Monitoring Test MT1A

Audit and Assurance

(International)
F8AA-MT1A-X08-A

Answers & Marking Scheme

The model answers to the questions are longer

and more detailed than would be expected from a
candidate in the examination. However, the model
answer may not include all valid points mentioned by
students credit will be given to students mentioning
such points.

The model answer may be used as guide to the form

and standard of answer students should aim to
achieve.

Accountancy Tuition Centre Ltd

ATC
INTERNATIONAL
1 CLOVER

Tutorial note: Watch out for the word and in the requirement.

Ethical matters

To ensure professional independence:

the proposed audit fee (together with fees from any other recurring work) should not be more
than 10% of gross practice income and that of the engagement partner;

any shares in Clover held by partners will need to be disposed of (at the earliest practicable
date) if the appointment is accepted;

any shares held by staff must be declared and such staff must not be engaged on the
assignment (it may be the partnerships policy that no shares can be held by any staff
member) if the appointment is accepted; and

potential conflicts of interest should be avoided (eg by not accepting the appointment if
already acting (as auditor or consultant) for a competitor of Clover).

Family or other close personal or business relationships between employees of Clover and the staff of
Future & Co must be identified and safeguards set up within the practice (eg staff are not involved in
any work related to Clover). If such relationships involve a partner within Future & Co. it is highly
unlikely that appointment can be accepted.
The duty of Future & Co to communicate with the existing auditor (Past & Co) should be explained to
the prospective client (Clover). The purpose of this is to ascertain the reasons behind the proposed
change, of which Future & Co should be aware, prior to accepting the nomination. The nomination
should be declined if Clover refuses authority for such communication.
The resignation of Past & Co may have been prompted by disagreement (eg over the truth and fairness
of the view shown by Clovers accounts) or the loss of professional understanding between the two
parties. This may cast doubt on the directors integrity and Future & Co. must carefully consider their
involvement with the client.

Practical matters

Staff of appropriate experience and technical ability need to be available for the new audit
whilst maintaining an efficient and effective service to existing clients.

The timescale for the completion of the audit, as envisaged by the directors, must be feasible.
The reporting deadlines for the companies will need to be met.

Schedules and draft accounts to be produced by the client should be in formats suitable for
audit purposes.

Any other services required (eg tax, company secretarial, management consultancy) must be
agreed. As Clover is a listed company, these will probably need to be dealt with through the
companys audit committee.

The involvement of specialists (experts) and other (or joint) auditors should be clearly
defined. The nature and scope of the reliance on internal audit (as a listed company) must be
carefully considered.

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2 EDCO

(a) Sources of information

The previous auditor may provide background information and information on

specific previous audit problems when replying to the etiquette letter sent by this
firm prior to accepting nomination as auditors.

(Note that since this is a first year audit, it will not be possible to review prior year
audit working papers or a permanent file for this client. It is highly unlikely that the
previous auditor will allow you full access to their past working papers and
permanent files.)

Any proposal document produced in order to pitch for the clients audit should
contain information about the nature of the business.

Brochures produced by the hotel advertising its facilities and advertisements,

articles or features in the local press.

The members of the hotel management themselves and the management of Edco, if
different.

Copies of previous financial accounts, as well as copies of the current years

management accounts.

Observation of the hotels activities from a visit to the site, possibly combined with
an overnight stay.

Hotels web site and relevant industry websites.

(b) Possible risk areas

Inherent risk

Inherent risk derives from the characteristics of the enterprise that is being audited, or the
circumstances of the particular audit assignment. It is the perceived risk that the financial
statements will be materially misstated. Inherent risk can be considered at two levels: that of
the financial statements themselves, and that of individual account balances.

The financial statements themselves

As this is a new audit client we do not have:

prior knowledge or experience of the business;

the relevant experience of managements contribution;
any specialised knowledge in this industry.

These factors contribute to a greater degree of inherent risk than would be the case in a long-
established client.

The existence of the microcomputers, their potentially rather insecure locations and the
possibility of lack of training for staff as to their use may contribute to the increased risk of
misstatement within the accounting records.

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 The high degree of staff turnover (possibly at all levels of the organisation) may mean that the
experience or calibre of management is not as high as the business requires, again leading to a
higher inherent risk.

The individual account balances

The largely cash-based nature of the business gives rise to potential problems regarding
completeness of recording of transactions. The cash-based nature of the business also gives
rise to the greater risk of misappropriation.

The wide variety of discounts offered by the hotel may present problems in ensuring their
proper accounting treatment, giving a greater risk of misstatements within the accounting
records.

Inventory may constitute an area of specific inherent risk due to problems of valuation
(especially foodstuffs) and its susceptibility to shrinkage.

Control risk

Control risk is the risk that the clients system of internal controls will fail to prevent or detect
material misstatement in, or omission from, the financial statements.

Areas of control risk within Edco include the following:

High staff turnover (meaning few experienced employees).

A high number of part-time employees (which could mean a lack of motivation and
commitment on their part, as well as a poor degree of training).

Reliance on the microcomputer for processing bookings and accounting transactions

(especially given the levels of staff turnover and part-time staff).

The potential lack of controls over the microcomputers (especially the one in
reception which could be open to unauthorised access).

The use of electronic tills. These require strong controls over master files so that
the appropriate prices are charged and recorded.

A potentially weak control environment, unless strong controls over the receipt of
cash and the giving of discounts have been established.

Tutorial note: Overall it is likely that there is a high degree of risk within Edco Ltd. These
must be assessed in order to tailor the audit approach to achieve a satisfactory level of
detection risk. This will provide the overall assurance required to give an appropriate audit
opinion on the financial statements.

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(c) Internal control objectives

Tutorial note: The internal control objectives of the accounting systems as a whole are to
ensure the complete and accurate processing of authorised transactions. To that end, each of
the subsidiary accounting systems of the business should aim to record only bona fide
information:

to ensure that the financial statements as a whole are not materially misstated; and
to assist in safeguarding the assets of the business.

(i) Room lettings

To ensure that all lettings are recorded and charged at authorised rates.

To ensure that account is taken of any discounts, seasonal price variation, number of
occupants and any facilities/services enjoyed by the customer during his stay.

To ensure that, as far as possible, rooms are only let to creditworthy customers.

To ensure that all room bookings are confirmed in writing by the customer.

To ensure that any deposits payable are collected and accurately and completely
recorded in the accounts.

To ensure that booked rooms not claimed by a specified time are available for re-
letting.

To ensure that all room charges are received and completely and accurately
recorded in the accounts.

To ensure that room letting records are as up-to-date as possible to help ensure
maximum occupancy rate in the hotel.

To ensure that rooms cannot be let and not recorded or paid for at the correct rate.

(ii) Part-time employee wages

To ensure that wages should be computed for bona fide employees only and using
authorised rates of pay and conditions.

To ensure that wages are calculated in agreement with records of work actually
performed (eg time sheets or a staff signing-in register).

To ensure that claims for overtime, bank holidays and bonuses are authorised.

To ensure that wages are paid to the appropriate employees.

To ensure that physical controls are present to ensure safe custody of cash and any
unclaimed wages.

To ensure that all payroll transactions are accurately recorded within the accounting
records and correctly accumulated therein.

To ensure all payroll deductions are correctly calculated and recorded and paid over by
the due dates.

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3 AUDIT COMMITTEES

(a) Roles and responsibilities

To monitor the integrity of the financial statements of the company, reviewing

significant financial reporting judgements contained in them;
To review the companys internal financial controls and the companys internal
control and risk management systems;
To monitor and review the effectiveness of the companys internal audit function;
To make recommendations to the board in relation to the appointment of the
external auditor and to approve the remuneration and terms of engagement of the
external auditor;
To review and monitor the external auditors independence and objectivity and the
effectiveness of the audit process;
To develop and implement policy on the engagement of the external auditor to
supply non-audit services;
To report to the board, identifying any matters in respect of which it considers that
action or improvement is needed and making recommendations as to the steps to be
taken;
To review arrangements by which staff of the company may, in confidence, raise
concerns about possible improprieties in matters of financial reporting or other
matters.
(b) Communication with audit committee

Tutorial note: Consider the audit cycle and at what stages communication (eg verbal,
written etc) is required.

At the commencement of each audit cycle, the auditor must establish that the terms
of engagement are appropriate. These should be discussed with the audit committee
as should the remuneration to be paid in respect of audit services provided.

The auditor must be independent of the company. The audit committee will discuss
the independence of the audit firm and the audit team, review their independence
policies and processes to maintain independence, and agree that the firm is
complying with appropriate ethical guidelines, ie ACCA..

Before the start of any audit fieldwork (eg the interim audit) the audit committee
should ensure that appropriate plans are in place for the audit, eg the overall
strategy, risk assessment, materiality, resources and work plans. This will involve
meeting with the senior audit team members and discussing these matters;

After each audit fieldwork stage (eg interim, inventory observation and final audit)
meet with and review the findings of the auditors work, eg:

discussing major issues that arose during the audit (both resolved and
unresolved);
key accounting and audit judgements;
levels of error identified during the audit; and
discussing with management and auditors why certain errors remain
unchanged.

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4 THREE SOURCES

Tutorial note: Considering the two components of appropriateness (ie relevance and reliability)
breaks down the mark allocation.

(i) Initials on a grid stamp for quantity, prices and extensions on purchase invoices

Relevance

Visual inspection of initials on a grid stamp provides evidence that an internal control has
been performed. As a test of control it provides evidence that this area of the purchases
system has operated effectively.

Reliability

The evidence is not conclusive since the grid could be initialled without the check being
performed. The auditor is more likely to rely on the checks having been performed if there is
other evidence (eg quantities cross-referenced to goods received notes and cast symbols).

If it is established that the check, though evidenced, is not being performed (eg if
reperformance identifies an error not detected by the client) no reliance should be placed on it
(unless isolation can be proven).

Sufficiency

The auditor will usually reperform the checks to substantiate the transaction (since the test of
control provides only indirect evidence regarding the completeness, accuracy and validity of
purchases).

(ii) Year-end bank report for audit purposes (confirmation letter)

Relevance

A bank report for audit purposes assists in ascertaining:

the existence and amount of liabilities;
the existence, amount, ownership and proper custody of assets.

It also provides other information relevant to disclosures in the financial statements (eg
contingent liabilities).

Reliability

Information given by a reputable bank is regarded as reliable (even if the bank attaches a
responsibility disclaimer) unless it is clearly wrong, suspicious inconsistent in itself, or in
conflict with other evidence. As documentary evidence received directly by the auditor from
an independent third party, it is more reliable than third party evidence held by the client (eg
monthly bank statements).

Sufficiency

Although the confirmation provides sufficient evidence concerning bank account balances per
the bank, they will still have to be reconciled to the clients cash book balances. Reconciling
items (essentially timing differences) will need to be verified against after-date bank
statements.

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 The confirmation will provide sufficient evidence of:
accrued charges even where they are calculated on a provisional basis (unless they
are material to the financial statements, which is unlikely);
security and assets held.

(iii) Comparison of weekly till rolls and cash bankings

Relevance

This is relevant to the completeness and accuracy of recorded cash receipts. The comparison
should also reveal seasonal trends in sales revenue.

Reliability

Analytical procedures carried out by the auditor provide most reliable evidence. Cash
bankings per the bank statement (third party documentary evidence) are more reliable than till
rolls generated by the client.

Sufficiency

The comparison is sufficient to confirm the completeness and accuracy of cash receipts once
they have been recorded on the till roll. However, additional evidence will be required to
confirm that till rolls are a materially complete and accurate record of sales transactions (eg
analytical procedures on gross profit margins and inventory reconciliations).

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 Marking Scheme

For most questions the marking scheme suggests you award 1 mark a point. However, the mark you
award for each point will depend on its relevance and the depth of the students discussion. So, a brief
point may be worth 1/2 mark or less while a point with a longer and deeper discussion could be worth 2
marks.

Also, marks are not allocated to specific points, as the student may mention a valid point which is not
given in the model answer obviously the student should be given credit for the point.

Many questions require the students to include a range of points in their answer, so an answer which
concentrates on one (or a few) points should normally be given a lower mark than one which considers
a range of points.

Marks Marks
1 CLOVER

Ethical matters
Generally 1 mark each point up to a maximum of 6

Practical matters
Generally 1 mark each point up to a maximum of 4
__
max 9

2 EDCO

(a) Sources of information

Generally 1 mark each point up to a maximum of 5

(b) Inherent risk areas

Generally 1 mark a point up to a maximum of 5
Control risk areas
Generally 1 mark a point up to a maximum of 4 9
__

(c) Internal control objectives

Generally 1/2 mark a point up to a maximum
for each of (i) and (ii) 3 6
__ __
20

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 Marks Marks
3 AUDIT COMMITTEE

(a) Responsibilities
Generally 1 mark for each up to a maximum 5

(b) Communications
Generally 1 mark a point up to a maximum of 2 marks for each element
Max of 7
__
12

4 THREE SOURCES

Discussion

Generally 1 mark each point on relevance/reliability/sufficiency

Maximum for any one of (i), (ii) & (iii) 43

Ideas: Relevance CAPER (balances)

CAVe (transactions)

Reliability internal v oral, visual v documentary v oral

generalisations/rules of thumb

Sufficiency risk, materiality, relevance, reliability, findings

__
max 9

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