe
data produced. Particular difficulties may be encountered in obtaining relevant data and
identifyingrelatedpartytransactions.
Internalaudit
Wherean ecommercebusinesshasaninternalauditdepartment, the externalauditorshould
seek to place reliance on the work of internal audit (relating to the assessment of risks and
evaluationofinternalcontrols).
Specialists
The auditor may require the skills of a specialist to make appropriate inquiries and to
understandtheimplicationsofresponsesobtained.Forexample,rapidchangesintheInternet
mayresultindifferentinteractionsofevolvingtechnologiesandprocesses.
Similarly the auditor needs to recognise whether the entity is developing incompatible or
redundanttechnology.
It may be appropriate to engage an IT specialist (e.g. where the audit practice does not have
accesstothenecessaryskillsinhouse).
Serviceorganisations
Entitieswhichdonothavethetechnicalexpertisetoestablishandoperateawebsiteproviding
ecommerce may outsource their web operations to a third party (e.g. to take orders and
payments).
Theauditorshould(ISA402):
considerhowtheserviceorganisationaffectstheaccounting andinternalcontrolsystemsin
ordertoplananeffectiveauditapproach;
obtainsufficientunderstandingoftheaccountingandinternalcontrolsystems,assesscontrol
risk,etc(assumingtheserviceorganisationsactivitiesaresignificanttotheentityandrelevant
totheaudit).
Specifically, the auditor needs to understand the contractual terms of relevant activities (e.g.
whatrecoursedoestheentityhaveintheeventofnonsupplyofservices).
Sealsofapproval
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When an entitys website displays a seal demonstrating compliance with the standards of the
sealprovider,theauditormustunderstandwhatassurancethesealdoesanddoesnotprovide.
Itislikelythatifasealrequiresregularverification(e.g.WebTrust)theauditpracticehasbeen
involvedintheawardingoftheseal.Theauditorwillneedto befamiliarwiththesecurityand
privacyissuesandrelevantinternalcontrolswhenplan

(c)
Implicationsfortheauditorsreport
(i)Corruptionofperpetualstockrecords
The loss of data (of physical stock quantities at the balance sheet date) gives rise to a
limitationofscope.
Tutorialnote:Itistherecordsoftheassetthathavebeendestroyednotthephysicalasset.
ThesystemsfailureinOctober2005isclearlyanonadjustingpostbalancesheeteventIfitis
material (such that nondisclosure could influence the economic decisions of users) should
disclose:
thenatureoftheevent(i.e.systemsfailure);and
anestimateofitsfinancialeffect(i.e.thecostofdisruptionandreconstructionofdatatothe
extentthatitisnotcoveredbyinsurance).
Tutorial note: The event has no financial effect on the realisability of stock, only on its
measurementforthepurposeofreportingitinthefinancialstatements.
If material this disclosure could be made in the context of explaining how stock has been
estimatedat30September2005(seelater).Ifsuchdisclosure,thattheauditorconsiderstobe
necessary, is not made, the audit opinion should be qualified except for disagreement (over
lackofdisclosure).
Tutorial note: Such qualifications are extremely rare since management should be persuaded to
makenecessary
disclosureinthenotestothefinancialstatementsratherthanhaveusersattentiondrawntothe
matterthroughaqualificationoftheauditopinion.
Thelimitationofscopeoftheauditorsworkhasbeenimposedbycircumstances.MAJALIWA
accountingrecords(forstock)areinadequate(nonexistent)fortheauditortoperformtestson
them.
Analternativeproceduretoobtainsufficientappropriateauditevidenceofstockquantitiesat
ayearendissubsequentcountandrollback.However,theextentofrollbacktestingislimited
asrecordsarestillunderreconstruction.
Theauditormaybeabletoobtainsufficientevidencethatthereisnomaterialmisstatement
throughacombinationofprocedures:
testingmanagementscontrolsovercountingstockafterthebalancesheetdateandrecording
stockmovements(e.g.salesandgoodsreceived);
reperformingthereconstructionforsignificantitemsonasamplebasis;
analyticalproceduressuchasareviewofprofitmarginsbystockcategory.

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An extensive range of stock is clearly material. The matter (i.e. systems failure) is not
howeverpervasive,asonlystockisaffected.
Unless the reconstruction is substantially completed (i.e. stock items not accounted for are
insignificant)theauditorcannotdeterminewhatadjustment,ifany,mightbedeterminedtobe
necessary.Theauditorsreportshouldthenbequalified,exceptfor,limitationofscope.
However,ifsufficientevidenceisobtainedtheauditorsreportshouldbeunqualified.
An explanatory paragraph would not be appropriate because this matter is not one of
significantuncertainty.
Tutorialnote:Anuncertaintyinthiscontextisamatterwhoseoutcomedependsonfutureactions
oreventsnotunderthedirectcontrolofMAJALIWA.
Ifthe2005auditorsreportisqualifiedexceptforongroundsoflimitationofscopethereare
twopossibilitiesforthestockfigureasat30September2005determinedoncompletionofthe
reconstructionexercise:
(1)itisnotmateriallydifferentfromthestockfigurereported;or
(2)itismateriallydifferent.
In(1),withthelimitationnowremoved,theneedforqualificationisremovedandthe2006
auditorsreportwouldbeunqualified(inrespectofthismatter).
In(2)theopeningpositionshouldberestatedandthecomparativesadjustedinaccordance
withReportingfinancialperformance.The2006auditorsreportwouldagainbeunqualified.
Tutorial note: If the error was not corrected in accordance with FRS 3 it would be a different
matter and the auditors report would be qualified (except for) disagreement on accounting
treatment.
(ii)Whollyownedforeignsubsidiary
Thecashtransferisanonadjustingpostbalancesheetevent.ItindicatesthatMIPANGOwas
tradingafterthebalancesheetdate.However,thatdoesnotprecludeBatikhavingcommenced
tradingbeforetheyearend.
The finance directors oral representationiswhollyinsufficient evidence with regard to the
existence(orotherwise)ofBatikat30September2005.Ifitexistedatthebalancesheetdateits
financialstatementsshouldhavebeenconsolidated(unlessimmaterial).
The lack of evidence that might reasonably be expected to be available (e.g. legal papers,
registrationpayments,etc)suggestsalimitationofthescopeoftheaudit.
Ifsuchevidencehasbeensoughtbutnotobtainedthenthelimitationisimposedbytheentity
(ratherthanbycircumstances).
Whilstthetransactionitselfmaynotbematerial,theinformationconcerningtheexistenceof
MIPANGO may be material to users and should therefore be disclosed (as a nonadjusting
event). The absence of such disclosure, if the auditor considered necessary, would result in a
qualified(exceptfor)opinion.
Tutorialnote: Anymatterthatisconsideredsufficientlymaterialtobeworthyofdisclosureasa
nonadjustingeventmustresultinsuchaqualifiedopinionifthedisclosureisnotmade.
IfMIPANGOexistedatthebalancesheetdateandhadmaterialassetsandliabilitiesthenits
nonconsolidationwouldhaveapervasiveeffect.Thiswouldwarrantanadverseopinion.
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Also,thenatureofthelimitation(beingimposedbytheentity)couldhaveapervasiveeffectif
the auditor is suspicious that other auditevidence hasbeen withheld.In thiscase theauditor
shoulddisclaimanopinion.

(c)Openingbalancesprincipalauditprocedures
Tutorial note: Opening balances means those account balances which exist at the beginning of
theperiod.Thequestion
clearlystatesthattheprioryearauditorsreportwasunqualifiedthereforeanydigressionintothe
priorperiodopinionbeing
otherthanunmodifiedorthepriorperiodnothavingbeenauditedwillnotearnmarks.
Reviewoftheapplicationofappropriateaccountingpoliciesinthefinancialstatementsforthe
yearended31December2004toensureconsistentwiththoseappliedin2005.
Where permitted (e.g. if there is a reciprocal arrangement with the predecessor auditor to
share audit working papers on a change of appointment), a review of the prior period audit
workingpapers.
Tutorial note: There is no legal, ethical or other professional duty that requires a predecessor
auditortomakeavailableitsworkingpapers.
Current period audit procedures that provide evidence concerning the existence,
measurementandcompletenessofrightsandobligations.Forexample:
afterdate receipts (in January 2005 and later) confirming the recoverable amount of trade
debtorsat31December,2004;
similarly,afterdatepaymentsconfirmingthecompletenessoftradeandothercreditors(for
services);
afterdatesalesofstockheldat31December2004;
reviewofJanuary2005bankreconciliation(confirmingclearanceofreconcilingitemsat31
December2004).
Analyticalproceduresonratioscalculatedmonthonmonthfrom31December2004,todate
andfurtherinvestigationofanydistortionsidentifiedatthebeginningofthecurrentreporting
period.Forexample:
stockturnover(bycategoryofmetal);
averagecollectionpayment(debtordays);
averagepaymentperiod(creditordays);
grossprofitpercentage(bymetal).
Examinationofhistoricaccountingrecords for fixedassets andliabilities(ifnecessary).For
example:
agreeingbalancesonassetregisterstotheclientstrialbalanceasat31December2004;
agreeing statements of balances on loan accounts to the financial statements as at 31
December2004.

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Iftheaboveproceduresdonotprovidesufficientevidence,additionalsubstantiveprocedures
should be performed. For example, if additional evidence is required concerning stock at 31
December2004,cutofftestsmaybereperformed.

(d).(a)Auditorsresponsibilitiesforotherinformation
The auditor has a professional responsibility to read other information to identify material
inconsistencieswiththeauditedfinancialstatements(ISA720OtherInformationinDocuments
ContainingAuditedFinancialStatements).
Amaterialinconsistencyariseswhenotherinformationcontradictsthatwhichiscontained
intheauditedfinancialstatements.Itmaygiverisetodoubtsabout:
theauditorsconclusionsdrawnfromauditevidence;and
thebasisfortheauditorsopiniononthefinancialstatements.
In certain circumstances, the auditor may have a statutory obligation (under national
legislation)toreportonother
information(e.g.ManagementReport).
Even where there is no such obligation (e.g. chairmans statement), the auditor should
considerit,asthecredibilityof
thefinancialstatementsmaybeunderminedbyanyinconsistency.
Theauditormustarrangetohaveaccesstotheotherinformationonatimelybasispriorto
datingtheauditorsreport.

Materialinconsistency
Ifamaterialinconsistencyisidentified,theauditorshoulddeterminewhetheritistheaudited
financialstatementsor
theotherinformationwhichneedsamending.
Ifanamendmenttotheauditedfinancialstatementsisrequiredbutnotmade,therewillbe
disagreement,resultingin
theexpressionofaqualifiedoradverseopinion.(Suchasituationwouldbeextremelyrare.)
Whereanamendmenttootherinformationisnecessary,butrefused,theauditorsreportmay
includeanemphasisof
matterparagraph(sincetheauditopinioncannotbeotherthanunqualifiedwithrespecttothis
matter).
Materialmisstatementoffact
A material misstatement of fact in other information exists when information which is not
relatedtomattersappearing
intheauditedfinancialstatementsisincorrectlystatedorpresentedinamisleadingmanner.
Ifmanagement do not act onadvicetocorrecta material misstatementthe auditorsshould
documenttheirconcernsto
thosechargedwithcorporategovernanceandobtainlegaladvice.
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Tutorial note: Marks would be awarded here for the implications for the auditors report.
However,suchmarks,whicharefortherestatementofknowledgewouldNOTbeawardedagainif
repeatedinanswersto(b).

QUESTION6
NABAKI AFRICA LTD (NA) main activity is the extraction and supply of building materials
includingsand, gravel,cement and similar aggregates.The companys year endis 31Mayand
yourfirmhasauditedNAforanumberofyears.
Themainassetonthebalancesheetrelatestononcurrentassets.Ajuniormemberofstaffhas
attemptedtopreparethenoncurrentassetnoteforthefinancialstatements.Thenotehasnot
beenreviewedbythesenioraccountantandsomaycontainerrors.

Land and Plant


and Motor
buildings
machinery
vehicles

Railway
trucks

Total

Cost

Shs000

Shs000

Shs000

Shs000

Shs000

1June2005

100,000

875,000

1,500,000

2,475,000

Additions

10,000

125,000

525,000

995,00

1,655,000

Disposals

(100,000)

(325,000)

(425,000)

31May2006

110,000

900,000

1,700,000

995,000

3,705,000

Depreciation

1stJune2005

60,000

550,000

750,000

1,360,000

Charge

2,200

180,000

425,000

199,000

806,200

Disposal

(120,000)

(325,000)

(445,000)

31May2006

62,200

610,000

850,000

199,000

1,721,200

NetBookValue

31May2006

47,800

290,000

NetBookValue

31May2005

40,000

325,000

850,000

796,000

1,983,800

750,000

1,115,000

Landandbuildingsrelatetocompanyofficesandlandforthoseoffices.

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Plantandmachineryincludesextractionequipmentsuchasdiggersanddumpertrucksused
toextractsandandgraveletc.
Motorvehiclesincludelargetruckstotransportthesand,graveletc.
Railwaytrucksrelatetocontainersusedtotransportsandandgraveloverlongdistanceson
therailwaynetwork.
Depreciationratesstatedinthefinancialstatementsareallbasedoncostandcalculatedusing
thestraightlinebasis.
Theratesare:
Landandbuildings

2%

Plantandmachinery 20%
Motorvehicles

33%

Railwaytrucks

20%

Disposalsinthemotorvehiclescategoryrelatestovehicleswhichwerefiveyearsold.
Required:
(a)Listtheauditworkyoushouldperformonrailwaytrucks.(10marks)
(b)Youhavejustcompletedyouranalyticalproceduresofthenoncurrentassetsnote.
Required:
(i)Excludingrailwaytrucks,identifyandexplainanyissueswiththenoncurrentassetnoteto
raisewithmanagement.
(ii)Explainhoweachissuecouldberesolved.(10marks)
Note:youdonotneedtorecasttheschedule.

SUGGESTEDSOLUTIONQUESTION6
(a)Auditworkonrailwaytrucks
Examineboardminutesauthorisingthepurchaseofthetrucks(authorization)
Cast the noncurrent asset ledger; agree total of railway trucks to the general ledger and
financialstatements(completeness)
Ensure that railway trucks are actually stated as such in the noncurrent asset note. As a
materialitem,ofthiscategoryisallowed(disclosure)
Cast the noncurrent asset note in the financial statements. Ensure the note agrees to the
amountdisclosedinthebalancesheet(disclosure)
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For a sample of assets from the ledger, confirm existence by physically seeing the trucks
(existence)
Identifythesupplierofrailwaytrucksfromapurchaseinvoice.Obtainallinvoicesfromthis
supplier and confirm completeness of recording in the noncurrent asset register
(completeness).Also,duringnoncurrentassetinspection,recorddetailsofsomerailwaytrucks
andensurethosetrucksarerecordedinthenoncurrentassetregister
Examine a sample of purchase invoices to confirm ownership of the trucks (rights and
obligations)
Reviewcompanypolicyfordepreciation.Asthisisanewcategoryofnoncurrentasset,obtain
representation letter point regarding accuracy of amount. Confirm with amount charged in
similar companies that the depreciation percentage appears to be correct (valuation and
allocation)
Agreedepreciationchargedinthenoncurrentassetnotetotheamountontheprofitandloss
account(valuationandallocation)
Check a sample of depreciation calculations to ensure that they are accurate and that they
conformtocompanypolicy(valuationandallocation)
Ensure that any sales tax has been correctly treated e.g. capitalised where this is non
recoverable(valuationandallocation)
Current value may also be confirmed using a specialist or appropriate trade journal and
compared to the net book value shown in the noncurrent asset register (valuation and
allocation).

(b)Issuestoraisewithmanagement
Landandbuildings
Thedepreciationratehasbeencorrectlyappliedat2%givenanestimatedlifeforthelandand
buildingscategoryof50years.However,theratehasbeenappliedtothewholebalancethatis
land and buildings. In most companies, the value of land is not thought to decrease and
thereforedepreciationisnotappropriate.
Toallocatedepreciationaccurately,asplitisrequiredbetweenthelandandbuildingsamounts
inthefinancialstatements.
Buildingswillthenbedepreciated,butnottheland.
Plantandmachinery
Depreciationhasbeenchargedinfullintheyearofacquisition,butnotchargedatallintheyear
ofdisposal.Thisappearstobeanappropriateaccountingpolicychargingdepreciationinthe
yearofdisposalwouldonlyamendtheprofitorlossonsaleinthatyearandsohaveaneutral
effectonthefinancialstatements..

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There appears to be an error in the disposals calculation as the depreciation amount exceeds
thecostbeingeliminatedTheredoesnotappeartobeanylogicalreasonforthissituationandit
shouldbediscussedwiththedirectorstoidentifythereason,ifany,forthistreatment.
If an error is found, then the depreciation amount must be decreased (or cost eliminated
increased)andtheprofitorlossonsaleamendedaccordingly.
Motorvehiclespoint1
Thedepreciationpercentagestatedinthefinancialstatementsis33%.However,thecalculation
iseither25%ontheyearendbalanceorabout21%oncostbroughtforwardandadditionsfor
the year. To be consistent, the noncurrent asset disclosure note must agree to the actual
calculationinthenoncurrentassetnote.
Thereasonforthedifferencemustbefoundandeitherthedisclosurenoteorthedepreciation
calculationamendedIftherehasbeenachangeinthedepreciationrate,thenthismustalsobe
disclosed in the financial statements. There has not been a change in accounting policy the
policy of depreciation is unchanged, it is only the method of applying that policy that has
changed.Thereisnoneedtoamendtheprioryearfigures.
Motorvehiclespoint2
Thecostanddepreciationeliminatedonsalearethesameamount;thisisnotsurprisinggiven
thattheassetswerefullydepreciated.However,thedepreciationpolicyformotorvehiclesisto
depreciate the category over three years. If those vehicles are now being kept for five years,
thenthedepreciationratemayneedrevisingtoshowtheactualusefullifeofthevehicles.
The depreciation rate needs to be discussed with company management, and if necessary the
rateamendedtoreflecttheactuallifeofthevehicles.

QUESTION7
YouareamanagerinafirmofCertifiedPublicAccountants.Youhavebeenassignedtoreview
and report on the following prospective financial information produced by one of your audit
clients,CusiterCo.Theinformationhasbeenproducedtosupportanapplicationfora$250,000
longtermloanfromabank.Thefundsfromtheloanwillbeinvested,on1January2008,innew
plantandequipmentthatwillbeusedtomanufactureanewproductrangefollowingarecent
purchaseofapatentedtechnology.

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Required:
(a)Explainthetermprospectivefinancialinformation(PFI).(3marks)

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(b)Explainthemattersthatshouldbeconsideredwhenplanningthenatureandscopeof
theexaminationofCusiterCosforecastbalancesheetandincomestatementasprepared
forthebank.(7marks)
(c) Describe the examination procedures you should use to verify Cusiter Cos
prospectivefinancialinformation.(9marks)
(d)Discussthe professionalaccountantsliabilityforreportingonprospectivefinancial
informationandthemeasuresthattheprofessionalaccountantmighttaketoreducethat
liability.(6marks)

SUGGESTEDSOLUTIONQUESTION7

(a)Prospectivefinancialinformation(PFI)
PFIisfinancialinformationbasedon:
assumptionsabouteventsthatmayoccurinthefuture;and
possibleactionsbyanentity.
Prospectivefinancialinformationcanbeintheformofaforecast,aprojectionoracombination
ofboth.
A forecast is PFI prepared on the basis of assumptions about future events that management
expectstotakeplaceandtheactionsmanagementexpectstotakeatthetimetheinformationis
prepared(bestestimateassumptions)1.
Aprojectionispreparedonthebasisof:
hypothetical assumptions about future events and management actions which are not
necessarilyexpectedtotakeplace(e.g.whenentitiesarestartinguporrestructuring);or
amixtureofbestestimateandhypotheticalassumptions.
1ISAE3400TheExaminationofProspectiveFinancialInformation
(b)Matterstobeconsidered
Tutorial note: Candidates at this level must appreciate that the matters to be considered when
planningthenatureandscopeoftheexaminationarenotthesamematterstobeconsideredwhen
deciding whether or not to accept an engagement. The scenario clearly indicates that the
assignment is being undertaken by the current auditor rendering any pre
engagement/professionaletiquetteconsiderationsirrelevanttoansweringthisquestion.
This PFI has been prepared to show an external user, the bank, the financial consequences of
Cusitersplanstohelpthebankinmakinganinvestmentdecision.IfCusiterissuccessfulinits
loan applicationthe PFI providesa management tool againstwhichthe results ofinvestingin
theplantandequipmentcanbemeasured.
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ThePFIisunpublishedratherthanpublished.Thatis,itispreparedatthespecificrequestofa
thirdparty,thebank.Itwillnotbepublishedtousersoffinancialinformationingeneral.
The auditors report on the PFI will provide only negative assurance as to whether the
assumptionsprovideareasonablebasisforthePFIandanopinionwhetherthePFIis:
properlypreparedonthebasisoftheassumptions;and
presentedinaccordancewiththerelevantfinancialreportingframework.
Thenatureoftheengagementisanexaminationtoobtainevidenceconcerning:
thereasonablenessandconsistencyofassumptionsmade;
properpreparation(onthebasisofstatedassumptions);and
consistent presentation (with historical financial statements, using appropriate accounting
principles).
Such an examination is likely to take the form of inquiry, analytical procedures and
corroboration.
The period of time covered by the prospective financial information is two years. The
assumptionsfor2008arelikelytobemorespeculativethanfor2007,particularlyinrelationto
theimpactonearnings,etcoftheinvestmentinnewplantandequipment.
The forecast for the year to 31 December 2007 includes an element of historical financial
information(becauseonlypartofthisperiodisinthefuture)henceactualevidenceshouldbe
available to verify the first three months of the forecast (possibly more since another three
monthperiodwillexpireattheendofthemonth).
Cusiter managements previous experience in preparing PFI will be relevant. For example, in
makingaccountingestimates(e.g.forprovisions,impairmentlosses,etc)orpreparingcashflow
forecasts(e.g.insupportofthegoingconcernassertion).
Thebasisofpreparationoftheforecast.Forexample,theextenttowhichitcomprises:
proformafinancialinformation(i.e.historicalfinancialinformationadjustedfortheeffectsof
theplannedloanandcapitalexpendituretransaction);
new information and assumptions about future performance (e.g. the operating capacity of
thenewequipment,salesgenerated,etc).
The nature and scope of any standards/guidelines under which the PFI has been prepared is
likelytoassisttheauditorindischargingtheirresponsibilitiestoreportonit.Also,ISAE3400
The Examination of Prospective Financial Information, establishes standards and provides
guidanceonengagementstoexamineandreportonPFIincludingexaminationprocedures.
Theplannednatureandscopeoftheexaminationislikelytotakeintoaccountthetimeandfee
budgets for the assignments as adjusted for any overlap with audit work. For example, the
examinationofthePFIislikelytodrawontheauditorsknowledgeofthebusinessobtainedin
auditing the financial statements to 31 December 2006. Analytical procedures carried out in
respectofthePFImayprovideevidencerelevanttothe31December2007audit.

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(c)Examinationprocedures
The arithmetic accuracy of the PFI should be confirmed, i.e. subtotals and totals should be
recastandagreed.
The actual information for the year to 31 December 2006 that is shown as comparative
information should be agreed to the audited financial statements for that year to ensure
consistency.
Balancesandtransactiontotalsforthequarterto31March2007shouldbeagreedtogeneral
ledger account balances at that date. The net book value of property, plant and equipment
shouldbeagreedtothenoncurrentassetregister;
accounts receivable/payable to control accounts and cash at bank to a bank reconciliation
statement.
Tendersforthenewequipmentshouldbeinspectedtoconfirmtheadditionalcostincludedin
property,plantandequipmentincludedintheforecastforthe yearto31December2008and
thatitcanbepurchasedwiththefundsbeinglentbythebank.
Thereasonablenessofallnewassumptionsshouldbeconsidered.Forexample,theexpected
usefullifeofthenewequipment,thecapacityatwhichitwillbeoperating,thevolumeofnew
productthatcanbesold,andatwhatprice.
Theforecastincomestatementshouldbereviewedforcompletenessofcostsassociatedwith
theexpansion.Forexample,operatingexpensesshouldincludesalariesofadditionalequipment
operativesorsupervisors.
TheconsistencyofaccountingpracticesreflectedintheforecastwithInternationalFinancial
ReportingStandards(IFRS)
should be considered. For example, the intangible asset might be expected to be less than
$10,000at31December2008asitshouldbecarriedatamortisedcost.
Thecostofproperty,plantandequipmentat31December2008is$280,000morethanasat
31December2007.
Considerationshouldbegiventotheadequacyofborrowing$250,000iftheactualinvestment
is$30,000more.
Thetermsofexistingborrowings(bothnoncurrentandshortterm)should bereviewedto
ensure that the forecast takes full account of existing repayment schedules. For example, to
confirmthatonly$23,000oftermborrowingswillbecome
currentbytheendof2007.
Trendsshouldbereviewedandfluctuationsexplained,forexample:
Revenueforthefirstquarterof2007isonly22%ofrevenue for2006andsomayappearto
be understated. However, revenue may not be understated if sales are seasonal and the first
quarteristraditionallyquieter.
Forecast revenue for 2007 is 18% up on 2006. However, forecast revenue for 2008 is only
19%upon2007.Asthegrowthin2007isbeforetheinvestmentinnewplantandequipmentit
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does not look as though the new investment will be contributing significantly to increased
growthinthefirstyear.
Thegrossprofit%ismaintainedataround29%forthethree years.However,theearnings
beforeinterestandtax(EBIT)%isforecasttofallby2%for2008.Earningsafterinterestmight
beworryingtothepotentiallenderasthisisforecasttorisefrom122%in2006to137%in
2007butthenfallto76%in2008.
Thereasonablenessofrelationshipsbetweenincomestatementandbalancesheetitemsshould
beconsidered.Forexample:
Theaveragecollectionperiodateachofthebalancesheetdatespresentedis66,69,66and66
daysrespectively(e.g.71/394 365=66days).Althoughitmayberealistictoassumethatthe
current average collection period may be maintained in future it is possible that it could
deteriorateif,forexample,newcustomerstakenontolaunchthenewproductarenotascredit
worthyastheexistingcustomerbase.
Thenumberof dayssalesininventoryateach balancesheetdateis66, 88,66 and 65days
respectively(e.g.50/278 365=66days).Thereasonfortheincreaseto88attheendofthe
first quarter must be established and managements assertion that 66 days will be re
establishedasthenormcorroborated.
As the $42,000 movement on retained earnings from 2007 to 2008 is the earnings before
income tax for 2008 it may be that there is no tax in 2008 or that tax effects have not been
forecast.(However,somedeferredtaxeffectmightbeexpected iftheinvestmentinnewplant
andequipmentislikelytoattractacceleratedcapitalallowances.)
(d)Professionalaccountantsliability
LiabilityforreportingonPFI
IndependentaccountantsmayberequiredtoreportonPFIformanyreasons(e.g.tohelpsecure
a bank loan). Such forecasts and projections are inherently unreliable. If the forecast or
projection does not materialise, and the client or lenders (or investors) consequently sustain
financialloss,theaccountantmayfacelawsuitsclaimingfinancialloss.
Courts in different jurisdictions use various criteria to define the group of persons to whom
independentaccountantsmaybeheldliableforprovidingareportonaninaccurateforecastor
projection. The most common of these are that an accountant is liable to persons with whom
thereisproximity:
(i)only(i.e.theclientwhoengagedtheindependentaccountant);
(ii)orwhoserelationshipwiththeaccountantsufficientlyapproachesprivity;
(iii)andtopersonsormembersofalimitedgroupofpersonsforwhosebenefitandguidance
theaccountantsuppliedtheinformationorknewthattherecipientoftheinformationintended
tosupplyit;
(iv)andtopersonswhoreasonablycanbeforeseentorelyontheinformation.
Measurestoreduceliability

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Assignificantassumptionswillbeessentialtoareadersunderstandingofafinancialforecast,
theindependentaccountantshouldensurethattheyareadequatelydisclosedandclearlystated
to be the managements responsibility. Hypothetical assumptions should be clearly
distinguishedfrombestestimates.
The introduction to any forecast (and/or report thereon) should include a caveat that the
prospectiveresultsmaynotbeattained.Specificandextensivewarnings(theactualresults
will vary) and disclaimers (we do not express an opinion) may be effective in protecting an
independent accountant sued for inaccuracies in forecasts or projections that they have
reportedon.
Anyreporttoathirdpartyshouldstate:
forwhomitisprepared,whoisentitledtorelyonit(ifanyone)andforwhatpurpose;
thattheengagementwasundertakeninaccordancewiththeengagementterms;
theworkperformedandthefindings.
An independent accountants report should avoid inappropriate and openended wording, for
example,wecertifyandweobtainedalltheexplanationsweconsiderednecessary.
Engagement terms to report on PFI should include an appropriate liability cap that is
reasonablegiventhespecificcircumstancesoftheengagement.
Theindependentaccountantmaybeabletoobtainindemnityfromaclientinrespectofclaims
fromthirdparties.Suchholdharmlessclausesobligatetheclienttoindemnifytheindependent
accountantfromthirdpartyclaims.

QUESTION8

(a) ISA 701 Modifications to The Independent Auditors Report includes suggested wording of
modifyingphrasesforusewhenissuingmodifiedreports.
Required:
Explainanddistinguishbetweeneachofthefollowingterms:
(i)qualifiedopinion;
(ii)disclaimerofopinion;
(iii)emphasisofmatterparagraph.(6marks)
(b)YouaretheauditmanagerofPetrieCo,aprivatecompany,thatretailskitchenutensils.The
draftfinancialstatementsfortheyearended31March2007showrevenue$422million(2006

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$418million),profitbeforetaxationof$18million(2006 $22million)andtotalassetsof
$307million(2006$234million).
YouarecurrentlyreviewingtwomattersthathavebeenleftforyourattentiononPetriesaudit
workingpaperfilefortheyearended31March2007:
(i)Petriesmanagementboarddecidedtorevaluepropertiesfortheyearended31March2007
that had previously all been measured at depreciated cost. At the balance sheet date three
propertieshadbeenrevaluedbyatotalof$17million.Anotherninepropertieshavesincebeen
revalued by $54 million. The remaining three properties are expected to be revalued later in
2007.(5marks)
(ii) On 1 July 2006 Petrie introduced a 10year warranty on all sales of its entire range of
stainless steel cookware. Sales of stainless steel cookware for the year ended 31 March 2007
totalled$182million.Thenotestothefinancialstatementsdisclosethefollowing:
Since1July2006,thecompanysstainlesssteelcookwareisguaranteedtobefreefromdefects
inmaterialsandworkmanshipundernormalhouseholdusewithina10yearguaranteeperiod.
No provision has been recognised as the amount of the obligation cannot be measured with
sufficientreliability.(4marks)
Your auditors report on the financial statements for the year ended 31 March 2006 was
unmodified.
Required:
Identifyandcommentontheimplicationsofthesetwomattersforyourauditorsreport
onthefinancialstatementsofPetrieCofortheyearended31March2007.
NOTE:Themarkallocationisshownagainsteachofthemattersabove.
(15marks)

QUESTION9
(a)Inthecaseofanassuranceengagementitisinthepublicinterestand,therefore,required
bythisCodeofEthics,
thatmembersofassuranceteamsbeindependentofassuranceclients.
IFACCodeofEthicsforProfessionalAccountants
Required:
Definethetermassuranceteam.(3marks)
(b) As a newlyqualified Certified Public Accountant, you have been asked to write an ethics
columnforatraineeaccountantmagazine.Inparticular,youhavebeenaskedtodraftguidance
onthefollowingquestionsaddressedtothemagazineshelpline:
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(i)Whatgiftsorhospitalityareacceptableandwhendotheybecomeaninducement?(5marks)
(ii) If a partner, who is an actuary, provides valuation services to an audit client, can we
continuewiththeaudit?(3marks)
(iii)Caninternalauditservicesbeundertakenforanauditclient?(4marks)
Required:
Foreachofthethreequestions,explainthethreatstoobjectivitythatmayariseandthe
safeguardsthatshouldbeavailabletomanagethemtoanacceptablelevel.
NOTE:Themarkallocationisshownagainsteachofthethreequestionsabove.(15marks)
6ProposedISA600(RevisedandRedrafted)TheAuditofGroupFinancialStatementsislikelyto
substantiallyincreasetheformalrequirementsintheareaofgroupaudits.
Required:
(a)OutlinethesignificantissuesthatarebeingaddressedintheIAASBsprojectongroup
audits.(5marks)
(b) Explain the need for a first time group auditor to analyse the group structure. (5
marks)
(c) Critically discuss the likely effectiveness of standard questionnaires sent to other
auditorsasameansofobtaininginformationrequired.(5marks)

SUGGESTEDSOLUTIONQN8AND9

QUESTION8ANS.
PETRIECO
(a)Independentauditorsreportterms
(i) Qualified opinion A qualified opinion is expressed when the auditor concludes that an
unqualified opinion cannot be expressed but that the effect of any disagreement with
management,orlimitationonscopeisnotsomaterialandpervasive astorequirean adverse
opinionoradisclaimerofopinion.
(ii) Disclaimer of opinion A disclaimer of opinion is expressed when the possible effect of a
limitation on scope is so material and pervasive that the auditor has not been able to obtain
sufficientappropriateauditevidenceandaccordingly
isunabletoexpressanopiniononthefinancialstatements.
(iii) Emphasis of matter paragraph An auditors report may be modified by adding an
emphasis of matter paragraph to highlight a matter affecting the financial statements that is
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includedinanotetothefinancialstatementsthatmoreextensivelydiscussesthematter.Such
anemphasisofmatterparagraphdoesnotaffecttheauditorsopinion.Anemphasisofmatter
paragraph may also be used to report matters other than those affecting the financial
statements (e.g. if there is a misstatement of fact in other information included in documents
containingauditedfinancialstatements).
(iii)isclearlydistinguishablefrom(i)and(ii)because(i)and(ii)affecttheopinionparagraph,
whereas(iii)doesnot.
(i)and(ii)aredistinguishablebythedegreeoftheirimpact onthefinancialstatements.In(i)
theeffectsofanydisagreementorlimitationonscopecanbeidentified withanexceptfor
opinion.In(ii)thematterispervasive,thatis,affectingthefinancialstatementsasawhole.
(ii) can only arise in respect of a limitation in scope (i.e. insufficient evidence) that has a
pervasiveeffect.(i)isnotpervasiveandmayalsoarisefrom disagreement(i.e.wherethereis
sufficientevidence).
(b)Implicationsforauditorsreport
(i)Selectiverevaluationofpremises
The revaluations are clearly material to the balance sheet as $17 million and $54 million
represent55%and176%oftotalassets,respectively(and231%intotal).Astheeffectsofthe
revaluationonlineitemsinthefinancialstatementsareclearlyidentified(e.g.revaluedamount,
depreciation,surplusinstatementofchangesinequity)thematterisnotpervasive.
The valuations of the nine properties after the year end provide additional evidence of
conditionsexistingattheyearendandarethereforeadjustingeventsperIAS10EventsAfterthe
BalanceSheetDate.
Tutorial note: It is now still less than three months after the year end so these valuations can
reasonablybeexpectedtoreflectyearendvalues.
However, IAS 16 Property, Plant and Equipment does not permit the selective revaluation of
assets thus the whole class of premises would need to have been revalued for the year to 31
March2007tochangethemeasurementbasisforthisreportingperiod.
The revaluation exercise is incomplete. Unless the remaining three properties are revalued
before the auditors report on the financial statements for the year ended 31 March 2007 is
signedoff:
(1)the$71revaluationmadesofarmustbereversedtoshowallpremisesatdepreciatedcost
asinpreviousyears;
OR
(2)theauditorsreportwouldbequalifiedexceptfordisagreementregardingnoncompliance
withIAS16.
Whenitisappropriatetoadopttherevaluationmodel(e.g.nextyear)thechangeinaccounting
policy(fromacostmodeltoarevaluationmodel)shouldbeaccountedforinaccordancewith
IAS16(i.e.asarevaluation).

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Tutorial note: IAS8 Accounting Policies,Changes inAccounting Estimatesand Errors doesnot


applytotheinitialapplicationofapolicytorevalueassetsinaccordancewithIAS16.
Assuming the revaluation is written back, before giving an unmodified opinion, the auditor
should consider why the three properties were not revalued. In particular if there are any
indicatorsofimpairment(e.g.physicaldilapidation)thereshouldbesufficientevidenceonthe
working paper file to show that the carrying amount of these properties is not materially
greaterthantheirrecoverableamount(i.e.thehigherofvalueinuseandfairvaluelesscoststo
sell).
Ifthereisinsufficientevidencetoconfirmthatthethreepropertiesarenotimpaired(e.g.ifthe
auditorwaspreventedfrominspectingtheproperties)theauditorsreportwouldbequalified
exceptforongroundsoflimitationonscope.
If there is evidence of material impairment but management fail to write down the carrying
amounttorecoverableamounttheauditorsreportwouldbequalifiedexceptfordisagreement
regardingnoncompliancewithIAS36ImpairmentofAssets.
(ii)10yearguarantee
$182 million stainless steel cookware sales amount to 431% of revenue and are therefore
material. However, the guarantee was only introduced three months into the year, say in
respectof$136million(3/4 182million)i.e.approximately32%ofrevenue.
The draft note disclosure could indicate that Petries management believes that Petrie has a
legal obligation in respect of the guarantee, that is not remote and likely to be material
(otherwisenodisclosurewouldhavebeenrequired).
A best estimate of the obligation amounting to 5% profit before tax (or more) is likely to be
consideredmaterial,i.e.$90,000(ormore).Therefore,ifitisprobablethat066%ofsalesmade
under guarantee will be returned for refund, this would require a warranty provision that
wouldbematerial.
Tutorialnote:Thereturnof2/3%ofsalesovera10yearperiodmaywellbeprobable.
Clearlythereisapresentobligationasaresultofapastobligatingeventforsalesmadeduring
theninemonthsto31 March2007.Althoughthelikelihoodofoutflowunderthe guaranteeis
likelytobeinsignificant(evenremote)itisprobablethatsomeoutflowwillbeneededtosettle
theclassofsuchobligations.
Thenoteinthefinancialstatementsisdisclosingthismatterasacontingentliability.Thisterm
encompassesliabilitiesthatdonotmeettherecognitioncriteria(e.g.ofreliablemeasurementin
accordancewithIAS37Provisions,ContingentLiabilitiesandContingentAssets).
However, it is extremely rare that no reliable estimate can be made (IAS 37) the use of
estimatesbeingessentialtothepreparationoffinancialstatements.Petriesmanagementmust
make a best estimate of the cost of refunds/repairs under guarantee taking into account, for
example:
the proportion of sales during the nine months to 31 March 2007 that have been returned
underguaranteeatthebalancesheetdate(andinthepostbalancesheeteventperiod);
theaverageageofcookwareshowingadefect;
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the expected cost of a replacement item (as a refund of replacement is more likely than a
repair,say).
Ifmanagementdonotmakeaprovisionforthebestestimateoftheobligationtheauditopinion
shouldbequalifiedexceptfornoncompliancewithIAS37(noprovisionmade).Thedisclosure
madeinthenotetothefinancialstatements,howeverdetailed,isnotasubstituteformakingthe
provision.
Tutorialnote:Nomarkswillbeawardedforsuggestingthatanemphasisofmatterofparagraph
wouldbeappropriate(drawingattentiontothemattermorefullyexplainedinthenote).
Managementsclaimthattheobligationcannotbemeasuredwithsufficientreliabilitydoesnot
give rise to a limitation on scope onthe audit.The auditorhas sufficient evidence of the non
compliancewithIAS37anddisagreeswithit.

QUESTION9ANS.
(a)Assuranceteam
Allmembersoftheengagementteam(fortheassuranceengagement);
Allotherswithinafirmwhocandirectlyinfluencetheoutcomeoftheassuranceengagement,
forexample:
thosewhorecommendthecompensationof,orwhoprovidedirectsupervisory,management
orotheroversightoftheassuranceengagementpartnerinconnectionwiththeperformanceof
theassuranceengagement;
thosewhoprovideconsultationregardingtechnicalorindustryspecificissues,transactionsor
eventsfortheassuranceengagement;and
thosewhoprovidequalitycontrolfortheassurance.
(b)Draftguidance
(i)Giftsandhospitality
Gifts and hospitality may be offered as an inducement i.e. to unduly influence actions or
decisions, encourage illegal or dishonest behaviour or to obtain confidential information. An
offerofgiftsand/orhospitalityfromaclientordinarilygivesrisetothreatstocompliancewith
thefundamentalprinciples,forexample:
selfinterestthreatstoobjectivityand/orconfidentialitymaybecreatedifagiftfromaclient
isaccepted;
intimidationthreatstoobjectivityand/orconfidentialitymayarisethroughthepossibilityof
suchoffersbeingmadepublicanddamagingthereputationoftheprofessionalaccountant(or
closefamilymember).
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The significance of such threats will depend on the nature, value and intent behind the offer.
There may be no significant threat to compliance with the fundamental principles if a
reasonable and informed third party would consider gifts and hospitality to be clearly
insignificant. For example, if the offer of gifts or hospitality is made in the normal course of
businesswithoutthespecificintenttoinfluencedecisionmakingortoobtaininformation.
If evaluated threats are other than clearly insignificant, safeguards should be considered and
appliedasnecessarytoeliminatethemorreducethemtoanacceptablelevel.
Offers of gifts and hospitality should not be accepted if the threats cannot be eliminated or
reducedtoanacceptablelevelthroughtheapplicationofsafeguards.
As the real or apparent threats to compliance with the fundamental principles do not merely
arise from acceptance of an inducement but, sometimes, merely from the fact of the offer
havingbeenmade,additionalsafeguardsshouldbeadopted.Forexample:
immediatelyinforminghigherlevelsofmanagement orthosechargedwith governancethat
aninducementhasbeenoffered;
informingthirdparties(e.g.aprofessionalbody)oftheoffer(afterseekinglegaladvice);
advisingimmediateorclosefamilymembers ofrelevantthreatsandsafeguardswherethey
are potentially in positions that might result in offers of inducements (e.g. as a result of their
employmentsituation);and
informinghigherlevelsofmanagementorthosechargedwithgovernancewhereimmediate
or close family members are employed by competitors or potential suppliers of that
organisation.
(ii)Actuarialservicestoanauditclient
IFACs Code of Ethics for Professional Accountants does not deal specifically with actuarial
valuationservicesbutwithvaluationservicesingeneral.
Avaluationcomprises:
makingassumptionsaboutthefuture;
applyingcertainmethodologiesandtechniques;
computingavalue(orrangeofvalues)foranasset,aliabilityorforabusinessasawhole.
A selfreview threat may be createdwhena firmor network firm2 performs avaluationfora
financialstatementauditclientthatistobeincorporatedintotheclientsfinancialstatements.
As an actuarial valuation service is likely to involve the valuation of matters material to the
financial statements (e.g. the present value of obligations) and the valuation involves a
significantdegreeofsubjectivity(e.g.lengthofservice),theselfreviewthreatcreatedcannotbe
reducedtoanacceptableleveloftheapplicationofanysafeguard.Accordingly:
suchvaluationservicesshouldnotbeprovided;or
thefirmshouldwithdrawfromthefinancialstatementauditengagement.

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If the net liability was not material to the financial statements the selfreview threat may be
reducedtoanacceptablelevelbytheapplicationofsafeguardssuchas:
involvinganadditionalprofessionalaccountantwhowasnotamemberoftheauditteamto
reviewtheworkdonebytheactuary;
confirming with the audit client their understanding of the underlying assumptions of the
valuationandthe
methodologytobeusedandobtainingapprovalfortheiruse;
obtaining the audit clients acknowledgement of responsibility for the results of the work
performedbythefirm;and
makingarrangementssothatthepartnerprovidingtheactuarialservicesdoesnotparticipate
intheaudit
engagement.
(iii)Internalauditservices
A selfreview threat may be created when a firm, or network firm, provides internal audit
servicestoafinancialstatementauditclient.Internalauditservicesmaycomprise:
an extension of the firms audit service beyond requirements of International Standards on
Auditing(ISAs);
assistanceintheperformanceofaclientsinternalauditactivities;or
outsourcingoftheactivities.
The nature ofthe servicemustbeconsidered in evaluating any threats toindependence.(For
thispurpose,internalauditservicesdonotincludeoperationalinternalauditservicesunrelated
totheinternalaccountingcontrols,financialsystemsorfinancialstatements.)
Services involving an extension of the procedures required to conduct a financial statement
auditinaccordancewithISAswouldnotbeconsideredtoimpairindependencewithrespectto
theauditclientprovidedthatthefirmsornetwork
firmspersonneldonotactorappeartoactinacapacityequivalenttoamemberofauditclient
management.
2i.e.anentityundercommoncontrol,ownershipormanagement withthefirm(oranyentity
thatareasonableandinformedthirdpartyhavingknowledgeofallrelevantinformationwould
reasonablyconcludeasbeingpartofthefirmnationallyorinternationally).
Whenthefirm,oranetworkfirm,providesanauditclientwithassistanceintheperformanceof
internal audit activities or undertakes the outsourcing, any selfreview threat created may be
reducedtoanacceptablelevelbyaclearseparationof:
themanagementandcontroloftheinternalauditbyclientmanagement;
theinternalauditactivities.

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Performing a significant portion of an audit clients internal audit activities may create a self
reviewthreat.Appropriatesafeguardsshouldincludetheauditclientsacknowledgementofits
responsibilitiesforestablishing,maintainingandmonitoringthesystemofinternalcontrols.
Othersafeguardsinclude:
theauditclientdesignatingacompetentemployee,preferablywithinseniormanagement,to
beresponsibleforinternalauditactivities;
theauditclient,auditcommitteeorsupervisorybodyapprovingthescope,riskandfrequency
ofinternalauditwork;
theauditclientbeingresponsibleforevaluatinganddeterminingwhichrecommendationsof
thefirmshouldbeimplemented;
theauditclientevaluatingtheadequacyoftheinternalauditproceduresperformedandthe
resultantfindingsbyobtainingandactingonreportsfromthefirm;and
appropriate reporting of findings and recommendations resulting from the internal audit
activitiestotheauditcommitteeorsupervisorybody.
Considerationshouldalsobegiventowhethersuchnonassuranceservicesshouldbeprovided
onlybypersonnelnotinvolvedinthefinancialstatementauditengagementandwithdifferent
reportinglineswithinthefirm.

QUESTION10
You are an audit manager in Ron & Co. One of your audit clients, MistiRead Co, is a specialist
supplier of crime fiction with over 120,000 customers. The company owns one large warehouse,
which contains at any one time about 1 million books of up to 80,000 different titles. Customers place
orders for books either over the Internet or by mail order. Books are despatched on the day of receipt
of the order. Returns are allowed up to 30 days from the dispatch date provided the books look new
and unread.
Due to the high inventory turnover, MistiRead maintains a perpetual inventory system using standard
off the shelf software. Ron & Co has audited the system for the last five years and has found no
errors within the software.
Continuous inventory checking is carried out by MistiReads internal audit department.
You are currently reviewing the continuous inventory checking system with an audit junior. The junior
needs experience in auditing continuous inventory checking systems and some basic knowledge on
NBAAs Code of Ethics and Conduct.

Required:
(a) Explain the advantages of using a perpetual inventory system. (4 marks)
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(b) List the audit procedures you should perform to confirm the accuracy of the continuous
inventory checking at MistiRead Co. For each procedure, explain the reason for carrying out
that procedure. (6 marks)
(c) Explain the fundamental principles set out in NBAAs Code of Ethics and Conduct of
integrity, objectivity and independence to accountants. (6 marks)
(d) During your preliminary audit planning you note that the engagement letter has been returned unsigned by the directors of MistiRead. When asked to explain their action, the directors indicate that
they cannot allow you access to information on the companys new website development as this
contains various trade secrets. You will not, therefore, be able to perform audit procedures on the
research and development expenditure incurred on the website and included in non-current assets.
Briefly explain the actions you should take as a result of the directors not signing the
engagement letter. (4 marks)

SUGGESTEDSOLUTIONQUESTION10
(a) Advantages of perpetual inventory systems
There is no disruption caused by an annual inventory count.
There is more accurate and regular inventory counting, which enables errors and slow moving or damaged
inventory to be identified earlier.
Actual inventory balances are known at any time, allowing re-ordering of best selling books to take place on a
timely basis. There will also be fewer causes of inventory reaching zero causing stockouts with orders not being
fulfilled.
Increased control over storekeepers because inventory is being reviewed regularly; this should decrease any
pilferage.
Auditors can rely on the computerised inventory system, reducing substantive audit tests of inventory during the
year and at the year end.

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(c) Fundamental ethical principles


Integrity
Integrity is essential for all people operating in the public interest. Integrity implies not only honesty, but also
related qualities of fairness, candour, intellectual honesty and confidentiality.
During an audit it is essential that directors can rely on an auditor to keep information about the company
confidential. If this was not the case then directors may be less forthcoming with essential information,
decreasing the effectiveness of the audit.
Objectivity
Objectivity is a state of mind that excludes bias, prejudice and compromise and that gives fair and impartial
consideration to all matters that are relevant to the task in hand, disregarding those that are not.
Accountants have to be objective because many of the factors which make up an opinion on a set of financial
statements relate to questions of judgement rather than fact. Accountants therefore need to be unbiased and
impartial in making their decisions, especially where they may need to challenge assumptions already made by
the directors.
Independence
Independence is freedom from situations and relationships which make it probable that a reasonable and
informed third party would conclude that objectivity is either impaired or could be impaired. Independence is
therefore related to and underpins objectivity.
Accountants will therefore not participate in any activity or relationship that may impair, or appear to impair, their
judgement.
They will also not accept anything which may appear to impair their judgement.
(d) Actions in respect of the engagement letter not being signed
Discuss the matter again with the directors in an attempt to reach a suitable compromise.
Remind the directors that statutory audits require the directors to make all the necessary information and
explanations available to the auditor.
Explain that lack of information on the website will result in a limitation in scope of the audit work.
Further explain that because the lack of evidence appears to relate to a material amount that the auditors
report will have to be modified with an except for qualification due to the lack of information and the possibility of
misstatement of non-current assets.
Finally note that auditor may have to decline to work for MistiRead unless suitable terms of engagement can be
agreed.

PAPER10
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic expression to every question
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Question 1
The micronix ltd, a company dealing with computer products has appointed your audit firm to
audit the companys accounts. You are assisting in the interim audit for the company and
assigned the debtors and sales section by the audit senior. Micronics systems ltd maintain
its accounting records on a mainframe computer system. There are about 20,000 debtors on
the sales ledger, which total approximately shs 100 million. The audit senior asks you to
liaise with the computer audit department of your firm in planning and conducting the audit of
debtors. During your conversation with the computer audit manager, he uses certain terms
with which you are not familiar. These include computer assisted audit techniques
(caats),general controls and application controls. Further, as a result of your conversation,
it seems that the computer audit department will not be able to visit the client whilst you are
carrying out your work but will visit the client shortly after you have left the client. The audit
senior is extremely annoyed at this and blames you for the lack of adequate planning.
Required:
(a) Explain what is meant by the following terms used in connection with computer
auditing:
(i) general controls
(ii) application controls
(i)
Computer assisted audit techniques (caats)
(ii)
Integrated test facility
(b) Describe the essential elements of the planning process when auditing
computerized systems.
(c) Describe four uses of caats in audit current assets and debtors
(d) Discuss whether you feel the audit senior is justified in blaming you for the lack of
adequate audit planning.
(e) List three disadvantages of the computer audit department visiting the client at a
different time to your interim audit visit.
Question 2
Viswa is a company that provides call centre services for a variety of organisations. It
operates in a medium sized city and your firm is the largest audit firm in the city. Viswa is
owned and run by two entrepreneurs with experience in this sector and has been in
existence for five years. It is expanding rapidly in terms of its client base, the number of staff
it employs and its profits. It is now 15 june 2004 and you have been approached to perform
the audit for the year ending 30 june 2004. Your firm has not audited this company before.
Viswa has had three different firms of
Auditors since its incorporation.
Viswas directors have indicated to you informally that the reason they wish to change
auditors is because of a disagreement about certain disclosures in the financial statements
in the previous year. The directors consider that the disagreement is a trivial matter and
have indicated that the company accountant will be able to provide you with the details once
the audit has commenced. Your firm has explained that before accepting the appointment,
there are various matters to be considered within the firm and other procedures to be
undertaken, some of which will require the co-operation of the directors. Your firm has other
clients that operate call centres. The directors have asked your firm to commence the audit
immediately because audited accounts are needed by the bank by 30 july 2004. Your firm is
very busy at this time of year.
Required:
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(a) Describe the matters to consider within your firm and the other procedures that
must be undertaken before accepting the appointment as auditor to viswa. (10
marks)
(b) Explain why it would be inappropriate to commence the audit before
consideration of the matters and the procedures referred to in (a) above have
been completed. (5 marks)
(c) explain the purpose of an engagement letter and list its contents. (5 marks)
Question 3
(a) Describe external auditors responsibilities and the work that the auditor should perform
in relation to the going concern status of companies. (5 marks)
(b) Describe the possible audit reports that can be issued where the going concern status of
a company is called into question; your answer should describe the circumstances in
which they can be issued. (5 marks)
(c) Tritel is a large telecommunications company that is listed on a stock exchange. It is
highly geared because, like many such companies, it borrowed a large sum to pay for a
license to operate a mobile phone network with technology that has not proved popular.
The companys share price has dropped by 50% during the last three years and there
have been several changes of senior management during that period. There has been
considerable speculation in the press over the last six months about whether the
company can survive without being taken over by a rival. There have been three
approaches made to the company by other companies regarding a possible takeover but
all have failed, mainly because the bidders pulled out of the deal as a result of the drop
in share prices generally.
The company has net assets, but has found it necessary to severely curtail its capital
investment program. Some commentators consider this to be fundamental to the future
growth of the business; others consider that the existing business is fundamentally
sound. It has also been necessary for the company to restructure its finances. Detailed
disclosures of all of these matters have always been made in the financial statements.
No reference has been made to the going concern status of the company in previous
auditors reports on financial statements and the deterioration in circumstances in the
current year is no worse than it has been in previous years.
Required:
(c) on the basis of the information provided above, describe the audit report that you
consider is likely to be issued in the case of tritel, giving reasons. (4 marks)
(d) explain the difficulties that would be faced by tritel and its auditors if tritels audit
report made reference
Question 4
You are the audit manager of tela & co, a medium sized firm of accountants. Your firm has
just been asked for assistance from jumper & co, a firm of accountants in an adjacent
country. This country has just implemented the internationally recognised codes on
corporate governance and jumper & co has a number of clients where the codes
Are not being followed. One example of this, from sgcc, a listed company, is shown below.
As your country already has appropriate corporate governance codes in place, jumper & co
have asked for your advice regarding the changes necessary in sgcc to achieve appropriate
compliance with corporate governance codes.
Extract from financial statements regarding corporate governance
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Mr sheppard is the chief executive officer and board chairman of sgcc. He appoints and
maintains a board of five executive and two non-executive directors. While the board sets
performance targets for the senior managers in the company, no formal targets or review of
board policies is carried out. Board salaries are therefore set and paid by mr sheppard
based on his assessment of all the board members, including himself, and not their actual
performance.
Internal controls in the company are monitored by the senior accountant, although detailed
review is assumed to be carried out by the external auditors; sgcc does not have an internal
audit department.
Annual financial statements are produced, providing detailed information on past
performance.
Required:
Write a memo to jumper & co which:
(a) explains why sgcc does not meet international codes of corporate governance
(b) explains why not meeting the international codes may cause a problem for sgcc, and
(c) recommends any changes necessary to implement those codes in the company.
(20 marks)
Question 5
Cerise, a limited liability company, manufactures computer-controlled equipment for
production-line industries such as cars, washing machines, cookers, etc. On 1 september
2004 the shareholder-managers decided, unanimously, to accept a lucrative offer from a
multi-national corporation to buy the companys patented technology and manufacturing
equipment.
By 10 september 2004 management had notified all the employees, suppliers and
customers that cerise would cease all manufacturing activities on 31 october 2004. The 200strong factory workforce and the majority of the accounts department and support staff were
made redundant with effect from that date, when the sale was duly completed.
The marketing, human resources and production managers will cease to be employed by the
company at 31 december 2004. However, the chief executive, sales manager, finance
manager, accountant and a small number of accounting and other support staff expect to be
employed until the company is wound down completely.
Cerises operations extend to fourteen premises, nine of which were put on the market on 1
november 2004. Cerise accounts for all tangible, non-current assets under the cost model
(i.e. At depreciated cost). Four premises are held on leases that expire in the next two to
seven years and cannot be sold or sub-let under the lease terms. The small head office
premises will continue to be occupied until the lease expires in 2007. No new lease
agreements were entered into during 2004.
All cerises computer-controlled products carry a one-year warranty. Extended warranties of
three and five years, previously available at the time of purchase, have not been offered on
sales of remaining inventory from 1 november onwards.
Cerise has three-year agreements with its national and international distributors for the sale
of equipment. It also has annual contracts with its major suppliers for the purchase of
components. So far, none of these parties have lodged any legal claim against cerise.
However, the distributors are withholding payment of their account balances pending
settlement of the significant penalties which are now due to them.
Required:
You are required to answer the following in the context of the final audit of the financial
statements of cerise for the year ending 31 december 2004:
(a) using the information provided, identify and explain the financial statement risks to be
taken into account in planning the audit. (6 marks)
(b) explain how the extent of the reliance to be placed on:
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(i) analytical procedures; and (4 marks)


(ii) management representations, (4 marks)
Should compare with that for the prior year audit.
(c) describe the principal audit work to be performed in respect of the carrying amount of the
following itemsin the balance sheet:
(i) amounts due from distributors; and (3 marks)
(ii) lease liabilities. (3 marks)
Question 6
Fraud and error present risks to an entity. Both internal and external auditors are required to
deal with risks to the entity. However, the responsibilities of internal and external auditors in
relation to the risk of fraud and error differ.
Required:
(a) explain how the internal audit function helps an entity deal with the risk of fraud
and error. (7 marks)
(b) explain the responsibilities of external auditors in respect of the risk of fraud and
error in an audit of financial statements. (7 marks)
(c) kilimanjaro ltd is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staffs are
partly paid on a commission basis. Well-established tour operators run the holidays that
kilimanjaro ltd sells. The networked reservations system through which holidays are booked
and the computerized accounting system are both well-established systems used by many
independent travel agencies.
payments by customers, including deposits, are accepted in cash and by debit and credit
card. Kilimanjaro ltd is legally required to pay an amount of money (based on its total sales
for the year) into a central fund maintained to compensate customers if the agency should
cease operations.
describe the nature of the risks to which kilimanjaro ltd is subject arising from fraud and
error. (6 marks)

Question 7
QUESTION 5
Saidia Yatima is a charity whose constitution requires that it raises funds for educational projects. These projects seek to
educate children and support teachers in certain countries. Charities in the country from which Ajio operates have recently
become subject to new audit and accounting regulations. Charity income consists of cash collections at fund raising
events, telephone appeals, and bequests (money left to the charity by deceased persons). The charity is small and the trustees
do not consider that the charity can afford to employ a qualified accountant. The charity employs a part-time bookkeeper and
relies on volunteers for fund raising. Your firm has been appointed as accountants and auditors to this charity because of the
new regulations. Accounts have been prepared (but not audited) in the past by a volunteer who is a recently retired Certified
Public Accountant.
Required:
(a)
Describe the risks associated with the audit of Saidia Yatima and explain the implications of these risks for overall
audit risk. (6 marks)
(b)
List and explain the audit tests to be performed on income and expenditure from fund raising events. (6 marks)
Solution :
QUESTION 5

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(a) Risks and implications for audit risk


INHERENT AND CONTROL RISKS
(i) Charities can be viewed as inherently risky because they are often managed by non-professionals and are susceptible to
fraud, although many charities and the volunteers that run them are people of the highest integrity who take a great deal of care over their
work. The assessment of this aspect of inherent risk depends on each individual charity and the areas in which it operates.
(ii) Charities are also at risk of being in violation of their constitutions which is important where funds are raised from public or
private donors who may well object strongly if funds are not applied in the manner expected. Other charities and regulatory bodies
supervising charities may also object. Again, the auditors will assess the level of risk. The involvement of a recently retired Certified Public
Accountant in the preparation of accounts in the past may lower the auditors assessed inherent risk to an extent.
(iii) Most small charities have a high level of control risk because formal internal controls are expensive and are not often in
place. This means that donations are susceptible to misappropriation. Charities rely on the trustworthiness of volunteers.
The auditors will assess the level of risk.
Detection risk
(iv) Detection risk comprises sampling risk and non-sampling risk. It is possible in this case that all transactions will be tested
and therefore sampling risk (the risk that samples are unrepresentative of the populations from which they are drawn) is not present.
(v) Non-sampling risk is the risk that auditors will draw incorrect conclusions because, for example, mistakes are made, or
errors of judgement are made in interpreting results, or because the auditors are unfamiliar with the client, as is the case here.

Audit risk
(vi) Audit risk is the product of inherent risk, control risk and detection risk and is the risk that the auditors will issue an inappropriate audit
opinion. This risk can be managed by decreasing detection risk by altering the nature, timing and extent of audit procedures applied.
Where inherent risk is high and controls are weak (as may be the case here) more audit work will be performed in appropriate areas in
order to reduce audit risk to an acceptable level.
(b) Audit tests fund raising events
(i) Attend fund raising events and observe the procedures employed in collecting, counting, banking and recording the cash.
This will help provide audit evidence that funds have not been misappropriated and that all income from such events has been recorded.
Sealed boxes or tins that are opened in the presence of two volunteers are often used for these purposes.
(ii) Perform cash counts at the events to provide evidence that cash has been counted correctly and that there is no collusion
between volunteers to misappropriate funds.
(iii) Examine bank paying in slips, bank statements and bank reconciliations and ensure that these agree with records made at
events. This also provides evidence as to the completeness of income.
(iv) Examine the records of expenditure for fund raising events (hire of equipment, entertainers, purchase of refreshments. etc.)
and ensure that these have been properly authorised (where appropriate) and that receipts have been obtained for all expenditure. This
provides evidence as to the completeness and accuracy of expenditure.
(v) Review the income and expenditure of fund raising events against any budgets that have been prepared and investigate
any significant discrepancies.
(vi) Ensure that all necessary licences (such as public entertainment licences) have been obtained by the trustees for such
events in order to ensure that no action is likely to be taken against the charity or volunteers.
(vii) Obtain representations from the trustees to the effect that there are no outstanding unrecorded liabilities for such events
again for completeness of expenditure and liabilities.

Suggested solutions
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Question 1
(a) (i) general controls
general controls relate to the environment in which the computer system are
developed ,maintained and operated .the objective of general controls are to ensure the
proper development and implementation of applications, and the integrity of the program and
data files and of computer operations. General controls include system development controls
,and general administrative controls such as division of duties ,back-up and stand-by
controls.
(ii)
Application controls
Application controls are defined by the standard as those that relate to the transactions
and standing data appertaining to such computer based accounting system and are,
therefore, specific to each application. The objectives of application controls are to ensure
the completeness and accuracy of the accounting records and the validity of the entries
made therein resulting from both manual and programming processing. Application
controls are normally divided into four parts:input controls ,processing controls, output
controls and master file controls.
(iii)
Computer Assisted Audit Techniques (CAATs)
In simple computer systems, the auditor may focus on the control environment, ensuring
that sufficient control comes from the input and output controls established by the
company. She may not probe into the detailed program checks built into software.
However ,in complex systems the auditor will place more reliance on existence of
programmed controls and assist the auditor in examining sample transaction data.there
are several types of caat ,for example ,audit software which examines the companys
computer files, test data which is submitted by the auditor for processing by the companys
computer and other techniques such as embedded audit facilities and application program
examination. Caats cannot examine general controls of a computer installation. These are
best examined by normal control evaluation methods, for example icqs, ices.
(b) the essential elements of the planning process can be described as the following:
(i) familiarization with the computer system in order to assess the specific needs and
problem of the audit. This would include a preliminary review and classification of the system
in operation .
(ii)selection of staff with the appropriate level of technical knowledge and skill
(iii)assessment of the timing of the audit work taking into account the availavility o f
computer time and the frequency with which data is updated and amended.
(iv)consideration of the reporting deadlines as this will have an effect on the usage of
caats.the shorter the deadline ,the more reliance may be placed on caats.
(v)consideration of the use of caats including the costs and benefits and their use ,as
this may have significant effect on the nature ,extent and timing of the audit tests.
(vi)reviewing work performed by internal auditors .caats performed by the internal
audit department may enable the auditor to reduce his audit work.the auditor will have
to asses the effectiveness and relevance of the internal audit function.
(vii)assessing the risks involved in the computer system.
(c ) four specific ways in which caats may help the auditor when auditing the sales and
debtors :
(i)compensation for loss of audit trail oncd a customers account has been
authorized, the only record of this authorization may be held on the computer file .caats may
be used to interrogate this file and extract the information.
(ii)selecting items for audit work .the auditor may use caats for selecting sample for
further audit wok ,for example customers who are above the credit limit ,or selecting items
for a debtors circularization.

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(iii)verification of items. The audit package will duplicate the processing performed by
the application programs and then compare its own results with the results produced by
application.for example ,the production of sales ledger control account items for a debtors
circularization.
(iv)conducting complex calculations.the auditor may wish to produce reports or carry
out statistical analysis on available data.for example ,he may wish to produce a debtors
ageing analysis or carry out an analytical review on sales and debtors.
(d)the formal planning of an audit should be carried out by the audit manager and
partner. Planning should take place befor the commencement of the audit in order to
achieve an efficient and effective audit .the use of the computer audit department should
be discussed at managerial level in the audit firm at an appropriate early stage in the
planning year in order to ensure that the computer audit staff are available at the time of
audit .responsiblility for planning the visit of the computer audit department should not be
delegated to a junior member of staff and therefore such a member staff cannot be
blamed for poor planning if the visit does not coincide with that of the main body of audit
staff. The audit senior should liaise with the computer audit manager in order to ensure
that the information to be generated by the use of caats is produced in a timely fashion.
(e)if the computer audit department visits the client on a different occasion then the
following disadvantages may arise.
(i)information required for the conduct of interm audit will have to be produced
manually ,for example a selection of debtors for circularizing.
(ii)the client may be unhappy because of the disruption caused by two audit visits.
(iii)the computer audit department will need advice by the audit staff, who carried out
the interim audit , on the work be performed.this will involve another audit visit by the staff
which will add to the cost of audit.
Question 2
(a) internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under
nbaaas rules of professional conduct).
Internal matters
Before accepting appointment the firm should ensure that:
(i) it has the necessary staff with appropriate competencies to complete the audit
(this seems likely given that the firm has other clients in this sector);
(ii) the staff are available at what is a busy time of year for the firm (it may be
possible that all of the staff with the necessary competencies are otherwise occupied);
(iii) the firm is independent of viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two entrepreneurs),
however, there may be staff or partners who are related to the client or are otherwise
connected with it;
(iv) there are no conflicts of interest that cannot be properly managed. Conflicts of
interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:
(v) seek the directors permission to communicate with the company accountant
about the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
(vi) seek the directors permission to communicate with the incumbent auditors. If
permission is refused, the appointment should not be accepted;

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(vii) ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if viswa refuses to give permission to
the incumbent auditors the appointment should not be accepted);
(viii) communicate with the incumbent auditors (preferably in writing) requesting all
the information which ought to be made available to enable the firm to decide whether or not
to accept the appointment (if there are no such matters, the incumbent auditors should
inform the firm of this);
(ix) seek appropriate transfer information (such as a copy of the last set of accounts
and a detailed trial balance reconciled to the accounts);
(x) indicate a likely fee (or the basis on which fees are calculated) to viswa, ensure
that this is acceptable and that the client is able to pay (by some form of credit check);
(xi) ensure that the incumbent auditor has properly resigned, been dismissed or has
not sought re-appointment in accordance with legal requirements.
(b) starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
(i) without the staff with appropriate competencies the firm will be in breach of the
rules (and may be found negligent if things were to go wrong);
(ii) without complying with the requirements relating to independence and conflicts of
interest, the firm will not only be in breach of the rules, but will lack objectivity and may find
that the client (or other party) objects to the appointment to another client in the same sector;
(iii) without performing appropriate procedures the firm will be unable to form an
opinion on the integrity of the client it may find itself associated with an entity engaging in
doubtful or even illegal activities (taking account of the disagreement over disclosures);
(iv) without agreeing a fee it is almost inevitable that misunderstandings or
disagreements will arise;
(v) without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have arisen in
the past;
(vi) without ensuring that the incumbent auditor is no longer in place, it will be
inappropriate for the firm to seek appointment.
(c) engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It:
(i) confirms the auditors acceptance of appointment and constitutes a contract
between the auditor and the client;
(ii) summarises the respective responsibilities of directors and auditors;
(iii) contains details on:
1. The responsibilities of the directors (for accounting records, the financial
statements and the accounting policies on which they are based);
2. The responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and disclosures,
to perform tests and to form an opinion on the financial statements);
3. The form of report to be issued;
4. Other services to be provided;
5. The basis of calculation of fees;
6. Applicable legislation.

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Question 3
(a) external auditor responsibilities going concern
Isa 570 going concern deals with this issue.
(i) auditors are required to consider the going concern status of companies and any
disclosures regarding going concern in forming their audit opinion. Companies that are listed
on stock exchanges may be required to make additional disclosures in relation to going
concern issues.
(ii) auditors are required to assess the adequacy of the means (the processes) by
which directors have satisfied themselves that the going concern basis is appropriate and
that adequate disclosures have been made. Auditors conduct an initial analysis at the
planning stage of the audit as well as assessments at later stages.
(iii) auditors should make enquiries of the directors and examine appropriate
documentation supporting the companys going concern status such as budgets and cash
flow forecasts.
(iv) auditors consider whether the period to which directors have paid particular
attention is adequate. This should normally be at least 12 months from the balance sheet
date. Auditors also enquire of management as to their knowledge of events or conditions
beyond this period that may cast significant doubt on the entitys ability to continue as a
going concern.
(v) auditors need to consider the appropriateness of assumptions which directors
have made, the sensitivity of assumptions to external and internal changes, any obligations,
guarantees or undertakings arranged with other entities, the existence and adequacy of
borrowing facilities and the directors plans to deal with any going concern problems.
(vi) auditors are required to document the extent of any concerns, taking account of
matters that have come to their attention during the course of the audit and in particular,
financial, operational, or other indicators of going concern problems that are present.
(vii) indicators of going concern issues would include trading losses, impairment of
assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans
where necessary, fundamental changes in the markets or technology having an adverse
effect on the company, loss of management, staff, customers or suppliers, or major litigation,
for example.
(viii) auditors should consider the need to obtain written management
representations.
(ix) auditors should consider the adequacy of any disclosures in the financial
statements.
(b) possible audit reports and circumstances
(i) where the auditors consider that there is a significant level of concern about the
entitys ability to continue as a going concern (but do not disagree with the going concern
basis), and where adequate disclosures of the situation are made, they modify (but do not
qualify) their opinion by including an emphasis of matter paragraph highlighting the
existence
Of a material uncertainty as to the going concern status of the entity and drawing attention to
the relevant note in the financial statements. Where adequate disclosures are not made, a
qualified or adverse opinion will be issued.
(ii) where the period to which directors have paid particular attention is less than 12
months from the balance sheet date, the auditors should consider the need to modify the
audit report as a result of a limitation in the scope of the audit.
(iii) where the auditors disagree with the preparation of the financial statements on
the going concern basis, they should issue an adverse opinion. This is very rare because
auditors rarely have sufficient evidence to be sure.

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(iv) if the auditors are unable to form an opinion on the going concern status of a
company because of a limitation in the scope of the audit, they will issue an except for
opinion, or disclaimer of opinion but this is unusual.
(c) report issued to tritel
(i) in the case of tritel, there are some indicators of going concern problems. However, the
company may still be a going concern and the fact that the company has been approached
by take-over bidders does not necessarily mean that there is a going concern problem
(possibly quite the opposite).
(ii) the audit opinion issued on tritel in the current year is not likely to make reference
to the going concern status of the company, as in previous years. The situation has not
deteriorated significantly in the current year and it will be difficult for auditors to justify any
change in their opinion from previous years.
(d) difficulties associated with reporting on going concern
(i) if the auditors of tritel were to report on a going concern problem, the mere act of
reporting might of itself create a going concern problem (a self-fulfilling prophecy). This is
particularly the case with large blue-chip companies where the issue of an audit report that
is modified in any way is unusual and might well cause the companys share price to drop,
thus precipitating a going concern problem.
(ii) this means that it is very difficult for companies such as tritel and their auditors to
send out any clear signal to the markets without running the risk of creating a panic.
(iii) however, recent events show that the consequences of companies and auditors
failing to report where severe financial difficulties are encountered can be disastrous for both
the company (its employees and shareholders) and auditors alike.
(iv) auditors are failing in their professional duties if they do not report on going
concern problems of which they are aware; however, situations involving large companies
are rarely clear cut and auditors who propose to make any changes at all to the audit report
are likely to encounter fierce resistance from management who may genuinely believe that
to make
Such a report would be wrong.
(v) in the companys annual financial statements, it is not the place of the auditor of
tritel to substitute his judgement for that of directors. However, where large companies
involved in complex financing arrangements are concerned, auditors may have to fight hard
against vested and powerful interests if they disagree with the directors judgements and
decide to make reference to the matter in the auditors report. An auditor making reference
to going concern issues in an audit report in such circumstances may lose the audit (and any
other work) and may run a significant risk of litigation.

Question 4
From: a manager, tela & co
To: jumper & co
Subject: corporate governance in the sgcc company
Date: 13 june 2006
As requested, i write to explain where your client sgcc does not appear to be following
appropriate corporate governance codes and to recommend changes to ensure that the
principles of good corporate governance are being followed.
Chief executive officer (ceo) and chairman
Mr sheppard is both ceo and chairman of sgcc. Corporate governance indicates that the
person responsible for running thecompany (the ceo) and the person responsible for
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controlling the board (the chairman) should be different people. This is to ensure that no one
individual has unrestricted powers of decision.
I recommend that mr sheppard is either the ceo or the chairman and that a second individual
is appointed to the other post to ensure that mr sheppard does not have too much power in
sgcc.
Composition of board
The current board ratio of executive to non-executive directors is 5:2. This means that the
executive directors can dominate the board proceedings. Corporate governance codes
suggest that there should be a balance of executive and non-executive directors so this
cannot happen. A minimum of three non-executive directors are also normally
recommended, although reports such as cadbury note this may be difficult to achieve.
I recommend that the number of executive and non-executive directors is equal to help
ensure no one group dominates the board.
This will mean appointing more non-executive directors to sgcc.
Director appointment
At present, mr sheppard appoints directors to the board, giving him absolute authority over
who is appointed. This makes the appointment procedure and qualities directors are being
appointed against difficult to determine. Corporate governance suggests
That appointment procedures should be transparent so that the suitability of directors for
board positions can be clearly seen.
I recommend that an appointments committee is established comprising three non-executive
directors to ensure there is no bias
In board appointments. Formal job descriptions should also be published making the
appointment process more transparent.
Review of board performance
It is correct that the performance of senior managers is reviewed, but this principle should
also be applied to the board. While mr sheppard may undertake some review, this is not
transparent and it is not clear what targets the board either met or did not meet.
I recommend that performance targets are set for each director and actual performance
assessed against these on a regular basis.
Reasons for underperformance should also be ascertained and where appropriate, changes
made to the composition of the board.
Board pay
At present, board members pay is set by mr sheppard. This process breaches principles of
good governance because the remuneration structure is not transparent and mr sheppard
sets his own pay. Mr sheppard could easily be setting remuneration
Levels based on his own judgements without any objective criteria.
I recommend that a remuneration committee is established comprising three non-executive
directors. They will set remuneration levels for the board, taking into account current salary
levels and the performance of board members. Remuneration should also be linked to
performance, to encourage a high standard of work.
Internal control
The system of internal control in sgcc does not appear to be reviewed correctly. While
external auditors will review the control system, this review is based on their audit
requirement and cannot be relied on to test the overall effectiveness of the system. The
system may therefore still contain weaknesses and errors.
I recommend that some more formal review of internal control is carried out, perhaps by
establishing an internal audit department, as noted below. The relationship with the
companys auditors must also be reviewed so that the work of the board and the auditors
regarding internal control is understood by both parties.
Internal audit
Sgcc does not have an internal audit department. Given the lack of formal review of internal
control in the company, this is surprising. Good corporate governance implies that the
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control system is monitored and that an internal audit department is established to carry out
this task.
I recommend that an internal audit department is established, reporting initially to the audit
committee who will monitor internal control and then summarise reports for the board.
Financial statements
There appears to be acceptable disclosure in the financial statements regarding the past
results of the company. However, the board should also provide an indication of how the
company will perform in the future, by a forecast review of operations or similar statement.
This is partly to enable investors to assess the value of their investment in the company.
I therefore recommend that the annual accounts of sgcc include some indication of the future
operations of the company.
Audit committee
There is no mention in the report of an audit committee. Good corporate governance implies
that there is some formal method of monitoring external auditors as well as checking that the
reports from the external auditors are given appropriate attention in the company.
I recommend that an audit committee is established made up from non-executive directors.
The committee will receive reports from the external and internal auditors (as mentioned
above) and ensure that the board takes appropriate action on these reports.
I hope this information is useful. Please contact me again if you require any further
assistance.
Sincerely
Ann c. Outent
Note to candidates: an alternative and allowable answer format was to answer sections (a),
(b) and (c) of the question separately.
Taking this approach would also allow other valid points in part (b) such as inability to obtain
a stock exchange listing.
Question 5
Cerise
(a) financial statement risks planning the final audit 31 december 2004
Computer-controlled equipment for production-line industries
cerise is manufacturing a relatively high-tech range of products. Inventory will be
overstated if sufficient allowance is not made for technical obsolescence and slow-moving
items (i.e. Writing inventory down to lower of cost and net realisable value).
as cerise is ceasing manufacture two months prior to the year end the items remaining in
inventory at the year end are likely to require being written down in value. The amount of
write down is required to be disclosed in accordance with ias 2 inventories2.
Cessation of trade
cerise ceased to trade during the year. The financial statements should not therefore be
prepared on a going concern basis, but on a break-up or other realisable basis.
this has implications for:
the reclassification of assets and liabilities (from non-current to current);
the carrying amount of assets (at recoverable amount); and
the completeness of recorded liabilities.
Redundant workforce
liabilities may not be disclosed (if contingent) or provided for, if there are claims arising
from the redundant workers (e.g. If their statutory or contractual rights have been breached).
although statutory redundancy pay, holiday pay, accrued overtime etc may well have all
been settled before the year end there may be additional liabilities in respect of former
employees (e.g. Pension obligations).
Sale of patented technology and manufacturing equipment
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all assets sold should be derecognised and the profit on disposal disclosed as an
exceptional item arising from the discontinuance of operations.
plant and equipment will be overstated if:
manufacturing equipment that has been sold is left on the books;
assets that were not part of the sale are not:
tested for impairment (in accordance with ias 36 impairment of assets);
written down to the higher of net selling price and value in use.
Accounts department
fewer (skeleton) staff being employed in the accounts department may increase the risk
of errors arising as staff assume
Wider areas of responsibility as the volume of transactions is reduced.
the risk of errors arising not being detected (i.e. Control risk) is also likely to increase. For
example, levels of supervision and degrees of segregation of duties may be reduced and
adherence to control procedures may slacken.
Premises
if the unsold properties meet all the criteria of ifrs 5 non-current assets held for sale and
discontinued operations at the balance sheet date they should be:
separately classified as held for sale.
carried at the lower of carrying amount (i.e. Depreciated cost) and fair value less estimated
costs to sell.
any after-date losses on disposal would provide evidence of impairment. (however, as it is
cerises policy to carry noncurrent assets at depreciated cost, impairment is less likely than if
they were carried at revalued amounts.)
unoccupied premises may fall into disrepair with time. The financial statements would be
misstated if the management of cerise sought to provide for:
dilapidations on the properties arising after the balance sheet date; and/or
future expectation of repairs on unsold properties.
Such provisions are contrary to ias 37 provisions, contingent liabilities and contingent
assets.
Tutorial note: consider a property with carrying amount $1 million (depreciated cost) and fair
value $16 million. Repair costs of $05 million incurred for deterioration after 31 december
2004 cannot be provided for, nor is the carrying amount impaired.
Onerous contracts
full provision should be made for the lease obligations under onerous contracts on four
premises in accordance with ias 37. This should not be extended to the head office
premises.
Product warranties
adequate provision must be made for warranties of:
one year (sales in the year to 31 december 2004);
up to three years (sales between 1 january 2002 and 31 october 2004); and
up to five years (sales between 1 january 2000 and 31 october 2004).
the provision may be understated if the basis of its calculation is no longer appropriate. For
example, if cerise must now outsource warranty work as it no longer has an in-house
capability.
Breach of agreements/contracts
since cerise no longer has the means of fulfilling contracts with distributors, provision
should be made for any compensation or penalties arising. Where the penalties due to
distributors for breach of supply agreements exceed the amounts due from them, the
receivables should be written down and provision made for any excess.
adequate provision should be made for breaches of contracts with suppliers (nonpurchase). If suppliers do not exercise their rights to invoke penalty clauses disclosure of the
contingent liability may be more appropriate than a provision.
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(b) reliance on audit work


(i) analytical procedures
Tutorial note: reliance on analytical procedures is only obtained through those that provide
substantive audit evidence.
This question therefore concerns substantive analytical procedures as evidence which are
optional not those at the
Planning and review stages (which are mandatory).
overall the extent of reliance on analytical procedures is likely to be less than that for the
prior year audit as the
Scale and nature of cerises activities will differ from the prior year.
there are a number of individually material transactions in the current year which will
require detailed substantive
Testing (e.g. Sale of patented technology and manufacturing equipment and sale of
premises).
budgetary information used for analytical procedures in prior periods (e.g. Budgeted
production/sales) will have less relevance in the current year as the cessation of trade is
unlikely to have been forecast.
information will be comparable with the prior year for at most 10 months (i.e. January to
october). Costs incurredin november/december will relate to winding down operations
rather than operational activities.
the impact of the one-off circumstance on carrying amounts is more likely to be assessed
through detailed substantive testing (e.g. After-date realisation) than reliance on ratios and
past history.
for example, analytical procedures on an aged-debt analysis and calculation of average
collection period used inprior years will not be relevant to assessing the adequacy of the
write-down now needed. Similarly, inventory turnover ratios will no longer be comparable
when inventory is no longer being replenished.
however, some reliance will still be placed on certain analytical procedures. For example,
in substantiating charges to the income statement for the 10 months of operations.
(ii) management representations
overall the extent of reliance on management representations is likely to be increased as
compared with the prior year audit.
the magnitude of matters of judgement and opinion is greater than in prior years. For
example, inventory/trade receivable write-downs, impairment losses and numerous
provisions. The auditor will seek to obtain as much corroborative evidence as is available.
However, where amounts of assets have still to be recovered and liabilities settled,
management will be asked to make representations on the adequacy of write-downs,
provisions, etc and the completeness of disclosures (e.g. For claims and other contingent
liabilities).
where negotiations are under discussion but not yet formalised (e.g. With a prospective
buyer for premises), management may be the only source of evidence (e.g. For the best
estimate of sale proceeds).
however, the extent to which reliance can be placed on representations depends on the
extent to which those making the representation can be expected to be well-informed on the
particular matters. Therefore, as the human resources and production directors will not be
available after the balance sheet date particular thought should be given to obtaining
representations on matters pertaining to employee obligations and product warranties (say).
(c) principal audit work carrying amount
Tutorial note: discussions with management and obtaining management representations are
not principal audit work.
(i) amounts due from distributors

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agreeing gross amounts due to accounts receivable balances (for sales made in the
normal course of business up to 31 october 2004 and in the running down of inventory to 31
december 2004).
as a significant portion of account balances outstanding will already be two months old at
31 december 2004, all receipts of after-date cash (if any) should be monitored for evidence
of recoverability.
Tutorial note: a standard direct confirmation of accounts receivable will not be principal audit
work in respect of the carrying amount since the scenario identifies recoverability as the
financial statements risk.
review of agreements with distributors to confirm the unexpired period (up to three years)
and the penalties stipulated.
recalculation of amounts due to distributors for the early termination of the agreements
with them.
review of cerises correspondence to the distributors (e.g. Offering financial settlement)
and responses received.
Tutorial note: distributors might settle for a waiver of the amounts they are owed and/or a
lump sum which amount to less than the penalties due to them under the terms of their
agreements.
(ii) lease liabilities
Tutorial note: it is clearly stated that no new lease agreements were entered into during the
year. Therefore
re-auditing from scratch what would have been examined in previous years as though it
was a new transaction is neither necessary nor efficient.
confirm the leases as operating leases to prior period working papers/disclosures in the
previous years financial statements.
to confirm contracts as onerous and justify full provision:
review cerises correspondence with the lessors requesting terms for an early exit from the
lease period;
visit premises to confirm that cerise is not receiving any economic benefit from them (i.e.
They are not still
Occupied or sub-let).
agree/reconcile the amounts provided for liabilities under onerous contracts to the present
value of the future minimum lease payments under non-cancellable operating leases.
agree/reconcile the future minimum lease payments used in the calculation of the
provision to those disclosed (under ias 17 leases) in the financial statements to 31
december 2003 as:
later than one year and not later than five years; plus
later than five years.
Tutorial note: the payments not later than one year in the prior year financial statements will
have been paid during the year and so form no part of the provision.
Question 6
(a) internal audit function: risk of fraud and error
(i) the internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of the risks
to which the entity is subject that would prevent it achieving its overall objectives such as
profitability. Corporate governance objectives also include the overarching need for the
management of an entity to exercise a stewardship function over the entitys assets.
(ii) a large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the business
as a whole, and in relation to specific areas, include the effective operation of an internal
audit function.
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(iii) internal audit can help management manage risks in relation to fraud and error,
and exercise proper stewardship by:
1. Commenting on the process used by management to identify and classify
the specific fraud and error risks to which the entity is subject (and in some cases
helping management develop and implement that process);
2. Commenting on the appropriateness and effectiveness of actions taken by
management to manage the risks identified (and in some cases helping management
develop appropriate actions by making recommendations);
3. Periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
4. Monitoring the incidence of fraud and error, investigating serious cases and
making recommendations for appropriate management responses.
(iv) in practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and reporting of
fraud and error. Routine internal controls (such as the controls over computer systems and
the production of routine financial information) and non-routine controls (such as controls
over year-endadjustments to the financial statements) are relevant.
(v) it should be recognised however that many significant frauds bypass normal
internal control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be reviewed
by internal audit in order to establish the nature of the risks, and to manage them effectively.

(b) external auditors: fraud and error in an audit of financial statements


(i) external auditors are required by isa 240 the auditors responsibility to consider
fraud in an audit of financial statements to consider the risks of material misstatements in the
financial statements due to fraud. Their audit procedures will then be based on a risk
assessment. Regardless of the risk assessment, auditors are required to be alert to the
possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entitys financial statements to material misstatements due to fraud.
(ii) auditors should make enquiries of management regarding managements
assessment of fraud risk, its process for dealing with risk, and its communications with those
charged with governance and employees. They should enquire of those charged with
governance about the oversight process.
(iii) auditors should also enquire of management and those charged with governance
about any suspected or actual instance of fraud.
(iv) auditors should consider fraud risk factors, unusual or unexpected relationships,
and assess the risk of misstatements due to fraud, identifying any significant risks. Auditors
should evaluate the design of relevant internal controls, and determine whether they have
been implemented.
(v) auditors should determine an overall response to the assessed risk of material
misstatements due to fraud and develop appropriate audit procedures, including testing
certain journal entries, reviewing estimates for bias, and obtaining an understanding of the
business rationale of significant transactions outside the normal course of business.
Appropriate management representations should be obtained.
(vi) auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than internal
auditors to small frauds (and errors), although they must always consider whether evidence
of single instances of fraud (or error) are indicative of more systematic problems.

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(vii) it is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with isas might not detect a material misstatement in the financial
statements arising from fraud. In practice, routine errors are much easier to detect than
frauds.
(viii) where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve further
investigations. They should also consider the need to report to management and those
charged with governance.
(ix) where serious frauds (or errors) are encountered, auditors need also to consider
the effect on the going concern status of the entity, and the possible need to report externally
to third parties, either in the public interest, for national security reasons, or for regulatory
reasons. Many entities in the financial services sector are subject to this type of regulatory
Reporting and many countries have legislation relating to the reporting of money laundering
activities, for example.
(c) nature of risks arising from fraud and error: kilimanjaro ltd
(i) kilimanjaro ltd is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the information
produced may be incomplete or incorrect. Inadequate controls also give rise to the risk of
fraud by those who understand the system and are able to manipulate it in order to hide the
Misappropriation of assets such as receipts from customers.
(ii) all networked systems are also subject to the risk of error because of the
possibility of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
(iii) all entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they may
misappropriate those assets (fraud) and then seek to hide the error or fraud by falsifying the
records.
(iv) kilimanjaro ltd is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card companies may
be liable for such frauds, attempts to use stolen cards can cause considerable
inconvenience.
(v) there is a risk of fraud perpetrated by senior management who might seek to
lower the amount of money payable to the central fund (and the companys tax liability) by
falsifying the companys sales figures, particularly if a large proportion of holidays are paid
for in cash.
(vi) there is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.

Question 1 (financial statement assertions)


You are the audit manager in the firm of elsam and co, an audit firm with ten national offices.
One of your clients, geita mining company, purchases diamond jewellery from three
manufacturers. The jewellery is then sold from geita mining companys four shops. This is
the only client your firm has in the diamond industry.
You are planning to attend the physical inventory count for geita mining company. Inventory
is the largest account on the balance sheet with each of the four shops holding material
amounts. Due to the high value of the inventory, all shops will be visited and test counts
performed.

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With the permission of the directors of geita mining company, you have employed alex
stewart (asseyers), a firm of specialist diamond valuers who will also be in attendance. Alex
stewart (asseyers) will verify that the jewellery is, in fact, made from diamonds and that the
jewellery is saleable with respect to current trends in fashion. Alex stewart (asseyers) will
also suggest, on a sample basis, the value of specific items of jewellery.
Counting will be carried out by shop staff in teams of two using pre-numbered count sheets.
Required:
(a) List and explain the reason for the audit procedures used in obtaining
Evidence in relation to the inventory count of inventory held in the shops. (10 marks)
(b) explain the factors you should consider when placing reliance on the work of alex
stewart (asseyers). (5 marks)
(c) describe the audit procedures you should perform to ensure that jewellery
inventory is valued correctly. (5 marks)
Question 2 (internal auditing)
You are the senior manager in the internal audit department of octball, a limited liability
company. You report to the chief internal auditor and have a staff of six junior auditors to
supervise, although the budget allows for up to ten junior staff.
In a recent meeting with the chief internal auditor, the difficulty of staff recruitment and
retention was discussed. Over the past year, five junior internal audit staff have left the
company, but only two have been recruited. Recruitment problems identified include location
of octballs head office in a small town over 150 kilometres from the nearest major city and
extensive foreign travel, often to cold climates.
Together with the chief internal auditor you believe that outsourcing the internal audit
department may be a way of alleviating the staffing problems. You would monitor the new
outsourced department in a part-time role taking on additional responsibilities in other
departments, and the chief internal auditor would accept the post of finance
Director (fd) on the board, replacing the retiring fd.
Two firms have been identified as being able to provide the internal audit service:
the nfa partnership, a local firm specialising in provision of accountancy and internal audit
services. Nfa does not audit financial statements or report to members, and t&m, octballs
external auditors, who have offices in 75 countries and employ in excess of 65,000 staff.
Required:
(a) discuss the advantages and disadvantages of appointing nfa as internal
auditors for octball. (8 marks)
(b) discuss the issues t&m need to consider before they could accept
appointment as internal auditors for octball. (7 marks)
(c) assume that an outsourcing company has been chosen to provide internal audit services.
Describe the control activities that octball should apply to ensure that the internal audit
service is being maintained to a high standard. (5 marks)
Question 3 ( planning and control of an audit)
(a) international standard on auditing 300 (revised) planning an audit of financial statements,
states that an auditor must plan the audit.
Explain why it is important to plan an audit. (5 marks)
(b) you are the audit manager in charge of the audit of tempest, a limited liability company.
The companys year end is 31 december, and tempest has been a client for seven years.
The company purchases and resells fittings for ships including anchors, compasses,
rudders, sails etc. Clients vary in size from small businesses making

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Yachts to large companies maintaining large luxury cruise ships. No manufacturing takes
place in tempest.
Information on the companys financial performance is available as follows:
2005 forecast 2004 actual
shs.000
shs.000
Revenue
45,928
40,825
Cost of sales
(37,998)
(31,874)

Gross profit
7,930
8,951
Administration costs
(4,994)
(4,758)
Distribution costs
(2,500)
(2,500)

Net profit
436
1,693

Non-current assets (at net book value)
3,600
4,500
Current assets
Inventory
200
1,278
Receivables
6,000
4,052
Cash and bank
500
1,590

Total assets
10,300
11,420

Capital and reserves


Share capital
1,000
1,000
Accumulated profits
5,300
5,764

Total shareholders funds


6,300
6,764
Non-current liabilities
1,000
2,058
Current liabilities
3,000
2,598

10,300
11,420

Other information
The industry that tempest trades in has seen moderate growth of 7% over the last year.
non-current assets mainly relate to company premises for storing inventory. Ten delivery
vehicles are owned with a net book value of tshs.300,000.
one of the directors purchased a yacht during the year.
inventory is stored in ten different locations across the country, with your firm again having
offices close to seven of those locations.
a computerised inventory control system was introduced in august 2005. Inventory
balances are now obtainable directly from the computer system. The client does not intend
to count inventory at the year-end but rely instead on the computerised inventory control
system.
Required:
Using the information provided above, prepare the audit strategy for tempest for the year
ending 31 december 2005. (15 marks)

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Question 4 (subsequent events)


(a) international standard on auditing 560 subsequent events explains the audit work
required in connection with subsequent events.
Required:
List the audit procedures that can be used prior to the auditors report being signed to
identify events that may require adjustment or disclosure in the financial statements. (5
marks)
(b) you are the auditor of oilrakers, a limited liability company which extracts, refines and
sells oil and petroleum related products.
The audit of oilrakers for the year ended 30 june 2005 had the following events:
Date event
15 august 2005 bankruptcy of major customer representing 11% of the trade receivables on
the balance sheet.
21 september 2005 financial statements approved by directors.
22 september 2005 audit work completed and auditors report signed.
1 november 2005 accidental release of toxic chemicals into the sea from the companys oil
refinery resulting in severe damage to the environment. Management had amended and
made adequate disclosure of the event in the financial statements.
23 november 2005 financial statements issued to members of oilrakers.
30 november 2005 a fire at one of the companys oil wells completely destroys the well.
Drilling a new well will take ten months with a consequent loss in oil production during this
time.
Required:
For each of the following three dates:
15 august 2005;
1 november 2005; and
30 november 2005
(i) state whether the events occurring on those dates are adjusting or non-adjusting
according to ias 10 events after the balance sheet date, giving reasons for your decision; (6
marks)
(ii) explain the auditors responsibility and the audit procedures that should be carried out. (9
marks)
Question 5 (computer assisted audit techniques)
(a) computer-assisted audit techniques (caats) are used to assist an auditor in the collection
of audit evidence from computerised systems.
Required:
List and briefly explain four advantages of caats. (4 marks)
(b) porthos, a limited liability company, is a reseller of sports equipment, specialising in
racquet sports such as tennis, squash and badminton. The company purchases equipment
from a variety of different suppliers and then resells this using the internet as the only selling
media. The company has over 150 different types of racquets
Available in inventory, each identified via a unique product code.
Customers place their orders directly on the internet site. Most orders are for one or two
racquets only. The ordering/sales software automatically verifies the order details, customer
address and credit card information prior to orders being verified and goods being
despatched. The integrity of the ordering system is checked regularly by
Archerweb, an independent internet service company.

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You are the audit manager working for the external auditors of porthos, and you have just
started planning the audit of the sales system of the company. You have decided to use test
data to check the input of details into the sales system. This will involve entering dummy
orders into the porthos system from an online terminal.
Required:
List the test data you will use in your audit of the financial statements of porthos to confirm
the completeness and accuracy of input into the sales system, clearly explaining the reason
for each item of data. (6 marks)
(c) you are also considering using audit software as part of your substantive testing of the
data files in the sales and inventory systems of porthos.
(i) list and briefly explain some of the difficulties of using audit software; (4 marks)
(ii) list the audit tests that you can program into your audit software for the sales and
inventory system in porthos, explaining the reason for each test. (6 marks)
Question 6
Isa 500 audit evidence (revised) states that management implicitly or explicitly makes
assertions relating to thevarious elements of financial statements including related
disclosures. Auditors may use three categories of assertions to form a basis for risk
assessments and the design and performance of further audit procedures. The three
categories
Suggested by isa 500 relate to (i) classes of transactions, (ii) account balances, and (iii)
presentation and disclosure.
One assertion applicable to all three categories is completeness: that all transactions,
events, assets, liabilities, equity interests and disclosures that should be included, are
included in the financial statements.
Required:
(a) List and describe six financial statement assertions, other than completeness, used
by auditors in the audit of financial statements. (6 marks)
(b) Mishili ltd is a small company that manufactures hosiery products. It employs
approximately 150 staff, all of whom are paid by bank transfer.
Temporary factory staffs are hired through an agency and are paid on piece rates
(i.e. For the number of items that they produce or process) on a weekly basis.
Supervisors at boulder authorise documentation indicating the number of items
produced or processed by agency staff. The agency is paid by bank transfer and it,
not boulder, is responsible for the deduction of tax and social insurance.
Permanent factory staff are paid on a weekly basis on the basis of hours worked as
evidenced by clock cards.
Administration and sales staff are paid a monthly salary. The two directors of the
company are also paid a monthly salary.
Sales staff are paid a quarterly bonus calculated on the basis of sales. Directors are
paid an annual bonus based on profits.
You will be performing the audit of the financial statements for the year ending 31
december 2004 and you willbe responsible for the figures in the financial statements
relating to payroll.
Required:

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Describe the substantive audit procedures you will perform on:


(i) the payroll balances in the balance sheet of mishili ltd; (10 marks)
(ii) the payroll transactions in the income statement of boulder. (4 marks)

Question 7 ( audit engagement)


Viswa is a company that provides call centre services for a variety of organizations. It
operates in a medium sized city and your firm is the largest audit firm in the city. Viswa is
owned and run by two entrepreneurs with experience in this sector and has been in
existence for five years. It is expanding rapidly in terms of its client base, the number of staff
it employs and its profits. It is now 15 june 2004 and you have been approached to perform
the audit for the year ending 30 june 2004. Your firm has not audited this company before.
Viswa has had three different firms of auditors since its incorporation.
Viswas directors have indicated to you informally that the reason they wish to change
auditors is because of a disagreement about certain disclosures in the financial statements
in the previous year. The directors consider that the disagreement is a trivial matter and
have indicated that the company accountant will be able to provide you with the details once
the audit has commenced. Your firm has explained that before accepting the appointment,
there are various matters to be considered within the firm and other procedures to be
undertaken, some of which will require the co-operation of the directors. Your firm has other
clients that operate call centers. The directors have asked your firm to commence the audit
immediately because audited accounts are needed by the bank by 30 july 2004. Your firm is
very busy at this time of year.
Required:
(c) Describe the matters to consider within your firm and the other procedures that
must be undertaken before accepting the appointment as auditor to viswa. (10
marks)
(d) Explain why it would be inappropriate to commence the audit before
consideration of the matters and the procedures referred to in (a) above have
been completed. (5 marks)
(e) Explain the purpose of an engagement letter and list its
Contents. (5 marks)

Question 8 (audit procedures)


There are a number of different methods of obtaining audit evidence. Methods include:
(i) analytical procedures;
(ii) audit sampling;
(iii) tests of controls;
(iv) detailed testing of transactions and balances;
(v) computer assisted audit techniques (caats).
These methods overlap and may be used for different purposes during an audit of financial
statements.
Required:
(a) Explain the advantages and disadvantages of each of the five methods of
evidence gathering listed above. (15 marks)
Nb: you are not required to describe the methods listed above.

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(b) Describe the relationship between the five methods of evidence gathering
described above.

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Question 9 ( audit procedures)


Auditors obtain several different confirmations from various sources during the course of
their audit.
Required:
(a)

describe the audit evidence provided by each of the confirmations listed below, the
practical difficulties in obtaining them and the alternative audit evidence available
when they are not provided:
(i) management representations. (2.5 marks)
(ii) direct confirmation of receivables. (3 marks)
(iii) confirmation of inventory held by third parties. (2.5 marks)
(iv) reports provided by auditors of third party service organizations. (2 marks)

(b) ias 2 inventories requires that inventories are measured at the lower of cost and net
realizable value.
Required:
(a) Explain why the audit of inventory is important to auditors. (2.5
Marks)
(b) define cost and net realizable value according to ias 2 inventories. (3)
(c) Describe the audit evidence that you would obtain for the cost and net realizable
value of finished inventory in a company that manufactures household furniture.
(4.5 marks)
Nb: you are not required to deal with inventory quantities.

Question 10 (going concern)


(d) Describe external auditors responsibilities and the work that the auditor should perform
in relation to the going concern status of companies. (5 marks)
(e) Describe the possible audit reports that can be issued where the going concern status of
a company is called into question; your answer should describe the circumstances in
which they can be issued. (5 marks)
(f) Tritel is a large telecommunications company that is listed on a stock exchange. It is
highly geared because, like many such companies, it borrowed a large sum to pay for a
licence to operate a mobile phone network with technology that has not proved popular.
The companys share price has dropped by 50% during the last three years and there
have been several changes of senior management during that period. There has been
considerable speculation in the press over the last six months about whether the
company can survive without being taken over by a rival. There have been three
approaches made to the company by other companies regarding a possible takeover but
all have failed, mainly because the bidders pulled out of the deal as a result of the drop
in share prices generally.
The company has net assets, but has found it necessary to severely curtail its capital
investment program. Some commentators consider this to be fundamental to the future
growth of the business, others consider that the existing business is fundamentally
sound. It has also been necessary for the company to restructure its finances. Detailed
disclosures of all of these matters have always been made in the financial statements.
No reference has been made to the going concern status of the company in previous

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auditors reports on financial statements and the deterioration in circumstances in the


current year is no worse than it has been in previous years.

Required:
(c) on the basis of the information provided above, describe the audit report that you
consider is likely to be issued in the case of tritel, giving reasons. (4 marks)
(d) explain the difficulties that would be faced by tritel and its auditors if tritels audit
report made reference

Suggested solutions
Question 1
(a) audit procedure physical count reason for procedure perform an overall review with
client staff check that clients physical count instructions are being
Ensure that they are following the clients followed as this will help to ensure that the count is
complete physical count instructions. Specifically ensure that: and accurate.
inventory is divided into appropriate sections confirms a clear layout of inventory
ensuring for recording perhaps by type of jewellery. Items are not missed.
staff are counting in pairs with one person prevents collusion and provides a check over
checking the inventory and another recording security of inventory (jewellery is high value)
and details. That the count sheets are not falsified.
appropriate checks are in place to ensure check to ensure that inventory is not double
that each item of jewellery is only counted counted. Once.
the shop is closed during the count. to ensure that there is no confusion regarding which
items are sold.
countsheets are pre-numbered. to ensure that no count sheets are lost.
Obtain a sample of inventory items already recorded check to ensure that the inventory
recorded on the inventory on the inventory sheets and agree to the sheets actually exists.
Jewellery inventory.
For a sample of jewellery in the shop, agree to the check to ensure that all inventory is
recorded on the count sheets. Inventory sheets check for completeness of recording.
Obtain a sample of countsheets, photocopy and to check that details on the count sheets are
not place on the audit file. Amended post physical count and for agreement to the final
inventory sheets to ensure quantities are recorded correctly.
Check all countsheets are returned after the ensures that all sheets are accounted for and
inventory physical inventory count. Is therefore not understated.
Obtain last inventory receipt note and sales invoice to ensure that cut off is correct.
Numbers. Subequent checking should show that goods received notes post physical count
are not included in payables for the year, and sales invoices after the physical inventory are
not included in sales for the year.
Review the condition of the jewellery with the to check that any inventory which is damaged
or independent valuer. Ensure that there are no unsaleable is correctly valued.
Reasons why the inventory could be obsolete (e.g.due to changes in fashion) or damaged.
Form an opinion regarding the overall accuracy to confirm that inventory quantities have
been correctly of the physical count. Recorded.
(b) factors to consider when placing reliance on the work of uj:
Dece need to confirm that they actually need an expert. It is not clear whether dece have the
necessary skills in-house.
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However, given that rocks forever is the only client in the diamond industry, then some
assistance would be expected as valuing diamonds is difficult.
Check that the specialist has relevant experience in valuing diamond jewellery. Part of the
appointment process will include checking the work portfolio of uj to show that they have
valued diamonds in other situations.
Ensure that uj is a member of an appropriate professional body. This will help ensure that uj
follow the appropriate ethical standards as these will be enforced by their professional body.
Check that uj cannot be influenced by the client for example because they are employed
by rocks forever. Being employed by the client would imply less independence and limit the
value of the specialists report.
Check that the report produced by the specialist regarding the valuation of the diamonds
appears to be reasonable. Although dece do not have any other clients retailing diamonds,
basic price comparisons for a given weight of diamond could still be obtained from other
shops or internet site to prove the accuracy of ujs figures.
(c) audit evidence
The jewellery inventory should be valued at the lower of cost and net realisable value.
For a sample of jewellery on the final inventory sheets, trace the cost of those items to the
original purchase invoice, ensuring that the description of goods on the invoice matches the
jewellery.
For jewellery sold after the end of the year, check a sample of sales invoices back to the
final inventory sheets ensuring that the sales value exceeds the cost. Where sales value is
less than cost, ensure that the jewellery is stated at the realisable
Value on the inventory sheet.
Review the report of the professional valuer. Ensure that the inventory is genuine. For the
items checked by the valuer, agree the valuation to the items of jewellery on the inventory
statements. Where there is a difference, for example due to age of the
Inventory or where it is unlikely to be sold due to changes in fashion, discuss with the client
and agree a realistic valuation.
In these situations, the value should be that provided by the professional valuer.
Where an item has been in inventory for a long period of time (perhaps over one year),
check the valuers report to find out whether any allowance is required.

Question 2
2 (a) benefits of outsourcing to nfa
Expertise available
The nfa partnership will be able to provide the necessary expertise for internal audit work.
They may be able to provide a broader range of expertise as they serve many different
clients therefore staff may be available for specialist work that octball could not afford to
employ.
Buy-in skills as necessary
If internal audit is only required for specific functions or particular jobs each year then the
expertise can be purchased as required. Taking this approach will minimise in-house costs.
Independence/qualifications
No information is provided on the qualification of staff in nfa, although as an independent
firm it is likely that care will be taken that staff do remain independent and have the
appropriate qualifications in order that they can provide an appropriate
High level of service.
Audit techniques training
Outsourcing will remove the need for training internal staff. Effectively training will be
provided for free as the outsourcing
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Firm will be responsible for keeping staff up-to-date with new auditing techniques and
processes.
Problems with outsourcing to nfa
Fee pressure
Nfa may experience some fee pressure, but only in respect of maintaining cost effectiveness
of the internal audit department.
The relationship needs to be managed carefully to ensure that nfa do not decrease the
quality of their work due to insufficient fees.
Knowledge
The nfa partnership will not have any prior knowledge of octball. This will be a disadvantage
as this will mean the partnership will need time to ascertain the accounting systems and
controls etc in octball before commencing work.
However, provision of an independent view may identify control weaknesses etc that the
current internal audit department have missed.
Location
The nfa partnership may not be able to provide this service to octball as they are a local firm
and therefore the issue of travel and working away from home would remain.
Continuity of service staffing
As provision of audit services is the nfa partnerships main activity, they should also be able
to budget for client requirements although this cannot be guaranteed as staff may still leave.
However, as a larger internal auditing firm, they will be able to offer staff better career
progression which should assist staff retention.
(b) items to be considered by t&m
Independence
T&m need to ensure that independence can be maintained in a number of areas:
independence regarding recommending systems or preparing working papers and
subsequent checking of those systems or working papers. While the internal audit
department may need to carry out these functions, t&m must ensure that separate staff are
used to provide the internal and external audit functions.
staff from t&m will be expected to follow the ethical guidance of acca which means that
steps will be taken to avoid conflicts of interest or other independence issues such as close
personal relationships building up with staff in octball.
Any real or perceived threats to independence will lower the overall trust that can be placed
on internal audit reports produced by t&m.
Training
As a firm of auditors, t&m will automatically provide training for its staff as part of the inhouse compliance with association regulations (e.g. Compulsory cpd was introduced from
january 2005). T&m will need to ensure that staff providing the internal audit function to
octball are aware of relevant guidance for internal auditors.
Skills
T&m must ensure that they have staff with the necessary skills and sufficient time to
undertake the internal audit work in octball. Skills may not be an issue because staff in t&m
will already understand audit procedures.
Fee pressure
There may be fee pressure on t&m, either to maintain the cost effectiveness of the internal
audit department, or to maintain the competitiveness of the audit fee itself in order to keep
the internal audit work.
Knowledge
As external auditors, t&m will already have knowledge of octball. This will assist in
establishing the internal audit department as systems documentation will already be
available and the audit firm will already be aware of potential weaknesses in the
Control systems.
(c) controls to maintain the standard of the internal audit department
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if t&m are appointed, ensure that the internal and external audit is managed by different
departments in the firm.
setting and review of performance measures such as cost, areas reviewed etc with
explanations obtained for any significant variances.
use of appropriate audit methodology, including clear documentation of audit work carried
out, adequate review, and appropriate conclusions drawn.
review of working papers by myself, ensuring adherence to international standards on
auditing where appropriate and any in-house standards on auditing.
the work plan for internal audit is agreed prior to work commencing and this is followed by
the outsourcing company.

Question 3
(a) importance of audit planning
According to international standard on auditing 300 (revised), the auditor should plan the
audit work so that the engagement will be performed in an effective manner. Specifically,
planning is required for the following reasons:
to develop a general strategy and detailed approach for the specific nature, timing and
extent of the audit work. This will help to ensure that the audit is carried out in an efficient
and timely manner.
so that attention is devoted to the important areas of the audit. Planning will also help to
identify problem areas so they can be addressed in a timely fashion.
to determine the amount of work to be carried out and therefore assist in determining the
number of staff required to perform the audit work.
to provide a document as a reference for an initial discussion of the approach to the audit
with the companys audit committee. The plan will also help ensure that audit work is coordinated with client staff: e.g. For production of specific documentation to assist the auditor.
to act as a basis for the production of the audit program.
(b) tempest ltd
Year end 31 december 2005
Prepared by: a manager
Audit strategy tempest ltd 31.12.05
Characteristics of entity
Tempest requires a normal statutory audit there are no audit or filing exemptions available.
The financial reporting framework is the international accounting standards and there are no
industry specific reporting requirements.
Tempest buys and then resells all types of fixtures and fittings for ships from yachts through
to large cruise ships. The company has ten warehouses, seven of which are located near to
branches of our audit firm.
Key dates
Key dates in the audit timetable are:
interim audit
final audit
meeting with audit committee
financial statements approved by management
Specific dates are to be confirmed.
Overview of audit approach
The shipping supply industry has grown by 7% during the last year. Tempests sales
increase is 12% indicating that the company continues to perform well with the industry.
There have been no changes to the accounting policies of tempest during the year.

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This is the first year that international standards on auditing (isas) are relevant to this
company. A detailed check will be required to ensure that no changes are required to the
audit plan.
The overall audit approach will be to use tests of control where possible. However, the fall in
gross profit indicates that sales may be understated or cost of sales (cos) overstated, so
additional substantive procedures may be required in this area.
Materiality determination
Materiality will initially be set at 1/2 to 1% of revenue as this figure appears to be more
accurate than gross profit.
Materiality on the balance sheet will be based on net asset values.
Identification of risk areas with a higher risk of mis-statement
A review of the draft financial statements for the company shows the following risks:
sales have increased by 12% but cos by 19%. There is a risk of cos being overstated.
inventory on the balance sheet is down significantly on last year indicating that there may
be valuation or quantity errors.
trade receivables have increased by about 50%, significantly more than the increase in
sales. This indicates that the company may have debt collection problems. Additional testing
may be required on after date cash collections to check
For bad debts.
non-current assets have fallen by $900k, which is significant given that most non-current
assets are land and buildings.
The reason for sale must be ascertained.
non-current liabilities have also fallen by $1 million. While not necessarily linked to the fall
in non-current assets, there is a possibility that non-current assets have been sold to pay off
the liabilities.
Audit approach extent of control testing
Audit testing will focus on the use of compliance testing where possible. However, changes
have been made to the inventory system limiting the extent of compliance testing. Client
systems have changed in the year with a new computerised inventory
Control system. Unfortunately, the change was not identified until audit planning started.
Three actions are necessary in respect of this system:
audit initial installation of the system including transfer of balances. One of the reasons for
the low inventory value could be omission of inventory balances on transfer.
test count inventory at the year end and agree to the computerised inventory records (and
visa versa) to test their accuracy. Note that the client will not be counting inventory at the
year end but relying on the computerised system.
test check bookings into and out of inventory from the purchases and sales systems.
Other risk areas
the client appears to be a going concern, although the fall in gross profit must be
investigated. Cash and profit forecasts for the next 12 months must also be obtained to
confirm ongoing profitability and that the fall in cash balances will not
Continue.
there is the possibility of related party transactions. One of the directors purchased a yacht
during the year. Checks to be made to determine whether company products were
purchased, and if so whether these were in the normal course of business.
a new engagement letter is required in isa format.
assistance may be required on the inventory count; three warehouses are located away
from our offices.

Question 4
(a) audit procedures to be used prior to the audit report being signed include:
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reviewing procedures established by management to try and ensure that subsequent


events are identified.
reading minutes of the meetings of directors, the audit committee and shareholders and
enquiring into unusual items.
obtaining and reading the companys latest interim accounts as well as any budgets and
cash flow forecasts.
obtaining additional evidence if possible from the companys lawyers concerning litigation
and claims.
asking management as to whether any subsequent events have occurred such as
new borrowing commitments
significant sales of assets
new shares or debentures issued
assets being destroyed by flood, fire etc or impounded by the government
unusual accounting adjustments made or being contemplated
checking whether any events have occurred that could call into question the validity of the
going concern assumption.
(b) 15 august 2005
(i) the bankruptcy of a major customer provides additional evidence of conditions existing at
the balance sheet date. The customer will not be able to pay debts due, therefore
receivables are overstated and the bad debt provision on the profit
And loss account is understated. An adjustment for the amount of the receivable should be
made in the financial statements.
(ii) the bankruptcy of the major customer takes place after the end of the year but before the
financial statements and the auditors report are signed. As the auditors report has not been
signed, the auditor is responsible for identifying material events that affect the financial
statements. This means that audit procedures should be carried out which are designed to
identify this event.
Specific procedures undertaken include:
confirming that the customer will not pay to a letter from the receiver or similar authorised
person.
confirming the amount due from the customer to invoices raised prior to the year end, and
if possible to a positive direct confirmation letter.
auditing the adjustment to the financial statements decreasing the receivable balance and
increasing the bad debt write off in the profit and loss account.
including the amount in the management representation letter to confirm no other amounts
are due from thecustomer.
1 november 2005
(i) the accidental release of toxic chemicals occurred after the balance sheet date. Assuming
that the inventory was not on the balance sheet at the year end, then the spill is indicative of
conditions that arose subsequent to the year end. No adjustment appears to be necessary.
However, the event may be significant in terms of the operations of the company (a large
legal claim could arise) and so disclosure of the event would be expected.
(ii) the accidental release of toxic chemicals takes place after the auditors report has been
signed but before the financial statements are sent to the members. At this stage of the
audit, the auditor does not have any responsibility to perform procedures or make inquiries
regarding the financial statements. The management of oilraker are responsible for telling
the auditor about any significant events, such as this one.
However, as the auditor is now aware of the event and this materially affects the financial
statements in terms of disclosure being required, the auditor does have to discuss the event
with management.
Specific procedures to be undertaken include:

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obtain information concerning the chemical release from management, reading local press
and if possible the companys lawyers the latter may be able to indicate whether there is
any legal liability.
discuss the appropriate accounting treatment with the directors, confirming that disclosure
is required in the circumstances.
read the disclosure note to confirm that the matter is adequately explained in the financial
statements.
obtain an updated letter of representation from the directors confirming that there are no
other events requiring disclosure.
amend the auditors report to include an emphasis of matter paragraph to draw attention to
the full disclosure noted in the financial statements. Date the new auditors report no earlier
than the date of the amended financial statements.
30 november 2005
(i) the fire at an oil well means that oilrakers oil production and presumably profits, will fall in
the next financial year.
The fire though does not provide additional evidence of conditions existing at the balance
sheet date as at this time there was no indication that this would occur. The event is
therefore non-adjusting in the financial statements. However,
Disclosure of the event should be made so that the financial statements do not give a
misleading position.
(ii) the fire at an oil well takes place after the financial statements have been issued. At this
time, the auditor has no obligation to make any inquiry at all regarding the financial
statements.
If the auditor becomes aware of the event, then the potential effect on the auditors report
must be considered.
Specific procedures undertaken include:
checking the board minutes, insurance claims and similar documents to ensure that the
fire will be covered by insurance and there is no contingent liability for replacing non-current
assets or clearing up any environmental damage.
inquiring of the directors how the members will be informed of the situation.
if the directors plan to re-issue the financial statements, ensure that appropriate disclosure
is made of the event.
if the directors do not intend to amend the financial statements, and you consider the
matter to be material to understanding the accounts, consider attempting to contact the
members directly, depending on the methods available in your country.
if necessary, contact the auditors lawyers to discuss what action can be taken regarding
the lack of disclosure.
Question 5
(a) the advantages of computer-assisted audit techniques (caats) are that they:
enable the auditor to test program controls if caats were not used then those controls
would not be testable.
enable the auditor to test a greater number of items quickly and accurately. This will also
increase the overall confidence for the audit opinion.
allow the auditor to test the actual accounting system and records rather than printouts
which are only a copy of those records and could be incorrect.
are cost effective after they have been setup as long as the company does not change its
systems.
allow the results from using caats to be compared with traditional testing if the two
sources of evidence agree then this will increase overall audit confidence.
(b) test data reason for test

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Input of an order for a negative number of ensures that only positive quantities are accepted
tennis racquets although the company cannot despatch negative
Quantities anyway.
Input of an order for ten tennis racquets there are reasonableness checks in the system to
identify possible input errors. A warning message should appear on screen asking the
customer to confirm any order for more than say two racquets.
Input of an order without payment details ensures that orders are paid for prior to despatch
being completed this also limits the number of bad debts.
Input of invalid inventory code ensures that the computer detects the invalid code
And presents an error message rather than taking the nearest code and accepting that.
Input of invalid customer credit card details online checking of credit card details to the credit
card company ensures that goods cannot be despatched without payment.
This will also limit the number of bad debts.
Input of invalid address ensures that the address and valid zip code is valid,
Possibly by accessing a database of valid codes. If the
Code is not valid an error message should be displayed.
This ensures that goods are only despatched to valid
Addresses.
(c) audit software
(i) difficulties of using audit software
substantial setup costs because the clients procedures and files must be understood in
detail before the audit software can be used to access and interrogate those files.
audit software may not be available for the specific systems setup by the client, especially
if those systems are bespoke. The cost of writing audit software to test those systems may
be difficult to justify against the possible benefits on the audit.
the software may produce too much output either due to poor design of the software or
using inappropriate parameters on a test. The auditor may waste considerable time checking
what appear to be transactions with errors in them when the fault is actually in the audit
software.
checking the clients files in a live situation. There is the danger that the clients systems
are disrupted by the audit program. The data files can be used offline, but this will mean
ensuring that the files are true copies of the live files.
(ii) audit tests
Audit software reason for test
Calculation check of the sales day book ensures that the computerised sales day book has
been cast correctly and helps to verify the sales balance in the financial statements.
Analysis of the aging of items in the help to detect inventory items which are relatively old
inventory ledger which may need valuing at net realisable value rather
Than cost.
Selecting a sample of inventory at the end removes bias from sample selection as well as
being of the year as part of the physical verification quicker than selecting the items
manually.
Selecting a sample of sales invoices for removes bias from sample selection as well as
being checking to despatch documentation quicker than selecting the items manually.
Checking completeness of sales invoice ensures that all sales invoices are recorded in the
sales numbers day book.
Check that all sales invoices have been all sales are paid for on ordering, unpaid sales
would be paid for a violation of systems rules and would need to be
Investigated by the auditor.
List large credit notes (perhaps more than the auditor will find reasons for the return this is
also a five racquets) for investigation by the auditor check on the accuracy of the ordering
system ordering errors may result in customers returning goods later.
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QUESTION 6
(a) six financial statement assertions
(i) existence: an asset, liability or equity interest exists;
(ii) cut off: transactions and events have been recorded in the correct accounting
period;
(iii) occurrence: a transaction or event that has been recorded took place and
pertains to the entity during the period;
(iv) accuracy and valuation: financial and other information is disclosed fairly and at
appropriate amounts;
(v) rights and obligations: the entity holds or controls the rights to assets, and
liabilities or obligations of the entity; and
(vi) classification: transactions and events have been recorded in the proper
accounts.
(b) substantive audit procedures
The main concerns with income statement and balance sheet entries for payroll relate to the
completeness and accuracy of transactions (existence and rights and obligations), with
proper cut-off (occurrence and measurement) and disclosure.
In relation to both balance sheet and income statement entries, i would ensure that
appropriate disclosures had been made in the financial statements in accordance with
accounting standards and the statutory framework. The disclosure of amounts paid to
directors is often particularly important.
(i) payroll balances in balance sheet, mishili ltd
1. Balances that are likely to appear in the balance sheet of mishili ltd are dealt with in
items 57 below. In all cases,i would ensure that the amounts appearing in the financial
statements can be traced through to supporting schedules and ensure that the
schedules are arithmetically accurate.
2. In all cases, i would check the amounts payable to payments made after the
period-end, to documentation supporting and authorising the bank transfer, and to the bank
statement.
3. In all cases, the extent of testing noted below will depend on the results of tests of
controls over payroll.
4. In all cases, i would perform analytical procedures on the amounts payable at the
period end by reference to the number of employees, the amounts payable at the end of
each week, month, quarter or year (as appropriate) during the period (and in prior periods)
and with reference to profits, production or sales levels, and/or tax and social insurance
rates, as appropriate.
5. Unpaid amounts due to the agency

I would consider the need to obtain confirmation from the agency of the amount
payable. If documentation from the agency is available at mishili ltd agreeing the
amount payable, this might suffice.

I would check the calculation of the amounts payable to supporting


documentation authorised by supervisors.

I would ensure that the amounts payable (particularly the rates payable) agreed
with correspondence with the agency and i would check such correspondence for
evidence of any disputes.
6. Unpaid wages and salaries due to permanent factory staff, administrative and
sales staff and directors, and unpaid bonuses due to sales staff and directors
o i would check the calculation of the amounts payable to appropriately
authorised clock cards or contracts, as appropriate.
7. Unpaid amounts due to tax authorities for tax and social insurance

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I would review correspondence with the tax authorities for evidence of any
disputes or underpayment and pay particular attention to any delay in the
payment of these amounts.

(ii) payroll transactions in the income statement, mishili ltd


1. As with balance sheet entries, i would ensure that the amounts appearing in the
income statement can be traced through to supporting schedules and ensure that the
schedules are arithmetically accurate.
2. In all cases, i would select a sample of entries in the income statement and trace
them through the ledgers and daybooks to source documentation such as clock cards for
permanent factory staff, documentation showing the amounts produced or processed
(agency staff) or contracts (administrative and sales staff and directors).
3. I would then trace a sample of source documentation (as noted above) in the
opposite direction, through the daybooks and ledgers to the schedules supporting the
financial statements and to the income statement.
4. I would perform analytical procedures on the amounts appearing in the ledgers for
each period, for each category of employee with reference to production and sales levels as
appropriate, the number of employees, and by
Comparison with prior periods, for example.

Question 7
(a) internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under
nbaaas rules of professional conduct).
Internal matters
Before accepting appointment the firm should ensure that:
(i) it has the necessary staff with appropriate competencies to complete the audit
(this seems likely given that the firm has other clients in this sector);
(ii) the staff are available at what is a busy time of year for the firm (it may be
possible that all of the staff with the necessary competencies are otherwise occupied);
(iii) the firm is independent of viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two entrepreneurs),
however, there may be staff or partners who are related to the client or are otherwise
connected with it;
(iv) there are no conflicts of interest that cannot be properly managed. Conflicts of
interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:
(v) seek the directors permission to communicate with the company accountant
about the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
(vi) seek the directors permission to communicate with the incumbent auditors. If
permission is refused, the appointment should not be accepted;
(vii) ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if viswa refuses to give permission to
the incumbent auditors the appointment should not be accepted);
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(viii) communicate with the incumbent auditors (preferably in writing) requesting all
the information which ought to be made available to enable the firm to decide whether or not
to accept the appointment (if there are no such matters, the incumbent auditors should
inform the firm of this);
(ix) seek appropriate transfer information (such as a copy of the last set of accounts
and a detailed trial balance reconciled to the accounts);
(x) indicate a likely fee (or the basis on which fees are calculated) to viswa, ensure
that this is acceptable and that the client is able to pay (by some form of credit check);
(xi) ensure that the incumbent auditor has properly resigned, been dismissed or has
not sought re-appointment in accordance with legal requirements.
(b) starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
(i) without the staff with appropriate competencies the firm will be in breach of the
rules (and may be found negligent if things were to go wrong);
(ii) without complying with the requirements relating to independence and conflicts of
interest, the firm will not only be in breach of the rules, but will lack objectivity and may find
that the client (or other party) objects to the appointment to another client in the same sector;
(iii) without performing appropriate procedures the firm will be unable to form an
opinion on the integrity of the client it may find itself associated with an entity engaging in
doubtful or even illegal activities (taking account of the disagreement over disclosures);
(iv) without agreeing a fee it is almost inevitable that misunderstandings or
disagreements will arise;
(v) without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have arisen in
the past;
(vi) without ensuring that the incumbent auditor is no longer in place, it will be
inappropriate for the firm to seek appointment.
(c) engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It:
(i) confirms the auditors acceptance of appointment and constitutes a contract
between the auditor and the client;
(ii) summarises the respective responsibilities of directors and auditors;
(iii) contains details on:
1. The responsibilities of the directors (for accounting records, the financial
statements and the accounting policies on which they are based);
2. The responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and disclosures,
to perform tests and to form an opinion on the financial statements);
3. The form of report to be issued;
4. Other services to be provided;
5. The basis of calculation of fees;
6. Applicable legislation.

Question 8
(a) advantages and disadvantages
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(i) analytical procedures


Advantages
1. The main advantage of analytical procedures is that they can be used at all stages
of the audit to enquire into the absolute amounts to be included in the financial statements,
and into the relationships between those amounts.
2. Analytical procedures are a good test for the overall reasonableness of an amount.
They can be used on a global basis, and they can be split down into their constituent
elements.
3. Analytical procedures enable the auditor to make comparisons on a continuous
basis, taking prior years into account, and providing the auditor with a better understanding
of both the business as a whole, and of individual account areas.
Disadvantages
1. Analytical procedures often have to be performed on management accounts, or
draft or incomplete accounts before the final financial statements have been prepared. This
means that significant adjustments, which are often made at a late stage, are not taken into
account.
2. Without a prior and proper understanding of the business, the auditor may be
tempted to accept the results of analytical procedures that show no unusual variations as
evidence that there is nothing wrong, which may not be the case if there have been
significant changes in the business of which the auditor is unaware (and which management
may wish to hide from the auditors).
3. Auditors may also be tempted to accept plausible explanations for changes and
variations without much further substantiation, where further investigation may actually be
warranted.
(ii) audit sampling
Advantages
1. Audit sampling enables the auditor to draw conclusions about a population without
testing all of the transactions or balances in the population as a whole.
2. Audit sampling also enables the auditor to concentrate on high risk or high value
items, and to differentiate between elements of a population which may be subject to
differing internal controls.
Disadvantages
1. There is always a risk that the auditors sample is not representative of the
population as a whole (known as sampling risk). Auditors calculate and accept this risk, and
perform other procedures to compensate for it, but it always remains a risk.
2. Sampling relies on the use of judgement in relation to materiality, exceptions, and
in drawing conclusions, for example. Judgement can be abused, or simply fail, particularly
where staff are inexperienced.
(iii) tests of controls
Advantages
1. Tests of controls enable the auditor to establish whether a control system in
operation is effective. If properly designed controls are operating as prescribed, auditors can
reduce the level of substantive testing required at the period-end.
2. Tests of controls mean that auditors do not have to concentrate all of their efforts
on substantive procedures at the period-end which would in many cases be impractical,
inefficient and not cost-effective.
Disadvantages
1. Tests of controls are often performed on a sample basis (disadvantages noted
above).
2. Tests of controls are often performed on routine transactions for which there are
high quality automated controls.
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The very high risk areas in financial statements are often outside this area and relate
to non-routine transactions and more intangible environmental or general controls which are
not easy to test.
(iv) detailed testing of transactions and balances
Advantages
1. In detailed testing of transactions and balances, auditors are directly examining the
figures and assertions that appear in the financial statements.
2. Detailed testing enables the auditors to form a view as to whether the figures on
which he is reporting are fairly stated and often involves third party, written confirmation
which is a good source of audit evidence.
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Disadvantages
1. Detailed testing of transactions and balances is often performed on a sample basis
(disadvantages noted above).
2. The level of testing of transactions and balances is determined by the level of
comfort obtained by the auditor from tests of controls. If too much comfort has been obtained
from tests of controls, it is likely that any error will be compounded by an inadequate level of
testing of transactions and balances.
(v) computer assisted audit techniques (caats)
Advantages
1. Caats enable the auditors to test a large volume of data, or the operation of the
controls in a system, accurately and quickly. They are therefore very-cost efficient when
operated properly.
2. Caats reduce the level of human error in testing and enable a very high level of
audit evidence to be derived.
3. The use of caats frees up expensive human resources that would otherwise be
engaged in routine, mechanical work to concentrate on judgemental areas.
Disadvantages
1. Caats are expensive to set up and require the co-operation of the client. It is
usually necessary for a continuing
Audit relationship to be present before it is worth committing the audit resources.
2. Major changes in client systems often require major changes in caats, which is
expensive. If the audit fee is based on the assumption that the prior years caats can be
used, and a change is made without warning, the client may have unrealistic expectations
about the level of service that can be provided for the fee.
(b) relationship between the methods of evidence gathering
(i) analytical procedures are often first used during the planning stage of the audit.
Materiality levels and levels of tolerable error are often derived (at least in part) from
analytical procedures. These are in turn used in audit sampling procedures.
(ii) analytical procedures help the auditor determine the audit approach (the levels
and areas for tests of controls and detailed testing).
(iii) the results of tests of controls determine the level of detailed testing of
transactions and balances. Analytical procedures provide indirect evidence as to the
effective operation of internal controls (if controls are working, analytical procedures may
help prove that the population as a whole is fairly stated).
(iv) detailed tests of transactions and balances are often performed towards the end
of the audit in conjunction with analytical procedures analytical procedures compensate to
an extent for the weaknesses in sampling procedures both for tests of controls and detailed
testing of transactions and balances (and vice versa).

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(v) sampling is used for both tests of controls and detailed testing of transactions and
balances. Where caats are used, sampling may not be necessary because caats can often
be used to test the whole population, either for tests of controls, or for detailed testing of
transactions and balances.

Question 9
Confirmations
(a) management representations
Evidence
(i) auditors obtain written representations from management on material matters
where other sufficient appropriate audit evidence cannot reasonably be expected to exist.
Isa 580 management representations deals with this subject.
(ii) such matters might include confirmation that all related party transactions have
been disclosed in the financial statements and confirmation of all matters that rely principally
on the exercise of judgement by directors such as soft provisions. The letter also usually
includes confirmation that all matters occurring since the balance sheet date that should be
brought to the attention of auditors have been brought to their attention, and that all of the
accounting records have been made available to the auditors.
(iii) management representations should not conflict with other audit evidence. If they
do, the matter should be investigated and resolved.
Practical difficulties
(iv) in practice, it is not always easy to obtain a signed management representation
letter. The letter should be addressed from the client to the auditor, but it can take the form
of a letter from the auditor to management that is acknowledged by management, or signed
minutes of a board or similar meeting.
(v) if management refuse to provide representations, this may be grounds for a
qualification of the audit report on the basis of a limitation in the scope of the audit. However,
this is an extreme step and auditors will always discuss with directors alternative wordings
that will be acceptable to them before considering qualification of the audit report. There may
be genuine uncertainty on the part of management as to the reasonableness of the
representations that auditors request them to make.
Alternative evidence
(vi) unfortunately, because of the content of these letters, there is very little
alternative evidence; that is why the letter is
Requested in the first place.
(vii) auditors need to think carefully about the content of the letter if management
refuses to sign altogether, and consider whether there is alternative evidence, whether the
matters are truly material and whether an audit qualification is needed. Auditors can exert
some pressure on management to sign by making this threat, in practice.
(b) direct confirmation of receivables
Evidence
(i) auditors often seek direct confirmation of receivables to ensure that the amounts
stated in the entitys accounts receivable ledger are not overstated. Confirmation also
provides evidence in relation to certain frauds and the quality of internal controls.
(ii) confirmation that an amount is owed is not confirmation that the amount will be
paid and auditors need additional evidence on the recoverability of receivables.

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(iii) there are two types of confirmation, positive and negative. In the former case, the
customer is requested to reply in any case, and the auditor can either insert the balance to
be confirmed or the customer can be requested to do so. In the latter case, a reply is only
requested if the customer disagrees. This method is only suitable where receivables are well
controlled.
Practical difficulties
(iv) the response rate to requests for confirmations is not always satisfactory and
repeated requests may be necessary. It is not uncommon for replies to be inaccurate,
especially where the amount stated is too low.
(v) where the customer is requested to insert the balance, the reconciliation can
sometimes be very difficult, even with the help of the client, and the customers assistance
may be needed.
Alternative evidence
(vi) where no reply is received it is important that alternative evidence is obtained on
the same balance (and not to test another balance). Where there is a discrepancy between
the clients records and the customers records, the matter should be investigated and
resolved.
(vii) sometimes, the customer can provide a reconciliation, particularly if the matter
only relates to timing differences. On other occasions there may be a dispute and a provision
may be necessary.
(viii) alternative evidence for receivables includes payment of the amount after the
period-end, a review of contracts and signed delivery notes, and analytical procedures on
the ageing of receivables.
(c) confirmation of inventory held by third parties
Evidence
(i) it is often not possible for auditors to confirm inventory held by third parties by
attendance at an inventory count and therefore the only evidence available is confirmation
from the third party.
(ii) it is particularly important to ensure that the confirmation is genuine because of
the possibility of fraudulent collusion between the third party and the client to inflate
inventory and profit figures.
(iii) the reliability of service from the third party and the quality of documentation and
correspondence are all taken account of as part of the auditors risk assessment in this area.
Practical difficulties
(iv) both the quality and quantity of inventory held should be confirmed. It is common
for third parties to use different descriptions or units of measurement in their records to those
used by the client and it is necessary to reconcile these items.
(v) it may be possible for the auditor of the third party to provide some evidence in
relation to the amounts held.
Alternative evidence
(vi) if the inventory held by the third party is likely to be material, the auditor must
consider the possibility of visiting the third party and attending the inventory count.
(vii) the auditor may review and test the controls over the movement of inventory to
and from the third party and the related records, in order to reduce the level of substantive
evidence needed at the period-end.
(viii) records that show negative inventory (more outs than ins) at either the client
or the third party may be indicative of misclassifications, for example.
(d) reports provided by auditors of service organisations
Evidence

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(i) where an entity has out-sourced a significant element of its accounting function to
a third party, as is increasingly common, the auditor may be forced to assess control risk as
high in that area unless he can perform tests of control.
(ii) in testing controls, it may be appropriate for auditors to obtain a letter from the
auditors of the service organisation. Such letters confirm either the suitablility of the design
of the system, or the suitability of the design of the system and its operating effectiveness.
(iii) only where the latter type of report is obtained can the auditors reduce their
assessment of control risk and perform reduced substantive testing. The auditors should
also consider the competence and experience of the service organisations auditors.
Practical difficulties and alternative evidence
(iv) the alternative is to visit the service organisation in order to perform tests of
controls, although this may be impracticable because it might be located on the other side of
the world, for example. It may also be costly because it will be necessary for the auditors to
obtain a working knowledge of the third partys system before it can be tested. Such systems
can be complex.
(v) auditors have no right to visit the third party or test controls there; if it is
considered absolutely essential to do this, the
Client may have to bring pressure on the third party to permit it.
(vi) in practice, a client that has out-sourced a significant element of its accounting (or
other) functions to a third party may well have made arrangements in respect of auditors as
part of the contractual arrangements with the third party.
(c ) inventories
(a) importance of inventory
(i) inventories are important to the financial statements because the inventory figure,
particularly for manufacturing companies, may be material to the balance sheet and income
statement, both in the current year and as a comparative figure.
(ii) inventories may be high risk if they are valuable, and/or easily portable. The
valuation of inventories is a matter requiring the exercise of judgement, which means that
inventories are sometimes used to manipulate the appearance of both the income statement
and the balance sheet.
(iii) in the income statement, there is a direct relationship between the inventory
figure and the profit for the period. If closing inventories are overstated, profits will be
overstated.
(iv) many key accounting and performance ratios are calculated using the inventory
figure. These include inventory turnover, inventory days, the current ratio and working capital
ratios. Many companies use these ratios for internal purposes and many third parties, such
as investment analysts, also use these figures to assess performance.
(v) poor inventory control will be reflected in inventory figures at the period-end. For
many companies, excess inventory is a sign of serious problems.
(vi) some significant cases of litigation against auditors have involved the alleged
overstatement of inventories in financial statements of companies where the auditors have
issued an unqualified audit report before the company has been taken over.
(vii) there is sometimes relatively little audit evidence for the inventory figure,
particularly for small companies and it is therefore important for auditors to scrutinise the
evidence available carefully and consider the scope for misstatement or deliberate
manipulation of the inventory figure.
(b) cost and net realisable value
(i) ias 2 requires that cost comprises all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location and condition.
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(ii) costs of purchase include the purchase price, import duties and other taxes,
transport, handling and other costs directly attributable to the acquisition of finished goods,
materials and services. Trade discounts, rebates and similar items are deducted.
(iii) costs of conversion include costs directly related to units of production such as
direct labour. They also include a systematic allocation of fixed and variable production
overheads that are incurred in converting materials to finished goods.
(iv) fixed production overheads are indirect costs of production that remain relatively
constant regardless of the volume of production such as depreciation, the maintenance of
factory buildings and equipment and the cost of factory management and administration.
The allocation of fixed overheads is based on a normal level of production.
(v) variable production overheads vary directly, or nearly directly, with the volume of
production and include indirect materials and labour. The allocation of variable overheads is
based on actual levels of production.
(vi) other costs might include the costs of designing products for specific customers
and borrowing costs, which may be included in certain circumstances.
(vii) costs not included are storage costs, unless these are necessary to the
production process prior to completion, general administrative overheads and selling costs.
(viii) net realisable value is the estimated selling price in the ordinary course of
business, less the estimated costs of completion and the estimated costs necessary to make
the sale, such as advertising costs.
(c) audit evidence
(i) the costs of purchase for a furniture manufacturing company will include purchase
costs such as the cost of timber, metals, fabrics, fillings and adhesives.
(ii) these costs can be checked on a sample basis from the inventory records through
to the daybooks, ledgers and purchase invoices, ensuring that the correct amounts have
been recorded in the correct period.
(iii) the variable production overheads will include direct labour costs (including tax
and social insurance costs), the cost of power for factory machinery, the cost of small tools
and similar items that are directly related to the level of production.
(iv) direct labour costs can be checked to payroll records, production records,
timesheets or clock cards, and payment records, including entries in the bank statements. It
is likely that the cost of power for machinery will have to be allocated, but if this is not
possible it may be necessary to include such costs in fixed overheads. In either case, the
cost can be traced to utility invoices and accruals. The costs of small tools can be checked in
the same way as purchase invoices, ensuring that capital items are not included in the
revenue accounts and vice versa.
(v) fixed production overheads will include depreciation of machinery, the cost of heat
and light in the factory, factory administration overheads and storage space for work in
progress. It is important to establish that the factory is operating at a normal level of activity.
If it is not, it is not appropriate to include overheads on the basis of an abnormal level of
activity.
(vi) depreciation can be checked to asset registers. It is important that auditors
examine both the accuracy of calculations, and the reasonableness of the depreciation rates
applied as costs may be inappropriately included as assets, otherwise. Factory
administration may include the wages and salaries of those administering the factory payroll
for example, and the costs of the offices in which such staff work. It may be necessary to
split such costs out from general administration overheads that should not be included. The
attributable payroll and overhead costs can be checked in the same way as
For direct factory costs.
(vii) analytical procedures can also be performed on all of the costs noted above and
compared with prior periods and budgets, as well as production levels, profits and factory
capacity where they vary directly with production or sales.
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Analytical procedures on gross margins will also provide audit comfort on costs.
(viii) cut-off tests may include checks between inventory records, the inventory itself,
and purchase and sales records for a period just before and just after the period-end. It may
also be necessary to examine provisions for goods dispatched or received but not invoiced
before the period-end.
(ix) the net realisable value of finished goods will only be relevant if it is likely to be
lower than cost, i.e. If furniture is to be sold at a loss. Auditors should review inventorycounting results and inventory records for old or slow-moving inventory and form an opinion,
in discussion with directors, as to whether any such inventories need to be reduced to net
realisable value.
(x) evidence from post year-end sales or contracts is a good source of evidence in
relation to net realisable value. If these are not available, it is important to review the entitys
previous experience of having to sell furniture below cost. Current market conditions are
relevant as is the existence of a high level of inventories, which may indicate problems.

Question 10
(a) external auditor responsibilities going concern
Isa 570 going concern deals with this issue.
(i) auditors are required to consider the going concern status of companies and any
disclosures regarding going concern in forming their audit opinion. Companies that are listed
on stock exchanges may be required to make additional disclosures in relation to going
concern issues.
(ii) auditors are required to assess the adequacy of the means (the processes) by
which directors have satisfied themselves that the going concern basis is appropriate and
that adequate disclosures have been made. Auditors conduct an initial analysis at the
planning stage of the audit as well as assessments at later stages.
(iii) auditors should make enquiries of the directors and examine appropriate
documentation supporting the companys going concern status such as budgets and cash
flow forecasts.
(iv) auditors consider whether the period to which directors have paid particular
attention is adequate. This should normally be at least 12 months from the balance sheet
date. Auditors also enquire of management as to their knowledge of events or conditions
beyond this period that may cast significant doubt on the entitys ability to continue as a
going concern.
(v) auditors need to consider the appropriateness of assumptions which directors
have made, the sensitivity of assumptions to external and internal changes, any obligations,
guarantees or undertakings arranged with other entities, the existence and adequacy of
borrowing facilities and the directors plans to deal with any going concern problems.
(vi) auditors are required to document the extent of any concerns, taking account of
matters that have come to their attention during the course of the audit and in particular,
financial, operational, or other indicators of going concern problems that are present.
(vii) indicators of going concern issues would include trading losses, impairment of
assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans
where necessary, fundamental changes in the markets or technology having an adverse
effect on the company, loss of management, staff, customers or suppliers, or major litigation,
for example.
(viii) auditors should consider the need to obtain written management
representations.
(ix) auditors should consider the adequacy of any disclosures in the financial
statements.

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(b) possible audit reports and circumstances


(i) where the auditors consider that there is a significant level of concern about the
entitys ability to continue as a going concern (but do not disagree with the going concern
basis), and where adequate disclosures of the situation are made, they modify (but do not
qualify) their opinion by including an emphasis of matter paragraph highlighting the
existence
Of a material uncertainty as to the going concern status of the entity and drawing attention to
the relevant note in the financial statements. Where adequate disclosures are not made, a
qualified or adverse opinion will be issued.
(ii) where the period to which directors have paid particular attention is less than 12
months from the balance sheet date, the auditors should consider the need to modify the
audit report as a result of a limitation in the scope of the audit.
(iii) where the auditors disagree with the preparation of the financial statements on
the going concern basis, they should issue an adverse opinion. This is very rare because
auditors rarely have sufficient evidence to be sure.
(iv) if the auditors are unable to form an opinion on the going concern status of a
company because of a limitation in the scope of the audit, they will issue an except for
opinion, or disclaimer of opinion but this is unusual.
(c) report issued to tritel
(i) in the case of tritel, there are some indicators of going concern problems. However, the
company may still be a going concern and the fact that the company has been approached
by take-over bidders does not necessarily mean that there is a going concern problem
(possibly quite the opposite).
(ii) the audit opinion issued on tritel in the current year is not likely to make reference
to the going concern status of the company, as in previous years. The situation has not
deteriorated significantly in the current year and it will be difficult for auditors to justify any
change in their opinion from previous years.
(d) difficulties associated with reporting on going concern
(i) if the auditors of tritel were to report on a going concern problem, the mere act of
reporting might of itself create a going concern problem (a self-fulfilling prophecy). This is
particularly the case with large blue-chip companies where the issue of an audit report that
is modified in any way is unusual and might well cause the companys share price to drop,
thus precipitating a going concern problem.
(ii) this means that it is very difficult for companies such as tritel and their auditors to
send out any clear signal to the markets without running the risk of creating a panic.
(iii) however, recent events show that the consequences of companies and auditors
failing to report where severe financial difficulties are encountered can be disastrous for both
the company (its employees and shareholders) and auditors alike.
(iv) auditors are failing in their professional duties if they do not report on going
concern problems of which they are aware; however, situations involving large companies
are rarely clear cut and auditors who propose to make any changes at all to the audit report
are likely to encounter fierce resistance from management who may genuinely believe that
to make
Such a report would be wrong.
(v) in the companys annual financial statements, it is not the place of the auditor of
tritel to substitute his judgment for that of directors. However, where large companies
involved in complex financing arrangements are concerned, auditors may have to fight hard
against vested and powerful interests if they disagree with the directors judgments and
decide to make reference to the matter in the auditors report. An auditor making reference
to going concern issues in an audit report in such circumstances may lose the audit (and any
other work) and may run a significant risk of litigation.
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Part 20
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic of an answer to every question
Question 1
The increased attention of parliament towards accountability of government and other
agencies has been a major stimulus for the development of the concept of value for money
auditing. The concept is well established in canada and a few other developed countries. In
tanzania and many other developing countries, value for money auditing is yet to be
introduced. The major constraint of introduction of value for money auditing is lack of both
human and financial resources. However, in view of the large-scale government and state
enterprise expenditure, the introduction of value for money auditing is inevitable.
Required
(a)
Distinguish between the value for money and value for money audit
(b)
What are major constraints for implementing value for money audit in tanzania?
(c)
Describe the purpose and scope of value for money audits
(d)
Discuss as to why definition of criteria is crucial in value for money audit
(e)
Focusing on major indicators, briefly explain the meaning of each of the following
terms as applied in value for money audit :- (a) economy (b)efficiency (c)
effectiveness (d) accountability (e) responsibility
(f)
Describe major components of planning phase for value for money audits
Question 2
Public sector auditing refers to the examination of and control on government receipts and
payments with a view of assessing the benefits derived from the use of public property, utility
or service and evaluate levels of responsibility and accountability of government officers to
the electorate. The audit exercise is governed by professional norms of independence,
competence and due care, and it draws its mandate from the constitution. The client is in
principle the government comprising the executive office, ministries, the treasury, local
governments, independent departments, and government executed projects.
Required.
(a)
Describe the comprehensive audit process in public sector audits
(b)
Briefly describe two main elements of public sector audits
(c)
Outline the status, functions and powers of controller and auditor general
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(d)
(e)
(f)
(g)

Describe the structure of public sector auditing in tanzania, what is the legal
framework
What are the main categories of public sector auditing in tanzania.
Enumerate the roles of public accounts committee
Describe the nature scope and purpose of audit committees in tanzania public
sector system as per regulation 28 of public finance act regulation.

Question 3
(a)
you are the partner in a firm of certified public accountant and a member of the local
golf club.
One day whilst at the club you are approached by another club member,
omoro, who seeks your
professional advice. Omoro has the opportunity to acquiring a
one-third share in the partnership
business of messrs. Anna and jessica. At
present these three gentlemen are equal partners but as anna is due to retire. Messrs.
Jessica would like
someone to take over annas share of the partnership. The firm,
which has been in business for over twenty years, specializes in the retailing
of
car
accessories. After having a brief discussion with omoro it agreed that you act for him.
required:
describe the procedures you will adopt following your initial discussion.
(b)
the companys organizational structure is part of the means by which management
controls the enterprises operations. The very structure itself , therefore , including
assignment of duties and
responsibilities and delegation of authority, may be proper
subject of auditors review.
required
(i) Briefly describe the management audit process
(ii) What are the major objectives of management audit
(iii) Describe three major steps for undertaking management audit
Question 4
You are auditing ktm ltd, a textile manufacturing company in dar es salaam. In due course of
your audit it has been realized that the client may have environmental issues which could
have an impact on the financial statements.
Required
(a)
what do you understand by the term environmental auditing?
(b)
describe any four environmental matters which could have impact on financial
statements
(b)
discuss major steps you would take in order to obtain the appropriate evidence.
Question 5
The isa 240 the auditors responsibility to consider fraud in an audit of financial statements
distinguishes fraud from error, sets out the auditors responsibilities with respect to fraud,
and provides additional guidance related to earnings management.
Required:
(a)
compare and contrast the auditors responsibility for the detection and reporting of
fraud and of error. Your answer should distinguish fraud from error. (5 marks)
(b)
explain the term professional skepticism and comment on its role in the detection of
fraud. (5
marks)
(c)
comment on the difficulties which earnings management present to the auditor. (5
marks)
Question 6
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(a)

There is no point of trying to audit the unauditable. Small companies should therefore
be exempt form the requirements of an audit. Discuss
(b)
The subject of the audit of small companies has recently received considerable
attention and publicity. Some authorities say that small companies cannot be audited,
so the audit of them should be abolished, others consider that the full audit should be
retained, while other proposes the audit review.
Required:
i.
Give a brief definition of a small companies which would highlight their
common characteristics
ii.
Consider the reasons why the audit of small companies creates special
problems
iii.
Show how your general audit approach would be modified when auditing
small companies
iv.
Consider, by means of examples , whether the accounts of small companies
can be audited
v.
Decide whether small companys accounts should be subject to a full audit, a
review or no audit. You should
include arguments to support your case,
including evidence from your earlier discussions and consideration of the
value of an
audit
Solution for Paper 20
Question 1
(a)
value for money audits tries to answer the question why and for whom money is
being used. Why money is being used refers to the purpose or the reason to justify
expenditure.
Value for money audits thus refers to the broad-based audit approach which aims at
reviewing and reporting on accountability and responsibility relationships by
examining the underlying activities, and operating and internal control systems
employed by the management in fulfilling its fiduciary responsibility to the user.
Value for money encompasses the systems and procedures to achieve economy,
efficiency and effectiveness. All other things being equal, economy is about keeping
the cost low, efficiency is about getting the most or best output form available
resources and effectiveness is about achieving stipulated aims or objectives.
(b)
the major constraint of introduction of value for money auditing is lack of both human
and financial resources. However, in view of the large-scale government and state
enterprise expenditure, the introduction of value for money auditing is inevitable.
It is often difficult to assess effectiveness because of the problems of valuing
outputs on a comparable basis. For example, the outputs of a fire brigade can
be measured by the number of call outs to attend a blaze. Do we value it
basing on the amount of losses as a result of the fire or based on other basis?
The objectives of not for profit organizations are also difficult to establish
because the quality of the service provided will be a significant feature of their
service. For example, a local authority has among its different objectives, to
collect all the waste out of the streets. The effectiveness of this service can
only be judged by establishing what standard or quality of service is required.
Economy can be achieved by sacrificing quality and neither outputs nor
impacts are necessarily measured in terms of quality.
Effectiveness might be difficult to define, measure or may even conflict. For
example, the effectiveness of the health service can be said to have improved
if hospitals have a greater success in treating various illness and other

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(c)

(d )

conditions or if the life expectancy of the population has increased. But this is
hardly the case in tanzania especially.
There can be emphasis for vfm audits and cost control rather than insisting on
achieving more future benefits and value. For example, client management
may be pressurized into short-term decisions to keep current spending levels
within limits and abandon a capital expenditure plan which could create future
benefits.
In profit making organizations efficiency of the organization as a whole can be
measured in terms of return on capital employed or by relating the quality of
output produced which has a market value and therefore a quantifiable
financial value of the resources and their cost required to make the output. On
the other hand, not for profit organizations the output does not have a market
value, and it is therefore more difficult to measure efficiency. In addition, it is
difficult to compare the output of one not for profit organization against
another one due to lack of a unified goal such as profit.
The auditor must understand clearly the operations of the client he/she is
investigating. With shortage of auditors with the necessary skills,
qualifications, and competence and, with the meagre audit resources
available, vfm audit may fail to achieve the desired objectives.
the scope of audit in a value for money audit means attesting both the financial and
the non-financial information, including the actual performance.
the scope must therefore address the input in terms of financial, human, material,
and management; the methodology in terms of administration and governance, and
the output in terms of the quantity and quality of benefit to be enjoyed, including the
intended user of the benefaction. This makes value for money audit a comprehensive
evaluation and assessment of the use of resources and benefits within wide
parameters of the audit, that is, there are no limits as long as there is room to further
improve the delivery of a satisfactory service. In view of this, value for money audit
requires use of relatively large resources of audit, and the auditor has to posses a
multitude of skills relevant to the audit.
purpose/objective
The object of value for money audit is to establish whether management of an entity
has developed appropriate systems and procedures to achieve value for money, i.e.
The extent to which public funds are expended economically and efficiently and the
extent to which the related execution of the budget is effective in meeting publics
satisfaction.
audit criteria
Audit criteria are reasonable and attainable standards of performance against which
economy, efficiency and effectiveness of activities can be assessed.
If audit criteria are not set, there will be no basis for comparison and consequently no
basis for arriving audit findings, conclusions and recommendations.
In financial auditing, the auditors usually apply generally accepted auditing practices
which evolve through practice and academic work.
Vfm auditing attempts to evaluate vast varieties of activities and functions and
therefore, there are no generally accepted criteria. Vfm auditors, therefore, operate in
more difficult terrain than the financial auditors.
types of audit criteria
I. General criteria ii. Specific criteria
General criteria
General criteria are broad statement of acceptable and reasonable performance. For
example the procedures in an organization may be cumbersome to be effective. In
this case generally accepted management practices can be adopted as audit criteria.
Specific criteria

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(e)

Specific criteria are more closely related to an entitys objectives, programs, systems
and controls.
In highly specialized technical areas, auditors may require the assistance of technical
experts. For technical projects this competence can be achieved through a team of
auditors consisting of auditors and technical experts from different discipline.
In vfm auditing auditors access the performance of a program/project against predetermined expectations of performance or criteria. In order to be acceptable criteria
must have certain characteristics as reliability, objectivity, usefulness,
understandability, comparability, appropriate and acceptable.
the use of criteria is crucial it enables the measurement of, or ability to judge, the
degree to which the client has conformed to expectations which were explicitly
articulated and sanctioned. A criteria is a reasonable standard against which
management practices and reporting systems are assessed. Standards can be
derived or developed from relevant sources including technical pronouncements of
the relevant profession, government regulations and directives, relevant literature
available, knowledgeable people, and common sense, that is what a reasonable
person would expect of management under the given circumstances. All parties to
the audit should ideally accept the criteria or standard to be used. However, the
criteria or standard require regular revision with a view of changing it to suit changing
circumstances of the audit.
economy:
the (lowest/constant/falling) amount of resources deployed to realize
the (rising) output. Emphasis of attention is the quantity or cost of input deployed.
The audit exercise consists of evaluation, comparison, and assessment of the
administrative activities in accordance with sound administrative principles, practices,
and management policies.
indicators:

Decisions are made with cost consciousness


Poor quality output due to low quality input
Suspension/delay in implementation of decisions due to rise in
market prices
Non payment/settlement of certain obligations e.g. Staff
overtime without justifiable reasons
Existence of savings not matching with the level of
performance
Generally, management becomes too conservative in making
decisions due to financial implications of those decisions.

effectiveness: the achievement of the goals and objectives irrespective of how


much resources were deployed. Emphasis of attention is realization of
the goal/ objective. The audit exercise involves evaluation, analysis,
and assessment of performance in relation to the management of the
objectives of the entity and the actual impact of activities in relation to
the planned impact.
indicators:

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Excessive waste of undesired output/goods (abnormal losses)


Excessive spending of financial resources in a given period
Existence of parallel operations/duplicate procedures
Management becoming too aggressive
Existence of idle capacity (holding a harmer to kill a fly which is
not there!).
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efficiency: the increase in the value, benefit, output, satisfaction, etc. At minimum
cost. In other words, the quality of output or rising output for a given one
unit of input. Lesser and lesser resources deployed with rising output, or
benefits. The audit exercise involves evaluation of the utilization of human,
financial, and other resources, including evaluation of information systems,
performance measures, monitoring arrangements, and the procedures
followed in remedying deficiencies in operations.
indicators:

Equipment/resources/efforts are used only for approved and/or


planned activities
Increase in the quality or satisfaction of the output at constant
or falling input efforts
Qualified staff with (voluntary) high motivation to work harder
Achievement of planned goals with minimum time spent
Realization of savings by cutting costs
Activities are planned and resources are allocated on time
Luke-worm management style, people are eager to learn,
there is willingness to accept ideas from others
Sound and adequate system of evaluation and monitoring

accountability
refers to the obligation of the government to the parliament demonstrating
whether the responsibility conferred has been accomplished according to
approved guidelines with efficiency, economy, (and effectiveness). It is
agreed that by accepting a responsibility, accountability is owed for the
actions taken and discharged. A report is to be availed stating how the
responsibility was discharged and to what extent the benefit or output has
been achieved. The output must clearly be understood, including its size or
magnitude required, with well-defined measurable
(e)
the audit planning phase consists of two stages: the overview stage, and the survey
stage.
The overview stage:
A small overview audit team consisting of in most cases of the principal (the leader
of the value for money audit team) and one or two other senior staff is formed to
gather the information necessary to gain a basic understanding of the entity and to
plan the survey. At this point the principal meet with senior management of the audit
entity in order to inform them of the audit and discuss the general audit approach,
timing, co-coordinating mechanisms, and any other relevant matters. The key to
planning a value for money audit understands the audited organization and the
environment in which it operates.
the audit team must gain an understanding of what the entity does and by what
authority it operates, its goals, products and its financial and other resources. At this
stage, the auditor may review matters such as:
Pertinent legislation, internal regulations and publications and orientation
materials,
The relevant external financial legislative or administrative regulations or
directives from relevant authorities,
Any internal or external guidelines managers must follow in their day to day
operations,
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The progress made by management on remedial action proposed in previous


audit and other reports,
Minutes of meetings of various committees,
The organization structure and objectives of the audited entity,
The appropriate personnel to contact within the audited entity.

Based on the information collected in the overview stage, the principal prepares a
preliminary analysis to:
Identify lines of audit inquiry i.e. The broad areas to be examined in order to gain
an improved understanding of the entity,
Identify sources of audit criteria for the areas to be examined during the survey
stage, and
Outline survey projects and prepare a plan for the conduct of the survey. This
plan enables a review to be made of the proposed lines of audit inquiry in terms
of relevance, significance and completeness, and enable judgement to be made
as to whether or not the survey will be conducted in a suitable manner. The
survey plan also serves as the basis for allocating staff of the appropriate skills,
and for preparation of the survey time budget.
The survey stage:
The purpose of the survey stage is to explore, in an efficient manner, potentially significant
lines of audit inquiry identified during the overview stage and expand on the initial knowledge
and understanding of accountability relationships and key management activities, systems
and controls. The major sources of information for conducting the survey include the
following:
Internal and published communications of the audited organization;
Interviews with managers of the audited organization;
Documented standards, policies and procedures applicable to key systems and
controls;
Sources for audit criteria identified in the overview stage;
Studies conducted by internal or external evaluation groups; and
Observations for the working environment.
During the survey stage, the auditor should ensure that appropriate audit criteria are
identified and discussed with members of the audited organization. The audit criteria should
posses the following characteristics:
Provide useful benchmarks for assessing management of financial, human and
physical resources, and for determining whether value-for-money is being
achieved;
Provide a means for managers to develop or compare their own management
procedures; and
Constitute a basis for senior managers to evaluate their systems and procedures.
The criteria used in audits should be few in number and expressed in non-technical terms to
facilitate communication. Their application should be made with consideration for the
environment in which the entity operates. Having specified audit criteria for assessment of
key management activities, systems and controls, the auditor collects evidence in order to
make a preliminary assessment of their adequacy. The auditor is primarily concerned with
controls to ensure that:
Prescribed standards, policies and practices are adhered to;
Needs of users are met;
Operations are carried out economically and efficiently; and
Reporting is appropriate, accurate, complete and timely.
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The preliminary assessment of each control should cover:


Those controls that are well designed and appear to function properly;
Those controls that are either not properly designed or appear not to function
properly, and
Those controls that are desirable but are non-existent.
The auditors preliminary assessment is the basis for:
Determining what matters appear to be significant and may be of a nature that
should be reported; and
Determining the nature extent and timing of further auditing procedures to
substantiate the underlying hypothesis for each matter of potential significance.
The final step in the survey stage is the preparation of the survey report which includes an
outline audit plan. The purpose of the audit plan is to define the overall audit scope in terms
of audit objectives and projects to address those matters that may require attention, to
identify resource requirements, including special skills needed, and to establish overall audit
and project time budgets, milestones or control points and deadlines.
Question 2
(a)
comprehensive auditing comprises both financial or regularity audits and
performance or value for money audits. The auditor undertakes to perform a
complete examination, assessment and evaluation of the clients operating systems,
resources and outputs in relation to its establishment.
(b)
the two elements of public sector audit are purpose and process. Purpose refers to
the formation of the opinion on an account under examination, while process refers to
the exercise of arriving to the opinion on the account under examination.
Purpose: in performing the audit, the auditor provides a service in the form of
assurances to users of the accounts i.e. Central government, local government,
independent department, taxpayer, and the public at large to the extent of the
expression of the auditors opinion.
Process: in the recent past the role of the external auditor has expanded extensively
with the assumption of the responsibility for appraising, and reporting on, the extent
to which the value for money is secured from a specific expenditure of public funds.
(c)

status
Authority for the creation of the office of the head of national audit services.
The process for the appointment of a cag and for his/her removal from office.
Constitutional position of the cag, means by which independence is secured, and
standing of the cag in relation to other public officers.
Relationship with parliament, other representative body or supreme authority.
Arrangement for remunerating the cag.
Functions
The activities, basis, and nature of duties.
Authority to examine and certify national fund accounts; revenue accounts,
government accounts, and any associated/trading and/or commercial accounts,
and stock and stores and stock accounts
Authority to undertake regularity function to check that expenditure is applied for
the purpose approved and that it conforms to the authority which governs it;
Authority to examine whether value for money is obtained in the use of public
resources, including extension of such an examination to the accounts for which
the cag is ordinarily not authorised to certify;

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Basis for reporting the results of an audit including reporting such subjects like
fraud, corruption, losses, irregularities, and how the report shall be issued and
the circumstances in a report must be issued with an audit certificate;
The extent to which regard is given to proposals made by a public accounts
committee or a similar body;
A duty to hear objections to or to answer requests for explanations of accounts
e.g for a member of the public and to hold an extra ordinary audit;
A provision for a legal action against an auditor improperly disclosing information
obtained during the course of an audit.

Powers
Provision delegation of all or some of the functions of the cag to principal officers;
The appointment of staff and provision for determining their pay and conditions of
service;
The right to employ auditors from outside the office reporting to the cag;
Arrangements for funding the office of the cag and the circumstances the
charging of audit fees is authorized;
Provision for the audit of annual accounts of the cags office, and whether this
includes value for money examinations
Right of access to papers, to obtain explanations and information with reference
to any restrictions, any special procedures relating to material bearing a security
classification;
Remedial action where access is denied or information withheld;
Discretion to decide the nature, timing, and extent of audit functions and of
reports.
(d)

Public sector audit in tanzania refers to audit of the government of tanzania


sector and parastatal sector. Government sector comprise ministries, regional
and district administrations, independent departments, and government executed
projects financed by loans and donations to the government. Parastatal sector
include organizations established by an act of parliament, presidential decree, or
any statute within tanzania, or public offices receiving subsidy directly or
indirectly from the government for its normal routine activities - for example tanzania railways corporation, national bank of commerce, tanzania
telecommunications company, tanzania electric supply company, and national
urban water authority, etc.
In public sector audits, the accounts do not play such an important role to audit
compared to the commercial sector. The budget forms a major part of the
accounts for the audit, and as a tool of communication. The concept of
government budget, i.e a statement of how money is to be raised and how it is to
be spent, embraces two major issues in auditing:
That the role of the government sector accounting is necessarily limited to
controlling expenditure in line with budgeted authority; and that the audit
and the auditors report are more important records of accountability than
the accounts themselves

(e)

The public sector audit function in tanzania can be categorized mainly in two - the
central government sector and the parastatal sector.

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Audit of the parastatal sector essentially follows the commercial sector audits
whereby the motive is to be able to confirm whether the accounts present a true
and fair view. On the other hand, public sector auditor aims at certifying the fair
use of a pubic property, hence the audit seeks to promote responsibility and
accountability of the various levels of authority in the government. The
government sector would consist for central, regional, local government,
executive offices, the clerk of the national assembly, independent departments,
the treasury, and government executed projects. The audits of the government
sector consist of three main areas:
o Fiscal audit
o Audit of corporation and other taxes
o Audit of value added tax (formerly customs and sales
tax).

Fiscal audits: fiscal audit refers to the examination of such areas as


expenditures/payment of moneys, payroll and other allowances, salary advances,
allowances, cash imprest, goods and services, postage, telephone, deposits,
appropriation accounts, etc. The audit report in this audit is addressed to the officer
responsible for the expenditure incurred who are normally the permanent secretary,
regional directors and heads of independent departments or chairman of the board of
directors. The main objectives of the report are two fold:
To provide assurance to the receiver that the financial activities under his/her
control are satisfactory; or
To get the receiver to make changes to activities where there is room for
improvement.

Audit of corporation and other taxes: the general objective of the audit of the income tax
department is to ensure that the revenue collected from corporation and other income
taxes are properly accounted for. In particular, the specific objectives are to ensure that
Mandatory tax laws are properly applied in ascertaining the total income of
persons liable to pay tax;
There are adequate safeguards, controls, and procedures for ensuring an
effective check on the assessment, collection, and proper allocation of taxes, and
that such safeguards, controls, and procedures are actually being implemented;
In general the departmental organization is sufficiently safeguarded against
errors, omissions, and frauds, and that there is no wilful omission or negligence
to collect taxes;
Instructions or circulars issued by the minister for finance and commissioner of
income taxes are being followed by the field officers and are in accordance with
the law;
All relevant registers prescribed to be kept are dully and properly maintained.
Audit of value added tax and other related taxes: this type of audit involves examination
of the following areas imports and exports, postal parcels, airports, bonded goods, oil
installations and refineries, transit goods, ships files, withholding taxes. The value added
tax department is responsible for the collection of about 80% of the total tax revenues.
This means it is a vital area of audit and the auditor is expected to exercise great
enthusiasm while examining the records.
(f)
The pac is a committee of the parliament of the united republic of tanzania which is
charged with the follow-up of audit queries and recommendations made on the
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accounts of the government ministries and independent departments. The committee


makes its report to the parliament in a summarised form. The report consist largely of
its views on matters raised in the annual audit report, recommendations for
surcharge or disciplinary proceedings against officers who have failed to carry out
their responsibilities, etc. On receipt of the report of the pac, the treasury takes up
implementation of the recommendations with the accounting officers on the issues
mentioned in the report and then reports back to the pac. Accounting officers are
oftenly called to appear in person before the committee to defend their cases. By
doing so, the pac helps to improve the standard of financial discipline in the country.
(f)

see class presentation.

Question 3
(a)
Agreement in writing of the work to be done including scope and extent of the
investigation required, the period to be covered and date of the report.
Obtain permission to approach the partners and also the auditors. These people
will supply you with information.
Obtain documentary evidence of the partnership including the partnership
agreement, several years accounts, and if possible, supporting schedules, details
of the history of the business, systems of accounting and control, loan
agreement, property leases etc.
Obtain background data e.g. Interfirm comparison data from trade association,
government statistics, published sources as extel and moodies.
Prepare a schedule of accounts for several years. Ensure each is adjusted so
that they are comparable. Note rations and more particularly , trends
Prepare a forecast of future results based on budgets or extrapolations from the
past adjusting for known differences e.g. Rent or interest
Examine the values of assets especially any property (a professional valuation
may be required) and the expiration of any lease.
Examine and reviews and partnership agreement both the present one and the
proposed one .see that the proposed terms are reasonable in terms of the profit
share and capital share obtained in return for consideration, time and expertise to
be input.
Examine any proposal for the valuation of goodwill
Examine the reason why the partnership change is proposed and why your client
was selected
Inquire into any partnership debts and especially contingent liabilities, long term
contracts, long term liabilities for dilapidations or redundancy pay.
Prepare the report in draft and discuss it with your client
If agreed, type the report and submit it formally.
(b)
(i)
Management audit is principally concerned with the examination of managements ability
to supervise the activities of the client, including its dynamism and flexibility with the
changing operating environment including taking advantage of opportunities arising in
the course of business. A critique is given on the policies and procedures in operation,
future plans, previous trends, discharge of fiduciary responsibility, responsiveness to
stakeholders and shareholder interests, and the use of resources and opportunities
available to the enterprise. The aim of the critique is to assist enterprise management by
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giving advise on the furtherance of the organizational objectives with a view of efficiency,
economy, and effectiveness. To be able to achieve management audit, it is important
that the auditor approaches his work and think like a strategic manager in the clients
business.
(ii)
The objectives of management auditing is to appraise, evaluate, and advise clients on
how best they should operate their business, including the means to get competitive
advantage over competitors and the ability for the client to capture new opportunities and
manage novel and uncertain business. To be able to do so the auditor must do a
complete surgery of the client, and a critical study of the operating environment. The
auditor must therefore demonstrate the competence and ability to accept the job. The
auditors competence may be dictated by the background training and education
received and the fundamental philosophy of the auditing firms themselves. The
objectives of management auditing may however change as the auditor develops an
understanding of and a familiarity with operations of the client, and as they broaden their
technical competence to deal with management matters as readily as they have dealt
with financial matters. The different objectives some of which may be overlapping and
others mutually exclusive are as follows:
Appraisal of plans and client objectives;
Appraisal of clients organizational structure;
Evaluation and assessment of clients performance;
Appraisal of clients controls of operations;
(iii)

familiarization
First the auditor must learn from operating management what the objectives of the
operation are, how they are to be accomplished, and how the results are determined.
This learning is accomplished in many ways. The auditor will discuss the operation with
knowledgeable people. The auditor will seek to find out how management determines
whether the activity is functioning correctly; how it reports results; how it evaluates its
employees; and what effect the activity has on other activities. He/she will walk
through the department or follow the function until he/she has a reasonably good idea of
what is being done, how it is being done, and why it is being done. When he/she has an
adequate understanding of the specific objectives, he/she then tries to familiarize
himself/herself with the controls that management has established to see that its
objectives are being attained (see the following notes).

Examines the organizational structure, the place of the units in the company, their
relationship with other units, and the assignment of functions and responsibilities.
The auditor traces significant activities by flow-charting them or by following selected
documents through the key control points.
Review of the policies and procedures that govern the unit or function being
examined. Written procedures, understood by employees and reasonably calculated to
carry out company plans and achieve company objectives, are an indication of a wellcontrolled activity. Where the procedures are not in writing, the auditor will have to
determine from discussions with management what is expected of its people and how
the assigned activities are to be carried out.
Review of the records generated or affected by the activity in which he/she is
interested. He/she wants to know what the records are supposed to do, why they are
needed, and whether other records duplicate them.
Finally, the auditor asks what management itself does to appraise the work
performed what kinds of reports it receives from its people and what kinds of reports it
submits to higher management. The process of familiarization is, of course, carried on
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throughout the entire audit. Sufficient familiarity is necessary at the outset so as to


prepare a workable audit program.
(ii)
verification
By verification of transactions, just as in a financial audit, the auditor is able to determine the
degree to which controls in an actual operation conform to the written and oral descriptions
and under-standings which management has given to the auditor. Verification requires the
auditor to examine in detail a selected sample of transactions, preferably by statistical
methods. The sample size will depend on the judgement of the auditor as to the degree of
reliance he/she needs that the sample reasonably represents the population from which it is
selected. In making his/her verification, the auditor is usually concerned with three things:
quality, timeliness, and cost. When he/her has established the degree to which transactions
have been handled correctly, promptly, and economically, he/she will be determining
whether or not in actual practice:
The organization structure and the assignment of responsibility follow the control
plans of departmental management
Procedures prescribed by management are being followed.
Prescribed internal checks are being enforced.
Prescribed procedures and other controls prove effective in coordinating the work
with that of other departments.
Operating records and reports are complete, timely, factual, and meaningful.
Standards of performance provide an effective basis for the appraisal of operating
results.
(iii) evaluation and recommendations
Evaluation begins as the knowledgeable auditor starts his/her review and even takes place
during the familiarization that the activity is well controlled or, on the other hand, that
something is wrong. Through verification these feelings may be confirmed; audit tests may
disclose conditions that were not apparent from the initial survey. Final evaluation, or
confirmation of the initial evaluation, usually awaits the results of such tests.
Recommendations should be made only when the auditor is completely satisfied that he/she
understands the operation, that his/her appraisal has taken the true measure of the
operation, and that his recommendations, take into account all the factors that affect the
operation. As a result of his examination and evaluation, the auditor should be in a position
to answer the following questions:

Do the established controls operate effectively? If not, what constructive steps can
be recommended?

If there are numerous deviations from established policies and procedures, does the
reason lie with the policies and procedures or with other factors?

Do departmental controls and practices conform to company policy? If not, what


should be recommended?

Do the established controls help management in attaining operating objectives?

Does operating management understand and utilize its controls to best advantage?

Does the structure of accounts, records, and reports follow the pattern of operating
responsibility, and does it conform to the way management looks at its operations?

Is there adequate coordination and cooperation with related departments? Are there
duplications or gaps in control?
In making recommendations to management, the auditor must see the problems as
management would see them. He/she must weigh the benefits of the safeguards afforded
by increased control against the costs that will be incurred. He/she must weigh the extent of
risk against the amount of potential loss. Of course, there will be occasions when the auditor
meets a situation which is beyond his/her experience or training when he/she is not in a
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position to make a practical suggestion to cure an apparent deficiency. Here the auditor
must resent his/her findings to management, making certain that all facts have been fairly
presented, and leave the determination of the action to be taken to management itself.
( iv) reporting
There must not be any reservations when reporting on the findings. The auditor provides the
best service to general management and maintains the best support with operating
management when he/she discusses currently and candidly the things found. Minor matters
usually can be cleared up as the audit progresses and need not be included in the formal
report. Referring to them in the working papers and showing there how they are corrected
should suffice. Generally, matters of greater impact should be discussed currently with the
lowest level of management capable of taking corrective action. Any formal report that tells
general management that all deficiencies were corrected before the report was issued finds
a friendly acceptance by both operating and general management. Also, while the auditor is
not bound to offer solutions for the problems he has encountered the responsibility for
correcting defects must ultimately
Question 4
(a)
see class notes
(b)
see class handout, the requirement of isa 1010
( c)
suggested solution (this is very important to you! remember these
proc)
Obtain an appropriate understanding of the company, its operations and, in
particular, its environmental issues.
Evaluate whether there is any possible risk of misstatement in the financial
statements as a result of environmental issues.
Enquire of management ot any systems or controls which are in place to
identify risk, evaluate control and account for environmental matters.
Obtain understanding of the control environment operating within the client
Obtain written representation from management on any environmental
matters
Otain evidence from environmental experts where the evidence in relation to
environmental matters is sufficiently persuasive.
Consider minutes oa directors, board committees or environmental officers
Review documentation
Review all assets impairment
Review liabilities and provisions to ensure all have been included
Review contingencies and ensure adequate disclosure
Include environmental issues in the review of appropriateness of going
concern
Obtain representation by management which may take the form of a statement to the
following effect
Management are not aware of any material liabilities or contingencies arising
from environmental matters, including those resulting from illegal or possible
illegal acts.
Managements are not aware of any environmental matters that may have a
material impact on the financial statements.
If aware of such matters, those matters have been properly disclosed in the
financial statements.
The auditor must review the following documents
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Publicly available industry information on environmental matters


Reports issued by environmental experts about the entity
Internal audit reports
Environmental expert reports (if any)
Reports on due diligence investigations
Reports on or to regulatory agencies
Correspondence with lawyers
Correspondence with enforcement agencies.

Question 5
Fraud versus error
misstatements in the financial statements can arise from fraud or error. The distinguishing
factor between fraud and error is whether the underlying action that results in the
misstatement is intentional or unintentional.
fraud may involve forgery (or other sophisticated and carefully organized schemes
designed to conceal), deliberate
Failure to record transactions, or intentional misrepresentations being made to the auditor.
Detection of fraud and error
the auditor is responsible for assessing the risk of misstatement in a financial statement
audit whether due to fraud or error. However, the auditors responsibility for detecting fraud
is different due to the characteristics of fraud.
the risk of not detecting a material misstatement arising from fraud is higher than that from
error because of the deceit involved in fraud. Attempts at concealment are even more
difficult to detect when accompanied by collusion (which may cause the auditor to believe
that audit evidence is persuasive when it is, in fact, false).
the auditors ability to detect a fraud depends on many factors (e.g. The frequency/extent
of manipulation, degree of collusion, relative size of amounts manipulated, seniority of
individuals involved). While the auditor may be able to identify potential opportunities for
fraud, it may be impossible for the auditor to determine intent, particularly in matters
involving management judgment (e.g. Accounting estimates).
audit procedures that are effective for detecting error may be ineffective for detecting
fraud.
Reporting of fraud and error
to shareholders the auditor has the same responsibility under isa 700 the auditors
report on financial statements for fraud as for error. For example, if the auditor is aware of a
limitation of scope or disagrees with an accounting treatment the audit opinion will be
qualified (assuming the matter to be material). However, if a matter is not material, it cannot
be reported.
to management and those charged with corporate governance the auditor should report
a matter which identifies or indicates fraud as soon as practicable to the appropriate level of
management. This is even if the matter appears inconsequential (e.g. A minor defalcation by
an employee). However, the auditor would not report such inconsequential errors.
to regulatory and enforcement authorities ordinarily, reporting to third parties on both
fraud and error is precluded by the auditors professional duty of confidentiality. However,
the auditor may have a duty to report the occurrence of fraud in some countries.
(b) professional skepticism
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professional skepticism recognizes the possibility that circumstances may exist that cause
the financial statements to be materially misstated.
it is an aspect of rigor that information and explanations obtained are assessed and
additional evidence sought as necessary.
due to the characteristics of fraud, the auditors attitude of professional skepticism is
particularly important when considering the risk of material misstatement. Professional
skepticism is an attitude that includes a questioning mind and a critical assessment of audit
evidence.
the auditor must be prepared to consider that a material misstatement due to fraud could
exist, notwithstanding theauditors past experience with the entity and the auditors belief
about the honesty and integrity of management and those charged with governance of the
entity.
when making inquiries and obtaining other audit evidence, the auditor exercises
professional skepticism so as not to be satisfied with less-than-persuasive audit evidence
based on a belief that management and those charged with governance are honest and
have integrity.
an audit of financial statements rarely involves the authentication of documentation, nor is
the auditor trained as (or expected to be) an expert in such authentication. However, the
auditor considers the reliability of the information to be used as audit evidence including
consideration of controls over its preparation and maintenance where relevant. Unless the
audit reveals audit evidence to the contrary, the auditor ordinarily accepts records and
documents as being genuine.
(c) earnings management difficulties for the auditor
earnings management aims to deceive users of financial statements by influencing their
perceptions about the entitys performance and profitability. At its extremes, it constitutes
fraudulent financial reporting. There are four broad categories:
intentional breach of financial reporting requirements which are, in isolation, immaterial;
unsuitable revenue recognition;
big bath provisions/reserve accounting;
improper accruals/estimation of liabilities.
overly conservative reporting (e.g. Creating reserves in good times for release on rainy
days) and aggressively optimistic outcomes both hold consequences for the quality of
financial reporting.
earnings management may be relatively innocuous (a tendency) and within gaap, or so
aggressive as to constitute fraud (i.e. In violation of gaap). One difficulty for the auditor is
establishing the boundary between acceptable and unacceptable earnings management
and an intention to commit fraud. This is a matter for judgment and requires an attitude of
professional skepticism.
earnings management may start out with small biased judgments in financial reporting
and/or structuring transactions.
If amounts are individually immaterial standard audit procedures may not detect them.
making use of flexibility in accounting estimates is often the beginning of aggressive
earnings management. Such flexibility may develop creative choices. Accounting standards
need to be rigorous and not so imprecise that it is impossible for an auditor to obtain
sufficient, appropriate audit evidence to confirm the amounts derived under them.
pressures and incentives may lead these actions to increase to the extent that they are not
acceptable under the applicable financial reporting framework. Controls that otherwise may
appear to be operating effectively may be overridden by management. In such a case it is
likely that management representations cannot be relied on.
opportunities for earnings management arise, in particular, where there is no accounting
standard covering a particular accounting issue. As many techniques of earnings

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management involve accruals the auditor must be alert to the level of accruals appropriate to
the industry and client and the appropriate recognition of liabilities.

Question 6
All companies in tanzania are required by the statute a t present to appoint an auditor and
his duties are fairly clearly prescribed.
The reasons for this requirement are simply the benefits gained, by all parties having any
contact with the company, in having credible accounts. The benefits of accountability by the
directors of ici for example to the companys shareholders are obvious and the necessity for
the accounting to be subject to audit is equally apparent.
Some criticism of the extension for the requirement to small companies has been made on
the grounds of cost and also of irrelevance. Consider the case of a ltd whose shareholders
are a with 90 shares and mrs a with 1. Firstly what is the use of accounts? It will be seen that
may parties has uses of them: a for decision making, the bank for lending etc. The utility of
these accounts if they were unauditied must surely be much less, indeed for some users,
they would have no uses.
We have now established the desirability of small companies having an audit. It is then
necessary to ask whether an audit of the accounts of small companies is possible. Several
points can be made:
The emphasis of modern writings on auditing, especially in the proposed standards and
guidelines, is on the internal control evaluation approach. This approach may mean the audit
connote confirm some assertions, the completeness of sales to quote an example.
The standard and guidelines have shown that while lack of internal control may make an
audit difficult, other factors such as the close supervision of the proprietor may make up for
the lack. An auditor is also faced with a smaller number of transactions and the ability to get
to know a small organisation more intimately.
If some items in a set of accounts are effectively unauditable may other items can exactly
and comprehensible verified.
A qualified audit report is better than no report at all. The quote the proposed standard, by
giving and adverse opinion or disclaiming an opinion, he deprives the reader of the report, of
any assurance, however limited
In conclusion, small companies are audited now and in nearly all cases, received unqualified
reports. The profession clearly believes that small companies are unauditable although
many auditors sign clear audit certificates with considerable reservations.
B.
Small companies are those which have these characteristics :Guidance is iaps 1005 which defines small entity as entity is any entity in which: (a) there is
concentration of ownership and management in a small
number of individuals (often a
single individual2); and (b) one or more of the following are also found: (i) few sources of
income; (ii) unsophisticated record-keeping; or (iii) limited internal controls together with the
potential for management override of controls.
Substantial domination of the management, and of accounting and financial
management and of accounting and financials management functions by one person
(often managing director who may also be chief shareholder)
Too few staff to enable the company to have a proper division of duties so that
internal controls are not fully reliable.
In terms of companies act 2002 a small company is one which satisfies two criteria
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o
o
o
o

Turnover not exceeding


Balance sheet total not exceeding
Average number of employee not exceeding
Item i. And ii
refer to small companies as companies with simple
organisation structure and iii . Simply on size.

Problems of auditing small companies : Reliance on internal control is not practical


Dominance by one manger/owner may mean control of staff but no
control over actions of the manager.
Lack of controls may mean errors and frauds occur an remain
undetected
Full books of account are not always maintained
Completeness of recording is a specially difficult problem
The manager /owner may be tempted to and will find it easy to
manipulate the financial statements
The following modifications to the general audit approach will be required :
Recording the system of accounting and controls , and compliance testing of the controls will
be reduced
Substantive testing of records will be enlarged and large samples (often 100%) taken more
complete verification of the balance sheet items more testing of the type where the auditor
does his own calculations and analyses a deeper involvement in the commercial situation of
the client such that analytical review can be more effective greater reliance on the
representations of management
The small companys accounts can be audited but in many cases only by accepting
assurances in some areas (e.g. Completeness) from management
Most balance sheet items are capable of acceptable audit verification fixed assets, stock,
debtors, bank, creditors etc
Profit and loss items my prove more difficult, for example;
Cash sales in retail companies. Till rolls and cash register totals are indicative but
management can (and do) by pass the tills for the proportion of the sales
In a manufacturing companies, significant sales of scrap are made for cash and no
record is kept.
Ratio analysis checks (e.g. Gross profit) are difficult in industries such as
greengrocery, farming, small manufacture.
Records may not be complete e.g. Lack of work in progress and finished goods
costing in the factory.
Records have been improved in recent years with the imposition of vat and statutory
sick pay.

Instructions
1.
Time allowed 3 hours
2.
The examination paper contains eight questions, attempt any six
3.
Marks will be given for clarity of language and logic expression to every question
Question 1
(a) explain the situations where an auditor may disclose confidential information about a
client. (8 marks)

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(b) you are an audit manager in malingumu and co, a firm of certified public accountants.
You are preparing the engagement letter for the audit of ancients, a public limited liability
company, for the year ending 30 june 2006.
Ancients has grown rapidly over the past few years, and is now one of your firms most
important clients.
Ancients has been an audit client for eight years and mckay & co has provided audit,
taxation and management consultancy advice during this time. The client has been satisfied
with the services provided, although the taxation fee for the period to 31 december 2005
remains unpaid.
Audit personnel available for this years audit are most of the staff from last year, including
mr grace, an audit partner and mr jones, an audit senior. Mr grace has been the audit
partner since ancients became an audit client. You are aware that allyson grace, the
daughter of mr grace, has recently been appointed the financial director at ancients.
To celebrate her new appointment, allyson has suggested taking all of the audit staff out to
an expensive restaurant prior to the start of the audit work for this year.
Required:
Identify and explain the risks to independence arising in carrying out your audit of ancients
for the year ending 30 june 2006, and suggest ways of mitigating each of the risks you
identify. (12 marks)
Question 2
Isa 610 considering the work of internal auditing states that when the external auditor
intends to use specific work of internal auditing, the external auditor should evaluate and
perform audit procedures on that work to confirm its adequacy for the external auditors
purposes.
Required:
(a) in relation to isa 610, explain the factors the external auditor will consider when
evaluating the work of the internal auditor. (5 marks)
(b) zpm is a listed limited liability company with a year end of 30 june. Zpms main activity is
selling home improvement or do-it-yourself (diy) products to the public. Products sold range
from nails, paint and tools to doors and showers; some stores also sell garden tools and
furniture. Products are purchased from approximately 200 different suppliers. Zpm has 103
stores in eight different countries.
Zpm has a well-staffed internal audit department, who report on a regular basis to the audit
committee. Areas where the internal and external auditors may carry out work include:
1. Attending the year end inventory count in 30 stores annually. All stores are visited on a
rotational basis.
2. Checking the internal controls over the procurement systems (e.g. Ensuring a liability is
only recorded when the inventory has been received).
3. Reviewing the operations of the marketing department.
Required:
For each of the above three areas, discuss
(i) the objectives of the internal auditor; (5 marks)
(ii) the objectives of the external auditor; and (5 marks)
(iii) whether the external auditor will rely on the internal auditor, and if reliance is required,
the extent of that reliance. (5 marks)
Question 3
International standards on auditing (isas) are produced by the international audit and
assurance standards board (iaasb), which is a technical committee of the international

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federation of accountants (ifac). In recent years, there has been a trend for more countries to
implement the isas rather than produce their own auditing standards.
A school friend who you have not seen for a number of years is considering joining nbaa as
a trainee accountant.
However, she is concerned about the extent of regulations which auditors have to follow and
does not understand why isas have to be used in your country.
Required:
Write a letter to your friend explaining the regulatory framework which applies to auditors.
Your letter should cover the following points:
(a) the due process of the iaasb involved in producing an isa. (4 marks)
(b) the overall authority of isas and how they are applied in individual countries. (8 marks)
(c) the extent to which an auditor must follow isas. (4 marks)
(d) the extent to which isas apply to small entities. (4 marks)
Question 4
(a) state the control objectives for the ordering, dispatch and invoicing of goods. (5
marks)
(b) atlantis standard goods (asg) co has a year end of 30 june 2006. Asg is a retailer of
kitchen appliances such as washing machines, fridges and microwaves. All sales are made
via the companys internet site with dispatch and delivery of goods to the customers house
made using asgs vehicles. Appliances are purchased from many different manufacturers.
The process of making a sale is as follows:
(1) potential customers visit asgs website and select the kitchen appliance that they require.
The website ordering system accesses the inventory specification file to obtain details of
products asg sells.
(2) when the customer chooses an appliance, order information including price, item and
quantity required are stored in the orders pending file.
(3) online authorisation of credit card details is obtained from the customers credit card
company automatically by asgs computer systems.
(4) following authorisation, the sales amount is transferred to the computerized sales day
book. At the end of each day the total from this ledger is transferred to the general ledger.
(5) reimbursement of the sales amount is obtained from each credit card company monthly,
less the appropriate commission charged by the credit card company.
(6) following authorisation of the credit card, order details are transferred to a goods awaiting
despatch file and allocated a unique order reference code. Order details are automatically
transferred to the dispatch departments computer system.
(7) in the despatch department, goods are obtained from the physical inventory, placed on
asg vehicles and the computerised inventory system updated. Order information is
downloaded on a hand held computer with a writable screen.
(8) on delivery, the customer signs for the goods on the hand held computer. On return to
asgs warehouse, images of the customer signature are uploaded to the orders file which is
then flagged as order complete.
This years audit planning documentation states that a substantive approach will be taken on
the audit.
Required:
Tabulate the audit tests you should carry out on the sales and despatch system, explaining
the reason for each test. (15 marks)
Question 5

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Value for money audits tries to answer the question why and for whom money is being
used.
Why money is being used refers to the purpose or the reason to justify expenditure.
For whom the money is being used responds to value received as measured by the utility or
satisfaction enjoyed by a specified user. Financial data simply shows how much money is
involved in a certain specified purpose, but does not necessarily demonstrate the value
received. To be able to demonstrate the extent of value received, measures of performance
must be put in place and somebody must be entrusted with the management and
supervision of the utility or satisfaction to be procured.
Required
(a)
Distinguish between value for money and value for money audit
(b)
Describe the purpose, scope and process of value of money audits in tanzania.
Why the use of criteria is important in value for money audits
(c)
Distinguish value for money audits in public and private sector in tanzania
(d)
Discuss the pro and cons of value for money audits
(e)
Write short notes on value for money; concepts and meaning
(f)
Describe the planning stage of value for money audits
(g)
Describe the process of executing value for money audits
(h)
What are the main impediments of value for money audits implementation in
tanzania?
Question 6
Formalized audit sampling procedures have been developed and become commonplace in
the majority of audit firms. The use of audit sampling, on all audit assignments, offers
innumerable benefits to all auditors.
(a)
What is an audit sampling? What are its merits and demerits
(b)
Distinguish between alpha and beta audit risks
(c)
Describe factors influencing planning of the audit procedures to sample account
balances and transactions.
(d)
Discuss factors to consider in designing a sample plan
(e)
Distinguish between:a. tolerable error and precision in audit sampling
b. Variable and monetary unit sampling
c. Attribute sampling and discovery sampling
d. Sample size and sampling risk
(f)
Write short notes on selection of sample size for variable sampling.
Question 7
The isa 240 the auditors responsibility to consider fraud in an audit of financial statements
distinguishes fraud from error, sets out the auditors responsibilities with respect to fraud,
and provides additional guidance related to earnings management.
Required:
(a)
compare and contrast the auditors responsibility for the detection and reporting of
fraud and of error. Your answer should distinguish fraud from error. (5 marks)
(b)
explain the term professional skepticism and comment on its role in the detection of
fraud. (5
marks)
(c)
comment on the difficulties which earnings management present to the auditor. (5
marks)
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Question 8
(a)
mewata a charity whose constitution requires that it raises funds for educational
projects. These projects seek to educate children and support teachers in certain countries.
Charities in the country from which mewata operates have recently become subject to new
audit and accounting regulations. Charity income consists of cash collections at fund raising
events, telephone appeals, and bequests (money left to the charity by deceased persons).
The charity is small and the trustees do not consider that the charity can afford to employ a
qualified accountant. The charity employs a part-time bookkeeper and relies on volunteers
for fund raising. Your firm has been appointed as accountants and auditors to this charity
because of the new regulations. Accounts have been prepared (but not audited) in the past
by a volunteer who is a recently retired certified public accountant.
Required:
(a) describe the risks associated with the audit of mewata under the headings inherent risk,
control risk and detection risk and explain the implications of these risks for overall audit
risk. (10 marks)
(b) list and explain the audit tests to be performed on income and expenditure from fund
raising events.
Question 9
(a)
Describe key features of banks and financial institutions which makes them different
from other entities
i.
Describe audit procedures to be adopted in audit of
i. Deposits in a bank
ii. Cash deposits
iii. Investments
iv. Balance sheet
(b)
Discuss main problematic areas in audit of insurance companies and describe
the audit procedures to be adopted.

Question 1
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(a) confidential information


General rules
Information obtained during an audit is normally held to be confidential; that is it will not be
disclosed to a third party.
However, client information may be disclosed where:
consent has been obtained from the client
there is a public duty to disclose or
there is a legal or professional right or duty to disclose.
However, these rules are general principles only; more detailed guidance is also available to
accountants, as explained below.
Nbaas code of ethics obligatory disclosure
As noted above, nbaas code of ethics confirms that when a member agrees to work for a
client in a professional capacity, it is an implied term of that agreement that the member will
not disclose a clients affairs to any other person.
The recognised exceptions to this rule are where a member knows or suspects that his client
has committed treason, or is involved in drug trafficking or terrorist offences. In this situation,
information must be disclosed to a competent authority. The actual disclosure will depend on
the laws of the jurisdiction where the auditor is located.
The auditor may also be obliged to provide information where a court demands disclosure.
Refusal to provide information is likely to be considered contempt of court with the auditor
being liable for this offence.
Nbaa code of ethics voluntary disclosure
A member may also disclose client confidential information voluntarily, that is without client
permission, in a limited number of situations.
to protect a members interest e.g. To allow a member to sue a client for unpaid fees or
defend an action for negligence.
where there is a public duty to disclose e.g. The client has committed an action against the
public interest such as unauthorized release of toxic chemicals.
(b) independence risks
Audit partner time in office
Mr grace has been the audit partner of ancients for eight years. His objectivity for the audit
may be threatened by the ongoing close relationship with the client. In other words, he may
be too friendly with the directors of ancients. This means he may not be willing or able to
take difficult decisions such as issuing a modified audit report for fear of prejudicing his
friendship with the directors. Rotating the audit partner would remove this threat.
Unpaid taxation fees
Ancients has not paid the taxation fees for work that took place nearly six months ago. The
non-payment of fees can be a threat to objectivity similar to that of an unpaid loan. In effect,
mckay is providing ancients with an interest free loan. The
Audit partner in mckay may not wish to issue a modified report for fear that the client leaves
and the loan is not repaid. The unpaid fee must be discussed with the directors in ancients
and reasons for non-payment obtained. Mckay may wish to delay starting the audit work for
this year until the fee is paid to remove the potential independence problem. If the fee is not
paid at all then mckay may decline to carry out the audit.
Fee income
No details are provided regarding fee income obtained from ancients. However, the
company is growing rapidly and mckay does provide other services besides audit. As a
limited liability company, mckay should ensure that no more than 10% of its recurring
practice income (including auditing, accountancy and other work combined) is derived from
this client. Obtaining more than 10% could indicate undue financial reliance on one client,
and impair objectivity regarding the audit report (again fear of issuing a modified report and
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losing the fee income from the audit client). If the 10% limit is close, mckay may have to limit
other services provided so that independence is not impaired. An annual review will be
required on clients where the
Fee is between 5 and 10% to ensure that the fee income rules will not be breached.
Allyson grace
Allyson grace is not deemed to be connected to mr grace because she is presumably over
the age of 18. If she was still a minor, then there would be a connection and it would be
inappropriate for mr grace to be the audit partner as he could in theory influence allysons
decisions. However, there may still appear to be an independence problem as mr grace may
not be objective in making audit decisions. He may not wish to annoy his daughter by having
to qualify the financial statements.
Appointing another audit partner would remove the perceived independence problem.
Meal
The offer of a meal by allyson may appear to be a threat to independence; having received
an expensive meal, the audit staff may be favourably disposed towards ancients and be less
inclined to investigate potential errors. Audit staff are allowed to receive modest benefits on
commercial terms; whether there is a benefit depends on how expensive the meal is. To
ensure no independence issues it would appear that the invitation should be declined. One
possible option would be for mr grace and allyson to pay personally as a purely social event
even though this may be unlikely. However, this does not remove the implied independence
issue.

Question 2
(a) factors to consider when evaluating and testing the work of the internal auditor include:
a check that the work is performed by persons having adequate technical training and
proficiency as internal auditors, by ensuring appropriate training programmes are in place
and the auditor has appropriate qualifications.
ensuring that the work of assistants is properly supervised, reviewed and documented by
reviewing the procedure
Manuals of internal audit and the audit working papers produced.
determining that sufficient and appropriate audit evidence is obtained to afford a
reasonable basis for the conclusions reached, again by reviewing the internal auditors
working papers.
checking that the conclusions reached are appropriate in the circumstances and that any
reports prepared are consistent with the results of the work performed by reviewing the work
performed and the reports produced.
ensuring any exceptions or unusual matters disclosed by internal audit are properly
resolved by the external auditor and management.
(b) (i) objectives of internal audit
Year end inventory count
The main aim of the year end inventory count is to ensure that the figure for inventory in the
financial statements is accurate. The objective of the internal audit department is to check
the accuracy of the inventory count to ensure that the physical goods inventory is correctly
stated on the inventory sheets. This objective is achieved by checking the control system
over counting inventory. Internal audit work will involve ensuring that all inventory is counted,
teams of two people are counting inventory, and then performing test counts to determine
the accuracy of the test counts.
Internal controls over procurement systems
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The internal auditor will be ensuring that the procurement system is achieving its key
objectives and operating according to company guidelines. Specific aims will include:
ensuring purchases are authorised
quantity discounts are obtained
inventory received is recorded on goods received notes or similar.
Reviewing operations of the marketing department
The internal auditor will review the work of the marketing department with aims such as
ensuring that the process is being managed effectively and information is available to the
marketing manager as required. Where deficiencies in the information provided are noted,
then an internal audit report will highlight those deficiencies and make recommendations for
improvement to the information systems. The objectives of internal audit in this case are
more to ensuring the efficiency of operations rather than any specific financial objective.
(ii) objectives of the external auditor
Year end inventory count
The external auditor also needs to ensure that the figure for inventory is materially correct for
the financial statements.
Part of the work of the external auditor is to attend the physical inventory count to ensure
that the quantities and condition of inventory is correctly recorded. Given that zpm does not
appear to have any perishable inventory, the main objective will be to ensure correct
recording of inventory quantity.
Internal controls over procurement systems
The external auditor will test the procurement system with the overall objective of
determining that the purchases and payables figures in the financial statements are correct.
The objectives of testing will be to ensure that the control system over procurement is
operating efficiently, and ensure complete and accurate recording of purchases and
payables
Liabilities. If errors are found then this implies that the financial statements could also
contain errors.
Reviewing operations of the marketing department
As the operations of the marketing department do not normally impact on the financial
statements, the external auditor may not actually review this function.
(iii) reliance by the external auditor
Year end inventory count
Zpm has 103 stores which is likely to mean that the external auditor will not be able to
attend the inventory count in all stores, simply due to lack of staff. However, if inventory
count procedures are the same at all stores, then reliance can be placed on the internal
auditor to attend some stores and check that the internal control systems are being correctly
applied in those stores. This reliance does not mean that the external auditor does not carry
out any work; the external auditor will compare results from stores tested with those of the
internal auditor. Results should be about the same; any differences in terms of errors found
will be investigated, and reasons for those differences obtained.
Internal controls over procurement systems
The external auditor may rely on the work of the internal auditor regarding the procurement
systems, where the work of the internal auditor is relevant to the financial statements. Some
areas such as ensuring quantity discounts are obtained are less important than ensuring
completeness of recording of liabilities. Again, the external auditor must perform some work
on the procurement systems; the presence of an internal auditor simply means that the work
can be reduced.
Reviewing operations of the marketing department
Given that the external auditor does not need to review the operations of the marketing
department then no formal reliance is needed on the work of the internal auditor. However,
internal audit reports may be reviewed to determine, for example, the effectiveness of

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advertising spend etc to help determine the going concern situation of the company. In the
case of zpm, the effectiveness of advertising new stores could be reviewed.

Question 3
Flat sg1
Millennium towers
Dar es salaam
17 june 2006
Dear jayne
I am pleased you are also thinking about accountancy as a career and understand your
concern regarding the use of auditing standards. I will try and explain the need for standards
in this letter.
The working procedure of the iaasb to produce an isa
The start of the process of producing an international standard on auditing (isa) is for a
subcommittee of the international audit and assurance standard board (iaasb) to determine
appropriate areas for an isa, or to note where existing isas need amendment.
The subcommittee produces an exposure draft on that subject, initially for consideration by
the iaasb. If the iaasb approve the exposure draft, then it is circulated to the member bodies
of the international federation of accountants (ifac) and any other organisations that have an
interest in auditing standards and published on the iaasb website.
These bodies make comments on the exposure draft. Comments are sent back to the iaasb
and the exposure draft is amended as necessary. Finally the exposure draft is re-issued as
an isa or an international auditing practice statement (iaps).
The whole process can take between one and two years.
The overall authority of isas and how isas are applied in individual countries
Isas are designed to be applied in the audit of financial statements and may be applied to
the audit of other historical financial information.
Each isa contains the basic principles and procedures to apply to that isa (identified by bold
type in the isa itself). Other text in the isa provides guidance on the implementation of the
principles. In other words, to apply the isa, the whole of the text, not simply the parts in bold
type, must be read and understood.
Isas are not designed to override the requirements for the audit of entities in individual
countries. So if our country did not require an audit of specific entities, then the isas would
not overrule that requirement.
Regarding the detailed requirements of an audit, such as the nature of testing or the issuing
of an engagement letter, where our country requirements meet those of the isa, then the isa
will be used. It is therefore unlikely that our country would issue a separate auditing
standard; the isa would be sufficient.
Where our local codes on audit differ from the isa, then the local requirements are used.
However, we are encouraged to introduce changes in our country so that the requirements
of the isa are met. For example, our country may require an engagement letter to be signed
every five years, but the isa requires one every year. In this case, local change is needed to
comply with the isa.
The extent to which an auditor must follow isas
An auditor should follow the isas wherever possible. However, in some situations an auditor
may consider it necessary to depart from the isa so that the objectives of the audit can be
achieved more efficiently. In this situation, the auditor can depart from the isa, but he or she
must be prepared to justify the departure. It is expected that departure from any isa will be
the exception rather than the rule.
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The extent to which isas apply to small entities


To be clear, isas are meant to be applicable to the audit of any entity, no matter what its
size. However, in small entities, the auditor may have to amend the audit approach to fit the
circumstances of that business. For example, there will be greater reliance on substantive
testing and management representations. However, the appropriate isas should be followed.
Conclusion
I hope that this clarifies your understanding of isas. Please let me know if i can be of further
assistance to you in your accountancy career.
Yours sincerely,

Question 4
(a) control objectives
Ordering of goods
goods are only supplied to authorised customers
Orders are recorded correctly regarding price, quantity, item and customer details
Despatch and invoicing of goods
orders are despatched to the correct customer
all despatches are correctly recorded
despatches only relate to goods ordered and paid for by customers
invoices raised relate to goods supplied by the company
(b) audit tests on sales and despatch system
Note to candidates: the focus of the answer should be on substantive tests. Compliance
tests are allowable where they relate to the system described.
Audit test
Using test data if necessary, access asgs website site and input order details for specific
goods. Trace
Those order details to the orders pending file.
For a sample of items in the orders pending file, agree to the orders awaiting despatch file,
ensuring that appliance details and quantities are the same.
agree sales details for that customer to the monthly reimbursement from the credit card
Company, checking amount received is the product price less the appropriate commission
Charged by the credit card company.
agree the sales amount to the sales ledger file.
Review goods awaiting despatch file for old items and inquire as to why those items are still
on file.
For a sample of days, cast the sales day book file and agree the total sales to the general
ledger
Accounts for that day.
For a sample of items in the goods awaiting despatch file, agree to the despatch information
held
On the despatch department computer.
For a sample of items on the despatch department computer,
agree back to the goods awaiting despatch file
Ensuring details of product, quantity and customer agree.
agree to the inventory records confirming that the correct appliance record was updated.
check customer signature is on file agreeing receipt of goods.
For a sample of items on the despatch department computer, review to see that evidence of
delivery to

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Customer is available. Investigate records where no delivery information is available


obtaining reasons
For this.
Review the despatch department computer files for items not flagged order complete.
Investigate and
Obtain reasons for these items.
Reason for test
Ensure that order details are completely and accurately recorded by the website software.
Ensure that details recorded agree to those input.
To ensure that details from the website software are completely and accurately transferred
to the orders
Awaiting despatch file.
To confirm that amounts are received for each appliance sold, and therefore that monies
received
Are complete and accurate.
To confirm that the amount of sales is not understated or overstated in the ledger, general
Ledger or financial statements.
To ensure that reasons for orders not being processed are being obtained. A large number
of old
Items may also indicate problems with the credit card authorisation systems which again will
need to
Be investigated.
To check the numerical accuracy of the day book and the accuracy of posting to the general
ledger file.
To confirm that order details are completely and accurately transferred to the despatch
department.
To ensure that the despatch information is accurate and that the despatch record itself
relates to a valid
Sale.
Ensures that the inventory system correctly records the appliance ordered and that the
inventory system
Remains accurate.
To confirm that evidence is available for receipt of goods confirming that goods have been
delivered.
To ensure that goods have been received and that procedures for investigating nondespatch or receipt
Are working.
To ensure that the despatch process is working correctly and that incomplete items are
being
Investigated.
Question 5
A)
value for money can simply be described as getting the best possible combination of
services from the least resources i.e. To maximize the benefits available at the lowest cost. It
is generally taken to mean the pursuit of economy, efficiency and effectiveness.
Economy is a measure of inputs to achieve a certain service
Effectiveness is a measure of outputs e.g. Services and facilities
Efficiency is the optimum of economy and effectives i.e. The measure of outputs
over inputs
Vfm tries to answer the question why and for whom money is being used. Why money is
being used refers to the purpose or the reason to justify expenditure. For whom the money is
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being used responds to value received as measured by the utility or satisfaction enjoyed by
a specified user.
Financial data simply shows how much money is involved in a certain specified purpose, but
does not necessarily demonstrate the value received. To be able to demonstrate the extent
of value received, measures of performance must be put in place and somebody must be
entrusted with the management and supervision of the utility or satisfaction to be procured.
whereas
Value for money audits thus refers to the broad-based audit approach which aims at
reviewing and reporting on accountability and responsibility relationships by examining the
underlying activities, and operating and internal control systems employed by the
management in fulfilling its fiduciary responsibility to the user
Vfma is a process that is super-imposed of accountability and responsibility relationships. It
is carried out to establish whether the government has complied with parliamentary approval
of the budget, and that the audit report is supported by true and fair underlying information.
The audit exercise is done by a professional person who undertakes the responsibility of
reporting to the parliament on the governments execution of the budget to the interest of the
electorate.
B)
the objective of value for money audit is to establish whether management of an
entity has developed appropriate systems and procedures to achieve value for money, i.e.
The extent to which public funds are expended economically and efficiently and the extent to
which the related execution of the budget is effective in meeting publics satisfaction.
The scope of audit in a value for money audit means attesting both the financial and the nonfinancial information, including the actual performance. Any meaningful assessment of value
for money must consider both quantitative and qualitative aspects of the issue on hand. The
issues are examined critically when evaluating accountability (output) of the government and
the assessment of the levels of responsibility (input resources) made available to the
government
The goal is satisfaction or benefit enjoyed by the mandate. The amount of benefit enjoyed is
what is crucial in the determination of the scope of the audit, as the mandate must be
informed unilaterally whether the benefit so enjoyed is in accordance with the approved
resources.
The scope must therefore address the input in terms of financial, human, material, and
management; the methodology in terms of administration and governance, and the output in
terms of the quantity and quality of benefit to be enjoyed, including the intended user of the
benefaction. This makes value for money audit a comprehensive evaluation and assessment
of the use of resources and benefits within wide parameters of the audit, that is, there are no
limits as long as there is room to further improve the delivery of a satisfactory service. In
view of this, value for money audit requires use of relatively large resources of audit, and the
auditor has to posses a multitude of skills relevant to the audit.
The broader scope of value for money audit requires integration of various specialized skills,
from different professions or authorities. In fact, value for money audit was developed out of
a combination of a number of disciplines including accountants, engineers, economists,
statisticians, management specialists, edp specialists, lawyers, social scientists, etc.
Members of the audit team who are not trained accountants require initial exposure on the
use of audit tools such as audit programmes, gathering and documenting audit evidence,
conducting interviews, etc. On the other hand trained accountants and auditors are not
necessarily trained as value for money specialists. It therefore follows that in order to
undertake a comprehensive audit assignment, a careful team is to be selected for the area
of audit from the relevant specialized skills and groomed with the auditors, making the team
members benefit from each others perspective.
The formation of audit teams for value for money audit assignments is both challenging and
rewarding. Each team member is made to learn a new skill to the extent the job can be
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done, thus promoting knowledge, improving communication and enhancing credibility and
usefulness of the audit reports.
The auditing process is done in basically three phases: planning; execution; and reporting.
Planning the audit involves the determination of the scope of the audit, the timing, the
objectives, criteria, methodology, and resources to be deployed to ensure that all important
transactions and activities and operating systems are covered by the audit. Execution refers
to the collection, testing, and analysing appropriate audit evidence in terms of quality and
quantity based on the objectives of the audit, criteria, and methodology developed in the
planning phase. The audit will apply appropriate audit procedures for testing and evaluating
existing internal controls; identifying effects of variances from pre-determined benchmarks.
the use of criteria is crucial it enables the measurement of, or ability to judge, the degree to
which the client has conformed to expectations which were explicitly articulated and
sanctioned. A criteria is a reasonable standard against which management practices and
reporting systems are assessed. Standards can be derived or developed from relevant
sources including technical pronouncements of the relevant profession, government
regulations and directives, relevant literature available, knowledgeable people, and common
sense, that is what a reasonable person would expect of management under the given
circumstances. All parties to the audit should ideally accept the criteria or standard to be
used. However, the criteria or standard require regular revision with a view of changing it to
suit changing circumstances of the audit.
The study on value for money can be analyzed in three ways:
A study of the economy, efficiency and effectiveness with reference to inputs.
Inputs refer to the money or resources used in the production process. The input
resources can be a financial cost or non-financial.
A study of economy, efficiency, and effectiveness with reference to outputs.
Outputs refer to the achievements of the production process as measured by
assessment of objectives realized.
A study of impacts of the use of resources in effecting the planned change.
Impact means the effect of the output results on the achievement of the
objectives originally agreed.
C)

public sector

private sector

(a) it is virtually a statutory requirement to (a) it is not a statutory requirement to undertake


undertake value for money audit through
vfm audit.
the controller and auditor general
(b) a post-audit review exercise is taken
(b) no responsibility for post audit review by
to ensure
that changes have been made
the
auditor. Since vfm is done at the
to improve economy, efficiency, and
request of management the auditors
effectiveness in line with audit
responsibility is discharged through
recommendations made in the audit report. Submission of an acceptable report as
hence it is possible to assess not for profit agreed.
entity using vfm.
(c) profitability is not usually the objective, (c) in a profit oriented organization the
but to provide satisfaction on the use of
operating objectives are expressed
money
public good or facility.
Terms. The organization and the profit
centres within it can be judged to have
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(d) vfm audit can be viewed as an attempt


to establish control over waste,
unnecessary or excessive spending.

operated effectively if they have achieved


a target profit within a given period.

D)
the objective of value for money audit is to provide assurance that the financial,
human, and physical resources entrusted to the government by the parliament, and to
operating officers by the government are being managed in due regard to economy,
efficiency, and effectiveness. The following are the advantages of value for money audit:
For those who confer responsibility, a comprehensive review of the responsibility
conferred (i) improves the accountability process, and provides the means for
measuring the extent to which corrective action has been implemented;

For those to whom responsibility is delegated, broad systematic reviews of all


significant activities, systems, and controls provides information on their
adequacy and suitability. In addition, suggestion on improvement should promote
the management of the business, and by adopting loyalty to the audit
observations and recommendations, management initiates corrective action on
sub-standard processes, thus improving further the value of the service provided.

Cons:
Requires large number of resources
Not necessarily done annually
Requires multi skill approaches.
E)
audit is a process that is super-imposed of accountability and responsibility
relationships. It is carried out to establish whether the government has complied with
parliamentary approval of the budget, and that the audit report is supported by true and fair
underlying information. The audit exercise is done by a professional person who undertakes
the responsibility of reporting to the parliament on the governments execution of the budget
to the interest of the electorate.
Accountability refers to the obligation of the government to the parliament demonstrating
whether the responsibility conferred has been accomplished according to approved
guidelines with efficiency, economy, (and effectiveness). It is agreed that by accepting a
responsibility, accountability is owed for the actions taken and discharged. A report is to be
availed stating how the responsibility was discharged and to what extent the benefit or
output has been achieved. The output must clearly be understood, including its size or
magnitude required, with well-defined measurable performance indicators. The reporting
process may be regular or intermittent, depending on the directive from the authority.
Economy refers to the amount of resources needed to acquire highest output at lowest cost,
viz. Rising output at constant (or falling) inputs. Emphasis is the control of the input or cost
by keeping it to minimum levels at given levels of output taken as a whole. Hence the auditor
is concerned about the quantity of input. Thus the input is clearly defined.
Efficiency, the auditor is concerned with the quality of output or rising output for a given one
unit of input. Hence the tools of measurement are comparison of the relationships of goods
or services produced with the amount of resources used to produce them. An efficient
operation is one which produces the highest output or return at minimum cost, lesser
resources, or at one unit of input. The input can be defined in terms of financial, material or
time resources, while the output is normally defined in terms of quality or size. The output,
the input, and the methodology or approach are clearly defined.
Effectiveness refers to the achievement of the goals and objectives of the certain operation
or activity. Proponents of effectiveness often ignore the magnitude, size, or quality of input
used to realize the intended objectives. Emphasis is goal realization, at the expense of input.
Hence, too much effort is contemplated with prolonged endurance, as the benefit is not
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enjoyed until the goal is accomplished. The output is clearly defined but the input is often
ambiguous.
F)
the audit-planning phase consists of two stages: the overview stage, and the survey
stage.
The overview stage:
A small overview audit team consisting of in most cases of the principal (the leader
of the value for money audit team) and one or two other senior staff is formed to
gather the information necessary to gain a basic understanding of the entity and to
plan the survey. At this point the principal meet with senior management of the audit
entity in order to inform them of the audit and discuss the general audit approach,
timing, co-ordinating mechanisms, and any other relevant matters. The key to
planning a value for money audit is understanding the audited organization and the
environment in which it operates.
The audit team must gain an understanding of what the entity does and by what
authority it operates, its goals, products and its financial and other resources. At this
stage, the auditor may review matters such as:
Pertinent legislation, internal regulations and publications and orientation materials,
The relevant external financial legislative or administrative regulations or directives from
relevant authorities,
Any internal or external guidelines managers must follow in their day to day operations,
The progress made by management on remedial action proposed in previous audit and
other reports,
Minutes of meetings of various committees,
The organization structure and objectives of the audited entity,
The appropriate personnel to contact within the audited entity.
Based on the information collected in the overview stage, the principal prepares a
preliminary analysis to:
Identify lines of audit inquiry i.e. The broad areas to be examined in order to gain an
improved understanding of the entity,
Identify sources of audit criteria for the areas to be examined during the survey stage,
and
Outline survey projects and prepare a plan for the conduct of the survey. This plan
enables a review to be made of the proposed lines of audit inquiry in terms of relevance,
significance and completeness, and enable judgment to be made as to whether or not
the survey will be conducted in a suitable manner. The survey plan also serves as the
basis for allocating staff of the appropriate skills, and for preparation of the survey time
budget.
The survey stage:
The purpose of the survey stage is to explore, in an efficient manner, potentially
significant lines of audit inquiry identified during the overview stage and expand on
the initial knowledge and understanding of accountability relationships and key
management activities, systems and controls. The major sources of information for
conducting the survey include the following:
Internal and published communications of the audited organization;
Interviews with managers of the audited organization;
Documented standards, policies and procedures applicable to key systems and controls;
Sources for audit criteria identified in the overview stage;
Studies conducted by internal or external evaluation groups; and
Observations for the working environment.
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During the survey stage, the auditor should ensure that appropriate audit criteria are
identified and discussed with members of the audited organization. The audit criteria should
posses the following characteristics:
Provide useful benchmarks for assessing management of financial, human and physical
resources, and for determining whether value-for-money is being achieved;
Provide a means for managers to develop or compare their own management
procedures; and
Constitute a basis for senior managers to evaluate their systems and procedures.
The criteria used in audits should be few in number and expressed in non-technical terms to
facilitate communication. Their application should be made with consideration for the
environment in which the entity operates. Having specified audit criteria for assessment of
key management activities, systems and controls, the auditor collects evidence in order to
make a preliminary assessment of their adequacy. The auditor is primarily concerned with
controls to ensure that:
Prescribed standards, policies and practices are adhered to;
Needs of users are met;
Operations are carried out economically and efficiently; and
Reporting is appropriate, accurate, complete and timely.
The preliminary assessment of each control should cover:
Those controls that are well designed and appear to function properly;
Those controls that are either not properly designed or appear not to function properly,
and
Those controls that are desirable but are non-existent.
The auditors preliminary assessment is the basis for:
Determining what matters appear to be significant and may be of a nature that should be
reported; and
Determining the nature extent and timing of further auditing procedures to substantiate
the underlying hypothesis for each matter of potential significance.
The final step in the survey stage is the preparation of the survey report which includes an
outline audit plan. The purpose of the audit plan is to define the overall audit scope in terms
of audit objectives and projects to address those matters that may require attention, to
identify resource requirements, including special skills needed, and to establish overall audit
and project time budgets, milestones or control points and deadlines.
G)
the execution phase consists of conducting tests, evaluating controls and collecting
sufficient and reliable evidence to conclude whether or not the matters identified in the
planning phase as having potential significance are indeed, of significance for reporting
purposes. The conclusions to be drawn relate to an assessment of the results of any
substantive testing of performance, accuracy of information, reliability of the key systems
and controls and the quality of results produced. The execution phase of the audit involves
the following steps:
Preparing a detailed audit plan:
The first step in the execution phase is the preparation of a detailed audit plan. The
plan outlines, by project, the assignments to be undertaken for each audit objective as
approved in the outline audit plan. Each project is planned to conduct tests and gather
audit evidence to accomplish specific audit objectives.

Selecting or preparing detailed audit programs:

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An audit program specifies the steps to be performed during the fieldwork portion of an
audit to determine whether the audit criteria are being met. In preparing and using
audit programs, the principal and the project leaders should always relate the cost of
collecting evidence to its value in helping to achieve the audit objectives under
examination.
Conducting tests and evaluating controls:
The purpose of testing is to gather appropriate audit evidence on the effective or
ineffective functioning of key activities, systems and controls identified in the survey
stage. This type of testing gives the auditor the necessary assurance as to the degree
of compliance with specified audit criteria.
Considering causes and effects:
An important aspect of value for money auditing is the consideration of causes and
effects, i.e. The reasons for and the significance of non-adherence to audit criteria.
However, it is recognized that a precise determination of cause and effect is seldom
feasible since these terms are relative, and the project leaders to ensure that the
evidence supporting the findings and results of the causes and effects analyses are
discussed with appropriate levels of management in the audited organization. The
viewpoint of management must be given due consideration before the reporting phase
of the audit begins.

Developing audit findings, conclusions and recommendations:


After collecting sufficient evidence, project leaders start to draft point form reports on
their projects when most of the fieldwork has been completed. The point form report
indicates the content, the structure of the analysis developed and the findings and
conclusions substantiated in the audit working papers. The formulation of
recommendations involves consideration of the following:
The state of the art;
The circumstances that influence the cause(s); i.e. Factors that restrict adherence to
criteria as well as factors that promote adherence;
Alternative courses for remedial action;
Effects on part, or on the entire entity, both positive and negative, which may arise if the
auditors recommendations are implemented;
The feasibility of implementing the course of action suggested; and
The plausibility and cost-effectiveness.
h)

The key issues are: lack of multi skill personnel in cag office; compromise of
economy for quality; difficulties of measuring effectiveness in public sector.
Other issues:
It is often difficult to assess effectiveness because of the problems of valuing
outputs on a comparable basis. For example, the outputs of a fire brigade can be
measured by the number of call outs to attend a blaze. Do we value it basing on
the amount of losses as a result of the fire or based on other basis?
The objectives of not for profit organizations are also difficult to establish
Because the quality of the service provided will be a significant feature of their service.
For example, a local authority has among its different objectives, to collect all the
waste out of the streets. The effectiveness of this service can only be judged by
establishing what standard or quality of service is required.
Economy can be achieved by sacrificing quality and neither outputs nor impacts
are necessarily measured in terms of quality.
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Effectiveness might be difficult to define, measure or may even conflict. For


example, the effectiveness of the health service can be said to have improved if
hospitals have a greater success in treating various illness and other conditions or
if the life expectancy of the population has increased. But this is hardly the case in
tanzania especially.
There can be emphasis for vfm audits and cost control rather than insisting on
achieving more future benefits and value. For example, client management may be
pressurized into short-term decisions to keep current spending levels within limits
and abandon a capital expenditure plan which could create future benefits.
In profit making organizations efficiency of the organization as a whole can be
measured in terms of return on capital employed or by relating the quality of output
produced which has a market value and therefore a quantifiable financial value of
the resources and their cost required to make the output. On the other hand, not
for profit organizations the output does not have a market value, and it is therefore
more difficult to measure efficiency. In addition, it is difficult to compare the output
of one not for profit organization against another one due to lack of a unified goal
such as profit.
The auditor must understand clearly the operations of the client he/she is investigating. With
shortage of auditors with the necessary skills, qualifications, and competence and, with the
meager audit resources available, vfm audit may fail to achieve the desired objectives.
Question 6
Refer to the handout
Question 7
Fraud versus error
misstatements in the financial statements can arise from fraud or error. The distinguishing
factor between fraud and error is whether the underlying action that results in the
misstatement is intentional or unintentional.
fraud may involve forgery (or other sophisticated and carefully organized schemes
designed to conceal), deliberate
Failure to record transactions, or intentional misrepresentations being made to the auditor.
Detection of fraud and error
the auditor is responsible for assessing the risk of misstatement in a financial statement
audit whether due to fraud or error. However, the auditors responsibility for detecting fraud
is different due to the characteristics of fraud.
the risk of not detecting a material misstatement arising from fraud is higher than that from
error because of the deceit involved in fraud. Attempts at concealment are even more
difficult to detect when accompanied by collusion (which may cause the auditor to believe
that audit evidence is persuasive when it is, in fact, false).
the auditors ability to detect a fraud depends on many factors (e.g. The frequency/extent
of manipulation, degree of collusion, relative size of amounts manipulated, seniority of
individuals involved). While the auditor may be able to identify potential opportunities for
fraud, it may be impossible for the auditor to determine intent, particularly in matters
involving management judgment (e.g. Accounting estimates).
audit procedures that are effective for detecting error may be ineffective for detecting
fraud.
Reporting of fraud and error
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to shareholders the auditor has the same responsibility under isa 700 the auditors
report on financial statements for fraud as for error. For example, if the auditor is aware of a
limitation of scope or disagrees with an accounting treatment the audit opinion will be
qualified (assuming the matter to be material). However, if a matter is not material, it cannot
be reported.
to management and those charged with corporate governance the auditor should report
a matter which identifies or indicates fraud as soon as practicable to the appropriate level of
management. This is even if the matter appears inconsequential (e.g. A minor defalcation by
an employee). However, the auditor would not report such inconsequential errors.
to regulatory and enforcement authorities ordinarily, reporting to third parties on both
fraud and error is precluded by the auditors professional duty of confidentiality. However,
the auditor may have a duty to report the occurrence of fraud in some countries.
(b) professional skepticism
professional skepticism recognizes the possibility that circumstances may exist that cause
the financial statements to be materially misstated.
it is an aspect of rigor that information and explanations obtained are assessed and
additional evidence sought as necessary.
due to the characteristics of fraud, the auditors attitude of professional skepticism is
particularly important when considering the risk of material misstatement. Professional
skepticism is an attitude that includes a questioning mind and a critical assessment of audit
evidence.
the auditor must be prepared to consider that a material misstatement due to fraud could
exist, notwithstanding theauditors past experience with the entity and the auditors belief
about the honesty and integrity of management and those charged with governance of the
entity.
when making inquiries and obtaining other audit evidence, the auditor exercises
professional skepticism so as not to be satisfied with less-than-persuasive audit evidence
based on a belief that management and those charged with governance are honest and
have integrity.
an audit of financial statements rarely involves the authentication of documentation, nor is
the auditor trained as (or expected to be) an expert in such authentication. However, the
auditor considers the reliability of the information to be used as audit evidence including
consideration of controls over its preparation and maintenance where relevant. Unless the
audit reveals audit evidence to the contrary, the auditor ordinarily accepts records and
documents as being genuine.
(c) earnings management difficulties for the auditor
earnings management aims to deceive users of financial statements by influencing their
perceptions about the entitys performance and profitability. At its extremes, it constitutes
fraudulent financial reporting. There are four broad categories:
intentional breach of financial reporting requirements which are, in isolation, immaterial;
unsuitable revenue recognition;
big bath provisions/reserve accounting;
improper accruals/estimation of liabilities.
overly conservative reporting (e.g. Creating reserves in good times for release on rainy
days) and aggressively optimistic outcomes both hold consequences for the quality of
financial reporting.
earnings management may be relatively innocuous (a tendency) and within gaap, or so
aggressive as to constitute fraud (i.e. In violation of gaap). One difficulty for the auditor is
establishing the boundary between acceptable and unacceptable earnings management
and an intention to commit fraud. This is a matter for judgment and requires an attitude of
professional skepticism.

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earnings management may start out with small biased judgments in financial reporting
and/or structuring transactions.
If amounts are individually immaterial standard audit procedures may not detect them.
making use of flexibility in accounting estimates is often the beginning of aggressive
earnings management. Such flexibility may develop creative choices. Accounting standards
need to be rigorous and not so imprecise that it is impossible for an auditor to obtain
sufficient, appropriate audit evidence to confirm the amounts derived under them.
pressures and incentives may lead these actions to increase to the extent that they are not
acceptable under the applicable financial reporting framework. Controls that otherwise may
appear to be operating effectively may be overridden by management. In such a case it is
likely that management representations cannot be relied on.
opportunities for earnings management arise, in particular, where there is no accounting
standard covering a particular accounting issue. As many techniques of earnings
management involve accruals the auditor must be alert to the level of accruals appropriate to
the industry and client and the appropriate recognition of liabilities.
Questiion 8
(a) risks and implications for audit risk
Inherent and control risks
(i) charities can be viewed as inherently risky because they are often managed by nonprofessionals and are susceptible
To fraud, although many charities and the volunteers that run them are people of the highest
integrity who take a great
Deal of care over their work. The assessment of this aspect of inherent risk depends on
each individual charity and the
Areas in which it operates.
(ii) charities are also at risk of being in violation of their constitutions which is important
where funds are raised from public
Or private donors who may well object strongly if funds are not applied in the manner
expected. Other charities and
Regulatory bodies supervising charities may also object. Again, the auditors will assess the
level of risk. The involvement
Of a recently retired certified public accountant in the preparation of accounts in the past
may lower the auditors
Assessed inherent risk to an extent.
(iii) most small charities have a high level of control risk because formal internal controls are
expensive and are not often in
Place. This means that donations are susceptible to misappropriation. Charities rely on the
trustworthiness of volunteers.
The auditors will assess the level of risk.
Detection risk
(iv) detection risk comprises sampling risk and non-sampling risk. It is possible in this case
that all transactions will be
Tested and therefore sampling risk (the risk that samples are unrepresentative of the
populations from which they are
Drawn) is not present.
(v) non-sampling risk is the risk that auditors will draw incorrect conclusions because, for
example, mistakes are made, or
Errors of judgement are made in interpreting results, or because the auditors are unfamiliar
with the client, as is the case
Here.
Audit risk
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(vi) audit risk is the product of inherent risk, control risk and detection risk and is the risk that
the auditors will issue an
Inappropriate audit opinion. This risk can be managed by decreasing detection risk by
altering the nature, timing and
Extent of audit procedures applied. Where inherent risk is high and controls are weak (as
may be the case here) more
Audit work will be performed in appropriate areas in order to reduce audit risk to an
acceptable level.
(b) audit tests fund raising events
(i) attend fund raising events and observe the procedures employed in collecting, counting,
banking and recording the cash.
This will help provide audit evidence that funds have not been misappropriated and that all
income from such events
Has been recorded. Sealed boxes or tins that are opened in the presence of two volunteers
are often used for these
Purposes.
(ii) perform cash counts at the events to provide evidence that cash has been counted
correctly and that there is no collusion
Between volunteers to misappropriate funds.
(iii) examine bank paying in slips, bank statements and bank reconciliations and ensure that
these agree with records made
At events. This also provides evidence as to the completeness of income.
(iv) examine the records of expenditure for fund raising events (hire of equipment,
entertainers, purchase of refreshments.
Etc.) And ensure that these have been properly authorised (where appropriate) and that
receipts have been obtained for
All expenditure. This provides evidence as to the completeness and accuracy of
expenditure.
(v) review the income and expenditure of fund raising events against any budgets that have
been prepared and investigate
Any significant discrepancies.
(vi) ensure that all necessary licences (such as public entertainment licences) have been
obtained by the trustees for such
Events in order to ensure that no action is likely to be taken against the charity or volunteers.
(vii) obtain representations from the trustees to the effect that there are no outstanding
unrecorded liabilities for such events
again for completeness of expenditure and liabilities.
Question 9
Please refer to hand out on specialized entities (audit of banks and financial institutions)

Weekend class examination paper


May, 2006 session
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic of an answer to every question
Question 1
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You are a training manager in mayrick associates, a firm of certified public accountants. The
firm has suffered a
Reduction in fee income due to increasing restrictions on the provision of non-audit services
to audit clients. The
Following proposals for obtaining professional work are to be discussed at a forthcoming inhouse seminar:
(a) cold calling (i.e. Approaching directly to seek new business) the chief executive officers
of local businesses and
Offering them free second opinions. (5 marks)
(b) placing an advertisement in a national accountancy magazine that includes the following:
if you have an asset on which a large chargeable gain is expected to arise when you
dispose of it, you
should be interested in the best tax planning advice. However your
gains might arise, there are techniques
you can apply. Hawk associates can ensure
that you consider all the alternative fact presentations so that
you minimize the amount
of tax you might have to pay. No tax saving no fee! (6 marks)
(c) displaying business cards alongside those of local tradesmen and service providers in
supermarkets and libraries.
The cards would read:
hawk acca associates
For professional accountancy, audit,
Business consultancy and taxation services
Competitive rates. Money back guarantees.
Required:
Comment on the suitability of each of the above proposals in terms of the ethical and other
professional issues that they raise.
Question 2
(a) computer-assisted audit techniques (caats) are used to assist an auditor in the collection
of audit evidence
from computerized systems.
Required:
List and briefly explain four advantages of caats.
(b) almenda, a limited liability company, is a reseller of sports equipment, specializing in
racquet sports such as
Tennis, squash and badminton. The company purchases equipment from a variety of
different suppliers and then
Resells this using the internet as the only selling media. The company has over 150 different
types of racquets
Available in inventory, each identified via a unique product code.
Customers place their orders directly on the internet site. Most orders are for one or two
racquets only. The
Ordering/sales software automatically verifies the order details, customer address and credit
card information prior
To orders being verified and goods being dispatched. The integrity of the ordering system is
checked regularly by
Raha.com, an independent internet service company.
You are the audit manager working for the external auditors of almenda, and you have just
started planning the
Audit of the sales system of the company. You have decided to use test data to check the
input of details into the
Sales system. This will involve entering dummy orders into the almenda system from an
online terminal.
Required:
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List the test data you will use in your audit of the financial statements of almenda to confirm
the completeness and accuracy of input into the sales system, clearly explaining the reason
for each item of data. (6 marks)
(c) you are also considering using audit software as part of your substantive testing of the
data files in the sales and
Inventory systems of almenda.
(i) list and briefly explain some of the difficulties of using audit software; (4 marks)
(ii) list the audit tests that you can program into your audit software for the sales and
inventory system in
almenda, explaining the reason for each test. (6 marks)
Question 3
(a) explain the purpose of a management representation letter. (5 marks)
(b) you are the manager in charge of the audit of dt-doubie, a public limited liability company
which
Manufactures specialist cars and other motor vehicles for use in films. Audited turnover is
tzs140,000, million with
Profit before tax of tzs 7500 million.
All audit work up to, but not including, the obtaining of management representations has
been completed. A
Review of the audit file has disclosed the following outstanding points:
Bakhresa
The company is facing a potential legal claim from the bakhresa company in respect of a
defective vehicle that
Was supplied for one of their films. Bakhresa maintains that the vehicle was not built strongly
enough while
The directors of dt-doubie argue that the specification was not sufficiently detailed. Dropping
a vehicle
50 metres into a river and expecting it to continue to remain in working condition would be
unusual, but this is
What bakhresa expected. Solicitors are unable to determine liability at the present time. A
claim for tzs 4,000 million being the cost of a replacement vehicle and lost production time
has been received by dt-doubie from bakhresa. The directors opinion is that the claim is not
justified.
Depreciation
Depreciation of specialist production equipment has been included in the financial
statements at the amount of
10% pa based on reducing balance. However the treatment is consistent with prior
accounting periods (which
Received an unmodified auditors report) and other companies in the same industry and
sales of old equipment
Show negligible profit or loss on sale. The audit senior, who is new to the audit, feels that
depreciation is being
Undercharged in the financial statements.
Required:
For each of the above matters:
(i) discuss whether or not a paragraph is required in the representation letter; and
(ii) if appropriate, draft the paragraph for inclusion in the representation letter. (10 marks)
(c) a suggested format for the letter of representation has been sent by the auditors to the
directors of dt-doubie
The directors have stated that they will not sign the letter of representation this year on the
grounds that they
Believe the additional evidence that it provides is not required by the auditor.
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Required:
Discuss the actions the auditor may take as a result of the decision made by the directors
not to sign the
Letter of representation. (5 marks)
Question 4
Isa 600 using the work of another auditor establishes standards and provides guidance
when an auditor, reporting on the financial statements of an entity, uses the work of another
auditor on the financial information of one or more components included in the financial
statements of that entity.
Required:
Comment on the extent to which isa 600 provides guidance on the following issues in the
context of a group audit:
(a) co-operation between auditors;
(b) multi-location audits;
(c) business empires;
(d) joint audits; and
(e) division of responsibility.
Question 5
The purpose of an external audit and its role are not well understood. You have been asked
to write some material for inclusion in your firms training materials dealing with these issues
in the audit of large companies.
Required:
(a) draft explanation dealing with the purpose of an external audit and its role in the audit of
large companies, for inclusion in your firms training materials. (10 marks)
(b) the external audit process for the audit of large entities generally involves two or more
recognisable stages. One
Stage involves understanding the business and risk assessment, determining the response
to assessed risk,
Testing of controls and a limited amount of substantive procedures. This stage is sometimes
known as the interim
Audit. Another stage involves further tests of controls and substantive procedures and audit
finalisation
Procedures. This stage is sometimes known as the final audit.
Describe and explain the main audit procedures and processes that take place during the
interim and final
Audit of a large entity.
(c) nbaa has recently issue guidance on outsourcing of internal auditing. What do you
understand by outsourcing of internal auditing? Enumerate any five guidance given by nbaa
on the matter.
Question 6
Mewata a charity whose constitution requires that it raises funds for educational projects.
These projects seek to educate children and support teachers in certain countries. Charities
in the country from which mewata operates have recently become subject to new audit and
accounting regulations. Charity income consists of cash collections at fund raising events,
telephone appeals, and bequests (money left to the charity by deceased persons). The
charity is small and the trustees do not consider that the charity can afford to employ a
qualified accountant. The charity employs a part-time bookkeeper and relies on volunteers
for fund raising. Your firm has been appointed as accountants and auditors to this charity
because of the new regulations. Accounts have been prepared (but not audited) in the past
by a volunteer who is a recently retired certified public accountant.
Required:
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(a) describe the risks associated with the audit of mewata under the headings inherent risk,
control risk and
detection risk and explain the implications of these risks for overall audit risk. (10 marks)
(b) list and explain the audit tests to be performed on income and expenditure from fund
raising events.
Weekend class examination paper solutions
Question 1
(a) cold calling
Tutorial note: recognising that there are three issues to address (i.e. cold calling, free and
second opinions) is likely to
Earn more marks than focusing on just one.
until relatively recently cold calling has been largely prohibited throughout the profession
(and still is in some countries E.g. Hong kong). Therefore the direct approach may not be
suitable.
where cold-calling restrictions have been relaxed it may still only be permitted for existing
business clients (i.e. To offer
Them additional services), the direct approach to non-business clients being prohibited. This
inhibits competition.
although the practice may be viewed as a bit grubby and commercial it is now generally
regarded as an accepted
Modern business practice. Along with other professional bodies.
whilst mayrick is permitted to cold call, the fundamental ethical principles must be
adhered to. Whilst solicitation which
Is decent, honest and truthful may be acceptable, cold calling which amounts to harassment
is not.
offering a service for free is not prohibited provided that the client is not misled about
future levels of fees.
there are strict ethical rules regarding second opinions (on accounting treatments).
Practitioners are advised not to
Provide second opinions, when requested, without following a procedure of contacting the
incumbent
Auditor/accountant. Therefore to be offering second opinions clearly goes against ethical
guidelines as the practice is
To be discouraged.
(b) tax planning
advertising is generally allowed subject to the observance of the fundamental principles of
ethical codes (e.g. Ifacs
code of ethics for professional accountants
although direct advertising (i.e. On television, radio, cinema) is prohibited in many
jurisdictions (e.g. Hong kong), an
Advertisement in a national accountancy magazine is generally permitted.
where advertising is permitted, the minimum requirements are that it be decent, honest,
truthful and in good taste.
These criteria may not be met in this proposal as:
expectations of favourable results (lower tax liabilities) may be unjustifiable (or created
deceptively);
techniques you can apply may imply an ability to influence taxation authorities;
the best is likely to be a self-laudatory statement and not based on verifiable facts;
the best may also be making an unjustifiable comparison with other professional
accountants in public practice;
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the best tax planning advice may be an unjustifiable claim of expertise or specialism in
the field of tax.
can ensure and the assertion of all may not be supportable claims, therefore the
advertisement is not honest in
These respects.
there is a fine line between tax avoidance and tax evasion and techniques you can apply
and alternative fact
Presentations may lean toward the latter and so not be in keeping with the integrity of the
profession.
the assertion of being able to minimise the amount of tax may expose mayrick associates
to litigation. The engagement
Risk associated with taking on this work would be high and so should carry commensurately
high fees.
the no tax saving no fee offer does not compensate for the risk associated with
undertaking the work advertised.
contingency fees, whereby no fee will be charged unless a specific result is obtained, are
prohibited by ifac (unless
Otherwise permitted by statute of member body).
(c) business cards
business cards may be considered a form of stationery and should be of an acceptable
professional standard and comply
With legal and member body requirements concerning names of partners, principals,
professional descriptions,
Designatory letters, etc.
whilst placing such an advertisement where a target audience might reasonably be
expected to exist (e.g. In an institute
Of directors or business mens club), displaying it alongside local tradesmen may appear to
belittle the status of
Professional accountants.
an advertisement the size of a business card would be sufficient to provide a name and
contact details and in this respect
Is suitable. However, the danger of giving a misleading impression is pronounced when
there is such limited space for
Information.
however, the tone of the advertisement may discredit the nbaa name. It is also unsuitable
that it seeks to take unfair
Advantage of the nbaa name. Although the nbaa mark can be used by mayrick associates
on letterheads and stationery
(for example) it cannot be used in any way which confuses it with the firm.
the emphasis on professional may be unsuitable as it could suggest that there are other
than professional accounting,
Audit (etc) services to be had.
offering a range of non-audit services in the same sentence as audit may mislead
interested persons picking up the
Card into thinking that mayrick can provide them together. This conflicts with the fact that
mayrick is restricted in providing
Non-audit services to audit clients.
there is no basis for asserting competitive rates.
it is unlikely that any professional would offer money back. In the event of dispute (e.g.
Over fees), the matter would
Be taken to arbitration (with their member body) if a satisfactory arrangement could not be
reached with the client.

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a tradesman may guarantee the quality of his work and that it can be made good in the
event that the customer is
Not satisfied. However, an auditor cannot guarantee a particular outcome for the work
undertaken (e.g. Reported profit
Or tax payable). Most certainly an auditor cannot guarantee the truth and fairness of the
financial statements in giving
An audit opinion.
Question 2
(a) the advantages of computer-assisted audit techniques (caats) are that they:
enable the auditor to test program controls if caats were not used then those controls
would not be testable.
enable the auditor to test a greater number of items quickly and accurately. This will also
increase the overall confidence
for the audit opinion.
allow the auditor to test the actual accounting system and records rather than printouts
which are only a copy of those
Records and could be incorrect.
are cost effective after they have been setup as long as the company does not change its
systems.
allow the results from using caats to be compared with traditional testing if the two
sources of evidence agree then
This will increase overall audit confidence.
(b) test data reason for test
Input of an order for a negative number of ensures that only positive quantities are accepted

Tennis racquets although the company cannot dispatch negative quantities anyway.
Input of an order for ten tennis racquets there are reasonableness checks in the system to
identify possible input errors. A warning message should appear on screen asking the
customer to confirm any order for more than say two racquets.
Input of an order without payment details ensures that orders are paid for prior to despatch
being completed this also limits the number of bad debts.
Input of invalid inventory code ensures that the computer detects the invalid code and
presents an error message rather than taking the nearest code and accepting that.
Input of invalid customer credit card details online checking of credit card details to the credit
Card company ensures that goods cannot be despatched without payment.
This will also limit the number of bad debts.
Input of invalid address ensures that the address and valid zip code is valid, possibly by
accessing a database of valid codes. If the code is not valid an error message should be
displayed.
This ensures that goods are only despatched to valid addresses.
(c) audit software
(i) difficulties of using audit software
substantial setup costs because the clients procedures and files must be understood in
detail before the audit
Software can be used to access and interrogate those files.
audit software may not be available for the specific systems setup by the client, especially
if those systems are
Bespoke. The cost of writing audit software to test those systems may be difficult to justify
against the possible
Benefits on the audit.
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the software may produce too much output either due to poor design of the software or
using inappropriate
Parameters on a test. The auditor may waste considerable time checking what appear to be
transactions with errors
In them when the fault is actually in the audit software.
checking the clients files in a live situation. There is the danger that the clients systems
are disrupted by the audit
Program. The data files can be used offline, but this will mean ensuring that the files are true
copies of the live
Files.
(ii) audit tests
Audit software reason for test
Calculation check of the sales day book ensures that the computerised sales day book has
been cast correctly and helps to verify the sales balance in the financial statements.
Analysis of the aging of items in the help to detect inventory items which are relatively old
inventory ledger which may need valuing at net realisable value rather than cost.
Selecting a sample of inventory at the end removes bias from sample selection as well as
being of the year as part of the physical verification quicker than selecting the items
manually.
Selecting a sample of sales invoices for removes bias from sample selection as well as
being checking to despatch documentation quicker than selecting the items manually.
Checking completeness of sales invoice ensures that all sales invoices are recorded in the
sales numbers day book.
Check that all sales invoices have been all sales are paid for on ordering, unpaid sales
would be paid for a violation of systems rules and would need to be investigated by the
auditor.
List large credit notes (perhaps more than the auditor will find reasons for the return this is
also a five racquets) for investigation by the auditor check on the accuracy of the ordering
system orderingerrors may result in customers returning goods later.
Question 3
(a) management representations are a form of audit evidence. They are contained in a letter,
written by the companys directors
And sent to the auditor, just prior to the completion of audit work and before the audit report
is signed.
Representations are required for two reasons:
Firstly, so the directors can acknowledge their collective responsibility for the preparation of
the financial statements and to
Confirm that they have approved those statements.
Secondly, to confirm any matters, which are material to the financial statements where
representations are crucial to obtaining Sufficient and appropriate audit evidence.
In the latter situation, other forms of audit evidence are normally unavailable because
knowledge of the facts is confined to Management and the matter is one of judgement or
opinion.
Obtaining representations does not mean that other evidence does not have to be obtained.
Audit evidence will still be Collected and the representation will support that evidence. Any
contradiction between sources of evidence should, as always, Be investigated.
(b) bakhresa
The amount of the claim is material being 50% of profit before taxation.
There is also a lack of definitive supporting evidence for the claim. The two main pieces of
evidence available are the claim

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From bakhresa itself and the legal advice from dt-doubie solicitors. However, any claim
amount cannot be accurately
Determined because the dispute has not been settled.
The directors have stated that they believe the claim not to be justified, which is one possible
outcome of the dispute.
However, in order to obtain sufficient evidence to show how the treatment of the potential
claim was decided for the financial
Statements, the auditor must obtain this opinion in writing. Reference must therefore be
made to the claim in the
Representation letter.
Paragraph for inclusion in representation letter.
a legal claim against dt-doubie by bakhresa has been estimated at 4,000 million by lions
roar. However, the directors
Are of the opinion that the claim is not justified on the grounds of breach of product
specification. No provision has been
Made in the financial statements, although disclosure of the situation is adequate. No similar
claims have been received or
Are expected to be received.
Depreciation
This matter is unlikely to be included in the letter of representation because the auditor
appears to have obtained sufficient Evidence to confirm the accounting treatment. The lack
of profit or loss on sale confirms that the depreciation charge is Appropriate large profits
would indicate over-depreciation and large losses, under-depreciation. The amount also
meets
Industry standards confirming that dt- doubie accounting policy is acceptable. Including the
point in the representation Letter is inappropriate because the matter is not crucial and does
not appear to be based on judgment or opinion. The only
Opinion here appears to be that of the auditor unless the feelings can be turned into some
appropriate audit evidence, the
Matter should be closed.
(c) lack of representation letter
The auditor may take the following actions:
Discuss the situation with the directors to try and resolve the issue that the directors have
raised. The auditor will need to
Explain the need for the representation letter again (and note that the signing of the letter
was mentioned in the engagement
Letter).
Ascertain exact reasons why the directors will not sign the letter. Consider whether
amendments can be made to the letter
To incorporate the directors concerns that will still provide the auditor with appropriate and
sufficient audit evidence.
The discussion must clearly explain the fact that if the auditor does not receive sufficient and
appropriate audit evidence, then
The audit report will have to be modified.
The reason for the audit qualification will be uncertainty regarding the amounts and
disclosures in the financial statements.
An except for qualification for the material uncertainty is likely, although a disclaimer may
be required, especially if the legal
Claim is thought to require a provision.
Even if the letter is subsequently signed, the auditor must still evaluate the reliability of the
evidence. If, in the auditors

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Opinion, the letter no longer provides sufficient or reliable evidence, then a qualification may
still be required.
Question 4
Group audit issues
Tutorial note: the answer which follows is indicative of the range of points which might be
made. Other relevant material will
Be given suitable credit.
(a) co-operation between auditors
isa 600 requires that other auditors, knowing the context in which the principal auditor will
use their work, should
Co-operate with the principal auditor.
however, this may be frustrated by legal and professional considerations. For example:
legal: when the component is not controlled by the parent (e.g. An associated company)
the other auditor cannot
Communicate with the principal auditors if the components management withholds their
permission;
professional: other auditors complying with national requirements may not be bound by the
ifac code of ethics
For professional accountants and isas (and/or the requirements of the country of the
parent).
it has been proposed that isa 600 (revised) will require that other auditors be instructed to
carry out their work in
Accordance with isas (as well as any national requirements applicable to the group financial
statements).
as isas are to be required for all eu statutory audits from 2005, co-operation between
auditors within the eu will be
Better facilitated. (similarly, wherever else iaasb pronouncements are promulgated.)
(b) multi-location audits
isa 600 applies when the financial information of a component is included in the financial
statements audited by the
Principal auditor. Components, including subsidiaries, associated companies, branches, etc,
could be in the same
Location as the parent or in multiple locations.
current guidance mostly relates to:
the group auditors relationship with other auditors;
co-operation between group and other auditors;
access to information; and
reporting responsibilities.
there is a lack of guidance on the application of other standards to group situations. So, for
example, although isa 3
Is understanding the entity and its environment and assessing the risks of material
misstatement identifies multiple
Locations as an issue which may give rise to a risk of materijal misstatement, it provides no
detail of the specific risks
Arising in a group audit.
(c) business empires
the risks associated with business empires (including horizontal groups and economic
dependency) have been
Significant contributors to major business failures (e.g. Enron and parmalat).
the concept of business empires is now recognised as a related party issue.
Tutorial note: interpretation sic12 consolidation special purpose entities (spes) provides
guidance for financial
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Reporting purposes on when an spe requires consolidation.


since there is none provided by isa 600 more auditing guidance is needed on the specific
risks associated with spes
And other related party issues (e.g. Economic dependency) and the audit procedures to be
undertaken to obtain sufficient
Evidence about their impact on the parents financial statements.
(d) joint audits
the isa does not deal with situations where two or more auditors are appointed as joint
auditors.
joint audits are more costly as there is replication of audit work because the auditors are
jointly and severally responsible
For the auditors report (which they both sign).
joint audits are therefore uncommon in many countries (france being a notable exception).
however, there have been calls for more joint auditing in the wake of enron and the
reduction in the number of global
Accountancy firms. If this is to be a practical solution to some of the problems of auditor
independence and audit quality
The cost, to the client, must not be prohibitive. This will require a new auditing standard.
(e) division of responsibility
under isa 600, the principal auditor has responsibility for reporting on the financial
statements of an entity
Notwithstanding that they include the financial information of components audited by others.
in many jurisdictions principal auditors have sole responsibility for their audit opinion and
any reference to other auditors
In their report is considered inappropriate.
whilst it is desirable that the auditors report should not be misunderstood (e.g. Reference
to other auditors may be
Interpreted as a qualification or division of responsibility) isa 600 permits a division of
responsibility when that accords
With local regulations.
as isas are more widely adopted separate guidance is needed for sole responsibility (as in
the uk) and a division where
National regulation permits reference to other auditors in the auditors report on the group
financial statements (e.g.
South america and the us).
Question 5
(a) training material: purpose of external audit and its role
(i) the external audit has a long history that derives largely from the separation of the
ownership and management of
Assets. Those who own assets wish to ensure that those to whom they have entrusted
control are using those assets
Wisely. This is known as the stewardship function.
(ii) the requirement for an independent audit helps to ensure that financial statements are
free of bias and manipulation
For the benefit of users of financial information.
(iii) companies are owned by shareholders but they are managed by directors (in very small
companies, owners and
Managers are the same, but many such companies are not subject to statutory audit
requirements).
(iv) the requirement for a statutory audit is a public interest issue: the public is invited to
invest in enterprises, it is in the

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Interests of the capital markets (and society as a whole) that those investing do so in the
knowledge that they will be
Provided with true and fair information about the enterprise. This should result in the
efficient allocation of capital as
Investors are able to make rational decisions on the basis of transparent financial
information.
(v) the requirement for an audit can help prevent investors from being defrauded, although
there is no guarantee of this
Because the external audit has inherent limitations. Reducing the possibility of false
information being provided by
Managers to owners is achieved by the requirement for external auditors to be independent
of the managers upon whose
Financial statements they are reporting.
(vi) the purpose of the external audit under international standards on auditing is for the
auditor to obtain sufficient
Appropriate audit evidence on which to base the audit opinion. This opinion is to the effect
that the financial statements
Give a true and fair view (or present fairly in all material respects) of the position,
performance (and cash flows) of the
Entity. This opinion is prepared for the benefit of shareholders.
(b) main audit procedures and processes: interim and final audit
(i) the interim audit generally involves risk assessment, the testing of internal controls, and
certain analytical and other
Substantive procedures. Many of these procedures are often performed concurrently.
(ii) risk assessment involves gathering information about the business, inquiries, analytical
procedures and determining the
Response to assessed risk. In practice it also involves the determination of materiality and
tolerable error.
(iii) risk assessment also involves evaluating the design of internal controls and determining
whether they have been
Implemented.
(iv) final audit procedures also involve a review of the financial statements as a whole to
ensure that they are internally
Consistent, and in accordance with the relevant financial reporting framework and the
auditors knowledge of the
Business.
(v) substantive procedures, which include analytical procedures, are designed to provide
evidence that the figures and
Disclosures in the financial statements are complete, relevant, and accurate. Arriving at the
final conclusions often
Involves the performance of further analytical procedures on the financial statements as a
whole.
(vi) it is common for auditors to provide management with lists of control weaknesses (both
structural and operational)
Together with recommendations for improvement both after the interim and final audits.
(vii) auditors are also required to communicate with those charged with governance.
Nb: mention could also be made of management representations, third party confirmations,
the review of working papers,
And a number of other matters.

Question 6
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(a) risks and implications for audit risk


Inherent and control risks
(i) charities can be viewed as inherently risky because they are often managed by nonprofessionals and are susceptible
To fraud, although many charities and the volunteers that run them are people of the highest
integrity who take a great
Deal of care over their work. The assessment of this aspect of inherent risk depends on
each individual charity and the
Areas in which it operates.
(ii) charities are also at risk of being in violation of their constitutions which is important
where funds are raised from public
Or private donors who may well object strongly if funds are not applied in the manner
expected. Other charities and
Regulatory bodies supervising charities may also object. Again, the auditors will assess the
level of risk. The involvement
Of a recently retired certified public accountant in the preparation of accounts in the past
may lower the auditors
Assessed inherent risk to an extent.
(iii) most small charities have a high level of control risk because formal internal controls are
expensive and are not often in
Place. This means that donations are susceptible to misappropriation. Charities rely on the
trustworthiness of volunteers.
The auditors will assess the level of risk.
Detection risk
(iv) detection risk comprises sampling risk and non-sampling risk. It is possible in this case
that all transactions will be
Tested and therefore sampling risk (the risk that samples are unrepresentative of the
populations from which they are
Drawn) is not present.
(v) non-sampling risk is the risk that auditors will draw incorrect conclusions because, for
example, mistakes are made, or
Errors of judgement are made in interpreting results, or because the auditors are unfamiliar
with the client, as is the case
Here.
Audit risk
(vi) audit risk is the product of inherent risk, control risk and detection risk and is the risk that
the auditors will issue an
Inappropriate audit opinion. This risk can be managed by decreasing detection risk by
altering the nature, timing and
Extent of audit procedures applied. Where inherent risk is high and controls are weak (as
may be the case here) more
Audit work will be performed in appropriate areas in order to reduce audit risk to an
acceptable level.
(b) audit tests fund raising events
(i) attend fund raising events and observe the procedures employed in collecting, counting,
banking and recording the cash.
This will help provide audit evidence that funds have not been misappropriated and that all
income from such events
Has been recorded. Sealed boxes or tins that are opened in the presence of two volunteers
are often used for these
Purposes.
(ii) perform cash counts at the events to provide evidence that cash has been counted
correctly and that there is no collusion
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Between volunteers to misappropriate funds.


(iii) examine bank paying in slips, bank statements and bank reconciliations and ensure that
these agree with records made
At events. This also provides evidence as to the completeness of income.
(iv) examine the records of expenditure for fund raising events (hire of equipment,
entertainers, purchase of refreshments.
Etc.) And ensure that these have been properly authorised (where appropriate) and that
receipts have been obtained for
All expenditure. This provides evidence as to the completeness and accuracy of
expenditure.
(v) review the income and expenditure of fund raising events against any budgets that have
been prepared and investigate
Any significant discrepancies.
(vi) ensure that all necessary licences (such as public entertainment licences) have been
obtained by the trustees for such
Events in order to ensure that no action is likely to be taken against the charity or volunteers.
(vii) obtain representations from the trustees to the effect that there are no outstanding
unrecorded liabilities for such events
again for completeness of expenditure and liabilities.
Special class examination paper
May, 2006 session
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic of an answer to every question
Question 1
You have been presented with the following draft financial information about mtakuja, a very
successful company that develops and licenses specialist computer software and hardware.
Its non-current assets mainly consist of property, computer hardware and investments, and
there have been additions to these during the year. The company is experiencing increasing
competition from rival companies, most of which specialise in hardware or software, but not
both. There is pressure to advertise and to cut prices.
You are the audit manager. You are planning the audit and are conducting a preliminary
analytical review and
Associated risk analysis for this client for the year ended 31 may 2004. You have been
provided with a summarized
Draft income statement which has been produced very quickly and certain accounting ratios
and percentages. You
Have been informed that the company accounts for research and development costs in
accordance with ias 38
Intangible assets.
Income statement
Year ended 31 may
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
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2003
Tzs000,000
15,206
3,009
12,197
3,006
994

2002
Tzs000,000
13,524
3,007
10,517
1,996
1,768
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Selling expenses
Profit from operations
Net interest receivable
Profit before tax
Income tax expense
Net profit
Retained profits
Dividends paid
Accounting
ratios
and
percentages
Earnings per share
Gross margin
Performance ratios include the
following
Expenses as a percentage of
revenue
Distribution costs
Administrative expenses
Selling expenses
Operating profit

3,002
5,195
995
6,190
3,104
3,086
1,617
1,469

274
6,479
395
6,874
1,452
5,422
3,983
1,439

043
080

104
078

020
007
020
034

015
013
002
048

Required:
(a) using the information above, comment briefly on the performance of the company for the
two years.
(8 marks)
(b) use your answer to part (a) to identify the areas that are subject to increased audit risk
and describe the
Further audit work you would perform in response to those risks. (12 marks)
(c ) explain the auditors responsibilities for the appropriateness of the going concern
assumption as a basis for the preparation of financial statements.
Question 2
Internal controls over non-current assets are designed to ensure the orderly and efficient
running of the business,
Adherence to management policies, safeguarding of assets, the prevention of fraud and
error and the
Completeness and accuracy of the accounting records.
Required:
List the internal controls that a small printing company with office equipment, motor vehicles
and plant and
Machinery should have in place to achieve the objectives described above. (10 marks)
(b) audit sampling is a technique for drawing conclusions about the characteristics of a
population by testing a
Sample drawn there from. Internal and external auditors use it for both tests of controls, and
substantive testing.
Required:
Describe the following:
(i) judgement sampling and statistical sampling;
(ii) a representative sample;
(iii) tolerable error;
(iv) two different methods of selecting a representative sample;
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(v) the extrapolation of errors.


Question 3
(a) explain the auditors responsibilities in respect of subsequent events. (5 marks)
(b) you are the audit manager of majaliwa co, a private limited liability company. You are
currently reviewing two
Matters that have been left for your attention on the audit working paper file for the year
ended 30 september
2005:
(i) majaliwa holds an extensive range of inventory and keeps perpetual inventory records.
There was no full
Physical inventory count at 30 september 2005 as a system of continuous stock checking is
operated by
Warehouse personnel under the supervision of an internal audit department.
A major systems failure in october 2005 caused the perpetual inventory records to be
corrupted before the
Year-end inventory position was determined. As data recovery procedures were found to be
inadequate,
Majaliwa is reconstructing the year-end quantities through a physical count and rollback.
The reconstruction
Exercise is expected to be completed in january 2006. (6 marks)
(ii) audit work on after-date bank transactions identified a transfer of cash from mipango co.
The audit senior has
Documented that the finance director explained that mipango commenced trading on 7
october 2005, after
Being set up as a wholly-owned foreign subsidiary of majaliwa. No other evidence has been
obtained.
(4 marks)
Required:
Identify and comment on the implications of the above matters for the auditors report on the
financial
Statements of majaliwa co for the year ended 30 september 2005 and, where appropriate,
the year ending
30 september 2006.
(c) describe the principal audit procedures to be carried out on the opening balances of the
financial statements
(d) explain the auditors responsibilities for other information in documents containing
audited financial
statements
Question 4
(a) there is a growing demand in both the public and private sectors for professional
accountants to provide assurance on a variety of subject matter by expressing a conclusion
regarding its quality or context..
Required:
Discuss this statement in the context of ifacs first international standard on assurance
engagements.
(b) knowledge of the business is crucial to determining the most effective and efficient audit
strategy for an entity using the internet for electronic commerce. Any auditor needs to have
an in-depth understanding of the related risks and the security measures to minimise them.
Required:
Discuss the impact of e-commerce on the audit process.

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Question 5
(a)
you are an audit manager of mawengu, a firm of certified public accountants. You are
assigning staff to the final audit of mizengwe for the year to 31 december 2002. You are
aware of the following matters:
(1) mizengwe has recently issued a profits warning. The company has announced that the
significant synergies
Expected from the acquisition of vanaka, a former competitor company, have not
materialized. Moreover, it has
Emerged that certain of vanakas assets are significantly impaired. Your firms corporate
finance department,
Assisted by two audit trainees, carried out due diligence work on behalf of mizengwe before
the purchase of vanaka
Was completed in december 2001.
(2) miadi, the assistant manager assigned to the interim audit of mizengwe, has since
inherited 5,000,000 shs1 shares in mizengwe. Miadi has told you that she has no intention of
selling the shares until the share price recovers
From the fall to tzs1,950 which followed the profit warning.
(3) anthony, an audit senior, has been assigned to the audits of mizengwe since joining the
firm nearly three years
Ago. He has confided to you that his father owned 1,001 shares in isthmus but sold them
only days before the
Profits warning at a share price of tzs 7,950. You are assured that anthony did not previously
know that his father
Had the shares.
Required:
Comment on the ethical and other professional issues raised by the above matters and their
implications, if any,for staffing the final audit of isthmus for the year to 31 december 2002.
(b) if there is a need for a uniform set of international accounting standards and international
auditing standards, there is also a need for global corporate governance standards.
Required:
Discuss and reach a conclusion.
Question 6
Write short notes on each of the following auditing concepts
a) Barnes- oxley compliance
b) Stages of investigations
c) Risk based internal auditing (rbia)
d) It audit risk
e) Legal framework of auditing in tanzania
f) Auditors liability
Solution for special class
Question 1
1 (a) performance
(i) the company has increased its revenues by 12% and its gross profit by 16% which in a
competitive market is very
Good (if not entirely credible) however, increased operating expenses have resulted in a
reduction in operating profits of
20%.
(ii) the gross margin is very high; this is not abnormal in this sector, especially for software
(although the margin is high
For hardware), but it may also be the result of errors, because the information has been
produced very quickly. This is
Also true of the other figures.
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(iii) total expenses as a percentage of revenue have increased substantially with the result
that operating profit as a
Percentage of revenue has reduced by around a third.
(iv) the increase in the selling expenses as a percentage of revenue may reflect the need for
the company to spend more
On advertising.
(v) the increase in the distribution costs as a percentage of revenue may reflect inefficiencies
in the method of distribution
In an industry that separates these functions.
(vi) the administrative expenses as a percentage of revenue have halved although they do
not represent a significant amount
In absolute terms.
(vii) the reduction in operating profits has been partially offset by increased net interest
receivable but profit before tax is still
Down 10%.
(viii) the reduction in profit before tax and the increased tax charge have resulted in a
reduction in profit after tax of over
40%.
(ix) total dividends have been increased, despite the lower profits.
(x) the reduction in earnings per share is partly due to the reduction in profits but there is
insufficient information to state
Whether it is also attributable to an increase in the number of shares, although this seems
likely.
(b) higher risk areas and audit procedures
Gross margin and operating expenses
(i) i would obtain a detailed schedule of revenue and cost of sales showing the opening and
closing inventory figures for
Both software and hardware and i would perform a detailed review of changes on, say, a
monthly, quarterly and halfyearly
Basis.
(ii) i would ascertain the accounting policies for revenue recognition for both software and
hardware and ensure that they
Were in accordance with relevant international accounting standards. I would then test the
application of these policies
To individual transactions. Ias 38 intangible assets requires that certain development costs
be capitalised in the balance
Sheet and that research costs and costs that do not meet the criteria for capitalisation be
expensed.
(iii) i would seek to establish why all three categories of operating expenses have changed
so dramatically, by enquiry and
By obtaining a schedule of operating expenses and a breakdown of the cost of sales figure.
(iv) i would perform detailed analytical procedures on operating expenses and cost of
sales/gross margins, on a quarterly
And monthly basis and i would also perform detailed testing of transactions in these areas in
order to ensure that
Misclassifications have not occurred.
(v) audit evidence provided by balance sheet work on the inventory figures (such as
analytical procedures performed on
The inventory levels and attendance at the inventory count) will also provide evidence in
relation to cost of sales.
(vi) it is possible that some reclassifications or even errors have been made some costs
appearing as operating expenses
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Might properly belong in cost of sales. It certainly seems odd that whilst sales have
increased by 12%, the cost of sales
Figure has hardly increased at all. The reduction in administrative expenses should also be
investigated.
(vii) i would obtain schedules relating to non-current assets and establish the extent to which
these had contributed to an
Increase in depreciation costs. I would enquire as to the nature of the additions and their
purpose. Additional non-current
Assets would also be expected to contribute to revenues. If the change in the earnings per
share figure is (partly) a result
Of a new issue of shares, it may be that the cash generated has been used for investment in
non-current assets.
(viii) because of the possibility of errors, i would increase my sample sizes during tests of
controls over the recording,
Processing and posting of transactions that are posted to revenue, cost of sales and
operating expense accounts.
(ix) i would perform detailed substantive testing on samples of transactions in these areas
from source documentation (such
As licensing documentation, payroll records, purchase invoices for components etc.)
Through to the daybooks, ledgers,
And schedules supporting the income statement (for completeness), and vice versa.
(x) the extent of substantive procedures will depend on the extent to which controls are
shown to be effective and i would
Be particularly careful to follow up any errors discovered in both tests of controls and
substantive testing. I would also
Pay particular attention to any unauthorised, substantial or late adjustments.
Interest receivable
(xi) i would ask for a breakdown of, and explanation for, the increase in net interest
receivable. I would perform further
Analytical procedures on the interest costs and income and ensure that these are in line with
current interest rates and
The types of investments held by the company.
Taxation
(xii) it seems strange that the tax figure has increased so dramatically. I would ask for copies
of the tax calculations for
Detailed review, and to corroborate explanations provided by management.
Dividends and earnings per share
(xiii) i would enquire as to why dividends had increased, despite the lower profits, and
establish whether this trend can be
Maintained in the face of falling profits. I would also enquire as to whether the company has
any plans to restructure in
Line with trends in the industry, what the company intends to do about the competition, and
whether there is any
Possibility of a take-over.
(xiv) i would establish whether there had been any share issue during the year that had
affected the calculation of the
Earnings per share and, if there had been, what was the purpose of the share issue.
(c) auditors responsibilities appropriateness of going concern assumption
Tutorial note: this is only a 5 mark requirement and comments contributing to an explanation
of directors responsibilities
Instead of, or as well as, auditors responsibilities will not earn marks.
The auditor should consider:
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the appropriateness of managements use of the going concern assumption (a


fundamental principle in the preparation
Of the financial statements) when planning and performing audit procedures and in
evaluating the results thereof; and
whether events or conditions may cast significant doubt on the entitys ability to continue
as a going concern (and stay
Alert to evidence of such events or conditions).
In particular the auditor should evaluate managements assessment of the appropriateness
of the going concern assumption
For a period of at least 12 months.
When there are significant doubts about the appropriateness of the assumption,
managements plans for future actions should
Be reviewed. Sufficient evidence should be gathered to confirm or dispel whether or not
material uncertainty exists. This may
Necessitate the performance of additional specific audit procedures (e.g. The examination of
cash flows and prospective
Financial information).
Written management representations should be sought confirming managements plans and
future actions.
Where the going concern is appropriate but a material uncertainty exists the auditor must
assess the adequacy of
Managements disclosure (of events/conditions and managements plans) in the financial
statements. If disclosure is:
adequate, the audit opinion should be unqualified opinion with an emphasis of matter
paragraph;
inadequate, the auditor should express a qualified or adverse opinion (as appropriate).
If the assumption is judged inappropriate the auditor should express an adverse opinion if
the financial statements have been
Drawn up on a going concern basis (irrespective of any disclosure made).
Question 2
(a) internal controls
(i) controls contributing to the orderly and efficient running of the business, safeguarding the
assets and adherence to
Management policies would include the following:
physical controls over access to the assets such as the locking of doors and the
maintenance of an appropriate fire
And flood resistant environment;
insurance against disaster and contingency plans;
the use of passwords for access to computers and plant and equipment;
the numerical or other tagging of all equipment, referenced to an asset register;
performing periodic asset audits;
internal regulations requiring staff who take equipment such as laptops and motor vehicles
home to ensure that
They are secure, and prohibiting staff from using their own software on company equipment;
the maintenance of firewalls and virus checking software.
(ii) controls contributing to the prevention of fraud and error, and the completeness and
accuracy of the accounting records
Would include the following;
the preparation and monitoring of capital expenditure budgets together with authorisation
of capital expenditure,
Disposals and depreciation rates by independent persons at an appropriate level within the
organisation who do
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Not have day-to-day responsibility for the related records or assets;


the maintenance of an asset register that is reconciled to the general ledger and the assets
themselves;
the periodic checking and review of asset lives, and fully depreciated assets, to ensure that
assets are being
Depreciated correctly, over an appropriate period of time.
(b) description
(i) judgement and statistical sampling
Judgement sampling uses the auditors judgement to select the number of items to be
tested, which items to be tested,
And to interpret the results. Statistical sampling uses probability theory to do the same.
Some judgement is always used
In statistical sampling in the assessment of materiality and in the determination of what
constitutes tolerable error, for
Example.
(ii) representative sample
A representative sample is one whose characteristics are the same as, or similar to, the
characteristics of the population
As a whole. All sample selection methods attempt to select samples that are representative.
For example, a sample of invoices that have not been properly authorised in 5% of cases will
be representative of all
Invoices if the population as a whole also has around 5% of invoices not authorised.
(iii) tolerable error
Tolerable error is the maximum error that the auditor is prepared to accept and still conclude
that the audit objective has
Been achieved.
For example, in relation to receivables, the auditor may be prepared to form the conclusion
that receivables are not
Materially misstated if sampling shows that the receivables population has a value that is
within plus or minus, say, 5%
Of the figure in the financial statements.
(iv) different methods of sample selection
Random selection requires the use of random number tables in order to select a
representative sample.
Haphazard selection may be deemed to approximate to random selection provided that no
bias is displayed.
Interval (or systematic) selection involves taking every nth item, starting at random.
Monetary unit sampling is also a
Form of systematic selection.
Block selection methods (taking one full part of the population) will probably not result in a
representative selection.
Block selection might involve obtaining confirmation of receivables from one region of the
country only, for example.
Nb: only two examples are required.
(v) extrapolation of errors
Errors found in a sample are extrapolated across the population as a whole, in order to
enable the auditor to form a
Conclusion on whether the population is materially misstated. It is important to remember
that there is not necessarily
A direct, linear relationship between errors in samples and errors in the populations from
which they are drawn.
Question 3
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(a) auditors responsibilities for subsequent events


auditors must consider the effect of subsequent events on:
the financial statements;
the auditors report.
subsequent events are all events occurring after a period end (i.e. Reporting date) i.e.:
events after the balance sheet date (as defined in frs 21); and
events after the financial statements have been issued.
Events occurring up to date of auditors report
the auditor is responsible for carrying out procedures designed to obtain sufficient
appropriate audit evidence that all
Events up to the date of the auditors report that may require adjustment of, or disclosure in,
the financial statements
Have been identified.
these procedures are in addition to those applied to specific transactions occurring after
the period end that provide
Audit evidence of period-end account balances (e.g. Stock cut-off and receipts from trade
debtors). Such procedures
Should ordinarily include:
reviewing minutes of board/audit committee meetings;
scrutinising latest interim financial statements/budgets/cash flows, etc;
making/extending inquiries to legal advisors on litigation matters;
inquiring of management whether any subsequent events have occurred that might affect
the financial statements
(e.g. Commitments entered into).
when the auditor becomes aware of events that materially affect the financial statements,
the auditor must consider
Whether they have been properly accounted for and adequately disclosed in the financial
statements.
Subsequent events discovered after the date of the auditors report but before financial
statements are issued
Tutorial note: after the date of the auditors report it is managements responsibility to inform
the auditor of facts which
May affect the financial statements.
if the auditor becomes aware of such facts which may materially affect the financial
statements, the auditor:
considers whether the financial statements need amendment;
discusses the matter with management; and
takes appropriate action (e.g. Audit any amendments to the financial statements and issue
a new auditors report).
if management does not amend the financial statements (where the auditor believes they
need to be amended) and the
Auditors report has not been released to the entity, the auditor should express a qualified
opinion or an adverse opinion
(as appropriate).
if the auditors report has been released to the entity, the auditor must notify those charged
with governance not to issue
The financial statements (and the auditors report thereon) to third parties.
Tutorial note: the auditor would seek legal advice if the financial statements and auditors
report were subsequently issued.
Subsequent events discovered after the financial statements have been issued
the auditor has no obligation to make any inquiry regarding financial statements that have
been issued.

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however, if the auditor becomes aware of a fact which existed at the date of the auditors
report and which, if known
At that date, may have caused the auditors report to be qualified, the auditor should:
consider whether the financial statements need revision;
discuss the matter with management; and
take appropriate action (e.g. Issuing a new report on revised financial statements).
(b) implications for the auditors report
(i) corruption of perpetual stock records
the loss of data (of physical stock quantities at the balance sheet date) gives rise to a
limitation of scope.
Tutorial note: it is the records of the asset that have been destroyed not the physical asset.
the systems failure in october 2005 is clearly a non-adjusting post balance sheet event (frs
21). If it is material
(such that non-disclosure could influence the economic decisions of users) jinack should
disclose:
the nature of the event (i.e. Systems failure); and
an estimate of its financial effect (i.e. The cost of disruption and reconstruction of data to
the extent that it is
Not covered by insurance).
Tutorial note: the event has no financial effect on the realisability of stock, only on its
measurement for the
Purpose of reporting it in the financial statements.
if material this disclosure could be made in the context of explaining how stock has been
estimated at
30 september 2005 (see later). If such disclosure, that the auditor considers to be
necessary, is not made, the
Audit opinion should be qualified except for disagreement (over lack of disclosure).
Tutorial note: such qualifications are extremely rare since management should be persuaded
to make necessary
Disclosure in the notes to the financial statements rather than have users attention drawn to
the matter through
A qualification of the audit opinion.
the limitation of scope of the auditors work has been imposed by circumstances. Majaliwa
accounting records (for
Stock) are inadequate (non-existent) for the auditor to perform tests on them.
an alternative procedure to obtain sufficient appropriate audit evidence of stock quantities
at a year end is
Subsequent count and rollback. However, the extent of roll back testing is limited as
records are still under
Reconstruction.
the auditor may be able to obtain sufficient evidence that there is no material misstatement
through a combination
Of procedures:
testing managements controls over counting stock after the balance sheet date and
recording stock
Movements (e.g. Sales and goods received);
reperforming the reconstruction for significant items on a sample basis;
analytical procedures such as a review of profit margins by stock category.
an extensive range of stock is clearly material. The matter (i.e. Systems failure) is not
however pervasive, as only
Stock is affected.

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unless the reconstruction is substantially completed (i.e. Stock items not accounted for are
insignificant) the auditor
Cannot determine what adjustment, if any, might be determined to be necessary. The
auditors report should then
Be qualified, except for, limitation of scope.
however, if sufficient evidence is obtained the auditors report should be unqualified.
an explanatory paragraph would not be appropriate because this matter is not one of
significant uncertainty.
Tutorial note: an uncertainty in this context is a matter whose outcome depends on future
actions or events not
Under the direct control of majaliwa.
if the 2005 auditors report is qualified except for on grounds of limitation of scope there
are two possibilities for
The stock figure as at 30 september 2005 determined on completion of the reconstruction
exercise:
(1) it is not materially different from the stock figure reported; or
(2) it is materially different.
in (1), with the limitation now removed, the need for qualification is removed and the 2006
auditors report would
Be unqualified (in respect of this matter).
in (2) the opening position should be restated and the comparatives adjusted in
accordance with frs 3 reporting
Financial performance. The 2006 auditors report would again be unqualified.
Tutorial note: if the error was not corrected in accordance with frs 3 it would be a different
matter and the
Auditors report would be qualified (except for) disagreement on accounting treatment.
(ii) wholly-owned foreign subsidiary
the cash transfer is a non-adjusting post balance sheet event. It indicates that mipango
was trading after the balance
Sheet date. However, that does not preclude batik having commenced trading before the
year end.
the finance directors oral representation is wholly insufficient evidence with regard to the
existence (or otherwise)
Of batik at 30 september 2005. If it existed at the balance sheet date its financial statements
should have been
Consolidated (unless immaterial).
the lack of evidence that might reasonably be expected to be available (e.g. Legal papers,
registration payments,
Etc) suggests a limitation of the scope of the audit.
if such evidence has been sought but not obtained then the limitation is imposed by the
entity (rather than by
Circumstances).
whilst the transaction itself may not be material, the information concerning the existence
of mipango may be material
To users and should therefore be disclosed (as a non-adjusting event). The absence of such
disclosure, if the
Auditor considered necessary, would result in a qualified (except for) opinion.
Tutorial note: any matter that is considered sufficiently material to be worthy of disclosure as
a non-adjusting
Event must result in such a qualified opinion if the disclosure is not made.
if mipango existed at the balance sheet date and had material assets and liabilities then its
non-consolidation would
Have a pervasive effect. This would warrant an adverse opinion.
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also, the nature of the limitation (being imposed by the entity) could have a pervasive
effect if the auditor is
Suspicious that other audit evidence has been withheld. In this case the auditor should
disclaim an opinion.
(c )opening balances principal audit procedures
Tutorial note: opening balances means those account balances which exist at the beginning
of the period. The question
Clearly states that the prior year auditors report was unqualified therefore any digression
into the prior period opinion being
Other than unmodified or the prior period not having been audited will not earn marks.
review of the application of appropriate accounting policies in the financial statements for
the year ended 31 december
2004 to ensure consistent with those applied in 2005.
where permitted (e.g. If there is a reciprocal arrangement with the predecessor auditor to
share audit working papers
On a change of appointment), a review of the prior period audit working papers.
Tutorial note: there is no legal, ethical or other professional duty that requires a predecessor
auditor to make available
Its working papers.
current period audit procedures that provide evidence concerning the existence,
measurement and completeness of
Rights and obligations. For example:
after-date receipts (in january 2005 and later) confirming the recoverable amount of trade
debtors at 31 december
2004;
similarly, after-date payments confirming the completeness of trade and other creditors
(for services);
after-date sales of stock held at 31 december 2004;
review of january 2005 bank reconciliation (confirming clearance of reconciling items at
31 december 2004).
analytical procedures on ratios calculated month-on-month from 31 december 2004, to
date and further investigation
Of any distortions identified at the beginning of the current reporting period. For example:
stock turnover (by category of metal);
average collection payment (debtor days);
average payment period (creditor days);
gross profit percentage (by metal).
examination of historic accounting records for fixed assets and liabilities (if necessary). For
example:
agreeing balances on asset registers to the clients trial balance as at 31 december 2004;
agreeing statements of balances on loan accounts to the financial statements as at 31
december 2004.
if the above procedures do not provide sufficient evidence, additional substantive
procedures should be performed. For
Example, if additional evidence is required concerning stock at 31 december 2004, cut-off
tests may be reperformed.
(d). (a) auditors responsibilities for other information
the auditor has a professional responsibility to read other information to identify material
inconsistencies with the

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Audited financial statements (isa 720 other information in documents containing audited
financial statements).
a material inconsistency arises when other information contradicts that which is contained
in the audited financial
Statements. It may give rise to doubts about:
the auditors conclusions drawn from audit evidence; and
the basis for the auditors opinion on the financial statements.
in certain circumstances, the auditor may have a statutory obligation (under national
legislation) to report on other
Information (e.g. Management report).
even where there is no such obligation (e.g. Chairmans statement), the auditor should
consider it, as the credibility of
The financial statements may be undermined by any inconsistency.
the auditor must arrange to have access to the other information on a timely basis prior to
dating the auditors report.
Material inconsistency
if a material inconsistency is identified, the auditor should determine whether it is the
audited financial statements or
The other information which needs amending.
if an amendment to the audited financial statements is required but not made, there will be
disagreement, resulting in
The expression of a qualified or adverse opinion. (such a situation would be extremely rare.)
where an amendment to other information is necessary, but refused, the auditors report
may include an emphasis of
Matter paragraph (since the audit opinion cannot be other than unqualified with respect to
this matter).
Material misstatement of fact
a material misstatement of fact in other information exists when information which is not
related to matters appearing
In the audited financial statements is incorrectly stated or presented in a misleading manner.
if management do not act on advice to correct a material misstatement the auditors should
document their concerns to
Those charged with corporate governance and obtain legal advice.
Tutorial note: marks would be awarded here for the implications for the auditors report.
However, such marks, which are
For the restatement of knowledge would not be awarded again if repeated in answers to (b).
Question 4
(a)
providing assurance
Tutorial note: a simple .discuss. Question should not be approached as .write everything i
know about this topic.. Candidates will beexpected to address the key words and phrases in
the statement in a logical order.
The statutory audit of historical financial statements is an example of a traditional assurance
service which has been provided by
Auditors for many years. Factors which have contributed to a growing demand for different
assurance services by accountants
Include:
. Business expansion (e.g. Through acquisitions and mergers) and globalization;
. Developments in information technology and communication networks;
. Greater accountability of corporate managers;
. The accounting profession taking the opportunity to provide non-audit services.
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In the public sector, assurance is increasingly sought on information concerning the


performance of national
Departments and education providers (in the private sector, there is an increasing demand
for large companies to assess the quality of their management and communications
systems, whilst consumers demand assurance that e-commerce ensures data integrity and
confidentiality.
Professional accountants bring independence to assurance services because they are
bound to adhere to an ethical code (e.g. Ifac.s.code of ethics for professional accountants.
Or the nbaas .rules of professional conduct.). Such codes require that other fundamental
principles, including integrity, professional competence, due care and confidentiality, be
observed. The term
.professional accountant. Includes .auditor..
The objective of an assurance engagement is to enhance the credibility of information (by
evaluating the subject matter against
Suitable criteria and to expressing a conclusion that conveys a degree of confidence to the
intended users).
Thus, assurance services improve the quality or context of information for decision-makers
to use. Quality concerns the relevance and reliability of information which is inter-related with
sufficiency (a measure of quantity). Context concerns the format in which information is
presented.
Types of assurance services include:
. Risk assessments . Evaluating whether an entity has appropriate systems to manage its
business risks;
. Performance measurement . Assessing the quality of performance measurement systems
as a basis for determining whether the organisation.s goals and objectives are achieved;
. Information systems . Providing assurance that the entity.s information systems provide
relevant and reliable information for
Financial and operating decisions;
. E-commerce . Evaluating whether an entity.s website conforms to the principles and criteria
for business-to-consumer
Electronic commerce.
Subject matter, which may be as at a point in time or for a period of time, must be identifiable
and in a form which allows evidence to be gathered. For example:
. Data (e.g. Prospective financial information);
. Systems (e.g. Internal controls);
. Behaviour (e.g. Corporate governance).
An engagement which seeks to provide a .high. (but not absolute) level of assurance (e.g.
An audit) is concluded by the expression of
An opinion on whether the subject matter (e.g. Financial statements) conform, in all material
respects, to suitable criteria (e.g.
Financial statement assertions). This is called .positive assurance..
However, an engagement may seek to provide only a .moderate. Level of assurance either
because the professional accountant.s
Procedures are less extensive than for an audit (e.g. A review engagement) or because the
subject matter is less reliable (e.g.
Prospective financial information). The conclusion is expressed in a .negative. Form (i.e.
That no information came to light to suggest that the subject matter did not conform with
stated criteria or assertions).
Additional points
. The profession has been slow to respond to the growing demand because of the
associated increase in exposure to professional liability.
. Isa 100 has been issued not just to establish standards and provide guidance but to act as
a framework for the development by
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The iapc of specific standards on assurance engagement.


(b) tutorial notes
(1) impact in the requirement means what effect (if any) this is reinforced by differences
in focus in the quote.
(2) in its widest sense the term audit process encompasses the stages of
engagement/client acceptance, planning,
testing/evidence, evaluation and reporting thus the one line of the requirement provides
a framework for a structured
Answer.
(3) the quote provides further context and clues for a discussion related risks and security
measures.
(4) in accordance with guidance on tackling discussion questions in the student accountant
article (november/december
2001) candidates would be awarded a mark for any sensible point introducing their answer
to indicate why the subject is
Topical. For example, referring to the recent publication of the international auditing
practices committees exposure draft
Electronic commerce using the internet or other public networks (effect on the audit of
financial statements).
Given the scope of this q candidates should neither be surprised nor deterred by the length
of this answer!
Engagement/client acceptance
An auditor must be competent to accept/continue an engagement for the audit of the
financial statements of an entity engaged in
E-commerce. In particular the auditor must have the means to assess the entitys security
infrastructure (an aspect of the control
Environment), evaluate internal controls and carry out detailed substantive procedures.
Knowledge of the business
The auditors knowledge of the business is fundamental to assessing the significance of ecommerce to the entitys business
Activities and any impact on audit risk. For example, the auditor should consider whether
security issues have been addressed and
The way in which:
_ e-commerce links to the entitys operating system e.g. Many e-commerce systems on
the internet (on-line shop fronts) are
Not yet linked with the entitys accounting (back office) systems;
_ internet transactions are captured and transferred to the entitys accounting records. This
may affect:
the completeness and accuracy of transaction recording;
the timing of revenue recognition;
recognition and recording of disputed transactions.
The auditor requires appropriate it skills and internet knowledge to:
understand the technology used;
assess the it skills of entity personnel;
adopt a through the computer audit approach (see later).
Specifically, the auditor of an entity involved in e-commerce needs to understand:
the wide range of risks that exists (e.g. Relating hacking, lack of authentication of
transactions, transmission failures, loss of
Trust, theft of customer identity, etc); and
the systems reliability and preventative and detection controls.
Materiality

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The auditor is unlikely to use traditional benchmarks to establish a materiality threshold


because:
materiality is not based solely on quantitative measures;
qualitative factors may include the assessment of a systems reliability (where it is as yet
unproven);
the impact of significant risks (see below) arising cannot be quantified in financial terms;
there may be no performance track record.
Tutorial note: a profit-based materiality threshold is likely to be inappropriate for a dot.com
company.
Risk assessment
The auditor considers e-commerce business risks in so far as they may impact on audit risk
including:
risks arising from relationships with e-commerce trading partners this concerns the
authenticity of customers/supplies and
The integrity of transactions;
risks related to the recording and processing of e-commerce transactions e.g. If an
unidentified individual can initiate a
Transaction, or there is a loss of visible evidence (audit trail);
pervasive e-commerce security risks (including viruses, hacking and other computer
crimes) which impact on the control
Environment;
denial of service i.e. Overloading the system with spoof orders to bring down the system;
fraud risks which are increased by the anonymity of customers (similarly money
laundering);
risks of system failures or crashes which restrict access and result in loss of data;
enhanced going concern risk of companies involved in internet activity generally and
dot.com companies in particular.
The way in which an entity uses it for e-com, including the entitys assessment of risk and
acceptable risk levels in the it systems, is significant to the security, completeness and
reliability of the financial information produced, and therefore affects the auditors
assessment of inherent and control risk.
dot.com entities
Particular risks relating to dot.com entities include:
the absence of a traditional asset base;
the treatment of costs incurred in setting up an infrastructure;
the need for on-going investment in web technology;
cash flow forecasts and business plans based on subjective judgments without any proven
basis;
lack of cash flows when business takes off (i.e. Over-trading);
generating intangibles such as brand value and customer service quality;
market pressures to achieve expectations;
value added through e-commerce resulting in a market capitalisation which is significantly
(sometimes phenomenally!) Higher
Than the book value of the underlying net assets.
Tutorial note: the market capitalisation of dot.com entities may be based on a revenue
multiple where the entity is just a middleman
Effectively taking a commission on the sale, but showing that commission as revenue less
cost of sale.
For many dot.com businesses (like amazon.com), the greatest impact of e-commerce is on
the sales system. Risk areas will
Include:
validity of customers and others;
creditworthiness and credit card transactions;
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despatching of products.
Going concern
When e-commerce businesses report significant losses in their start-up phase, the
appropriateness of the going concern
Assumption (which underlies the preparation of the financial statements) should be
assessed. The auditor should consider:
the extent to which the losses are due to non-recurring transactions and events;
cash flow and break-even forecasts;
the entitys business plans (e.g. To further extend operating activities e.g. Into
warehousing and distribution);
whether financial arrangements are adequate to ensure the viability of continued
operations.
Controls
Internal controls seek to ensure that transactions are authorised and correctly (i.e.
Completely and accurately) recorded and that
Assets are safeguarded. The nature of e-commerce transactions demands that controls are
more sophisticated and extensive (e.g.
Encompassing data privacy).
Security measures aimed at ensuring transaction integrity include:
encryption i.e. Scrambling into code which can only be decrypted with the right key;
hash values i.e. A total of fields to check that numerical values in a transaction have not
been tampered with;
digital signatures verify that transaction has been sent by an authorised user;
6-8 digit passwords of alpha-numeric combination;
bio-metrics i.e. Physical attributes (e.g. Thumbprints, voice recognition, retina scans);
transaction certificates typically obtained by a consumer and presented electronically to
a supplier who checks its validity
With the provider of the certification service.
Systems failures
Systems failures (both at the entity and for outsourced functions) can affect the entitys
reputation and result in a potential loss of
Customers, with a significant impact on profit. The auditor considers the entitys contingency
and business continuity plans.
Evidence
In contrast to traditional businesses which focus on controls relating to each stage of
transaction recording, system controls for
E-commerce focus on transaction execution (e.g. Fulfilling a customer order). The auditor
must obtain evidence of both the design
And operation of controls relating to transaction execution to ensure that:
fictitious or multiple identities are identified (i.e. Authentic customer);
customers browsing and those placing orders are distinguished;
input is validated and duplication or omission of transactions is prevented;
terms of trade are determined at the same time the order is processed (this may require
that payment is collected when an
Order is placed);
causes of transaction failures (e.g. Credit card authorisation failure and breaks in
communication) are addressed;
incomplete processing is prevented (e.g. By rejecting the order).
It is highly unlikely that a round the computer approach will be appropriate as both input of
transactions and processing are
Electronic. Even though physical goods may be dispatched (though not always e.g. Software
suppliers) there is typically less

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Conventional external audit evidence and the traditional audit paper trail is virtually
eliminated (e.g. On-line customer orders and
Confirmation thereof)
Audit trails including access and transaction logs may deter and detect unauthorised users
and rogue transactions. Although entities may not have automatic access to these and other
unusual activity logs, service-level agreements with the isp (internet service provider) may
provide for them to be retrieved on demand for audit purposes.
Electronic records can be more easily destroyed or altered than more robust physical
records (without leaving evidence of such
Destruction or alteration). Therefore the auditor must assess whether security of information
policies and security controls are
Adequate to prevent unauthorised access or changes to the financial records. Particular
consideration should be given to:
the controls incorporated in system design to ensure data integrity (e.g. Record integrity
checks, electronic date stamps using
Digital signatures, version control of electronic evidence, etc);
controls over the data interface (between front and back office systems);
controls over real time requirements (e.g. To provide a buffer between transactions
processed on the internet and existing
Operating systems);
the accessibility, integrity and retention of e-com records.
Computer assisted audit techniques
File interrogation software (which accessed the entitys data and master files) may be used
to examine all (rather than a sample
Of) items in a population. Files on on-line systems may be interrogated using interactive
enquiry software.
Analytical procedures
Analytical procedures must be used at the planning and overall review stages. However,
their use as substantive analytical
Procedures may be limited as traditional relationships (e.g. Between transaction and account
balances) may no longer be
Appropriate.
A significant factor in the use of analytical procedures is the extent of disintermediation (i.e.
Direct connection of producers and
Consumers to eliminate such middlemen as wholesalers, distributors and retailers). This
may affect, for example:
levels of inventory held (if any);
the nature of customer accounts (e.g. Individuals rather than retail or wholesale).
Also, the comparability of balances with prior periods may be affected by the reliability of the
data produced. Particular difficulties
May be encountered in obtaining relevant data and identifying related party transactions.
Internal audit
Where an e-commerce business has an internal audit department, the external auditor
should seek to place reliance on the work
Of internal audit (relating to the assessment of risks and evaluation of internal controls).
Specialists
The auditor may require the skills of a specialist to make appropriate inquiries and to
understand the implications of responses
Obtained. For example, rapid changes in the internet may result in different interactions of
evolving technologies and processes.
Similarly the auditor needs to recognise whether the entity is developing incompatible or
redundant technology.

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It may be appropriate to engage an it specialist (e.g. Where the audit practice does not have
access to the necessary skills inhouse).
Service organisations
Entities which do not have the technical expertise to establish and operate a website
providing e-commerce may outsource their
Web operations to a third party (e.g. To take orders and payments).
The auditor should (isa 402):
consider how the service organisation affects the accounting and internal control systems
in order to plan an effective audit
Approach;
obtain sufficient understanding of the accounting and internal control systems, assess
control risk, etc (assuming the service
Organisations activities are significant to the entity and relevant to the audit).
Specifically, the auditor needs to understand the contractual terms of relevant activities (e.g.
What recourse does the entity have in the event of non-supply of services).
Seals of approval
When an entitys website displays a seal demonstrating compliance with the standards of the
seal provider, the auditor must
Understand what assurance the seal does and does not provide. It is likely that if a seal
requires regular verification (e.g. Webtrust) the audit practice has been involved in the
awarding of the seal. The auditor will need to be familiar with the security and privacy issues
and relevant internal controls when plan
Question 5
Note: there are changes of names from ithmus to mizengwe and are use interchangeably
(a)
(1) profits warning
Ethical and professional issues
the profit warning increases the inherent risk of this assignment. As more work may be
needed than for the prior year
(e.g. On vanakas impaired assets), additional staff may need to be assigned to the audit.
an advocacy threat may occur if a dispute (potential legal action) arises between isthmus
and kloser. For example, if
The due diligence work should have recognised the significant impairments.
kloser should undertake a review of the due diligence work and audit for the year-ended
31 december 2001 to ensure
There were no findings which should have alerted them to the problems in vanaka which
precipitated the profit warning.
a self-review threat may arise in that the prior year-end audit, which followed the
purchase, may have lacked objectivity.
For example, the involvement of the corporate finance department in due diligence may
have resulted in less audit work
Being carried out on vanakas assets and operating results than would otherwise have been
performed.
if kloser was negligent in undertaking the due diligence work (e.g. Because assets were
impaired at the time of
Acquisition and/or the assumptions underlying the expected synergies were
unrealistic/hypothetical), to whom will kloser
Be liable? To whom was the due diligence work reported? (isthmus, isthmuss shareholders,
providers of finance for the
Acquisition?)
Tutorial note: to illustrate that these model answers are not exhaustive consider, for
example, that credit was given to
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Candidates who argued that the trainees involvement in the audit would be beneficial (to
kloser and/or isthmus).
Implications for staffing
As a safeguard for the provision of the other service (due diligence) the audit personnel
seconded to the corporate finance
Department may not have participated in the audit for the year ended 31 december 2001.
Any such bar should continue.
If the secondees are involved in the audit, appropriate safeguards would include not
assigning them to the audit areas most
Closely associated with due diligence and close monitoring and review of their work.
More senior/better quality/experienced staff should be assigned to the audit (than would
have been necessary had the profit
Warning not been issued).
(2) shares inherited
Ethical and professional issues
a self-interest threat has arisen as mercedes has a direct financial interest in isthmus (i.e.
She controls the shares). In
Particular, in wishing the share price to increase mercedes might be in a position to overlook
unrecorded liabilities and
Losses discovered during the conduct of the audit (say).
even though mercedes may have independence of mind and be known to act with the
utmost integrity, she cannot have
Independence in appearance.
this inadvertent violation (i.e. Through inheritance) of an independence principle does not
impair the independence of
Kloser or the audit team providing:
klosers established policies and procedures have resulted in mercedes having reported
promptly her inheritance
Of the shares;
kloser promptly advises mercedes that the shares should be disposed of; and
the disposal occurs at the earliest practical date, or she is removed.
mercedes does not intend to dispose of the shares quickly as she is waiting for the share
price to recover.
it is unlikely that kloser would consider offering her adequate compensation for an earlier
disposal (the loss in share
Value since the fall being 5,000 (7,950 1,950) = 30,000,000).
although ifacs independence statement requires mercedes removal from the audit team,
kloser may require stricter
Safeguards and prohibit all professional staff from holding direct financial interests.
Mercedes may therefore be asked to
Choose between staying with the firm or disposing of the shares at the earliest practical
date.
if any work has been done by mercedes on the audit of isthmus since she inherited the
shares (e.g. In reviewing interim
Audit work or planning the year-end or final audit visits) that work should be re-reviewed by
another professional
Accountant.
Implications for staffing
This threat is so significant that mercedes should be removed from the audit team unless
she disposes of the shares before
She undertakes any further tasks relating to the audit of isthmus.
(3) dealing in shares
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Ethical and professional issues


a self-interest threat would have arisen only if anthony had known that a close family
member (a parent) had shares in
Isthmus (but he did not). A self-interest threat cannot now arise as his father has disposed of
the shares.
providing anthony did not knowingly prompt his father to sell the shares, he has not
committed a criminal act (e.g. Of
Insider dealing).
Tutorial note: if he committed such an act he should be instantly dismissed by the firm and
any professional body
Under which he is registered (e.g.nbaa) notified for disciplinary action.
however, if he in some way communicated (e.g. In a careless remark) something that
prompted his father to sell the
Shares, he may be in breach of his duty of confidentiality. This should be investigated and
appropriate action taken (e.g.
He may be cautioned or given a written warning).
if he unknowingly gave his father price sensitive information, then his father may be guilty
of insider dealing (or similar)
For having acted on it.
Implications for staffing
Unless there is any reason to suppose that anthony has acted improperly (e.g. If he has
delayed disclosing the matter) there
Is no reason why he should not continue his position in the audit team.
However, if his father were to come under suspicion of insider dealing then anthony should
be withdrawn from this
Assignment.
Overall
Given the high profile attaching to this listed client it would be timely to have all members
assigned to the audit team renew
Their written declarations of independence and confidentiality.
(b)
corporate governance standards
Tutorial notes: much guidance has been given to students about answering discussion
questions (see the accountant
Vol.14 no.4 of december, 2002) and this answer has been structured in accordance with that
guidance. A proposition taking the form if then
provides candidates with an opportunity to discuss the truth (or otherwise) of the if
and its consequential effect (if any)
On the then . If you are struggling to balance your arguments for and against consider
whether what you have put forward as
An argument for cannot be looked at from another perspective to provide a contrary view.
Introduction
The oecd (organisation for economic cooperation and development) and world bank are
actively involved in initiatives to promote
Corporate governance (e.g. Holding an annual forum on the subject). In 1999, the oecd
issued a set of corporate governance
Principles which, although non-binding, reflect the concepts of:
the rights of shareholders;
the equitable treatment of stakeholders;
the role of stakeholders;
disclosure and transparency; and
board responsibilities.

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These principles are now being promoted as a framework for dialogue and consultation with
emerging and transition economies
With the aim of improving corporate governance practices.
Further, in june 2000, oecd issued governance guidelines for multinationals that provide
voluntary principles and standards for
Responsible business consistent with applicable laws. The international forum on
accountancy development (ifad) is an initiative of ifac and the world bank. Its vision is to
achieve a rational framework of reporting on the performance of economic entities, which
serves the objectives of issuers and users across the world. This vision calls for, inter alia,
improving corporate governance practices using the oecd principles of corporate governance
as a point of reference.
Need for iass
The need for a uniform set of international accounting standards to provide for the
transparency and consistency of financial
Reporting is evident in that iosco (the international organisation of securities commissions)
endorsed 30 international accounting standards for cross-border listings.
Although these are not (yet) global standards, it is envisaged that iass will become the
international (i.e. Global) standards and
Will not require reconciliation to us gaap.
Need for isas
The auditing profession plays a key role in both national and international regulation and the
development of transparent
International standards on auditing (isas) provides a high level of assurance on the reliability
of financial reporting.
Isas and international audit practice statements (iapss) have been formulated by ifac through
its international auditing practices committee (iapc). A significant number of ifac members
use the isa as a basis for developing their own national standards. Iapc is now working with
iosco for endorsement of isas.
Need for corporate governance standards
Corporate governance may be defined as the ethical corporate behaviour by directors or
others charged with governance in the
Creation of wealth for all stakeholders. It is about how these persons:
provide stewardship over the business of an entity to achieve corporate objectives;
balance the corporate objectives with the expectations of society; and
provide accountability to stakeholders.
The need for governance has increased as primary stakeholders have become more
removed from management and the control of the entities they own. The use of outside
directors in governance roles has been shown to provide protection to entity stakeholders.
The growth of global capital markets and the significant frauds which are being perpetrated
in these markets has put this need on
A global scale. Corporate governance can counter financial statement fraud, corruption and
money laundering.
If investors are to invest, stamping out corruption (for example) is important. An
infrastructure is therefore needed for regulation,
Corporate governance, disclosure and transparency.
The importance of the role of corporate governance is reflected in the iapcs isa 260.
Auditors are required to communicate audit matters of governance interest to those charged
with corporate governance on a timely basis. That the isa requires the auditor to identify
those responsible for governance, when the entity has not, emphasises the need for
governance systems to be established.
It has widely been reported that had corporate governance and public governance existed in
southeast asia, then the economic

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Crisis that occurred in 1997 may have been avoided (because the speculators would not
have such a free hand as they did).
Arguments for global corporate governance standards
Corporate governance on a national basis is appropriate when investing and financing by
companies is on a national basis.
However, a set of global rules should be applicable, as a minimum, to entities listing shares
or obtaining financing in the public
Capital markets outside of their national boundaries.
Requiring companies who participate in global capital markets to follow global rules will
provide greater protection to global
Investors. Corporate governance will still be required at a national level.
The use of global shares by global business enterprises increases the need for corporate
governance rules to be global. Global
Shares (i.e. The same form of shares for listing in a home country and a non-home country)
enable virtually seamless cross-border trading. As their use becomes more widespread,
global stakeholders will need higher quality global accounting, auditing and corporate
governance standards.
Regulators are national, not international, so international consistency is needed to avoid
regulation arbitrage. Global standards are necessary because national and international
standards will not converge of their own volition. Local subsidiaries of international groups
tend to be content (e.g. On cost grounds) to comply with lower local standards (e.g.
Accounting and auditing) and not adopt the higher standards of their parents location.
Companies in some countries (e.g. In india) have been advised not to globalise until there is
a framework for good corporate
Governance. It is therefore asserted that global standards are key to developing countries
prospects for sustainably mobilising
Capital for economic growth. Developing countries can further benefit by imitating the
models and systems of another rather than incurring the costs of developing their own
models.
There does not have to be a one size fits all approach to global standards because there
are universally recognised standards that can provide benchmarks (e.g. Responsibility,
accountability, fairness and transparency). If universal principles of transparency and
objectivity (for example) can support international accounting and auditing frameworks, then
a global corporate governance model can cater for different legal structures and cultural
identities.
Oecds voluntary code provides a point of reference for multinationals which are encouraged
to:
contribute to economic, social and environmental progress;
respect the human rights of those affected by their activities;
encourage local capacity building;
encourage human capital formation (e.g. By creating employment opportunities and
through training programs);
refrain from seeking/accepting exemption from environmental, health and safety, equal
opportunities and labour legislation,
Etc;
support and uphold good corporate governance (principles and practices);
abstain from improper involvement in local political activities.
Arguments against global corporate governance standards
Development of corporate governance and its implementation needs to be at a national level
because regulators are national and
It is not appropriate, given the need to respect diverse cultures and legal structures, to
prescribe a global standard. For example:
concern in the us is for increasing shareholders value;
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continental europes economic philosophy is creating employment;


in japan companies work with the government towards the national strategy.
Many people fear that global corporate governance standards may attempt to impose an
anglo-american business model on
Developing countries. Corporate governance and the composition of boards should suit the
local business environment to encourage economic success.
Iapc has established as a principle that auditors determine the relevant persons who are
charged with governance responsibilities.
However, that there may be no such persons suggests that the needed for governance is not
yet proven at a national level.
Global standards are unnecessary because they emerge eventually by a natural process of
convergence. For example, international financial reporting standards (ifrss) have been
issued by the international accounting standards board in place of separate international
accounting standards (iass) and uk financial reporting standards (frss) since the end of 2001.
International standards are not global standards. If accounting and auditing standards have
only reached an international level,
Then the need for corporate governance standards at the present time is only international
not global.
Conclusion
A global corporate governance framework is essential for high-quality financial reporting and
auditing standards to be interpreted,
Used and enforced consistently throughout the world.
Alternatively
Accounting standards have been implemented on a nation by nation basis before the
international acceptance by iosco of
International accounting standards. Auditing standards are following suit. The oecd
principles are very general and, as the needfor global corporate governance standards is
apparent, the initiatives to create them will continue to emerge.

Question 6
(a )
what

is

the

sarbox

act

or

sarbanes-oxley

act

Sarbanes-oxley is a us law passed in 2002 to strengthen corporate governance and restore


investor confidence. Act was sponsored by us senator paul sarbanes and us representative michael
oxley.
Sarbanes-oxley law passed in response to a number of major corporate and accounting
scandals involving prominent companies in the united states. These scandals resulted in a loss of
public trust in accounting and reporting practices.
Legislation is wide ranging and establishes new or enhanced standards for all us public
company boards, management, and public accounting firms.
Sarbanes-oxley law contains 11 titles, or sections, ranging from additional corporate board
responsibilities to criminal penalties. Requires security and exchange commission (sec) to
implement rulings on requirements to comply with the new law.

What does sarbanes oxley address?

Establishes new standards for corporate boards and audit committees


Establishes new accountability standards and criminal penalties for corporate management
Establishes new independence standards for external auditors
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Establishes a public company accounting oversight board (pcaob) under the security and
exchange commission (sec) to oversee public accounting firms and issue accounting standards
(b )
(c )

refer to standard class question 5


The main aim of internal auditing is to assist the organisation to achieve
Its objectives.

So if the organisations objective is to add shareholder value then that is the


aim ofinternal auditing. If it is to relieve famine in central africa, then that is
what internal auditors should be doing. Seems obvious, but its worth making
the point that internal auditing is not special. It should be able to justify its
existence just like any other process in the organisation.

A risk is a set of circumstances that hinder the achievement of objectives.


Rbia why does internal auditing exist?

I dont like the phrase internal controls as it is used traditionally by


accountants and auditors to describe controls in financial systems.
Finding lorry drivers reduces a risk but doesnt really fit the
description of an internal control. However, weve got the phrase,
so lets stick with it.

Rbia why does internal auditing exist?

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transfer them, the best example being insurance.


tolerate them, without planning any contingencies. These are the
asteroid hits
Earth type of risk. This does not mean that no-one will address this
risk
Governments may decide to try and deflect asteroids using nuclear
missiles.
tolerate them, and plan contingencies. These are the hurricane
destroys
Factory type of risk.
introduce some processes to reduce the consequence or likelihood
of a risk.
These processes are usually referred to as controls and include
everything
From having a clear strategy to installing a fire alarm. This method of
Management is known as treatment.
However, we will define any process which manages risk in one of
the above ways
As an internal control. Thus:
An internal control is a process which manages a risk.
This use of the phrase internal controls is consistent with that used
by the uk
Treasury in its book the management of risk principles and
concepts. Also known
As the orange book. Its well worth reading (see chapter 9).

assuring the organisations executive that it is monitoring the


system of internal
Control which brings the remaining risks to within acceptable levels.

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Internal auditing provides an independent and objective opinion to an


organisations management as to whether its risks are being managed to
acceptable levels.

Part ii
Question 1
An early textbook on auditing outlined the objective of an audit as follows:
1. The detection of fraud
2. The detection of technical errors
3. The detection of errors of principle
Required:
a.
Contract this early of auditing with the objectives and nature of the modern
statutory audit of a limited company as we know today.
b.
State why the objective and nature of auditing have changed.
c.
Show ho the audit work necessary to detect fraud or technical errors differs from
the work required to carry out a statutory audit of a limited company with an
adequate system of internal control.
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d.

Briefly describe the action you would take if, during a statutory audit , your tests
reveal that :
i.
The cashier has misappropriated some tshs.400, 000 form the
petty cash fund.
ii.
The managing director has over a period of years overstated
stocks by increasing amounts with the admitted aim of overstating
profits to keep the shareholders happy.

Question 2
Fraud and error present risks to an entity. Both internal and external auditors are required to
deal with risks to the entity. However, the responsibilities of internal and external auditors in
relation to the risk of fraud and error differ.
Required:
(a) explain how the internal audit function helps an entity deal with the risk of fraud
and error. (7 marks)
(b) explain the responsibilities of external auditors in respect of the risk of fraud and
error in an audit of financial statements. (7 marks)
(c) kilimanjaro ltd is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staffs are
partly paid on a commission basis. Well-established tour operators run the holidays that
kilimanjaro ltd sells. The networked reservations system through which holidays are booked
and the computerized accounting system are both well-established systems used by many
independent travel agencies.
payments by customers, including deposits, are accepted in cash and by debit and credit
card. Kilimanjaro ltd is legally required to pay an amount of money (based on its total sales
for the year) into a central fund maintained to compensate customers if the agency should
cease operations.
describe the nature of the risks to which kilimanjaro ltd is subject arising from fraud and
error. (6 marks)
Question 3
Client confidentiality underpins the relationship between certified public accountants (t) in
practice and their clients.
It is a core element of nbaas rules of professional conduct.
Required:
(a) explain the circumstances in which nbaas rules of professional conduct permit or require
external auditors to disclose information relating to their clients to third parties without the
knowledge or consent of the client. (4 marks)
(b) a waste disposal company has breached tax regulations, environmental regulations and
health and safety regulations. The auditor has been approached by the tax authorities, the
government body supervising the award of licences to such companies and a trade union
representative. All of them have asked the auditor to provide them with information about the
company. The auditor has also been approached by the police. They are investigating a
suspected fraud perpetrated by the managing director of the company and they wish to ask
the auditor certain questions about him.
Required:
Describe how the auditor should respond to these types of request. (6 marks)

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( c) the objectivity of the external auditor may be threatened or appear to be threatened


where:
(i) there is undue dependence on any audit client or group of clients;
(ii) the firm, its partners or staff have any financial interest in an
audit client;
(iii) there are families or other close personal or business relationships
between the firm, its partners or staff and the audit client;
(iv) the firm provides other services to audit clients.
Required:
(a) for each of the four examples given above, explain why the objectivity of
the external auditor may be threatened, or appear to be threatened, and
why the threat is important. (6 marks)
(b) describe nbaas requirements that reduce the threats to auditor
objectivity for each of the four examples given above. (4 marks)

Solution: 1
a. Early auditing and modern statutory auditing:
Fraud was a primary consideration. Today its detection is a by
product. The auditor has a duty to discover only those frauds
which affect the true and fair view.
At all times fraud by the management , in the sense of producing
misleading accounts, has been important but much more
emphasis is now placed on fairness view given by the accounts
The deterrent effect of an audit has always been relevant but
more emphasis is now placed on the directors role in preventing
fraud by installing adequate systems.
Technical errors were important ( e.g. Failure to accrue a
subscription to the chamber of commerce) but now the material
convention is listened to .
Errors of principle (e.g. Failure to depreciate buildings), as an
idea has given way to ideas like generally accepted accounting
principles and the ifrs requirements
Emphasis in early times on vouching all transactions (time and
resources were available at modest cost). Now emphasis on
reliance on indirect evidence such as compliance tests and
analytical review
Auditing every thing has given way to audits focusing on high
risk areas
Emphasis on vouching or ticking everything to a sampling even a
statistical sampling approach
Change from post year end audits to interim and year end date
inclusions
Change of report from true and correct to true and fair
Increase in companies act accounting and auditing requirements
Changes from vague text book and obscure legal case
indications of audit practice through u statements to auditing
standards and guidelines
Changes in law have made auditors aware of obligations to third
party users of account.

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b. Objective have changed because :


Increased separation of ownership and control has switched the
emphasis from fraud of employees to validation of director
produced financial statements
Increased size of business has made the vouching approach
impractical.
Increasing cost of auditing has forced auditing to become more
efficient.
Increased investor sophistication ( e.g. More institutional
shareholdings).
Mores sophisticated accounting and control systems e.g.
Computers
Changes in company law and professional body requirements
c. Since the objective of statutory audit is to give an opinion on the truth and
fairness of financial statements and not to discover fraud, clearly the work
performed will be different.
Specifically:Truth and fairness auditing requires the materiality concept but
fraud and error seeking requires a detailed approach
Modern auditing requires a reliance wherever possible on
internal controls and the installation of such a system is a matter
for directors. It is true that the review o systems may indicate
weak areas where fraud and errors could occur.
The truth and fairness auditing can be conducted by sampling
and analytical review. Fraud and error are discovered by detailed
investigation
Modern auditing is focused on high risk areas with minimal
testing of other areas.
D.

I. Since the matter is not material (unlike london oil storage co. Ltd,
1904), the following action may be appropriate.

Inform the directors of the matter.


Request that they investigate other matters which may now be
suspect (other work done by the cashier, other cash funds
etc.). You may be asked to d this yourself for an extra fee.
Documents fully all actions and findings
Review all controls in the petty cash area
Review again all audit work and all internal control in areas
involving the cashier.

Further work is not required as the matter does not affect the audit
objectives unless internal controls are now suspect.
Ii. The auditors nightmare. He should:
Fully determine the true stocks at each year end ( if possible)
Inform the remaining directors
Request that any adjustments ( including tax effects ) should be
correctly treated in the accounts e.g. As prior year adjustments
under ifrs with fully disclosure
If the accounts are not correctly adjusted or if uncertainty
remains, qualify the report.
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Carefully review all audit work and the current and previous year
accounts.
Reliance can no longer be placed on the letter of representation
and other evidence may have to be sought
Review office procedures to determine what went wrong with
earlier audits
Check professional indemnity insurance.

Answer 2
1 (a) internal audit function: risk of fraud and error
(i) the internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of the risks
to which the entity is subject that would prevent it achieving its overall objectives such as
profitability. Corporate governance objectives also include the overarching need for the
management of an entity to exercise a stewardship function over the entitys assets.
(ii) a large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the business
as a whole, and in relation to specific areas, include the effective operation of an internal
audit function.
(iii) internal audit can help management manage risks in relation to fraud and error,
and exercise proper stewardship by:
1. Commenting on the process used by management to identify and classify
the specific fraud and error risks to which the entity is subject (and in some cases
helping management develop and implement that process);
2. Commenting on the appropriateness and effectiveness of actions taken by
management to manage the risks identified (and in some cases helping management
develop appropriate actions by making recommendations);
3. Periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
4. Monitoring the incidence of fraud and error, investigating serious cases and
making recommendations for appropriate management responses.
(iv) in practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and reporting of
fraud and error. Routine internal controls (such as the controls over computer systems and
the production of routine financial information) and non-routine controls (such as controls
over year-end adjustments to the financial statements) are relevant.
(v) it should be recognized however that many significant frauds bypass normal
internal control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be reviewed
by internal audit in order to establish the nature of the risks, and to manage them effectively.

(b) external auditors: fraud and error in an audit of financial statements


(i) external auditors are required by isa 240 the auditors responsibility to consider
fraud in an audit of financial statements to consider the risks of material misstatements in the
financial statements due to fraud. Their audit procedures will then be based on a risk
assessment. Regardless of the risk assessment, auditors are required to be alert to the
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possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entitys financial statements to material misstatements due to fraud.
(ii) auditors should make enquiries of management regarding managements
assessment of fraud risk, its process for dealing with risk, and its communications with those
charged with governance and employees. They should enquire of those charged with
governance about the oversight process.
(iii) auditors should also enquire of management and those charged with governance
about any suspected or actual instance of fraud.
(iv) auditors should consider fraud risk factors, unusual or unexpected relationships,
and assess the risk of misstatements due to fraud, identifying any significant risks. Auditors
should evaluate the design of relevant internal controls, and determine whether they have
been implemented.
(v) auditors should determine an overall response to the assessed risk of material
misstatements due to fraud and develop appropriate audit procedures, including testing
certain journal entries, reviewing estimates for bias, and obtaining an understanding of the
business rationale of significant transactions outside the normal course of business.
Appropriate management representations should be obtained.
(vi) auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than internal
auditors to small frauds (and errors), although they must always consider whether evidence
of single instances of fraud (or error) are indicative of more systematic problems.
(vii) it is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with isas might not detect a material misstatement in the financial
statements arising from fraud. In practice, routine errors are much easier to detect than
frauds.
(viii) where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve further
investigations. They should also consider the need to report to management and those
charged with governance.
(ix) where serious frauds (or errors) are encountered, auditors need also to consider
the effect on the going concern status of the entity, and the possible need to report externally
to third parties, either in the public interest, for national security reasons, or for regulatory
reasons. Many entities in the financial services sector are subject to this type of regulatory
Reporting and many countries have legislation relating to the reporting of money laundering
activities, for example.
(c) nature of risks arising from fraud and error: kilimanjaro ltd
(i) kilimanjaro ltd is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the information
produced may be incomplete or incorrect. Inadequate controls also give rise to the risk of
fraud by those who understand the system and are able to manipulate it in order to hide the
Misappropriation of assets such as receipts from customers.
(ii) all networked systems are also subject to the risk of error because of the
possibility of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
(iii) all entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they may
misappropriate those assets (fraud) and then seek to hide the error or fraud by falsifying the
records.
(iv) kilimanjaro ltd is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card companies may
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be liable for such frauds, attempts to use stolen cards can cause considerable
inconvenience.
(v) there is a risk of fraud perpetrated by senior management who might seek to
lower the amount of money payable to the central fund (and the companys tax liability) by
falsifying the companys sales figures, particularly if a large proportion of holidays are paid
for in cash.
(vi) there is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.

Solution 3
(a) internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under
nbaaas rules of professional conduct).
Internal matters
Before accepting appointment the firm should ensure that:
(i) it has the necessary staff with appropriate competencies to complete the audit
(this seems likely given that the firm has other clients in this sector);
(ii) the staff are available at what is a busy time of year for the firm (it may be
possible that all of the staff with the necessary competencies are otherwise occupied);
(iii) the firm is independent of viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two entrepreneurs),
however, there may be staff or partners who are related to the client or are otherwise
connected with it;
(iv) there are no conflicts of interest that cannot be properly managed. Conflicts of
interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:
(v) seek the directors permission to communicate with the company accountant
about the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
(vi) seek the directors permission to communicate with the incumbent auditors. If
permission is refused, the appointment should not be accepted;
(vii) ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if viswa refuses to give permission to
the incumbent auditors the appointment should not be accepted);
(viii) communicate with the incumbent auditors (preferably in writing) requesting all
the information which ought to be made available to enable the firm to decide whether or not
to accept the appointment (if there are no such matters, the incumbent auditors should
inform the firm of this);
(ix) seek appropriate transfer information (such as a copy of the last set of accounts
and a detailed trial balance reconciled to the accounts);
(x) indicate a likely fee (or the basis on which fees are calculated) to viswa, ensure
that this is acceptable and that the client is able to pay (by some form of credit check);
(xi) ensure that the incumbent auditor has properly resigned, been dismissed or has
not sought re-appointment in accordance with legal requirements.
(b) starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
(i) without the staff with appropriate competencies the firm will be in breach of the
rules (and may be found negligent if things were to go wrong);
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(ii) without complying with the requirements relating to independence and conflicts of
interest, the firm will not only be in breach of the rules, but will lack objectivity and may find
that the client (or other party) objects to the appointment to another client in the same sector;
(iii) without performing appropriate procedures the firm will be unable to form an
opinion on the integrity of the client it may find itself associated with an entity engaging in
doubtful or even illegal activities (taking account of the disagreement over disclosures);
(iv) without agreeing a fee it is almost inevitable that misunderstandings or
disagreements will arise;
(v) without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have arisen in
the past;
(vi) without ensuring that the incumbent auditor is no longer in place, it will be
inappropriate for the firm to seek appointment.
(c) engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It:
(i) confirms the auditors acceptance of appointment and constitutes a contract
between the auditor and the client;
(ii) summarises the respective responsibilities of directors and auditors;
(iii) contains details on:
1. The responsibilities of the directors (for accounting records, the financial
statements and the accounting policies on which they are based);
2. The responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and disclosures,
to perform tests and to form an opinion on the financial statements);
3. The form of report to be issued;
4. Other services to be provided;
5. The basis of calculation of fees;
6. Applicable legislation

Question 5
The auditor can look at an operation in different ways. For example the audit can be:
1. Transaction oriented
2. Systems oriented, or
3. Results oriented.

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In practice, most audits are a mix of these approaches but the underlying focus of these
different ways of carrying out an audit is worthy of examination, because the approach will
have implications on the type of audit conclusions and on the impact of the audit report.
Required
Elucidate and exemplify each of the three ways of operation audit above.
Suggested solution
1. Transaction oriented
Audit objective
To determine whether the operations are being carried out in compliance with the standards
and procedures as laid out in the accounting manual.
Audit approach
Select a representative sample of transactions and check whether they have been carried
out according to the procedures outlined in the accounting manual.
Follow up on any transactions that have not been properly carried out: not properly
authorised / errors in amounts / indicate waste or abuse / not properly recorded / etc.
Determine underlying reasons for observed findings.
Form of report
Findings: list of transactions that have not been properly carried out or recorded.
Conclusions: certain areas of the accounting manual are not being complied with.
Recommendations: correct wrong transactions and increase compliance with certain
controls as set out in the accounting manual.
Impact of report
With its predominant emphasis on individual transaction, there is a serious danger that this
report does not get the attention of management. In fact, it can have a negative impact. If
when a manager reads it and finds that the total impact of the weaknesses listed is small,
the conclusion derived is that what the auditor finds is not of significance.
2. Systems oriented
Audit objective
To determine whether the internal controls are adequate to ensure that operations are being
carried out properly; that assets are safeguarded; and that there is minimal waste, misuse
and abuse.
Audit approach
Examine the controls in place and, on the basis of a risk assessment, professional
judgement and comparison with standards, determine whether these controls are adequate
and whether, in the opinion of the auditor, any controls are missing.
Select a sample of transactions to test whether the controls in place are operating as
intended.
Conclude on the adequacy of the internal controls.
Form of report
Findings: list of inadequate or missing internal controls (illustrated with examples of
transactions that have not been properly carried out).
Conclusions: assessment of the strengths and weaknesses of the controls in place.
Recommendations: strengthen certain controls and introduce certain additional controls.
Impact of report
The report focuses on what needs to be done and therefore any management actions are
likely to improve the controls and reduce the likelihood of the waste or abuse observed by
the auditor.
3. Results oriented
Audit objective
To determine whether the operations are being carried out economically, efficiently and
effectively and whether the organisation's objectives are being met.
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Audit approach
Identify the major expenditures, revenues, outputs and outcomes of the entity and conduct a
risk assessment.
Assess the appropriateness of management reports on expenditures, revenues and outputs.
Review studies and reports on the effectiveness of the operations and on programme
performance.
On the basis of these reports conclude whether managers have appropriate information to
know how economic, efficient and effective are the operations.
If these reports do not contain sufficient information to assess performance properly, the
auditor can decide to conclude on the inadequacy of the measures or to determine directly
whether performance is adequate.
Where the auditor decides to assess performance, this can be done by:
Comparing results against plans and budgets
* performing analysis (such as trends in unit cost or in levels of
efficiency),
or
* making comparisons with standards or with the performance of
other organizations.
Form of report
Findings: clarity of objectives and accountability / the extent and quality of the measurement
and reporting of performance / examples of failures in performance / trends in performance.
Conclusions: appropriateness of the performance framework / adequacy of the
measurement and reporting of performance / adequacy of the internal controls / an
assessment of performance or changes in performance.
Recommendations: review of programme / improve measurement and reporting of
performance / improve operations / strengthen internal controls.
Impact of report
By focusing on the impact of what the auditor has observed, the message of the audit report
is most likely to capture the attention of senior management.
Question 2
During the course of your audit of the fixed assets of nedco ltd at 31 march 2004 two
problems have arisen.
(i)

The calculations of the cost of direct labour incurred on assets in course of


construction by the companys employees have been accidentally destroyed for
the early part of the year. The direct labour cost involved is tsh 10,000/=

(ii)

The company has received a government grant of tshs25, 000/= towards the cost
of plant and equipment acquired during the year and expected to last for ten
years. The grant has been credited in full to the profit and loss account as
exceptional income.
Other relevant financial information is as follows.
Tshs.
Profit before tax
100,000/=
Fixed asset additions
133,000/=
Assets constructed by company
34,000/=
Fixed asset at net book value
666,667/=

(iii)

Required:
(a)

List the general forms of qualification available to auditors in drafting their report and
state the circumstance in which each is appropriate.

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(b)

State whether you feel that a qualified audit report would be necessary with respect
to the treatment of the government grant, draft the section of the report describing the
matter (the whole report is not required).

(c)

On the assumption that you decide that a qualified audit report is necessary with
respect to the treatment of the government grant, draft the section of the report
describing the matter (the whole report is not required).

(d)

Outline the auditor general responsibility with regard to the statement in the
directors report concerning the valuation of land and buildings.

Answer:
(a)
Isa auditors report on financial statements suggests that the auditors may need to
qualify their audit opinion under one of two main circumstances:
(i)

Limitation in scope of the auditors examination; and

(ii)

Disagreement with the treatment or disclosure of a matter in the financial


statements (including inherent uncertainties).

For both circumstances there can be two levels of qualified opinion:


(i)

Material but not fundamental, where the circumstances prompting the uncertainty or
disagreement is material but confined to one particular aspect of the financial
statements, so that is does not affect their overall value to any potential user;

(ii)

The more serious qualification where the extent of the uncertainty or disagreement is
such that it will fundamental to the overall view shown by the financial statements, i.e.
The financial statements are or could be misleading.

The general form of qualification appropriate to each potential situation may be seen by the
following table. (audit qualification table- make sure its on your finger tip)
Circumstance
Limitation of scope
Disagreement
(b)

fundamental
disclaimer of opinion
adverse opinion

Whether a qualification of the audit opinion would be required in relation to either of


the two circumstance described in the question would depend on whether or not the
auditors considered either of them to be material. An item is likely to be considered
as material in the context of a companys financial statements if its omission,
misstatement or non-disclosure would prevent a proper understanding of those
statements on the part of a potential user. Whilst for some audit purposes materiality
will be considered in absolute terms. More often than not it will be considered as a
relative term.
(i)

Loss of records relating to direct labour costs for assets in the course of
construction

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material but not


fundamental
except formight
except for

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The loss of records supporting one of the asset figures in the balance sheet
would cause a limitation in scope of the auditors work. The tshs.10,000/=,
which is the value covered by the lost records, represents 29.4% of the
expenditure incurred during the year on assets in course of construction but
only 6% of total additions to fixed assets during the year and 1.5% of the year
end net book value for fixed assets. The total amount of tshs.10,000/=
represents 10% of pre-tax profit but, as in relation to asset values. The real
consideration by the auditors should be the materiality of any over-or understatement of assets resulting from error in arriving at the tshs.10,000/= rather
than the total figure itself.
Provides there are no suspicious circumstances surrounding the loss of these
records and the total figure for additions to assets in the course of
construction seems reasonable in the light of other audit evidence obtained,
then it is unlikely that this matter would be seen as sufficiently material to
merit any qualification of the audit opinion. If other records have been lost as
well, however, it may be necessary for the auditors to comment on the
directors failure to maintain proper books and records.
(ii)

Government grant credited in total to profit and loss account


The situation here is one of disagreement, since best accounting practice, as
laid down by ias 20, requires that capital-based grants should be credited to
the profit and loss account over the useful like of the asset to which they
relate.
This departure from ias 20 does not seem to be justifiable and would be
material to the reported pre-tax profits for the year, representing as it does
22.5% of that figure.
Whilst this overstatement of profit (and corresponding understatement of
undistributable reserves) would be material to the financial statements, it is
not likely to be seen as fundamental and therefore an except for qualified
opinion would be appropriate.

(c)

Qualified audit report extract


as explained in note.government grants in respect of new plant and equipment
have been credited in full to profits instead of being spread over the lives of the
relevant assets as required by statement of standard accounting practice 4; the effect
of so doing has been to increase profits before and after tax for the year by
tshs.22,500/=
except for.

(d)

The auditors general responsibility with regard to the statement in the directors
report concerning the valuation of land and buildings is to satisfy themselves that this
is consistent with the treatment and disclosure of this item in the audited financial
statements. If the auditors are not satisfied on the question of consistency then an
appropriate opinion will be required following their audit report.

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Paper 40
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains eight questions, attempt any six
3.
Marks will be given for clarity of language and logic expression to every question
Question 1
according to isa 200, irrespective of whether an audit is being conducted in the private or
public sector, the basic principles of auditing remain the same. What may differ for audits
carried out in the public sector is the audit objective and scope. These factors are often
attributable to differences in the audit mandate and legal requirements or the form of
reporting (for example, public sector entities may be required to prepare additional financial
reports).
required
(a) List and describe 10 main elements of public sector entities which make it different
from the private sector
(b) Describe the power, functions and duties of the cag
(c) What are the control aspects of the cag?
(d) Discuss four factors which affects the independence of the cag
(e) Describe three categories of public sector audit in tanzania
(f) What are the main audit procedures to be adopted in audit of vat?
(g) List and describes main issues and factors which the cag normally investigates in
order to satisfy himself as to proper accountability of regularity and processes of
public spending. What are the key documents investigated as per section 25 of
public finance act.
(h) Describe the regularity, performance public sector audits
(i) Discuss the functions of cag in accordance with section 143 of the constitution
(j) Describe main features of government accounting system
(k) Describe the main issues which are included in cag final report to the president and
the parliament.
(l) Discuss the roles, functions and powers of pac and laac.
(m) Describe the reporting process in public sector audit.
(n) What is the role, composition and functions of public sector audit committees as per
regulation 28 of public finance act.
Question 2
Value for money audits tries to answer the question why and for whom money is being
used.
Why money is being used refers to the purpose or the reason to justify expenditure.
For whom the money is being used responds to value received as measured by the utility or
satisfaction enjoyed by a specified user. Financial data simply shows how much money is
involved in a certain specified purpose, but does not necessarily demonstrate the value
received. To be able to demonstrate the extent of value received, measures of performance
must be put in place and somebody must be entrusted with the management and
supervision of the utility or satisfaction to be procured.
Required
(i)
Distinguish between value for money and value for money audit
(j)
Describe the purpose, scope and process of value of money audits in tanzania.
Why the use of criteria is important in value for money audits
(k)
Distinguish value for money audits in public and private sector in tanzania
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(l)
(m)
(n)
(o)
(p)

Discuss the pro and cons of value for money audits


Write short notes on value for money; concepts and meaning
Describe the planning stage of value for money audits
Describe the process of executing value for money audits
What are the main impediments of value for money audits implementation in
tanzania?

Question 3
You are the manager responsible for the audit of new stead products ltd for the year ended
30 september 1999. The company is a wholesaler of do-it-yourself products. It operates
from rented premises; its fixed assets comprises motor vehicles, a microcomputer and some
minor fixtures and fittings. The accounting records (sales ledger, purchase ledger, nominal
ledger and payroll) are maintained on a microcomputer by a bookkeeper and a part-time
accountant prepares the annual accounts and quarterly management accounts.
The summarises draft accounts for the year ended 30 september 1999, and the previous
years audited accounts, are as follows.
Profit and loss accounts
For the year ended 30 september
Sales
Cost of sales
Gross profit
Overheads
Profits before tax
Taxation
Retained profit
Balance sheet as at 30 september
Fixed assets
Current assets
Stock
Trade debtors
Prepayment

1999
tshs.
1,043,900
680,600
363,300

1998
Tshs.
506,700
355,200
151,500

272,100
91,200
22,800
68,400

147,400
4,100
1,100
3,000

1999
tshs
20,400

1999
tshs
8,900

273,000
239,200
5,500

52,600
95,500
1,500

417,700

149,600

Current liabilities
Trade creditors
Accruals
Taxation
Bank overdraft
Net current assets
Net assets
Directors loan account

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178,800
37,800
22,800
86,100
325,500
92,200
112,600
15,400
97.200

71,300
21,200
1,100
20,700
114,300
35,300
44,200
15,400
28,800
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Called up share capital

1,000

1,000

Profit and loss account

96,200
27,800
97,200
28,800
The company sells low value items to a large number of customers. Most sales are on
credit, with less than 5% of sales being in cash. It has over 700 live accounts on the sales
ledger of which 70% are new customers in the past year. You have carried out audit checks
on the accounting systems (i.e. Compliance tests) and these tests have shown that the
systems are generally reliable. However, there is no formal system for recording receipt of
goods; the only record of receipt of foods is the suppliers delivery note, but as this is not
dated by the goods received department, there is a greater risk of purchases cut-off errors.
Your review of the accounts in to enable you to plan the audit of the year-end accounts, so
that guidance is given to the audit staff and more time is spent in areas of highest audit risk.
Required:
(a)

Calculate appropriate ratios for both years, and comment on the financial
performance of new stead products ltd for the year ended 30 september 1999,
both in comparison with the previous year in absolute terms.

(b)

From your review of the financial statements and the other matters included in
the question, suggest the amount of audit works you should perform and the
particular procedures you should carry out to minimise the audit risk for the
following g items appearing in the final accounts:
(i)
(ii)
(iii)
(iv)

Stock and gross profit margin:


Trade debtors;
Trade creditors;
Bank overdraft and cash flow forecast.

Question 4
You are auditing ktm ltd, a textile manufacturing company in dar es salaam. In due course of
your audit it has been realized that the client may have environmental issues which could
have an impact on the financial statements. Discuss major steps you would take in order to
obtain the appropriate evidence.
Question 5
Fraud and error present risks to an entity. Both internal and external auditors are required to
deal with risks to the entity. However, the responsibilities of internal and external auditors in
relation to the risk of fraud and error differ.
Required:
(a) explain how the internal audit function helps an entity deal with the risk of fraud
and error. (7 marks)
(b) explain the responsibilities of external auditors in respect of the risk of fraud and
error in an audit of financial statements. (7 marks)
(c) kilimanjaro ltd is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staffs are
partly paid on a commission basis. Well-established tour operators run the holidays that
kilimanjaro ltd sells. The networked reservations system through which holidays are booked
and the computerized accounting system are both well-established systems used by many
independent travel agencies.
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payments by customers, including deposits, are accepted in cash and by debit and credit
card. Kilimanjaro ltd is legally required to pay an amount of money (based on its total sales
for the year) into a central fund maintained to compensate customers if the agency should
cease operations.
describe the nature of the risks to which kilimanjaro ltd is subject arising from fraud and
error. (6 marks)

Question 6
Nabaki africa ltd (na) main activity is the extraction and supply of building materials including
sand, gravel, cement and similar aggregates. The companys year end is 31 may and your
firm has audited na for a number of years.
The main asset on the balance sheet relates to non current assets. A junior member of staff
has attempted to prepare the non-current asset note for the financial statements. The note
has not been reviewed by the senior accountant and so may contain errors.
Land and Plant
and Motor
Railway
Total
buildings
machinery
vehicles
trucks
Cost
Shs 000
Shs 000
Shs 000
Shs 000
Shs 000
1 june 2005
100,000
875,000
1,500,000
-2,475,000
Additions
10,000
125,000
525,000
995,00
1,655,000
Disposals
-(100,000)
(325,000)
-(425,000)
31 may 2006
110,000
900,000
1,700,000
995,000
3,705,000
Depreciation
1st june 2005
Charge
Disposal
31 may 2006
Net book value
31 may 2006
Net book value
31 may 2005

60,000
2,200
-62,200

550,000
180,000
(120,000)
610,000

750,000
425,000
(325,000)
850,000

-199,000
-199,000

1,360,000
806,200
(445,000)
1,721,200

47,800

290,000

850,000

796,000

1,983,800

40,000

325,000

750,000

--

1,115,000

land and buildings relate to company offices and land for those offices.
plant and machinery includes extraction equipment such as diggers and dumper trucks
used to extract sand and gravel etc.
motor vehicles include large trucks to transport the sand, gravel etc.
railway trucks relate to containers used to transport sand and gravel over long distances
on the railway network.
Depreciation rates stated in the financial statements are all based on cost and calculated
using the straight line basis.
The rates are:
Land and buildings
2%
Plant and machinery 20%
Motor vehicles
33%
Railway trucks
20%
Disposals in the motor vehicles category relates to vehicles which were five years old.
Required:
(a) list the audit work you should perform on railway trucks. (10 marks)
(b) you have just completed your analytical procedures of the non-current assets note.
Required:
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(i) excluding railway trucks, identify and explain any issues with the non-current asset note to
raise with management.
(ii) explain how each issue could be resolved. (10 marks)
Note: you do not need to re-cast the schedule.
Question 7
During the course of your audit of the fixed assets of nedco ltd at 31 march 2004 two
problems have arisen.
(iv)

The calculations of the cost of direct labour incurred on assets in course of


construction by the companys employees have been accidentally destroyed for
the early part of the year. The direct labour cost involved is tsh 10,000/=

(v)

The company has received a government grant of tshs25, 000/= towards the cost
of plant and equipment acquired during the year and expected to last for ten
years. The grant has been credited in full to the profit and loss account as
exceptional income.
Other relevant financial information is as follows.
Tshs.
Profit before tax
100,000/=
Fixed asset additions
133,000/=
Assets constructed by company 34,000/=
Fixed asset at net book value
666,667/=

(vi)

Required:
(e)

List the general forms of qualification available to auditors in drafting their report and
state the circumstance in which each is appropriate.

(f)

State whether you feel that a qualified audit report would be necessary with respect
to the treatment of the government grant, draft the section of the report describing the
matter (the whole report is not required).

(g)

On the assumption that you decide that a qualified audit report is necessary with
respect to the treatment of the government grant, draft the section of the report
describing the matter (the whole report is not required).

(h)

Outline the auditor general responsibility with regard to the statement in the
directors report concerning the valuation of land and buildings.

Suggested solutions
Question 1
(a) the two elements of public sector audit are purpose and process. Purpose refers to
the formation of the opinion on an account under examination, while process refers to the
exercise of arriving to the opinion on the account under examination.
Purpose: in performing the audit, the auditor provides a service in the form of assurances to
users of the accounts i.e. Central government, local government, independent department,
taxpayer, and the public at large to the extent of the expression of the auditors opinion.
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Process: in the recent past the role of the external auditor has expanded extensively with the
assumption of the responsibility for appraising, and reporting on, the extent to which the
value for money is secured from a specific expenditure of public funds. Main elements of
public sector audit are purpose and process list and describe 10 main elements of public
sector entities which make it different from the private sector
Other elements
Accounts are not major issues
Parliament have dual role
The audit mandate is derived from constitution
The auditor is permanent (cag) but differs in person
Budget forms major part of audit work
Coordinated and executed by sai
Applies the intosai standards
Tutorial note: the question asks about 10 elements, but all of them are embodied on the two
key elements i.e. Purpose and process.
(b)

status (section 26 of the pfa)


Authority for the creation of the office of the head of national audit services.
The process for the appointment of a cag and for his/her removal from office.
Constitutional position of the cag, means by which independence is secured, and
standing of the cag in relation to other public officers.

Relationship with parliament, other representative body or supreme authority.

Arrangement for remunerating the cag.

Functions (section 31 of the public finance act)


The activities, basis, and nature of duties.
Authority to examine and certify national fund accounts; revenue accounts,
government accounts, and any associated/trading and/or commercial accounts, and
stock and stores and stock accounts
Authority to undertake regularity function to check that expenditure is applied for the
purpose approved and that it conforms to the authority which governs it;
Authority to examine whether value for money is obtained in the use of public
resources, including extension of such an examination to the accounts for which the
cag is ordinarily not authorised to certify;
Basis for reporting the results of an audit including reporting such subjects like fraud,
corruption, losses, irregularities, and how the report shall be issued and the
circumstances in a report must be issued with an audit certificate;
The extent to which regard is given to proposals made by a public accounts
committee or a similar body;
A duty to hear objections to or to answer requests for explanations of accounts e.g
for a member of the public and to hold an extra ordinary audit;
A provision for a legal action against an auditor improperly disclosing information
obtained during the course of an audit.
Powers (section 32 of public finance act)
Call upon any public officer for any explanation and information, which the cag may
require in order to enable him to perform his functions.
Summon and examine on oath any person as he may determine in connection with
eh receipt or expenditure of public moneys or the receipt or issue of any public
property affected by provision of the public finance act.
Provision delegation of all or some of the functions of the cag to principal officers;
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The appointment of staff and provision for determining their pay and conditions of
service;
The right to employ auditors from outside the office reporting to the cag;
Arrangements for funding the office of the cag and the circumstances the charging of
audit fees is authorized;
Provision for the audit of annual accounts of the cags office, and whether this
includes value for money examinations
Right of access to papers, to obtain explanations and information with reference to
any restrictions, any special procedures relating to material bearing a security
classification;
Remedial action where access is denied or information withheld;
Discretion to decide the nature, timing, and extent of audit functions and of reports.
Tutorial notes: always the powers relates to the functions and duties for this purpose. The
status has been added for purpose of additional revision.
C) section (16) 2 , no warrant shall be issued by the paymaster- general for the purpose of
meeting any expenditure unless a grant of credit sufficient to cover the sum involved has
been issued by the cag and :
o The expenditure has been authorized for the financial year during which the
withdrawals is to take place;
By an appropriation act;
By supplementary appropriation act
By warrant issue under section 21(1) of the pfa
Tutorial notes : the cag is both the controller and auditor general because he is the one who
grants exchequer credit transfer to meet any government expenditure.
D) despite the requirement for the auditor becoming independent, various factors such as
ineffective legislature, bad vices such as corruption, and political, economic, and social
influences may affect the impact of audit findings. In these circumstances complete
independence is unrealistic
Tutorial notes: the question does not conclude that cag is independent but these are
challenges to cag independence.
E)

the audits of the government sector consist of three main areas:


1. Fiscal audit
2. Audit of corporation and other taxes
3. Audit of value added tax (formerly customs and sales tax).

Fiscal audits: fiscal audit refers to the examination of such areas as expenditures/payment of
moneys, payroll and other allowances, salary advances, allowances, cash imprest, goods
and services, postage, telephone, deposits, appropriation accounts, etc. The audit report in
this audit is addressed to the officer responsible for the expenditure incurred who are
normally the permanent secretary, regional directors and heads of independent departments
or chairman of the board of directors. The main objectives of the report is two fold:
To provide assurance to the receiver that the financial activities under his/her control
are satisfactory; or
To get the receiver to make changes to activities where there is room for
improvement.
Audit tool
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Audit tools include public finance act no.6 of 2001, treasury circulars. The audit clients
include ministries, independent departments, regional development directorates, urban and
district councils, and all government-funded entities.
Audit of corporation and other taxes: the general objective of the audit of the income tax
department is to ensure that the revenue collected from corporation and other income taxes
are properly accounted for. In particular, the specific objectives are to ensure that
Mandatory tax laws are properly applied in ascertaining the total income of persons
liable to pay tax;
There are adequate safeguards, controls, and procedures for ensuring an effective
check on the assessment, collection, and proper allocation of taxes, and that such
safeguards, controls, and procedures are actually being implemented;
In general the departmental organization is sufficiently safeguarded against errors,
omissions, and frauds, and that there is no wilful omission or negligence to collect
taxes;
Instructions or circulars issued by the minister for finance and commissioner of
income taxes are being followed by the field officers and are in accordance with the
law;
All relevant registers prescribed to be kept are dully and properly maintained.
Audit of value added tax and other related taxes: this type of audit involves examination of
the following areas imports and exports, postal parcels, airports, bonded goods, oil
installations and refineries, transit goods, ships files, withholding taxes. The value added tax
department is responsible for the collection of about ??% of the total tax revenues. This
means it is a vital area of audit and the auditor is expected to exercise great enthusiasm
while examining the records.
F)

audit of value added and other taxes can be done in two stages. These stages are:1. Scrutiny of correct import and export documents in the customs houses and entry
points involving a general review of transactions and a detailed examination of
samples.
2. Audit of the ships files and transit and trans-shipment documents to see that the
department has accounted for satisfactorily for all the goods which enter or leave
the port/airport. Verification of the ships manifest should enable the auditor to
ensure that:
All the goods delivered /landed at the port have been assessed for duty;
The assessment has been properly done;
The duty has been collected and credited to the exchequer;
Where no duty has been levied, the goods have been otherwise accounted
for satisfactorily.
G) section 31(2) of the public finance act requires the cag, in addition to satisfying himself
as to the matters specified in that behalf in the constitution and any other written law, to
satisfy himself that: a. All accounts
i. Section 25(1); a balance sheet showing the assets and liabilities of the
consolidated fund
ii. A statement of the source and application of funds for the
consolidated fund showing revenues, expenditures and financing of
the fund for the year
iii. A summary statement of revenue and expenditure, being a summary
of all the statements signed by accounting officers under subsection
2(a) and (2) (c) of this section

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b.

c.
d.

e.

H)

iv. A statement of the amounts outstanding at the end of the year in


resprct of the public debt
v. A statement of the amounts guaranteed by the government at the end
of the financial year in respect of bank overdrafts, loans, public loan
issues and other contingent liabilities
vi. A statement of the amount outstanding at the end of the year in
respect of the loans issued by the government
vii. A summary of statement of arrears of revenue for each revenue head
being a summary of the statements of arrears of revenue signed by
accounting officers.
viii. A summary statement of commitments outstanding for the supply of
goods and services for each vote at the end of the financial year being
a summary of the amount included for such commitments in the
statement signed by accounting officers under subsection (2) (b)
ix. Summary of statement of stores and other assets for each vote being
a summary of the statements of assets signed by the accountings
officers under subsection ( 2) (e) above
x. Such other statements and in such for as the national assembly may
from time to time require.
All reasonable precautions have been taken to safeguard
i. Collection of revenue
ii. The receipt and custody, disposal , issue and proper use of the public
property, and that the law, directions and instructions applicable
thereto have been duly observed.
All expenditures of public monies has been properly authorixed and applied to
the purposes for which they were appropriated and the law, directions and
instructions applicable thereto have been duly observed.
All expenditure of public monies has been properly authorized and applied to
the purposes for which they were appropriated and that the law, directions
and instructions applicable thereto have been duly observed and provide an
effective check of the assessment and collection of revenue
Economy , efficiency and effectiveness have been achieved in the use of the
public moneys resources.

regularity audit, performance audit, and comprehensive audit


Regularity audit
Regularity audit embraces the following:

Attestation of financial accountability of accountable entities, involving


examination and evaluation of financial records and expression of opinion on
financial statements;

Attestation of financial accountability of the government administration as a


whole;

Audit of financial statements;

Audit of financial systems and transactions including an evaluation of compliance


with applicable statutes and regulations;

Audit of internal controls and internal audit functions;

Audit of the probity and propriety of administrative decisions taken within the
audited entity, and

reporting of any other matters arising from or relating to the audit that the sai
considers should be disclosed.

Performance audits
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Performance auditing is concerned with the audit of the economy, efficiency, and
effectiveness. It embraces the following:
Audit of the economy of administrative activities in accordance with sound administrative
principles, practices, and management policies;
Audit of the efficiency of utilization of human, financial, and other resources, including
examination of information systems, performance measures, and monitoring
arrangements, and procedures followed by audited entities for remedying identified
deficiencies; and
Audit of the effectiveness of performance in relation to the management of the objectives
of the audited entity, and audit of the actual impact of activities compared with the
intended impact.
Comprehensive audit
Comprehensive auditing comprises both financial or regularity audits and performance or
value for money audits. The auditor undertakes to perform a complete examination,
assessment and evaluation of the clients operating systems, resources and outputs in
relation to its establishment.
I)
section 143 of the constitution of the united republic of tanzania (urt) as amended,
requires the cag to among other things:
1. To grant to the treasury credit on the exchequer account;
2. To satisfy himself that all monies appropriated by an act of parliament and disbursed
has been applied for the purpose for which they were appropriated and that the
expenditure conforms to the authority which governs it; and
3. At least once every year to audit and report upon the public accounts of all officers
and authorities of the government of the urt and the accounts of the national
assembly. Thus the controller and controller and controller and auditor general has a
statutory responsibility to ensure observance of the procedures in all matters right
from the stage of levy to the final stage of actual accounting for revenues credited.
4. The cag has also to ensure that the system of internal control is well framed and
properly applied and is adequate to: Ensure an effective check on prompt assessment, collection, and proper
accounting for revenue;
Safeguard against errors and fraud;
Ensure that the regulations and procedures are actually followed with a
reasonable degree of efficiency.

J)

the government accounting system:


The government accounting system has traditionally been designed to satisfy the
requirements for responsibility and accountability roles. It has the following broader
objectives:
To confirm to the electorate and other legal machinery that government activities are
carried in an orderly and satisfactory manner;
To show that the accounting and budgeting systems are intertwined and complementary
to each other;
Designed in such a way that the accounts are kept in such a way that it is possible to
determine the purpose of each and every activity or use of public money;
Designed to facilitate audit by the controller and auditor general and enable him to inform
the electorate on the use of public property;

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Designed to be simple and clear enough to allow sound internal controls to be


administered, promote appraisals, and facilitate both regularity and performance audits;
and
Enable the accounting officer to obtain necessary feedback and input information for
planning future government business.
The exchequer account
This account is kept by bank of tanzania on behalf of the government in the form of a
consolidated fund. The account is credited with government receipts like taxes,
government (bank) borrowings, and interest on government investments, dividend and other
remittances from public institutions, fees, fines, and proceeds on the sale of government
properties, etc.
Section 11 of the pfa, subject to article 135 of the constitution, all revenues or other moneys
raised or received for the purpose of the government ( not being revenues or other moneys
that are payable by or under any law into some other fund established for any specific
purpose or that may, by or under any law , be retained by the authority that received them
for the purpose of defraying the expenses of that authority) shall be paid into or from a
consolidated fund.
Withdrawals are restricted to the vote system, whereby each accounting officer has been
allocated to manage. The accounting officers are then accountable to the executive and the
parliament on the withdrawals made. The votes are compiled together in a government
budget for scrutiny by the parliament before use.
Under section 16(1), subject to article 139 of the constitution, no money shall be withdrawn
from the consolidated fund except upon the authority of a warrant under the hand of the
paymaster general addressed to the accountant general
Section (16) 2 , no warrant shall be issued by the paymaster- general for the purpose of
meeting any expenditure unless a grant of credit sufficient to cover the sum involved has
been issued by the cag and :
o The expenditure has been authorized for the financial year during which the
withdrawals is to take place;
By an appropriation act;
By supplementary appropriation act
By warrant issue under section 21(1) of the pfa

K)
instances where parliamentary control has been infringed as the national assembly
has a prime interest in knowing that the revenue appropriated by it for chosen purposes are
not spent with impunity on other things.
Instances where public officers have failed to make audited accounts available to the
national assembly in accordance with the appropriation law.
Instances of wasteful and uneconomic expenditure or losses due to negligence or
lack of reasonable foresight.
Instances where larger grants or loans have been made to parastatal organizations
and other bodies and there is reason to believe that the proper or best use is not
being made of it by such organizations.
Instances where there is evidence that governments interest in commercial
undertakings has not been properly safeguarded.
Instances where officers have speculated with government funds granted for specific
purposes - e.g. If an officer obtains a government advance to build a house to live in
but instead rents it for self-aggrandizement.
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Accounting errors involving more than shs.100,000/= affecting the appreciation of the
accounts - e.g. Commission of a financial guarantee given by the government to an
institution engaged in commercial activities, etc. Generally, a precise explanation
furnished by the accounting officer in reply to audit queries is given along with the
report to enable the pac/ or respective parliamentary commitee to debate on it
without the need to call for further information. Agreement of accounting officers
whose accounts are being reported upon is obtained as to the accuracy and fairness
of the comments made in the report.
L) the pac/laac committee of the parliament of the united republic of tanzania, which is
charged with the follow-up of audit queries and recommendations made on the accounts
of the government ministries and independent departments. The committee makes its
report to the parliament in a summarized form. The report consist largely of its views on
matters raised in the annual audit report, recommendations for surcharge or disciplinary
proceedings against officers who have failed to carry out their responsibilities, etc. On
receipt of the report of the pac, the treasury takes up implementation of the
recommendations with the accounting officers on the issues mentioned in the report and
then reports back to the pac. Accounting officers are often called to appear in person
before the committee to defend their cases. By doing so, the pac helps to improve the
standard of financial discipline in the country.
M)

the main objective of the report are: To provide assurance to the receiver that the financial activities under his/her
control are satisfactory, and
To get the receiver to make changes to activities where there is room to
improvement.

The reporting of the results of the audit is done during the audit as well as at the end of
the audit.
During the audit: the reporting during the audit contains audit queries, which relate to
transaction errors that require the attention of the auditor that are raised both verbally
and in writing.
At the end of field work: working papers prepared at field are kept in temporary file
and cross-referenced to audit programs and senior auditor reviews the working
papers to ensure that all audit work has been completed and the team has presented
its findings in a neat and readily understandable manner.
Interpreting the results of an audit:
errors: indicate that internal control is weak:
Weakness means the operating systems are poor and/or client staff not
complying or with rules and regulations; or there is intention to defraud, the
auditor should establish exactly what has gone wrong.

Contents of the report:


paragraphs:
(a) scope of audit
(b) review of previous recommendations
(c) summary of important recommendation
(d) matters arising or findings and
(e) Legal obligations & recommendations
Verbal reporting: this includes direct contacts and discussion of the draft with the
auditee.
Final audit report: the final audit report is prepared after the discussion of the draft report
with the auditee. The report is addressed to the most senior executive who can ensure
that the report is acted upon.
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Follow-up of outstanding report: follow-up of issues outstanding is facilitated by an audit


queries register kept by the auditor.
Annual reporting to the president and the parliament: the annual report is drawn from the
summary of important recommendations. The report draws the attention of the causes of the
major weaknesses observed and recommends the means to eradicate errors and frauds. If a
reply has been received, to the audit letter, managements response should be noted in the
annual report. If a reply is awaited, this should otherwise be noted. Only a small portion of
the matters raised during the year find their way into the annual audit report and only those
that are of major importance
N)

please refer to class presentations


key issues
The committee is appointed by the accounting officer
The maximum number of members is 5 and minimum is 3
The members are from amongst senior most employees of the mda or
government institutions department or section
The member from cag and accountant general can be invited as participants
The accounting officer is not a member
The chief accountant and chief internal auditor can attend the meeting as
participants
The main functions includes
o Review of internal auditor work plan
o Review and deliberate on internal auditor findings and progress report
o Undertake investigations
o Ensures vfm of government spending
o Review external auditors report
The tenure of members is five years

Tutorial notes: you can clearly see the difference between this and the one in private sector.
Question 2
A)
value for money can simply be described as getting the best possible combination of
services from the least resources i.e. To maximize the benefits available at the lowest cost. It
is generally taken to mean the pursuit of economy, efficiency and effectiveness.
Economy is a measure of inputs to achieve a certain service
Effectiveness is a measure of outputs e.g. Services and facilities
Efficiency is the optimum of economy and effectives i.e. The measure of outputs
over inputs
Vfm tries to answer the question why and for whom money is being used. Why money is
being used refers to the purpose or the reason to justify expenditure. For whom the money is
being used responds to value received as measured by the utility or satisfaction enjoyed by
a specified user.
Financial data simply shows how much money is involved in a certain specified purpose, but
does not necessarily demonstrate the value received. To be able to demonstrate the extent
of value received, measures of performance must be put in place and somebody must be
entrusted with the management and supervision of the utility or satisfaction to be procured.
whereas
Value for money audits thus refers to the broad-based audit approach which aims at
reviewing and reporting on accountability and responsibility relationships by examining the
underlying activities, and operating and internal control systems employed by the
management in fulfilling its fiduciary responsibility to the user
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Vfma is a process that is super-imposed of accountability and responsibility relationships. It


is carried out to establish whether the government has complied with parliamentary approval
of the budget, and that the audit report is supported by true and fair underlying information.
The audit exercise is done by a professional person who undertakes the responsibility of
reporting to the parliament on the governments execution of the budget to the interest of the
electorate.
B)
the objective of value for money audit is to establish whether management of an
entity has developed appropriate systems and procedures to achieve value for money, i.e.
The extent to which public funds are expended economically and efficiently and the extent to
which the related execution of the budget is effective in meeting publics satisfaction.
The scope of audit in a value for money audit means attesting both the financial and the nonfinancial information, including the actual performance. Any meaningful assessment of value
for money must consider both quantitative and qualitative aspects of the issue on hand. The
issues are examined critically when evaluating accountability (output) of the government and
the assessment of the levels of responsibility (input resources) made available to the
government
The goal is satisfaction or benefit enjoyed by the mandate. The amount of benefit enjoyed is
what is crucial in the determination of the scope of the audit, as the mandate must be
informed unilaterally whether the benefit so enjoyed is in accordance with the approved
resources.
The scope must therefore address the input in terms of financial, human, material, and
management; the methodology in terms of administration and governance, and the output in
terms of the quantity and quality of benefit to be enjoyed, including the intended user of the
benefaction. This makes value for money audit a comprehensive evaluation and assessment
of the use of resources and benefits within wide parameters of the audit, that is, there are no
limits as long as there is room to further improve the delivery of a satisfactory service. In
view of this, value for money audit requires use of relatively large resources of audit, and the
auditor has to posses a multitude of skills relevant to the audit.
The broader scope of value for money audit requires integration of various specialized skills,
from different professions or authorities. In fact, value for money audit was developed out of
a combination of a number of disciplines including accountants, engineers, economists,
statisticians, management specialists, edp specialists, lawyers, social scientists, etc.
Members of the audit team who are not trained accountants require initial exposure on the
use of audit tools such as audit programmes, gathering and documenting audit evidence,
conducting interviews, etc. On the other hand trained accountants and auditors are not
necessarily trained as value for money specialists. It therefore follows that in order to
undertake a comprehensive audit assignment, a careful team is to be selected for the area
of audit from the relevant specialized skills and groomed with the auditors, making the team
members benefit from each others perspective.
The formation of audit teams for value for money audit assignments is both challenging and
rewarding. Each team member is made to learn a new skill to the extent the job can be
done, thus promoting knowledge, improving communication and enhancing credibility and
usefulness of the audit reports.
The auditing process is done in basically three phases: planning; execution; and reporting.
Planning the audit involves the determination of the scope of the audit, the timing, the
objectives, criteria, methodology, and resources to be deployed to ensure that all important
transactions and activities and operating systems are covered by the audit. Execution refers
to the collection, testing, and analysing appropriate audit evidence in terms of quality and
quantity based on the objectives of the audit, criteria, and methodology developed in the
planning phase. The audit will apply appropriate audit procedures for testing and evaluating
existing internal controls; identifying effects of variances from pre-determined benchmarks.

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the use of criteria is crucial it enables the measurement of, or ability to judge, the degree to
which the client has conformed to expectations which were explicitly articulated and
sanctioned. A criteria is a reasonable standard against which management practices and
reporting systems are assessed. Standards can be derived or developed from relevant
sources including technical pronouncements of the relevant profession, government
regulations and directives, relevant literature available, knowledgeable people, and common
sense, that is what a reasonable person would expect of management under the given
circumstances. All parties to the audit should ideally accept the criteria or standard to be
used. However, the criteria or standard require regular revision with a view of changing it to
suit changing circumstances of the audit.
The study on value for money can be analyzed in three ways:
A study of the economy, efficiency and effectiveness with reference to inputs. Inputs
refer to the money or resources used in the production process. The input resources can
be a financial cost or non-financial.
A study of economy, efficiency, and effectiveness with reference to outputs. Outputs
refer to the achievements of the production process as measured by assessment of
objectives realized.
A study of impacts of the use of resources in effecting the planned change. Impact
means the effect of the output results on the achievement of the objectives originally
agreed.
C)

public sector

private sector

(a) it is virtually a statutory requirement to (a) it is not a statutory requirement to undertake


undertake value for money audit through
vfm audit.
the controller and auditor general
(b) a post-audit review exercise is taken
(b) no responsibility for post audit review by
to ensure
that changes have been made
the
auditor. Since vfm is done at the
to improve economy, efficiency, and
request of management the auditors
effectiveness in line with audit
responsibility is discharged through
recommendations made in the audit report. Submission of an acceptable report as
hence it is possible to assess not for profit agreed.
entity using vfm.
(c) profitability is not usually the objective, (c) in a profit oriented organization the
but to provide satisfaction on the use of
operating objectives are expressed in
money
public good or facility.
Terms. The organization and the profit
centres within it can be judged to have
(d) vfm audit can be viewed as an attempt
operated effectively if they have achieved
to establish control over waste,
a target profit within a given period.
unnecessary or excessive spending.
D)
the objective of value for money audit is to provide assurance that the financial,
human, and physical resources entrusted to the government by the parliament, and to
operating officers by the government are being managed in due regard to economy,
efficiency, and effectiveness. The following are the advantages of value for money audit:
For those who confer responsibility, a comprehensive review of the responsibility
conferred (i) improves the accountability process, and provides the means for
measuring the extent to which corrective action has been implemented;
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For those to whom responsibility is delegated, broad systematic reviews of all


significant activities, systems, and controls provides information on their
adequacy and suitability. In addition, suggestion on improvement should promote
the management of the business, and by adopting loyalty to the audit
observations and recommendations, management initiates corrective action on
sub-standard processes, thus improving further the value of the service provided.

Cons:
Requires large number of resources
Not necessarily done annually
Requires multi skill approaches.
E)
audit is a process that is super-imposed of accountability and responsibility
relationships. It is carried out to establish whether the government has complied with
parliamentary approval of the budget, and that the audit report is supported by true and fair
underlying information. The audit exercise is done by a professional person who undertakes
the responsibility of reporting to the parliament on the governments execution of the budget
to the interest of the electorate.
Accountability refers to the obligation of the government to the parliament demonstrating
whether the responsibility conferred has been accomplished according to approved
guidelines with efficiency, economy, (and effectiveness). It is agreed that by accepting a
responsibility, accountability is owed for the actions taken and discharged. A report is to be
availed stating how the responsibility was discharged and to what extent the benefit or
output has been achieved. The output must clearly be understood, including its size or
magnitude required, with well-defined measurable performance indicators. The reporting
process may be regular or intermittent, depending on the directive from the authority.
Economy refers to the amount of resources needed to acquire highest output at lowest cost,
viz. Rising output at constant (or falling) inputs. Emphasis is the control of the input or cost
by keeping it to minimum levels at given levels of output taken as a whole. Hence the auditor
is concerned about the quantity of input. Thus the input is clearly defined.
Efficiency, the auditor is concerned with the quality of output or rising output for a given one
unit of input. Hence the tools of measurement are comparison of the relationships of goods
or services produced with the amount of resources used to produce them. An efficient
operation is one which produces the highest output or return at minimum cost, lesser
resources, or at one unit of input. The input can be defined in terms of financial, material or
time resources, while the output is normally defined in terms of quality or size. The output,
the input, and the methodology or approach are clearly defined.
Effectiveness refers to the achievement of the goals and objectives of the certain operation
or activity. Proponents of effectiveness often ignore the magnitude, size, or quality of input
used to realize the intended objectives. Emphasis is goal realization, at the expense of input.
Hence, too much effort is contemplated with prolonged endurance, as the benefit is not
enjoyed until the goal is accomplished. The output is clearly defined but the input is often
ambiguous.
F)
the audit-planning phase consists of two stages: the overview stage, and the survey
stage.
The overview stage:
A small overview audit team consisting of in most cases of the principal (the leader
of the value for money audit team) and one or two other senior staff is formed to
gather the information necessary to gain a basic understanding of the entity and to
plan the survey. At this point the principal meet with senior management of the audit
entity in order to inform them of the audit and discuss the general audit approach,
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timing, co-ordinating mechanisms, and any other relevant matters. The key to
planning a value for money audit is understanding the audited organization and the
environment in which it operates.
The audit team must gain an understanding of what the entity does and by what
authority it operates, its goals, products and its financial and other resources. At this
stage, the auditor may review matters such as:

Pertinent legislation, internal regulations and publications and orientation


materials,

The relevant external financial legislative or administrative regulations or


directives from relevant authorities,

Any internal or external guidelines managers must follow in their day to day
operations,

The progress made by management on remedial action proposed in previous


audit and other reports,

Minutes of meetings of various committees,

The organization structure and objectives of the audited entity,

The appropriate personnel to contact within the audited entity.


Based on the information collected in the overview stage, the principal prepares a
preliminary analysis to:
Identify lines of audit inquiry i.e. The broad areas to be examined in order to gain an
improved understanding of the entity,
Identify sources of audit criteria for the areas to be examined during the survey stage,
and

Outline survey projects and prepare a plan for the conduct of the survey. This
plan enables a review to be made of the proposed lines of audit inquiry in terms of
relevance, significance and completeness, and enable judgment to be made as to
whether or not the survey will be conducted in a suitable manner. The survey plan also
serves as the basis for allocating staff of the appropriate skills, and for preparation of the
survey time budget.
The survey stage:
The purpose of the survey stage is to explore, in an efficient manner, potentially
significant lines of audit inquiry identified during the overview stage and expand on
the initial knowledge and understanding of accountability relationships and key
management activities, systems and controls. The major sources of information for
conducting the survey include the following:

Internal and published communications of the audited organization;

Interviews with managers of the audited organization;

Documented standards, policies and procedures applicable to key systems


and controls;

Sources for audit criteria identified in the overview stage;

Studies conducted by internal or external evaluation groups; and

Observations for the working environment.


During the survey stage, the auditor should ensure that appropriate audit criteria are
identified and discussed with members of the audited organization. The audit criteria should
posses the following characteristics:

Provide useful benchmarks for assessing management of financial, human


and physical resources, and for determining whether value-for-money is being
achieved;

Provide a means for managers to develop or compare their own management


procedures; and
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Constitute a basis for senior managers to evaluate their systems and


procedures.
The criteria used in audits should be few in number and expressed in non-technical terms to
facilitate communication. Their application should be made with consideration for the
environment in which the entity operates. Having specified audit criteria for assessment of
key management activities, systems and controls, the auditor collects evidence in order to
make a preliminary assessment of their adequacy. The auditor is primarily concerned with
controls to ensure that:

Prescribed standards, policies and practices are adhered to;

Needs of users are met;

Operations are carried out economically and efficiently; and

Reporting is appropriate, accurate, complete and timely.


The preliminary assessment of each control should cover:
Those controls that are well designed and appear to function properly;
Those controls that are either not properly designed or appear not to function
properly, and
Those controls that are desirable but are non-existent.
The auditors preliminary assessment is the basis for:
Determining what matters appear to be significant and may be of a nature that
should be reported; and
Determining the nature extent and timing of further auditing procedures to
substantiate the underlying hypothesis for each matter of potential significance.
The final step in the survey stage is the preparation of the survey report which includes an
outline audit plan. The purpose of the audit plan is to define the overall audit scope in terms
of audit objectives and projects to address those matters that may require attention, to
identify resource requirements, including special skills needed, and to establish overall audit
and project time budgets, milestones or control points and deadlines.
G)
the execution phase consists of conducting tests, evaluating controls and collecting
sufficient and reliable evidence to conclude whether or not the matters identified in the
planning phase as having potential significance are indeed, of significance for reporting
purposes. The conclusions to be drawn relate to an assessment of the results of any
substantive testing of performance, accuracy of information, reliability of the key systems
and controls and the quality of results produced. The execution phase of the audit involves
the following steps:
Preparing a detailed audit plan:
The first step in the execution phase is the preparation of a detailed audit plan. The
plan outlines, by project, the assignments to be undertaken for each audit objective as
approved in the outline audit plan. Each project is planned to conduct tests and gather
audit evidence to accomplish specific audit objectives.
Selecting or preparing detailed audit programs:
An audit program specifies the steps to be performed during the fieldwork portion of an
audit to determine whether the audit criteria are being met. In preparing and using
audit programs, the principal and the project leaders should always relate the cost of
collecting evidence to its value in helping to achieve the audit objectives under
examination.

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Conducting tests and evaluating controls:


The purpose of testing is to gather appropriate audit evidence on the effective or
ineffective functioning of key activities, systems and controls identified in the survey
stage. This type of testing gives the auditor the necessary assurance as to the degree
of compliance with specified audit criteria.
Considering causes and effects:
An important aspect of value for money auditing is the consideration of causes and
effects, i.e. The reasons for and the significance of non-adherence to audit criteria.
However, it is recognized that a precise determination of cause and effect is seldom
feasible since these terms are relative, and the project leaders to ensure that the
evidence supporting the findings and results of the causes and effects analyses are
discussed with appropriate levels of management in the audited organization. The
viewpoint of management must be given due consideration before the reporting phase
of the audit begins.
Developing audit findings, conclusions and recommendations:
After collecting sufficient evidence, project leaders start to draft point form reports on
their projects when most of the fieldwork has been completed. The point form report
indicates the content, the structure of the analysis developed and the findings and
conclusions substantiated in the audit working papers. The formulation of
recommendations involves consideration of the following:

The state of the art;

The circumstances that influence the cause(s); i.e. Factors that restrict
adherence to criteria as well as factors that promote adherence;

Alternative courses for remedial action;

Effects on part, or on the entire entity, both positive and negative, which may
arise if the auditors recommendations are implemented;

The feasibility of implementing the course of action suggested; and

The plausibility and cost-effectiveness.


h)

The key issues are: lack of multi skill personnel in cag office; compromise of economy
for quality; difficulties of measuring effectiveness in public sector.
Other issues:
It is often difficult to assess effectiveness because of the problems of valuing
outputs on a comparable basis. For example, the outputs of a fire brigade can be
measured by the number of call outs to attend a blaze. Do we value it basing on
the amount of losses as a result of the fire or based on other basis?
The objectives of not for profit organizations are also difficult to establish
Because the quality of the service provided will be a significant feature of their service.
For example, a local authority has among its different objectives, to collect all the
waste out of the streets. The effectiveness of this service can only be judged by
establishing what standard or quality of service is required.
Economy can be achieved by sacrificing quality and neither outputs nor impacts
are necessarily measured in terms of quality.
Effectiveness might be difficult to define, measure or may even conflict. For
example, the effectiveness of the health service can be said to have improved if
hospitals have a greater success in treating various illness and other conditions or
if the life expectancy of the population has increased. But this is hardly the case in
tanzania especially.
There can be emphasis for vfm audits and cost control rather than insisting on
achieving more future benefits and value. For example, client management may be

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pressurized into short-term decisions to keep current spending levels within limits
and abandon a capital expenditure plan which could create future benefits.
In profit making organizations efficiency of the organization as a whole can be
measured in terms of return on capital employed or by relating the quality of output
produced which has a market value and therefore a quantifiable financial value of
the resources and their cost required to make the output. On the other hand, not
for profit organizations the output does not have a market value, and it is therefore
more difficult to measure efficiency. In addition, it is difficult to compare the output
of one not for profit organization against another one due to lack of a unified goal
such as profit.
The auditor must understand clearly the operations of the client he/she is
investigating. With shortage of auditors with the necessary skills, qualifications, and
competence and, with the meager audit resources available, vfm audit may fail to
achieve the desired objectives.

Question 3
Answer:
(a)
key ratios derived from the accounts are as follows.
1999
Gross profit percentage
net profit percentage
expenses/sales (%)
Average age of stock (months)
average age of debtors (months)
average age of creditors (months)
current ratio
acid test ratio
bank overdraft/shareholders funds

34.8%
8.74%
26.1%
3.1
2.7
3.2
1.28
0.75
0.89

1998
29.9%
0.81%
29.1%
1.8
2.3
2.4
1.31
0.85
0.72

Sales have increased in 1999 by 106% over 1998. This substantial increase in turnover has
been accompanied by a significant improvement in the gross profit percentage from 29.9%
to 34.9%. Over the same period, liquidity has declined, with the bank overdraft increasing
from tshs20, 700 to tshs86, 100. The increase in stocks and creditors has been financed in
part by this increase, in the bank overdraft. The average age of stock held has increased
significantly, raising the possibility that stocks have been overvalued. The average age of
debtors has also increased, raising the possibility that debtors may be overstated. The
average age of trade creditors has increased which suggests that, provided that cut off is
correct and that there hive not been significant misclassifications of amounts between
account headings, the average settlement period has increased. This delay in settlement
has been used as a source of finance for working capital requirements; presumably,
creditors will not be prepared to allow much more lengthening of the settlement period.
As already mentioned, there is the possibility that stocks have been overvalued. Given also
the absence of a proper system for recording purchases receipts, there could be errors in
the accounts, which go towards explaining the increase in gross profit margin.
Especially since sales have increased so much, it may be that sales vary significantly at
different times of the year. The average age of stocks, debtors and creditors calculated
above have been based on annual sales and cost of sales figures rather than on monthly
figures. It should therefore be borne in mind that the increases in these ratios on a monthly
basis may not be as high as those calculated above.

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(c)

The particular points i would address are set out below.


(i)

Stock values have increase by 229%, and the gross profit percentage has
increased substantially. In considering whether stocks have been
overvalued, i would consider the following.
1. Has the counting of stocks been carried out completely and
accurately? Have all stocks been counted once and once only, and
has the summarization of stocks been computed accurately?
2. Is stock valued at the lower of cost and net realizable value (nrv)?
In order to test for nrv, i would check a sample of stock lines of
significant value to selling prices after the year-end. If items are sold
at less than cost, they should be valued at nrv.
3. Is the recording or obsolete stocks provided against, or otherwise
correctly valued at the lower of cost and net realizable value?
Records of stock movements are probably limited, but the
techniques of enquiry and observation may help to identify any
errors, which may have been made.
4. Are slow moving or obsolete stocks provided against, or otherwise
correctly valued at the low of cost and net realizable value?
Records of stock movements are probably limited, but the
techniques of enquiry and observation may help to identify any
errors, which may have been made.
5. Has sales cut-off been performed correctly, with stock dispatched
before the year-end being included as sales but not in year-end
stocks, and stocks dispatched after the year-end being recorded in
year-end stocks but not in the years sales? I would check a small
sample of dispatches each side of the year-end.
6. In view of the lack of a proper system of recording the date goods
were received.
Has the purchases cut-off been performed
correctly? Goods received before the year-end should be recorded
as purchases in the year, with the invoices either posted to the
purchase ledge before the year-end, or included in the year-end
accruals. I would check a sample of goods received each side of
the year-end to ensure correct treatment, and check the
reconciliation of the statements of major suppliers.
7. The increase in gross profit percentage should be discussed with
management in order to establish if there is any known reason for
the increase. Given the btype of merchandise involced, it would be
unusual for gross profit margins to fluctuate much, anf so we can

Question 4

Obtain an appropriate understanding of the company, its operations and , in


particular , its environmental issues.
Evaluate whether there is any possible risk of misstatement in the financial
statements as a result of environmental issues.

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Enquireof management ot any systems or controls which are in place to


identify risk, evaluate control and account for environmental matters.
Obtain understanding of the control environment operating within the client
Obtain written representation from management on any environmental
matters
Otain evidence from environmental experts where the evidence in relation to
environmental matters is sufficiently persuasive.
Consider minutes oa directors, board committees or environmental officers
Review documentation
Review all assets impairment
Review liabilities and provisions to ensure all have been included
Review contingencies and ensure adequate disclosure
Include environmental issues in the review of appropriateness of going
concern

Obtain representation by management which may take the form of a statement to the
following effect
Management are not aware of any material liabilities or contingencies arising
from environmental matters, including those resulting from illegal or possible
illegal acts.
Managements are not aware of any environmental matters that may have a
material impact on the financial statements.
If aware of such matters, those matters have been properly disclosed in the
financial statements.
The auditor must review the following documents
Publicly available industry information on environmental matters
Reports issued by environmental experts about the entity
Internal audit reports
Environmental expert reports (if any)
Reports on due diligence investigations
Reports on or to regulatory agencies
Correspondence with lawyers
Correspondence with enforcement agencies.
Question 5
1 (a) internal audit function: risk of fraud and error
(i) the internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of the risks
to which the entity is subject that would prevent it achieving its overall objectives such as
profitability. Corporate governance objectives also include the overarching need for the
management of an entity to exercise a stewardship function over the entitys assets.
(ii) a large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the business
as a whole, and in relation to specific areas, include the effective operation of an internal
audit function.
(iii) internal audit can help management manage risks in relation to fraud and error,
and exercise proper stewardship by:
1. Commenting on the process used by management to identify and classify
the specific fraud and error risks to which the entity is subject (and in some cases
helping management develop and implement that process);

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2. Commenting on the appropriateness and effectiveness of actions taken by


management to manage the risks identified (and in some cases helping management
develop appropriate actions by making recommendations);
3. Periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
4. Monitoring the incidence of fraud and error, investigating serious cases and
making recommendations for appropriate management responses.
(iv) in practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and reporting of
fraud and error. Routine internal controls (such as the controls over computer systems
and the production of routine financial information) and non-routine controls (such as
controls over year-end adjustments to the financial statements) are relevant.
(v) it should be recognized however that many significant frauds bypass normal
internal control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be reviewed
by internal audit in order to establish the nature of the risks, and to manage them effectively.
(b) external auditors: fraud and error in an audit of financial statements
(i) external auditors are required by isa 240 the auditors responsibility to consider
fraud in an audit of financial statements to consider the risks of material misstatements in the
financial statements due to fraud. Their audit procedures will then be based on a risk
assessment. Regardless of the risk assessment, auditors are required to be alert to the
possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entitys financial statements to material misstatements due to fraud.
(ii) auditors should make enquiries of management regarding managements
assessment of fraud risk, its process for dealing with risk, and its communications with those
charged with governance and employees. They should enquire of those charged with
governance about the oversight process.
(iii) auditors should also enquire of management and those charged with governance
about any suspected or actual instance of fraud.
(iv) auditors should consider fraud risk factors, unusual or unexpected relationships,
and assess the risk of misstatements due to fraud, identifying any significant risks. Auditors
should evaluate the design of relevant internal controls, and determine whether they have
been implemented.
(v) auditors should determine an overall response to the assessed risk of material
misstatements due to fraud and develop appropriate audit procedures, including testing
certain journal entries, reviewing estimates for bias, and obtaining an understanding of the
business rationale of significant transactions outside the normal course of business.
Appropriate management representations should be obtained.
(vi) auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than internal
auditors to small frauds (and errors), although they must always consider whether evidence
of single instances of fraud (or error) are indicative of more systematic problems.
(vii) it is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with isas might not detect a material misstatement in the financial
statements arising from fraud. In practice, routine errors are much easier to detect than
frauds.
(viii) where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve further

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investigations. They should also consider the need to report to management and those
charged with governance.
(ix) where serious frauds (or errors) are encountered, auditors need also to consider
the effect on the going concern status of the entity, and the possible need to report externally
to third parties, either in the public interest, for national security reasons, or for regulatory
reasons. Many entities in the financial services sector are subject to this type of regulatory
Reporting and many countries have legislation relating to the reporting of money laundering
activities, for example.
(c) nature of risks arising from fraud and error: kilimanjaro ltd
(i) kilimanjaro ltd is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the information
produced may be incomplete or incorrect. Inadequate controls also give rise to the risk of
fraud by those who understand the system and are able to manipulate it in order to hide the
Misappropriation of assets such as receipts from customers.
(ii) all networked systems are also subject to the risk of error because of the
possibility of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
(iii) all entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they may
misappropriate those assets (fraud) and then seek to hide the error or fraud by falsifying the
records.
(iv) kilimanjaro ltd is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card companies may
be liable for such frauds, attempts to use stolen cards can cause considerable
inconvenience.
(v) there is a risk of fraud perpetrated by senior management who might seek to
lower the amount of money payable to the central fund (and the companys tax liability) by
falsifying the companys sales figures, particularly if a large proportion of holidays are paid
for in cash.
(vi) there is a risk that staff may seek to maximize the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.
Question 7
(e)

Isa auditors report on financial statements suggests that the auditors may need to
qualify their audit opinion under one of two main circumstances:
(iii)

Limitation in scope of the auditors examination; and

(iv)

Disagreement with the treatment or disclosure of a matter in the financial


statements (including inherent uncertainties).

For both circumstances there can be two levels of qualified opinion:


(iii)

Material but not fundamental, where the circumstances prompting the uncertainty or
disagreement is material but confined to one particular aspect of the financial
statements, so that is does not affect their overall value to any potential user;

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(iv)

The more serious qualification where the extent of the uncertainty or disagreement is
such that it will fundamental to the overall view shown by the financial statements, i.e.
The financial statements are or could be misleading.

The general form of qualification appropriate to each potential situation may be seen by the
following table. (audit qualification table- make sure its on your finger tip)
Material but not
Circumstance
Limitation of scope
Disagreement
(f)

fundamental
except formight
except for

fundamental
disclaimer of opinion
adverse opinion

Whether a qualification of the audit opinion would be required in relation to either of


the two circumstance described in the question would depend on whether or not the
auditors considered either of them to be material. An item is likely to be considered
as material in the context of a companys financial statements if its omission,
misstatement or non-disclosure would prevent a proper understanding of those
statements on the part of a potential user. Whilst for some audit purposes materiality
will be considered in absolute terms. More often than not it will be considered as a
relative term.
(iii)

Loss of records relating to direct labour costs for assets in the course of
construction
The loss of records supporting one of the asset figures in the balance sheet
would cause a limitation in scope of the auditors work. The tshs.10,000/=,
which is the value covered by the lost records, represents 29.4% of the
expenditure incurred during the year on assets in course of construction but
only 6% of total additions to fixed assets during the year and 1.5% of the year
end net book value for fixed assets. The total amount of tshs.10,000/=
represents 10% of pre-tax profit but, as in relation to asset values. The real
consideration by the auditors should be the materiality of any over-or understatement of assets resulting from error in arriving at the tshs.10,000/= rather
than the total figure itself.
Provides there are no suspicious circumstances surrounding the loss of these
records and the total figure for additions to assets in the course of
construction seems reasonable in the light of other audit evidence obtained,
then it is unlikely that this matter would be seen as sufficiently material to
merit any qualification of the audit opinion. If other records have been lost as
well, however, it may be necessary for the auditors to comment on the
directors failure to maintain proper books and records.

(iv)

Government grant credited in total to profit and loss account


The situation here is one of disagreement, since best accounting practice, as
laid down by ias 20, requires that capital-based grants should be credited to
the profit and loss account over the useful like of the asset to which they
relate.
This departure from ias 20 does not seem to be justifiable and would be
material to the reported pre-tax profits for the year, representing as it does
22.5% of that figure.

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Whilst this overstatement of profit (and corresponding understatement of


undistributable reserves) would be material to the financial statements, it is
not likely to be seen as fundamental and therefore an except for qualified
opinion would be appropriate.
(g)

Qualified audit report extract


as explained in note.government grants in respect of new plant and equipment have
been credited in full to profits instead of being spread over the lives of the relevant
assets as required by statement of standard accounting practice 4; the effect of so doing
has been to increase profits before and after tax for the year by tshs.22,500/=
except for.

(h)

The auditors general responsibility with regard to the statement in the directors
report concerning the valuation of land and buildings is to satisfy themselves that this
is consistent with the treatment and disclosure of this item in the audited financial
statements. If the auditors are not satisfied on the question of consistency then an
appropriate opinion will be required following their audit report.

Test for standard class


Instructions
1.
Time allowed 3 hours
2.
The examination paper contains eight questions, attempt any six
3.
Marks will be given for clarity of language and logic of expression to
question

every

Question 1
(a) explain the auditors responsibilities in respect of subsequent events.
(b) you are the audit manager of jinack co, a private limited liability company. You are
currently reviewing two matters that have been left for your attention on the audit working
paper file for the year ended 30 september 2005:
(i) jinack holds an extensive range of inventory and keeps perpetual inventory records. There
was no full physical inventory count at 30 september 2005 as a system of continuous stock
checking is operated by warehouse personnel under the supervision of an internal audit
department.
A major systems failure in october 2005 caused the perpetual inventory records to be
corrupted before the year-end inventory position was determined. As data recovery
procedures were found to be inadequate, jinack is reconstructing the year-end quantities
through a physical count and rollback. The reconstruction exercise is expected to be
completed in january 2006. (6 marks)
(ii) audit work on after-date bank transactions identified a transfer of cash from batik co. The
audit senior has documented that the finance director explained that batik commenced
trading on 7 october 2005, after being set up as a wholly-owned foreign subsidiary of jinack.
No other evidence has been obtained (4 marks)
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Required:
Identify and comment on the implications of the above matters for the auditors report on the
financial statements of jinack co for the year ended 30 september 2005 and, where
appropriate, the year ending 30 september 2006.
Question 2
according to isa 200, irrespective of whether an audit is being conducted in the private or
public sector, the basic principles of auditing remain the same. What may differ for audits
carried out in the public sector is the audit objective and scope. These factors are often
attributable to differences in the audit mandate and legal requirements or the form of
reporting (for example, public sector entities may be required to prepare additional financial
reports).
required
(o) List and describe 10 main elements of public sector entities which make it different
from the private sector
(p) Describe the power, functions and duties of the cag
(q) What are the control aspects of the cag?
(r) Discuss four factors which affects the independence of the cag
(s) Describe three categories of public sector audit in tanzania
(t) What are the main audit procedures to be adopted in audit of vat?
(u) List and describes main issues and factors which the cag normally investigates in
order to satisfy himself as to proper accountability of regularity and processes of
public spending. What are the key documents investigated as per section 25 of
public finance act.
(v) Describe the regularity, performance public sector audits
(w) Discuss the functions of cag in accordance with section 143 of the constitution
(x) Describe main features of government accounting system
(y) Describe the main issues which are included in cag final report to the president and
the parliament.
(z) Discuss the roles, functions and powers of pac and laac.
(aa) Describe the reporting process in public sector audit.
(bb) What is the role, composition and functions of public sector audit committees as per
regulation 28 of public finance act.
Question 3
Nabaki africa ltd (na) main activity is the extraction and supply of building materials including
sand, gravel, cement and similar aggregates. The companys year end is 31 may and your
firm has audited na for a number of years.
The main asset on the balance sheet relates to non current assets. A junior member of staff
has attempted to prepare the non-current asset note for the financial statements. The note
has not been reviewed by the senior accountant and so may contain errors.

Cost
1 june 2005
Additions
Disposals
31 may 2006

Land and
buildings
Shs 000
100,000
10,000
-110,000

Plant
and
machinery
Shs 000
875,000
125,000
(100,000)
900,000

Motor
vehicles
Shs 000
1,500,000
525,000
(325,000)
1,700,000

Railway
trucks
Shs 000
-995,00
-995,000

Total
Shs 000
2,475,000
1,655,000
(425,000)
3,705,000

Depreciation
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1st june 2005


Charge
Disposal
31 may 2006
Net book value
31 may 2006
Net book value
31 may 2005

60,000
2,200
-62,200

550,000
180,000
(120,000)
610,000

750,000
425,000
(325,000)
850,000

-199,000
-199,000

1,360,000
806,200
(445,000)
1,721,200

47,800

290,000

850,000

796,000

1,983,800

40,000

325,000

750,000

--

1,115,000

land and buildings relate to company offices and land for those offices.
plant and machinery includes extraction equipment such as diggers and dumper trucks
used to extract sand and gravel etc.
motor vehicles include large trucks to transport the sand, gravel etc.
railway trucks relate to containers used to transport sand and gravel over long distances
on the railway network.
Depreciation rates stated in the financial statements are all based on cost and calculated
using the straight line basis.
The rates are:
Land and buildings
2%
Plant and machinery 20%
Motor vehicles
33%
Railway trucks
20%
Disposals in the motor vehicles category relates to vehicles which were five years old.
Required:
(a) list the audit work you should perform on railway trucks. (10 marks)
(b) you have just completed your analytical procedures of the non-current assets note.
Required:
(i) excluding railway trucks, identify and explain any issues with the non-current asset note to
raise with management.
(ii) explain how each issue could be resolved. (10 marks)
Note: you do not need to re-cast the schedule.
Question 4
The auditor is accountable to those who appointed her of his conduct while making his report
on the audit .she has to assess whether management to the entity has carried out its
fiduciary responsibility in a manner acceptable to owners the business and to improve the
accountability in the manner acceptable to the owners of the business.
Required
Write short notes on the following
i.
Re kingston cotton mill (1896) case
ii.
Duty of due care and skills
iii.
Contemporary audit practice
iv.
Liability, performance and standards expectation gaps
v.
Auditor duty of confidentiality
vi.
Peer review
vii.
Audit risk minimization strategies
viii.
Quality control
ix.
Professional skepticism
x.
Professional indemnity insurance
Question 5

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Client confidentiality underpins the relationship between certified public accountants (t) in
practice and their clients.
It is a core element of nbaas rules of professional conduct.

Required:
(a) explain the circumstances in which nbaas rules of professional conduct permit or require
external auditors to disclose information relating to their clients to third parties without the
knowledge or consent of the client. (4 marks)
(b) a waste disposal company has breached tax regulations, environmental regulations and
health and safety regulations. The auditor has been approached by the tax authorities, the
government body supervising the award of licences to such companies and a trade union
representative. All of them have asked the auditor to provide them with information about the
company. The auditor has also been approached by the police. They are investigating a
suspected fraud perpetrated by the managing director of the company and they wish to ask
the auditor certain questions about him.
Required:
Describe how the auditor should respond to these types of request. (6 marks)
( c) the objectivity of the external auditor may be threatened or appear to be threatened
where:
(i) there is undue dependence on any audit client or group of clients;
(ii) the firm, its partners or staff have any financial interest in an
audit client;
(iii) there are families or other close personal or business relationships
between the firm, its partners or staff and the audit client;
(iv) the firm provides other services to audit clients.
Required:
(a) for each of the four examples given above, explain why the objectivity of
the external auditor may be threatened, or appear to be threatened, and
why the threat is important. (6 marks)
(b) describe nbaas requirements that reduce the threats to auditor
objectivity for each of the four examples given above. (4 marks)
Question 6
An early textbook on auditing outlined the objective of an audit as follows:
4. The detection of fraud
5. The detection of technical errors
6. The detection of errors of principle
Required:
e.
Contract this early of auditing with the objectives and nature of the modern
statutory audit of a limited company as we know today.
f.
State why the objective and nature of auditing have changed.
g.
Show ho the audit work necessary to detect fraud or technical errors differs from
the work required to carry out a statutory audit of a limited company with an
adequate system of internal control.
h.
Briefly describe the action you would take if, during a statutory audit , your tests
reveal that :
i.
The cashier has misappropriated some tshs.400, 000 form the
petty cash fund.
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ii.

The managing director has over a period of years overstated


stocks by increasing amounts with the admitted aim of overstating
profits to keep the shareholders happy.

Question 7
You are auditing friendship textile ltd, a textile manufacturing company in dar es salaam. In
due course of your audit it has been realized that the client may have environmental issues
which could have an impact on the financial statements.
Required
(a)
what do you understand by the term environmental auditing?
(b)
describe any four environmental matters which could have impact on financial
statements
(b)
discuss major steps you would take in order to obtain the appropriate evidence.
Question 8
Write short notes on the following:(a)
Audit committees in public and private sector
(b)
Good corporate governance practices
(c)
Complex audit situation
(d)
Management audit
(e)
Audit of assets and liabilities
(f)
Computer assisted audit techniques
(g)
Audit documentation
(h)
Forensic auditing
(i)
Audit charter

Question 1
(a) auditors responsibilities for subsequent events
auditors must consider the effect of subsequent events on:
the financial statements;
the auditors report.
subsequent events are all events occurring after a period end (i.e. Reporting date) i.e.:
events after the balance sheet date (as defined in frs 21); and
events after the financial statements have been issued.
Events occurring up to date of auditors report

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the auditor is responsible for carrying out procedures designed to obtain sufficient
appropriate audit evidence that all events up to the date of the auditors report that may
require adjustment of, or disclosure in, the financial statements have been identified.
these procedures are in addition to those applied to specific transactions occurring after
the period end that provide audit evidence of period-end account balances (e.g. Stock cut-off
and receipts from trade debtors). Such procedures should ordinarily include:
reviewing minutes of board/audit committee meetings;
scrutinising latest interim financial statements/budgets/cash flows, etc;
making/extending inquiries to legal advisors on litigation matters;
inquiring of management whether any subsequent events have occurred that might affect
the financial statements (e.g. Commitments entered into).
when the auditor becomes aware of events that materially affect the financial statements,
the auditor must consider whether they have been properly accounted for and adequately
disclosed in the financial statements.
Subsequent events discovered after the date of the auditors report but before financial
statements are issued
Tutorial note: after the date of the auditors report it is managements responsibility to inform
the auditor of facts which may affect the financial statements.
if the auditor becomes aware of such facts which may materially affect the financial
statements, the auditor:
considers whether the financial statements need amendment;
discusses the matter with management; and
takes appropriate action (e.g. Audit any amendments to the financial statements and issue
a new auditors report).
if management does not amend the financial statements (where the auditor believes they
need to be amended) and the auditors report has not been released to the entity, the auditor
should express a qualified opinion or an adverse opinion (as appropriate).
if the auditors report has been released to the entity, the auditor must notify those charged
with governance not to issue the financial statements (and the auditors report thereon) to
third parties.
Tutorial note: the auditor would seek legal advice if the financial statements and auditors
report were subsequently issued.
Subsequent events discovered after the financial statements have been issued
the auditor has no obligation to make any inquiry regarding financial statements that have
been issued.
however, if the auditor becomes aware of a fact which existed at the date of the auditors
report and which, if known at that date, may have caused the auditors report to be qualified,
the auditor should:
consider whether the financial statements need revision;
discuss the matter with management; and
take appropriate action (e.g. Issuing a new report on revised financial statements).
(b) implications for the auditors report
(i) corruption of perpetual stock records
the loss of data (of physical stock quantities at the balance sheet date) gives rise to a
limitation of scope.
Tutorial note: it is the records of the asset that have been destroyed not the physical asset.
the systems failure in october 2005 is clearly a non-adjusting post balance sheet event (frs
21). If it is material (such that non-disclosure could influence the economic decisions of
users) jinack should disclose:
the nature of the event (i.e. Systems failure); and
an estimate of its financial effect (i.e. The cost of disruption and reconstruction of data to
the extent that it is
Not covered by insurance).
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Tutorial note: the event has no financial effect on the realisability of stock, only on its
measurement for the
Purpose of reporting it in the financial statements.
if material this disclosure could be made in the context of explaining how stock has been
estimated at
30 september 2005 (see later). If such disclosure, that the auditor considers to be
necessary, is not made, the audit opinion should be qualified except for disagreement (over
lack of disclosure).
Tutorial note: such qualifications are extremely rare since management should be persuaded
to make necessary
Disclosure in the notes to the financial statements rather than have users attention drawn to
the matter through a qualification of the audit opinion.
the limitation of scope of the auditors work has been imposed by circumstances. Jinacks
accounting records (for stock) are inadequate (non-existent) for the auditor to perform tests
on them.
an alternative procedure to obtain sufficient appropriate audit evidence of stock quantities
at a year end is
Subsequent count and rollback. However, the extent of roll back testing is limited as
records are still under
Reconstruction.
the auditor may be able to obtain sufficient evidence that there is no material misstatement
through a combination of procedures:
testing managements controls over counting stock after the balance sheet date and
recording stock
Movements (e.g. Sales and goods received);
reperforming the reconstruction for significant items on a sample basis;
analytical procedures such as a review of profit margins by stock category.
an extensive range of stock is clearly material. The matter (i.e. Systems failure) is not
however pervasive, as only stock is affected.
unless the reconstruction is substantially completed (i.e. Stock items not accounted for are
insignificant) the auditor cannot determine what adjustment, if any, might be determined to
be necessary. The auditors report should then be qualified, except for, limitation of scope.
however, if sufficient evidence is obtained the auditors report should be unqualified.
an explanatory paragraph would not be appropriate because this matter is not one of
significant uncertainty.
Tutorial note: an uncertainty in this context is a matter whose outcome depends on future
actions or events not under the direct control of jinack.
if the 2005 auditors report is qualified except for on grounds of limitation of scope there
are two possibilities for the stock figure as at 30 september 2005 determined on completion
of the reconstruction exercise:
(1) it is not materially different from the stock figure reported; or
(2) it is materially different.
in (1), with the limitation now removed, the need for qualification is removed and the 2006
auditors report wouldbe unqualified (in respect of this matter).
in (2) the opening position should be restated and the comparatives adjusted in
accordance with frs 3 reporting financial performance. The 2006 auditors report would
again be unqualified.
Tutorial note: if the error was not corrected in accordance with frs 3 it would be a different
matter and the
Auditors report would be qualified (except for) disagreement on accounting treatment.
(ii) wholly-owned foreign subsidiary

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the cash transfer is a non-adjusting post balance sheet event. It indicates that batik was
trading after the balance sheet date. However, that does not preclude batik having
commenced trading before the year end.
the finance directors oral representation is wholly insufficient evidence with regard to the
existence (or otherwise)of batik at 30 september 2005. If it existed at the balance sheet date
its financial statements should have been consolidated (unless immaterial).
the lack of evidence that might reasonably be expected to be available (e.g. Legal papers,
registration payments, etc) suggests a limitation of the scope of the audit.
if such evidence has been sought but not obtained then the limitation is imposed by the
entity (rather than by circumstances).
whilst the transaction itself may not be material, the information concerning the existence
of batik may be material
To users and should therefore be disclosed (as a non-adjusting event). The absence of such
disclosure, if the auditor considered necessary, would result in a qualified (except for)
opinion.
Tutorial note: any matter that is considered sufficiently material to be worthy of disclosure as
a non-adjusting
Event must result in such a qualified opinion if the disclosure is not made.
if batik existed at the balance sheet date and had material assets and liabilities then its
non-consolidation would have a pervasive effect. This would warrant an adverse opinion.
also, the nature of the limitation (being imposed by the entity) could have a pervasive
effect if the auditor is suspicious that other audit evidence has been withheld. In this case the
auditor should disclaim an opinion.

Question 2
(a) the two elements of public sector audit are purpose and process. Purpose refers to
the formation of the opinion on an account under examination, while process refers to the
exercise of arriving to the opinion on the account under examination.
Purpose: in performing the audit, the auditor provides a service in the form of assurances to
users of the accounts i.e. Central government, local government, independent department,
taxpayer, and the public at large to the extent of the expression of the auditors opinion.
Process: in the recent past the role of the external auditor has expanded extensively with the
assumption of the responsibility for appraising, and reporting on, the extent to which the
value for money is secured from a specific expenditure of public funds. Main elements of
public sector audit are purpose and process list and describe 10 main elements of public
sector entities which make it different from the private sector
Other elements
Accounts are not major issues
Parliament have dual role
The audit mandate is derived from constitution
The auditor is permanent (cag) but differs in person
Budget forms major part of audit work
Coordinated and executed by sai
Applies the intosai standards
Tutorial note: the question asks about 10 elements, but all of them are embodied on the two
key elements i.e. Purpose and process.

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(b)

status (section 26 of the pfa)


Authority for the creation of the office of the head of national audit services.
The process for the appointment of a cag and for his/her removal from office.
Constitutional position of the cag, means by which independence is secured, and
standing of the cag in relation to other public officers.

Relationship with parliament, other representative body or supreme authority.

Arrangement for remunerating the cag.

Functions (section 31 of the public finance act)


The activities, basis, and nature of duties.
Authority to examine and certify national fund accounts; revenue accounts,
government accounts, and any associated/trading and/or commercial accounts, and
stock and stores and stock accounts
Authority to undertake regularity function to check that expenditure is applied for the
purpose approved and that it conforms to the authority which governs it;
Authority to examine whether value for money is obtained in the use of public
resources, including extension of such an examination to the accounts for which the
cag is ordinarily not authorised to certify;
Basis for reporting the results of an audit including reporting such subjects like fraud,
corruption, losses, irregularities, and how the report shall be issued and the
circumstances in a report must be issued with an audit certificate;
The extent to which regard is given to proposals made by a public accounts
committee or a similar body;
A duty to hear objections to or to answer requests for explanations of accounts e.g
for a member of the public and to hold an extra ordinary audit;
A provision for a legal action against an auditor improperly disclosing information
obtained during the course of an audit.
Powers (section 32 of public finance act)
Call upon any public officer for any explanation and information, which the cag may
require in order to enable him to perform his functions.
Summon and examine on oath any person as he may determine in connection with
eh receipt or expenditure of public moneys or the receipt or issue of any public
property affected by provision of the public finance act.
Provision delegation of all or some of the functions of the cag to principal officers;
The appointment of staff and provision for determining their pay and conditions of
service;
The right to employ auditors from outside the office reporting to the cag;
Arrangements for funding the office of the cag and the circumstances the charging of
audit fees is authorized;
Provision for the audit of annual accounts of the cags office, and whether this
includes value for money examinations
Right of access to papers, to obtain explanations and information with reference to
any restrictions, any special procedures relating to material bearing a security
classification;
Remedial action where access is denied or information withheld;
Discretion to decide the nature, timing, and extent of audit functions and of reports.
Tutorial notes: always the powers relates to the functions and duties for this purpose. The
status has been added for purpose of additional revision.

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C) section (16) 2 , no warrant shall be issued by the paymaster- general for the purpose of
meeting any expenditure unless a grant of credit sufficient to cover the sum involved has
been issued by the cag and :
o The expenditure has been authorized for the financial year during which the
withdrawals is to take place;
By an appropriation act;
By supplementary appropriation act
By warrant issue under section 21(1) of the pfa
Tutorial notes : the cag is both the controller and auditor general because he is the one who
grants exchequer credit transfer to meet any government expenditure.
D) despite the requirement for the auditor becoming independent, various factors such as
ineffective legislature, bad vices such as corruption, and political, economic, and social
influences may affect the impact of audit findings. In these circumstances complete
independence is unrealistic
Tutorial notes: the question does not conclude that cag is independent but these are
challenges to cag independence.
E)

the audits of the government sector consist of three main areas:


4. Fiscal audit
5. Audit of corporation and other taxes
6. Audit of value added tax (formerly customs and sales tax).

Fiscal audits: fiscal audit refers to the examination of such areas as expenditures/payment of
moneys, payroll and other allowances, salary advances, allowances, cash imprest, goods
and services, postage, telephone, deposits, appropriation accounts, etc. The audit report in
this audit is addressed to the officer responsible for the expenditure incurred who are
normally the permanent secretary, regional directors and heads of independent departments
or chairman of the board of directors. The main objectives of the report is two fold:
To provide assurance to the receiver that the financial activities under his/her control
are satisfactory; or
To get the receiver to make changes to activities where there is room for
improvement.
Audit tool
Audit tools include public finance act no.6 of 2001, treasury circulars. The audit clients
include ministries, independent departments, regional development directorates, urban and
district councils, and all government-funded entities.
Audit of corporation and other taxes: the general objective of the audit of the income tax
department is to ensure that the revenue collected from corporation and other income taxes
are properly accounted for. In particular, the specific objectives are to ensure that
Mandatory tax laws are properly applied in ascertaining the total income of persons
liable to pay tax;
There are adequate safeguards, controls, and procedures for ensuring an effective
check on the assessment, collection, and proper allocation of taxes, and that such
safeguards, controls, and procedures are actually being implemented;
In general the departmental organization is sufficiently safeguarded against errors,
omissions, and frauds, and that there is no wilful omission or negligence to collect
taxes;

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Instructions or circulars issued by the minister for finance and commissioner of


income taxes are being followed by the field officers and are in accordance with the
law;
All relevant registers prescribed to be kept are dully and properly maintained.
Audit of value added tax and other related taxes: this type of audit involves examination of
the following areas imports and exports, postal parcels, airports, bonded goods, oil
installations and refineries, transit goods, ships files, withholding taxes. The value added tax
department is responsible for the collection of about ??% of the total tax revenues. This
means it is a vital area of audit and the auditor is expected to exercise great enthusiasm
while examining the records.
F)

audit of value added and other taxes can be done in two stages. These stages are:3. Scrutiny of correct import and export documents in the customs houses and entry
points involving a general review of transactions and a detailed examination of
samples.
4. Audit of the ships files and transit and trans-shipment documents to see that the
department has accounted for satisfactorily for all the goods which enter or leave
the port/airport. Verification of the ships manifest should enable the auditor to
ensure that:
All the goods delivered /landed at the port have been assessed for duty;
The assessment has been properly done;
The duty has been collected and credited to the exchequer;
Where no duty has been levied, the goods have been otherwise accounted
for satisfactorily.
G) section 31(2) of the public finance act requires the cag, in addition to satisfying himself
as to the matters specified in that behalf in the constitution and any other written law, to
satisfy himself that: f. All accounts
i. Section 25(1); a balance sheet showing the assets and liabilities of the
consolidated fund
ii. A statement of the source and application of funds for the
consolidated fund showing revenues, expenditures and financing of
the fund for the year
iii. A summary statement of revenue and expenditure, being a summary
of all the statements signed by accounting officers under subsection
2(a) and (2) (c) of this section
iv. A statement of the amounts outstanding at the end of the year in
resprct of the public debt
v. A statement of the amounts guaranteed by the government at the end
of the financial year in respect of bank overdrafts, loans, public loan
issues and other contingent liabilities
vi. A statement of the amount outstanding at the end of the year in
respect of the loans issued by the government
vii. A summary of statement of arrears of revenue for each revenue head
being a summary of the statements of arrears of revenue signed by
accounting officers.
viii. A summary statement of commitments outstanding for the supply of
goods and services for each vote at the end of the financial year being
a summary of the amount included for such commitments in the
statement signed by accounting officers under subsection (2) (b)

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ix. Summary of statement of stores and other assets for each vote being
a summary of the statements of assets signed by the accountings
officers under subsection ( 2) (e) above
x. Such other statements and in such for as the national assembly may
from time to time require.
g. All reasonable precautions have been taken to safeguard
i. Collection of revenue
ii. The receipt and custody, disposal , issue and proper use of the public
property, and that the law, directions and instructions applicable
thereto have been duly observed.
h. All expenditures of public monies has been properly authorixed and applied to
the purposes for which they were appropriated and the law, directions and
instructions applicable thereto have been duly observed.
i. All expenditure of public monies has been properly authorized and applied to
the purposes for which they were appropriated and that the law, directions
and instructions applicable thereto have been duly observed and provide an
effective check of the assessment and collection of revenue
j. Economy , efficiency and effectiveness have been achieved in the use of the
public moneys resources.
H)

regularity audit, performance audit, and comprehensive audit


Regularity audit
Regularity audit embraces the following:
Attestation of financial accountability of accountable entities, involving examination and
evaluation of financial records and expression of opinion on financial statements;
Attestation of financial accountability of the government administration as a whole;
Audit of financial statements;
Audit of financial systems and transactions including an evaluation of compliance with
applicable statutes and regulations;
Audit of internal controls and internal audit functions;
Audit of the probity and propriety of administrative decisions taken within the audited
entity, and
reporting of any other matters arising from or relating to the audit that the sai considers
should be disclosed.

Performance audits
Performance auditing is concerned with the audit of the economy, efficiency, and
effectiveness. It embraces the following:
Audit of the economy of administrative activities in accordance with sound administrative
principles, practices, and management policies;
Audit of the efficiency of utilization of human, financial, and other resources, including
examination of information systems, performance measures, and monitoring
arrangements, and procedures followed by audited entities for remedying identified
deficiencies; and
Audit of the effectiveness of performance in relation to the management of the objectives
of the audited entity, and audit of the actual impact of activities compared with the
intended impact.
Comprehensive audit
Comprehensive auditing comprises both financial or regularity audits and performance or
value for money audits. The auditor undertakes to perform a complete examination,
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assessment and evaluation of the clients operating systems, resources and outputs in
relation to its establishment.
I)
section 143 of the constitution of the united republic of tanzania (urt) as amended,
requires the cag to among other things:
5. To grant to the treasury credit on the exchequer account;
6. To satisfy himself that all monies appropriated by an act of parliament and disbursed has
been applied for the purpose for which they were appropriated and that the expenditure
conforms to the authority which governs it; and
7. At least once every year to audit and report upon the public accounts of all officers and
authorities of the government of the urt and the accounts of the national assembly. Thus
the controller and controller and controller and auditor general has a statutory
responsibility to ensure observance of the procedures in all matters right from the stage
of levy to the final stage of actual accounting for revenues credited.
8. The cag has also to ensure that the system of internal control is well framed and properly
applied and is adequate to: Ensure an effective check on prompt assessment, collection, and proper
accounting for revenue;
Safeguard against errors and fraud;
Ensure that the regulations and procedures are actually followed with a
reasonable degree of efficiency.

J)

the government accounting system:


The government accounting system has traditionally been designed to satisfy the
requirements for responsibility and accountability roles. It has the following broader
objectives:
To confirm to the electorate and other legal machinery that government activities are
carried in an orderly and satisfactory manner;
To show that the accounting and budgeting systems are intertwined and complementary
to each other;
Designed in such a way that the accounts are kept in such a way that it is possible to
determine the purpose of each and every activity or use of public money;
Designed to facilitate audit by the controller and auditor general and enable him to inform
the electorate on the use of public property;
Designed to be simple and clear enough to allow sound internal controls to be
administered, promote appraisals, and facilitate both regularity and performance audits;
and
Enable the accounting officer to obtain necessary feedback and input information for
planning future government business.

The exchequer account


This account is kept by bank of tanzania on behalf of the government in the form of a
consolidated fund. The account is credited with government receipts like taxes,
government (bank) borrowings, and interest on government investments, dividend and other
remittances from public institutions, fees, fines, and proceeds on the sale of government
properties, etc.
Section 11 of the pfa, subject to article 135 of the constitution, all revenues or other moneys
raised or received for the purpose of the government ( not being revenues or other moneys
that are payable by or under any law into some other fund established for any specific
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purpose or that may, by or under any law , be retained by the authority that received them
for the purpose of defraying the expenses of that authority) shall be paid into or from a
consolidated fund.
Withdrawals are restricted to the vote system, whereby each accounting officer has been
allocated to manage. The accounting officers are then accountable to the executive and the
parliament on the withdrawals made. The votes are compiled together in a government
budget for scrutiny by the parliament before use.
Under section 16(1), subject to article 139 of the constitution, no money shall be withdrawn
from the consolidated fund except upon the authority of a warrant under the hand of the
paymaster general addressed to the accountant general
Section (16) 2 , no warrant shall be issued by the paymaster- general for the purpose of
meeting any expenditure unless a grant of credit sufficient to cover the sum involved has
been issued by the cag and :
o The expenditure has been authorized for the financial year during which the
withdrawals is to take place;
By an appropriation act;
By supplementary appropriation act
By warrant issue under section 21(1) of the pfa

K)
instances where parliamentary control has been infringed as the national assembly
has a prime interest in knowing that the revenue appropriated by it for chosen purposes are
not spent with impunity on other things.
Instances where public officers have failed to make audited accounts available to the
national assembly in accordance with the appropriation law.
Instances of wasteful and uneconomic expenditure or losses due to negligence or
lack of reasonable foresight.
Instances where larger grants or loans have been made to parastatal organizations
and other bodies and there is reason to believe that the proper or best use is not
being made of it by such organizations.
Instances where there is evidence that governments interest in commercial
undertakings has not been properly safeguarded.
Instances where officers have speculated with government funds granted for specific
purposes - e.g. If an officer obtains a government advance to build a house to live in
but instead rents it for self-aggrandizement.
Accounting errors involving more than shs.100,000/= affecting the appreciation of the
accounts - e.g. Commission of a financial guarantee given by the government to an
institution engaged in commercial activities, etc. Generally, a precise explanation
furnished by the accounting officer in reply to audit queries is given along with the
report to enable the pac/ or respective parliamentary commitee to debate on it
without the need to call for further information. Agreement of accounting officers
whose accounts are being reported upon is obtained as to the accuracy and fairness
of the comments made in the report.
L) the pac/laac committee of the parliament of the united republic of tanzania, which is
charged with the follow-up of audit queries and recommendations made on the accounts
of the government ministries and independent departments. The committee makes its
report to the parliament in a summarized form. The report consist largely of its views on
matters raised in the annual audit report, recommendations for surcharge or disciplinary
proceedings against officers who have failed to carry out their responsibilities, etc. On
receipt of the report of the pac, the treasury takes up implementation of the
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recommendations with the accounting officers on the issues mentioned in the report and
then reports back to the pac. Accounting officers are often called to appear in person
before the committee to defend their cases. By doing so, the pac helps to improve the
standard of financial discipline in the country.
M)

the main objective of the report are: To provide assurance to the receiver that the financial activities under his/her
control are satisfactory, and
To get the receiver to make changes to activities where there is room to
improvement.

The reporting of the results of the audit is done during the audit as well as at the end of
the audit.
During the audit: the reporting during the audit contains audit queries, which relate to
transaction errors that require the attention of the auditor that are raised both verbally
and in writing.
At the end of field work: working papers prepared at field are kept in temporary file and
cross-referenced to audit programs and senior auditor reviews the working papers to
ensure that all audit work has been completed and the team has presented its findings in
a neat and readily understandable manner.
Interpreting the results of an audit:
errors: indicate that internal control is weak:
Weakness means the operating systems are poor and/or client staff not
complying or with rules and regulations; or there is intention to defraud, the
auditor should establish exactly what has gone wrong.
Contents of the report:
paragraphs:
(a) scope of audit
(b) review of previous recommendations
(c) summary of important recommendation
(d) matters arising or findings and
(f) Legal obligations & recommendations
Verbal reporting: this includes direct contacts and discussion of the draft with the
auditee.
Final audit report: the final audit report is prepared after the discussion of the draft report
with the auditee. The report is addressed to the most senior executive who can ensure
that the report is acted upon.
Follow-up of outstanding report: follow-up of issues outstanding is facilitated by an audit
queries register kept by the auditor.
Annual reporting to the president and the parliament: the annual report is drawn from the
summary of important recommendations. The report draws the attention of the causes of the
major weaknesses observed and recommends the means to eradicate errors and frauds. If a
reply has been received, to the audit letter, managements response should be noted in the
annual report. If a reply is awaited, this should otherwise be noted. Only a small portion of
the matters raised during the year find their way into the annual audit report and only those
that are of major importance
N)

please refer to class presentations


key issues
The committee is appointed by the accounting officer
The maximum number of members is 5 and minimum is 3
The members are from amongst senior most employees of the mda or
government institutions department or section
The member from cag and accountant general can be invited as participants

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The accounting officer is not a member


The chief accountant and chief internal auditor can attend the meeting as
participants
The main functions includes
o Review of internal auditor work plan
o Review and deliberate on internal auditor findings and progress report
o Undertake investigations
o Ensures vfm of government spending
o Review external auditors report
The tenure of members is five years

Tutorial notes: you can clearly see the difference between this and the one in private sector.

Question 3
(a) audit work on railway trucks
examine board minutes authorising the purchase of the trucks (authorization)
cast the non-current asset ledger; agree total of railway trucks to the general ledger and
financial statements(completeness)
ensure that railway trucks are actually stated as such in the non-current asset note. As a
material item, of this category is allowed (disclosure)
cast the non-current asset note in the financial statements. Ensure the note agrees to the
amount disclosed in the balance sheet (disclosure)
for a sample of assets from the ledger, confirm existence by physically seeing the trucks
(existence)
identify the supplier of railway trucks from a purchase invoice. Obtain all invoices from this
supplier and confirm completeness of recording in the non-current asset register
(completeness). Also, during non-current asset inspection, record details of some railway
trucks and ensure those trucks are recorded in the non-current asset register
examine a sample of purchase invoices to confirm ownership of the trucks (rights and
obligations)
review company policy for depreciation. As this is a new category of non-current asset,
obtain representation letter point regarding accuracy of amount. Confirm with amount
charged in similar companies that the depreciation percentage appears to be correct
(valuation and allocation)
agree depreciation charged in the non-current asset note to the amount on the profit and
loss account (valuation and allocation)
check a sample of depreciation calculations to ensure that they are accurate and that they
conform to company policy (valuation and allocation)
ensure that any sales tax has been correctly treated e.g. Capitalised where this is nonrecoverable (valuation and allocation)
current value may also be confirmed using a specialist or appropriate trade journal and
compared to the net book value shown in the non-current asset register (valuation and
allocation).

(b) issues to raise with management


Land and buildings
The depreciation rate has been correctly applied at 2% given an estimated life for the land
and buildings category of 50 years. However, the rate has been applied to the whole balance

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that is land and buildings. In most companies, the value of land is not thought to decrease
and therefore depreciation is not appropriate.
To allocate depreciation accurately, a split is required between the land and buildings
amounts in the financial statements.
Buildings will then be depreciated, but not the land.
Plant and machinery
Depreciation has been charged in full in the year of acquisition, but not charged at all in the
year of disposal. This appears to be an appropriate accounting policy charging
depreciation in the year of disposal would only amend the profit or loss on sale in that year
and so have a neutral effect on the financial statements..
There appears to be an error in the disposals calculation as the depreciation amount
exceeds the cost being eliminated there does not appear to be any logical reason for this
situation and it should be discussed with the directors to identify the reason, if any, for this
treatment.
If an error is found, then the depreciation amount must be decreased (or cost eliminated
increased) and the profit or loss on sale amended accordingly.
Motor vehicles point 1
The depreciation percentage stated in the financial statements is 33%. However, the
calculation is either 25% on the year end balance or about 21% on cost brought forward and
additions for the year. To be consistent, the non-current asset disclosure note must agree to
the actual calculation in the non-current asset note.
The reason for the difference must be found and either the disclosure note or the
depreciation calculation amended if there has been a change in the depreciation rate, then
this must also be disclosed in the financial statements. There has not been a change in
accounting policy the policy of depreciation is unchanged, it is only the method of applying
that policy that has changed. There is no need to amend the prior year figures.
Motor vehicles point 2
The cost and depreciation eliminated on sale are the same amount; this is not surprising
given that the assets were fully depreciated. However, the depreciation policy for motor
vehicles is to depreciate the category over three years. If those vehicles are now being kept
for five years, then the depreciation rate may need revising to show the actual useful life of
the vehicles.
The depreciation rate needs to be discussed with company management, and if necessary
the rate amended to reflect the actual life of the vehicles.

Question 4
Please refer to your class notes
Question 5
(a) confidential information
General rules
Information obtained during an audit is normally held to be confidential; that is it will not be
disclosed to a third party.
However, client information may be disclosed where:
consent has been obtained from the client
there is a public duty to disclose or
there is a legal or professional right or duty to disclose.
However, these rules are general principles only; more detailed guidance is also available to
accountants, as explained below.
Nbaas code of ethics obligatory disclosure
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As noted above, nbaas code of ethics confirms that when a member agrees to work for a
client in a professional capacity, it is an implied term of that agreement that the member will
not disclose a clients affairs to any other person.
The recognised exceptions to this rule are where a member knows or suspects that his client
has committed treason, or is involved in drug trafficking or terrorist offences. In this situation,
information must be disclosed to a competent authority. The actual disclosure will depend on
the laws of the jurisdiction where the auditor is located.
The auditor may also be obliged to provide information where a court demands disclosure.
Refusal to provide information is
Likely to be considered contempt of court with the auditor being liable for this offence.
Nbaa code of ethics voluntary disclosure
A member may also disclose client confidential information voluntarily, that is without client
permission, in a limited number of situations.
to protect a members interest e.g. To allow a member to sue a client for unpaid fees or
defend an action for negligence.
-where there is a public duty to disclose e.g. The client has committed an action against the
public interest such as unauthorized release of toxic chemicals.
(b) independence risks
Audit partner time in office
Mr grace has been the audit partner of ancients for eight years. His objectivity for the audit
may be threatened by the ongoing close relationship with the client. In other words, he may
be too friendly with the directors of ancients. This means he may
Not be willing or able to take difficult decisions such as issuing a modified audit report for
fear of prejudicing his friendship with the directors. Rotating the audit partner would remove
this threat.
Unpaid taxation fees
Ancients has not paid the taxation fees for work that took place nearly six months ago. The
non-payment of fees can be a threat to objectivity similar to that of an unpaid loan. In effect,
mckay is providing ancients with an interest free loan. The audit partner in mckay may not
wish to issue a modified report for fear that the client leaves and the loan is not repaid. The
unpaid fee must be discussed with the directors in ancients and reasons for non-payment
obtained. Mckay may wish to delay starting the audit work for this year until the fee is paid to
remove the potential independence problem. If the fee is not paid at all then mckay may
decline to carry out the audit.
Fee income
No details are provided regarding fee income obtained from ancients. However, the
company is growing rapidly and mckay does provide other services besides audit. As a
limited liability company, mckay should ensure that no more than 10% of its recurring
practice income (including auditing, accountancy and other work combined) is derived from
this client. Obtaining more than 10% could indicate undue financial reliance on one client,
and impair objectivity regarding the audit report (again fear of issuing a modified report and
losing the fee income from the audit client). If the 10% limit is close, mckay may have to limit
other services provided so that independence is not impaired. An annual review will be
required on clients where the fee is between 5 and 10% to ensure that the fee income rules
will not be breached.
Allyson grace
Allyson grace is not deemed to be connected to mr grace because she is presumably over
the age of 18. If she was still a minor, then there would be a connection and it would be
inappropriate for mr grace to be the audit partner as he could in theory influence allysons
decisions. However, there may still appear to be an independence problem as mr grace may
not be objective in making audit decisions. He may not wish to annoy his daughter by having
to qualify the financial statements.
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Appointing another audit partner would remove the perceived independence problem.
Meal
The offer of a meal by allyson may appear to be a threat to independence; having received
an expensive meal, the audit staff may be favourably disposed towards ancients and be less
inclined to investigate potential errors. Audit staff are allowed to receive modest benefits on
commercial terms; whether there is a benefit depends on how expensive the meal is. To
ensure no independence issues it would appear that the invitation should be declined. One
possible option would be for mr grace and allyson to pay personally as a purely social event
even though this may be unlikely. However, this does not remove the implied independence
issue.
Question 6
a. Early auditing and modern statutory auditing:
Fraud was a primary consideration. Today its detection is a by
product. The auditor has a duty to discover only those frauds
which affect the true and fair view.
At all times fraud by the management , in the sense of producing
misleading accounts, has been important but much more
emphasis is now placed on fairness view given by the accounts
The deterrent effect of an audit has always been relevant but
more emphasis is now placed on the directors role in preventing
fraud by installing adequate systems.
Technical errors were important ( e.g. Failure to accrue a
subscription to the chamber of commerce) but now the material
convention is listened to .
Errors of principle (e.g. Failure to depreciate buildings), as an
idea has given way to ideas like generally accepted accounting
principles and the ifrs requirements
Emphasis in early times on vouching all transactions (time and
resources were available at modest cost). Now emphasis on
reliance on indirect evidence such as compliance tests and
analytical review
Auditing every thing has given way to audits focusing on high
risk areas
Emphasis on vouching or ticking everything to a sampling even a
statistical sampling approach
Change from post year end audits to interim and year end date
inclusions
Change of report from true and correct to true and fair
Increase in companies act accounting and auditing requirements
Changes from vague text book and obscure legal case
indications of audit practice through u statements to auditing
standards and guidelines
Changes in law have made auditors aware of obligations to third
party users of account.
b. Objective have changed because :
Increased separation of ownership and control has switched the
emphasis from fraud of employees to validation of director
produced financial statements
Increased size of business has made the vouching approach
impractical.

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Increasing cost of auditing has forced auditing to become more


efficient.
Increased investor sophistication ( e.g. More institutional
shareholdings).
Mores sophisticated accounting and control systems e.g.
Computers
Changes in company law and professional body requirements

c. Since the objective of statutory audit is to give an opinion on the truth and
fairness of financial statements and not to discover fraud, clearly the work
performed will be different.
Specifically:Truth and fairness auditing requires the materiality concept but
fraud and error seeking requires a detailed approach
Modern auditing requires a reliance wherever possible on
internal controls and the installation of such a system is a matter
for directors. It is true that the review o systems may indicate
weak areas where fraud and errors could occur.
The truth and fairness auditing can be conducted by sampling
and analytical review. Fraud and error are discovered by detailed
investigation
Modern auditing is focused on high risk areas with minimal
testing of other areas.
D.

I. Since the matter is not material (unlike london oil storage co. Ltd,
1904), the following action may be appropriate.

Inform the directors of the matter.


Request that they investigate other matters which may now be
suspect (other work done by the cashier, other cash funds
etc.). You may be asked to d this yourself for an extra fee.
Documents fully all actions and findings
Review all controls in the petty cash area
Review again all audit work and all internal control in areas
involving the cashier.

Further work is not required as the matter does not affect the audit
objectives unless internal controls are now suspect.
Ii. The auditors nightmare. He should:
Fully determine the true stocks at each year end ( if possible)
Inform the remaining directors
Request that any adjustments ( including tax effects ) should be
correctly treated in the accounts e.g. As prior year adjustments
under ifrs with fully disclosure
If the accounts are not correctly adjusted or if uncertainty
remains, qualify the report.
Carefully review all audit work and the current and previous year
accounts.
Reliance can no longer be placed on the letter of representation
and other evidence may have to be sought
Review office procedures to determine what went wrong with
earlier audits
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Check professional indemnity insurance.

Question 7

Obtain an appropriate understanding of the company, its operations and , in


particular , its environmental issues.
Evaluate whether there is any possible risk of misstatement in the financial
statements as a result of environmental issues.
Enquireof management ot any systems or controls which are in place to
identify risk, evaluate control and account for environmental matters.
Obtain understanding of the control environment operating within the client
Obtain written representation from management on any environmental
matters
Otain evidence from environmental experts where the evidence in relation to
environmental matters is sufficiently persuasive.
Consider minutes oa directors, board committees or environmental officers
Review documentation
Review all assets impairment
Review liabilities and provisions to ensure all have been included
Review contingencies and ensure adequate disclosure
Include environmental issues in the review of appropriateness of going
concern

Obtain representation by management which may take the form of a statement to the
following effect
Management are not aware of any material liabilities or contingencies arising
from environmental matters, including those resulting from illegal or possible
illegal acts.
Managements are not aware of any environmental matters that may have a
material impact on the financial statements.
If aware of such matters, those matters have been properly disclosed in the
financial statements.
The auditor must review the following documents
Publicly available industry information on environmental matters
Reports issued by environmental experts about the entity
Internal audit reports
Environmental expert reports (if any)
Reports on due diligence investigations
Reports on or to regulatory agencies
Correspondence with lawyers
Correspondence with enforcement agencies.
Question 8
Please refer to your class notes and handouts

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PAPER 50
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic expression to every question
Question 1
The micronix ltd, a company dealing with computer products has appointed your audit firm to
audit the companys accounts. You are assisting in the interim audit for the company and
assigned the debtors and sales section by the audit senior. Micronics systems ltd maintain
its accounting records on a mainframe computer system. There are about 20,000 debtors on
the sales ledger, which total approximately shs 100 million. The audit senior asks you to
liaise with the computer audit department of your firm in planning and conducting the audit of
debtors. During your conversation with the computer audit manager, he uses certain terms
with which you are not familiar. These include computer assisted audit techniques
(caats),general controls and application controls. Further, as a result of your conversation,
it seems that the computer audit department will not be able to visit the client whilst you are
carrying out your work but will visit the client shortly after you have left the client. The audit
senior is extremely annoyed at this and blames you for the lack of adequate planning.
Required:
(f) Explain what is meant by the following terms used in connection with computer
auditing:
(i) general controls
(ii) application controls
(iii)
Computer assisted audit techniques (caats)
(iv)
Integrated test facility
(g) Describe the essential elements of the planning process when auditing
computerized systems.
(h) Describe four uses of caats in audit current assets and debtors
(i) Discuss whether you feel the audit senior is justified in blaming you for the lack of
adequate audit planning.
(j) List three disadvantages of the computer audit department visiting the client at a
different time to your interim audit visit.
Question 2
Viswa is a company that provides call centre services for a variety of organisations. It
operates in a medium sized city and your firm is the largest audit firm in the city. Viswa is
owned and run by two entrepreneurs with experience in this sector and has been in
existence for five years. It is expanding rapidly in terms of its client base, the number of staff
it employs and its profits. It is now 15 june 2004 and you have been approached to perform
the audit for the year ending 30 june 2004. Your firm has not audited this company before.
Viswa has had three different firms of
Auditors since its incorporation.
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Viswas directors have indicated to you informally that the reason they wish to change
auditors is because of a disagreement about certain disclosures in the financial statements
in the previous year. The directors consider that the disagreement is a trivial matter and
have indicated that the company accountant will be able to provide you with the details once
the audit has commenced. Your firm has explained that before accepting the appointment,
there are various matters to be considered within the firm and other procedures to be
undertaken, some of which will require the co-operation of the directors. Your firm has other
clients that operate call centres. The directors have asked your firm to commence the audit
immediately because audited accounts are needed by the bank by 30 july 2004. Your firm is
very busy at this time of year.
Required:
(f) Describe the matters to consider within your firm and the other procedures that
must be undertaken before accepting the appointment as auditor to viswa. (10
marks)
(g) Explain why it would be inappropriate to commence the audit before
consideration of the matters and the procedures referred to in (a) above have
been completed. (5 marks)
(c) explain the purpose of an engagement letter and list its contents. (5 marks)
Question 3
(g) Describe external auditors responsibilities and the work that the auditor should perform
in relation to the going concern status of companies. (5 marks)
(h) Describe the possible audit reports that can be issued where the going concern status of
a company is called into question; your answer should describe the circumstances in
which they can be issued. (5 marks)
(i) Tritel is a large telecommunications company that is listed on a stock exchange. It is
highly geared because, like many such companies, it borrowed a large sum to pay for a
licence to operate a mobile phone network with technology that has not proved popular.
The companys share price has dropped by 50% during the last three years and there
have been several changes of senior management during that period. There has been
considerable speculation in the press over the last six months about whether the
company can survive without being taken over
By a rival. There have been three approaches made to the company by other companies
regarding a possible takeover but all have failed, mainly because the bidders pulled out
of the deal as a result of the drop in share prices generally.
The company has net assets, but has found it necessary to severely curtail its capital
investment program. Some commentators consider this to be fundamental to the future
growth of the business, others consider that the existing business is fundamentally
sound. It has also been necessary for the company to restructure its finances. Detailed
disclosures of all of these matters have always been made in the financial statements.
No reference has been made to the going concern status of the company in previous
auditors reports on financial statements and the deterioration in circumstances in the
current year is no worse than it has been in previous years.
Required:
(c) on the basis of the information provided above, describe the audit report that you
consider is likely to be issued in the case of tritel, giving reasons. (4 marks)
(d) explain the difficulties that would be faced by tritel and its auditors if tritels audit
report made reference
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Question 4
You are the audit manager of tela & co, a medium sized firm of accountants. Your firm has
just been asked for assistance from jumper & co, a firm of accountants in an adjacent
country. This country has just implemented the internationally recognised codes on
corporate governance and jumper & co has a number of clients where the codes
Are not being followed. One example of this, from sgcc, a listed company, is shown below.
As your country already has appropriate corporate governance codes in place, jumper & co
have asked for your advice regarding the changes necessary in sgcc to achieve appropriate
compliance with corporate governance codes.
Extract from financial statements regarding corporate governance
Mr sheppard is the chief executive officer and board chairman of sgcc. He appoints and
maintains a board of five executive and two non-executive directors. While the board sets
performance targets for the senior managers in the company, no formal targets or review of
board policies is carried out. Board salaries are therefore set and paid by mr sheppard
based on his assessment of all the board members, including himself, and not their actual
performance.
Internal controls in the company are monitored by the senior accountant, although detailed
review is assumed to be carried out by the external auditors; sgcc does not have an internal
audit department.
Annual financial statements are produced, providing detailed information on past
performance.
Required:
Write a memo to jumper & co which:
(a) explains why sgcc does not meet international codes of corporate governance
(b) explains why not meeting the international codes may cause a problem for sgcc, and
(c) recommends any changes necessary to implement those codes in the company.
(20 marks)
Question 5
Cerise, a limited liability company, manufactures computer-controlled equipment for
production-line industries such as cars, washing machines, cookers, etc. On 1 september
2004 the shareholder-managers decided, unanimously, to accept a lucrative offer from a
multi-national corporation to buy the companys patented technology and manufacturing
equipment.
By 10 september 2004 management had notified all the employees, suppliers and
customers that cerise would cease all manufacturing activities on 31 october 2004. The 200strong factory workforce and the majority of the accounts department and support staff were
made redundant with effect from that date, when the sale was duly completed.
The marketing, human resources and production managers will cease to be employed by the
company at 31 december 2004. However, the chief executive, sales manager, finance
manager, accountant and a small number of accounting and other support staff expect to be
employed until the company is wound down completely.
Cerises operations extend to fourteen premises, nine of which were put on the market on 1
november 2004. Cerise accounts for all tangible, non-current assets under the cost model
(i.e. At depreciated cost). Four premises are held on leases that expire in the next two to
seven years and cannot be sold or sub-let under the lease terms. The small head office
premises will continue to be occupied until the lease expires in 2007. No new lease
agreements were entered into during 2004.

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All cerises computer-controlled products carry a one-year warranty. Extended warranties of


three and five years, previously available at the time of purchase, have not been offered on
sales of remaining inventory from 1 november onwards.
Cerise has three-year agreements with its national and international distributors for the sale
of equipment. It also has annual contracts with its major suppliers for the purchase of
components. So far, none of these parties have lodged any legal claim against cerise.
However, the distributors are withholding payment of their account balances pending
settlement of the significant penalties which are now due to them.
Required:
You are required to answer the following in the context of the final audit of the financial
statements of cerise for the year ending 31 december 2004:
(a) using the information provided, identify and explain the financial statement risks to be
taken into account in planning the audit. (6 marks)
(b) explain how the extent of the reliance to be placed on:
(i) analytical procedures; and (4 marks)
(ii) management representations, (4 marks)
Should compare with that for the prior year audit.
(c) describe the principal audit work to be performed in respect of the carrying amount of the
following itemsin the balance sheet:
(i) amounts due from distributors; and (3 marks)
(ii) lease liabilities. (3 marks)
Question 6
Fraud and error present risks to an entity. Both internal and external auditors are required to
deal with risks to the entity. However, the responsibilities of internal and external auditors in
relation to the risk of fraud and error differ.
Required:
(a) explain how the internal audit function helps an entity deal with the risk of fraud
and error. (7 marks)
(b) explain the responsibilities of external auditors in respect of the risk of fraud and
error in an audit of financial statements. (7 marks)
(c) kilimanjaro ltd is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staffs are
partly paid on a commission basis. Well-established tour operators run the holidays that
kilimanjaro ltd sells. The networked reservations system through which holidays are booked
and the computerised accounting system are both well-established systems used by many
independent travel agencies.
payments by customers, including deposits, are accepted in cash and by debit and credit
card. Kilimanjaro ltd is legally required to pay an amount of money (based on its total sales
for the year) into a central fund maintained to compensate customers if the agency should
cease operations.
describe the nature of the risks to which kilimanjaro ltd is subject
arising from fraud and error. (6 marks)

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Suggested solutions
Question 1
(a) (i) general controls
general controls relate to the environment in which the computer system are
developed ,maintained and operated .the objective of general controls are to ensure the
proper development and implementation of applications, and the integrity of the program and
data files and of computer operations. General controls include system development controls
,and general administrative controls such as division of duties ,back-up and stand-by
controls.
(iv)
Application controls
Application controls are defined by the standard as those that relate to the transactions
and standing data appertaining to such computer based accounting system and are,
therefore, specific to each application. The objectives of application controls are to ensure
the completeness and accuracy of the accounting records and the validity of the entries
made therein resulting from both manual and programming processing. Application
controls are normally divided into four parts:input controls ,processing controls, output
controls and master file controls.
(v)
Computer assisted audit techniques (caats)
In simple computer systems, the auditor may focus on the control environment, ensuring
that sufficient control comes from the input and output controls established by the
company. She may not probe into the detailed program checks built into software.
However ,in complex systems the auditor will place more reliance on existence of
programmed controls and assist the auditor in examining sample transaction data.there
are several types of caat ,for example ,audit software which examines the companys
computer files, test data which is submitted by the auditor for processing by the companys
computer and other techniques such as embedded audit facilities and application program
examination. Caats cannot examine general controls of a computer installation. These are
best examined by normal control evaluation methods,for example icqs, ices.
(b) the essential elements of the planning process can be described as the following:
(i)familiarisation with the computer system in order to assess the specific needs and
problem of the audit. This would include a preliminary review and classification of the system
in operation .
(ii)selection of staff with the appropriate level of technical knowledge and skill
(iii)assessment of the timing of the audit work taking into account the availavility o f
computer time and the frequency with which data is updated and amended.
(iv)consideration of the reporting deadlines as this will have an effect on the usage of
caats.the shorter the deadline ,the more reliance may be placed on caats.
(v)consideration of the use of caats including the costs and benefits and their use ,as
this may have significant effect on the nature ,extent and timing of the audit tests.
(vi)reviewing work performed by internal auditors .caats performed by the internal
audit department may enable the auditor to reduce his audit work.the auditor will have to
asses the effectiveness and relevance of the internal audit function.
(vii)assessing the risks involved in the computer system.
four specific ways in which caats may help the auditor when auditing the sales and debtors
:
(i)compensation for loss of audit trail oncd a customers account has been
authorized ,the only record of this authorization may be held on the computer file .caats may
be used to interrogate this file and extract the information.

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(ii)selecting items for audit work .the auditor may use caats for selecting sample for
further audit wok ,for example customers who are above the credit limit ,or selecting items
for a debtors circularization.
(iii)verification of items. The audit package will duplicate the processing performed by
the application programs and then compare its own results with the results produced by
application.for example ,the production of sales ledger control account items for a debtors
circularization.
(iv)conducting complex calculations.the auditor may wish to produce reports or carry
out statistical analysis on available data.for example ,he may wish to produce a debtors
ageing analysis or carry out an analytical review on sales and debtors.
(d)the formal planning of an audit should be carried out by the audit manager and
partner. Planning should take place befor the commencement of the audit in order to
achieve an efficient and effective audit .the use of the computer audit department should
be discussed at managerial level in the audit firm at an appropriate early stage in the
planning year in order to ensure that the computer audit staff are available at the time of
audit .responsiblility for planning the visit of the computer audit department should not be
delegated to a junior member of staff and therefore such a member staff cannot be
blamed for poor planning if the visit does not coincide with that of the main body of audit
staff. The audit senior should liaise with the computer audit manager in order to ensure
that the information to be generated by the use of caats is produced in a timely fashion.
(e)if the computer audit department visits the client on a different occasion then the
following disadvantages may arise.
(i)information required for the conduct of interm audit will have to be produced
manually ,for example a selection of debtors for circularizing.
(ii)the client may be unhappy because of the disruption caused by two audit visits.
(iii)the computer audit department will need advice by the audit staff, who carried out
the interim audit , on the work be performed.this will involve another audit visit by the staff
which will add to the cost of audit.
Question 2
(a) internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under
nbaaas rules of professional conduct).
Internal matters
Before accepting appointment the firm should ensure that:
(i) it has the necessary staff with appropriate competencies to complete the audit
(this seems likely given that the firm has other clients in this sector);
(ii) the staff are available at what is a busy time of year for the firm (it may be
possible that all of the staff with the necessary competencies are otherwise occupied);
(iii) the firm is independent of viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two entrepreneurs),
however, there may be staff or partners who are related to the client or are otherwise
connected with it;
(iv) there are no conflicts of interest that cannot be properly managed. Conflicts of
interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:

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(v) seek the directors permission to communicate with the company accountant
about the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
(vi) seek the directors permission to communicate with the incumbent auditors. If
permission is refused, the appointment should not be accepted;
(vii) ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if viswa refuses to give permission to
the incumbent auditors the appointment should not be accepted);
(viii) communicate with the incumbent auditors (preferably in writing) requesting all
the information which ought to be made available to enable the firm to decide whether or not
to accept the appointment (if there are no such matters, the incumbent auditors should
inform the firm of this);
(ix) seek appropriate transfer information (such as a copy of the last set of accounts
and a detailed trial balance reconciled to the accounts);
(x) indicate a likely fee (or the basis on which fees are calculated) to viswa, ensure
that this is acceptable and that the client is able to pay (by some form of credit check);
(xi) ensure that the incumbent auditor has properly resigned, been dismissed or has
not sought re-appointment in accordance with legal requirements.
(b) starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
(i) without the staff with appropriate competencies the firm will be in breach of the
rules (and may be found negligent if things were to go wrong);
(ii) without complying with the requirements relating to independence and conflicts of
interest, the firm will not only be in breach of the rules, but will lack objectivity and may find
that the client (or other party) objects to the appointment to another client in the same sector;
(iii) without performing appropriate procedures the firm will be unable to form an
opinion on the integrity of the client it may find itself associated with an entity engaging in
doubtful or even illegal activities (taking account of the disagreement over disclosures);
(iv) without agreeing a fee it is almost inevitable that misunderstandings or
disagreements will arise;
(v) without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have arisen in
the past;
(vi) without ensuring that the incumbent auditor is no longer in place, it will be
inappropriate for the firm to seek appointment.
(c) engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It:
(i) confirms the auditors acceptance of appointment and constitutes a contract
between the auditor and the client;
(ii) summarises the respective responsibilities of directors and auditors;
(iii) contains details on:
1. The responsibilities of the directors (for accounting records, the financial
statements and the accounting policies on which they are based);
2. The responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and disclosures,
to perform tests and to form an opinion on the financial statements);
3. The form of report to be issued;
4. Other services to be provided;
5. The basis of calculation of fees;
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6. Applicable legislation.

Question 3
(a) external auditor responsibilities going concern
Isa 570 going concern deals with this issue.
(i) auditors are required to consider the going concern status of companies and any
disclosures regarding going concern in forming their audit opinion. Companies that are listed
on stock exchanges may be required to make additional disclosures in relation to going
concern issues.
(ii) auditors are required to assess the adequacy of the means (the processes) by
which directors have satisfied themselves that the going concern basis is appropriate and
that adequate disclosures have been made. Auditors conduct an initial analysis at the
planning stage of the audit as well as assessments at later stages.
(iii) auditors should make enquiries of the directors and examine appropriate
documentation supporting the companys going concern status such as budgets and cash
flow forecasts.
(iv) auditors consider whether the period to which directors have paid particular
attention is adequate. This should normally be at least 12 months from the balance sheet
date. Auditors also enquire of management as to their knowledge of events or conditions
beyond this period that may cast significant doubt on the entitys ability to continue as a
going concern.
(v) auditors need to consider the appropriateness of assumptions which directors
have made, the sensitivity of assumptions to external and internal changes, any obligations,
guarantees or undertakings arranged with other entities, the existence and adequacy of
borrowing facilities and the directors plans to deal with any going concern problems.
(vi) auditors are required to document the extent of any concerns, taking account of
matters that have come to their attention during the course of the audit and in particular,
financial, operational, or other indicators of going concern problems that are present.
(vii) indicators of going concern issues would include trading losses, impairment of
assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans
where necessary, fundamental changes in the markets or technology having an adverse
effect on the company, loss of management, staff, customers or suppliers, or major litigation,
for example.
(viii) auditors should consider the need to obtain written management
representations.
(ix) auditors should consider the adequacy of any disclosures in the financial
statements.
(b) possible audit reports and circumstances
(i) where the auditors consider that there is a significant level of concern about the
entitys ability to continue as a going concern (but do not disagree with the going concern
basis), and where adequate disclosures of the situation are made, they modify (but do not
qualify) their opinion by including an emphasis of matter paragraph highlighting the
existence
Of a material uncertainty as to the going concern status of the entity and drawing attention to
the relevant note in the financial statements. Where adequate disclosures are not made, a
qualified or adverse opinion will be issued.
(ii) where the period to which directors have paid particular attention is less than 12
months from the balance sheet date, the auditors should consider the need to modify the
audit report as a result of a limitation in the scope of the audit.
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(iii) where the auditors disagree with the preparation of the financial statements on
the going concern basis, they should issue an adverse opinion. This is very rare because
auditors rarely have sufficient evidence to be sure.
(iv) if the auditors are unable to form an opinion on the going concern status of a
company because of a limitation in the scope of the audit, they will issue an except for
opinion, or disclaimer of opinion but this is unusual.
(c) report issued to tritel
(i) in the case of tritel, there are some indicators of going concern problems. However, the
company may still be a going concern and the fact that the company has been approached
by take-over bidders does not necessarily mean that there is a going concern problem
(possibly quite the opposite).
(ii) the audit opinion issued on tritel in the current year is not likely to make reference
to the going concern status of the company, as in previous years. The situation has not
deteriorated significantly in the current year and it will be difficult for auditors to justify any
change in their opinion from previous years.
(d) difficulties associated with reporting on going concern
(i) if the auditors of tritel were to report on a going concern problem, the mere act of
reporting might of itself create a going concern problem (a self-fulfilling prophecy). This is
particularly the case with large blue-chip companies where the issue of an audit report that
is modified in any way is unusual and might well cause the companys share price to drop,
thus precipitating a going concern problem.
(ii) this means that it is very difficult for companies such as tritel and their auditors to
send out any clear signal to the markets without running the risk of creating a panic.
(iii) however, recent events show that the consequences of companies and auditors
failing to report where severe financial difficulties are encountered can be disastrous for both
the company (its employees and shareholders) and auditors alike.
(iv) auditors are failing in their professional duties if they do not report on going
concern problems of which they are aware; however, situations involving large companies
are rarely clear cut and auditors who propose to make any changes at all to the audit report
are likely to encounter fierce resistance from management who may genuinely believe that
to make
Such a report would be wrong.
(v) in the companys annual financial statements, it is not the place of the auditor of
tritel to substitute his judgement for that of directors. However, where large companies
involved in complex financing arrangements are concerned, auditors may have to fight hard
against vested and powerful interests if they disagree with the directors judgements and
decide to make reference to the matter in the auditors report. An auditor making reference
to going concern issues in an audit report in such circumstances may lose the audit (and any
other work) and may run a significant risk of litigation.

Question 4
From: a manager, tela & co
To: jumper & co
Subject: corporate governance in the sgcc company
Date: 13 june 2006
As requested, i write to explain where your client sgcc does not appear to be following
appropriate corporate governance codes and to recommend changes to ensure that the
principles of good corporate governance are being followed.
Chief executive officer (ceo) and chairman
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Mr sheppard is both ceo and chairman of sgcc. Corporate governance indicates that the
person responsible for running thecompany (the ceo) and the person responsible for
controlling the board (the chairman) should be different people. This is to ensure that no one
individual has unrestricted powers of decision.
I recommend that mr sheppard is either the ceo or the chairman and that a second individual
is appointed to the other post to ensure that mr sheppard does not have too much power in
sgcc.
Composition of board
The current board ratio of executive to non-executive directors is 5:2. This means that the
executive directors can dominate the board proceedings. Corporate governance codes
suggest that there should be a balance of executive and non-executive directors so this
cannot happen. A minimum of three non-executive directors are also normally
recommended, although reports such as cadbury note this may be difficult to achieve.
I recommend that the number of executive and non-executive directors is equal to help
ensure no one group dominates the board.
This will mean appointing more non-executive directors to sgcc.
Director appointment
At present, mr sheppard appoints directors to the board, giving him absolute authority over
who is appointed. This makes the appointment procedure and qualities directors are being
appointed against difficult to determine. Corporate governance suggests
That appointment procedures should be transparent so that the suitability of directors for
board positions can be clearly seen.
I recommend that an appointments committee is established comprising three non-executive
directors to ensure there is no bias
In board appointments. Formal job descriptions should also be published making the
appointment process more transparent.
Review of board performance
It is correct that the performance of senior managers is reviewed, but this principle should
also be applied to the board. While mr sheppard may undertake some review, this is not
transparent and it is not clear what targets the board either met or did not meet.
I recommend that performance targets are set for each director and actual performance
assessed against these on a regular basis.
Reasons for underperformance should also be ascertained and where appropriate, changes
made to the composition of the board.
Board pay
At present, board members pay is set by mr sheppard. This process breaches principles of
good governance because the remuneration structure is not transparent and mr sheppard
sets his own pay. Mr sheppard could easily be setting remuneration
Levels based on his own judgements without any objective criteria.
I recommend that a remuneration committee is established comprising three non-executive
directors. They will set remuneration levels for the board, taking into account current salary
levels and the performance of board members. Remuneration should also be linked to
performance, to encourage a high standard of work.
Internal control
The system of internal control in sgcc does not appear to be reviewed correctly. While
external auditors will review the control system, this review is based on their audit
requirement and cannot be relied on to test the overall effectiveness of the system. The
system may therefore still contain weaknesses and errors.
I recommend that some more formal review of internal control is carried out, perhaps by
establishing an internal audit department, as noted below. The relationship with the
companys auditors must also be reviewed so that the work of the board and the auditors
regarding internal control is understood by both parties.
Internal audit
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Sgcc does not have an internal audit department. Given the lack of formal review of internal
control in the company, this is surprising. Good corporate governance implies that the
control system is monitored and that an internal audit department is established to carry out
this task.
I recommend that an internal audit department is established, reporting initially to the audit
committee who will monitor internal control and then summarise reports for the board.
Financial statements
There appears to be acceptable disclosure in the financial statements regarding the past
results of the company. However, the board should also provide an indication of how the
company will perform in the future, by a forecast review of operations or similar statement.
This is partly to enable investors to assess the value of their investment in the company.
I therefore recommend that the annual accounts of sgcc include some indication of the future
operations of the company.
Audit committee
There is no mention in the report of an audit committee. Good corporate governance implies
that there is some formal method of monitoring external auditors as well as checking that the
reports from the external auditors are given appropriate attention in the company.
I recommend that an audit committee is established made up from non-executive directors.
The committee will receive reports from the external and internal auditors (as mentioned
above) and ensure that the board takes appropriate action on these reports.
I hope this information is useful. Please contact me again if you require any further
assistance.
Sincerely
Ann c. Outent
Note to candidates: an alternative and allowable answer format was to answer sections (a),
(b) and (c) of the question separately.
Taking this approach would also allow other valid points in part (b) such as inability to obtain
a stock exchange listing.
Question 5
Cerise
(a) financial statement risks planning the final audit 31 december 2004
Computer-controlled equipment for production-line industries
cerise is manufacturing a relatively high-tech range of products. Inventory will be
overstated if sufficient allowance is not made for technical obsolescence and slow-moving
items (i.e. Writing inventory down to lower of cost and net realisable value).
as cerise is ceasing manufacture two months prior to the year end the items remaining in
inventory at the year end are likely to require being written down in value. The amount of
write down is required to be disclosed in accordance with ias 2 inventories2.
Cessation of trade
cerise ceased to trade during the year. The financial statements should not therefore be
prepared on a going concern basis, but on a break-up or other realisable basis.
this has implications for:
the reclassification of assets and liabilities (from non-current to current);
the carrying amount of assets (at recoverable amount); and
the completeness of recorded liabilities.
Redundant workforce
liabilities may not be disclosed (if contingent) or provided for, if there are claims arising
from the redundant workers (e.g. If their statutory or contractual rights have been breached).

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although statutory redundancy pay, holiday pay, accrued overtime etc may well have all
been settled before the year end there may be additional liabilities in respect of former
employees (e.g. Pension obligations).
Sale of patented technology and manufacturing equipment
all assets sold should be derecognised and the profit on disposal disclosed as an
exceptional item arising from the discontinuance of operations.
plant and equipment will be overstated if:
manufacturing equipment that has been sold is left on the books;
assets that were not part of the sale are not:
tested for impairment (in accordance with ias 36 impairment of assets);
written down to the higher of net selling price and value in use.

Accounts department
fewer (skeleton) staff being employed in the accounts department may increase the risk
of errors arising as staff assume
Wider areas of responsibility as the volume of transactions is reduced.
the risk of errors arising not being detected (i.e. Control risk) is also likely to increase. For
example, levels of supervision and degrees of segregation of duties may be reduced and
adherence to control procedures may slacken.
Premises
if the unsold properties meet all the criteria of ifrs 5 non-current assets held for sale and
discontinued operations at the balance sheet date they should be:
separately classified as held for sale.
carried at the lower of carrying amount (i.e. Depreciated cost) and fair value less estimated
costs to sell.
any after-date losses on disposal would provide evidence of impairment. (however, as it is
cerises policy to carry noncurrent assets at depreciated cost, impairment is less likely than if
they were carried at revalued amounts.)
unoccupied premises may fall into disrepair with time. The financial statements would be
misstated if the management of cerise sought to provide for:
dilapidations on the properties arising after the balance sheet date; and/or
future expectation of repairs on unsold properties.
Such provisions are contrary to ias 37 provisions, contingent liabilities and contingent
assets.
Tutorial note: consider a property with carrying amount $1 million (depreciated cost) and fair
value $16 million. Repair costs of $05 million incurred for deterioration after 31 december
2004 cannot be provided for, nor is the carrying amount impaired.
Onerous contracts
full provision should be made for the lease obligations under onerous contracts on four
premises in accordance with ias 37. This should not be extended to the head office
premises.
Product warranties
adequate provision must be made for warranties of:
one year (sales in the year to 31 december 2004);
up to three years (sales between 1 january 2002 and 31 october 2004); and
up to five years (sales between 1 january 2000 and 31 october 2004).
the provision may be understated if the basis of its calculation is no longer appropriate. For
example, if cerise must now outsource warranty work as it no longer has an in-house
capability.
Breach of agreements/contracts

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since cerise no longer has the means of fulfilling contracts with distributors, provision
should be made for any compensation or penalties arising. Where the penalties due to
distributors for breach of supply agreements exceed the amounts due from them, the
receivables should be written down and provision made for any excess.
adequate provision should be made for breaches of contracts with suppliers (nonpurchase). If suppliers do not exercise their rights to invoke penalty clauses disclosure of the
contingent liability may be more appropriate than a provision.
(b) reliance on audit work
(i) analytical procedures
Tutorial note: reliance on analytical procedures is only obtained through those that provide
substantive audit evidence.
This question therefore concerns substantive analytical procedures as evidence which are
optional not those at the
Planning and review stages (which are mandatory).
overall the extent of reliance on analytical procedures is likely to be less than that for the
prior year audit as the
Scale and nature of cerises activities will differ from the prior year.
there are a number of individually material transactions in the current year which will
require detailed substantive
Testing (e.g. Sale of patented technology and manufacturing equipment and sale of
premises).
budgetary information used for analytical procedures in prior periods (e.g. Budgeted
production/sales) will have less relevance in the current year as the cessation of trade is
unlikely to have been forecast.
information will be comparable with the prior year for at most 10 months (i.e. January to
october). Costs incurredin november/december will relate to winding down operations
rather than operational activities.
the impact of the one-off circumstance on carrying amounts is more likely to be assessed
through detailed substantive testing (e.g. After-date realisation) than reliance on ratios and
past history.
for example, analytical procedures on an aged-debt analysis and calculation of average
collection period used inprior years will not be relevant to assessing the adequacy of the
write-down now needed. Similarly, inventory turnover ratios will no longer be comparable
when inventory is no longer being replenished.
however, some reliance will still be placed on certain analytical procedures. For example,
in substantiating charges to the income statement for the 10 months of operations.
(ii) management representations
overall the extent of reliance on management representations is likely to be increased as
compared with the prior year audit.
the magnitude of matters of judgement and opinion is greater than in prior years. For
example, inventory/trade receivable write-downs, impairment losses and numerous
provisions. The auditor will seek to obtain as much corroborative evidence as is available.
However, where amounts of assets have still to be recovered and liabilities settled,
management will be asked to make representations on the adequacy of write-downs,
provisions, etc and the completeness of disclosures (e.g. For claims and other contingent
liabilities).
where negotiations are under discussion but not yet formalised (e.g. With a prospective
buyer for premises), management may be the only source of evidence (e.g. For the best
estimate of sale proceeds).
however, the extent to which reliance can be placed on representations depends on the
extent to which those making the representation can be expected to be well-informed on the
particular matters. Therefore, as the human resources and production directors will not be

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available after the balance sheet date particular thought should be given to obtaining
representations on matters pertaining to employee obligations and product warranties (say).
(c) principal audit work carrying amount
Tutorial note: discussions with management and obtaining management representations are
not principal audit work.
(i) amounts due from distributors
agreeing gross amounts due to accounts receivable balances (for sales made in the
normal course of business up to 31 october 2004 and in the running down of inventory to 31
december 2004).
as a significant portion of account balances outstanding will already be two months old at
31 december 2004, all receipts of after-date cash (if any) should be monitored for evidence
of recoverability.
Tutorial note: a standard direct confirmation of accounts receivable will not be principal audit
work in respect of the carrying amount since the scenario identifies recoverability as the
financial statements risk.
review of agreements with distributors to confirm the unexpired period (up to three years)
and the penalties stipulated.
recalculation of amounts due to distributors for the early termination of the agreements
with them.
review of cerises correspondence to the distributors (e.g. Offering financial settlement)
and responses received.
Tutorial note: distributors might settle for a waiver of the amounts they are owed and/or a
lump sum which amount to less than the penalties due to them under the terms of their
agreements.
(ii) lease liabilities
Tutorial note: it is clearly stated that no new lease agreements were entered into during the
year. Therefore
re-auditing from scratch what would have been examined in previous years as though it
was a new transaction is neither necessary nor efficient.
confirm the leases as operating leases to prior period working papers/disclosures in the
previous years financial statements.
to confirm contracts as onerous and justify full provision:
review cerises correspondence with the lessors requesting terms for an early exit from the
lease period;
visit premises to confirm that cerise is not receiving any economic benefit from them (i.e.
They are not still
Occupied or sub-let).
agree/reconcile the amounts provided for liabilities under onerous contracts to the present
value of the future minimum lease payments under non-cancellable operating leases.
agree/reconcile the future minimum lease payments used in the calculation of the
provision to those disclosed (under ias 17 leases) in the financial statements to 31
december 2003 as:
later than one year and not later than five years; plus
later than five years.
Tutorial note: the payments not later than one year in the prior year financial statements will
have been paid during the year and so form no part of the provision.
Question 6
(a) internal audit function: risk of fraud and error
(i) the internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of the risks
to which the entity is subject that would prevent it achieving its overall objectives such as
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profitability. Corporate governance objectives also include the overarching need for the
management of an entity to exercise a stewardship function over the entitys assets.
(ii) a large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the business
as a whole, and in relation to specific areas, include the effective operation of an internal
audit function.
(iii) internal audit can help management manage risks in relation to fraud and error,
and exercise proper stewardship by:
1. Commenting on the process used by management to identify and classify
the specific fraud and error risks to which the entity is subject (and in some cases
helping management develop and implement that process);
2. Commenting on the appropriateness and effectiveness of actions taken by
management to manage the risks identified (and in some cases helping management
develop appropriate actions by making recommendations);
3. Periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
4. Monitoring the incidence of fraud and error, investigating serious cases and
making recommendations for appropriate management responses.
(iv) in practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and reporting of
fraud and error. Routine internal controls (such as the controls over computer systems and
the production of routine financial information) and non-routine controls (such as controls
over year-endadjustments to the financial statements) are relevant.
(v) it should be recognised however that many significant frauds bypass normal
internal control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be reviewed
by internal audit in order to establish the nature of the risks, and to manage them effectively.

(b) external auditors: fraud and error in an audit of financial statements


(i) external auditors are required by isa 240 the auditors responsibility to consider
fraud in an audit of financial statements to consider the risks of material misstatements in the
financial statements due to fraud. Their audit procedures will then be based on a risk
assessment. Regardless of the risk assessment, auditors are required to be alert to the
possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entitys financial statements to material misstatements due to fraud.
(ii) auditors should make enquiries of management regarding managements
assessment of fraud risk, its process for dealing with risk, and its communications with those
charged with governance and employees. They should enquire of those charged with
governance about the oversight process.
(iii) auditors should also enquire of management and those charged with governance
about any suspected or actual instance of fraud.
(iv) auditors should consider fraud risk factors, unusual or unexpected relationships,
and assess the risk of misstatements due to fraud, identifying any significant risks. Auditors
should evaluate the design of relevant internal controls, and determine whether they have
been implemented.
(v) auditors should determine an overall response to the assessed risk of material
misstatements due to fraud and develop appropriate audit procedures, including testing
certain journal entries, reviewing estimates for bias, and obtaining an understanding of the

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business rationale of significant transactions outside the normal course of business.


Appropriate management representations should be obtained.
(vi) auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than internal
auditors to small frauds (and errors), although they must always consider whether evidence
of single instances of fraud (or error) are indicative of more systematic problems.
(vii) it is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with isas might not detect a material misstatement in the financial
statements arising from fraud. In practice, routine errors are much easier to detect than
frauds.
(viii) where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve further
investigations. They should also consider the need to report to management and those
charged with governance.
(ix) where serious frauds (or errors) are encountered, auditors need also to consider
the effect on the going concern status of the entity, and the possible need to report externally
to third parties, either in the public interest, for national security reasons, or for regulatory
reasons. Many entities in the financial services sector are subject to this type of regulatory
Reporting and many countries have legislation relating to the reporting of money laundering
activities, for example.
(c) nature of risks arising from fraud and error: kilimanjaro ltd
(i) kilimanjaro ltd is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the information
produced may be incomplete or incorrect. Inadequate controls also give rise to the risk of
fraud by those who understand the system and are able to manipulate it in order to hide the
Misappropriation of assets such as receipts from customers.
(ii) all networked systems are also subject to the risk of error because of the
possibility of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
(iii) all entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they may
misappropriate those assets (fraud) and then seek to hide the error or fraud by falsifying the
records.
(iv) kilimanjaro ltd is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card companies may
be liable for such frauds, attempts to use stolen cards can cause considerable
inconvenience.
(v) there is a risk of fraud perpetrated by senior management who might seek to
lower the amount of money payable to the central fund (and the companys tax liability) by
falsifying the companys sales figures, particularly if a large proportion of holidays are paid
for in cash.
(vi) there is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.
Instructions
1.
Time allowed 3 hours
2.
The examination paper contains six questions, attempt any five
3.
Marks will be given for clarity of language and logic expression to every question
Question 1
The micronix ltd, a company dealing with computer products has appointed your audit firm to
audit the companys accounts. You are assisting in the interim audit for the company and
assigned the debtors and sales section by the audit senior. Micronics systems ltd maintain
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its accounting records on a mainframe computer system. There are about 20,000 debtors on
the sales ledger, which total approximately shs 100 million. The audit senior asks you to
liaise with the computer audit department of your firm in planning and conducting the audit of
debtors. During your conversation with the computer audit manager, he uses certain terms
with which you are not familiar. These include computer assisted audit techniques
(caats),general controls and application controls. Further, as a result of your conversation,
it seems that the computer audit department will not be able to visit the client whilst you are
carrying out your work but will visit the client shortly after you have left the client. The audit
senior is extremely annoyed at this and blames you for the lack of adequate planning.
Required:
(k) Explain what is meant by the following terms used in connection with computer
auditing:
(i) general controls
(ii) application controls
(v)
Computer assisted audit techniques (caats)
(vi)
Integrated test facility
(l) Describe the essential elements of the planning process when auditing
computerized systems.
(m) Describe four uses of caats in audit current assets and debtors
(n) Discuss whether you feel the audit senior is justified in blaming you for the lack of
adequate audit planning.
(o) List three disadvantages of the computer audit department visiting the client at a
different time to your interim audit visit.

Question 2
Viswa is a company that provides call centre services for a variety of organisations. It
operates in a medium sized city and your firm is the largest audit firm in the city. Viswa is
owned and run by two entrepreneurs with experience in this sector and has been in
existence for five years. It is expanding rapidly in terms of its client base, the number of staff
it employs and its profits. It is now 15 june 2004 and you have been approached to perform
the audit for the year ending 30 june 2004. Your firm has not audited this company before.
Viswa has had three different firms of auditors since its incorporation.
Viswas directors have indicated to you informally that the reason they wish to change
auditors is because of a disagreement about certain disclosures in the financial statements
in the previous year. The directors consider that the disagreement is a trivial matter and
have indicated that the company accountant will be able to provide you with the details once
the audit has commenced. Your firm has explained that before accepting the appointment,
there are various matters to be considered within the firm and other procedures to be
undertaken, some of which will require the co-operation of the directors. Your firm has other
clients that operate call centres. The directors have asked your firm to commence the audit
immediately because audited accounts are needed by the bank by 30 july 2004. Your firm is
very busy at this time of year.
Required:
(h)
Describe the matters to consider within your firm and the other procedures that
must be undertaken before accepting the appointment as auditor to viswa. (10
marks)

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(i)

Explain why it would be inappropriate to commence the audit before


consideration of the matters and the procedures referred to in (a) above have
been completed. (5 marks)
(c) explain the purpose of an engagement letter and list its contents. (5 marks)
Question 3
(j) Describe external auditors responsibilities and the work that the auditor should perform
in relation to the going concern status of companies. (5 marks)
(k) Describe the possible audit reports that can be issued where the going concern status of
a company is called into question; your answer should describe the circumstances in
which they can be issued. (5 marks)
(l) Tritel is a large telecommunications company that is listed on a stock exchange. It is
highly geared because, like many such companies, it borrowed a large sum to pay for a
licence to operate a mobile phone network with technology that has not proved popular.
The companys share price has dropped by 50% during the last three years and there
have been several changes of senior management during that period. There has been
considerable speculation in the press over the last six months about whether the
company can survive without being taken over
By a rival. There have been three approaches made to the company by other companies
regarding a possible takeover but all have failed, mainly because the bidders pulled out
of the deal as a result of the drop in share prices generally.
The company has net assets, but has found it necessary to severely curtail its capital
investment program. Some commentators consider this to be fundamental to the future
growth of the business, others consider that the existing business is fundamentally
sound. It has also been necessary for the company to restructure its finances. Detailed
disclosures of all of these matters have always been made in the financial statements.
No reference has been made to the going concern status of the company in previous
auditors reports on financial statements and the deterioration in circumstances in the
current year is no worse than it has been in previous years.
Required:
(c) on the basis of the information provided above, describe the audit report that you
consider is likely to be issued in the case of tritel, giving reasons. (4 marks)
(d) explain the difficulties that would be faced by tritel and its auditors if tritels audit
report made reference
Question 4
You are the audit manager of tela & co, a medium sized firm of accountants. Your firm has
just been asked for assistance from jumper & co, a firm of accountants in an adjacent
country. This country has just implemented the internationally recognised codes on
corporate governance and jumper & co has a number of clients where the codes
Are not being followed. One example of this, from sgcc, a listed company, is shown below.
As your country already has appropriate corporate governance codes in place, jumper & co
have asked for your advice regarding the changes necessary in sgcc to achieve appropriate
compliance with corporate governance codes.
Extract from financial statements regarding corporate governance
Mr sheppard is the chief executive officer and board chairman of sgcc. He appoints and
maintains a board of five executive and two non-executive directors. While the board sets
performance targets for the senior managers in the company, no formal targets or review of
board policies is carried out. Board salaries are therefore set and paid by mr sheppard
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based on his assessment of all the board members, including himself, and not their actual
performance.
Internal controls in the company are monitored by the senior accountant, although detailed
review is assumed to be carried out by the external auditors; sgcc does not have an internal
audit department.
Annual financial statements are produced, providing detailed information on past
performance.
Required:
Write a memo to jumper & co which:
(a) explains why sgcc does not meet international codes of corporate governance
(b) explains why not meeting the international codes may cause a problem for sgcc, and
(c) recommends any changes necessary to implement those codes in the company.
(20 marks)

Question 5
Cerise, a limited liability company, manufactures computer-controlled equipment for
production-line industries such as cars, washing machines, cookers, etc. On 1 september
2004 the shareholder-managers decided, unanimously, to accept a lucrative offer from a
multi-national corporation to buy the companys patented technology and manufacturing
equipment.
By 10 september 2004 management had notified all the employees, suppliers and
customers that cerise would cease all manufacturing activities on 31 october 2004. The 200strong factory workforce and the majority of the accounts department and support staff were
made redundant with effect from that date, when the sale was duly completed.
The marketing, human resources and production managers will cease to be employed by the
company at 31 december 2004. However, the chief executive, sales manager, finance
manager, accountant and a small number of accounting and other support staff expect to be
employed until the company is wound down completely.
Cerises operations extend to fourteen premises, nine of which were put on the market on 1
november 2004. Cerise accounts for all tangible, non-current assets under the cost model
(i.e. At depreciated cost). Four premises are held on leases that expire in the next two to
seven years and cannot be sold or sub-let under the lease terms. The small head office
premises will continue to be occupied until the lease expires in 2007. No new lease
agreements were entered into during 2004.
All cerises computer-controlled products carry a one-year warranty. Extended warranties of
three and five years, previously available at the time of purchase, have not been offered on
sales of remaining inventory from 1 november onwards.
Cerise has three-year agreements with its national and international distributors for the sale
of equipment. It also has annual contracts with its major suppliers for the purchase of
components. So far, none of these parties have lodged any legal claim against cerise.
However, the distributors are withholding payment of their account balances pending
settlement of the significant penalties which are now due to them.
Required:
You are required to answer the following in the context of the final audit of the financial
statements of cerise for the year ending 31 december 2004:
(a) using the information provided, identify and explain the financial statement risks to be
taken into account in planning the audit. (6 marks)
(b) explain how the extent of the reliance to be placed on:
(i) analytical procedures; and (4 marks)
(ii) management representations, (4 marks)
Should compare with that for the prior year audit.
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(c) describe the principal audit work to be performed in respect of the carrying amount of the
following itemsin the balance sheet:
(i) amounts due from distributors; and (3 marks)
(ii) lease liabilities. (3 marks)
Question 6
Fraud and error present risks to an entity. Both internal and external auditors are required to
deal with risks to the entity. However, the responsibilities of internal and external auditors in
relation to the risk of fraud and error differ.
Required:
(a) explain how the internal audit function helps an entity deal with the risk of fraud
and error. (7 marks)
(b) explain the responsibilities of external auditors in respect of the risk of fraud and
error in an audit of financial statements. (7 marks)
(c) kilimanjaro ltd is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staffs are
partly paid on a commission basis. Well-established tour operators run the holidays that
kilimanjaro ltd sells. The networked reservations system through which holidays are booked
and the computerised accounting system are both well-established systems used by many
independent travel agencies.
payments by customers, including deposits, are accepted in cash and by debit and credit
card. Kilimanjaro ltd is legally required to pay an amount of money (based on its total sales
for the year) into a central fund maintained to compensate customers if the agency should
cease operations.
describe the nature of the risks to which kilimanjaro ltd is subject
arising from fraud and error. (6 marks)

Suggested solutions
Question 1
(a) (i) general controls
general controls relate to the environment in which the computer system are
developed ,maintained and operated .the objective of general controls are to ensure the
proper development and implementation of applications, and the integrity of the program and
data files and of computer operations. General controls include system development controls
,and general administrative controls such as division of duties ,back-up and stand-by
controls.
(vi)
Application controls
Application controls are defined by the standard as those that relate to the transactions
and standing data appertaining to such computer based accounting system and are,
therefore, specific to each application. The objectives of application controls are to ensure
the completeness and accuracy of the accounting records and the validity of the entries
made therein resulting from both manual and programming processing. Application
controls are normally divided into four parts:input controls ,processing controls, output
controls and master file controls.
(vii)
Computer assisted audit techniques (caats)
In simple computer systems, the auditor may focus on the control environment, ensuring
that sufficient control comes from the input and output controls established by the
company. She may not probe into the detailed program checks built into software.
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However ,in complex systems the auditor will place more reliance on existence of
programmed controls and assist the auditor in examining sample transaction data.there
are several types of caat ,for example ,audit software which examines the companys
computer files, test data which is submitted by the auditor for processing by the companys
computer and other techniques such as embedded audit facilities and application program
examination. Caats cannot examine general controls of a computer installation. These are
best examined by normal control evaluation methods,for example icqs, ices.
(b) the essential elements of the planning process can be described as the following:
(i)familiarisation with the computer system in order to assess the specific needs and
problem of the audit. This would include a preliminary review and classification of the system
in operation .
(ii)selection of staff with the appropriate level of technical knowledge and skill
(iii)assessment of the timing of the audit work taking into account the availavility o f
computer time and the frequency with which data is updated and amended.
(iv)consideration of the reporting deadlines as this will have an effect on the usage of
caats.the shorter the deadline ,the more reliance may be placed on caats.
(v)consideration of the use of caats including the costs and benefits and their use ,as
this may have significant effect on the nature ,extent and timing of the audit tests.
(vi)reviewing work performed by internal auditors .caats performed by the internal
audit department may enable the auditor to reduce his audit work.the auditor will have to
asses the effectiveness and relevance of the internal audit function.
(vii)assessing the risks involved in the computer system.
four specific ways in which caats may help the auditor when auditing the sales and debtors
:
(i)compensation for loss of audit trail oncd a customers account has been
authorized ,the only record of this authorization may be held on the computer file .caats may
be used to interrogate this file and extract the information.
(ii)selecting items for audit work .the auditor may use caats for selecting sample for
further audit wok ,for example customers who are above the credit limit ,or selecting items
for a debtors circularization.
(iii)verification of items. The audit package will duplicate the processing performed by
the application programs and then compare its own results with the results produced by
application.for example ,the production of sales ledger control account items for a debtors
circularization.
(iv)conducting complex calculations.the auditor may wish to produce reports or carry
out statistical analysis on available data.for example ,he may wish to produce a debtors
ageing analysis or carry out an analytical review on sales and debtors.
(d)the formal planning of an audit should be carried out by the audit manager and
partner. Planning should take place befor the commencement of the audit in order to
achieve an efficient and effective audit .the use of the computer audit department should
be discussed at managerial level in the audit firm at an appropriate early stage in the
planning year in order to ensure that the computer audit staff are available at the time of
audit .responsiblility for planning the visit of the computer audit department should not be
delegated to a junior member of staff and therefore such a member staff cannot be
blamed for poor planning if the visit does not coincide with that of the main body of audit
staff. The audit senior should liaise with the computer audit manager in order to ensure
that the information to be generated by the use of caats is produced in a timely fashion.

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(e)if the computer audit department visits the client on a different occasion then the
following disadvantages may arise.
(i)information required for the conduct of interm audit will have to be produced
manually ,for example a selection of debtors for circularizing.
(ii)the client may be unhappy because of the disruption caused by two audit visits.
(iii)the computer audit department will need advice by the audit staff, who carried out
the interim audit , on the work be performed.this will involve another audit visit by the staff
which will add to the cost of audit.
Question 2
(a) internal matters and other procedures before appointment
The firm needs to consider a variety of commercial issues and ethical matters (under
nbaaas rules of professional conduct).
Internal matters
Before accepting appointment the firm should ensure that:
(i) it has the necessary staff with appropriate competencies to complete the audit
(this seems likely given that the firm has other clients in this sector);
(ii) the staff are available at what is a busy time of year for the firm (it may be
possible that all of the staff with the necessary competencies are otherwise occupied);
(iii) the firm is independent of viswa. It is unlikely that there will be any issues
concerning shareholdings in the client (because it is owned and run by two entrepreneurs),
however, there may be staff or partners who are related to the client or are otherwise
connected with it;
(iv) there are no conflicts of interest that cannot be properly managed. Conflicts of
interest may exist because the firm has other clients in this sector.
Other procedures
The firm should:
(v) seek the directors permission to communicate with the company accountant
about the nature of the disagreement and the directors should authorise the accountant to
co-operate with the firm;
(vi) seek the directors permission to communicate with the incumbent auditors. If
permission is refused, the appointment should not be accepted;
(vii) ask the client to write to the incumbent auditors notifying them of the change and
giving them permission to communicate with the firm (if viswa refuses to give permission to
the incumbent auditors the appointment should not be accepted);
(viii) communicate with the incumbent auditors (preferably in writing) requesting all
the information which ought to be made available to enable the firm to decide whether or not
to accept the appointment (if there are no such matters, the incumbent auditors should
inform the firm of this);
(ix) seek appropriate transfer information (such as a copy of the last set of accounts
and a detailed trial balance reconciled to the accounts);
(x) indicate a likely fee (or the basis on which fees are calculated) to viswa, ensure
that this is acceptable and that the client is able to pay (by some form of credit check);
(xi) ensure that the incumbent auditor has properly resigned, been dismissed or has
not sought re-appointment in accordance with legal requirements.
(b) starting the audit
It is inappropriate to start the audit before the procedures referred to above have been
completed because:
(i) without the staff with appropriate competencies the firm will be in breach of the
rules (and may be found negligent if things were to go wrong);
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(ii) without complying with the requirements relating to independence and conflicts of
interest, the firm will not only be in breach of the rules, but will lack objectivity and may find
that the client (or other party) objects to the appointment to another client in the same sector;
(iii) without performing appropriate procedures the firm will be unable to form an
opinion on the integrity of the client it may find itself associated with an entity engaging in
doubtful or even illegal activities (taking account of the disagreement over disclosures);
(iv) without agreeing a fee it is almost inevitable that misunderstandings or
disagreements will arise;
(v) without communicating with the accountant and the incumbent auditor, it is quite
possible that disagreements over disclosures will arise, similar to those that have arisen in
the past;
(vi) without ensuring that the incumbent auditor is no longer in place, it will be
inappropriate for the firm to seek appointment.
(c) engagement letter
The engagement letter is of benefit to both the client and auditor and helps prevent
misunderstandings. It:
(i) confirms the auditors acceptance of appointment and constitutes a contract
between the auditor and the client;
(ii) summarises the respective responsibilities of directors and auditors;
(iii) contains details on:
1. The responsibilities of the directors (for accounting records, the financial
statements and the accounting policies on which they are based);
2. The responsibilities of auditors and the scope of the audit (their duty to conduct an
audit in accordance with auditing standards, to review accounting policies and disclosures,
to perform tests and to form an opinion on the financial statements);
3. The form of report to be issued;
4. Other services to be provided;
5. The basis of calculation of fees;
6. Applicable legislation.

Question 3
(a) external auditor responsibilities going concern
Isa 570 going concern deals with this issue.
(i) auditors are required to consider the going concern status of companies and any
disclosures regarding going concern in forming their audit opinion. Companies that are listed
on stock exchanges may be required to make additional disclosures in relation to going
concern issues.
(ii) auditors are required to assess the adequacy of the means (the processes) by
which directors have satisfied themselves that the going concern basis is appropriate and
that adequate disclosures have been made. Auditors conduct an initial analysis at the
planning stage of the audit as well as assessments at later stages.
(iii) auditors should make enquiries of the directors and examine appropriate
documentation supporting the companys going concern status such as budgets and cash
flow forecasts.
(iv) auditors consider whether the period to which directors have paid particular
attention is adequate. This should normally be at least 12 months from the balance sheet
date. Auditors also enquire of management as to their knowledge of events or conditions
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beyond this period that may cast significant doubt on the entitys ability to continue as a
going concern.
(v) auditors need to consider the appropriateness of assumptions which directors
have made, the sensitivity of assumptions to external and internal changes, any obligations,
guarantees or undertakings arranged with other entities, the existence and adequacy of
borrowing facilities and the directors plans to deal with any going concern problems.
(vi) auditors are required to document the extent of any concerns, taking account of
matters that have come to their attention during the course of the audit and in particular,
financial, operational, or other indicators of going concern problems that are present.
(vii) indicators of going concern issues would include trading losses, impairment of
assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans
where necessary, fundamental changes in the markets or technology having an adverse
effect on the company, loss of management, staff, customers or suppliers, or major litigation,
for example.
(viii) auditors should consider the need to obtain written management
representations.
(ix) auditors should consider the adequacy of any disclosures in the financial
statements.
(b) possible audit reports and circumstances
(i) where the auditors consider that there is a significant level of concern about the
entitys ability to continue as a going concern (but do not disagree with the going concern
basis), and where adequate disclosures of the situation are made, they modify (but do not
qualify) their opinion by including an emphasis of matter paragraph highlighting the
existence
Of a material uncertainty as to the going concern status of the entity and drawing attention to
the relevant note in the financial statements. Where adequate disclosures are not made, a
qualified or adverse opinion will be issued.
(ii) where the period to which directors have paid particular attention is less than 12
months from the balance sheet date, the auditors should consider the need to modify the
audit report as a result of a limitation in the scope of the audit.
(iii) where the auditors disagree with the preparation of the financial statements on
the going concern basis, they should issue an adverse opinion. This is very rare because
auditors rarely have sufficient evidence to be sure.
(iv) if the auditors are unable to form an opinion on the going concern status of a
company because of a limitation in the scope of the audit, they will issue an except for
opinion, or disclaimer of opinion but this is unusual.
(c) report issued to tritel
(i) in the case of tritel, there are some indicators of going concern problems. However, the
company may still be a going concern and the fact that the company has been approached
by take-over bidders does not necessarily mean that there is a going concern problem
(possibly quite the opposite).
(ii) the audit opinion issued on tritel in the current year is not likely to make reference
to the going concern status of the company, as in previous years. The situation has not
deteriorated significantly in the current year and it will be difficult for auditors to justify any
change in their opinion from previous years.
(d) difficulties associated with reporting on going concern
(i) if the auditors of tritel were to report on a going concern problem, the mere act of
reporting might of itself create a going concern problem (a self-fulfilling prophecy). This is
particularly the case with large blue-chip companies where the issue of an audit report that

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is modified in any way is unusual and might well cause the companys share price to drop,
thus precipitating a going concern problem.
(ii) this means that it is very difficult for companies such as tritel and their auditors to
send out any clear signal to the markets without running the risk of creating a panic.
(iii) however, recent events show that the consequences of companies and auditors
failing to report where severe financial difficulties are encountered can be disastrous for both
the company (its employees and shareholders) and auditors alike.
(iv) auditors are failing in their professional duties if they do not report on going
concern problems of which they are aware; however, situations involving large companies
are rarely clear cut and auditors who propose to make any changes at all to the audit report
are likely to encounter fierce resistance from management who may genuinely believe that
to make
Such a report would be wrong.
(v) in the companys annual financial statements, it is not the place of the auditor of
tritel to substitute his judgement for that of directors. However, where large companies
involved in complex financing arrangements are concerned, auditors may have to fight hard
against vested and powerful interests if they disagree with the directors judgements and
decide to make reference to the matter in the auditors report. An auditor making reference
to going concern issues in an audit report in such circumstances may lose the audit (and any
other work) and may run a significant risk of litigation.

Question 4
From: a manager, tela & co
To: jumper & co
Subject: corporate governance in the sgcc company
Date: 13 june 2006
As requested, i write to explain where your client sgcc does not appear to be following
appropriate corporate governance codes and to recommend changes to ensure that the
principles of good corporate governance are being followed.
Chief executive officer (ceo) and chairman
Mr sheppard is both ceo and chairman of sgcc. Corporate governance indicates that the
person responsible for running thecompany (the ceo) and the person responsible for
controlling the board (the chairman) should be different people. This is to ensure that no one
individual has unrestricted powers of decision.
I recommend that mr sheppard is either the ceo or the chairman and that a second individual
is appointed to the other post to ensure that mr sheppard does not have too much power in
sgcc.
Composition of board
The current board ratio of executive to non-executive directors is 5:2. This means that the
executive directors can dominate the board proceedings. Corporate governance codes
suggest that there should be a balance of executive and non-executive directors so this
cannot happen. A minimum of three non-executive directors are also normally
recommended, although reports such as cadbury note this may be difficult to achieve.
I recommend that the number of executive and non-executive directors is equal to help
ensure no one group dominates the board.
This will mean appointing more non-executive directors to sgcc.
Director appointment

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At present, mr sheppard appoints directors to the board, giving him absolute authority over
who is appointed. This makes the appointment procedure and qualities directors are being
appointed against difficult to determine. Corporate governance suggests
That appointment procedures should be transparent so that the suitability of directors for
board positions can be clearly seen.
I recommend that an appointments committee is established comprising three non-executive
directors to ensure there is no bias
In board appointments. Formal job descriptions should also be published making the
appointment process more transparent.
Review of board performance
It is correct that the performance of senior managers is reviewed, but this principle should
also be applied to the board. While mr sheppard may undertake some review, this is not
transparent and it is not clear what targets the board either met or did not meet.
I recommend that performance targets are set for each director and actual performance
assessed against these on a regular basis.
Reasons for underperformance should also be ascertained and where appropriate, changes
made to the composition of the board.
Board pay
At present, board members pay is set by mr sheppard. This process breaches principles of
good governance because the remuneration structure is not transparent and mr sheppard
sets his own pay. Mr sheppard could easily be setting remuneration
Levels based on his own judgements without any objective criteria.
I recommend that a remuneration committee is established comprising three non-executive
directors. They will set remuneration levels for the board, taking into account current salary
levels and the performance of board members. Remuneration should also be linked to
performance, to encourage a high standard of work.
Internal control
The system of internal control in sgcc does not appear to be reviewed correctly. While
external auditors will review the control system, this review is based on their audit
requirement and cannot be relied on to test the overall effectiveness of the system. The
system may therefore still contain weaknesses and errors.
I recommend that some more formal review of internal control is carried out, perhaps by
establishing an internal audit department, as noted below. The relationship with the
companys auditors must also be reviewed so that the work of the board and the auditors
regarding internal control is understood by both parties.
Internal audit
Sgcc does not have an internal audit department. Given the lack of formal review of internal
control in the company, this is surprising. Good corporate governance implies that the
control system is monitored and that an internal audit department is established to carry out
this task.
I recommend that an internal audit department is established, reporting initially to the audit
committee who will monitor internal control and then summarise reports for the board.
Financial statements
There appears to be acceptable disclosure in the financial statements regarding the past
results of the company. However, the board should also provide an indication of how the
company will perform in the future, by a forecast review of operations or similar statement.
This is partly to enable investors to assess the value of their investment in the company.
I therefore recommend that the annual accounts of sgcc include some indication of the future
operations of the company.
Audit committee

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There is no mention in the report of an audit committee. Good corporate governance implies
that there is some formal method of monitoring external auditors as well as checking that the
reports from the external auditors are given appropriate attention in the company.
I recommend that an audit committee is established made up from non-executive directors.
The committee will receive reports from the external and internal auditors (as mentioned
above) and ensure that the board takes appropriate action on these reports.
I hope this information is useful. Please contact me again if you require any further
assistance.
Sincerely
Ann c. Outent
Note to candidates: an alternative and allowable answer format was to answer sections (a),
(b) and (c) of the question separately.
Taking this approach would also allow other valid points in part (b) such as inability to obtain
a stock exchange listing.

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Question 5
Cerise
(a) financial statement risks planning the final audit 31 december 2004
Computer-controlled equipment for production-line industries
cerise is manufacturing a relatively high-tech range of products. Inventory will be
overstated if sufficient allowance is not made for technical obsolescence and slow-moving
items (i.e. Writing inventory down to lower of cost and net realisable value).
as cerise is ceasing manufacture two months prior to the year end the items remaining in
inventory at the year end are likely to require being written down in value. The amount of
write down is required to be disclosed in accordance with ias 2 inventories2.
Cessation of trade
cerise ceased to trade during the year. The financial statements should not therefore be
prepared on a going concern basis, but on a break-up or other realisable basis.
this has implications for:
the reclassification of assets and liabilities (from non-current to current);
the carrying amount of assets (at recoverable amount); and
the completeness of recorded liabilities.
Redundant workforce
liabilities may not be disclosed (if contingent) or provided for, if there are claims arising
from the redundant workers (e.g. If their statutory or contractual rights have been breached).
although statutory redundancy pay, holiday pay, accrued overtime etc may well have all
been settled before the year end there may be additional liabilities in respect of former
employees (e.g. Pension obligations).
Sale of patented technology and manufacturing equipment
all assets sold should be derecognised and the profit on disposal disclosed as an
exceptional item arising from the discontinuance of operations.
plant and equipment will be overstated if:
manufacturing equipment that has been sold is left on the books;
assets that were not part of the sale are not:
tested for impairment (in accordance with ias 36 impairment of assets);
written down to the higher of net selling price and value in use.
Accounts department
fewer (skeleton) staff being employed in the accounts department may increase the risk
of errors arising as staff assume
Wider areas of responsibility as the volume of transactions is reduced.
the risk of errors arising not being detected (i.e. Control risk) is also likely to increase. For
example, levels of supervision and degrees of segregation of duties may be reduced and
adherence to control procedures may slacken.
Premises
if the unsold properties meet all the criteria of ifrs 5 non-current assets held for sale and
discontinued operations at the balance sheet date they should be:
separately classified as held for sale.
carried at the lower of carrying amount (i.e. Depreciated cost) and fair value less estimated
costs to sell.
any after-date losses on disposal would provide evidence of impairment. (however, as it is
cerises policy to carry noncurrent assets at depreciated cost, impairment is less likely than if
they were carried at revalued amounts.)
unoccupied premises may fall into disrepair with time. The financial statements would be
misstated if the management of cerise sought to provide for:
dilapidations on the properties arising after the balance sheet date; and/or
future expectation of repairs on unsold properties.

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Such provisions are contrary to ias 37 provisions, contingent liabilities and contingent
assets.
Tutorial note: consider a property with carrying amount $1 million (depreciated cost) and fair
value $16 million. Repair costs of $05 million incurred for deterioration after 31 december
2004 cannot be provided for, nor is the carrying amount impaired.
Onerous contracts
full provision should be made for the lease obligations under onerous contracts on four
premises in accordance with ias 37. This should not be extended to the head office
premises.
Product warranties
adequate provision must be made for warranties of:
one year (sales in the year to 31 december 2004);
up to three years (sales between 1 january 2002 and 31 october 2004); and
up to five years (sales between 1 january 2000 and 31 october 2004).
the provision may be understated if the basis of its calculation is no longer appropriate. For
example, if cerise must now outsource warranty work as it no longer has an in-house
capability.
Breach of agreements/contracts
since cerise no longer has the means of fulfilling contracts with distributors, provision
should be made for any compensation or penalties arising. Where the penalties due to
distributors for breach of supply agreements exceed the amounts due from them, the
receivables should be written down and provision made for any excess.
adequate provision should be made for breaches of contracts with suppliers (nonpurchase). If suppliers do not exercise their rights to invoke penalty clauses disclosure of the
contingent liability may be more appropriate than a provision.
(b) reliance on audit work
(i) analytical procedures
Tutorial note: reliance on analytical procedures is only obtained through those that provide
substantive audit evidence.
This question therefore concerns substantive analytical procedures as evidence which are
optional not those at the
Planning and review stages (which are mandatory).
overall the extent of reliance on analytical procedures is likely to be less than that for the
prior year audit as the
Scale and nature of cerises activities will differ from the prior year.
there are a number of individually material transactions in the current year which will
require detailed substantive
Testing (e.g. Sale of patented technology and manufacturing equipment and sale of
premises).
budgetary information used for analytical procedures in prior periods (e.g. Budgeted
production/sales) will have less relevance in the current year as the cessation of trade is
unlikely to have been forecast.
information will be comparable with the prior year for at most 10 months (i.e. January to
october). Costs incurredin november/december will relate to winding down operations
rather than operational activities.
the impact of the one-off circumstance on carrying amounts is more likely to be assessed
through detailed substantive testing (e.g. After-date realisation) than reliance on ratios and
past history.
for example, analytical procedures on an aged-debt analysis and calculation of average
collection period used inprior years will not be relevant to assessing the adequacy of the
write-down now needed. Similarly, inventory turnover ratios will no longer be comparable
when inventory is no longer being replenished.

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however, some reliance will still be placed on certain analytical procedures. For example,
in substantiating charges to the income statement for the 10 months of operations.
(ii) management representations
overall the extent of reliance on management representations is likely to be increased as
compared with the prior year audit.
the magnitude of matters of judgement and opinion is greater than in prior years. For
example, inventory/trade receivable write-downs, impairment losses and numerous
provisions. The auditor will seek to obtain as much corroborative evidence as is available.
However, where amounts of assets have still to be recovered and liabilities settled,
management will be asked to make representations on the adequacy of write-downs,
provisions, etc and the completeness of disclosures (e.g. For claims and other contingent
liabilities).
where negotiations are under discussion but not yet formalised (e.g. With a prospective
buyer for premises), management may be the only source of evidence (e.g. For the best
estimate of sale proceeds).
however, the extent to which reliance can be placed on representations depends on the
extent to which those making the representation can be expected to be well-informed on the
particular matters. Therefore, as the human resources and production directors will not be
available after the balance sheet date particular thought should be given to obtaining
representations on matters pertaining to employee obligations and product warranties (say).
(c) principal audit work carrying amount
Tutorial note: discussions with management and obtaining management representations are
not principal audit work.
(i) amounts due from distributors
agreeing gross amounts due to accounts receivable balances (for sales made in the
normal course of business up to 31 october 2004 and in the running down of inventory to 31
december 2004).
as a significant portion of account balances outstanding will already be two months old at
31 december 2004, all receipts of after-date cash (if any) should be monitored for evidence
of recoverability.
Tutorial note: a standard direct confirmation of accounts receivable will not be principal audit
work in respect of the carrying amount since the scenario identifies recoverability as the
financial statements risk.
review of agreements with distributors to confirm the unexpired period (up to three years)
and the penalties stipulated.
recalculation of amounts due to distributors for the early termination of the agreements
with them.
review of cerises correspondence to the distributors (e.g. Offering financial settlement)
and responses received.
Tutorial note: distributors might settle for a waiver of the amounts they are owed and/or a
lump sum which amount to less than the penalties due to them under the terms of their
agreements.
(ii) lease liabilities
Tutorial note: it is clearly stated that no new lease agreements were entered into during the
year. Therefore
re-auditing from scratch what would have been examined in previous years as though it
was a new transaction is neither necessary nor efficient.
confirm the leases as operating leases to prior period working papers/disclosures in the
previous years financial statements.
to confirm contracts as onerous and justify full provision:
review cerises correspondence with the lessors requesting terms for an early exit from the
lease period;

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visit premises to confirm that cerise is not receiving any economic benefit from them (i.e.
They are not still
Occupied or sub-let).
agree/reconcile the amounts provided for liabilities under onerous contracts to the present
value of the future minimum lease payments under non-cancellable operating leases.
agree/reconcile the future minimum lease payments used in the calculation of the
provision to those disclosed (under ias 17 leases) in the financial statements to 31
december 2003 as:
later than one year and not later than five years; plus
later than five years.
Tutorial note: the payments not later than one year in the prior year financial statements will
have been paid during the year and so form no part of the provision.
Question 6
(a) internal audit function: risk of fraud and error
(i) the internal audit function in any entity is part of the overall corporate governance
function of an entity. Corporate governance objectives include the management of the risks
to which the entity is subject that would prevent it achieving its overall objectives such as
profitability. Corporate governance objectives also include the overarching need for the
management of an entity to exercise a stewardship function over the entitys assets.
(ii) a large part of the management of risks, and the proper exercise of stewardship,
involves the maintenance of proper controls over the business. Controls over the business
as a whole, and in relation to specific areas, include the effective operation of an internal
audit function.
(iii) internal audit can help management manage risks in relation to fraud and error,
and exercise proper stewardship by:
1. Commenting on the process used by management to identify and classify
the specific fraud and error risks to which the entity is subject (and in some cases
helping management develop and implement that process);
2. Commenting on the appropriateness and effectiveness of actions taken by
management to manage the risks identified (and in some cases helping management
develop appropriate actions by making recommendations);
3. Periodically auditing or reviewing systems or operations to determine
whether the risks of fraud and error are being effectively managed;
4. Monitoring the incidence of fraud and error, investigating serious cases and
making recommendations for appropriate management responses.
(iv) in practice, the work of internal audit often focuses on the adequacy and
effectiveness of internal control procedures for the prevention, detection and reporting of
fraud and error. Routine internal controls (such as the controls over computer systems and
the production of routine financial information) and non-routine controls (such as controls
over year-endadjustments to the financial statements) are relevant.
(v) it should be recognised however that many significant frauds bypass normal
internal control systems and that in the case of management fraud in particular, much higher
level controls (those relating to the high level governance of the entity) need to be reviewed
by internal audit in order to establish the nature of the risks, and to manage them effectively.

(b) external auditors: fraud and error in an audit of financial statements


(i) external auditors are required by isa 240 the auditors responsibility to consider
fraud in an audit of financial statements to consider the risks of material misstatements in the
financial statements due to fraud. Their audit procedures will then be based on a risk
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assessment. Regardless of the risk assessment, auditors are required to be alert to the
possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entitys financial statements to material misstatements due to fraud.
(ii) auditors should make enquiries of management regarding managements
assessment of fraud risk, its process for dealing with risk, and its communications with those
charged with governance and employees. They should enquire of those charged with
governance about the oversight process.
(iii) auditors should also enquire of management and those charged with governance
about any suspected or actual instance of fraud.
(iv) auditors should consider fraud risk factors, unusual or unexpected relationships,
and assess the risk of misstatements due to fraud, identifying any significant risks. Auditors
should evaluate the design of relevant internal controls, and determine whether they have
been implemented.
(v) auditors should determine an overall response to the assessed risk of material
misstatements due to fraud and develop appropriate audit procedures, including testing
certain journal entries, reviewing estimates for bias, and obtaining an understanding of the
business rationale of significant transactions outside the normal course of business.
Appropriate management representations should be obtained.
(vi) auditors are only concerned with risks that might cause material error in the
financial statements. External auditors might therefore pay less attention than internal
auditors to small frauds (and errors), although they must always consider whether evidence
of single instances of fraud (or error) are indicative of more systematic problems.
(vii) it is accepted that because of the hidden nature of fraud, an audit properly
conducted in accordance with isas might not detect a material misstatement in the financial
statements arising from fraud. In practice, routine errors are much easier to detect than
frauds.
(viii) where auditors encounter suspicions or actual instances of fraud (or error), they
must consider the effect on the financial statements, which will usually involve further
investigations. They should also consider the need to report to management and those
charged with governance.
(ix) where serious frauds (or errors) are encountered, auditors need also to consider
the effect on the going concern status of the entity, and the possible need to report externally
to third parties, either in the public interest, for national security reasons, or for regulatory
reasons. Many entities in the financial services sector are subject to this type of regulatory
Reporting and many countries have legislation relating to the reporting of money laundering
activities, for example.
(c) nature of risks arising from fraud and error: kilimanjaro ltd
(i) kilimanjaro ltd is subject to all of the risks of error arising from the use of computer
systems. If programmed controls do not operate properly, for example, the information
produced may be incomplete or incorrect. Inadequate controls also give rise to the risk of
fraud by those who understand the system and are able to manipulate it in order to hide the
Misappropriation of assets such as receipts from customers.
(ii) all networked systems are also subject to the risk of error because of the
possibility of the loss or corruption of data in transit. They are also subject to the risk of fraud
where the transmission of data is not securely encrypted.
(iii) all entities that employ staff who handle company assets (such as receipts from
customers) are subject to the risk that staff may make mistakes (error) or that they may
misappropriate those assets (fraud) and then seek to hide the error or fraud by falsifying the
records.

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(iv) kilimanjaro ltd is subject to problems arising from the risk of fraud perpetrated by
customers using stolen credit or debit cards or even cash. Whilst credit card companies may
be liable for such frauds, attempts to use stolen cards can cause considerable
inconvenience.
(v) there is a risk of fraud perpetrated by senior management who might seek to
lower the amount of money payable to the central fund (and the companys tax liability) by
falsifying the companys sales figures, particularly if a large proportion of holidays are paid
for in cash.
(vi) there is a risk that staff may seek to maximise the commission they are paid by
entering false transactions into the computer system that are then reversed after the
commission has been paid.
Question 1
Score supermarkets ltd is a wholesaler of do-it yourself products. You are the manager
responsible for the audit of the company for the year ended 31st december 2002. It operates
in a rented premise; its fixed assets comprise motor vehicles, a microcomputer and some
minor fixtures and fittings. The accounting records (sales ledger, purchases ledger, nominal
ledger and payroll) are maintained on a microcomputer by a bookkeeper, and a part-time
accountant prepares the annual accounts and quarterly management accounts.
The summarized draft accounts for the year ended 31st december 2002, and the previous
years audited accounts are as follows:

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FOR THE YEAR ENDED 31ST DECEMBER,2002


2002
Shs
Sales
Cost of Sales

2001
Shs

104,390,000.00

50,670,000.00

68,060,000.00

35,520,000.00

Gross profit

36,330,000.00

15,150,000.00

Overheads

27,210,000.00

14,740,000.00

Profit before tax

9,120,000.00

410,000.00

Taxation

2,280,000.00

110,000.00

Retained profit

6,840,000.00

300,000.00

BALANCE SHEET AS AT 31ST DECEMBER,2000


Fixed assets

2,040,000.00

890,000.00

Stock

17,300,000.00

5,260,000.00

Trade Debtors

23,920,000.00

9,550,000.00

Current assets

Prepayments

550,000.00

150,000.00

41,770,000.00

14,960,000.00

17,880,000.00

7,130,000.00

Accruals

3,780,000.00

2,120,000.00

Taxation

2,280,000.00

110,000.00

Current Liabilities
Trade creditors

Bank overdraft

8,610,000.00

2,070,000.00

32,550,000.00

11,430,000.00

9,220,000.00

3,530,000.00

11,260,000.00

4,420,000.00

1,540,000.00

1,540,000.00

9,720,000.00

2,880,000.00

Called up share capital

100,000.00

100,000.00

Profit and loss account

9,620,000.00

2,780,000.00

9,720,000.00

2,880,000.00

Net current assets


Net assets
Director's loan account

The company sells low value items to a larger number of customers. Most of the sales are
on credit, with less than 5% of sales being in cash. It has over 700 live accounts on the
sales ledger of which 70% are new customers in the past year. You have carried out audit
checks on the accounting systems (ie compliance tests) and these tests have shown that the
systems are generally reliable. However, there is no formal system of recording receipts of
goods; the only record of receipt of goods is the suppliers delivery note, but this is not dated
by the goods received department , there is a greater risk of purchases cut-off errors. Your
review of goods is to enable you to plan the audit of the year-end accounts, so that guidance
is given to the audit staff and more time is spent in areas of highest audit risk.
Required :

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(a)
(b)

(a)
(b)
(c)
(d)
(c)
(d)
(e)

Calculate appropriate ratios for both years, and comment on the financial
performance of shoprite ltd for the year ended 31st december,2002, both in
comparison with the previous year and in absolute terms.
From your review of the financial statements and other matters included in the
question, suggest the amount of audit work you should perform and the particular
procedures you should carry out to minimize the audit risk of the following items
appearing in the final accounts:
Stock and gross profit margin
Trade debtors
Trade creditors
Bank overdraft and cash flow forecasts
State those matters you would wish , as auditors , to raise with management
Indicate why you would want to discuss these particular issues
In respect to each matter you wish to raise outline two questions you would put to the
management during this analytical review stage of audit

Question 2
Tanzania auditing standard (tas) no.8 highlights on the growing recognition by management
of the benefits of good internal control, and the complexities of an adequate system of
internal control have led to the development of internal auditing as a form of control over all
other internal controls. The emergence of the internal auditors as experts in internal control
is the result of an evolutionary process similar in many ways to the evolution of independent
auditing.
Required
(a)
(b)

Explain why the internal and independent auditors review of internal control
procedures differ in purpose.
Explain the reasons why internal auditors should or should not report their
findings on internal control to the following selection of company officials:
(vii)
(viii)

(c)

The board of directors


The chief accountant

Explain whether the independent auditors can place any reliance upon the
internal auditors work when the latters main role is to be of service and
assistance to management.

Question 3
One of the essential parts of any audit procedures is performance of analytical procedures
on the information contained in a set of financial statements.
Required
Describe the consideration that the auditors should bear in mind when conducting such
procedures indicating the specific tests that they might adopt and the contents of their
working papers dealing with this part of the audit.
Question 4

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The micronix ltd, a company dealing with computer products has appointed your audit firm to
audit the companys accounts. You are assisting in the interim audit for the company and
assigned the debtors and sales section by the audit senior. Micronics systems ltd maintain
its accounting records on a mainframe computer system. There are about 20,000 debtors on
the sales ledger, which total approximately shs 100 million. The audit senior asks you to
liaise with the computer audit department of your firm in planning and conducting the audit of
debtors. During your conversation with the computer audit manager, he uses certain terms
with which you are not familiar. These include computer assisted audit techniques
(caats),general controls and application controls. Further, as a result of your conversation,
it seems that the computer audit department will not be able to visit the client whilst you are
carrying out your work but will visit the client shortly after you have left the client. The audit
senior is extremely annoyed at this and blames you for the lack of adequate planning.
Required:
(p) Explain what is meant by the following terms used in connection with computer
auditing:
(i) general controls
(ii) application controls
(iii) computer assisted audit techniques (caats)
(q) Describe the essential elements of the planning process when auditing
computerized systems.
(r) Discuss whether you feel the audit senior is justified in blaming you for the lack of
adequate audit planning.
(s) List three disadvantages of the computer audit department visiting the client at a
different time to your interim audit visit.
Question 5
(a) Briefly describe to whom the auditor has a responsibility in relation to a statutory
audit and what are her duties.illustrate your answer by reference to case law.
(b) Explain what you understand by the following terms ;
a. Quality control
b. Peer review
c. Professional indemnity insurance
d. The duty of confidentiality

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Solution question 1
Answer:
(a)
key ratios derived from the accounts are as follows.
2000
Gross profit percentage
net profit percentage
expenses/sales (%)
Average age of stock (months)
average age of debtors (months)
average age of creditors (months)
current ratio
acid test ratio
bank overdraft/shareholders funds

34.8%
8.74%
26.1%
3.1
2.7
3.2
1.28
0.75
0.89

1998
29.9%
0.81%
29.1%
1.8
2.3
2.4
1.31
0.85
0.72

Sales have increased in 1999 by 106% over 1998. This substantial increase in turnover has
been accompanied by a significant improvement in the gross profit percentage from 29.9%
to 34.9%. Over the same period, liquidity has declined, with the bank overdraft increasing
from tshs20, 700 to tshs86, 100. The increase in stocks and creditors has been financed in
part by this increase, in the bank overdraft. The average age of stock held has increased
significantly, raising the possibility that stocks have been overvalued. The average age of
debtors has also increased, raising the possibility that debtors may be overstated. The
average age of trade creditors has increased which suggests that, provided that cut off is
correct and that there hive not been significant misclassifications of amounts between
account headings, the average settlement period has increased. This delay in settlement
has been used as a source of finance for working capital requirements; presumably,
creditors will not be prepared to allow much more lengthening of the settlement period.
As already mentioned, there is the possibility that stocks have been overvalued. Given also
the absence of a proper system for recording purchases receipts, there could be errors in
the accounts, which go towards explaining the increase in gross profit margin.
Especially since sales have increased so much, it may be that sales vary significantly at
different times of the year. The average age of stocks, debtors and creditors calculated
above have been based on annual sales and cost of sales figures rather than on monthly
figures. It should therefore be borne in mind that the increases in these ratios on a monthly
basis may not be as high as those calculated above.
(d)

The particular points i would address are set out below.


(i)

Stock values have increase by 229%, and the gross profit percentage has
increased substantially. In considering whether stocks have been
overvalued, i would consider the following.
1. Has the counting of stocks been carried out completely and
accurately? Have all stocks been counted once and once only, and
has the summarization of stocks been computed accurately?

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2. Is stock valued at the lower of cost and net realizable value (nrv)?
In order to test for nrv, i would check a sample of stock lines of
significant value to selling prices after the year-end. If items are sold
at less than cost, they should be valued at nrv.
3. Is the recording or obsolete stocks provided against, or otherwise
correctly valued at the lower of cost and net realizable value?
Records of stock movements are probably limited, but the
techniques of enquiry and observation may help to identify any
errors, which may have been made.
4. Are slow moving or obsolete stocks provided against, or otherwise
correctly valued at the low of cost and net realizable value?
Records of stock movements are probably limited, but the
techniques of enquiry and observation may help to identify any
errors, which may have been made.
5. Has sales cut-off been performed correctly, with stock dispatched
before the year-end being included as sales but not in year-end
stocks, and stocks dispatched after the year-end being recorded in
year-end stocks but not in the years sales? I would check a small
sample of dispatches each side of the year-end.
6. In view of the lack of a proper system of recording the date goods
were received.
Has the purchases cut-off been performed
correctly? Goods received before the year-end should be recorded
as purchases in the year, with the invoices either posted to the
purchase ledge before the year-end, or included in the year-end
accruals. I would check a sample of goods received each side of
the year-end to ensure correct treatment, and check the
reconciliation of the statements of major suppliers.
7. The increase in gross profit percentage should be discussed with
management in order to establish if there is any known reason for
the increase. Given the btype of merchandise involced, it would be
unusual for gross profit margins to fluctuate much, anf so we can

Solution question 2
(a)

The internal auditors review and test the system of internal control and report to
management in order to improve the information received by managers and to help
in their task of running the company. The internal auditors will recommend changes
to the system to make sure that the management receives objective information
which is efficiently produced. The internal auditors will also have a duty to search for
and discover fraud.
The external auditors review of the system of internal control in order to determine
the extent of the substantive work required on the year end accounts. The external
auditors report to share holders rather than the managers or directors.
the external auditors usually however issue a letter of weakness to the mangers,
laying out any areas of weakness and recommendations for improvement in the

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system of internal control. The external auditors report on the truth and fairnessof
the financial statements, not directly on the system of internal control. The auditors
do not have a specific duty to detect fraud, although they should plan their audit
procedures so as to detect any material misstatment in the accounts on which they
give opinion.
(b)

(i)
board of directors
a high level independence is achieved by the internal auditors if they report directly to
the board . There may be problems with this approach.
(1) The members of the board may not understand all the implications of the internal
audit reports when accounting or technical information is required.
(2) The board may not have enough time to spend considering the reports in
sufficient depth . Important recommendations might therefore remain
unimplemented.
The way round these problems might be dlegated the review of internal audit report
to an audit committee, which would act as a kind of sub- committee to the main
board. The audit committee might be made up largely of non-executive directors who
have more time and more independence from the day to day running of the
company.
(ix)
Chief accountant
It would be inappropriate fot internal audit to reporty to the chief accountant, who is
largerly in charge of running the system of intern control. It may be feasible for him or
her to receive report as well as the bord. Otherwise , the internal audit function
cannot be effectively independent as the chief accountant could suppress
unfavourable reports or could just not act on the recommendations of such reports.

the internal audit function is itself part of the system of internal control; it is an
internal control over internal controls . As such, the external auditors should be able to test it
and, if it is found to be reliable, they can rely on it.
To check the reliability of the work of the internal auditors, i would consider the following
matters.
(i)
The degree of independence of the internal auditors
I would assess the organizational status and reporting responsibilities of the
internal auditors and consider any restrictions placed upon them. Although
internal auditors are employees of the enterprise and cannot therefore be
independent of it , they should be able to plan and carry out their work as they
wiwh and have access to seniour management. They should be free fo any
responsibility which may create a conflict of interest, and of a situation where
those staff on whom they are reporting are responsible for their or their staffs
appointment, promotion or pay.
(ii)
The scope and objective of the internal audit function
I would examine the internal auditors formal terms of reference and ascertain
the scope and objectives of internal audit assignments
(iii)

Quality of work (due professional care)


I would consider whether the work of internal audit is properly planned ,
controlled , recorded and reviewed. Examples of good practice include the
existence of an adequate audit manual, plans and procedures for supervision
of individual assignements, and statsfactory arrangements for ensuring
adequate quality control , reprting and follow- up.

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(iv)

(v)

Technical competence
Internal audit should be performed by persons having adequate training and
competence as auditors . Indications of technical competence may be
membership of an appropriate professional body or attendance at regular
training courses.
Reports
I would consider the quality of reports issued by internal audit and find out
whether management considers and acts upon such reports.

If i find that where the internal auditors work is reliable, i will be able to place reliance on
that work when appropriate. This may mean that i will need to carry out lees audit work.
However, it should be emphasized that i cannot rely totally on the internal auditors work in
relation ot any paticular audit objective. Internal audit work provides only one form of
evidence , an the internal auditors are not independent of the company management. I may
be able to reduce the number of items which i test , but i will not be able to leave a particular
type of test ( example , a debtors circularization) entirely to internal audit. I remain
responsible for the opinion which i form on the accounts.

Question 4
Solution
(a) (i) general controls
general controls relate to the environment in which the computer system are
developed ,maintained and operated .the objective of general controls are to ensure the
proper development and implementation of applications, and the intergrity of the program
and data files and of computer operations:auditing in computer environment(tas 5) .general
controls include system development controls ,and general administrative controls such as
division of duties ,back-up and stand-by controls.
(viii) Application controls
Application controls are defined by the standard as those that relate to the transactions
and standing data appertaining to such computer based accounting system and are
,therefore ,specific to each application.the objectives of application controls are to ensure
the completeness and accuracy of the accounting records and the validity of the entries
made therein resulting from both manual and programming processing.application
controls are normally divided into four parts:input controls ,processing controls,output
controls and master file controls.
(ix)
Computer assisted audit techniques (caats)
In simple computer systems, the auditor may focus on the control environment ,ensuring
that sufficient control comes from the input and output controls established by the
company. She may not probe into the detailed program checks built into software.however
,in complex systems the auditor will place more reliance on existence of programmed
controls and assist the auditor in examining sample transaction data.there are several
types of caat ,for example ,audit software which examines the companys computer
files,test data which is submitted by the auditor for processing by the companys computer
and other techniques such as embedded audit facilities and application program

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examination. Caats cannot examine general controls of a computer installation. These are
best examined by normal control evaluation methods,for example icqs,ices.
(b) the essential elements of the planning process can be described as the following:
(i)familiarisation with the computer system in order to assess the specific needs and
problem of the audit.this would include a preliminary review and classification of the system
in operation .
(ii)selection of staff with the appropriate level of technical knowledge and skill
(iii)assesment of the timing of the audit work taking into account the availavility o f
computer time and the frequency with which data is updated and amended.
(iv)consideration of the reporting deadlines as this will have an effect on the usage of
caats.the shorter the deadline ,the more reliance may be placed on caats.
(v)consideration of the use of caats including the costs and benefits and their use ,as
this may have significant effect on the nature ,extent and timing of the audit tests.
(vi)reviewing work performed by internal auditors .caats performed by the internal
audit department may enable the auditor to reduce his audit work.the auditor will have to
asses the effectiveness and relevance of the internal audit function.
(vii)assessing the risks involved in the computer system.
four specific ways in which caats may help the auditor when auditing the sales and debtors
:
(i)compensation for loss of audit trail oncd a customers account has been
authorized ,the only record of this authorization may be held on the computer file .caats may
be used to interrogate this file and extract the information.
(ii)selecting items for audit work .the auditor may use caats for selecting sample for
further audit wok ,for example customers who are above the credit limit ,or selecting items
for a debtors circularization.
(iii)verification of items. The audit package will duplicate the processing performed by
the application programs and then compare its own results with the results produced by
application.for example ,the production of sales ledger control account items for a debtors
circularization.
(iv)conducting complex calculations.the auditor may wish to produce reports or carry
out statistical analysis on available data.for example ,he may wish to produce a debtors
ageing analysis or carry out an analytical review on sales and debtors.
(d)the formal planning of an audit should be carried out by the audit manager and
partner. Planning should take place befor the commencement of the audit in order to
achieve an efficient and effective audit .the use of the computer audit department should
be discussed at managerial level in the audit firm at an appropriate early stage in the
planning year in order to ensure that the computer audit staff are available at the time of
audit .responsiblility for planning the visit of the computer audit department should not be
delegated to a junior member of staff and therefore such a member staff cannot be
blamed for poor planning if the visit does not coincide with that of the main body of audit
staff. The audit senior should liaise with the computer audit manager in order to ensure
that the information to be generated by the use of caats is produced in a timely fashion.
(e)if the computer audit department visits the client on a different occasion then the
following disadvantages may arise.
(i)information required for the conduct of interm audit will have to be produced
manually ,for example a selection of debtors for circularizing.
(ii)the client may be unhappy because of the disruption caused by two audit visits.

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(iii)the computer audit department will need advice by the audit staff, who carried out
the interim audit , on the work be performed.this will involve another audit visit by the staff
which will add to the cost of audit.

Solution
(a)

Duty to the company with whom the contract has been made .this is a duty
to exercise reasonable care and skill.this duty includes carrying out the work
expediously and abiding by the professional confidentiality rules.the company
would be entitled to sue the auditors for losses suffered as a direct result of a
failure in any one of these areas.
Duty to the members as individual members:although the members appoint
the auditor in general meeting and the audit report is actually addressed to
them ,the caparo case demonstrated that no direct duty of care is owed to the
shareholder as individual shareholders using the accounts as and aid to
speculation.
Duty to third parties (including the shareholders):to prove such a duty exiss to
a third pary the plaintiff must establish proximity; that is ,that the auditor
knew or ought to have known or could reasonably be expected to have known
that the plaintiff was one of the class of persons who were likely to place
reliance on the audit report.it must also shown that it would be just and
reasonable to impose such a duty of care;this allows the courts to allocate
some degree of responsibility to the plaintiffs for ensuring that they have
drawn their decision making information from all the right sources,not just
form the financial statements.
That proved ,the plaintiff would still have to prove actual negligence ,actual
reliance on the negligent statement and actual loss follownt from the reliance.
Ensuring that audits are conducted in accordance with the contemporary
standards of best practice is the surest defence against any accusation of
negligence. Compliance with approved auditing standards and the application of
rigorous quality control techniques are two general examples.the use of statistical
sampling and analytical review proceduresare more specific illustration of best
practice
Cases in chronological order
Ultramares corporation vs touche(1931)
Canler vs crane christmas(1951)
Hedley byrne vs heller & partners(1963)
Jeb fastener vs marks bloom & co (1981)
Twomax & goode v dickson,mc farlane & robinson(1982)
Lloyd cheyham & co vs littlejohn & co (1982)
Al saudi banque vs clarke pixley(1989)
Caparo industries vs dickman(1990)
Berg sons & co vs adams (1992)
Galoo ltd vs bright graham murray(1993)
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(c) (i) quality control


Quality control represents a conscious effort by an accounting /auditing firm to
ensure that the professional services it provides are of consistently high quality
,conform with established professional standardards and meet any external
monitoring requirements.
There is a risk that if standards are allowed to drop then audit judgements may be
unreliable and if this occurs ,there is a possibility that the firm may be sued for
negligence.
Quality control procedures include:
Client acceptance /screening procedures
Education in and adherence of professional ethics
Acuisition and maintanance of requisite skills and competences
Adequately planning ,controlling and recording the audit process
Audit file review
Internal quality control review

The tas no on quality control provides more detail on each of these areas.
(ii)peer review
while many large auditing firms monitor their quality control system internally,it is also
possibe to have them audited by external parties normally another auditing firm of
comparable size.thus ones quality control system can be audited by ones peers.
it is envisaged that all registered audit firms will be subjected to quality review in a
period of 5 years.wach firm will be reviewed once during the peirod and if found not in
compliance with auddtit standards ,procedures and policies will be rewiewed again after 2
years of the first review.it is expected that 25 practicing firms in dar es salaam will be
reviewed in the first year of quality review operationalization. July 2002.
(iii)professional indemnity insurance
In view of the risk that an auditro will be sued ,either by a client or by a third party ,on the
grounds of negligence ,the majority of auditing firms take out what is commonly known as
professional indemnity insurance.some accounting bodies require all their practising
members to carry sufficient professional indmnity insurance what is sufficient is generally
related to the size of their overall fee income.
Cases aginst auditors have become very popular in recent years.;auditors everywhere find it
difficult to get sufficient coverage because of perceived risk raised the level of premium
(x)
The duty of confidentiality
A central part of auditors professional duties is to maintain auditor /client confidentiality;
this is disclosing nothing about the clients affairs whether personal or financial without first
obtaining the permission of a client. The duty of confidentiality is not complete however.
There are instances when the law requires the auditor to break the duty (treason, and
terrorist offences are most likely) and other instances where disclosure is necessary to
protect the auditors own interests and where disclosure is required or permitted by statute.
Auditors are naturally reluctant to breach the confidentiality rules set out by their
professional bodies .an accountant can provide the best service and advice when the
client is fully honest .if a client suspects that the auditor will breach the duty of
confidentiality that client may be less than willing to be totally honest about her financial
transaction-thus an accountants task is made much harder.

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What is meant by reasonable care and skill?


An auditor has an implied duty to exercise reasonable care and skill in the conduct of audit
work and into formation of the audit opinion. Reasonable care and skill means working to at
least the standards required by the relevant professional bodies or regulators. These
standards take the form of professional rules of conduct (dealing mainly with ethical
behavior) and auditing standards and guidelines (dealing with practical auditing which
ensures that they are 'fit and proper persons' and thus eligible to be registered auditors.
How may it be judged by outsiders?
Auditors will be judged on a continuing basis by their colleagues (for internal quality control
purposes) and by the regulators from their professional body. True outsiders will rarely have
the opportunity to judge the quality of audit work except at second hand when a court
investigates allegations of negligence leveled at auditors. In such situations it is likely that
the auditing standards and guidelines referred to above will be the yardstick against which
an auditor's competence is judged. Expert witnesses may be employed by either the
prosecution or the defence in order to prove allegations of negligence or substantiate the
defendant's claims that the audit work was carried out with reasonable care and skill and in
accordance with auditing standards.
How should professional standards be maintained?
i)
By education and training prior to qualification
ii)
By requiring continuing professional development/education once an auditor
is registered.
iii)
By installing quality control review systems in all practicing firms
iv)
By external monitoring of auditing practice by the relevant professional
bodies
Question 2

A) to what extent is it acceptable to provide audit, accounting and systems


advisory services to the same client?
Professional independence demands that auditors retain a sense of distance from their
client: this involves not becoming involved in executive or managerial decisions; not allowing
the fees to become such a large proportion of the whole income of the practice that
professional judgement can be distorted by the fear of potential loss; not auditing accounting
records or examining internal control systems which have been prepared/ implemented by
the auditors themselves; and maintaining a satisfactory distance at the personal relationship
level. Professional standards also require that other financial involvement is kept to a
minimum.
In the case of private limited companies it is frequently necessary to proved a much fuller
service than would be appropriate for public limited company and this may include
participation in the preparation of the accounting records. The duties to be undertaken by a
professional firm on behalf of its client should be clearly sent out in a letter of engagement.
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Anne and josephat must ensure that the client accepts full responsibility for such records
and that objectivity in carrying out the audit is not impaired.
It is usually possible to retain audit objectivity by employing neutral staff on other audit-client
related tasks - a version of chinese walls - but the smaller the accounting practice the more
difficult this is likely to prove.
With regard to systems and control advice the auditor should attempt to draw a line between
advice on the one hand and implementation on the other. Advice on available systems,
faults with present systems and guidance on possible strategies are all a fundamental part of
a professional service but auditor assistance in decision making and the implementation of
those decisions goes beyond professional status and enters the realm of executive activity at this point the auditor's independence is severely damaged.
Smith and jones should try to retain their independence and credibility to outsiders and their
objectivity by refraining from becoming too involved in the provision of non-audit services
and by instituting appropriate measures to ensure that where non-audit services are
provided an adequate distance is placed at the staff level between audit staff and other who
provide non-audit assistance to the client.
b)

The acceptability and desirability of smith and jones continuing to act as auditors
given the circumstances described.
The professional bodies recommend that, in order to prevent dependence and in order to
enhance perceived independence and to aid objectivity the recurring fees paid by one client
should not exceed 15% of the gross fee income of the practice (10% for quoted and public
interest companies). The two facts to be considered are that currently southern engineering
contributes 20% to the gross fee income of smith and jones and is contemplating a public
issue of shares.
If the public issue does not occur smith and jones can consider ways of reducing the fee
dependence to below the professionally recommended norm, perhaps by dropping the
consultancy and/or accounting services they now provide.
If southern engineering does go public then smith and jones will be forced to give up the
accounting work since professional independence rules do not permit auditors of public
companies to also provide accounting services on a regular basis. This may have the result
hat the fee income from southern drops to below the margin 15% level; if not, then the
auditors will have to consider further measures. In the light to be provided as a matter of
course. Depending on the proximity to the 15% limit the auditors may still continue to provide
consultancy services but they should take steps to insulate audit and consultancy work
completely. Since the case is very marginal in terms of the professional requirements the
circumstances should be kept under constant review.
c)
Resignation procedures
Deposit a written notice of resignation at the registered office stating/specifying the date
of resignation.
Include with such written notice a statement that there are no circumstances connected
with the resignation which should be brought to the attention of the shareholders or,
alternatively, a statement of such particulars.

d)
Actions southern engineering should take
Within 14 days send a copy of the auditor's notice to the registrar of companies
a copy of any statement of circumstances connected with the resignation should be sent
within 14 days to all persons entitled to receive copies of the annual accounts. If the
auditor's statement is defamatory, the company may apply to the court for permission to
withhold the statement.

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e)
The auditor's rights when the company attempts to remove them
To receive from the company a copy of any notice proposing their dismissal - the
resolution may carry special notice.
To make representations (not exceeding a reasonable length) in writing to the company
and to request that these be circulated to the members
If they have not been sent out the auditors may require that the representations are read
out at the meeting.
The auditor has the right to speak at the meeting at which a resolution to dismiss him or
her is proposed.

Question 3
Improving the independence of external audit
Reduce the permitted level of fee income from 15% of gross fee income to some lower
figure, thus making it more difficult for auditors to provide other services
Prohibit the provision of non-audit services to audit clients thus circumventing the
independence/integrity problem arising from such work.
Require audit appointments to be rotated between audit firms every four or five years to
prevent too close a client/auditor relationship building up
Take public company auditing into the public sector and have audit fees paid centrally
and audit appointments made by the ministry of trade and industries.
Question 4
Hint: the purpose of the question is to examine student on professional ethics.
a)

b)
c)

The statement on independence warns that personal relationships with a client can
affect objectivity. There is a paricular need thereforfor a practice to ensure that its
objective approach to an assignement is not endangered as a result of a personal
relationship. Problems of this nature can arise if an officer or senioremployeeof an
audit client is so closel connected with the partneror snior menberrofstaff
responsiblefor the conduct of audit as it give rise to real fears of a lack of
independence. closely connected in this context includes spouses and cohabites ,
children and their sppouses, brothers and sisters and any dependent relative. It
follows that one shouldnot audit company of ones brother because of circumstances
set out above
This question raises tow particular issues, firstly the previous auditor of a company
cannot give professional clearance to the auditor who intends to succeed him . It is
for the latter aftermaking the necessary inquiries with the previous audiotr to decid3e
, having taken into accountall the circumstances, whether he or she should act.
Secondly, the detailed guidance on changes in professional appointmnet does
include a requirement for the previous auditor to co-operatepromptly and reasonably
in theprovision of handover information.
However , if fees are still oving to the previous auditor, the prospective auditor is not
on that account expected to refuse to act. Whetherhe does so ornot is entirely a
matter for his own judgment, and so too, is the realted question of howfarhe may go
in assisting the previous auditor to recover those fee. Additionally there isno
pressureon the previous audiotr to provideinformation abvouta client if fees are owing

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from that client. The previous auditor should be prepared to show confiedencein his
level of charging by taking relevant action to recover his fees. The
prospectiveaudotrwill ask the clent the reasons why the fee has not been paid.
d)

There is no objection in principle to a practice providing servicesto aclient additonal


to the audit. However, care must be taken not to performmanaggment functions. In
the case of manby audit clients, it is common to provide a range of accounting
serviceswhich may include the preparation of financial statements. However, in the
case of public companies, a practice should not participatein the preparation of the
companys accounts except in relation to assistance of a routinve clerical nature onr
in emergnvecy situations. Such assistance might not include, for example , work on
the financlisation of statutory accounts including consolidations and tax procvisions. It
is imprtantthat the scale andnature ofsuch work is regularly reviewed, that theclient
accepts responsibility for the records as its own, and that the practice makes
appropriate audit tests even where it has proecessed certain records.

e)

A firms objectivity may be threatened or appear to be threatened when it is involved


in , or thereatened with , litigation in relation to client. Litigation between the auditor
and client could represent a breakdown of the trust which should exist between them
. When a client company expresses an intention to commence lagal action against
an audit firm, the firm and the company may be placed in adversarial positions which
cluld call into question the objectivity of the auditor and thus his her ability to report
fairly and impartially on the companys accounts. At the same time, the management
of the company may mnot be willing to disclose relevant information to the auditor.
The issue by the audit client or a writ for negligneceagainst the auditor would
considered to impair independence . It is not possible to specify the point at which it
would be improper to act as auditor. In this case the client company as only
threatened to sue the firm for negligence. A firm should have regard to circumstances
where litigation, or potential litagation,might reasonably be percieived by the public
as adversely affecting the auditors independence

e)
student members are bound by the ethical requirment of the board. They also remain
bound during the period between the successful completion of the examinations and their
admission to membership, at which point they become subject to the same requirmens
intheir new capacity.
Question 1
An internal control system can be described as comprising the control environment and
control procedures. It includes all the policies and procedures (internal controls) adopted by
the directors and management of an entity to assist in achieving their objective of ensuing,
as far as practicable, the orderly and efficient conduct of its business, including adherence to
internal policies, the safeguarding of assets, the prevention and detection of fraud and error,
the accuracy and completeness of the accounting records, and the timely preparation of
reliable financial information.
Required:
Explain the meaning and relevance to the auditors giving an opinion on financial statements
of each of the management objectives above.
Question 2
Isa highlights on the growing recognition by management of the benefits of good internal
control, and the complexities of an adequate system of internal control have led to the
development of internal auditing as a form of control over all other internal controls. The
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emergence of the internal auditors as experts in internal control is the result of an


evolutionary process similar in many ways to the evolution of independent auditing.
Required
(d)
Explain why the internal and independent auditors review of internal control
procedures differ in purpose.
(e)
Explain the reasons why internal auditors should or should not report their findings on
internal control to the following selection of company officials:
(x)
The board of directors
(xi)
The chief accountant
(f)
Explain whether the independent auditors can place any reliance upon the internal
auditors work when the latters main role is to be of service and assistance to
management.
Question 3
Mohamed enterprises limited is an old established family company whose auditor , mr.
Temba , fcca, has recently died.
You have been approached by the directors with a request that your firm accept appointment
as auditors to the company and they have also asked if you, or one of your partners , would
accept appointment as a director of the company and if a member of your staff would
accept appointment as secretary of the company.
Required :
(a)
State what do you understand by letter of engagement and list its main contents.
(b)
State the steps to be taken to establish your firms appointment as auditors
(c)
State the matters which you feel should be included in a suitable letter of
engagement
(d)
Write your proposed reply giving your reasons, to the request that you or one of
your partners should accept appointment as a directors and that a member of
your staff should accept appointment as secretary.
(e)
Draw up a checklist of the points you would need to consider before accepting
the appointment covering:
a. Legal
b. Ethical
c. Practical and other matters
Solution to question 1 series 4
The auditors objective in evaluating and testing internal controls is to determine the degree
of reliance, which they may place on the information contained in the accounting records. If
they obtain reasonable assurance by means of tests of controls that the internal control
system is effective in ensuring the completeness and accuracy of the accounting records
and the validity of the entries therein , they may limit the extent of their substantive
procedures.
(a)
the orderly and efficient conduct of the business
An organisation which is efficient and conducts its affairs in an orderly manner is mch
more likely to be able to supply the auditors with sufficent appropriate audit evidence
on which to base thwir audit opinion. More importantly , thelevel of inherent and
control risk will be lower, giving extra assurance that the financial statements do not
contain material errors.
(b)
adherance to internal policies
Management is responsible for setting up an effective system of internal control and
management policy provides broad framework within which internal controls have to
operate. Unless management does have a pre-determined set of policies, then it is
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very difficult to imagine how the company could be expected to operate efficiently.
Management policy will cover all aspects of the companys activities and will range
from corporate objectives to specifc areas such as determining selling prices and
wage rates.
Given that the auditors must have a sound understanding of the companys affairs
generally, and of specific areas of control in particular, then the fact that management
policies are followed will make the task of theaauditors easier in that they will be able
to rely more readly on the information produced by the systems established by
management.
(c)

(d)

safeguarding of assets
This objective may relate to the physical protection of assets (for example locking
monies in the safe at night) or to less direct safegurding ( for example ensuring that
ther is adequate insurance cover for all assets ) it can also be seen as relating to the
maintanance of proper records in respect of all assets.
the auditors will be concernied to ensure that the company has properlsy
safeguarded its assets so that they can form an opinion on the existence of assets
and , more generally , on whether the companys recoredas can be taken as reliable
basis for the preparation of financial statements. Reliance on the underlying records
will be particularly significant where the figures in the financial statements are
derived from such records rather than as the result of physical inspection.
Prevention and detection of fraud and errors
The directors are responsible for taking reasonable steps to prevent and detect fraud.
They are also responsible for preparing financial statements which give a true and
fair view of entitys affaris. However , the auditors must plan and perfom their audit
procedures and evaluate and report the results thereof, recorginising that fraud and
error may materially affect the fianancial statements. A strong system of internal
control will give thye auditors some assurance that frauds and errors are not
occuring , unless management are colluding to overcome that system.

(e)

accuracy and completeness of the accounting records / timely preparation of


reliable financial information
This objective is most clearly related to statutory requirements relating both
management and auditors. The company has an obligation under the companies act
2002 to maintain proper accounting records. The auditors form an opinion on
whether the company has fulfilled its obligation and also conclude whether the
financial statements are in agreement with underlying records.
Solution to question 2 series 2
(b)
The internal auditors review and test the system of internal control and report to
management in order to improve the information received by managers and to help
in their task of running the company. The internal auditors will recommend changes
to the system to make sure that the management receives objective information
which is efficiently produced. The internal auditors will also have a duty to search for
and discover fraud.
The external auditors review of the system of internal control in order to determine
the extent of the substantive work required on the year end accounts. The external
auditors report to share holders rather than the managers or directors.
the external auditors usually however issue a letter of weakness to the mangers,
laying out any areas of weakness and recommendations for improvement in the
system of internal control. The external auditors report on the truth and fairnessof
the financial statements, not directly on the system of internal control. The auditors
do not have a specific duty to detect fraud, although they should plan their audit

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procedures so as to detect any material misstatment in the accounts on which they


give opinion.
(b)

(i)
board of directors
A high level independence is achieved by the internal auditors if they report directly
to the board . There may be problems with this approach.
(3) The members of the board may not understand all the implications of the internal
audit reports when accounting or technical information is required.
(4) The board may not have enough time to spend considering the reports in
sufficient depth . Important recommendations might therefore remain
unimplemented.
The way round these problems might be dlegated the review of internal audit report
to an audit committee, which would act as a kind of sub- committee to the main
board. The audit committee might be made up largely of non-executive directors who
have more time and more independence from the day to day running of the
company.

(xii)
Chief accountant
It would be inappropriate fot internal audit to reporty to the chief accountant, who is
largerly in charge of running the system of intern control. It may be feasible for him or
her to receive report as well as the bord. Otherwise , the internal audit function
cannot be effectively independent as the chief accountant could suppress
unfavourable reports or could just not act on the recommendations of such reports.
(c )
the internal audit function is itself part of the system of internal control; it is an
internal control over internal controls . As such, the external auditors should be able to test it
and, if it is found to be reliable, they can rely on it.
To check the reliability of the work of the internal auditors, i would consider the following
matters.
(vi)
The degree of independence of the internal auditors
I would assess the organizational status and reporting responsibilities of the
internal auditors and consider any restrictions placed upon them. Although
internal auditors are employees of the enterprise and cannot therefore be
independent of it , they should be able to plan and carry out their work as they
wiwh and have access to seniour management. They should be free fo any
responsibility which may create a conflict of interest, and of a situation where
those staff on whom they are reporting are responsible for their or their staffs
appointment, promotion or pay.
(vii)
The scope and objective of the internal audit function
I would examine the internal auditors formal terms of reference and ascertain
the scope and objectives of internal audit assignments
(viii) Quality of work (due professional care)
I would consider whether the work of internal audit is properly planned ,
controlled , recorded and reviewed. Examples of good practice include the
existence of an adequate audit manual, plans and procedures for supervision
of individual assignements, and statsfactory arrangements for ensuring
adequate quality control , reprting and follow- up.
(ix)
Technical competence
Internal audit should be performed by persons having adequate training and
competence as auditors . Indications of technical competence may be
membership of an appropriate professional body or attendance at regular
training courses.
(x)
Reports
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I would consider the quality of reports issued by internal audit and find out
whether management considers and acts upon such reports.
If i find that where the internal auditors work is reliable, i will be able to place reliance on
that work when appropriate. This may mean that i will need to carry out lees audit work.
However, it should be emphasized that i cannot rely totally on the internal auditors work in
relation ot any paticular audit objective. Internal audit work provides only one form of
evidence , an the internal auditors are not independent of the company management. I may
be able to reduce the number of items which i test , but i will not be able to leave a particular
type of test ( example , a debtors circularization) entirely to internal audit. I remain
responsible for the opinion which i form on the accounts.
Question 1
(a)
you are the auditor of an industrial holding company and the majority of its subsidiary
companies. During the year under review the holding company acquired a controlling
interest in a long established company.
Required: indicate, in considering the group accounts, the work you would undertake
on the following items relating to the new subsidiary:
1.goodwill
2. Minority interests
3. Turnover
4. Unrealized inte-company profits
5. Revenue reserves
(b)

you have been invited to accept an appointment as a joint auditor


(a)
What are the general merits and demerits of such a joint audit from your
standpoint?
(b)
What are considerations, should you decide to accept the appointment, which
would be likely to dictate the division of the work involved between the two of
you.
(c)
What are the arrangements, which you would make as regards, audit
documentation and files?

Question 2
(c)

There is no point of trying to audit the unauditable. Small companies should therefore
be exempt form the requirements of an audit.
Discuss
(d)
The subject of the audit of small companies has recently received considerable
attention and publicity. Some authorities say that small companies cannot be audited,
so the audit of them should be abolished, others consider that the full audit should be
retained, while other proposes the audit review.
Required:
v.
Give a brief definition of a small companies which would highlight their common
characteristics
vi.
Consider the reasons why the audit of small companies creates special problems
vii.
Show how your general audit approach would be modified when auditing small
companies
viii.
Consider, by means of examples , whether the accounts of small companies