Questions

SECTION A: Compulsory question (this question carries 40 marks).

 

QUESTION 1

Pets Ltd manufactures and sells a range of products for pet animals. Your firm is Birkbeck LLP which has recently been appointed as the external auditors of Pets Ltd. As the audit manager, you are preparing to carry out the audit of Pets Ltd for the year ended 31 March 2022.

 

Pets Ltd operates from a Head Office based in Central London, with a factory and warehouse based in East London. 90% of Pets Ltd’ sales are made to a range of small and large retailers across the UK. These sales are made through a network of sales agents engaged by Pets Ltd on a commission payment basis. Pets Ltd is trying to develop its online sales presence which currently constitutes 10% of the company’s sales.

 

Sales system

The sales persons visit customer sites personally and orders taken are emailed to the sales department at the Head Office where staff complete a two-part pre-printed sequentially numbered sales order form. One copy is sent to the central warehouse and the other copy sent to the finance department. The sales orders are batched and sent to the warehouse and finance department at the end of each working day. Upon receipt of the batched sales orders, sequentially numbered goods despatch notes are completed and filed at the warehouse and orders that are available in stock are despatched to their destinations the following morning. In order to speed up the sales process, the sales persons have discretion to grant sales discounts up to a maximum of ten percent. The sales persons are granted access to the customer master data file to be able to record details of new customers and any discounts granted. A copy of the sales order is used to raise the sales invoice by the finance department. The sales invoices are batched and entered weekly into the sales ledger by the sales ledger clerks. The sales ledger is computerised and at the end of each month, an aged list of balances and customer statements are produced. The sales persons distribute the monthly customer statements when they visit customers’ sites on their rounds.

 

Required:

1. ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment describes the five components of an entity’s internal control.

Required:

Identify and briefly explain the FIVE components of an entity’s internal control.       (10 Marks)

 

Internal control is a process that entity uses to provide reasonable assurance regarding the achievement of its objectives in the following five areas: effectiveness and efficiency of operations, including safeguarding of assets; reliability of financial reporting; and compliance with applicable laws and regulations. There are five essential components of internal control: Control Environment, Risk Assessment, Control Activities, Information and Communication, and Monitoring (Mohammed et al., 2021).

The first component, Control Environment sets the tone for the entire organization. It includes factors such as integrity and ethical values, commitment to competence, management’s philosophy and operating style, condescension assignment of authority and responsibility, and human resources policies and practices. The second component is Risk Assessment which involves identifying and assessing risks to achievement of the entity’s objectives.

 

The third component is Control Activities which are policies and procedures that help ensure management directives are carried out. They include activities such as approvals, authorizations, verifications, reconciliations, segregation of duties. The fourth component is Information and Communication which involves creating a system to ensure accurate, timely and relevant information is available to those who need it in order to make informed decisions (Lubenchenko & Redko, 2021). The fifth and final component is Monitoring which periodically assessing’s whether practices are effective in mitigating risks identified in risk assessment process. It also includes

 

 

1. Identify and explain THREE deficiencies in the Sales system of Pets Ltd and provide a recommendation to address each of these deficiencies.

For each your answer should consider: (i) Weakness, (ii) Implication, and (iii) Suggestion for improvement.                                                                                                                       (15 marks)

 

Pets Ltd is a company that specializes in the sale of pet supplies. In recent years, the company has struggled to increase sales and profitability. One reason for this may be deficiencies in the sales system. Below are three deficiencies in the Sales system of Pets Ltd and recommendations for addressing each one.

 

One deficiency is that Pets Ltd does not have a dedicated sales team. Instead, the company relies on its customer service representatives to handle sales tasks such as taking orders and upselling products. This is not an effective use of customer service representatives’ time, and it prevents them from providing the best possible service to customers. To address this deficiency, Pets Ltd should hire a dedicated sales team.

 

Another deficiency is that Pets Ltd does not offer any discounts or promotions. This makes it difficult to compete with other pet supply companies that do offer discounts and promotions. To address this deficiency, Pets Ltd should consider offering discounts and promotions on a regular basis.

 

Finally, Pets Ltd’s return policy is very strict. This may discourage customers from making purchases, as they know that they will have difficulty returning items if they are not satisfied with them. To address this deficiency, Pets Ltd should relax its return policy and make it more customer-friendly.

 

1. i) Define application controls; and

Application controls are a type of internal control that helps to ensure the accuracy and completeness of data in financial applications. Financial applications are computer programs that are used to record and track financial transactions. Application controls help to ensure that transactions are recorded correctly and that data is complete. There are two main types of application controls: input controls and processing controls. Input controls help to ensure that data is entered correctly into the system. Processing controls help to ensure that data is processed correctly. Application controls are an important part of internal control systems because they help to ensure the accuracy of financial data.

1. ii) Identify and explain TWO application controls that should be adopted by Pets Ltd to ensure the completeness and accuracy of the input of its online sales segment. (5 marks)

 

Pets Ltd should consider adopting two application controls to ensure the completeness and accuracy of its online sales segment: data validation and data integrity checks.

 

Data validation involves ensuring that only valid data is entered into the system. For example, Pets Ltd could set up a rule that only allows whole numbers to be entered into the price field. This would prevent errors such as typos or incorrect decimals from being inputted. Data integrity checks, on the other hand, involve ensuring that once data has been entered into the system, it cannot be changed or deleted (Almasria et al., 2021). This would prevent accidental or malicious changes to sales data. For example, Pets Ltd could create a log of all changes made to sales records, and require that any changes be authorized by a manager.

 

Both of these application controls would help to ensure the completeness and accuracy of Pets Ltd’s online sales data. By adopting them, Pets Ltd can provide its customers with accurate information and avoid any potential issues that could arise from incorrect or incomplete data.

 

1. Your audit manager mentioned that upon completing this audit you will undertake a review engagement at the Transport for London (TFL London).

Required:

Explain FIVE key differences between reasonable and limited assurance.                    (10 marks)

 

 

When expressing an opinion on financial statements, auditors can provide either a reasonable assurance or a limited assurance. A reasonable assurance is the highest level of assurance and indicates that the auditor believes there is a low risk that the financial statements are materially misstated. A limited assurance is less reassuring and indicates that the auditor believes there is a moderate risk that the financial statements are materially misstated. There are five key differences between these two levels of assurance:

 

1. Evidence gathering: When performing a reasonable assurance engagement, auditors will collect extensive evidence in order to reduce the risk of material misstatement to a low level. When performing a limited assurance engagement, auditors will collect less evidence and thus there is a greater risk of material misstatement (Mohammed et al., 2021).

 

2. Journal entries and disclosures: When conducting a reasonable assurance engagement, auditors will assess whether journal entries and disclosures are appropriate. For a limited assurance engagement, auditors will not assess journal entries and disclosures.

 

3. Accounting estimates: For a reasonable assurance engagement, auditors will perform additional procedures to obtain sufficient evidence about management’s use of accounting estimates. For a limited assurance engagement, auditors will test accounting estimates only if there is evidence of material misstatement.

 

4. Reasonable assurance is given when the auditor is more confident in the financial statements. Limited assurance is given when the auditor has less confidence in the financial statements.

 

5. Reasonable assurance can be given for unaudited financial statements. Limited assurance can only be given for audited financial statements. For reasonable assurance, the auditor will usually issue a “clean” opinion. For limited assurance, the auditor may issue a “qualified” or “adverse” opinion.

 

TOTAL 40 MARKS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SECTION B: Answer ONLY TWO (2) of the THREE (3) questions available (these questions carry 30 marks each).

 

QUESTION 2

You are an audit senior of Birkbeck LLP and in the process of planning the audit of Sound Plc. Sound plc has been an audit client for eight years and specialises in manufacturing professional head phones.

Jane Star was the previous audit engagement partner for Sound Plc. She had completed seven years as the audit engagement partner and has recently been rotated off the audit engagement. The current audit partner, Ahmad Zahir, has suggested that in order to maintain a close relationship with Sound Plc, the previous audit engagement partner Jane should undertake the role of independent review partner this year. In addition Sound Plc has requested that Jane assist them by attending their audit committee meetings, as a non-executive director has recently left the company. Sound Plc has also asked Jane and the other partners at Birkback LLP to help them in recruiting a new non-executive director.

The total fees received from Sound Plc for last year equated to 16.5% of the firm’s total fee income. The current year’s audit fee has not yet been confirmed, but along with taxation and other possible non-audit fees the total income from Sound Plc this year could be greater than for last year. Last year’s audit fee was being paid monthly by Sound Plc but no payments have been made for the last three months. The audit manager on the Sound Plc engagement has just announced that she is leaving Birkback LLP to join Sound Plc as the financial controller.

Required:

1. Explain each of the FIVE Fundamental Principles of the ACCA’s Code of Ethics and Conduct.                                                                                                                                       (10 marks)

The ACCA’s Code of Ethics and Conduct sets out the fundamental principles that guide the professional conduct of its members. These principles are Integrity, Objectivity, Professional Competence and Due Care, Confidentiality, and Professional Behaviour.

 

Integrity requires members to be honest and straightforward in all dealings with others, and to avoid any action that could reasonably be interpreted as dishonest or misleading. Members must also ensure that their own personal interests do not conflict with their professional obligations.

 

Objectivity requires members to make decisions based on factual evidence and unbiased analysis. Members must not allow their own personal beliefs or interests to influence their judgement.

 

Professional Competence and Due Care requires members to maintain the required level of competence for their role, and to exercise due care when undertaking work on behalf of clients. Members must also keep up to date with changes in relevant laws and regulations.

 

Confidentiality requires members to respect the confidentiality of information entrusted to them by clients or other third parties. Members must not use or disclose confidential information without prior consent, except where required by law or professional regulation (Almasria et al., 2021).

 

Professional Behaviour requires members to act in a professional manner at all times, and to avoid any action that could bring discredit

 

 

1. Using the information above, identify and explain FIVE Ethical Threats which may affect the independence of Birkbeck LLP’ financial statement audit of Sound Plc; and for each threat, explain how the auditor may respond to reduce these to an acceptable level.

For each your answer should consider: (i) Ethical Threat, (ii) Explanation, and (iii) Auditor Response.                                

                                                                                                                                                          (20 marks)

 

There are a number of ethical threats which may affect the independence of Birkbeck LLP’s financial statement audit of Sound Plc. These include:

 

Five Ethical Threats which may affect the independence of Birkbeck LLP are: (i) Self-interest threat, (ii) Familiarity threat, (iii) Intimidation threat, (iv) Advocacy Threat

and (v) Self-Review Threat.

 

(i) Self-interest threat arises when an auditor has personal interest in the client that may influence the auditor’s judgment. For example, if an auditor owns shares in the client company or is a member of its board of directors, then the auditor may be tempted to overlook any irregularities in order to protect his own interests.

 

(ii) Familiarity threat arises when an auditor is too close to the client and this relationship may cloud the auditor’s judgment. For example, if an auditor has been working with the same client for many years, he may become too familiar with the client’s business and affairs and may not be as objective when assessing the client’s financial statements (Almasria et al., 2021).

 

(iii) Intimidation threat arises when an auditor is threatened or coerced by the management of the client company into approving the financial statements even though they contain errors or irregularities. This threat is often linked to self-interest as the auditor may fear losing his job.

 

(iv) Advocacy Threat

 

When auditors are in a position where they represent the client, they put themselves at danger of being accused of advocating for the client. Simply acting in this manner does not, by itself, constitute a risk. The danger arises, however, when auditors support or represent a client in a way that another person would interpret to be advocacy (Lubenchenko & Redko, 2021). In other words, when auditors engage in advocacy. This danger could also come about as a result of the relationship that a client has with the auditors.

 

(v) Self-Review Threat

 

The relationship that auditors have with their customers is the root cause of the threat posed by self-review. In addition to their principal auditing function, several auditors also offer a variety of supplementary services. For instance, some auditors also offer services in the areas of account preparation and tax preparation. When auditors are responsible for auditing their own earlier work, this presents a potential risk known as self-review.

 

TOTAL 30 MARKS

 

 

 

QUESTION 3

 

You are an Audit Manager of Birkback LLP. You are in the final audit stage of the external audit of A-Mart Plc for the year ended 30 April 2022. A-Mart Plc is a retailer offering food and furniture to about 20 million customers every year across the United Kingdom. A-Mart Plc serves its customers through a channel network of 1,000 stores and online services. A-Mart Plc’s loss before tax per the draft financial statements for the year ended 30 April 2022 was £89.1m (2021: profit of £69.1m) and total assets as at that date were £2.1bn (2021: £3.1bn).

 

At a meeting held recently between the audit engagement team and the CFO of A-Mart Plc, you confirmed the following information obtained from A-Mart Plc’s accounting records and the notes to the draft financial statements:

 

Trade payables and other liabilities                                                                                       

2022             2021

£m                 £m

Trade payables                                                                 276.0          273.5

Refund liabilities                                                                 2.4                6.2

Deferred revenue from sale of gift cards               10.2              60.8

Other creditors and accruals                                       120.4          180.3

                                409.0          520.8

Notes:

• Trade payables do not bear interest and are generally settled on 30-day terms.
• Other creditors and accruals also do not bear

 

Required:

 

1. i) Describe THREE key assertions related to trade payables and other liabilities balances.

Trade payables and other liabilities are important accounting concepts that businesses use to manage their financial obligations. Trade payables are amounts owed to suppliers for goods or services that have been received but not yet paid for. Other liabilities are amounts owed to creditors for expenses that have been incurred but not yet paid for. Both trade payables and other liabilities appear on a company’s balance sheet, and both can have a significant impact on a company’s financial health. Here are three key assertions related to trade payables and other liabilities:

1. Trade payables and other liabilities are important sources of short-term financing for businesses.
2. Trade payables and other liabilities can have a significant impact on a business’s cash flow.
3. Trade payables and other liabilities must be managed carefully to avoid default and financial difficulties.

 

1. ii) Describe SIX audit procedures you will perform in relation to trade payables and other liabilities.

You should as a minimum provide one audit procedure for each item identified in the schedule of trade and other liabilities.                                                                                                  (15 marks)

 

As part of the audit process, there are a number of procedures that can be performed in relation to trade payables and other liabilities. Here are six of the most common:

 

1. Inspect supporting documentation – This includes reviewing invoices, credit notes, and other documentation to ensure that all transactions have been correctly recorded.

 

2. Reconcile accounts – This involves comparing the balances in the company’s records to those in the creditors’ records. Any discrepancies will need to be investigated.

 

3. Test cut-off – This is done to check that all transactions have been correctly recorded in the correct period. For example, if an invoice is dated June 30 but is not received until July 2, it should be included in the July 1 accounts.

 

4. Review aged debts – This involves checking that all outstanding debts are still valid and that there are no old debts that have been forgotten about.

 

5. Analyze trends – This helps to identify any patterns in the data which could indicate potential problems. For example, if outstanding debts are increasing year on year, this could indicate cash flow difficulties.

 

6. Compare with prior periods – This helps to identify any changes in the level of payables or

 

1. The CFO of A-Mart called a meeting with you in which she disclosed to you that they have just found a fraud within the accounts department which they believe has been going on for a number of years. The CFO knows that as part of the audit you tested the controls and believed that it was your responsibility to identify and report fraud, and is now asking you why you didn’t find and report the fraud.

Required:

Outline your response to the CFO.                                                                                                    (10 marks)

As the CFO of A-Mart, you have just discovered a fraud within the accounts department which you believe has been going on for a number of years. Your first step should be to inform the board of directors and audit committee, as they will need to be involved in the investigation and decision-making process. Next, you should engage an external forensic accounting firm to conduct a thorough review of the books and records. Once the extent of the fraud is known, you can work with management to develop a plan to mitigate the losses and improve internal controls to prevent future occurrences (Sun, 2019). The CFO’s role in this situation is to provide leadership and guidance through a difficult situation while protecting the interests of the company.

1. ISA 230 Audit Documentation deals with the auditor’s responsibility to prepare audit documentation for an audit of financial statements.
   Required:
   State the purpose and FOUR benefits of documenting audit work. (5 marks)

The purpose of documenting audit work is to provide a record of the audit process, to ensure that all relevant information is captured, and to create a point of reference for future audits. There are four main benefits to documenting audit work: improved communication, increased efficiency, improved accuracy, and reduced risks.

 

Improved communication: Documentation provides a clear and concise record of the audit process, which can be easily shared with colleagues or clients. This eliminates ambiguity and ensures that everyone is on the same page (Chan & Vasarhelyi, 2018). Additionally, documented work can be used as a training tool for new staff members.

 

Increased efficiency: By documenting the audit process, you can create a blueprint that can be followed in future audits. This saves time and effort as you will not need to start from scratch each time. Additionally, it allows you to identify and fix any areas of the process that are inefficient.

 

Improved accuracy: Documentation provides a detailed account of the audit process, which helps to ensure that all steps are carried out correctly. This minimizes errors and ensures that the final results are accurate.

 

Reduced risks: Proper documentation can help to reduce the risks associated with audit projects.

TOTAL 30 MARKS

 

 

 

References

Chan, D. Y., & Vasarhelyi, M. A. (2018). Innovation and practice of continuous Auditing1. In Continuous Auditing. Emerald Publishing Limited.

Sun, T. (2019). Applying deep learning to audit procedures: An illustrative framework. Accounting Horizons, 33(3), 89-109.

Lubenchenko, О. Е., & Redko, О. Y. (2021). Using Tests of Controls in the Audit Practice. Statistics of Ukraine, 94(3), 81-91.

Mohammed, M. J., Hiloaliabi, J. A., Al-taie, B. F. K., & Flayyih, H. H. (2021). The Effect of using Audit Procedures in Accordance with the IAS 545 in Assessing Audit Risk. Studies of Applied Economics, 39(11).

Almasria, N., Airout, R. M., Samara, A. I., Saadat, M., & Jrairah, T. S. (2021). The role of accounting information systems in enhancing the quality of external audit procedures. Journal of management Information and Decision Sciences, 24(7), 1-23.

 

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