ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Practice questions
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Required
(a) Describe and illustrate, by the use of suitable examples, the way in which
statistics and judgement can be used in audit sampling, in relation to:
(i) the audit of the sales system
(ii) writing directly to trade receivables, asking them to confirm the balance
owed
(iii) the verification of year end trade receivables.
(b) Based on your answer to (a), above, discuss the advantages and disadvantages
of the use of statistical or judgmental sampling.
16 Internal audit questionnaire
As external auditor, you are planning to rely on the work of the internal audit
department at your client.
Required
Prepare questions for inclusion in a questionnaire to be sent to the head of the
internal audit function, which, when completed, will allow you to assess how much
reliance, if any, you can place on the work of the internal audit function.
17 Sopot
You are auditing the purchases system of Sopot. In this system:
(1) purchase orders are raised by the purchasing manager and signed by the
managing director
(2) goods are received by the goods receiving department, which prepares a
goods received note
(3) purchase invoices are posted to the purchase ledger by the book-keeper. The
purchase ledger is maintained on a small microcomputer
(4) cheques paying suppliers are signed by the managing director.
A junior member of the audit staff has asked you a number of questions on the
subject of internal control.
Required
(a) Define the term ‘internal control’ and set out the five elements which make up
an internal control system.
(b) Describe the reasons why it is important to the auditor that there should be a
good system of internal controls in operation.
(c) List the stages you would go through in carrying out the audit of the
purchases system and briefly describe how these involve consideration and
testing of the system of internal control.
(d) Describe the effect on your audit work, and the action you would take:
(i) if you found a weakness in one of the controls in the purchases system
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(ii) if you concluded that weaknesses in the system of internal control in the
purchases system were so serious that you would not be able to rely on
internal controls in your audit work on purchases.
18 Control activities
Control activities may be defined as policies, procedures and operations that help to
enable management directives to be carried out. These activities are detailed
procedures designed to prevent, or to detect and correct, errors that may arise in
processing information.
Required
(a) Set out six examples of types of controls and illustrate each one in the context
of the purchases or trade payables system.
(b) Explain why, even where tests of controls prove satisfactory, substantive
procedures can never be completely eliminated.
19 Ascertaining and recording accounting systems
Discuss the usefulness of the different methods available to an auditor for
ascertaining and recording an entity’s accounting and internal control system.
20 Grander Products
Grander Products has the following wages and salaries system for its 40
pieceworkers who are paid weekly in cash.
Each employee fills in a record of work completed which is signed by one of two
supervisors before being passed to the accounts department. The payroll clerk takes
these details, and prepares the payroll, referring to the personnel records kept by
the company secretary. The payroll clerk then requests a cheque for the weekly cash
wages and prepares the pay packets which are distributed by the supervisors.
Required
Draft questions to be included in an internal control questionnaire for weekly wages
paid in cash.
21 Pivo
Mr Pivo, a client of your firm, is the managing director of Pivo, which buys do-it-
yourself tools from large manufacturers and sells them to small retailers.
As the firm has been expanding, Mr Pivo has recently purchased a microcomputer.
He has asked your advice about the controls which should be exercised over the
computer when processing accounting data. Initially, Mr Pivo is proposing to use
the computer for producing sales invoices and maintaining the sales ledger.
The sales system data files will comprise:
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standing data files containing customer names, addresses and credit limits and a
price file containing the part numbers, descriptions and selling prices of the
company’s products
transaction files containing the outstanding transactions for each customer’s
account, the values of individual invoices, credit notes, cash, discount and
adjustments posted to the sales ledger in the month and the ageing and the total
balance on each customer’s account.
The system will operate as follows:
1) The customer details, and the part numbers and quantities of the goods
dispatched are input into the computer, which calculates the invoice value by
accessing the standing data file. When the operator confirms that the invoice
details have been input correctly, the computer prints the invoice and posts it
to the sales ledger.
(2) Cash received and discounts are input into the system from the cash book,
and they are matched to the invoices which are being paid.
(3) Credit notes and adjustments can be input directly into the sales ledger.
(4) At the end of the month the computer prints:
(i) a summary of the invoices, credit notes, adjustments, cash and discounts
posted to the sales ledger in the month
(ii) an aged list of receivables
(iii) customer statements, which show the outstanding transactions at the
end of the month.
(5) The computer has the facility to print out during the month the summaries
described in part (4) above, and the details of any customer account.
Required
(a) List and describe the procedures which should be carried out in setting up the
files containing:
(i) the customer names, addresses and credit limits
(ii) the price list of the products the company sells
(iii) sales ledger balances which are to be transferred from the manual
system to the new computer system.
(b) List and describe the controls which should be exercised over:
(i) the input of transaction data, to ensure the risk of errors is minimised
and that there is no unauthorised input of transactions
(ii) the amendment of standing data files containing customer names,
addresses and credit limits
(iii) the amendment of the prices of the products the company sells.
(c) List and describe the procedures which should be carried out to ensure the
accuracy of the transaction file data, which contains balances on customers’
accounts and the outstanding transactions making up those balances.
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22 Sales cycle controls
When considering the internal controls in a sales cycle the auditor will need to
consider the following stages:
The processing of orders
The despatch and return of goods
Required
(a) Specify the control objectives for each of the above stages in a sales cycle
where all sales are made on a credit basis, and explain their importance.
(b) List the internal controls you would expect to see in place in a simple manual
system in order to achieve those objectives.
23 Countrywide Sales
The transport department of Countrywide Sales operates a fleet of 100 motor
vehicles. Some vehicles are purchased for cash and some are leased.
Required
(a) List the internal controls you would expect to see in place over capital and
revenue expenditure on the vehicle fleet.
(b) Set out the tests of control that the auditor might perform.
24 Faroff Supplies
Faroff Supplies employs 100 salesmen, each of whom covers a different area and is
supplied with a car. At the end of each week each salesman submits an expense
claim on a pre-printed form with supporting vouchers attached. Expenditure is on
fuel together with invoices for hotel accommodation, meals and entertaining.
Each claim is scrutinised by the assistant accountant. He raises any queries with the
salesman concerned and makes out cheques for signature by two directors.
The amount of salesmen’s expenses paid out annually is material to the financial
statements.
Required
(a) Discuss the shortcomings of this system and suggest ways in which it could be
improved.
(b) List the tests of control that the auditor might perform on this system.
25 Caraway Manufacturing
Caraway Manufacturing is a long-established manufacturing company. The audit
manager has been provided with the following extracts from the draft financial
statements for 20X6 prior to the final audit planning meeting with the financial
controller.
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Draft statement of financial position (extracts)
Draft20X6 Actual20X5
$000 $000
Property,plantandequipment 32,560 31,850
Receivables
Trade 3,600 2,150
Other 250 200
Inventory
Rawmaterials 1,200 870
Work‐in‐progress 350 450
Finishedgoods 1,860 1,610
Currentliabilities
Trade 2,060 1,470
Other 500 450
Draft income statement (extracts)
Draft20X6 Actual20X5
$000 $000
Revenue 43,150 40,750
Costofsales(29,180) (29,040)
–
––––– ––––––
Grossprofit 13,970 11,710
Depreciationandlossonsalesofproperty,plantand
equipment
(3,450) (2,010)
Otherexpenses (2,340) (2,280)
–
––––– ––––––
Profitbeforetax 8,180 7,420
–
––––– ––––––
The manager has reviewed these extracts and has identified three financial statement
headings which he believes require further investigation. These are property, plant and
equipment, trade receivables and inventory. He has also calculated the following
accounting ratios:
Draft20X6 Actual20X5
Tradereceivablescollectionperiod 30days 19days
Inventoryturnover 8.6times 9.9times
Grossprofitpercentage 32% 29%
Required
(a) Explain why the manager has selected these three headings for further
investigation.
(b) Set out the further information that the manager should request from the
financial controller at the final audit planning meeting in order to clarify the
situation with regards to these financial statement headings.
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26 Opening balances
Set out:
(a) the auditor’s responsibilities in respect of the opening balances in the financial
statements which he is auditing
(b) the audit work that might be used to reach a conclusion on the opening
balances.
27 Compton Components
The audit manager of Compton Components has decided that audit software can be
used effectively in the audit of sales and trade receivables. He has discussed this
with the firm’s computer audit department and with the finance director of
Compton Components and this approach has been agreed as a feasible one.
Furthermore, the finance director has asked his internal audit department to
investigate the possibility of installing embedded software to help the external
auditors in their work.
Required
(a) Describe, giving examples, how audit software in general could assist the
audit firm in their audit of sales and receivables.
(b) Discuss the extent to which the external auditor could rely on the results of the
internal auditor’s use of embedded software.
28 Ray Products
Ray Products is a manufacturing company. As external auditor you have been
provided with the following schedule of the company’s property, plant and
equipment at 30th June 20X7. This reflects a revaluation carried out by a firm of
chartered surveyors in April 20X7.
Freeholdland
andbuildings
Plantand
machinery
$000 $000
Costat1stJuly20X6 1,000 753
Additions‐129
Revaluation 120‐
Disposals‐(85)
–
––––––– ––––––––
Cost/valuationat30thJune20X7 1,120 797
–
––––––– ––––––––
Accumulateddepreciationat1stJuly20X6 50 231
Chargefortheyear 22 130
Disposals‐(46)
–
––––––– ––––––––
Accumulateddepreciationat30thJune20X7 72 315
–
––––––– ––––––––
Carryingvalueat30thJune20X7 1,048 482
–
––––––– ––––––––
Carryingvalueat30thJune20X6 950 522
–
––––––– ––––––––
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Required
List the tests of detail you would carry out on the above figures.
29 Invisible Industries
Invisible Industries specialises in the development of drugs for the pharmaceutical
industry.
Required
State how you would verify the following items appearing in the statement of
financial position of Invisible Industries at 31st December 20X6. You are not
required to consider presentation and disclosure:
(a) Patents $350,000
(b) Research and development $1,200,000
(c) Goodwill on the acquisition of a sole trader competitor $50,000
30 Plastico Products
Plastico Products manufactures plastic products and has an extensive product range
which is revised frequently. Your firm has audited Plastico Products for many
years.
The company maintains computerised inventory records and carries out quarterly
inventory counts. The inventory records are adjusted for any discrepancies between
the records and the physical count.
The managing director is concerned that the quarterly inventory counts are
disruptive and time-consuming. He has proposed the introduction of continuous
checking throughout the year with no full year-end inventory count.
Required
(a) Describe how you might use audit software to assist you in your testing of the
current inventory system.
(b) List the concerns you, as auditor, would have when deciding whether you
support the managing director’s proposal.
31 Count instructions
The following is a set of instructions for the year end physical inventory count at a
manufacturer. Production is to continue on the day of the year end count.
(1) Counting is to be carried out by staff from the warehouse and the accounts
department. Counters are to report at 8am on 30th June to the warehouse
manager.
(2) The warehouse manager will issue sequentially numbered inventory sheets
which will include pre-printed descriptions of the inventory lines and the
quantities supplied by the inventory controller.
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(3) The count area is to be divided into sections and each will be allocated a
section by the warehouse manager. Items are to be marked once counted.
(4) The production manager will estimate the materials required for use in
production on the day and ensure that they are taken out of the warehouse
and moved to the production department.
(5) Goods to be despatched on the day are to be taken out of the warehouse
before counting commences and labelled accordingly. Any items not
despatched at the end of the day will be included in inventory. The number of
the last despatch note will be recorded by the warehouse manager.
(6) Any emergency requisitions of raw materials are to be reported to the
warehouse manager.
(7) Damaged inventory is to be noted as such on the inventory sheets.
(8) Any discrepancies between physical and book inventory will be referred to
the warehouse manager.
(9) All inventory sheets are to be signed by the counter and returned to the
warehouse manager at the end of the count. The warehouse manager will
check the numerical sequence of the inventory sheets.
Required
Identify the strengths and the weaknesses of the above instructions, explaining
clearly their significance.
32 DebtCo
The revenue of DebtCo for the year ended 30th June 20X5 was $7.5 million, its draft
profit before tax was $200,000 and its net assets $1.8 million. At that date the
receivables ledger contained 140 live accounts totalling trade receivables of $1.6
million. The accounts can be broken down as follows:
Valuerange Numberofbalances
$000
100‐150 2
50‐100 6
10‐50 40
1‐10 60
0‐1 29
Creditbalances(alllessthan$1,000) 3
––––––––
140
––––––––
The auditor is to use direct confirmation to confirm receivables balances.
Required
(a) List the factors which should be taken into account when selecting a sample of
receivables for confirmation and how those factors should be applied to
Debtco’s receivables.
(b) Set out the procedures to be performed:
(i) when planning and performing the confirmation
(ii) when following up the results.
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33 Cash and bank
(a) Describe four matters which would be included in a bank confirmation letter
and explain why they are important to the auditor.
(b) State the audit evidence you would seek in respect of the following:
(i) Cash at bank and bank loan.
(ii) Cash (comprised of floats, unbanked cash and travellers’ cheques).
34 Payables ledger balances
In your audit procedures to date you have found a large number of errors in your
client’s payables ledger. You have decided to write to a number of trade payables to
obtain direct confirmation of the balances due.
Required
(a) The confirmation letter to the suppliers could either state the balance or ask
the supplier to give the balance himself. Set out the arguments for each of
these two approaches.
(b) List other substantive procedures which you could use to verify the amount of
trade payables.
(c) List the substantive procedures you would carry out to discover the existence
of unrecorded liabilities.
35 Audit of accounting estimates
(a) Explain why the audit of accounting estimates is a difficult area for the auditor.
(b) List the audit evidence you would seek in respect of a provision for damages
in respect of an action brought by a customer for breach of contract
36 Izzard Electronics
You are the external auditor of Izzard Electronics.
A management representation letter has been prepared in which the directors have
been asked to confirm that all sales income has been included in the financial
statements and that when there is weak evidence of expenditure, the expenditure
has been for the benefit of the company and not for the personal benefit of any
employee or director.
Required
(a) Discuss the reliability of audit evidence provided by directors in the
management representation letter and whether you should rely wholly on the
representations of the directors or whether you should obtain other evidence.
(b) Describe the action you would take and the conclusions you would reach if
the directors refused to sign a management representation letter. Your answer
should specifically consider the statements in the letter concerning
completeness of sales income and validity of expenditure.
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37 Subsequent events
Identify four areas of the financial statements to which a review of subsequent
events might be relevant. For each area state what kind of information available
after the reporting period might be relevant, and why.
38 Eden Electronics
During the course of your audit of Eden Electronics for the year ended 30th April,
you establish that the company did not carry out a year end physical inventory
count at one of its retail branches and there are no alternative procedures that can be
applied to confirm the quantities. The directors have estimated the branch inventory
value.
At the conclusion of your audit you decide that the problem is material, but not
pervasive, to the view given by the financial statements.
Required
(a) Explain the different types of modified audit opinions, giving an example of
situations which may give rise to each type.
(b) Set out the main elements of the audit report for the situation set out above.
39 Posh Perfumes
Posh Perfumes has been in existence, importing perfume, for a number of years. The
managing director had built up the business using contacts he already had in the
industry. The company imports only one brand of perfume which is manufactured
exclusively by one company. The perfume is distributed via ‘shops within shops’ at
20 branches of a well-known store. Under this agreement, Posh Perfumes pays a
percentage of its takings to the store, with a minimum annual payment of $10,000
per store.
The audit is nearing completion but you have just heard that the French
manufacturer is facing serious financial difficulties and that supplies have ceased.
Required
(a) Set out the further information the auditor would require before reaching his
audit opinion.
(b) Set out the possible forms of report that the auditor may issue.
40 Creed Computers
Creed Computers sells personal computers (PCs) to independent shops. You are the
external auditor of Creed Computers. Your interim audit revealed the following
issues:
(1) The half year physical inventory count revealed that some PCs supposed to be
in inventory were missing and that other machines which had been returned
by customers were in inventory but had not been recorded as having been