Case Study: Auditing and Assurance

Questions:

Case Study 1:
As a result of work undertaken during the planning stage and audit evidence collected for the tests of
controls stages of the audit, Robert Smith has determined that there is a low risk of material
misstatement (low inherent and control risk) for the following account balances:

1. Wages and salaries

2. Electricity
3. Repairs and maintenance

Due to the expected reliability of these controls, Robert has undertaken extensive testing of the
controls regarding these account balances, and has concluded that the controls are reliable.

Required:
Identify one substantive audit procedure for each of the account balances above that will provide
sufficient appropriate audit evidence regarding the accuracy of that account balance.

Case Study 2:
You are reviewing your audit assistants work for Orange Pty Ltd for the year ended 30 June 2015,
and note the following matters:

Your audit assistant undertook a test of controls for 50 sales transactions. This test resulted in
three errors. When planning the test, a tolerable error of 5 per cent had been established. The
audit assistants working papers noted that none of the errors found were materials, either
individually or in aggregate, and she therefore concluded that the controls were reliable.
Your audit assistants working papers on the accounts payable testing contain the following
notes and conclusion:

1. In order to test accounts payable, I selected all balances over $100,000 and vouched these to
supporting invoices. The sample selected comprised $2,565,650 of total accounts payable of
$5,168,000. One invoice for $102,500 had been incorrectly recorded on the accounts payable listing, as
the goods were not actually received until after year end.
2. Given the error relates to only 4% of accounts payable tested, which would be a total error of $206,702
of the overall accounts payable balance, it is not material as this is less than the materiality level set for
this audit and, therefore, no further work has been performed. I am satisfied that the accounts payable
balance of Orange is fairly stated.

ANSWERS :

Case Study 1

Substantive audit procedures for wages and salaries

Robert had undertaken accrued wages as well as salary account at the end of accounting period.
Most of the audit works on wage system performs at the time of interim period for substantive audit
procedures (Whittington 2011). It confirms payroll costs as well as wages accruals as a final part of
audits. Interim audit work on wages depends upon normal stages of recording, testing internal
controls as well as evaluating for the same. It is advisable in using computer as an audit tool for
testing data as well as audit software. It employs at interim period as well as final audit of wages.
Testing data consists of data submission by an auditor for application controls like data validation
checks. It uses valid as well as invalid transactions for checking operational control at the same time.
It tests for ensuring accuracy levels as well as completeness of balances in respect with wages costs
and payroll deductions. It enables observing clocking procedures as well as supervision levels in
selected payroll agreed hours (Reding 2011). Wages and salaries needs to be audited as per the
given rules as well as substantive audit procedures as far as possible. Auditors require proper
evaluation in implementation of audit software for conducting audit report at the end of the financial
year.

Substantive audit procedures for electricity

Robert needs to evaluate business in accordance with auditing procedures for assisting financial
health of organization. Electricity is one of the expenses that are borne by companies and industries.
Companies have different types of internal controls in case of expenses like electricity (Pflugarth
2011). Some invoices include certain signature levels as well as written contract requirements. It
requires reasonableness check on ordinary variable expenses like electricity. Having bill from two
electric companies taken from one location and causes in case of audit flag. It should have one
electricity supplier for the same. Electricity should be received and paid on timely manner. Auditors
require selection of random invoices for electricity bill. It needs proper original documentation in
against paid amount as well as finding mistakes at the same time (Louwers 2011).

Substantive audit procedures for repairs and maintenance

Robert needs classify asset because it will; help in recording of fixed assets in correct form. It
classifies as capital assets. It ensures capitalization of recording of major part of fixed assets. For
instance, repair and maintenance costs treated as expenses as well as significant amount spent for
asset improvement at the same time (Leung 2011). It ensures capitalization of additional asset values
in an overall manner. Auditors requires in examining selected repair and maintenance work for
supporting essential transactions for determination of capitalization of repair costs. Audit procedures
for repairs and maintenance include presentation as well as disclosure in the financial statements. It
requires testing details in account balances uses by auditor professional in the near future.
Professional judgment determines in scrutinizing balanced accounts in case of repairs as well as
maintenance in the most appropriate way. Variation as well as allocation ensures examining invoices
for future analysis purpose (Hooks 2011).

Case Study 2

(1).
On reviewing Orange Pty Ltd, it is noticed that occurs three potential sampling errors on 50 sales
transactions. On planning test, it got around 5 percent tolerable errors that need consideration as far
as possible. Audit risk includes uncertainties for sampling attributes for factors at the end of financial
year (Hall and Hall 2011). It includes aspects from audit risk like sampling risk as well as non-
sampling risk. It provides reliable information from the internal control of audit transaction in Orange
Pty Limited. It accepts uncertainty caused from cost and time requirements for future analysis
purpose. It examines data as well as adverse consequences in possible erroneous conclusion from
data sampling techniques. Sample evaluation relates with likelihood from existing monetary
misstatements as well as deviations in and from prescribed controls on proportionate terms. It selects
non-statistical analysis for statistical sampling that affects auditors decision-making process (Arens
2011).

(2).
Part A
After evaluating Orange Pty Ltd annual report, it tests for account payable options as selection of
balances $100000 and vouched for supporting invoices. Sampling requires testing accounts payable
for current liabilities for Orange Pty Limited. It ensures acquisition of goods for resale by the
manufacturer (Whittington 2011). Accounts payable refers as obligations for credit transactions at the
same time. It reports gross method as well as net method in purchase assertions in case of cost of
goods sold. It requires reconciliation of accounts payable ledger in accordance with control account
for future analysis purpose. It ensures purchase cut offs in determination of purchased goods for
analytical procedures. It involves cash disbursements in recording payables in the most appropriate
way. In case of audit report, auditors need to calculate receivable reports at the same time. Sampling
selected consists of $2565650 that totals amounting to accounts payable as $5168000. Invoices
comprises for $102500 as it is incorrectly recorded. It ensures accounts payable in listing of goods in
way of account payable options as mentioned in the balance sheet of Orange Pty Ltd. Auditors need
to review at the trend lines of sales as well as accounts payable as unusual trends. It helps in
measuring accounts payable collection period at the same time (Hall and Hall 2011).

Part B
In this particular question, errors records only 4% of accounts payable tests for total error of
$206702. It sets for materiality set in audit process in final audit process in the most appropriate way.
On critical analysis, it is stated that Orange Pty Ltd is fairly stated in the financial statements in the
near future. Auditors requires in reviewing selected credit memos as per audit report analysis. It
assess entries related to provision for bad as well as doubtful debts as per the business environment
(Whittington 2011). Auditors need to evaluate in the account payable attributes as per the test errors
for future analysis purpose. It records auditing errors for setting solutions for the material
misstatement in the financial statement analysis of Orange Pty Limited.

The first article in this series of two on Paper P7 case study questions discussed question style, what to look for
in the requirements, how higher-level skills are tested, and the meaning of professional marks within a question
requirement. This second article goes through part of a typical Section A case study question, applying the
recommended approach described in the previous article. This approach comprises four stages.

STAGE 1 UNDERSTANDING THE REQUIREMENT

The first thing to do is to read and fully understand the question requirement. Here is the requirement we will be
looking at in this article:

Prepare a report, to be used by a partner in your firm, in which you identify and evaluate the professional, ethical,
and other issues raised in deciding whether to accept the appointment as provider of an assurance opinion as
requested by Petsupply Co. (12 marks)

Note: this requirement includes two professional marks.

Having read the requirement, break it down. You are asked to do two things:
identify, ie state from the information provided
evaluate, ie discuss from a critical point of view.

The requirement asks you to consider professional, ethical, and other issues. This could cover a wide range of
considerations, such as:

ethics: independence, competence, conflicts of interest, confidentiality, assessing integrity

professional issues: the risk profile of the work requested, the fee and whether it is sufficient to
compensate for high risk, availability of staff, managing client expectations, logistical matters such as
 timing, legal and regulatory matters such as money laundering, and (in some cases) obtaining
professional clearance
other issues: whether the work fits with the commercial strategy of the audit firm, the potential knock-on
effect of taking on the work such as the impact on other clients, or on other work performed for this client.

You are asked to produce a report, so remember that the professional marks available will be awarded for using
the correct format, the use of professional business language, and for presenting your comments as a logical flow
culminating in a conclusion.

From reading the requirement, you know that the question scenario will be based on a potential assurance
assignment and will be broadly based around acceptance issues.

STAGE 2 READING THE SCENARIO

When reading through the detail of the scenario, you should now be alert to information relevant to this
requirement. Highlight important points that you think are relevant to the scenario and remember to focus on
issues that could affect your acceptance of a potential assurance assignment.

Now read the following extract from the scenario and highlight the salient points remember to look out for any
factors relevant to the ethical, professional, and other issues described above.

Extract: You are a senior manager in Dyke & Co, a small firm of Chartered Certified Accountants, which
specialises in providing audits and financial statement reviews for small to medium-sized companies. You are
responsible for evaluating potential assurance engagements, and for producing a brief report on each
prospective piece of work to be used by the partners in your firm when deciding whether to accept or decline the
engagement. Dyke & Co is keen to expand the assurance services offered, as a replacement for revenue lost
from the many small-company clients choosing not to have a statutory audit in recent years. It is currently May
2007.

Petsupply Co has been an audit client of Dyke & Co for the past three years. The company owns and operates a
chain of retail outlets selling pet supplies. The finance director of Petsupply Co recently communicated with your
firm to enquire about the provision of an assurance report on data provided in the Environmental Report
published on the companys website. The following is an extract from the e-mail sent to your firm from the finance
director of Petsupply Co:

At the last board meeting, my fellow directors discussed the content of the Environmental Report. They are keen
to ensure that the data contained in the report is credible, and they have asked whether your firm would be willing
to provide some kind of opinion verifying the disclosures made. Petsupply Co is strongly committed to disclosing
environmental data, and information gathered from our website indicates that our customers are very interested
in environmental matters. It is therefore important to us that Petsupply Co reports positive information which
should help to retain existing customers, and to attract new customers. I am keen to hear your views on this
matter at your earliest convenience. We would like verification of the data as soon as possible.

You have looked at PetsupplyCos Environmental Report on the company website, and found a great deal of
numerical data provided, some of which is shown below in Table 1.

TABLE 1: PETSUPPLY CO'S ENVIRONMENTAL REPORT NUMERICAL DATA

Petsupply Co:
environmental key
performance Actual KPI Actual KPI
indicator year to 30 year to 30 Reason for
(KPI)/target April 2007 April 2006 variance/trend

To spend $1m per

annum on Petsupply Co has
developing more liquid funds
environmentally- $1.1m spent $0.75m spent available in the year to
friendly packaging on relevant on relevant 2007 to spend on
and bags development development development projects

To increase the 50 tonnes of 25 tonnes of Petsupply Co has

amount of waste waste waste doubled the amount of
 Petsupply Co:
environmental key
performance Actual KPI Actual KPI
indicator year to 30 year to 30 Reason for
(KPI)/target April 2007 April 2006 variance/trend

recycled by 10% per recycled recycled waste recycled due to

annum installation of
recycling bins at all
stores

To ensure that at Customers complete

least 90% of our surveys in store to
customers are very rate our policies; data
happy with shows that customers
PetsupplyCos are extremely happy
environmental 95% very 70% very with our progress on
policies happy happy environmental matters

STAGE 3 TAKE TIME TO THINK ABOUT THE REQUIREMENT AND THE

SCENARIO
As discussed in the previous article, you must take time and not rush to answer. When evaluating this particular
scenario try to think widely about the information provided. Your answer should cover a broad range of issues
rather than concentrating on one or two. Your comments must be tailored to the scenario. It is pointless, for
example, to write about a general acceptance issue which is not specifically related to Petsupply Co.

It is important to appreciate that few marks will be available for stating the issue. The higher-level skill marks in
this question will be awarded for a discussion of why the issue is relevant to the decision about whether or not to
provide the assurance service to Petsupply Co. The requirement is to evaluate the scenario and therefore it is
crucial to demonstrate an appreciation that there may be two conflicting sides to the discussion.

Table 2 shows an example of a thought process which identifies the issues and explains why each issue is
relevant to the requirement; the issues are shown in the order in which they appear in the question.

TABLE 2: EXAMPLE OF A THOUGHT PROCESS WHICH IDENTIFIES ISSUES AND

SHOWS RELEVANCE TO THE REQUIREMENT

Issue from the scenario Why relevant to the requirement

The engagement will provide an extra source

Your firm is keen to provide more assurance services
due to loss of income from audit services
of revenue, and accepting the assignment fits
the commercial strategy of Dyke & Co. But,
the firm should not put the fact that it wants
more revenue from providing assurance
services above the more important
consideration of ethical and professional
issues, and the overall assessment of the risk
attached to the assignment. It will also be
important to consider whether the assignment
is a one-off engagement or is likely to be an
ongoing service.

Your firm will already possess good business

understanding, which will reduce the risk
associated with the engagement, and should
Petsupply Co has been a client for three years also cut down on planning time. However,
 Issue from the scenario
The assurance service requested is to provide an
opinion on environmental key performance indicators
Petsupply Co is keen to disclose positive data in order directors with confidence about the data,
to maintain customer satisfaction
Petsupply Co requires a verification of the
environmental data
Petsupply Co wants the work performed as quickly as
possible
Why relevant to the requirement
Dyke & Co must consider various ethical
matters, as Petsupply Co is already an audit
client, including the appropriateness of
providing a non-audit service, and the impact
on the level of fees received from an existing
client. It is irrelevant to discuss whether there
are general threats, such as financial interests
in Petsupply Co, as Dyke & Co already
provides the audit service, and should
therefore already have conducted general
ethical clearance.
This appears to be a very specialist
assignment and it is questionable whether a
small firm of accountants would possess
relevant skills and experience. However, the
firm could either spend time and money
training staff to perform the assignment, or
bring in specialists to perform the work. This
would enable Dyke & Co to build up
experience in this area, enabling it to provide
further services of this type, which fits in with
the firms commercial strategy. However,
whether the skills are developed in house, or
bought in, there will be considerable expense
involved; Dyke & Co would need to carefully
consider the fee charged as the firm will want
to recover as much cost as possible.
There is a high inherent risk attached to the
environmental data. Petsupply Co has a clear
reason to manipulate the data in order to
disclose that targets are being met. In
deciding whether to accept the assignment,
Dyke & Co must consider whether this risk
can be reduced to an acceptable level. It may
be difficult for Dyke & Co to challenge the
given its lack of experience in this area.
The client appears to have an unrealistic
expectation of what an assurance service can
provide. Before any decision is made about
acceptance, Dyke & Co must explain to the
client that its report will not verify or certify the
data, and is likely to provide at best limited
assurance over the data the expectation of
the client clearly needs to be managed.
As discussed above, Dyke & Co will need to
either develop or buy-in expertise in this area,
and due to the high inherent risk identified
above, the firm will want to spend plenty of
time gathering evidence. The client again may
have unrealistic expectations about the
 Issue from the scenario Why relevant to the requirement

timeframe in which the opinion could be

provided.

It would be relatively easy to gather evidence

on the amount spent on development, as this
is similar to a substantive audit procedure but
it may be hard for Dyke & Co to substantiate if
the money has really been spent on
environmentally-friendly packaging.
Quantifying how much waste has been
recycled will depend on the strength of the
system put in place by Petsupply Co to
capture the data. Equally, it would be difficult
to gather detailed evidence to reach an
opinion on customer satisfaction as it is a very
subjective measure, not suitable for
quantification. All of the above points suggest
that the engagement will involve testing some
subjective issues, and possibly relying on the
controls put in place by the client, both of
Some of the data shown in the environmental report is which have an impact on the overall risk
not well defined assessment of the work requested.

Table 2 is not an answer, it is a thought process. This is what you should be thinking about after reading through
the scenario. The previous article stressed the importance of thinking through the scenario. It may help to jot
these ideas down in an answer plan before making a start on your written answer, as this will help you to
prioritise the points and give the report a logical flow.

STAGE 4 WRITING THE REPORT

The requirement states that two professional marks are available. As discussed in the previous article, these
marks are not for the technical content of the answer, but for the way the relevant points are communicated. The
report will be evaluated on the following:

Use of a report format a brief introduction, clear separate sections each discussing a different point, and a
final conclusion.
Style of writing the report is addressed to the partner and so language should be appropriate. You do not
need to explain things that would be obvious to a partner, and you must be tactful.
Clarity of explanation make sure that each point is explained simply and precisely, and avoid ambiguity.
Evaluation skills demonstrate that each point may have a positive and a negative side.

Remember, when answering any question requirement it is quality not quantity that counts. You should make
each point succinctly and remain focused on the specific requirement. Questions can be time pressured, but it is
important to remember that you should be able to read the requirement, think about it, and write an answer in the
time available. This means that there is only a limited amount of time available for actually writing the answer, so
keep it short and to the point. Irrelevant waffle earns no marks and will detract from the professional skills
evaluation. What follows is an outline report format for this requirement:
Introduction
Report is internal, addressed to a partner, covering proposed assurance service for existing audit client

Section 1 ethical matters

Provision of non-audit service
Impact on total fee from client
Competence to perform work specialised engagement
Section 2 risk-related matters
High inherent risk figures prone to manipulation
Data highly subjective
Need to rely on systems put in place by client

Section 3 commercial matters

Fee will have to be high enough to compensate for high risk
Fee may need to compensate for specialists if used
Strategic fit assignment in line with commercial goals of Dyke & Co
Build up experience in non-audit service
Ascertain whether assignment will be recurring

Section 4 other matters

Managing client expectation regarding type of opinion sought
Managing client expectation regarding timeframe

Conclusion
Summary of key issues and decision on acceptance

Note: not all of the above points are necessary to secure a pass mark; the marking scheme is also flexible
enough to cater for comments that may not appear in the model answer.

SUMMARY
This article shows how to approach one requirement from a typical Section A question in Paper P7. It is important
to practise technique by attempting as many questions as possible, starting with the Pilot Paper for Paper P7.