p7 Tuition Study Note DEC2013

ACCA P7 ADVANCED AUDIT & ASSURANCE
Tuition Note
For exams in DEC 2013
Lesco Group Limited, April 2014 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Lesco Group Limited.
1 Accounting Practise Center (A.P.C) www.accaapc.com
CONTENTS
CHAPTER1BEFORE THE ENGAGEMENT SERVICES: ....................... 5
CHAPTER 1 ADVERTISING: (DEC2010 Q4) ......................................................... 6 CHAPTER 1 ADVERTISING: (JUNE 2004) ............................................................. 8 CHAPTER 1 TENDERING+FEES (JUNE09 Q2) ........................................................ 9 CHAPTER 1 FACTORS TO BE CONSIDERED JUNE2008Q1(C) ...................................... 14 CHAPTER 1 QUALITY CONTROLDEC2007 Q1(C).................................................. 20 CHAPTER 1 ETHICS THEORY: .......................................................................... 23 CHAPTER 1 JUNE2008 Q4 (SMITH & CO) ......................................................... 25 CHAPTER 1 DEC2008 Q4(BECKER & CO) ......................................................... 29 CHAPTER 1 ENGAGEMENT LETTER Q: ................................................................ 34 CHAPTER 1 MONEY LAUNDERING (DEC2009 Q2(C)) ............................................ 35 CHAPTER 1 ISA250 ................................................................................... 37
CHAPTER2 PERFORM AN ENGAGEMENT SERVICE:........................ 38

CHAPTER 2 Q1: WHAT DOES AN AUDIT FLOWCHART LOOK LIKE? ................................ 38 CHAPTER 2 Q2:JUNE2009 Q1(A) .................................................................. 39 CHAPTER2 Q3:DEC2009 Q1(A)(B) ............................................................... 42 CHAPTER2 Q4: JUNE2008 Q1 (A+B)(BUSINESS RISKS) ........................................ 44 CHAPTER2 Q5:JUNE2012 Q1(RISK OF MATERIAL MISSTATEMENT/AUDIT RISKS) ............ 50 CHAPTER2 Q6: SATGE 3:JUNE2010 Q2 ........................................................... 55 CHAPTER2 Q7: BIG ACCOUNTING QUESTIONS ..................................................... 60 Chapter2 Q7: 1, conceptual framework: ................................................. 61 Chapter2 Q7: 2,IAS1 Presentation of Financial Statements ....................... 63 Chapter2 Q7: 3,IAS2 Inventories .......................................................... 64
Audit Question [ DEC2009 Q2] IAS2 ............................................................... 65
Chapter2 Q7: 4, IAS7 Statement of cash flows ........................................ 66 Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in Accounting Estimates and errors ................................................................................................ 67
Audit question [DEC2011 Q3 ] IAS 8 ............................................................... 69
Chapter2 Q7: 6,IAS10 Events after the Reporting Period .......................... 71

Audit question ISA560 [DEC2009 Q5] ............................................................. 72
Chapter2 Q7: 7,IAS 11 Construction Contracts ........................................ 75

Audit question [june2011 Q2] IAS11:.............................................................. 77
Chapter2 Q7: 8,IAS12 Income Taxes ..................................................... 79

Audit question: [Q11:DEC2008 Q1] IAS 12 ...................................................... 83
Chapter2 Q7: 9,IAS16 Property, Plant and Equipment .............................. 84 Chapter2 Q7: 10,IAS17 Leases ............................................................. 88
Audit question1: [June2009Q3] leases ............................................................ 92
Chapter2 Q7: 11,IAS 18 Revenue .......................................................... 94

Audit questions: (IAS18 revenue recognition) .................................................. 95 Q Harrier (June2004) (IAS18 revenue recognition) ........................................... 96 2 Accounting Practise Center (A.P.C) www.accaapc.com
Chapter2 Q7: 12,IAS 19 Employee Benefit ............................................. 97

Audit question (June2012 Q5(b)) IAS19 .......................................................... 99
Chapter2 Q7: 13,IAS 20 Accounting for Government Grants and Disclosure of Government Assistance ...................................................................... 101
Audit Question [june2010 Q1 (c)(ii)] IAS 20 .................................................. 103
Chapter2 Q7: 14,IAS 21 The effects of Changes in Foreign Exchange Rates ....................................................................................................... 104
Audit question: Grissom Co (June2010 Q1 extract) ......................................... 105
Chapter2 Q7: 15,IAS 23 Borrowing Costs ............................................. 106

Audit question:[june2012 Q5] IAS23 Borrowing cost ....................................... 108
Chapter2 Q7: 16,IAS 24 Related Party Transactions .............................. 110

Audit question:[Q15june2008 Q3]related party transactions ............................ 112
Chapter2 Q7: 17,IAS28 Investments in Associates ................................ 116

Audit Question [June2010 Q1] IAS28 ............................................................ 118
Chapter2 Q7: 18, Financial instruments IAS32,37,39 IFRS9 ................... 119

Audit question [Q17] IAS32,39 IFRS7 ........................................................... 125 Audit question:[DEC2011 Q3(b)] Financial instruments(relating to 3rd party work) ................................................................................................................ 126
Chapter2 Q7: 19,IAS33 Earnings Per share .......................................... 127

Audit question [june2009 Q5 Pluto] IAS 33: (Ajusted) ................................... 130
Chapter2 Q7: 21,IAS 36 Impairment of Assets ...................................... 131

Audit question: [Q] impairment IAS36 .......................................................... 133 Audit question [DEC2010 Q3 Clooney]impairment IAS36 ................................. 135
Chapter2 Q7: 22,IAS 37 Provisions, Contingent liabilities and Contingent Assets ....................................................................................................... 137
Audit question [ DEC2007 Q1(b)] provision .................................................... 139
Chapter2 Q7: 23,IAS38 Intangible Assets ............................................. 141

Audit question IAS 38 [ june2008 Q5] Blod .................................................... 144 Audit question [ DEC2011 Q1] IAS 38 ........................................................... 146
Chapter2 Q7: 24, IAS40 Investment Property ....................................... 147

Audit question [DEC2008 Q3] IAS40 ............................................................. 149
Chapter2 Q7: 25, IFRS2 Share-based Payment ..................................... 152

Audit question [ DEC2008 Q1(b)(i)] IFRS2 share based payment: .................... 155
Chapter2 Q7: 26, IFRS5 Non-current Assets Held for Sale and Discontinued Operations........................................................................................ 157
Audit question1 IFRS 5 [ DEC2007(a) ] ......................................................... 160 Audit question2 [june2011 Q1a]IFRS 5.......................................................... 162
Chapter2 Q7: 27, IFRS8 Operating Segments ....................................... 165

Audit question1 IFRS8 [ DEC2009 Q1(d)] ...................................................... 167
Chapter2 Q7 :28, IFRS10,11,12 .......................................................... 169

Audit question [Shire DEC2005] IFRS11 Joint Arrangements ............................ 172
Chapter2 Q7 :29, IFRS13 Fair Value Measurement ................................ 173

Audit question [DEC2008 Q3(a)]fair value ..................................................... 175
Chapter2Group audit ............................................................................................................ 176

June2012 Q1(a(i+iii)): Group audit ............................................................... 177
STAGE 5 OF AUDIT FLOWCHART ................................................ 181

DEC2012 Q2 AUDIT FINDINGS ................................................................... 182 CHAPTER 2 JUNE2011 Q3 OPENING BALANCES (ISA510&ISA710)(B) .................. 189 CHAPTER2 :DEC2010 Q2 NEWMAN & CO(C) [ISA720 OTHER INFORMATION] ........... 191
STAGE 6 AUDIT REPORT ............................................................ 193

CHAPTER 2 JUNE2012 Q5(B) ...................................................................... 193 CHAPTER 2 JUNE2011 Q5 NASSAU GROUP ...................................................... 195
NON AUDIT ENGAGEMENT SERVICES......................................... 199

INTERIM FINANCIAL INFORMATION DEC2012 Q5(B) ........................................... 200 PROSPECTIVE FINANCIAL INFORMATION CHAPTER 2 JUNE2012 Q2(A) ..................... 202 DUE DILIGENCE REVIEW CHAPTER 2 JUNE2008 Q2 ............................................. 207 FORENSIC AUDIT CHAPTER 2 DEC2008 Q2 ............................................... 211 SOCIAL AND ENVIRONMENTAL AUDIT DEC2008 Q1(C) ........................................ 216 JUNE2012 Q2(B)(II): SOCIAL AND ENVIRONMENTAL AUDIT ................................... 218 CHAPTER 2 DEC2010 Q2(B) SOCIAL AND ENVIRONMENTAL AUDIT ......................... 220
CHAPTER3 CURRENT ISSUES ..................................................... 221

CHAPTER3 JUNE2009 Q2(D) TRANSNATIONAL AUDIT ......................................... 222 CHAPTER3 DEC2009 Q4 ........................................................................... 225 JUNE2008 Q2(C) JOINT AUDIT .................................................................... 227 CHAPTER3 Q5 DEC2010 NEESON&CO(B) Q4.................................................. 229 CHAPTER3 JUNE2010 Q5(B) AUDITORS LIABILITY ........................................... 231
Chapter1Before the engagement services:

In this chapter we will be going through: 1. 2. 3. 4. 5. Advertisement issues How to draft a tendering document Professional appointment issues Quality control issues Regulatory issues
The best way to learn these knowledge is to copy note from tuition video.
Chapter 1 Advertising: (DEC2010 Q4) Neeson&Co An advertisement could be placed in national newspapers to attract new clients. The draft advertisement has been given to you for review: Neeson & Co is the largest and most professional accountancy and audit provider in the country. We offer a range of services in addition to audit, which are guaranteed to improve your business effi ciency and save you tax. If you are unhappy with your auditors, we can offer a second opinion on the report that has been given. Introductory offer: for all new clients we offer a 25% discount when both audit and tax services are provided. Our rates are approved by ACCA.
Required: Evaluate each of the suggestions made above, commenting on the ethical and professional issues raised. 8marks
Answer to Neeson&Co: Back up Any comments made by the advertisement should be backed up with evidence. For example it says Neeson&Co is the largest and most professional accountancy provider in the country so sales revenue and number offices should be made to back up this evidence. Definitely clear The advertisement should be definitely clear.The business efficiency can not be guaranteed by the firm and this seems that its not honest by Neeson. The second opinion offered by Neeson&Co may imply that the audit work done by Neeson&Co is low and as a result client would not be happy with the first opinion given and hence second opinion would be issued again. And this comment in the advertisement is not professional. Ensure to comply with laws and regulation The advertisement should comply with laws and regulation. The guarantee to save tax means maybe Neeson would use some tricks to help client save time which may not comply with laws and regulation because not in every circumstance that the tax can be saved. Fundamental ethics Neeson&Co cant quote rates are approved by ACCA because ACCA does not approve any rates and this would be seen as unprofessional.
Legal obligation It seems that if taxes cant be saved and also business efficiency hasn't been improved so that client may take potential legal action against Neeson&Co resulting in further future cash outflow from Neeson&Co. Low balling The 25% of introductory fees is low balling and its not prohibited but Neeson&Co should need to make sure by charging such a low amount of fees the quality of the work should be maintained, ie, following ISAs to do the audit work.
Chapter 1 (June 2004)Hawk Assocaite
Displaying business cards alongside those of local tradesman and service providers in supermarkets and libraries. The cards would read: Hawk ACCA Associates For PROFRSSIONAL Accountancy, Audit, Business Consultancy and Taxation services Competitive rates. Money back guarantees. (4marks)
Answer to June2004 Hawk Associate: Advertisement in the super markets and libraries is not professional and they should advertise their firm using eg, financial magazines. Professional is in capital and this implies only their firm is professional while others are not and firms shouldnt criticize others. Competitive rate is vague and compare to whom? So this information is misleading. Money back guarantees may mean they can help company save tax and if not they would give money back to them and this will: Firstly involving some illegal techniques to help company save tax and hence its a breach of laws and regulations. Secondly it implies that the quality of services provided to the company may not be good and hence give their money back.
Chapter 1 tendering+Fees (June09 Q2)

The Dragon Group is a large group of companies operating in the furniture retail trade. The group has expanded rapidly in the last three years, by acquiring several subsidiaries each year. The management of the parent company, Dragon Co, a listed company, has decided to put the audit of the group and all subsidiaries out to tender, as the current audit firm is not seeking re-election. The financial year end of the Dragon Group is 30 September 2009. You are a senior manager in Unicorn & Co, a global firm of Chartered Certified Accountants, with offices in over 150 countries across the world. Unicorn & Co has been invited to tender for the Dragon Group audit (including the audit of all subsidiaries). You manage a department within the firm which specialises in the audit of retail companies, and you have been assigned the task of drafting the tender document. You recently held a meeting with Edmund Jalousie, the group finance director, in which you discussed the current group structure, recent acquisitions, and the groups plans for future expansion. Meeting notes Dragon Group Group structure The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the subsidiaries are located in the same country as the parent, and half overseas. Most of the foreign subsidiaries report under the same financial reporting framework as Dragon Co, but several prepare financial statements using local accounting rules. Acquisitions during the year Two companies were purchased in March 2009, both located in this country: (i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit opinion expressed by the incumbent auditors on the financial statements for the year ended 30 September 2008 was qualified by a disagreement over the non-disclosure of a contingent liability. The contingent liability relates to a court case which is still on-going. (ii) Minotaur Co, a large company, whose operations are distribution and warehousing. This represents a diversification away from retail, and it is hoped that the Dragon Group will benefit from significant economies of scale as a result of the acquisition. Other matters The acquisitive strategy of the group over the last few years has led to significant growth. Group revenue has increased by 25% in the last three years, and is predicted to increase by a further 35% in the next four years as the acquisition of more subsidiaries is planned. The Dragon Group has raised finance for the
acquisitions in the past by becoming listed on the stock exchanges of three different countries. A new listing on a foreign stock exchange is planned for January 2010. For this reason, management would like the group audit completed by 31 December 2009.
Required: (a)Recommend and describe the principal matters to be included in your firms tender document to provide the audit service to the Dragon Group. (10 marks)
(b) Explain FOUR reasons why a firm of auditors may decide NOT to seek re-election as auditor. (6 marks) (c) Using the specific information provided, evaluate the matters that should be considered before accepting the audit engagement, in the event of your firm being successful in the tender. (7 marks) Professional marks will be awarded in part (c) for the clarity and presentation of the evaluation. (4 marks)
Answer to June2009 Q2a-c: (a) Recourses Detailed background of our firm should be included for example the expertise and clients we serve. Clients needs Because Dragon group is going to go listed onto the stock exchange and so we can provide non audit services such as corporate governance advice relating to the listing. We have offices in over 150 countries across the world so we can deal with audit with your subsidiaries all around the world more effectively. Way to do the audit We should include how we perform the audit service to ensure appropriate quality of work maintained such as following ISA to do the risk assessment. Also we ensure quality during the audit by having appropriate quality control procedures during the audit such as hot review on the audit work we have done. Extra benefit We can provide recommendation to address internal control weakness to management in the management letter as an extra service for example. Fees Fees should be broken down into how its calculated by clearly laying out different classes of staff involved, such as hourly rate for audit manager and partner.
(b) Overdue fees Where a client hasn't paid their fees there has been outstanding for some time and such overdue fees would be seen as loan to client which may cause a self interest threat, ie, in order to keep the loan auditor may issue whatever opinion that client wants so that a safeguard for this is not to seek re-election. Resources As the company expands the audit firm may not have enough resources to do the audit any more. Such as the company is listing on a stock exchange and the audit firm is a lack of relevant experts who know the regulation of the stock exchange and so the firm may not seek re-election. Integrity When the management doesn't comply with specific accounting standards such as a deliberate failure to provide a provision in the financial statements and this action would be seen as a lack of integrity. So in order for the audit firm to remain good reputation they should not seek re-election. Conflict of interest Such as the existing company we are auditing is damaging the environment and didn't disclose the fact. Another company is waiting for out firms tendering but they are competitors and if we audit both companies which would cause a conflict of interest so we should resign the first company as by continuing to be an auditor for this would damage our firms reputation.
(c) Evaluation of matters to be considered: Recourses As dragon group has expanded rapidly in the last three years so we must ensure we have enough audit staff to audit those components. Management integrity As a qualified opinion issued by previous auditor over a deliberate non-disclosure of contingent liability we should question managements integrity and if they not integrate then we should not accept the engagement service because if after conducting the service and we find information we obtained is fake then it will still have an impact on our audit opinion. Previous auditor It would be necessary to contact previous auditor to gather information regarding the non disclosure of contingent liability with clients permission of whether it should be disclosed in the individual financial statements of Mermaid Co, and at group level. Experiences Given Minotaur Co is involved in distribution and warehousing but this is not a very complicated industry for Unicorn&Co because it has its offices over 150countries and it should have relevant experience into auditing this eg, bringing in staff from a different department more experienced in clients with distribution operations Time There will be only 3months for Unicorn&Co to complete the audit and Unicorn&Co should consider whether to allocate more recourses to this engagement given this client is large and it needs to spend more time into it.
Chapter 1 June2008Q1(c)
You are a senior audit manager in Mitchell & Co, a firm of Chartered Certified Accountants. You are reviewing some information regarding a potential new audit client, Medix Co, a supplier of medical instruments. Extracts from notes taken at a meeting that you recently held with the finance director of Medix Co, Ricardo Feller, are shown below: Meeting notes meeting held 1 June 2008 with Ricardo Feller Medix Co is a provider of specialised surgical instruments used in medical procedures. The company is owner managed, has a financial year ending 30 June 2008, and has invited our firm to be appointed as auditor for the forthcoming year end. The audit is not going out to tender. Ricardo Feller has been with the company since January 2008, following the departure of the previous finance director, who is currently taking legal action against Medix Co for unfair dismissal. Company background Medix Co manufactures surgical instruments which are sold to hospitals and clinics. Due to the increased use of laser surgery in the last four years, demand for traditional metal surgical instruments, which provided 75% of revenue in the year ended 30 June 2007, has declined rapidly. Medix Co is expanding into the provision of laser surgery equipment, but research and development is at an early stage. The directors feel confident that the laser instruments currently being designed will eventually receive the necessary licence for commercial production, and that the laser product will replace surgical instruments as a leading source of revenue. There is currently one scientist working on the laser equipment, subcontracted by Medix Co on a freelance basis. The building in which the research is being carried out has recently been significantly extended by the construction of a large laboratory. A considerable revenue stream is derived from agents who are not employed by Medix Co. The agents earn a commission based on the value of sales they have secured for Medix Co during the year. There are many suppliers into the market and agents are used by all manufacturers as a means of marketing and distributing their products. The companys manufacturing facility is located in another country, where operating costs are significantly lower. The facility is under the control of a local manager who visits the head office of Medix Co annually for a meeting with senior management. Products are imported via aeroplane. The overseas plant and equipment is owned by the company and was constructed 12 years ago specifically for the manufacture of metal surgical instruments. The company has a bank overdraft facility and makes use of the facility most months. A significant bank loan, which will carry a variable interest rate, is currently being negotiated. The terms of the loan will be finalised once the audited financial statements have been viewed by the bank.
After receiving permission from Medix Co, you held a discussion with the current audit partner of Medix Co, Mick Evans, who runs a small accounting and audit practice of which he is one of two partners. Mick told you the following: Medix Co has been an audit client for three years. We took over from the previous auditors following a disagreement between them and the directors of Medix Co over fees. As we are a small practice with low overheads we could offer lower fees than our predecessors. We could also do the audit very quickly, which pleased the client, as they like to keep costs as low as possible. During our audits we have found the internal systems and controls to be quite weak. Despite our recommendations, there always seemed to be a lack of interest in making improvements to the accounting systems, as this was seen to be a waste of money. There have been two investigations by the tax authorities, which we did not deal with, as we are not tax experts. In the end the directors sorted it all out, and I believe that the tax matter is now resolved. We never had a problem getting access to accounting books and records. However, the managing director, Jon Tate, once gave us what he described as the wrong cash book by mistake, and replaced it with the proper version later in the day. We never found out why he was keeping two cash books, but cash was an immaterial asset so we didnt worry about it too much. We are resigning as auditors because the work load is too much for our small practice, and as Medix Co is our only audit client we have decided to focus on providing non-audit services in the future. You have also found a recent press cutting regarding Medix Co: Extract from local newspaper business section, 2 June 2008 It appears that local company Medix Co has breached local planning regulations by building an extension to its research and development building for which no local authority approval has been given. The land on which the premises is situated has protected status as a greenfield site which means approval by the local authority is necessary for any modification to commercial buildings. A representative of the local planning office stated today: We feel that this is a serious breach of regulations and it is not the first time that Medix Co has deliberately ignored planning rules. The company was successfully sued in 2003 for constructing an access road without receiving planning permission, and we are considering taking legal action in respect of this further breach of planning regulations. We are taking steps to ensure that these premises should be shut down within a month. A similar breach of regulations by a different company last year resulted in the demolition of the building.
Required: Prepare briefing notes, to be used by an audit partner in your firm, assessing the professional, ethical and other issues to be considered in deciding whether to proceed with the appointment as auditor of Medix Co. Note: requirement (c) includes 2 professional marks. (12 marks)
Answer: June2008 Q1(c) Briefing notes To: Audit partner From: Audit manager Date: exam date Subject: Factors to consider regarding appointment as auditor of Medix Co Introduction: This briefing note summarises the main factors we should consider in deciding whether to take the appointment further. Time to build up knowledge Because this is the last month before the financial statement year end we would questions whether we have enough time to quickly build up the knowledge of Medixcompany. Expertise Given Medix company operates in a very sophisticated industry so we need to question whether we should refer to expertise when doing the audit and if yes this will increase audit fees charged to client and given client wants to keep the audit costs as low as possible this may not be acceptable. Control system Given Medix company has a weak internal control system so we should not rely on its system but rather we should use full substantive testing approach and this increases the costs and also time spent as well and it may not be acceptable by client given he wants to keep the costs down. Opening balance Because this is a new audit client and we should consider extra work done on the opening balance of its financial statement given a weak internal control system exists. Management style Medix company is being sued by previous finance director and previous auditor resigned as a result of a disagreement with the management so the history shows we may find it difficult to maintain the good relationship with management. Fee pressure Medix company is now struggling to raise finance and so there would be a risk that after we become its auditor we cant collect our money back as audit fee and as a result this creates lots of threats to objectivity, ie, intimidation threat by threatening not to pay for us unless to give a wrong audit opinion satisfying client.
Reputation Medix company has been in breach of laws an regulation and this has impair its reputation within the industry and if we were to become its auditor then it will impact on our reputation as well. Advocacy threat Medixcompany has in breach of laws and if we were to become an auditor of them then we would be seen as promoting its status saying clients breach of laws is right and hence this will impair our objectivity in expressing an audit opinion. Competence Medixcompany is in such a sophisticated industry and we should question ourselves whether we have competence in carrying out such an audit, eg, experience before in auditing the work in progress in a similar industry. Public interest Medix company has in breach of laws before involving in activities damaging the environment and its doing harm to public interest so we would be better not to become its auditor. Time It seems that there would be only 1 month before we start our audit and given the complexity of clients business activities we may not have enough time to carry out such an audit service.
Integrity Given there are two cash book presented by managing director and we can reasonably assume that fraudulent transactions may occur here and hence we should question the integrity of management and if they are lying then we shouldn't accept as an auditor. Staff and resources We should consider whether we have enough staff and recourses to carry out the audit given part of its Medixcompanys operations are overseas and if no we shouldn't accept as an auditor. Easy It seems that medix company is going to raise finance from the bank and the audit report may be relied on by bank as well and this creates higher risk for us because given time, recourses, expertise analysis maybe we don't have time to carry out this audit as expected.
Conclusion: So from the above analysis it would be better for us not to be as an auditor for Medixcompany.
DEC2007 Q1(c)
(e) (i) Identify and describe FOUR quality control procedures that are applicable to the individual audit engagement; and (8 marks) (ii) Discuss TWO problems that may be faced in implementing quality control procedures in a small firm of Chartered Certified Accountants, and recommend how these problems may be overcome. (4 marks)
Answer to DEC2007 Q1(c):
(i) Pre appointment checks Auditors should check the client before accepting this engagement such as: Obtaining professional clearance from previous auditors to ensure theres no problem to accept this engagement letter from previous auditors perspective. Considering any conflict of interest among its existing clients. Due diligence in client whether they are involved in money laundering activities. Planning Auditor should plan their audit before its actually implemented by clearly setting up appropriate audit strategy and detailed audit plan. Planning meeting Auditors should hold a planning meeting before audit is implemented by clearly stating the responsibility of members for example. Documenting the work During the audit auditors should document the work properly according to ISA. Direction, supervision and review of work During the audit there should be an audit supervisor or manager directing the audit work, eg, act as a mentor during the audit and if any problems arise from audit junior they can come to supervisor or manager for a solution. Audit work should be reviewed after the work has been done, ie, hot review on the work before audit report is signed to identify any mistakes within the audit work. Delegate work based on knowledge and experience Auditors should be delegated work based on knowledge and experience this means for example audit junior should not be delegated the work to audit fair value.
(ii)Competence
Problem:
In order to keep up to date with the knowledge particularly for ISA and IFRS staff should be trained but its too expensive to set up an inhouse training within the small firm.
Recommendation:
So this can be outsourced to an external training company to do so because due to economic of scale within that external training company a lower cost incurred comparing to setting up in house. Review
Problem:
It may not be possible to hold an independent review of an engagement within the firm because of the small number of senior and experienced auditors.
Recommendation:
An external review service may be purchased.
Chapter 1 Ethics: Basic knowledge: ACCA particularly identifies there are 5 principles we need to follow: Professional behavior: We shouldnt do anything that discredits ACCAs reputation. Integrity: Both accountant and auditor should lie to others. Competence and due care: Professional accountants should pass ACCA exams and accumulate relevant experience and do annual continues professional development. They should also follow rules to do the work and finish the work within the reasonable amount of time. Confidentiality Professional accountants should keep clients confidential information and should not disclose them to 3rd parties. If clients company is involved in illegal activities and we can: 1. Seek legal advice 2. Disclose those to appropriate authority. Objectivity This means audit opinion should be trustable.
And there are 6 threats to objectivity: 1. Self interest threat In order for auditor to keep benefit then auditor helps to cover up the fraud by client making its opinion not objective. 2. Self review threat Checking auditors own work would mean auditor will lose profeesional skepticism when trying to audit client and the opinion given wouldnt be objective. 3. Advocacy threat It may seem that auditor is trying to promote the status of client s company making any audit opinion subsequently issued not objective.
4. Familiarity threat This means there is a close relationship between auditor and Client Company and this would mean: a. auditor will cover up fraud made by clients company; b. auditor may lose professional skepticism when auditing the clients company. So it will make audit opinion not objective. 5. Intimidation threat Clients Company threatens auditors and in order to keep benefit auditor would issue whatever opinion that clients wants and making it not objective. 6. Management threat Audit form makes a management decision on behalf of clients company and this may run a risk that clients company would fail. In order not being affected by clients company audit firm would issue an audit opinion which is not trustable.
Chapter 1 June2008 Q4 (Smith & Co) You are an audit manager in Smith & Co, a firm of Chartered Certified Accountants. You have recently been made responsible for reviewing invoices raised to clients and for monitoring your firms credit control procedures. Several matters came to light during your most recent review of client invoice files: Norman Co, a large private company, has not paid an invoice from Smith & Co dated 5 June 2007 for work in respect of the financial statement audit for the year ended 28 February 2007. A file note dated 30 November 2007 states that Norman Co is suffering poor cash flows and is unable to pay the balance. This is the only piece of information in the file you are reviewing relating to the invoice. You are aware that the final audit work for the year ended 28 February 2008, which has not yet been invoiced, is nearly complete and the audit report is due to be issued imminently. Wallace Co, a private company whose business is the manufacture of industrial machinery, has paid all invoices relating to the recently completed audit planning for the year ended 31 May 2008. However, in the invoice file you notice an invoice received by your firm from Wallace Co. The invoice is addressed to Valerie Hobson, the manager responsible for the audit of Wallace Co. The invoice relates to the rental of an area in Wallace Cos empty warehouse, with the following comment handwritten on the invoice: rental space being used for storage of Ms Hobsons speedboat for six months she is our auditor, so only charge a nominal sum of $100. When asked about the invoice, Valerie Hobson said that the invoice should have been sent to her private address. You are aware that Wallace Co sometimes uses the empty warehouse for rental income, though this is not the main trading income of the company. In the miscellaneous invoices raised file, an invoice dated last week has been raised to Software Supply Co, not a client of your firm. The comment box on the invoice contains the note referral fee for recommending Software Supply Co to several audit clients regarding the supply of bespoke accounting software.
Required: Identify and discuss the ethical and other professional issues raised by the invoice file review, and recommend what action, if any, Smith & Co should now take in respect of: (a) Norman Co; (8 marks) (b) Wallace Co; and (5 marks) (c) Software Supply Co. (4 marks) (17 marks)
Answer to June2008 Q4: (a) Matters to consider: In order to secure the payment, audit firm would issue a wrong audit opinion to maximize its benefit and hence creating self interest threat to objectivity. Audit firm is not chasing money from client company would suggest there is a good relationship between them and a familiarity threat exists meaning audit firm may help company conceal some mistakes in the financial statements but still issue a clean audit report. Because Norman is suffering poor cash flows and is unable to pay for audit firm and this may create intimidation threat meaning Norman may threaten not to pay the firm unless a clean audit report is given. Before accepting an engagement letter to Norman company auditors should do a detailed pre-appointment check to ensure this client is a going concern entity. Actions: 1. Auditor should raise this issue to audit committee to secure payments. 2. Auditors should quickly invoice management about the audit work service fees. 3. Auditor should have a detailed pre-appointment check client in the future before working for them. 4. Auditors should perform an independent partner check for last year audit work as well since they havent paid the firm in the last year.
(b) Matters to consider: In order to keep the cheap rental expense of $100 auditor would issue a wrong audit opinion and hence leads to self interest threat. The $100 nominal value would suggest theres a good relationship between client and audit firm and hence familiarity threat would exist meaning auditors would lose professional skepticism when doing the audit and hence giving a wrong audit opinion. The nominal $100 would create an intimidation threat as well because client would threaten to withdraw this offer unless a clean audit report is given by auditors. This is about managers work and hence its senior so all its work done would have a big impact onto the overall opinion given. Actions: 1. Partners should perform an independent review on work done by audit manager. 2. When necessary report to ACCA about this issue. 3. Remove managers from the audit team for this client. 4. Carefully check whether there are any relationships that manager with other clients and if yes then remove him/her from other services as well.
(c) Matters to consider: This will increase business risk because if the software quality is bad then it would be seen that audit firms work quality would be bad as well and hence leads to an impairment of audit firms reputation. Actions: 1. Tell client about the referral fees. 2. Make written confirmation that client knows about referral fees. 3. Make sure that other audit staff involved in audit have no further interest in software company because if yes then any other threats to objectivity would be created.
Chapter 1 DEC2008 Q4(Becker & Co) You are a senior manager in Becker & Co, a firm of Chartered Certified Accountants offering audit and assurance services mainly to large, privately owned companies. The firm has suffered from increased competition, due to two new firms of accountants setting up in the same town. Several audit clients have moved to the new firms, leading to loss of revenue, and an over staffed audit department. Bob McEnroe, one of the partners of Becker & Co, has asked you to consider how the firm could react to this situation. Several possibilities have been raised for your consideration: 1. Murray Co, a manufacturer of electronic equipment, is one of Becker & Cos audit clients. You are aware that the company has recently designed a new product, which market research indicates is likely to be very successful. The development of the product has been a huge drain on cash resources. The managing director of Murray Co has written to the audit engagement partner to see if Becker & Co would be interested in making an investment in the new product. It has been suggested that Becker & Co could provide finance for the completion of the development and the marketing of the product. The finance would be in the form of convertible debentures. Alternatively, a joint venture company in which control is shared between Murray Co and Becker & Co could be established to manufacture, market and distribute the new product. 2. Becker & Co is considering expanding the provision of non-audit services. Ingrid Sharapova, a senior manager in Becker & Co, has suggested that the firm could offer a recruitment advisory service to clients, specialising in the recruitment of finance professionals. Becker & Co would charge a fee for this service based on the salary of the employee recruited. Ingrid Sharapova worked as a recruitment consultant for a year before deciding to train as an accountant. 3. Several audit clients are experiencing staff shortages, and it has been suggested that temporary staff assignments could be offered. It is envisaged that a number of audit managers or seniors could be seconded to clients for periods not exceeding six months, after which time they would return to Becker & Co.
Required: Identify and explain the ethical and practice management implications in respect of: (a) A business arrangement with Murray Co. (7 marks) (b) A recruitment service offered to clients. (7 marks) (c) Temporary staff assignments. (6 marks) (d) I heard one of the audit managers say that our firm had lost an audit client to a competitor because of lowballing. What is lowballing and is it allowed? (3 marks)(DEC2009 Q4)
(23 marks)
Answer to DEC2008 Q4: (a) In order to make investment in the product more successful audit firm would issue a favorable audit opinion to clients company even though its financial statements are wrong and this creates self interest threat. By starting up a joint venture it may suggest audit firm and Murray Company are close friends and hence this creates familiarity threat meaning Audit firm would lose professional skepticism when doing the actual audit. The finance is in the form of convertible loan meaning it can be converted into cash or equity at the end of the life of project and an intimidation threat exists meaning if audit firm is not going to issue a clean audit report then Murray Company may not pay for audit firm for cash/equity. A management threat arises as well because a joint venture is set up and any management decision made by the audit firm may result in company failure and hence there is a risk that audit firm may get sued and hence in order not being sued by Murray company, audit firm would issue whatever opinion that they want. By investing in such a project there is a business risk that audit firm reputation would be impaired if the project goes badly and hence there might be less future clients go to Becker&Co. Audit firm would have 2 choices including: 1. Accept the offer but IFAC code of ethics says the threats to objectivity making opinion not objective to be so significant and no safeguard would put in place to minimize the threat and hence audit firm would be better not doing audit services for this client. 2. Reject the offer and continue to provide audit service to this client.
(b) By receiving more income from the audit client would creates a self interest threat because in order to keep this interest audit firm would issue whatever opinion that client wants. Because Becker & Co would charge a fee for this service based on the salary of the employee recruited so the higher salary that Becker&co argues then higher income stream would flow into audit firm and hence greater self interest threat. By recruiting members to do the financial work the employees and audit firm would become friends and hence familiarity threats is created because by subsequently checking work done by those staff auditor would lose professional skepticism. Intimidation threat would be created because if the quality of recruited staff is poor then client would sue us or require a clean audit report even though the financial statements are not true and fair. If the staff recruited is poor quality then there would be an impairment on audit firms reputation and hence future client may not go to Becker&Co for those services including audit service any more.
(c) Audit firm would have an incentive to send higher level staff to the company and hence earn more fees and this creates a higher self interest threat. After auditor working on this company they may have a good relationship with staff there and hence a familiarity threat is created meaning auditor would lose professional skepticism when doing the actual audit or ignore the mistakes staff have made as well. If quality of auditor sent to client s company is poor then an intimidation threat would create meaning client would choose to sue us for negligence or we give a clean audit report in order not get sued. Audit manager or partner sent would be so senior and hence they would have a big impact on the audit work so this needs to be carefully checked.
(d) Low balling means audit firm would charge a low fee to attract audit service from client in the hope to win the tender contact and provide future services to client. This is not banned by ACCA as long as audit firm can demonstrate they would complete the work with competence and due care. But as the fees is cut back then auditor may not spend enough time doing the work and stick to auditing standards and hence quality of the audit work would be lowered down.
Chapter 1 Engagement Letter Q: State 6 items that could be included in an engagement letter.(3marks) Fee cover note: how the fees are calculated. Address to directors. Responsibilities of auditors and directors. Scope of audit. Extra services provided to client Signature and date.
Chapter 1 Money Laundering (DEC2009 Q2(c)) There are specific regulatory obligations imposed on accountants and auditors in relation to detecting and reporting money laundering activities. You have been asked to provide a training session to the new audit juniors on auditors responsibilities in relation to money laundering. Required: Prepare briefing notes to be used at your training session in which you: (i)Explain the term money laundering. Illustrate your explanation with examples of money laundering offences, including those which could be committed by the accountant; and (ii)Explain the policies and procedures that a firm of Chartered Certified Accountants should establish in order to meet its responsibilities in relation to money laundering. (10 marks) Professional marks will be awarded in part (c) for the format of the answer, and the quality of the explanations provided. (2 marks)
Answer to DEC2009 Q2(c): (i) Definition: Money laundering is to convert crime money into a legitimate form. 3 stages: Placing It seems that Heron co receives cash from customer and this is placing and cash may be illegal from customers. Layering $2m of electronic bank transfer to an overseas financial institution would be a layering, ie, creating transactions to cover the true source of money. Integration Then getting money out from the financial institution of $2m then the source of money would become legitimate. Offences: Auditor committee money laundering activities. Auditor helps client to establish money laundering system. Doing tipping off meaning auditors would inform client about the potential investigation of money laundering activities by other departments and hence interrupt the investigation process.
(ii) Train all relevant staff to money laundering issues. Appoint a money laundering reporting officer to deal with money laundering activities and this will often be a senior audit partner. Due diligence review of clients company including their address, directors register etc. Review procedures would be put in place to review working papers of clients company to see if they are involved in money laundering activities. Quality control procedures would be put in place like pre appoint check of the clients company whether it would involve in money laundering activities.
Chapter 1 ISA250 The purpose of ISA250 Consideration of Laws and regulations in an audit of financial statements is to establish standards and provide guidance on the auditors responsibility to consider laws and regulations in an audit of financial statements. Required: Explain the auditors responsibilities for reporting non-compliance that comes to the auditors attention during the conduct of an audit. (5marks)
Answer to ISA250: Auditors are not responsible for the non-compliance with laws by client. But if the non-compliance with laws would result in a material misstatement in the clients financial statements then auditors should modify its audit report. Before that auditors should raise this issue to audit committee. If this is not applicable then auditor should seek legal advice first. If Client Company is involved in money laundering issues then auditor should report this to relevant authority.
Chapter2 Perform an engagement service:
Chapter 2 Q1: What does an audit flowchart look like?
Chapter 2 Q2:June2009 Q1(a) Required: (a) (i) Identify and explain the aspects of a clients business which should be considered in order to gain an understanding of the company and its operating environment; and (6 marks) (ii) Recommend the procedures an auditor should perform in order to gain business understanding. (4 marks) Professional marks will be awarded in part (a) for the clarity, format and presentation of the briefing notes. (2 marks)
Answer to June2009 Q1(a): (i) Internal control system Auditors need to review clients internal control system including its control environment, internal control procedures etc to better understand whether a control testing approach or full substantive testing approach to audit would be used. External factors Auditors need to review the level of competition within the industry because for example if the industry is so competitive then in order for the company to keep up with the industry average profit then company would have an incentive to manipulate the financial statements. Auditors need to review the laws and regulations as well because if clients companys activity is not fulfilling the current laws and regulations then there might be risks that financial statements would be misstated, eg, failure to disclose contingent liability to the note of the Financial statements. Performance measurement Auditors need to review companys performance measurement as well because for example if manager is measured based on profit then profit would be overstated in order to earn more bonus. Companys structure and its accounting policy Auditors need to review its structure and its accounting policy and if the companys structure is so complicated then during the actual consolidation there would be potential misstatements to the financial statements as well. Companys strategy, plan and its related business risks For example companys strategy would be a market leader in the industry so its plan would be launching a new product and there is a business risk that this may fail resulting in the financial statements being misstated.
(ii) Perform analytical procedure to identify any unusual transactions and this can help auditors to identify whether trends for the financial statements would be reasonable, ie, consistent with growth in economy. Enquire with internal auditors about internal control system of company to understand its its effectiveness. Inspect business plan by management to understand its potential business risks. Observe internal control operations physically to verify internal control procedures are working effectively. Recalculate some material balances to verify its accuracy.
Chapter2 Q3:DEC2009 Q1(a)(b)

ISA 520 Analytical Procedures requires that the auditor performs analytical procedures during the initial risk assessment stage of the audit. These procedures, also known as preliminary analytical review, are usually performed before the year end, as part of the planning of the final audit. Required: (i) Explain, using examples, the reasons for performing analytical procedures as part of risk assessment; and (ii) Discuss the limitations of performing analytical procedures at the planning stage of the final audit. (6 marks) (b) Explain and differentiate between the terms overall audit strategy and audit plan. (4 marks)
Answer to DEC2009 Q1(a)(b): (i) It can help auditors better understand the client. Eg, perform analytical procedures for new client by comparing its profit with its competitor would provide the auditor with a better picture about the relative performance of the entity within its business environment. It can help auditors better identify high risk areas. Eg, preform analytical procedures by comparing its financial information,eg200% increase in profit with the non- financial information such as economic recession happens outside the market would clearly show that revenue may be overstated and hence this is a high risk area. (ii) It may not reflect the whole year figure because this is done based on interim financial information. Because its not done at the year-end so some figures such as impairment should be ignored. For some companies internal control system would be weak during the year and hence the analytical procedure on these results may not be correct.
(b) Audit strategy sets out the scope, timing, nature and direction of the audit and it tells auditor which audit approach should be used, ie, system based or full substantive approach and how the recourses would be allocated. Audit plan sets out the risk assessment, materiality and potential audit procedures to be used. Audit strategy leads to audit plan meaning that audit plan, ie, if system based approach is used then less audit procedures would be included in the audit plan. Any changes in the audit plan should lead to a change in the audit strategy as well, eg, during the audit a material risky balance is omitted so further procedures should be planned and recourses allocation schedule would also be changed.
Chapter2 Q4: June2008 Q1 (a+b)(business risks)

You are a senior audit manager in Mitchell & Co, a firm of Chartered Certified Accountants. You are reviewing some information regarding a potential new audit client, Medix Co, a supplier of medical instruments. Extracts from notes taken at a meeting that you recently held with the finance director of Medix Co, Ricardo Feller, are shown below: Meeting notes meeting held 1 June 2008 with Ricardo Feller Medix Co is a provider of specialised surgical instruments used in medical procedures. The company is owner managed, has a financial year ending 30 June 2008, and has invited our firm to be appointed as auditor for the forthcoming year end. The audit is not going out to tender. Ricardo Feller has been with the company since January 2008, following the departure of the previous finance director, who is currently taking legal action against Medix Co for unfair dismissal. Company background Medix Co manufactures surgical instruments which are sold to hospitals and clinics. Due to the increased use of laser surgery in the last four years, demand for traditional metal surgical instruments, which provided 75% of revenue in the year ended 30 June 2007, has declined rapidly. Medix Co is expanding into the provision of laser surgery equipment, but research and development is at an early stage. The directors feel confident that the laser instruments currently being designed will eventually receive the necessary licence for commercial production, and that the laser product will replace surgical instruments as a leading source of revenue. There is currently one scientist working on the laser equipment, subcontracted by Medix Co on a freelance basis. The building in which the research is being carried out has recently been significantly extended by the construction of a large laboratory. A considerable revenue stream is derived from agents who are not employed by Medix Co. The agents earn a commission based on the value of sales they have secured for Medix Co during the year. There are many suppliers into the market and agents are used by all manufacturers as a means of marketing and distributing their products. The companys manufacturing facility is located in another country, where operating costs are significantly lower. The facility is under the control of a local manager who visits the head office of Medix Co annually for a meeting with senior management. Products are imported via aeroplane. The overseas plant and equipment is owned by the company and was constructed 12 years ago specifically for the manufacture of metal surgical instruments. The company has a bank overdraft facility and makes use of the facility most
months. A significant bank loan, which will carry a variable interest rate, is currently being negotiated. The terms of the loan will be finalised once the audited financial statements have been viewed by the bank. After receiving permission from Medix Co, you held a discussion with the current audit partner of Medix Co, Mick Evans, who runs a small accounting and audit practice of which he is one of two partners. Mick told you the following: Medix Co has been an audit client for three years. We took over from the previous auditors following a disagreement between them and the directors of Medix Co over fees. As we are a small practice with low overheads we could offer lower fees than our predecessors. We could also do the audit very quickly, which pleased the client, as they like to keep costs as low as possible. During our audits we have found the internal systems and controls to be quite weak. Despite our recommendations, there always seemed to be a lack of interest in making improvements to the accounting systems, as this was seen to be a waste of money. There have been two investigations by the tax authorities, which we did not deal with, as we are not tax experts. In the end the directors sorted it all out, and I believe that the tax matter is now resolved. We never had a problem getting access to accounting books and records. However, the managing director, Jon Tate, once gav e us what he described as the wrong cash book by mistake, and replaced it with the proper version later in the day. We never found out why he was keeping two cash books, but cash was an immaterial asset so we didnt worry about it too much. We are resigning as auditors because the work load is too much for our small practice, and as Medix Co is our only audit client we have decided to focus on providing non-audit services in the future. You have also found a recent press cutting regarding Medix Co: Extract from local newspaper business section, 2 June 2008 It appears that local company Medix Co has breached local planning regulations by building an extension to its research and development building for which no local authority approval has been given. The land on which the premises is situated has protected status as a greenfield site which means approval by the local authority is necessary for any modification to commercial buildings. A representative of the local planning office stated today: We feel that this is a serious breach of regulations and it is not the first time that Medix Co has deliberately ignored planning rules. The company was successfully sued in 2003 for constructing an access road without receiving planning permission, and we are considering taking legal action in respect of this further breach of planning regulations. We are taking steps to ensure that these premises should be shut down
within a month. A similar breach of regulations by a different company last year resulted in the demolition of the building. Required: (a) Using the information provided, identify and explain the principal business risks facing Medix Co. (12 marks) (b) (i) Discuss the relationship between the concepts of business risk and risk of material misstatement; and (4 marks)
Answer to June2008Q1(a+b): (a) Demand Demand of traditional market is declining. There is a risk that continues decline in demand in the traditional market will result in less profit made by company. R&D The research and development would be costly for company. There is a risk that given poor liquidity position of company because company seems to make uses of the facility most months and because R&D expenses are huge cost to company so company may not have enough money to invest in this area hence making this unsuccessful. License Management is confident that licence is received for commercial production in the future. There is a risk that license may not be received by company given this is a highly regulated country and hence this will make the future production not successful decreasing shareholders wealth as a result. Scientist There is just one scientist working in the company. There is a risk that this scientist may leave the company and hence stop researching and developing of products process and this will result in company suffering greater loss given huge expenses input in the R&D process. Scientist is subcontracted not employed by the company. There is a risk that scientist may bring his knowledge and research results out from company to its competitors and if this is the case companys financial position will be again threatened resulting in decrease in profit and shareholders wealth. Agent A large amount of revenue is from agent. There is a risk that if the agent is not successful in selling products which may result in a further decrease in profit and cash flow from company. There is a risk that agent may try to overstate the sales revenue in order to maximize commission received and given a weak internal control system exists within company and this may not be easily detected.
Oversea The manufacturing facility is located overseas. There is a risk that quality of product may not be guaranteed and if the quality of product is poor then it will impact on the demand of products and hence impair the profitability of company. There is a risk that company will have to pay high expenses in importing goods from other country and hence this will decrease the profit of company. There is a risk that company will have to suffer foreign exchange rate risk and hence it will decrease it profit given an increase in the expenses. Old asset The overseas plant and equipment were built 12 years ago. There is a risk that given the assets are too old and it may not have sufficient future capacity to produce new products in the future and hence decrease profit of company. Bank overdraft Company relies very much on the bank overdraft and this is more expensive than other bank loans. There is a risk that it will further impair its profitability because company has to pay more as a result of the expensive expense. Weak internal control system The internal control system of clients company is so weak. There is a risk that fraudulent transactions happened which cant be detected and it may lead to company suffering a loss. Tax authority Two tax investigations into company happened. There is a risk that company may not comply with tax regulations which would result in further penalties paid by company as a result and hence impair its profitability position. Shut down The building has no local authority approval. There is a risk that building may be shut down and as a result company needs to find another place to building the building which may be expensive to company and hence impair its profitability position.
Regulations Company has been in breach of local planning regulations. There is a risk that company will need to pay related penalty which would impair its liquidity position. Reputation Company breaches the regulation. There is a risk that demands for the product by customers will decrease as a result of the bad publicity company creates, ie, breaches in regulation.
Impairment of building The building has been impaired last year. There is a risk that company may find it more difficult to raise finance because of a worsen position in its non-current assets.
(b) (i) Business risk is the risk that business fails, ie, as a result of this risk company will have to pay more expenses. Risk of material misstatement is the risk that the financial statement of clients company may be misstated. Business risk will lead to risks of material misstatement, ie, in Medix Co the decline in demand of products by customers is a business risk and this would lead to risk of material misstatement in financial statement, ie, risk of inventory being overstated. Business risk would relate to going concern status of company as well. Ie, in Medix Co it is struggling to raise finance given poor quality assets it has and as a result of the lack of finance it would impact on its going concern status, ie, doesn't have enough cash flow to operate its business.
Chapter2 June2012 Q1(Risk of material misstatement/Audit risks)

You are a manager in Magpie & Co, responsible for the audit of the CS Group. An extract from the permanent audit file describing the CS Groups history and operations is shown below: Permanent file (extract) Crow Co was incorporated 100 years ago. It was founded by Joseph Crow, who established a small pottery makingtableware such as dishes, plates and cups. The products quickly grew popular, with one range of products becominghighly sought after when it was used at a royal wedding. The companys products have retained their popularity overthe decades, and the Crow brand enjoys a strong identity and good market share. Ten years ago, Crow Co made its first acquisition by purchasing 100% of the share capital of Starling Co. Both companies benefited from the newly formed CS Group, as Starling Co itself had a strong brand name in the pottery market. The CS Group has a history of steady profitability and stable management. Crow Co and Starling Co have a financial year ending 31 July 2012, and your firm has audited both companies for several years. Acquisition of Canary Co The most significant event for the CS Group this year was the acquisition of Canary Co, which took place on 1 February 2012. Crow Co purchased all of Canary Cos equity shares for cash consideration of $125 million, and further contingent consideration of $30 million will be paid on the third anniversary of the acquisition, if the Groups revenue grows by at least 8% per annum. Crow Co engaged an external provider to perform due diligence on Canary Co, whose report indicated that the fair value of Canary Cos net assets was estimated to be $110 million at the date of acquisition. Goodwill arising on the acquisition has been calculated as follows:
$m
Fair value of consideration: Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill 125 30
155 (110) 45
To help finance the acquisition, Crow Co issued loan stock at par on 31 January 2012, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.
Canary Co manufactures pottery figurines and ornaments. The company is considered a good strategic fit to the Group, as its products are luxury items like those of Crow Co and Starling Co, and its acquisition will enable the Group to diversify into a different market. Approximately 30% of its sales are made online, and it is hoped that online sales can soon be in troduced for the rest of the Groups products. Canary Co has only ever operated as a single company, so this is the first year that it is part of a group of companies. Financial performance and position The Group has performed well this year, with forecast consolidated revenue for the year to 31 July 2012 of $135 million (2011 $125 million), and profit before tax of $85 million (2011 $84 million). A breakdown of the Groups forecast revenue and profit is shown below: Crow Co $ million Revenue Profit tax Note: Canary Cos results have been included from 1 February 2012 (date of acquisition), and forecast up to 31 July 2012, the CS Groups financial year end. The forecast consolidated statement of financial position at 31 July 2012 recognises total assets of $550 million. Other matters Starling Co received a grant of $35 million on 1 March 2012 in relation to redevelopment of its main manufacturing site. The government is providing grants to companies for capital expenditure on environmentally friendly assets. Starling Co has spent $25 million of the amount received on solar panels which generate electricity, and intends to spend the remaining $10 million on upgrading its production and packaging lines. On 1 January 2012, a new IT system was introduced to Crow Co and Starling Co, with the aim of improving financial reporting controls and to standardise processes across the two companies. Unfortunately, Starling Cosfinance director left the company last week. Required: Evaluate the risks of material misstatement to be considered in the audit planning of the individual and consolidated financial statements of the CS Group (18 marks) before Starling Co $ million Canary Co $ million CS Group $ million
69
35
50 3
16 2
135 8.5
Answer to June2012 Q1: Contingent consideration Step1:Contingent consideration is $155m. Step 2:According to IFRS3 business combination that contingent consideration should include the probability of payment and also should discount to present value. Step 3:Theres a risk that $155m hasn't included the probability of being paid and hasn't been discounted to its present value resulting in over/understatement of goodwill figure. Net assets Step 1:Fair value of identifiable net assets is $110m. Step 2:According to IFRS3 business combination that this should net of deferred tax implication. Step 3:There is a risk that $110m hasn't included deferred tax implication, ie, net of deferred tax liability resulting in misstatement in identifiable net assets figure. Goodwill Step 1:Goodwill is $45m. Step 2:According to IAS36 impairment of assets management should conduct an impairment test for goodwill at the year-end by comparing its carrying value and its recoverable amount. Step 3:There is a risk that an impairment test has not been done resulting in overstatement of goodwill in statement of financial position and understatement of expenses in the statement of profit or loss. Loan stock Step 1:Crow co issued a loan stock at par. Step 2:According to IFRS9 financial instrument when calculating the fair value of financial liability at inception the repayment at premium of $20m should be included. Step 3:There is a risk that this is not done which would impact on the calculation of finance cost and hence resulting in understatement of expenses in statement of profit or loss and financial liability in the statement of financial position. Financial cost Step 1:Interest is paid annually and to its year end its half a year now. Step 2:Finance cost should be accrued at the year end, ie, half a year amounts to $2.5m($100mX5%X1/2) by DR I/S $2.5m, CR interest payable $2.5m. Step 3:There is a risk that this is not done which would result in understatement of expenses in the statement of profit or loss and liability in the statement of financial position.
Online sales Step 1:30% of sales are made online. Step 2:According to IAS18 revenue recognition sales revenue is recognized when the risks and rewards of products have been transferred from seller to buyer; no managerial involvement on the goods; related expenses can be measured reliably. So company should recognize a sales revenue when the above conditions are met. Step 3:There is a risk that company may not record the sales revenue correctly given complexity in online sales system which would result in revenue figure being misstated in statement of profit or loss and relating assets such as receivable or cash being misstated in statement of financial position. Canary revenue and profit before tax Step 1:Canary Co revenue and profit before tax are $16m and $2m. Step 2+3:There is a risk that Canary Co may overstate its revenue and profit before tax figure in order to argue for a better price. Group position Step 1:The forecast revenue without including Canary co is $119m($135m-$16m) and the profit before tax is $6.5m ($8.5m-$2m) which are less than the actual 2011 figure of $125m and $8.4m. Step 2+3:There is a risk that both revenue and profit before tax figures are understated given a new incorporation of Canary Co into the group happens. Grant Step 1:Starling Co received a grant of $35m. Step 2:According to IAS20 Government Grant the receipt of grant should be deferred and released over the life of the asset to recognize income in statement of profit or loss. Step 3:There is a risk that Starling Co may recognize the full $35m at inception and hence this would result in overstatement of revenue in statement of profit or loss and understatement of liability in statement of financial position. Grant repayment Step 1:Starling Co has not spent the rest of grant of $10m. Step 2:If Starling Co hasn't spent this $10m onto the qualifying assets then it may become repayable and According to IAS37 provision, contingent liability and contingent assets if the cash outflow is possible then a contingent liability should be disclosed to the financial statement and if the repayment becomes probable then a provision should be recognized. Step 3:There is a risk that this is not done resulting in either under disclosure or understatement of expenses in statement of profit or loss and liability in the statement of financial position.
New IT system Step 1:New IT system as introduced to both companies. Step 2:Because of the unfamiliarity of the system there would be a risk that errors may occur in transferring data from old to new system. Step 3:This would result in the overall financial statement being misstated. Finance director Step 1:Finance director left Starling Co last week. Step 2+3:This would increase the likelihood of misstatement in the individual financial statement because of a lack of expertise in the financial reporting process.
Chapter2 Q7: June2010 Q2

Mac Co is a large, private company, whose business activity is events management, involving the organisation of conferences, meetings and celebratory events for companies. Mac Co was founded 10 years ago by Danny Hudson and his sister, Stella, who still own the majority of the companys shares. The company has grown rapidly and now employs more than 150 staff in 20 offices. You are a manager in the business advisory department of Flack & Co. Your firm has just been engaged to provide the internal audit service to Mac Co. In your initial conversation with Danny and Stella, you discovered that currently there is a small internal audit team, under the supervision of Lindsay Montana, a recently qualified accountant. Before heading up the internal audit department, Lindsay was a junior finance manager of the company. The members of the internal audit team will be reassigned to roles in the finance department once your firm has commenced the provision of the internal audit service. Mac Co is not an existing client of your firm, and to gain further understanding of the company, you held a meeting with Lindsay Montana. Notes from this meeting are shown below. Notes of meeting held with Lindsay Montana on 1 June 2010 The internal audit team has three employees, including Lindsay, who reports to the finance director. The other two internal auditors are currently studying for their professional examinations. The team was set up two years ago, and initially focused on introducing financial controls across all of Mac Cos offices. Nine months ago the finance director instructed the team to focus their attention on introducing operational controls in order to achieve cost savings due to a cash flow problem being suffered by the company. The team does not have time to perform much testing of financial or operational controls. In the course of her work, Lindsay finds many instances of management policies not being adhered to, and the managers of each location are generally reluctant to introduce controls as they want to avoid bureaucracy and paperwork. As a result, Lindsays recommendations are often ignored. Three weeks ago, Lindsay discovered a fraud operating at one of the offices while reviewing the procedures relating to the approval of new suppliers and payments made to suppliers. The fraud involved an account manager authorizing the payment of invoices received from fictitious suppliers, with payment actually being made into the account managers personal bank account. Lindsay reported the account manager to the finance director, and the manager was immediately removed from office. This situation has highlighted to Danny and Stella that something needs to be
done to improve controls within their organisation. Danny and Stella are considering taking legal action against Mac Cos external audit provider, Manhattan & Co, because their audit procedures did not reveal the fraud. Danny and Stella are deciding whether to set up an audit committee. Under the regulatory framework in which it operates, Mac Co is not required to have an audit committee, but a disclosure note explaining whether an auditcommittee has been established is required in the annual report. Required: (a) Evaluate the benefits specific to Mac Co of outsourcing its internal audit function. (6 marks) (b) Explain the potential impacts on the external audit of Mac Co if the decision is taken to outsource its internal audit function. (4 marks) (c) Recommend procedures that could be used by your firm to quantify the financial loss suffered by Mac Co as a result of the fraud. (4 marks) (d) Prepare a report to be presented to Danny and Stella in which you: (i) Compare the responsibilities of the external auditor and of management in relation to the prevention and detection of fraud; and (4 marks) (ii) Assess the benefits and drawbacks for Mac Co in establishing an audit committee. (4 marks) Professional marks will be awarded in respect of requirement (d) for the presentation of your answer, and the clarity of your discussion. (4 marks) (26 marks)
Answer to June2010 Q2: (a) Roles assigned After outsourcing the internal audit function the role of financial manager may be reassigned to other parts of the company and this will benefit the company for having extra resources for having such employees. External expertise Because currently there are two internal auditors within the clients company not being qualified so a decision of outsourcing the internal audit function will have extra expertise to do the internal service for client and this will improve the overall internal audit quality as well. Focus It seems that the team currently lacks a consistent focus. They are directed by the finance director, who has changed the focus from financial reporting controls to operational controls, and it seems the team is too small to do both. Outsourcing the function will provide as many staff as necessary to cover a range of activities. Time Because currently there are two internal auditors within the clients company so for outsourcing the internal audit function that it will have extra resources to focus on other areas of the company. (b) Audit strategy If after outsourcing its internal audit function then the internal control system off client company improved and so the external audit firm may rely on the internal control system and hence spent less time doing the full substantive testing and this would result in less audit fees charged. Assessable of the working papers by outsourcing firm If the outsourcing firms working papers are accessible by external auditor and this will reduce the work done by external auditor and hence reduce the fees charged. Internal control system changes If the internal control system changes and this will impact on the amount of work done by audit firm and hence impact on its fees as well.
Report If external auditor replies on type2 report then this will decrease its work load and hence fees charged as well. (c) Enquire with the police and lawyer to verify if the amount can be reimbursed ith clients permission. Inspect the insurance policy to verify if it covers this situation and the losses can be reimbursed. Compare a list of unapproved suppliers to a list of actually approved suppliers by the company to identify the discrepancies of suppliers and its related amount. Use computerized assisted audit techniques to identify the suppliers with the same bank account to the accountant manager. (d) Report to: Danny and Stella Hudson Content: Responsibilities in respect of fraud Audit committees: benefits and drawbacks Introduction: The objective of the report is to compare the responsibilities of the external auditor and of management in relation to the detection of fraud, and also to outline the benefits and drawbacks for Mac Co of establishing an audit committee.
(i) Responsibilities of the external auditor and of management in relation to the detection of fraud Management has a primary responsibility in establishing a sound internal control system to prevent and detect of fraud. Management should assess the internal control system continuously. Auditor would be responsible for the fraud happened within company if they are material to the financial statements. This means auditors would focus more on the fraud impact on the accounts rather than its operational issues. Auditor would assess the internal control system at the planning stage of audit to determine its audit strategy.
(ii) Benefits This can improve the overall internal control system which clients company because originally Lindsay reports internal control system weaknesses to the finance director and if the control environment is weak then it will have an impact on the quality of internal control system if finance director refuses to change the internal control system required by Lindsay. Audit committee would have more power and status not like Lindsay who is just the current junior financial manager then they may adopt the internal control recommendations more easily. Drawbacks Its difficult in the real world to recuitstaff who are independent and with relevant skills. They may not have time to devote to their role as a member of the committee. This could be a problem for Mac Co, whose business activities are quite specialised. The audit committee members should expect to receive a fee commensurate with their level of experience and knowledge, so the fees may be significant. This could be an issue for Mac Co due to its cash flow problem.
Chapter2 Q7: Big Accounting questions Please outline all the accounting standards contents in ACCA paper and related audit work to it.(35 accounting standards outlined below)
Chapter2 Q7: 1, conceptual framework:

Its objective is to provide useful information to users of financial statements but how? We need to make sure information in the FS is: Relevant Reliable To help users making their economic decisions like using fair value; To ensure financial statement figures are correct(audited); From past event(shown in the contract); Free from bias(no window dressing); not overstating value(prudence); Showing substance of transaction like recognize finance lease rather than operating lease(substance over form); No missing information(complete). Disclosing diluted EPS and its comparative figures to help users to make their decisions. Information should be translated in easy language to be understood by to users with reasonable business and accounting knowledge and should be clear and precise as well.
Comparable Understandable
Of course when preparing the financial statements the underlying assumptions would be: 1.Going concern. This means company can operate its business for more than 12 months and hence non-current assets and liabilities would need to be recognized. When a company is not a going concern entity any more then company needs to prepare its financial statements under break up basis and this means to reclassify its non-current assets and liabilities into current assets and liabilities. If there is significant uncertainties about the going concern status of the company then company should disclose those uncertainties in the note of the financial statement as per IAS1 presentation of financial statements. Auditor should bring shareholders attention by adding emphasis of matter paragraph after the actual opinion paragraph as well. 2. Accruals. This means company should recognize its revenue provided the expenses can be matched against each other like in IAS20 government grant. This is also against cash basis where looking at sales revenue-we will not recognize sales revenue until we receive the cash but rather we would DR receivable CR sales revenue even if we havent received cash payment.
Chapter2 Q7: 2,IAS1 Presentation of Financial Statements

Accounting Issues: Statement of Financial Position(not balance sheet); Statement of profit or loss and other comprehensive income; Statement of changes in equity. Audit Works: Inspect the financial statements to ensure company has used break up basis, ie, to reclassify all non-current assets and liabilities into current assets and liabilities if company is not a going concern entity. Inspect disclosures made by management regarding certainties about going concern status of the company is adequate. Obtain a written representation from management to confirm company is a going concern entity at the review stage.
Chapter2 Q7: 3,IAS2 Inventories

Accounting Issues: 1,whats the difference between inventory and property, plant and equipment? Aim: The aim of inventory is held for sale; The aim of PP&E is to hold for production of goods or delivery of services or for administrative purposes. Period: Inventory is within 1 year; while PP&E is more than 1 year. 2, How can we measure inventory? Initial measurement: The initial cost of inventory would be including all costs of purchase, plus the costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Subsequent measurement: Value at the lower of Cost and Net Realizable Value(Estimated selling price-Estimated costs to sell) Costs are usually measured using FIFO, Weighted average cost.(LIFO is banned) Audit Works: 1, initial measurement: Costs should be agreed to invoices and purchase agreement and bank statement and cash book; If manufactured, costs should be agreed to material requisitions, timesheets, personnel records; 2, subsequent measurement: NRV should be agreed to post year-end selling prices and invoices. Inspect inventory condition and if its damaged then it should be valued using NRV.
Audit Question [ DEC2009 Q2] IAS2

Banana Co designs specific items for customers according to contractually agreed specifications. And you are at the review stage of audit. After the year end, Cherry Co, a major customer with whom Banana Co has several significant contracts, announced its insolvency, and that procedures to shut down the company had commenced.
The amount of contract is $50,000 while the total asset within statement of financial position is $500,000. Required: Comment on the matters to be considered relating to the above inventory.
Answer: Materiality The inventory of $50,000 accounts for 10% of total asset and it's material to statement of financial position. Accounting treatment Because the inventory is for specific use and Cherry Co is in insolvency and hence inventory cant be used by Cherry co and they are with no use any more so according to IAS2 the value should be written down to lower of cost and net realizable value according to IAS2. Audit opinion If this is not done properly then a qualified audit opinion with an except for qualification due to material misstatement should be given.
(Tutor tips: this is at the review stage of audit and hence any matters to be considered should be taking into account the impact on audit report if the adjustment is not done properly)
Chapter2 Q7: 4, IAS7 Statement of cash flows

Accounting Issues: It incorporates operating cash flows, investing cash flows and financing cash flows. In operating cash flows element, non-cash flow items should be added it back. Audit works: Agree opening cash flows to last year end cash flow to verify its accuracy.
Review and verify the non-cash item such as depreciation is added back to the operating cash flows. (Statement of cash flow is often in the form of prospective financial information (forecast) and it requires audit work to be performed to verify its reasonableness, eg, check the assumptions. )
Chapter2 Q7: 5,IAS8 Accounting Policies, Changes in Accounting Estimates and errors
Accounting Issues: If the company is going to use another accounting policy this year and find an error relating to last years account then the company should adjust for this year and last years financial statements.(retrospective adjusting) If the company is going to use another accounting estimate this year and the company should adjust for current year financial statements and future one.(prospective adjusting) But how to determine whether this is a change in accounting policy or estimate? Well, if theres a change in Measurement basis of the figure, eg, value the inventory using FIFO but now use weighted average method; use replacement cost rather than historic cost. Recognition basis of the figure, eg, recognize as an expense before but now for asset(eg,IAS 23 borrowing costs) Presentation basis of the figure, eg, recognize the depreciation expense into cost of sales now rather than in administrative expenses before. You are going to change in the accounting policy only if: 1, a change in laws / accounting standards and you are required to do so; 2, gives a fairer presentation to the users of FS. And anything that is not changing the measurement, recognition or presentation of figures are deemed to be a change in accounting estimate such as: Allowance for receivables; Useful life/ depreciation method of the non-current assets; Warranty provision relating to return of goods from customers. An error may happen if theres a Misuse of the accounting standard last year; Fraud happened last year; Omit some figures in last years account.
Summary: Changes in accounting policy this year: Assume it happens in last year as well and of course this year happens; Adjust for last year closing retained earnings taken into account in the changes to be brought forward in this years statement of changes in equity. Material prior period errors found: Correct last years material errors; Adjust for last year closing retained earnings taken into account in the error effect to be brought forward in this years statement of changes in equity. Changes in accounting estimate: Use the new one to continue the calculation.
Audit works: 1, Inspect the changes in accounting policy and ensure its consistent and properly disclosed. 2, Inspect the changes in accounting estimate and verify the nature and the amount have been disclosed properly.
Audit question [DEC2011 Q3 ] IAS 8

Pine Co Pine Co operates a warehousing and distribution service, and owns 120 properties. During the year ended 31 July 2011, management changed its estimate of the useful life of all properties, extending the life on average by 10 years. The financial statements contain a retrospective adjustment, which increases opening non-current assets and equity by a material amount. Information in respect of the change in estimate has not been disclosed in the notes to the financial statements. Required: Identify and explain the potential implications for the auditors report of the accounting treatment of the change in accounting estimates. (5 marks)
Answer to audit question [DEC2011 Q3 ] IAS 8:

Pine Co
Materiality The increase in non-current asset amount is material by question. Accounting treatment This is a change in accounting estimate not change in accounting policy so this does require prospective adjustment not retrospective adjustment. This means management shouldn't restate the opening balance of non current asset and retained earnings. Audit report implication If management has corrected this mistake then an unmodified audit report would be given. If management still insist to restate the opening balance of non-current asset and retained earnings then an modified audit report with qualified audit opinion would be given with an except for material misstatement in the financial statement. Auditor should explain the reasons why a qualified audit opinion would be given in the basis of opinion paragraph. And this paragraph would be placed before the actual opinion paragraph.
Chapter2 Q7: 6,IAS10 Events after the Reporting Period

Accounting Issues: Time line:
YR start
YR end
Audit report signed
FS authorized to issue
This is the event happened between financial statement year end and the financial statements are authorized to be issued to the shareholders to be discussed at the AGM(annual general meeting). They will be either adjusting events or non-adjusting events Magical way to distinguish the adjusting events and non-adjusting events: Is it because of this event then it will affect the figure as at the year end?
-Adjusting events Change in judgments, estimate or assumptions after the year end. Eg, 1, inventory sold at a loss? Change in assumptions that closing inventory should be valued at the lower of cost and net realizable value (IAS 2); 2, Customers go bankruptcy so that recoverability of the receivable balance at the year end has been changed. 3, If company is involved in going concern problems after the year end and because the financial statement should be prepared under going concern basis and now this is changed. -Non-adjusting events Theres no link between financial statement figures at the year end and events after the FS year end. Eg, 1, fire destroyed the inventory after the year end (cant s predict!) 2, dividends are declared after the year end or share issues after the year end (no link between figures and events)
Audit works: Can be active responsibility; passive responsibility. And this is according to ISA560 subsequent events.
Audit question ISA560 [DEC2009 Q5]

Subsequent events (a) Guidance on subsequent events is given in ISA 560 (Redrafted) Subsequent Events. Required: Explain the auditors responsibility in relation to subsequent events. (6 marks) (b) You are the manager responsible for the audit of Lychee Co, a manufacturing company with a year ended 30 September 2009. The audit work has been completed and reviewed and you are due to issue the audit report in three days. The draft audit opinion is unmodified. The financial statements show revenue for the year ended 30 September 2009 of $15 million, net profit of $3 million, and total assets at the year end are $80 million. The finance director of Lychee Co telephoned you this morning to tell you about the announcement yesterday, of a significant restructuring of Lychee Co, which will take place over the next six months. The restructuring will involve the closure of a factory, and its relocation to another part of the country. There will be some redundancies and the estimated cost of closure is $250,000. The financial statements have not been amended in respect of this matter. Required: In respect of the announcement of the restructuring: (i) Comment on the financial reporting implications, and advise the further audit procedures to be performed; and (6 marks) (ii) Recommend the actions to be taken by the auditor if the financial statements are not amended. (4 marks) (16 marks)
Answer to ISA560 [DEC2009 Q5]Subsequent Events

(a) Events between FS year end and audit report is signed: Auditor would have active responsibility to identify any subsequent events. Procedures would include for example: Enquire with management to verify any subsequent events have occurred. Reading minutes of meetings of shareholders and management to verify any subsequent events have occurred. Reviewing the latest interim financial statements to verify any subsequent events have occurred. Events between audit report signed and the FS are issued: Auditor would have a passive responsibility to identify any subsequent events. Ie, they don't need to perform procedures actively to identify those events. But management would have the responsibility to tell auditors any subsequent events. If any events occurred which would materially affect the FS then this matter should be discussed with management. If this matter has been dealt with by management either disclose or amend it then auditors should perform additional audit procedures relating to this issue and a new audit report would be issued. If management refuses to deal with this event and it is material to the FS then a qualified audit opinion should be issued by auditors. Events after financial statements are issued: Auditor would have a passive responsibility to identify any subsequent events. Ie, they don't need to perform procedures actively to identify those events. If any events occurred which would materially affect the FS then this matter should be discussed with management. If this matter has been dealt with by management either disclose or amend it then auditors should perform additional audit procedures relating to this issue and a new audit report would be issued. If management refuses to deal with this event and it is material to the FS then a qualified audit opinion should be issued by auditors. 73 Accounting Practise Center (A.P.C) www.accaapc.com
(b) (i) Materiality: Based on revenue: $250,000/15 million = 167% Based on profit: $250,000/3 million = 83% Based on assets: $250,000/80 million = <1% So this is material to statement of profit or loss and other comprehensive income. Accounting: A note detailing the nature of the event and the amount should be provided according to IAS10. Company needs to determine the probability of cash outflow to see whether provision or contingent liability should be accounted for disclosed to the note of the financial statement. Audit procedures: Enquire with management and read board minutes relating to this to gain an understanding about the reason for the restructuring. Inspect the note to financial statements which should disclose the non-adjusting event, providing a brief description of the event, and an estimate of the financial effect. Inspect detail copy of the announcement about the nature of the restructuring, ie, the number of employees to be affected. Agree the $250,000 potential cost of closure to supporting documentation like a schedule showing the number of staff to be made redundant and these should be supported by payroll details. (ii) Auditor should raise this issue to those charged with governance, ie, audit committee to persuade them to correct this misstatement. If misstatement still exists then auditor should modify his audit report by giving a qualification of audit opinion due to material misstatement in the fiancnial statement. Auditor should explain the reasons for the qualification in the basis of opinion paragraph and this is before the actual opinion paragraph. Auditor can choose to raise this issue to the annual general meeting to shareholders.
Chapter2 Q7: 7,IAS 11 Construction Contracts

Accounting Issues: 1,When youre trying to build this tower it may take you more than 1 year to finish. After finishing off this tower and you may try to sell off to the client. So before finishing off this tower will you keep it as a inventory?(IAS2) The answer is no! Remember inventory is current asset which is less than 1 accounting year. 2,Next question is because the contractor is building this tower so he may have to pay for material, labor costs etc. So when is the cost being recognized? The contractor can get the sales revenue only when after selling off this tower to client. So before selling off this tower, the contractor gets no cash from the client. So does the contractor recognize no revenue at all? To answer this question: According to Prudence concept, the sales revenue should be recognized after this tower has been sold off to the client. According to Accruals concept, the expenses relating to the building of the tower should be matched with the revenue from the tower. So one is contradict with another. But here in this case, Accruals concept wins. 3,But how much does the revenue and expenses should be recognized? IAS 11 Construction Contract gives us the guidance. 4, Guidance by IAS 11 construction contract (Diagram)
Mark up
Fixed Price or Mark up?

yes No
Profit=price(cost+mark up)-cost
Profit making contract?

yes
Recognize loss in full
Outcome is certain?
No
Revenue=costs(no profit/loss)
yes Recognize based on stage of

75 completion Accounting Practise Center (A.P.C) www.accaapc.com
5, Stage of completion Sales basis method (work certified method): work certified to date Contract price Cost method: Costs incurred to date Total contract costs
Audit question [june2011 Q2] IAS11: Construction Contract(attachment1)

In the last week, two significant issues have arisen at Bill Co. The first issue concerns a major contract involving the development of an old riverside warehouse into a conference centre in Bridgetown. An architect working on the development has discovered that the property will need significant additional structural improvements, the extra cost of which is estimated to be $350,000. The contract was originally forecast to make a profit of $200,000. The development is currently about one third complete, and will take a further 15 months to finish, including this additional construction work. The customer has been told that the completion of the contract will be delayed by around two months. However, the contract price is fixed, and so the additional costs must be covered by Bill Co. Forecast profit before tax is $25 million. Hello Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co. (i) I have just received some information on two significant issues that have arisen over the last week, from Sam Compton, the companys finance director. This information is provided in attachment 1. I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the risks of material misstatement relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks. (8 marks)
Answer to [june2011 Q2] IAS11

Matters to be considered Materiality: The loss on the contract of $150,000 represents 6% of the forecast profit before tax and is therefore material to the statement of profit or loss. Accounting treatment: 1. The $150,000 loss needs to be recognized immediately to the statement of profit and loss and other comprehensive income. 2. the delay completion of contract would result in penalties and this should be accounted for under IAS37 provision, contingent liabilities and contingent asset. Risks of material misstatement: There is a risk that loss of $150,000 has not been recognized in the statement of profit or loss and hence overstate the profit figure by $150,000. There is also a risk that a failure to provide for a provision or disclose contingent liability in the note of the FS and this would result in understatement of liability and expense or under disclosure. Audit procedures: Inspect the customer-signed contract to verify the fixed price and any penalty clauses relating to late completion. Recalculate the budget for the Bridgetown development to verify the accuracy of the schedule and confirm the expected loss of $150,000. Inspect report made by the architect regarding the structural improvements to verify the estimate of the additional costs. Discuss the additional costs with contractors to assess if the estimate appears reasonable. Review Bill Cos cash flow forecast to ensure adequate funds to cover the additional costs.
Chapter2 Q7: 8,IAS12 Income Taxes

Accounting issues: In the statement of profit or loss and other comprehensive income:
Sale revenue Cost of sales Gross profit Expenses Profit before tax Tax expense (@30%) Profit after tax
$ 1,000 (300) 700 (100) 600 (50) 550
You can see although tax rate is 30% but we use 30%Xprofit before tax which does not equal to 50, why? The reason being within the tax expense there are 3 components: (mnemonics: CPD) Current tax payable (based on last year taxable profit) Provision (under/(over)) Deferred tax movement
Because of permanent and temporary difference which leads to the difference in taxable profit calculation and accounting profit calculation. Permanent differences are the amounts which represent income or expense for accounting purposes but are not taxable/allowable for tax purposes. Example: client entertaining. Temporary differences are amounts which represent income or expense for accounting purposes and tax purposes but in difference periods. Example: depreciation and capital allowances. Notice: The deferred tax transfer is not cash flow!!! Before we look at deferred tax, why not start off by looking at current taxation? (this is what you have already learnt in F3, just a recap.)
Current tax:
Companies have to pay tax on taxable profits. The tax charge is normally ESTIMATED at the end of the financial year and charged to the statement of comprehensive income, and paid in the following year. The double entry for taxation would be: DR Taxation expense (Statement of comprehensive income) CR Taxation liability (Statement of financial position) The double entry for when the tax is paid a few months later: DR Taxation liability (Statement of financial position) CR Bank (Statement of financial position) Since the amount paid is likely to differ from the estimated tax charge originally recognized, a balance will be left on the taxation liability account being an under or over provision of the tax charge.
Deferred tax:
What is deferred tax? Illustrate with an example: Imagine you have a building with a carrying value of $1000. During the year you have revalued this building to $1,100 then you make a profit from it of $100 which is not realized yet. DR NCA 100 CR revaluation reserve 100 So for the tax mans perspective, because you will somehow in the future realized this profit when sold so they may require you to provide for a future tax obligation(deferred tax) of $100Xtax rate although you are not paying money now but you will in the future. Concept: So we know that deferred tax is a future obligation to be settled by company depending on the future tax law. So deferred tax does not necessarily fulfill the liability definition (present obligation). Deferred tax arises because of temporary differences (TD). Temporary difference is the difference between CV and TB. DT=TD* X CT% *TD=CV - TB TD: Temporary difference between carrying value and tax base CV: Carrying value of asset/liability. TB: tax base in the tax mans book.(in real practice we will try to refer to different tax regulations to calculate the tax base) DT: Deferred tax liability/asset CT%: Corporation tax rate
Deferred tax is a future liability recognized today. And deferred tax is based on temporary difference (timing difference between accounting and tax law). So the amount we owe to the tax authority will be finally paid back to them in the subsequent years. Typically, in P7, Deferred Tax Asset is most commonly tested. The recoverability of Deferred Tax Asset will be limited depending on the forecast profit company will make.
Audit Works: [Q11:DEC2008 Q1] Income taxes IAS 12 So we usually focus on the profit forecast, management accounts for the company performance to estimate the company future profit making ability to establish if it can utilize the deferred tax asset (unutilized losses) to set against the future profit.
Audit question: [Q11:DEC2008 Q1] IAS 12

(b) Describe the principal audit procedures to be carried out in respect of the following: (ii) The recoverability of the deferred tax asset. (4 marks)
Answer to [Q11:DEC2008 Q1] Income taxes IAS 12

(ii) Principal audit procedures recoverability of deferred tax asset Agree figures in the current and deferred tax calculation to tax correspondence. Inspect profitability forecast to agree there is enough forecast taxable profit to offset against the loss. Perform analytical procedure by evaluating assumptions used in the forecast to ensure its in line with auditors business understanding. Perform analytical procedure by assessing time taken to generate profit to recover tax losses and if it takes many years to generate such profit and the recognition of deferred tax asset would be restricted. Inspect tax correspondence to verify theres no restriction for company to carry forward and use losses against future taxable profits.
Chapter2 Q7: 9,IAS16 Property, Plant and Equipment

Accounting Issues: Initial measurement: Capital expenditure Capital expenditure is the costs of acquiring non-current assets. According to IAS 16 the following costs may be capitalised in the statement of financial position on acquisition of a non-current asset: (Mnemonic: IIIID) Initial cost (purchase price) Import duty not refundable(if asset is bought from other country) Installation costs Intended use relating costs (lawyer, surveyor costs) Delivery costs Finance cost (IAS 23 see F7 & P2) Revenue expenditure Revenue expenditure is expenditure on maintaining the capacity of noncurrent assets. Costs that are regarded as revenue expenditure should be expensed in the statement of comprehensive income and may not be capitalised according to IAS 16 are: (Mnemonic: RIM) Repairs expenses Insurance expenses Maintenance expense After weve purchased the non current asset the accountant needs to record that non current asset into the non- current asset register. A non-current asset register is generally maintained in the finance department. Companies can purchase specifically designed packages or a register can simply be maintained on an Excel spreadsheet. And this is used to reconcile the NCA in the NCA register to the individual asset in place, ie, an example of control procedure by company.
Sample of Non-current asset register:

Asset type Date purchased Description Cost Depreciation Carrying value Disposal proceeds Disposal date
Machine
1 July 2013
Drink machine
$7m $700,000 $6.3m $3m Jan-2014
Year ended 31 DEC 2013 Year ended 31 DEC 2014
Subsequent measurement Cost model: cost-accumulated depreciation*=carrying value Depreciation method should be reviewed each year to see whether or not it is reasonable. A change in depreciation method should be treated as a change in accounting estimate and prospective adjusting method according to IAS 8 should be applied. Ie, disclose the depreciation method in the note of the financial statements. Revaluation Model: revalued amount
IAS 16 the test was whether the expenditure was Capital or Revenue e.g. an improvement could be capitalised but maintenance or repair could not be capitalized. The following circumstances should be capitalized: (mnemonics: LOSE) L: Life extension O: major overhaul cost S: separate component, eg, new enguine for an aircraft E: energy saving, eg, improving production capacity
Basic idea: 1, economic benefits are excessed 2, component treated seperatly 3, major overhaul cost
Revaluation Basic Idea: As time goes by initial costs of asset may be very different from their market value. Eg, if a company purchased a property 35 years ago and therefore subsequently charged depreciation for 35 years, it would be safe to assume that the carrying value of the asset would be significantly different from todays market value. If revaluation policy per IAS 16 may be adopted (i.e. the business has a choice), and if so the following rules must be applied per the standard: (mnemonic: CRRR) 1, No Cherry picking(If a company chooses to revalue an asset they must revalue all assets in that category.) 2, Regular (Revaluations must be regular but IAS 16 doesn't specify how often) 3, Revalued amount(Subsequent depreciation must be based on the revalued amounts.) 4, Revaluation Reserve (Gains from revaluations are taken to revaluation reserve rather than retained
earnings unless they are sold)
Calculation: Revalued amount CV of asset on revaluation date Revaluation gain/(loss) $ X (X) X/(X)
DR Asset cost DR Accumulated depreciation CR Revaluation reserve
Journal (Statement of financial position) (Statement of financial position) (Statement of financial position)
Audit work: IAS16 PP&E does not test it much, but if the asset involves finance cost and then make sure its capitalized correctly. Also, if it involves impairment issue ,then make sure an impairment test is properly conducted by management. Also the discount rate used by management to determine value in use of the asset should be verified for reasonableness.
Chapter2 Q7: 10,IAS17 Leases

Accounting issues:
Introduction You want to have a photocopier and you have two choices: 1, you can buy it and then you become the owner of the photocopier; 2, you can lease it from the lessor and then you would become the lessee. Long term-finance lease Short term-operating lease
But the key to differentiate between them is not just the time length it takes but rather substance over form. IAS 17 leases describes two types (forms) of leases: *Finance lease: lease that transfers the risks and rewards of the asset from the lessor to the lessee. *Operating lease: any leases other than finance lease.
5 senarios So the substance over form concept behind it can be summarized as follows: IAS 17 prescribes there are 5 common scenarios that the lease is a finance lese. (one of them fulfilled then its a finance lease and if none of them fulfills then its an operating lease.)
1, ownership of asset has been transferred from lessor to lessee. 2, lessee has the option to purchase asset at a price which is sufficiently lower than its FV. 3, lease term is almost the same as the major part of economic life of asset. (IFRS doesn't specify the period but US GAAP has given us guidance of >75%.) 4, at the start of the lease, PV of minimum lease payment is close to FV of asset. (again, IFRS doesn't specify the percentage but US GAAP has given us a guidance of >90%.) 5, leased assets are specified nature and can only be used by lessee and they can be used by others if any significant modification to assets occurs.
Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred from the lessor to lessee then its considered to be a finance lease. So the typical risks and rewards may include: Risks: costs of repairing, maintaining and insuring the assets. Risk of obsolescence Risks of losses from idle capacity of the asset (if machine breaks down then lessee bears the loss) Rewards: Use of assets for almost all of its useful life. Use of the assets is not disrupted.
Accounting Treatment: Lessee Finance lease: Initial measurement Subsequent measurement Lessor
DR PPE CR lease liability PPE: DR I/S-depre expense CR accumulated depreciation Lease liability: DR lease liability DR I/S-finance cost CR cash
DR lease receivable CR lease asset
DR cash (from lessee) CR lease receivable CR I/S-interest income

Expense the lease revenue received on a straight line basis
Operating lease:
Expense the lease payment on a straight line basis
DR cash CR I/S
Keep the assets in FS and depreciates it.
DR I/S CR cash
DR I/S-depreciation expense CR accumulated depreciation
Sale and leaseback transaction: Idea: any abnormal gain/loss would be deferred and released back as income over the life of the lease. Accounting question: Q: Finco Ltd Finco Ltd has 4 sale and leaseback transactions during the year which can be shown as follows: Description 1, sale and finance lease back 2, sale at fair value operating lease back 3, sale at overvalue and operating lease back 4, sale at undervalue and operating lease back
Sale proceeds $m Fair value $m Book(carrying) value $m
50 80 85 65
50 80 65 85
32 55 70 60
Required: Show how to deal with the above transactions.
Audit work: 1The main piece of audit evidence is the lease agreement, as this will allow the auditor to: 1Agree the length of the lease 2Agree the lease payments 3Assess how much of the rights and obligations of ownership have been transferred. 2 For operating leases, any prepayment or accrual should be recalculated. 3 For finance leases, the present value of minimum lease payments should be recalculated and the discount rate agreed as appropriate.
[June2009Q3] leases
Audit question1: [June2009Q3] leases Robster Co is a company which manufactures tractors and other machinery to be used in the agricultural industry. You are the manager responsible for the audit of Robster Co, and you are reviewing the audit working papers for the year ended 28 February 2009. The draft financial statements show revenue of $105 million, profit before tax of $32 million, and total assets of $45 million. Two matters have been brought to your attention by the audit senior, both of which relate to assets recognised in the statement of financial position for the first time this year: Leases In July 2008, Robster Co entered into five new finance leases of land and buildings. The leases have been capitalized and the statement of financial position includes leased assets presented as non-current assets at a value of $36 million, and a total finance lease payable of $32 million presented as a non-current liability. Required: (a) In your review of the audit working papers, comment on the matters you should consider, and state the audit evidence you should expect to find in respect of: (i) the leases (8 marks)
Answer to audit question1 [June2009Q3] leases

Matters to consider Materiality The amount recognised in non-current assets accounts for 8% of total assets, and the total finance lease payable accounts for 71% of total assets so they are material to statement of financial position. Accounting treatment Whether this is finance lease or operating lease and the key is to see whether risk and reward of ownership of assets has been passed from lessor to lessee. Indicators where risks and rewards have been transferred: 1. Robster Co is responsible for repairs and maintenance of the assets 2. Robster Co can obtain this asset at nominal value at the end of asset life. 3. The lease period is almost the same as useful life of the assets 4. The present value of the minimum lease payments is amounts to most of the fair value of the asset. Finance cost associated with leases would need to be expensed to statement of profit or loss. Leased asset should be depreciated over the shorter of lease term and economic useful life of assets. The finance lease payable recognised of $32 million should be split between current and non-current liabilities in the statement of financial position. Audit evidence A review of the lease contract including consideration of the major clauses of the lease which indicate whether risk and reward has passed to Robster Co. A calculation of the present value of minimum lease payments and comparison with the fair value of the assets obtained from lease contract at the start of the lease. A recalculation of the finance charge expensed during the accounting period, and agreement of the interest rate used in the lease contract. Agreement to the cash book of amounts paid to the lessor. A recalculation of the depreciation charged, and agreement that the period used in the calculation is the shorter of the lease term and the useful life of the assets. A recalculation and confirmation of the split of the total finance lease payable between current and non-current liabilities.
Chapter2 Q7: 11,IAS 18 Revenue

Accounting issues: The recognition criteria: Stage of completion of service can be measured reliably. Involvement (theres no managerial involvement within business.) Risks and rewards have been transferred from the seller to the buyer. Reliably measure the future economic benefit. The measurement of Revenue: Revenue is measured at the fair value of consideration received or receivable, net off trading discounts and rebate allowed by the entity. Substance over form: Such as consignment stock, sometimes risks and rewards of the goods have not been transferred from the seller to the buyer. So liability and inventory may be misstated?
Audit work: Check whether risks and rewards have been transferred by inspecting customer signed contract and terms attached to it--Whether the purchaser has the right to return the goods; --Whether the seller can enforce return of the goods; --Whether the seller has full control of the goods(eg, setting the selling price.) Tips: revenue is often tested in Q1 such as audit risks, risks of material misstatement. Remember when the question shows deposit, then a liability should be recognized(because youre not providing a service right now.)
Audit questions: (IAS18 revenue recognition) Q Bluebell (DEC 2008) (IAS18 revenue recognition) Revenue comprises sales of hotel rooms, conference and meeting rooms. Revenue is recognised when a room is occupied. A 20% deposit is taken when the room is booked. Required Risk of material misstatement of the above.
Answer: 20% deposit is taken when the room is booked. According to IAS18 revenue recognition this amount should be presented as a liability on the statement of financial position. There is a risk that this amount has been recognized as a revenue and hence leads to overstatement of revenue in the statement of profit or loss and understatement of liabilities in statement of financial position.
Q Harrier (June2004) (IAS18 revenue recognition) New cars are imported, on consignment, every three months from one supplier. Harrier pays the purchase price of the cars three months after taking delivery. Harrier does not return unsold cars, although it has a legal right to do so. Required Risk of material misstatement of the above.
Answer: Harrier(consignee) would purchase the cars after 3 months after taking delivery and it doesn't return cars back to consignor. According to IAS18 revenue recognition if risks and rewards have been transferred from consignor to consignee when cars are delivered then consignee should recognize the expense and inventory in its account and here its the case. There is a risk that this is not done, ie, not DR I/S CR payable; DR inventory CR cost of sales and hence this will lead to understatement of expense and liability as well as inventory.
Chapter2 Q7: 12,IAS 19 Employee Benefit

Accounting Issues: Some companies will offer benefit to its employees. These benefits may include: 1, Short/long term and termination benefit: Accounting: DR I/S CR cash/liability Short term benefit would include: Monetary benefit: Wages and salary Paid sick leave Compensated absence. Non-monetary salary: Medical care, housing, cars etc Long term benefit would include: shares; bonus etc. Termination benefit would include: redundancy payments etc.
2, Post-employment benefit: pensions etc. 2 types: Defined contribution pension scheme: not guarantee to pay employee an amount of money when they retire. So DR I/S CR cash Defined benefit pension scheme: guarantee to pay employee an amount of money when they retire. The accounting for this is to separate assets and liabilities in the disclosure. (remain in companys account) Disclosure: Asset
b/f bal Return on asset Contributions in Benefits out Actuarial gains/losses c/f bal 97 Accounting Practise Center (A.P.C) www.accaapc.com b/f bal Interest cost Service cost Benefits out Actuarial gains/losses c/f bal
Liability
Accounting journals:
b/f bal (c/f from last year by actuary) Return on asset(discount rate X b/f) DR asset CR I/S Interest cost (discount rate X b/f): DR I/S CR liability Contributions in (company putting money in): DR asset CR cash (only cash item) Service cost (including current&past service cost: employees work for you and you have to pay for them): DR I/S CR liability Benefits out (money paid to those retired): DR liability CR asset c/f(by actuary then b/f to next year) Actuarial gains/losses: Gain: DR liability CR OCI Loss: DR OCI CR liability
By whom? The scheme surplus or deficit each year is valued by Actuary!
Audit work: 1,Perform analytical procedures on Scheme costs to verify its reasonableness. (for example, an ageing workforce may be on higher average salaries and nearer retirement, which may suggest a higher liability to the company or strong Stock Market performance may indicate that Scheme assets should have grown faster than predicted, leading to a Surplus). 2, Agree the valuation figure, eg, closing assets and liabilities to the most recent actuarial valuation. 3,Assess the reliability, experience, independence of the actuary. qualifications, experience and
4, Compare actuarys assumptions with other audit evidence (e.g. staff turnover assumptions with personnel records). 5, Inspect a list of assets form Schemes investment manager to verify the existence of assets. 6, Recalculate the pension expense recorded in the statement of profit or loss to verify its accuracy.
Audit question (June2012 Q5(b)) IAS19 Snipe Co has in place a defined benefit pension plan for its employees. An actuarial valuation on 31 January 2012 indicated that the plan is in deficit by $105 million. The draft financial statements recognise revenue of $85 million, profit before tax of $1 million, and total assets of $175 million The deficit is not recognised in the statement of financial position. An extract from the draft audit report is given below: Auditors opinion In our opinion, because of the significance of the matter discussed below, the financial statements do not give a true and fair view of the financial position of Snipe Co as at 31 January 2012, and of its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards. Explanation of adverse opinion in relation to pension The financial statements do not include the companys pension plan. This deliberate omission contravenes accepted accounting practice and means that the accounts are not properly prepared. Required: Critically appraise the extract from the proposed audit report of Snipe Co for the year ended 31 January 2012. (7 marks)
Answer: (only 7 points required) Basis of opinion paragraph: Any qualified audit opinion is given then a basis of qualification opinion paragraph should be placed before the actual opinion paragraph. In this case its adverse opinion so basis for adverse opinion should be placed before the actual opinion paragraph. In the basis of opinion paragraph the $10.5m of defined benefit pension plan should be quantified. And auditor needs to state whether this $10.5m would be material to the financial statement. In the basis of opinion paragraph this auditor should state whether this $10.5m would be a deficit or surplus. Also auditor needs to state if the deficit has been recognized then liabilities would increase by $10.5m and equity would decrease by $10.5m. Auditor needs to consider whether other accounting entries have been omitted as well such as service cost, gain on asset, finance costs, actuarial gains and losses because these would impact on the statement of profit or loss as well. There should be reference to IAS19 employee benefit to tell users that this standard has been breached. The word deliberate is not professional and auditor should use The plan may have been omitted in error and an adjustment to the financial statements may have been suggested by the audit firm and is being considered by management. Qualified opinion paragraph Because the deficit of $10.5m only represents 6% of total asset and its material to the financial statement but not pervasive so an adverse opinion would not be correct and auditor should issue an except for qualification opinion due to material misstatement in the financial statement.
Chapter2 Q7: 13,IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
Accounting Issues: What is government grant? Government grant is the cash or asset given by government to help company if it fulfills the conditions set by government. This may be categorized as: Capital grants- grants which are made to contribute towards the acquisition of asset Revenue grants- grants which are made for other purposes like paying wages. When recognized? A grant can be recognized in the FS when: 1, entity complies with the condition set by government 2, the grants will be received. Usually we will use the deferred income method to reverse the deferred income over the useful life of asset. And this is based on Accrual concept or Matching principle.
Disclosure:
Accounting policy adopted, including method of presentation(net off or separate method?) Nature and extent of government grants recognised and other forms of assistance received (eg, buy a machine?) Unfulfilled conditions and other contingencies attached to recognised government assistance (eg, repayment?)
Accounting treatment: Step1: Treat the grant separately DR cash CR deferred income Step2: Release deferred income matched with depreciation expense of asset: DR deferred income (over life of asset) CR I/S(revenue)
Audit work:
Inspect the grant agreement to verify: -What is the grant for -The total amount of the grant -The conditions under which it would have to be repaid. Inspect cashbook and bank statements to verify receipt of the grant. Inspect Board Minutes to assess whether company has done anything (or is about to do anything) that might make the grant repayable. Recalculate any release of deferred grant income to ensure it matches with the related expense.
Audit Question [june2010 Q1 (c)(ii)] IAS 20

Hodges Co This companys operations involve the manufacture and distribution of packaged nuts and dried fruit. The government paid a grant in November 2009 to Hodges Co, to assist with costs associated with installing new, environmentally friendly, packing lines in its factories. The packing lines must reduce energy use by 25% as part of the conditions of the grant, and they began operating in February 2010. (c) Recommend the principal audit procedures that should be performed on: (ii) The condition attached to the grant received by Hodges Co. (4 marks)
Answer to[june2010 Q1 (c)(ii)]: (only 4points required) 1. Inspect the grant agreement to verify: -The conditions of 25% reduction in energy use is stated. - Financial impact if company is to repay the grant and determine whether company would pay in part or in full.
2. Inspect Board Minutes about whether management has put procedures regarding energy saving into place to assess whether company has done anything (or is about to do anything) that might make the grant repayable. 3. Enquire with management about how energy efficiency is monitored to verify whether condition has been breached by company. 4. Enquire with employees about their views on how well the packing lines are performing to verify whether condition has or would be breached by company.
Chapter2 Q7: 14,IAS 21 The effects of Changes in Foreign Exchange Rates

Accounting issues: This deals with 2 issues: (i) foreign transaction: When you purchase/sell goods from/to other company in other countries Step1: You need to firstly translate this transaction in functional currency at spot rate. Step2: You need to retranslate the monetary item (Bank, receivable, payable,NCL,CL) at the year end and leave non-monetary items(NCA, CA). How to determine your functional currency? Mainly this is the currency that when youre trying to prepare your trial balance.
(ii) foreign subsidiary Statement of financial position: closing rate Statement of comprehensive income: average rate To group company: Exchange differences on the subsidiary are taken to Equity. In the SFP: Reserves In the statement of profit or loss and other comprehensive income: other comprehensive income To single company: Exchange differences are taken to statement of profit or loss.
Audit works: 1, Agree the exchange rates used for all retranslation against published rates. 2, Inspect exchange differences have been recognized in the correct place (statement of profit or loss or Equity as appropriate).
Audit question: Grissom Co (June2010 Q1 extract) Brass Co This company is a new and significant acquisition, purchased in January 2010. It is located overseas, in Chocland, a developing country, and has been purchased to supply cocoa beans, a major ingredient for the goods produced by Willows Co. The company uses local currency to measure and present its financial statements. Required: Risk of material misstatement of the above.
Answer: Company financial statements are denominated in different currencies. 1. According to IAS21 The Effects of Changes in Foreign Exchange Rates before consolidation, assets, liabilities, should be retranslated using closing exchange rate but for income and expense they should be retranslated using average rate. There is a risk that company has used the wrong rate to translate the above resulting in misstatement of assets, liabilities, income and expense. 2. Gains or losses relating to retranslation should be recognized in equity or other comprehensive income. There is a risk that gains or losses have been recorded in the statement of profit or loss leading to misstatement in profit or loss and equity. 3. cost of investment should be retranslated using the closing year end rate and gains or losses should be taken into equity. There is a risk that this is not done resulting misstatement of goodwill figure.
Chapter2 Q7: 15,IAS 23 Borrowing Costs

Accounting issues: IAS 23 borrowing costs specifies that in some circumstances that these interest expense can be capitalised as cost to the building. 1, it should be a qualifying asset: the asset takes a substantial period of time to get ready for its intended use or sale.
Example: *Inventories that require a substantial period of time to bring them to a saleable condition, eg, a big ship *Manufacturing plants *Power generation facilities *Investment properties
2, The amount to capitalise? Borrowing costs temporary investement income General funds raised not specific for the asset? (use weighted average borrowing costXasset value) 3, when to capitalise? Start capititalisation: Later of ABB(mncmonic) A: activity begins (start building) B:Borrowing costs incurred (take loan) B: Buy something(buy the land) Pause to be capitalised When the activity is disruppted, eg, strike Ceased to be capitalised When the asset is intented for use not necessarily actually for use.
Disclosure: Amount of borrowing cost capitalised during the period Capitalisation rate used
Audit work: Obtain breakdown of borrowing costs and recalculate them to verify its accuracy.
Agree interest payments to bank statements and cash book. Agree interest payments to loan documentation.
Inspect the loan agreement to verify whether this loan is directly attributable to the asset and if not average rate may be used.
Audit question:[june2012 Q5] IAS23 Borrowing cost

You are the partner responsible for performing an engagement quality control review on the audit of Snipe Co. You are currently reviewing the audit working papers and draft audit report on the financial statements of Snipe Co for the year ended 31 January 2012. The draft financial statements recognise revenue of $85 million, profit before tax of $1 million, and total assets of $175 million. (a) During the year Snipe Cos factory was extended by the self-construction of a new processing area, at a total cost of $5 million. Included in the costs capitalised are borrowing costs of $100,000, incurred during the six-month period of construction. A loan of $4 million carrying an interest rate of 5% was taken out in respect of the construction on 1 March 2011, when construction started. The new processing area was ready for use on 1 September 2011, and began to be used on 1 December 2011. Its estimated useful life is 15 years. Required: In respect of your file review of non-current assets: Comment on the matters that should be considered, and the evidence you would expect to find regarding the new processing area. (8 marks)
Answer: (a) Matters to be considered Materiality The total cost of the new processing area of $5 million represents 29% of total assets and is material to the statement of financial position. The borrowing costs are not material to the statement of financial position, representing less than 1% of total assets; But they are material to profit because it represents 10% of profit before tax.
Accounting According to IAS23 the borrowing costs should be capitalized if its a qualifying asset and the period to capitalize would be during the period of construction and when construction is substantially completed then it should be ceased to be capitalized. New processing area was ready for use on 1 September, so capitalisation of borrowing costs should have ceased at that point. It seems that the borrowing costs have been appropriately capitalised at $100,000 ($4m x 5% x 6/12). There should therefore be five months depreciation included in profit for the year ended 31 January 2012, amounting to $138,889 ($5m/15 years x 5/12).
Evidence A breakdown of the components of the $49 million capitalised costs (excluding $100,000 borrowing costs) reviewed to ensure all items are correct for capitalisation. A copy of the approved budget or capital expenditure plan for the extension. An original copy of the loan agreement, confirming the amount borrowed and the interest rate. Recalculation of the borrowing cost, depreciation charge and agree of all figures to the draft financial statements.
Chapter2 Q7: 16,IAS 24 Related Party Transactions

Accounting issues: Definition: Parties are related if one party has control or significant influence over the other party.
Scenario: If A controls(>50%) or joint controls(=50%) B and have significant influence over C then A&B are related parties, A&C are related parties as well. Also B&C are related parties because A could have power to force one sub to do something against another. If A have significant influence over B&C then A&B, A&C are related parties but B&C are not related parties because A cant control over B or C to do something. If a person has significant influence or control over A then this person&A are related parties. (particularly if this person is a member of the key management team in A or close family) IAS 24 states there are particularly some situations which may be related parties transactions: Associate and subsidiary Key management Post-employment benefit: pension plan Close family Related party transactions are transactions between related parties. So what should we disclose under IAS 24 related party disclosures?
Transaction: purchase/sale of goods? Parties: X Company; Y Company. Relationship: eg, parent and subsidiary Value: $
Date
Audit work: 1, To find out who are the related parties: -Inspect shareholder register -Inspect Board Minutes for evidence of directors raising related party issues -Inspect prior year related party disclosures 2, Inspect abnormal contract to identify: -At a price other than market price -At an odd time -Between 2 companies who have no obvious reason to do business -Lacking in overall business logic. 3, Inspect the disclosure relating to related parties transactions to ensure the following details have been disclosed:
Transaction:.. Parties. Relationship. Value.
Date
Audit question:[Q15june2008 Q3]related party transactions

3 (a) Discuss why the identification of related parties, and material related party transactions, can be difficult for auditors. (5 marks) You are an audit manager responsible for providing hot reviews on selected audit clients within your firm of Chartered Certified Accountants. You are currently reviewing the audit working papers for Pulp Co, a long standing audit client, for the year ended 31 January 2008. The draft statement of financial position (balance sheet) of Pulp Co shows total assets of $12 million (2007 $115 million).The audit senior has made the following comment in a summary of issues for your review: Pulp Cos statement of financial position (balance sheet) shows a receivable classified as a current asset with a value of $25,000. The only audit evidence we have requested and obtained is a management representation stating the following: (1) that the amount is owed to Pulp Co from Jarvis Co, (2) that Jarvis Co is controlled by Pulp Cos chairman, Peter Sheffield, and (3) that the balance is likely to be received six months after Pulp Cos year end. The receivable was also outstanding at the last year end when an identical management representation was provided, and our working papers noted that because the balance was immaterial no further work was considered necessary. No disclosure has been made in the financial statements regarding the balance. Jarvis Co is not audited by our firm and we have verified that Pulp Co does not own any shares in Jarvis Co. Required: (b) In relation to the receivable recognised on the statement of financial position (balance sheet) of Pulp Co as at 31 January 2008: (i) Comment on the matters you should consider. (5 marks) (ii) Recommend further audit procedures that should be carried out. (4 marks) (c) Discuss the quality control issues raised by the audit seniors comments. (3 marks) (17 marks)
Answer to june2008 Q3: (a) Definition Related party transaction is difficult to define. Ie transactions between parties related by control or influence are disclosed. But its difficult to define control or influence in the real life. Accounting system Its difficult to separate related party transactions from other transactions unless management has classify the related party sales into other categories of sales. Disclosure Disclosure of related party transactions may be reluctant by management because its confined to management. Apply Its difficult to apply materiality concept because some of the related party transactions are not material by amount and auditors may not spot this during the audit. Concealment Business may conceal related party transaction in order to cover up the fraud so auditor may find it harder to reveal these transactions.
(b) (i) Matters to consider: Accounting standards According to IAS24 related party transactions only two senaior persons in two different companies are not related parties unless one has significant influcen or control over another. In the working paper because Javis company is controlled by Pulbs chairman so transaction between the two would be related party transaction The receivable balance has been over 1 year and current assets are within 1 year and so management should consider the recoverability of this receivable and write off as a bad debt expense. Maybe its because the management is going to window dress the financial statement because by classifying the non current assets into current assets this would make liquidity position of company look better. Materiality $25,000 is not material by amount but its related part transaction so its material bby nature. Audit report implication The classification of the receivable would constitute a material misstatement. The lack of disclosure of related party transaction would constitute a material misstatement so if these are not adjusted then auditor should issue an except for qualification of audit opinion. (ii) Inspect management representation about parties involved in the transactions. Enquire with management about the transaction to verify its in line with auditors business common sense, eg, should this be classified as receivable or long term investment. Inspect the invoices relating to the transaction noticing if value of transaction is significantly lower than the market rate. Inspect the invoices relating to the transaction noticing if the date of transaction is odd.
Auditors can perform analytical procedure by performing a liquidity analysis of company and if it suggests that the liquidity position of company is poor then it is running a risk that management would like to manipulate the financial position, ie, window dress the liquidity position of company. (c) Because they failed to spot weakness of management representation and it implies there was an inadequate independent review of work done last year. There is no disclosure has been made to related party transaction this implies theres a poor planning meeting of audit has been held. The delegation of task is not based on knowledge and experience because the high risk area has been delegated to the audit senior who may lack of experience to do so.
Chapter2 Q7: 17,IAS28 Investments in Associates

Accounting issues: The investor will have significant influence if he has invested 20%-50% of shares in another company (associate).
The significant influence is the power to participate into the decision making process of the company. The 20%-50% is just a subjective test and in reality even if company fails this test, maybe it is still having/ having no significant influence over another company:
-if you have 19% shares of another company but there are remaining shareholdings around from 0.5%-1% and if this is the case, you have significant power to participate into the decision making process regardless of the failure of the test. -If you have 25% shares of another company but theres a very big shareholder
who is holding 70% of shares in the company and in this case you are too small and even though you comply with the test(20%-50%) but you have no significant influence.
How to account for an associate: (Cost + Growth) [Equity Accounting] $ X X X
Investment at cost +group share of post-acquisition of associate (Growth) Investment in associate for CSOFP Presentation in CSOFP: Non-current assets Property, plant and equipment Goodwill Investment in associate Presentation in CSOCI:
Parent Gross profit Expenses Profit in Associate (45% of associate profit after tax) Profit before tax
X X X
Subsidiary
Adjustments
Group
X (X) X X
X (X) X
X (X) X
Audit work: Inspect share certificate to verify the % of shares owned by company. Inspect directors register and contract to verify their power to affect policy making decisions.
Audit Question [June2010 Q1] IAS28

Grissom Co This is a non-trading parent company, which wholly owns three subsidiaries Willows Co, Hodges Co and Brass Co, all of which are involved with the core manufacturing and marketing operations of the group. This year, the directors decided to diversify the groups activities in order to reduce risk exposure. Non-controlling interests representing long-term investments have been made in two companies an internet-based travel agent, and a chain of pet shops. In the consolidated statement of financial position, these investments are accounted for as associates, as Grissom Co is able to exert significant influence over the companies.
Required:
Evaluate the principal audit risks to be considered in your planning of the final audit of the consolidated financial statements for the year ending 30 June 2010.
Answer to [june2010 Q1] IAS28

Grissom Co Non-controlling interests Two companies have been accounted for as associate. According to IAS 28 investment in associate if Grissom co can demonstrate it has significant influence over those two companies then they should be accounted for as associate using equity method otherwise they should be accounted for as simple investments. There is a risk that Grissom Co has wrongly classified those companies as associate but rather they should be simple investment resulting in non-current assets being misstated and profit being overstated because income from associate is recognized.
Chapter2 Q7: 18, Financial instruments IAS32,37,39 IFRS9

Accounting issues: Financial instrument : Any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial asset: This is a contract if a party is holding then it can give benefit to the holder. Financial liability: This is a contract if a party is holding then it will deliver cash to other party or cost us something when exchanging financial instrument. Eg, Debt; redeemable preference shares. Equity instrument Something not for cash or any other assets but they are settled in shares. Eg, Shares; irredeemable preference shares. Summary: Financial assets Examples Initial recognition Initial measurement Subsequent measurement* Become party to contract Price-discount-issue cost Based on 2 tests Based on intention Financial liabilities/ Equity instrument
*Subsequent measurement: Financial assets Debt Amortized cost FVTPL FVTOCI Business model test(hold not sell) CCC test (simple cash flow) All others No Equity No Held for trading Not held for trading* Financial liabilities Debt/Equity All others Held for trading no
Note: *If the equity is not for trading then at initial recognition company can make an irrecoverable election that classifies this under FVTOCI only with dividend income in P/L. And this is sometimes known as strategic equity-buying shares
in order to acquire the entire company in the future. *Financial asset tests:
Business model test

(Hold it till maturity?)
NO
FVTPL
yes
Contractual cash flow characteristic(CCC) test (does debt contain principle and interest only?)
yes
NO
Amortized Cost
Financial liability test (base on intention)
Intention
Keep
Amortized Cost
Trade
FV
Accounting Treatment: 1, Financial Asset Amortized cost Years Opening balance Interest (at effective interest rate)
DR financial asset CR I/S(interest receivable)
Outstanding
Installment (repayment)
Closing balance
DR cash CR financial asset
FVTPL Gains/losses goes into I/S.
2, Financial liability(not held for trading) Amortized cost (OIOIC) Years Opening balance Interest (at effective interest rate)
DR I/S(interest payable) CR financial liability
Outstanding
Installment (payment)
Closing balance
DR financial liability CR cash
Compound financial instrument (IAS 32) Convertible debt Treatment:

Inception:
Debt element
Convertible debt
: PV of future cash flow (use effective interest rate on comparable bond if theres no conversion)
conversion
Equity element
: value of the future As a balancing figure Or (total value-debt-issue costs from debt + equity pro-rata)
Subsequent: Debt element using amortized cost.
Financial instrument impairment (IAS 39)

Under IAS 39, impairment of financial instrument applies to financial assets carried at amortized cost. What we do is to look for indicators of impairment. If theres Objective evidence that event has occurred(not happen in the future); The impairment expense can be estimated reliably. Then we should recognize an impairment loss to the I/S.
Disclosure about financial instrument (IFRS 7)

We are required to disclose (significance and risks) 1, Information about significance of financial instrument; SOFP: Financial performance and position for each class financial instrument I/S: Separate disclosures for each class of financial instrument; If financial instrument is not carried at FVTPL then disclose interest expense on that; Disclose any impairment losses. Other information: Information about the nature of financial instrument in detail; Accounting policy of how to treat those financial instrument; Fair value of financial instrument(IFRS 13): how to determine and its value; Its cash flow relating to the financial instrument.
2, Information about risks of financial instrument. Qualitative of risks: Risk exposure- risks included and what would happen? Risk management-how to manage the risks? Quantitative of risks: Data about exposure Credit risk-collateral and the quality of it Liquidity risk-how to manage this risk?(risk of default on payment of interest?) Market risks-market prices change? (fair value changes?)
Audit work: Perform analytical procedures by assessing valuation model used to verify its reasonableness. Inspect disclosures about each financial instrument such as market risk disclosure about changes in fair value to verify its completeness. Agree value of financial instrument to specialist working papers. Inspect financial instrument contract to verify its in line with auditors business understanding. Perform analytical procedures relating to experience, reputation and the way experts determine the value for financial instrument to ensure they are competent to do the work.
Audit question [Q17] IAS32,39 IFRS7 To help cash flows in a year of expansion, the company raised finance by issuing debentures which are potentially convertible into equity on maturity in 2015. To manage the risk associated with overseas expansion, in October 2009, the company entered for the first time into several forward exchange contracts which end in February 2010. The contracts were acquired at no cost to Papaya Co and are categorised as financial assets at fair value.
Required: Assess the risks of material misstatement to be addressed when planning the final audit for the year ending 31 December 2009.
Answer: 1. Debentures: Company has convertible debentures. According to IAS 32 financial instruments at the inception of the convertible debenture, it should be split between debt and equity element. The debt element would be the present value of future cash flow and equity element would be the balancing figure. There is a risk that a spit is not done properly resulting in misstatement in the debt and equity element and profit in statement of profit or loss because of the misstatement in finance cost.
2. Forward contracts: This is as financial assets at fair value through profit or loss. According to IFRS9 financial instrument this should be recognized at fair value. There is a risk that this transaction is not recognized at all or they might be measured wrongly resulting in assets or liabilities in the statement of financial position, income/expense in the statement of profit or loss being misstated. According to IFRS 7 financial instruments disclosures about the significance and risks relating to forward contract must be made. There is a risk of under disclosure per IFRS7 as well.
Audit question:[DEC2011 Q3(b)] Financial instruments(relating to 3rd party work)

Spruce Co Spruce Co is also involved in energy production. It has a trading division which manages a portfolio of complex financial instruments such as derivatives. The portfolio is material to the financial statements. Due to the specialist nature of these financial instruments, an auditors expert was engaged to assist in obtaining sufficient appropriate audit evidence relating to the fair value of the financial instruments. The objectivity, capabilities and competence of the expert were confirmed prior to their engagement. Required: Explain the procedures that should be performed in evaluating the adequacy of the auditors experts work. (5 marks)
Answer to DEC2011 Q3(b): Review the auditors experts working papers and reports to ensure that the work meets the objectives of the audit. Evaluate the appropriateness of models used by the expert to determine fair value. Compare the findings of the expert with results produced by management, eg compare the fair values determined by the expert with those determined by management. Reperform any calculations contained in the experts working papers, eg recalculate movements in fair value on the derivatives. Agree figures used in calculations to supporting documentation, eg contracts relating to derivative financial instruments.
Chapter2 Q7: 19,IAS33 Earnings Per share

Accounting issues: Earnings per share(EPS) is important because its one of the ratios to measure public companys profitability. EPS means how much earnings that a share of company may earn. If EPS=10, this means that for every share within a company then it can earn $10. EPS is very easy to be understood by non-financial investors and its very simple as well. The next question is how we can calculate EPS? Basic EPS is calculated as: PAT-irredeemable preference share dividend* Weighted average number of ordinary shares * irredeemable preference share dividend means dividend in this year only not cumulative figure. When trying to calculate basic EPS you should be aware of any changes in capital structures, eg, bonus issue and right issue. Say if a bonus issue happens in the middle of the year then the EPS would fall in the second half of the year because of an increase in number of shares but no increase in profit. So its unfair on EPS in the year it happens so we should then pretend the bonus issue happened ALL this year and ALL last year. Same as right issue. Say if a right issue happens in the middle of the year then EPS would fall in the second half of the year because of an increase in number of shares but theres not an increase in profit as it should have been because we know the right issue is the issue of shares at a discount hence it will decrease its profit a little bit so EPS may fall. So its unfair on EPS in the year it happens so we should then pretend the bonus issue happened ALL this year and ALL last year. So how can we pretend to do this? Well, we calculate Bonus Fraction for this year and Inverted Bonus Fraction for last year. The key to this is to make information comparable. Bonus Fraction for Bonus issue: Shares we have Shares we had Bonus Fraction for right issue: MV TERP
But basic EPS does not consider when a company may try to issue some convertible loan notes where an investor may convert this into shares and hence increase the number of shares in the future and also company may save interest expenses as well. Also this does not consider when a company gives out share options then at some point in the future when an investor takes up the share options which may increase the number of shares in the future. In order to address this problem, we need to calculate diluted EPS. Comparable with basic EPS. Diluted EPS is to show to shareholders that the EPS of the company may fall in the future. There are two clues we can find this: convertible loan and share options. Diluted EPS is calculated as: Basic EPS+ interest saved on convertible loan note Number of ordinary shares+ new shares converted or taken up
Since we know how to calculate the basic and diluted EPS, the next question is Is EPS flawless? Well, the answer is certainly NO! There are some limitations I would like to discuss with you. 1, We cant compare the EPS companies to companies because they have different accounting policies, estimates which may result in different profit figure and also different capital structure changes during the year resulting in different number of shares as well. 2, EPS is based on profit so you can argue that it may be subject to manipulation by company by just manipulating the accounting policy and estimates. 3, EPS is based on past information not the future one. 4, If you look at the denominator you will find the number of shares can be manipulated as well if a company has got loads of cash in the year and then the company can buy back shares in the share market which means the shares falls and hence EPS may increases as a result. 5, Although company calculates diluted EPS to give a sign for potential impact in the future resulting from certain activities to the users but its calculation is based on current earnings so to a certain extent its not a reliable measure for
users as well. Listed companies must, on the face of the Income Statement present: Basic EPS Diluted EPS.
Audit work: 1 Recalculate basic EPS and diluted EPS. 2 Ensure any necessary restatements of prior year EPS have been done, and suitably disclosed.
Audit question [june2009 Q5 Pluto] IAS 33: (Ajusted) You are the partner responsible for performing an engagement quality control review on the audit of Pluto Co, a listed company. You are currently reviewing the engagement partners proposed audit report on the financial statements of Pluto Co for the year ended 31 March 2009. During the year the company has undergone significant reorganization, involving the discontinuance of two major business segments. Extracts of the proposed audit report are shown below: Emphasis of matter paragraph The directors have decided not to disclose the Earnings per Share for 2009, as they feel that the figure is materially distorted by significant discontinued operations in the year. Our opinion is not qualified in respect of this matter. Required:
1, Does Pluto Do something wrong? 2, Is it correct to quote a breach in IAS33 EPS in the emphasis of matter paragraph?
Answer: 1. yes it has done something wrong because for listed companies EPS, Diluted EPS and its comparatives should be disclosed in the note of the financial statement to make information comparable. 2. no its not correct because auditor would include significant uncertainty about going concern status of the company in the emphasis of matter paragraph and a failure to disclose the PES, diluted EPS and its comparatives would just be a material misstatement and its nothing to do with significant uncertainty about going concern status of Pluto.
Chapter2 Q7: 21,IAS 36 Impairment of Assets

Accounting issues: Impairment means decrease. According to prudence concept we cannot overstate the asset value. And in order to ensure that amount is prudent we can use a test called impairment test. The question is when do we do the impairment test and how can we do impairment test? When there are Indications of impairment at the reporting date Internal:
-Asset obsolete or damage; -Operating losses for the current period; -Loss of key employees; -Reconstructions.
External:
-Adverse change in the commercial environment(decrease demand for the asset)
To determine value in use of the asset we calculate the present value of the future cash flow relating to this asset. And the discount rate used would be depend on companys industry specific knowledge, like using weighted average cost of capital or project specific discount rate etc. To determine the net realizable value we take fair value(selling price)-costs to sell this asset. And the higher of the above two would be the recoverable amount. Impairment reversal: We need to reverse the revaluation reserve we have recognized first and the remaining amount would be the impairment expenses.
Audit work: Inspect a copy of correspondence to verify impairment indicator exists. Inspect asset condition to determine whether it would need further impairment. Enquire with management to verify their Future intentions to use or to sell the asset and this forms a basis for recoverable amount. Inspect management representation that an impairment test has been carried out. Inspect draft sales agreements for impairment review evidence. Inspect cash flow projections relating to value in use. Inspect management account after the reporting date of company results to confirm an impairment review is necessary. (for CGU) Review managements impairment review to establish the reasonableness of value in use by examining its discount factor used. Review managements impairment review to establish the reasonableness of the assumption regarding the future cash inflow, ie, in line with sales revenue growth.
Audit question: [Q] impairment IAS36 You are the manager responsible for the audit of Aspersion, a limited liability company, which mainly provides national cargo services with a small fleet of aircraft. The draft accounts for the year ended 30 September 2008 show profit before taxation of $2.7 million (2007 $2.2 million) and total assets of $10.4 million (2007 $9.8 million). (b) Aspersion owns two light aircraft which were purchased in 2005 to provide business passenger flights to a small island under a three year service contract. It is now known that the contract will not be renewed when it expires at the end of March 2009. The aircraft, which cost $450,000 each, are being depreciated over fifteen years. (7 marks) Required: comment on the matters that you would consider and the audit evidence you should find.
Answer: (only 7 points required)

(i)Matters to consider:
Materiality The depreciated value of aircraft is $720,000($900,000/15 X3) and its 7% of total assets and its material to the statement fo financial position. Accounting According to IAS36 impairment of assets an impairment test would be carried out if theres indicator that asset would be impaired. And here for Aspersion because the contract would not be renewed any more so this would be impairment indicator. Management should carry out an impairment test comparing carrying value of asset with its recoverable amount and the recoverable amount would be determined using the higher of value in use and net realizable value of the asset. If an impairment loss is recognized auditor would need to determine whether it would be material to the financial statement by calculating its materiality.
Audit report implication
If the impairment loss is material to financial statement and hasn't been recognized by management or has been recognized wrongly then auditor would need to qualify their audit opinion with an except for due to material misstatement.
(ii)Audit evidence
A copy of the service contract and any correspondence to verify contract would not be renewed. Aircraft inspection result to ascertain its condition and determine whether it would need further impairment. Notes of enquiries of management to verify their Future intentions to use or to sell the asset and this forms a basis for recoverable amount. Management representation that an impairment test has been carried out. Draft sales agreements for impairment review evidence. Cash flow projections relating to value in use.
Audit question [DEC2010 Q3 Clooney]impairment IAS36 Clooney Co is one of the worlds leading leisure travel providers, operating under several brand names to sell package holidays. The company catered for more than 10 million customers in the last 12 months. Draft figures for the year ended 30 September 2010 show revenue of $3,200 million, profit before tax of $150 million, and total assets of $4,100 million. Clooney Cos executives earn a bonus based on the profit before tax of the company. You are the manager responsible for the audit of Clooney Co. The final audit is nearing completion, and the following points have been noted by the audit senior for your attention: One part of the companys activities, operating under the Shellys Cruises brand, provides cruise holidays. Due to economic recession, the revenue of the Shellys Cruises business segment has fallen by 25% this year, and profit before tax has fallen by 35%. Shellys Cruises contributed $640 million to total revenue in the year to 30 September 2010, and has identifiable assets of $235 million, including several large cruise liners. The Shellys Cruises brand is not recognized as an intangible asset, as it has been internally generated. Required: Comment on the matters that you should consider, and state the audit evidence you should expect to find in your review of the audit working papers for the year ended September 2010 in respect of: Shellys Cruises (7 marks)
Answer to DEC2010 Q3(b) Matters to be considered Accounting According to IAS36 impairment of assets theres an indicator suggesting the brand would be impaired, ie, due to economic recession. So an impairment review should be performed by management by comparing carrying value of brand and recoverable amount from the higher of value in use and fair value minus costs to sell. Materiality It accounts for 20% of revenue($640m/43200m) and 5.7% of total assets ($235m/$4,100m) and so its material to statement of profit or loss and statement of financial position. Audit report implication If the impairment test is not done by management then auditors should issue an except for qualification regarding this. (ii) Evidence Review management account after the reporting date of Shelly company detailing the performance of Shelly to confirm an impairment review is necessary. Obtain a management representation stating performance of Shelly is bad impairment review has been done. Review managements impairment review to establish the reasonableness of value in use by examining its discount factor used. Review managements impairment review to establish the reasonableness of the assumption regarding the future cash inflow, ie, in line with sales revenue growth.
Chapter2 Q7: 22,IAS 37 Provisions, Contingent liabilities and Contingent Assets

Accounting Issues:
1, Provision:
A provision is an uncertain future obligation that the business may or may not have to settle. You can only recognize the provision if these 3 criteria are met: (mnemonics: POR) P: probable that resources will be transferred to settle the liability(asset/other resources); O: present obligation whether its legal (law) or constructive (published information) from past event; R: reliable estimate of the amount of payment can be made. Double entry: DR Relevant expense a/c CR Provision
(Statement of comprehensive income) (Statement of financial position)
Disclosure: (to show how the opening provision may be reconciled to the closing provision) Opening provision Provision Closing provision $55m $20m $75m
2, contingent liabilities
A contingent liability exists when: Situation1: A possible obligation that arises from past events and existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Situation2: A present obligation that arises from past events but it fails criteria P and R (above) of a provision. Disclosure: 1, nature of contingent liability 2, likely financial effect 3, uncertainty of the amount and timing
3, contingent assets
A contingent asset arises from probable future income. Situation: It is a probable/possible asset that arises from past events whose existence in confirmed by the occurrence or non occurrence of uncertain future events not wholly within the control of the entity. If it becomes virtually certain(>95%) that the company can receive the asset rather than just a contingent asset so that they can recognize the asset in the financial statements rather than disclose it. Disclosure: (when its probable) 1, nature of contingent liability 2, likely financial effect To sum up: Liability (outflow) Asset (inflow) Disclose Ignore Ignore
Probable(>50%) Possible(20%-50%) Remote(<20%) Audit work:
Provide (provision) Disclose Ignore
1. Use general analytical procedures to compare provision recorded year on year to verify its reasonableness. 2. Use CCTRAIN Claims- correspondence with customer obligation Correspondence -with layer-determine whether provision, contingent liability would be needed. Terms of contractcompanys obligation Representation/recalculate provision-there are no further expenses needed to provide for-determine the exact amount of expenses and liability. Insurance companyto verify if any reimbursement can be obtained by company and this will form the basis for the amount recognized as liability. News-obligation
Audit question [ DEC2007 Q1(b)] provision

One customer, Sawyer Co, communicated in November 2007, via its lawyers with Island Co, claiming damages for injuries suffered by a drilling machine operator whose arm was severely injured when a machine malfunctioned. Kate Shannon, the chief executive officer of Island Co, has told you that the claim is being ignored as it is generally known that Sawyer Co has a poor health and safety record, and thus the accident was their fault. Two orders which were placed by Sawyer Co in October 2007 have been cancelled. All machines are supplied carrying a one year warranty. A warranty provision is recognised on the balance sheet at $25 million (2006 $24 million). Kate Shannon estimates the cost of repairing defective machinery reported by customers, and this estimate forms the basis of the provision.
Required:
Explain the principal audit procedures to be performed during the final audit in respect of the estimated warranty provision in the balance sheet of Island Co as at 30 November 2007. (5 marks)
Answer to [DEC2007 Q1(b)] provision

Inspect correspondence with customer to understand the claims made by them at the year end. Inspect correspondence with lawyer to determine the possibility that company can win the case if customers sue the company and this will form the basis for company to recognize a provision or disclose as a contingent liability. Inspect the terms of contract to understand the obligation of Island Co. Recalculate the warranty provision. Inspect the written representation that there are no further repairmen of assets apart from $2.5m in the statement of financial position to determine there are no other provision needs to be provided for or contingent liability disclosed. Enquire with management to determine advice given by company and if company said they would bear the compensation costs then this would help determining the full provision amounts to be provided for or contingent liability amount to be disclosed. Inspect insurance contract to determine whether company can get compensation reimbursement from insurance company and if yes then this would reduce the liability that company needs to provide for. Inspect the news regarding this claim by customer to determine companys liability regarding this issue. General Analytical procedures: Perform analytical procedures to compare the level of warranty provision year on year to verify its reasonableness. Perform analytical procedures to verify assumptions used are consistent with the auditors understanding of the business
Chapter2 Q7: 23,IAS38 Intangible Assets

Accounting issues: Intangible assets are something you cant touch, ie, without physical substance. Things like Goodwill, Patents, Brands / trademarks, Copyrights and customer lists etc. You can recognize the intangible assets as a non-current asset in the SOFP if they are externally generated, ie, you purchase them and they have a fair value for this. You cannot recognize the intangible assets as a non-current asset in the SOFP if they are internally generated, ie, you cant reliably measure their value is because even though they engage an expert to put a value onto the asset but everybody has different opinion on the assets as well. An exception for this is the development costs.* Initial recognition: Identifiable: You purchase it and youve got a contract. Asset definition: Control by company- for human assets which are not controllable by business. Also its probable that future economic benefit will flow into entity. Cost: Can be reliably measured.
Subsequent measurement: Amortize it over its useful life using straight line method. Double entry: DR Amortisation expense (Statement of comprehensive income) CR Accumulated amortisation (Statement of financial position)
*Exception Research and development costs (R&D) Research expenses: this means that you search for the internet and other information to see whether the plan is workable. So it should be expensed to I/S not capitalize as asset because its not probable that this can help company generate into future economic benefit. Development costs: when company sees that the plan is workable then it starts to invest money into developing the asset ,eg, design and test for the product. Then if the development costs meets the following criteria then it should be capitalized as an intangible asset. (mnemonic: USER:TIM) The asset can be used or sold Economic benefit will be probable to flow into entity Enough resource to complete the process The process is technically feasible Theres management intention to complete the process The costs of this can be measured reliably.
Audit work for other intangible assets:

Agree cost of intangible to purchase documentation Agree cash outflow relating to this intangible asset to cash book or bank statement. Inspect the purchase documentation relating to this intangible asset to verify the rights of intangible assets actually belong to the company.
Audit work relating to reaseach&development costs:

Inspect detailed business plan to determine how company would use this asset. Inspect customer order if company is to sell the asset. Inspect cash flow projections to verify if there is enough cash flow to carry out the development process. Inspect statement of cash flow to verify there is enough cash balance within company to support the development process. Inspect the overdraft facility to ensure there are enough resources to complete the development process. Inspect result of scientific tests relating to this asset to verify its technically feasible. Inspect management representation to ensure company has an intention to complete the development process. Inspect invoices relating to this project to confirm related expenses can be measured reliably by company.
Audit question IAS 38 [ june2008 Q5] Blod An internally generated brand name has been included in the statement of financial position at a fair value of $10million. Audit working papers show that the matter was discussed with the financial controller, who stated that the $10 million represents the present value of future cash flows estimated to be generated by the brand name. The member of the audit team who completed the work programme on intangible assets has noted that this treatment appears to be in breach of IAS 38 Intangible Assets, and that the management refuses to derecognize the asset. Required: From the information provided above, recommend the matters which should be included as findings from the audit in your report to those charged with governance, and explain the reason for their inclusion. (7 marks)
Answer:
Materiality This is 13% of total asset ($10m/$78m) and its material to the statement of financial position. Accounting treatment Although company can use the brand to generate into future economic benefit and it seems to fulfill the asset definition. But an internally generated brand name is not identifiable and therefore cannot be recognize as an intangible asset in the statement of financial position.
Reason to notice to those charged with governance It can give management an opportunity to correct that material misstatement before a qualified opinion is given. Those charged with governance, ie, audit committee should co-operate with external auditor to require management to correct that material misstatement. External auditor should tell audit committee why a potential qualification of audit opinion would be given due to a breach in IAS38 intangible assets and state its materiality as well to the financial statement. If management still refuses to correct that material misstatement then auditor needs to modify his audit report by issuing an except for qualification audit opinion due to material misstatement in the financial statement.
Audit question [ DEC2011 Q1] IAS 38

Maple & Co
A significant amount has been invested in the new website, which is seen as a major strategic development for the company. The website has generated minimal sales since its launch last month, and advertising campaigns are currently being conducted to promote the site. Required: Identify and explain the principal audit risks to be considered in planning the final audit
Answer: Company has developed the website. According to IAS38 intangible assets the development cost would be capitalized if it fulfills certain criteria and one of them is company can use this website to generate into future economic benefit and given this website has generated minimum sales so it cant be capitalized. There is a risk that company has capitalized this development costs and hence overstating the asset within statement of financial position and understating expense in the statement of profit or loss.
Chapter2 Q7: 24, IAS40 Investment Property

Accounting issues: Classification of investment property if it fulfills the following criteria: Investment purpose Complete Empty Earns capital gain or let it out to earn rental income and if not: Use by company: IAS 16; held for sale: IAS2 Asset has been completed and if not, IAS 16 until its finished The asset is not occupied by the business and if not: IAS16. Or if lessee leases property from lessor but from a groups perspective this is not an investment property
And they should be recognize at cost initially. Subsequent measurement: Fair value model (widely used) Get the fair value: From Price From Similar asset within the area From Value from institution for similar assets From Discount future cash flow Then any gain/losses should be recognized into the Income statement. Gain: DR Investment property(NCA) CR I/S Loss: DR I/S CR investment property(NCA) Disclosures: Fair value model An entity that adopts this must also disclose a reconciliation of the carrying amount of the investment property at the beginning and end of the period. Opening IP value 100 Increase 50 Closing IP value 150
Audit work:
General assets procedures: Inspect purchase document of investment property to verify the cost of each building. And because the property was acquired this year then the price shouldn't be too far away from that as at the year-end so any big differences between the two would imply a misstatement exists. Inspect purchase document of investment property to ensure it belongs to company. Inspect investment property physically to determine condition of the properties supporting the valuation. Far value procedures: Audit procedures should focus on the appraisal of the work of the expert valuer. Procedures could include the following: Inspect the written instructions Co provided to the valuer to get an understanding about the scope of their work. Perform analytical procedures to evaluate assumptions used by valuer in the report are in line with auditors business understanding. Inspect valuers method used to determine fair value and ensure its consistent with by IAS40. Perform analytical procedures by reviewing forecast rental income from properties as an evidence for valuation. Inspect the date of the valuation report and ensure its close to the Co financial statement year end so that fair value used would be reasonable. Inspect any subsequent events, eg, sale of investment property after the year end and this would provide evidence for property valuation, eg, using fair value in the contract price.
Audit question [DEC2008 Q3] IAS40

You are the manager responsible for the audit of Poppy Co, a manufacturing company with a year ended 31 October 2008. In the last year, several investment properties have been purchased to utilize surplus funds and to provide rental income. The properties have been revalued at the year-end in accordance with IAS 40 Investment Property, they are recognized on the statement of financial position at a fair value of $8 million, and the total assets of Poppy Co are $160 million at 31 October 2008. An external valuer has been used to provide the fair value for each property. Required: (i) Recommend the enquiries to be made in respect of the external valuer, before placing any reliance on their work, and explain the reason for the enquiries; (7 marks) (ii) Identify and explain the principal audit procedures to be performed on the valuation of the investment properties. (6 marks)
Answer to [ DEC2008 Q3]Investment property:

(i) Competence Is the valuer a member of a recognised professional body such as surveyors? Does the valuer have any necessary licence to carry out valuations for companies? How much experience does the valuer have in providing valuations of the investment properties held by Poppy Co? Is there any evidence of the reputation of the valuer, e.g. recommendations from other companies to provide such service? institute of registered
Objectivity Does the valuer have any financial benefit in Poppy Co, e.g. shares held in the company? Does the valuer have any personal relationship with any director or employee of Poppy Co? Is the fee paid for the valuation service reasonable and a market based price?
(ii) Audit procedures General assets procedures: Inspect purchase document of investment property to verify the cost of each building. And because the property was acquired this year then the price shouldn't be too far away from that as at the year end so any big differences between the two would imply a misstatement exists. Inspect purchase document of investment property to ensure it belongs to company. Inspect investment property physically to determine condition of the properties supporting the valuation. Far value procedures: Audit procedures should focus on the appraisal of the work of the expert valuer. Procedures could include the following: Inspect the written instructions Co provided to the valuer to get an understanding about the scope of their work. Perform analytical procedures to evaluate assumptions used by valuer in the report are in line with auditors business understanding. Inspect valuers method used to determine fair value and ensure its consistent with by IAS40. Perform analytical procedures by reviewing forecast rental income from properties as an evidence for valuation. Inspect the date of the valuation report and ensure its close to the Co financial statement year end so that fair value used would be reasonable. Inspect any subsequent events, eg, sale of investment property after the year end and this would provide evidence for property valuation, eg, using fair value in the contract price.
Chapter2 Q7: 25, IFRS2 Share-based Payment

Accounting issues: Share based payment really covers a lot of areas. Senario1: If you are going to purchase something but you are not paying cash but instead you are paying in shares or share options and you can use IFRS2. Senario2: If you are going to give some incentive to the management of your company saying to them if you work for me for the next 10 years then I will give you shares/share options then you can also use IFRS2 to account for it. The issue with senario1 is about measurement of the value. Because you are going to pay in shares/options and if you can establish the fair value of the item you bought(usually in selling price) then you should use the fair value of the item you bought otherwise you can use the fair value of the shares. The issue with senario2 is about recognition and measurement of the expense. If you think about it that you are trying to give incentive to management by offering them shares at the end of 5(say) years they have worked for you, the shares you are going to give to them actually cost you nothing because youre just giving shares to them so does the company have to recognize the related expense to the financial statement? Well, IFRS2 says because management has worked for the company and the company is going to give shares usually at a low price to the management but otherwise they could trade it in the stock market at a higher price so company should recognize an expense relating to it. Some companies may also argue that recognizing the share based payment expense will double hit the EPS because as expenses are recognized and shares are issued then EPS will be twice lower. But as long as management has provided the service for you and you earn the revenue then you should recognize the expense and also you are going to give them shares and of course you have to take them into account into the FS as well for PRUDENCE concept.
The question is how can we measure the expense? Step1: identify the type of scheme. Pay (settle) in shares or cash? Step2: follow the formula: Obligation= number of rights expected to vest X FV X timing ratio Obligation The total expense we should recognize at the end of the vesting period. There may be changes in the expense we recognize each year because of our estimates and any changes in them would be a change in accounting estimate and this would be accounted for under IAS8 by just using prospective adjusting method. In order words, just provide for it. number of rights expected to vest: number of people left the company+no of people expected to leave next year Fair value (FV) If its settled in shares then FV should use the value at grant date because it has been written into the contract. If its settled in cash which means the company will pay cash to the employees based on the future share price. So if the share price at the end of the vesting period(the end that employee has worked for the company)is $50m then CR liability 50m. so the Fair value here will be the FV of options at the end of each year. Timing ratio=year end / vesting period
Audit work:
Agree the following calculation by management to the contract: Number of employees Number of options granted per employee Grant date of the share options Vesting period for the scheme Required performance conditions attached to the options Recalculate the share based payment expense to ensure its accuracy. Review a forecast of employee turnover rates during the vesting period to verify its reasonableness and this would help determine total number of share options granted. Inspect written representation from management to confirm assumptions used in the calculation are reasonable. Agree fair value of share options to specialists report and calculation. Agree that the fair value calculated is at the grant date if this is share options. Agree that the fair value calculated is at the each year end if this is share appreciation right.
Audit question [ DEC2008 Q1(b)(i)] IFRS2 share based payment:

Note2: significant items included in operating expenses: 2008($m) Share-based payment expense(i) Damaged property repair expenses(ii) 138 100 2007($m)
(i) In June 2008 Bluebell Co granted 50 million share options to executives and employees of the company. The cost of the share option scheme is being recognised over the three year vesting period of the scheme. It is currently assumed that all of the options will vest and the expense is calculated on that basis. Bluebell Co operates in a tax jurisdiction in which no deferred tax consequences arise from share-based payment schemes. (b) Describe the principal audit procedures to be carried out in respect of the following: (i) The measurement of the share-based payment expense; (6 marks)
Answer to DEC2008 Q1(b)(i)

Agree the following calculation by management to the contract: Number of employees Number of options granted per employee Grant date of the share options Vesting period for the scheme Required performance conditions attached to the options Recalculate the share based payment expense to ensure its accuracy. Review a forecast of employee turnover rates during the vesting period to verify its reasonableness and this would help determine total number of share options granted. Inspect written representation from management to confirm assumptions used in the calculation are reasonable. Agree fair value of share options to specialists report and calculation. Agree that the fair value calculated is at the grant date because this is share options not share appreciation rights.
Chapter2 Q7: 26, IFRS5 Non-current Assets Held for Sale and Discontinued Operations
Accounting issues: Non-current assets held for sale: When the non-current asset within your company is about to be sold to the 3rd party maybe because its falling in value then if some criteria are fulfilled then you can reclassify this non-current asset into current asset as NCA HFS and discontinued operations under IFRS5. Classification: The idea behind the criteria is that you should prove that this sale is probable: Selling purposes by management Available for sale under current condition Locate a buyer actively Expected to complete within 12 months from the year end If the above criteria are proved then company can reclassify the non-current asset into non-current asset held for sale under current asset. Subsequent measurement: 1, no depreciation or amortization (because we are not consuming the asset any more-not for continued use but for sale.) 2, further impairment losses DR I/S CR non-current asset held for sale
Discontinued operations A discontinued operation is an operation if its closed or sold during the year or held for sale at the year end. A discontinued operation should: 1, Dispose of or plan to dispose of a separate major line of business or geographical area of operations; (Major line of business: eg, financial service industry; supermarket. geographical area: Canada division) 2, A subsidiary acquired exclusively with a view to resale. Note: it should be subject to impairment as well same as above. But the key to discontinued operations is about DISCLOSURE. (to help users predict future performance based on continuous operations.)
Disclosure: Net cash flow detailing operating, investing and financing activities. Single line in the statement of comprehensive income showing post tax profit or loss on discontinued operation. Analysis of the profit or loss above in the note detailing how to arrive this figure showing detailed: Revenue $1,000 expense $50 Pre-tax profit $950 Income tax Current tax ($15) Deferred tax ($25) Gains/losses on measurement to NRV
Audit work: For assets / operations that have been disposed of: Agree proceeds to sales documentation and bank statements. Recalculate any gain or loss on disposal and ensure separately disclosed in the financial statements. Verify date on sales documentation to prove asset was sold before year end. For assets / operations held for sale: Inspect Board Minutes to confirm intention to sell. Inspect correspondence with agent to confirm company is actively trying to sell the asset. If company has advertised the asset for sale, inspect advertising documentation. Obtain management representation to confirm Boards intention to sell. Inspect correspondence between company and any interested parties regarding the sale. If company has made any announcements regarding the plan to sell, inspect copies and agree date before year end. Assess asset / operation for impairment, as a plan to sell often indicates asset/ operation is not performing as well as company.
Audit question1 IFRS 5 [ DEC2007(a) ] Alpha Co, a listed company, permanently closed several factories in May 2007, with all costs of closure finalised and paid in August 2007. The factories all produced the same item, which contributed 10% of Alpha Cos total revenue for the year ended 30 September 2007 (2006 23%). The closure has been discussed accurately and fully in the chairmans statement and Directors Report. However, the closure is not mentioned in the notes to the financial statements, nor separately disclosed on the financial statements. The audit senior has proposed an unmodified audit opinion for Alpha Co as the matter has been fully addressed in the chairmans statement and Directors Report.
Required:
Evaluate whether the audit seniors proposed audit report is appropriate, and where you disagree with the proposed report, recommend the amendment necessary to the audit report of:
(i) Alpha Co; (6 marks)
Answer to [ DEC2007(a) ] IFRS 5

Auditors reports Alpha Accounting treatment
According to IFRS5 non-current assets held for sale and discontinued operations closure of factories at the year-end should be disclosed in the financial statements as discontinued operations. General disclosure would include: Profit after tax of the discontinued operations Fair value of the discontinued operations. Separate disclosure would include: If product lines of the business would be closed and they are in separate areas or they are separate products then they should be separately disclosed.
Materiality
This is material to statement of profit or loss because it accounts for 10% of total revenue Auditors opinion is not correct given this is a material misstatement in the fisnancial statement and hence an except for qualification of audit opinion would be given due to material misstatement. A basis of qualification audit opinion would need to be placed before the actual opinion paragraph and it needs to detail the reasons why qualification audit opinion would be given due to a breach of IFRS5.
Audit question2 [june2011 Q1a]IFRS 5

The second issue concerns one of Bill Cos specialist divisions, which trades under the name Treasured Homes and which deals exclusively in the redevelopment of non-industrial historic buildings such as castles and forts. These buildings are usually acquired as uninhabitable ruins, and are then developed into luxury residences for wealthy individuals. The management of Bill Co decided last week to sell this division, as although it is profitable, it generates a lower margin than other business divisions. Treasured Homes operates separately from the rest of the business, and generates approximately 15% of the total revenue of the company. In a board minute dated 1 June 2011, it was noted that interest has already been expressed in this division from a potential buyer, and it is hoped that sale negotiations will soon commence, leading to sale in August 2011. There is a specific office building and some other tangible assets that will be sold as part of the deal. These assets are recorded at $76 million in the financial statements. No redundancies will be necessary as employees contracts will transfer to the new owners.
Required:
I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the risk of material misstatement relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks. (8 marks)
Answer to [June2011 Q1(a)] IFRS 5

Only 8 points required
Materiality Treasured Homes is material to the group because it represents 8% of total assets of the financial statements. Accounting A non-current asset held for sale is recognized if management has an intention to sell the asset; asset is available for sale immediately; company locates a buyer actively and the sale would be expected to complete within 12months after the Financial statement year end. Because a buyer is interested in buying it and a sale is expected to begin in August 2011. Asset is complete and management is going to sell that to the customer so it can be classified as a non-current asset held for sale. As per IFRS5 the asset should be separately disclosed measuring at the lower of carrying value and net realizable value and the asset is not depreciated any more. Its likely that treasured homes meet the definition of discontinued operation because it operates separately from the normal business operation and because it accounts for 15% of total revenue so its a major line of business. Risk of material misstatement There is a risk that the classification of non-current asset held for sale is not made leading to overstatement of non-current asset and understatement of current asset in the statement of financial position. Also misstatement in the expenses as well if depreciation continues to be charged. There is a risk that separate disclosure for the discontinued operation is not made.
Audit procedures Obtain a management representation confirming management is planning to sell the asset. Inspect board minutes for evidence that management are planning to sell the asset. Inspect the asset physically to verify its available for sale. Inspect the legal correspondence with potential buyer to confirm company is actively locating a buyer. Obtain management representation to confirm the sale would be completed within the next 12months after the financial statement year end. Confirm that separate disclosure of discontinued operation has been made in the statement of financial position, statement of profit or loss, and statement of cash flows. Confirm that depreciation has not been charged as required by IFRS 5.
Chapter2 Q7: 27, IFRS8 Operating Segments
Accounting issues: This area typically applies only to listed companies. The aim of the IFRS8 is to give more information to the users of FS to make their economic decision. Think about it in this way, if you have a company which is operating in many industries such as retail, mineral, financial services & education etc. If theres a rise in price due to increase in transportation fees then which industry will be mostly affected? Well to some extent, the retail industry will be mostly affected and the financial service and education will be least affected. So when investors try to invest their money into these industries they want to know these segments(companies in different industries) are operating effectively so we come to IFRS8. Another example would be if a company has many subsidiaries all round the world such as in Asia, America, Canada, Singapore etc. and if you want to invest your money into these companies say in China and you want to know whether the company operating in China will be good and maybe you will then take into account of political reasons etc. So IFRS8 here just gives us some guidance of when trying to show the results of different companies, how to do that?
Firstly, we should decide whether this is an operating segment? An operating segment would have the following features: 1, It has business activities earning revenue and incurring expenses. 2, The operating results will be reviewed by CEO to make economic decisions. 3, Theres separate financial information for each segments showing assets, liabilities, revenue, expenses and profits etc. Secondly, once it fulfills the definition of operating segment then you will need to decide whether this would be reportable? An operating segment would be reportable if: Its more than 10%of revenue, profits or assets of all segments; If theres a loss then we need to decide whether the loss is higher than the higher of total profits and loss and if no then it doesn't fulfill this criteria. Only one of the criteria needs to be fulfilled. Thirdly, once the operating segments are classified but they do not add up to 75% in total then we need to break the other operating segments down in order to make the total up to 75%. If other operating segments doesn't fulfill the definition of operating segement then we can bring them together if they have similar products/types of customers/distribution methods or regulatory environment. Fourthly, we need to decide how to disclose the operating segements. Revenue, total assets&liabilities, interest income&expense, tax&depreciation should be disclosed. Audit work: Agree segmental analysis to the totals reported in the Financial Statements. Perform analytical procedure by comparing figures with prior year to ensure consistency of presentation. Agree this years analysis back to management accounts.
Audit question1 IFRS8 [ DEC2009 Q1(d)] You are the manager responsible for the audit of Papaya Co, a listed company, which operates a chain of supermarkets, with a year ending 31 December 2009. There are three business segments operated by the company two segments are supermarket chains which operate under internally generated brand names, and the third segment is a new financial services division. The first business segment comprises stores branded as Papaya Mart. This segment makes up three-quarters of the supermarkets of the company, and are large out of town stores, located on retail parks on the edge of towns and cities. These stores sell a wide variety of items, including food and drink, clothing, household goods, and electrical appliances. In September 2009, the first overseas Papaya Mart opened in Farland. This expansion was a huge drain on cash resources, as it involved significant capital expenditure, as well as an expensive advertising campaign to introduce the Papaya Mart brand in Farland. The second business segment comprises the rest of the supermarkets, which are much smaller stores, located in city centres, and branded as Papaya Express. The Express stores offer a reduced range of products, focussing on food and drink, especially ready meals and other convenience items. The company also established a financial services division on 1 January 2009, which offers loans, insurance services and credit cards to customers. Required: Assess the risks of material misstatement to be addressed when planning the final audit for the year ending 31 December 2009, producing your answer in the form of briefing notes to be used at the audit planning meeting.
Answer to [ DEC2009 Q1(d)]IFRS8 Business segments There are many operating segments. According to IFRS8 operating segments for listed companies such as Papaya Co the information relating to those operating segments should be disclosed in the note of the financial statements. There is a risk relating to non-disclosure of information relating to these operating segments.
Chapter2 Q7 :28, IFRS10,11,12

Accounting issues: IFRS 10 Consolidated Financial Statements This is a result from the convergence of the FASB in USA and IASB. IFRS 10 replaces the definition of control in IAS27 but the preparation of separate financial statements in IAS27 remains unchanged and consolidation process does not change per IFRS3. The definition of control per IAS27: the power to govern financial and operational policies of an entity to obtain benefit. But the definition of control under IFRS10: When investor is exposed or has rights to variable returns(profit/loss) from its involvement with the investee and has the ability to affect those returns through its power over the investee. There are 3 steps to determine control and we use a mnemonic called PAR. P: Power instrument: voting rights and potential voting rights; power to appoint directors on the board. A: activities(relevant). I like to think about relevant activities which are based on the purpose of the organization. Such as if your company is going to manufacture high fashion clothes then a relevant activity would be to determine the selling price of the high fashion clothes in the whole market etc. An participation in preparation of accounts for the company is just an irrelevant activity. R: returns (either positive or negative) The returns here could be positive or negative which means through the direction of the activity within the company then the investor may be exposed to or have right to profit or loss not necessarily benefit(profit.) Also the returns are variable which means that if the company is doing a good job so it earns a larger amount of profit then it will distribute larger amount of dividend to shareholders and this is called variable which is against fixed. Eg, a preference shareholder is just exposed to the fixed dividend received from the company so it does not necessarily have control over the entity.
IFRS 11 Joint Arrangements This is based on the concept of joint control. Joint control just prevents any party who control the whole business. Before setting up the joint control you need to have a look at whether the party has control per IFRS10. If yes then move on to see their agreements to establish whether there would be an unanimous consent over the relevant activities by parties sharing control. And if yes then you should decide whether this is a joint operation(JO) or joint venture(JV). These are the two types of joint arrangements. JOINT OPRATION (JO) This means that parties do business together using their own assets and settling their liabilities. The accounting for this follows the substance over form which means the assets and liabilities remain in each parties FS and just a sharing of revenue, expense, assets and liabilities. JOINT VENTURE (JV) Parties may set up a business together and put their assets and liabilities in then the assets and liabilities belong to the business rather than belong to their own. The accounting for this is to use equity accounting which means the growth of business goes into the income statement and SOFP where its added to the cost.
IFRS 12 disclosures of interests in other entities This is a new IFRS on disclosure of group relationships that requires the ultimate parent to disclose all its relationship with other entities. The parent company is required by IRS12 to list: All of its subsidiaries and state the reason why it has control not significant influence. All of its associates and state the reasons why it has significant influence not control. All of its joint arrangements and state the reasons why it has joint controls.
Audit work: Inspect their agreement to verify joint control. Examine the term control by inspecting directors register and terms to verify their power to govern policy making decision. Inspect disclosure is appropriate as per IFRS12.
Audit question [Shire DEC2005] IFRS11 Joint Arrangements In July 2008, Shire entered into an agreement to share in the future economic benefits of an extensive oil pipeline.
Required: Using the information provided, identify and explain the audit risks to be addressed when planning the final audit of Shire Oil Co for the year ending 31 December 20X8.
Answer: The agreement to share in future profit seems to be a joint arrangement. If there is joint control then we should decide whether this is joint operation or joint venture. If its joint operation then assets and liabilities should b e recognized in each parties financial statements. If its joint venture then Shire should use equity accounting method. There is a risk that the above accounting is wrong and hence financial statements would be materially misstated.
Chapter2 Q7 :29, IFRS13 Fair Value Measurement

Accounting issues: In this IFRS 13 we need to know 1, Definition of fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Here, the price would be the exit price. 2, How to measure fair value -For financial assets&non-financial assets, liability and equity instrument, we use this hierarchy. Level1: quoted price If there is an active market then the market price from that market on the measurement date should be used. Level2: similar quoted price If level one fails then level two requires that similar market data should be used to establish the approximated market value. Level3: unobservable inputs(management best estimate, eg, present value) If level one and two fails to determine the fair value then you can use level three where you can use financial model to determine fair value.
-For non-financial assets, we should use highest and best use value Eg, to determine the fair value of land you need to consider which way that the land may generate into a highest value. Either for industrial use or residential use.
Audit work:
Inspect valuers working papers to verify methods used are in line with auditors understanding. Enquire with management about controls over the estimation process when the valuation for the items is complex as this will reduce the control risk. Perform analytical procedures by comparing methods used for estimates with prior years to ensure consistency. Consider the use of an outside auditors expert to assess the estimate and the assumptions on which it is based. Obtain written representations from management that they believe the assumptions behind their estimates to be reasonable.
Audit question [DEC2008 Q3(a)]fair value

(a) Financial statements often contain material balances recognised at fair value. For auditors, this leads to additional audit risk. Required: Discuss this statement. (7 marks)
Answer to [ DEC2008 Q3]fair value

Inherent risk This will increase the inherent risk because of its subjectivity in nature. For example when determing the fair value for asset using disoucnting cash flow, lots of discount rates would be used by management and it's subjective. (For example when management tries to use fair value model for the asset they may assess the market condition of that asset and the future intention of how to use that asset to generate into future economic benefit and they can base on this to give a fair value to the asset and this is subjective.) This will increase the inherent risk because its subject to manipulation by management. Management sometimes would use fair value model to value assets in order to overstate its asset value to attempt window dressing. This will increase the inherent risk because its complexity. For example in IAS19 employee benefit when the actuary gives a fair value to the pension asset or liability then the process is very complicated and its easy to make mistakes.
Control risk This will increase control risk because sometimes fair value determination is beyond companys control. For example when valuing the pension asset and liabilities its up to the actuary to value them not company and hence any mistakes happened during the valuation process may not be detected by the company internal control system. Detection risk This will increase detection risk because auditors may lack of knowledge when dealing fair value. For example if auditor has no knowledge about financial instrument then auditor may not detect any errors within the fair value figure of financial asset and hence give a wrong audit opinion. 175 Accounting Practise Center (A.P.C) www.accaapc.com
Group audit
Accounting issues: Based on single entity concept within the group there would be parent and subsidiary. For associate which is outside the group. Consolidated statement of financial position would be prepared showing assets, liabilities which are based on definition of control whilst for equity which is based on ownership. When acquiring a subsidiary the excess amount of money paid would be goodwill (positive-show in the non-current assets). If we spend less money than its actual net assets then the difference would be bargain purchase which would be presented in the consolidated statement of profit or loss and other comprehensive income and retained earnings. For associate we use equity accounting method. For subsidiary we show the excess amount we paid as non-current asset. Goodwill would be subject to impairment at each year end but not amortization. Net assets should include deferred tax implication, ie, minus deferred tax liability and add deferred tax asset back. Audit work: Look at the questions below.(the current examiner test this quite consistently.)
June2012 Q1(a(i+iii)): Group audit

You are a manager in Magpie & Co, responsible for the audit of the CS Group. An extract from the permanent audit file describing the CS Groups history and operations is shown below: Permanent file (extract) Crow Co was incorporated 100 years ago. It was founded by Joseph Crow, who established a small pottery makingtableware such as dishes, plates and cups. The products quickly grew popular, with one range of products becominghighly sought after when it was used at a royal wedding. The companys products have retained their popularity overthe decades, and the Crow brand enjoys a strong identity and good market share. Ten years ago, Crow Co made its first acquisition by purchasing 100% of the share capital of Starling Co. Both companies benefited from the newly formed CS Group, as Starling Co itself had a strong brand name in the pottery market. The CS Group has a history of steady profitability and stable management. Crow Co and Starling Co have a financial year ending 31 July 2012, and your firm has audited both companies for several years. Acquisition of Canary Co The most significant event for the CS Group this year was the acquisition of Canary Co, which took place on 1 February 2012. Crow Co purchased all of Canary Cos equity shares for cash consideration of $125 million, and further contingent consideration of $30 million will be paid on the third anniversary of the acquisition, if the Groups revenue grows by at least 8% per annum. Crow Co engaged an external provider to perform due diligence on Canary Co, whose report indicated that the fair value of Canary Cos net assets was estimated to be $110 million at the date of acquisition. Goodwill arising on the acquisition has been calculated as follows:
$m
Fair value of consideration: Cash consideration Contingent consideration Less: fair value of identifiable net assets acquired Goodwill 125 30
155 (110) 45
To help finance the acquisition, Crow Co issued loan stock at par on 31 January 2012, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.
Canary Co manufactures pottery figurines and ornaments. The company is considered a good strategic fit to the Group, as its products are luxury items like those of Crow Co and Starling Co, and its acquisition will enable the Group to diversify into a different market. Approximately 30% of its sales are made online, and it is hoped that online sales can soon be introduced for the rest of the Groups products. Canary Co has only ever operated as a single company, so this is the first year that it is part of a group of companies. Financial performance and position The Group has performed well this year, with forecast consolidated revenue for the year to 31 July 2012 of $135 million (2011 $125 million), and profit before tax of $85 million (2011 $84 million). A breakdown of the Groups forecast revenue and profit is shown below: Crow Co $ million Revenue Profit tax Note: Canary Cos results have been included from 1 February 2012 (date of acquisition), and forecast up to 31 July 2012, the CS Groups financial year end. The forecast consolidated statement of financial position at 31 July 2012 recognises total assets of $550 million. Other matters Starling Co received a grant of $35 million on 1 March 2012 in relation to redevelopment of its main manufacturing site. The government is providing grants to companies for capital expenditure on environmentally friendly assets. Starling Co has spent $25 million of the amount received on solar panels which generate electricity, and intends to spend the remaining $10 million on upgrading its production and packaging lines. On 1 January 2012, a new IT system was introduced to Crow Co and Starling Co, with the aim of improving financial reporting controls and to standardise processes across the two companies. Unfortunately, Starling Cosfinance director left the company last week. before Starling Co $ million Canary Co $ million CS Group $ million
69
35
50 3
16 2
135 8.5
Required:
(i) Identify and explain the implications of the acquisition of Canary Co for the audit planning of the individual and consolidated financial statements of the CS Group; (8 marks) (iii) Recommend the principal audit procedures to be performed in respect of the goodwill initially recognized on the acquisition of Canary Co. (5 marks)
Answer to June2012 Q1(a)(i)+(iii) (a) (i) Individual financial statement: Auditors should consider the time to start their audit work to avoid any delay in work because now its June2012 and the financial statement year end is July2012 then its just 1 month away before auditors start their audit.
Auditors would need to consider performing professional clearance asking previous auditors of Canary Co about any circumstances that may influence its audit strategy and audit plan as this is an initial engagement. Auditors would need to consider whether an expert would be used to obtain sufficient and appropriate audit evidence relating to its sales revenue because 30% of Canary Co sales are made online. Auditors need to understand clients company including understand its internal control system because a new IT system was introduced to Crow Co so auditor should assess whether there would be further internal control weakness which may lead to a potential misstatement in its financial statement. Consolidated financial statements: Auditors would need to consider extra work done on the transactions occurred in July because Canary and Group have a different financial statement year end. Auditor should assess the new materiality because Canary has been newly introduced into the group so the materiality for the group has changed.
Auditors should consider whether component would be significant component and based on calculation revenue of Canary Co would account for 11.9% of the group(16/135) and profit before tax would account for 23.5% of the group (2/8.5) so Canary would be a significant component of the group. Auditor should consider extra works to be done as well such as engaging an expert auditing goodwill and auditors should ensure there enough time to carry out the audit of the group.
(iii) (actions+document(what)+reasons(why/assertions)) Agree the cash consideration of $125m to bank statement and its cash book. Obtain the breakdown of contingent consideration and recalculate it,eg,on a discount basis to verify its accuracy. Enquire with management of company about the likelihood of payment to Canary co to verify its reasonableness in contingent consideration. Inspect external expert report on the valuation of fair value of net assets at acquisition to verify its accuracy. Inspect the purchase document of Canary from management to verify this is approval.
Stage 5 of audit flowchart

Review stage of audit In this stage we will be going through: 1. audit findings 2. opening balance 3. subsequent events 4. other information 5. final analytical procedures 6. management representation
DEC2012 Q2 Audit findings

(a) You are a manager in Sambora& Co, responsible for the audit of the Jovi Group (the Group), which is listed. The Groups main activity is steel manufacturing and it comprises a parent company and five subsidiaries. Sambora& Co currently audits all components of the Group. You are working on the audit of the Groups financial statements for the year ended 30 June 2012. This morning the audit engagement partner left a note for you: Hello The audit senior has provided you with the draft consolidated financial statements and accompanying notes which summarise the key audit findings and some background information. At the planning stage, materiality was initially determined to be $900,000, and was calculated based on the assumption that the Jovi Group is a high risk client due to its listed status. During the audit, a number of issues arose which meant that we needed to revise the materiality level for the financial statements as a whole. The revised level of materiality is now determined to be $700,000. One of the audit juniors was unsure as to why the materiality level had been revised. There are two matters you need to deal with: (i) Explain why auditors may need to reassess materiality as the audit progresses. (4 marks) (ii) Assess the implications of the key audit findings for the completion of the audit. Your assessment must consider whether the key audit findings indicate a risk of material misstatement. Where the key audit findings refer to audit evidence, you must also consider the adequacy of the audit evidence obtained, but you do not need to recommend further specific procedures. (18 marks) Thank you The Groups draft consolidated financial statements, with notes referenced to key audit findings, are shown below:
Draft consolidated statement of profit or loss and other comprehensive income
Note
Revenue Cost of sales Gross profit Operating expenses Operating profit Share of profit of associate Finance costs Profit before tax Taxation Profit for the year Other comprehensive income/expense for the year, net of tax: Gains on property revaluation Actuarial losses on defined benefit plan Other comprehensive income/expense Total comprehensive income for the year
30June2012 Draft $000 98,795 (75,250) 23,545 (14,900) 8,645 1,010 (380) 9,275 (3,200) 6,075
30June2011 Actual $000 103,100 (74,560) 28,540 (17,500) 11,040 900 (340) 11,600 (3,500) 8,100
3 4
800 (1,100) (300) 5,775
(200) (200) 7,900
Notes: Key audit findings statement of profit or loss and other comprehensive income
1. Revenue has been stable for all components of the Group with the exception of one subsidiary, Copeland Co, which has recognised a 25% decrease in revenue. 2. Operating expenses for the year to June 2012 is shown net of a profit on a property disposal of $2 million. Our evidence includes agreeing the cash receipts to bank statement and sale documentation, and we have confirmed that the property has been removed from the non-current asset register. The audit junior noted when reviewing the sale document, that there is an option to repurchase the property in five years time, but did not discuss the matter with management. 3. The property revaluation relates to the Groups head office. The audit team have not obtained evidence on the revaluation, as the gain was immaterial based on the initial calculation of materiality. 4. The actuarial loss is attributed to an unexpected stock market crash. The Groups pension plan is managed by Axle Co a firm of independent fund managers who maintain the necessary accounting records relating to the plan. Axle Co has supplied written representation as to the value of the defined benefit plans assets and
liabilities at 30 June 2012. No other audit work has been performed other than to agree the figure from the financial statements to supporting documentation supplied by Axle Co.
Draft consolidated statement of financial position 30 June 2012 Draft $000 Assets Non-current assets Property, plant and equipment Goodwill Investment in associate Assets classified as held for sale Current assets Inventory Receivables Cash and cash equivalents Total assets Equity and liabilities Equity Share capital Revaluation reserve Retained earnings Non-controlling interest Total equity Non-current liabilities Defined benefit pension plan Long-term borrowings Deferred tax Current liabilities Trade payables Provisions Total liabilities Total equity and liabilities 6,200 2,700 64,670 118,420 7,300 2,800 55,700 104,100 10,820 9,250 35,000 1,350 12,500 3,300 33,600 12,500 2,500 29,400 4,000 48,400 8,600 8,540 2,100 118,420 8,000 7,800 2,420 104,100 81,800 76,300 5,350 4,230 30 June 2011 Actual $000
5 6 7
5,350 4,230 7,800
4,350 53,750
43,000 1,950
Notes: Key audit findings statement of financial position 5. The goodwill relates to each of the subsidiaries in the Group. Management has confirmed in writing that goodwill is stated correctly, and our other audit procedure was to arithmetically check the impairment review conducted by management. 6. The associate is a 30% holding in James Co, purchased to provide investment income. The audit team have not obtained evidence regarding the associate as there is no movement in the amount recognised in the statement of financial position. 7. The assets held for sale relate to a trading division of one of the subsidiaries, which represents one third of that subsidiarys net assets. The sale of the division was announced in May 2012, and is expected to be complete by 31 December 2012. Audit evidence obtained includes a review of the sales agreement and confirmation from the buyer, obtained in July 2012, that the sale will take place. 8. Two of the Groups subsidiaries are partly owned by shareholders external to the Group. 9. A loan of $8 million was taken out in October 2011, carrying an interest rate of 2%, payable annually in arrears. The terms of the loan have been confirmed to documentation provided by the bank. Required: Respond to the note from the audit engagement partner. (22 marks) Note: The split of the mark allocation is shown within the partners note. (22 marks)
Answer to DEC2012 Q2: (a) you can also talk about change in risk; change in internal control system; outsourcing its ICS to 3rd party; departure of NEDs during the year like audit committee collapse; fraud has been found during the audit etc. (i) The auditor shall revise materiality if they become aware of information during the audit that would have caused the auditors to determine a different level of materiality initially During the audit, the auditor becomes aware of a matter which impacts on the auditors understanding of the clients business and which leads the auditor to believe that the initial assessment of materiality was wrong and must be revised. For example, the actual results of the audit client may turn out to be quite different to the forecast results on which the initial level of materiality was based. Theres a change in the clients circumstances may occur during the audit, for example, a decision to dispose of a major part of the business. This again would cause the auditor to consider if the previously determined level of materiality were still appropriate. If adjustments are made to the financial statements after the initial assessment of materiality, then the materiality level would need to be adjusted. (b) Operating expenses The disposal of property involves a recognition from statement of financial position of $2m but its given the right to repurchase at the end of the asset life and this may imply that its not a sale but just a loan. So it may be accounted for under IFRS9 financial instrument. Further audit work will be needed to verify the substance of the transaction. Revaluation The audit evidence relating to this is not sufficient. Because the materiality has been revised to $700,000 and this revaluation has exceeded this figure so that further audit procedures relating to revaluation would need to be carried out.
Actuarial losses The audit evidence relating to this is not sufficient because auditors just rely on the records of Alex Co which a service organization. So auditors should also gain an understanding of this service organization and perform other audit procedures to support its records. Goodwill The goodwill doesn't change but from the evidence of decline in sales revenue of one subsidiary of 25% this may mean that there would be impairment in the goodwill. So auditors need to challenge the assumption made by management regarding goodwill. Associate Associate in the statement of financial position remains unchanged but there is profit from associate in the statement of profit or loss and this is unual and it may imply that figures in the statement of financial position is wrong. Auditors need to enquire with management for the accounting entry relating to this to assess any potential mistakes. Assets held for sale Assets held for sale should be disclosed under current assets rather than non-current assets in the statement of financial position. The $7.8m is unclear about whether it would be just the asset or net of assets and liabilities as a result of the assets held for sale and the IFRS5 requires there should be a split between assets and liabilities not to net them off. It seems that the assets held for sales meet the definition of discontinued operation and so according to IFRS5 there should be a single line figure disclosed on the face of the statement of profit or loss and other comprehensive income about the post-tax profit or loss of the discontinued operation. Further audit work should be done to ensure the above are corrected. NCI Non controlling interest has been disclosed properly under equity but in the statement of profit or loss and other comprehensive income it hasn't disclosed the profit after tax attributable to NCI and also total comprehensive income attributable to NCI. So auditors would discuss with management whether this will be made or not.
Loan The finance cost accrued for the year should be $120,000($8X2%X9/12) but there is just an increase in the finance costs in the statement of profit or loss and other comprehensive income of $40,000 and this may imply that there would be an understatement of the finance cost. So auditors would need to review the notes regarding this to ensure its accuracy.
Chapter 2 June2011 Q3 Opening balances (ISA510&ISA710)(b)

Your firm has been approached by Wexford Co to provide the annual audit. Wexford Co operates a chain of bookshops across the country. The shops sell stationery such as diaries and calendars, as well as new books. The financial year will end on 31 July 2011, and this will be the first year that an audit is required, as previously the company was exempt from audit due to its small size. (b) Wexford Cos financial statements for the year ended 31 July 2010 included the following balances: Profit before tax $50,000 Inventory $25,000 Total assets $350,000 The inventory comprised stocks of books, diaries, calendars and greetings cards.
Required: In relation to opening balances where the financial statements for the prior period were not audited: Explain the audit procedures required by ISA 510 Initial Audit Engagements Opening Balances, and recommend the specific audit procedures to be applied to Wexford Cos opening balance of inventory. (8 marks)
Answer to Q June2011 Q3: (b) Genera procedures: Auditor shall read the most recent financial statements for information relevant to opening balances, including disclosures. Auditor shall obtain sufficient appropriate evidence about whether the opening balances contain misstatements that materially affect the current years financial statements by determining whether the prior periods closing balances have been correctly brought forward. The auditor should determine whether the opening balances reflect the application of appropriate accounting policies. Auditor shall obtain sufficient appropriate evidence about whether the accounting policies reflected in the opening balances have been consistently applied in the current periods financial statements, and that any changes in accounting policies have been accounted for under IAS8. Specific procedures: Auditor should inspect records of any inventory counts held at the prior period year end, 31 July 2010, to confirm the quantity of items held in inventory agrees to accounting records. Auditor should Observe an inventory count at the current period year end, 31 July 2011, and reconciliation of closing inventory quantities back to opening inventory quantities Auditor should inspect management accounts for evidence of any inventory items written off in the current financial period to identify any obsolete inventory. Auditor should discuss with management regarding any slow moving items of inventory which were included in opening inventory.
Chapter2 :DEC2010 Q2 Newman & Co(C) [ISA720 other information]

(c) You have a trainee accountant assigned to you, who has read the notes taken at your meeting with Ali Monroe. She is unsure of the implications of the charitable donations being disclosed as a different figure in the financial statements compared with the other information published in the annual report: Disclosure note in the financial statement is $9m while in the sustainability report this is $10m. Required: (i) Explain the responsibility of the auditor in relation to other information published with the financial statements; and (ii) Recommend the action to be taken by Newman & Co if the figure relating to charitable donations in the other information is not amended. (8 marks)
Answer to DEC2010 Q2(c):

(i) Auditors should read the other information and compare to financial statements to establish whether financial statements are misstated or other information paragraph is misstated. If the financial statements are materially misstated and management refuses to correct the material misstatement then auditors should qualify his audit opinion. If financial statements are correct but the other information paragraph is wrong then auditors should modify his audit report by adding another matter paragraph. If any of these material misstatements are not corrected by management then auditors should think about withdraw from the engagement letter but they need to seek legal advice first.
(ii) Auditors should perform audit procedures to obtain sufficient and appropriate audit evidence suggesting the $9m in the financial statements is correct. If $9m is correct then auditors should present the audit work result to management telling them the $10m in the sustainability report is wrong. If the management refuses to change the disclosure paragraph then auditors should add other matter paragraph after the actual opinion paragraph telling shareholders that there is a material inconsistency between financial statements and the non financial information paragraph. If management refuses to change the disclosure paragraph then auditors should need to reconsider the integrity of management and review its management representation again and where necessary resign as an auditor.
Stage 6 Audit report

Critique Style: Chapter 2 June2012 Q5(b)
(b) Snipe Co has in place a defined benefit pension plan for its employees. An actuarial valuation on 31 January 2012 indicated that the plan is in deficit by $105 million. The deficit is not recognised in the statement of financial position. An extract from the draft audit report is given below: Auditors opinion In our opinion, because of the significance of the matter discussed below, the financial statements do not give a true and fair view of the financial position of Snipe Co as at 31 January 2012, and of its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards. Explanation of adverse opinion in relation to pension The financial statements do not include the companys pension plan. This deliberate omission contravenes accepted accounting practice and means that the accounts are not properly prepared. Required: Critically appraise the extract from the proposed audit report of Snipe Co for the year ended 31 January 2012. Note: you are NOT required to re-draft the extract of the audit report. (7 marks) (15 marks)
Answer to June2012 Q5(b): The title for the paragraphs are not correct. Firstly, explanation of adverse opinion in relation to pension should be basis of adverse opinion . And this should be placed before opinion paragraph. Auditors opinion should be opinion paragraph. The matter is not quantified. The paragraph should clearly state the amount of $105 million, and state that this is material to the financial statements. The paragraph does not say whether the pension plan is in surplus or deficit, i.e. whether it is an asset or a liability which is omitted from the financial statements. There is no description of the impact of this omission on the financial statements. Wording such as if the deficit had been recognised, total liabilities would increase by $105 million. No reference is made to the relevant accounting standard IAS 19 Employee Benefits. Reference should be made in order to help users understanding of the breach of accounting standards that has been made. The use of the word deliberate when describing the omission of the pension plan is not professional and the plan may have been omitted in error and an adjustment to the financial statements may have been suggested by the audit firm and is being considered by management. It is unlikely that this issue alone would be sufficient to give rise to an adverse opinion so ax except for qualification should be issued because this is just material misstatement not pervasive.
Matter to be considered style:
Chapter 2 June2011 Q5 Nassau Group

You are the manager responsible for the audit of the Nassau Group, which comprises a parent company and six subsidiaries. The audit of all individual companies financial statements is almost complete, and you are currently carrying out the audit of the consolidated financial statements. One of the subsidiaries, Exuma Co, is audited by another firm, Jalousie & Co. Your firm has fulfilled the necessary requirements of ISA 600 Special Considerations Audits of Group Financial Statements (Including the Work of Component Auditors) and is satisfied as to the competence and independence of Jalousie & Co. You have received from Jalousie & Co the draft audit report on ExumaCos financial statements, an extract from which is shown below: Basis for Qualified Opinion (extract) The company is facing financial damages of $2 million in respect of an on-going court case, more fully explained in note 12 to the financial statements. Management has not recognised a provision but has disclosed the situation as a contingent liability. Under International Financial Reporting Standards, a provision should be made if there is an obligation as a result of a past event, a probable outflow of economic benefit, and a reliable estimate can be made. Audit evidence concludes that these criteria have been met, and it is our opinion that a provision of $2 million should be recognised. Accordingly, net profit and shareholders equity would have been reduced by $2 million if the provision had been recognised. Qualified Opinion (extract) In our opinion, except for effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view of the financial position of Exuma Co as at 31 March 2011... An extract of Note 12 to ExumaCos financial statements is shown below: Note 12 (extract) The company is the subject of a court case concerning an alleged breach of planning regulations. The plaintiff is claiming compensation of $2 million. The management of Exuma Co, after seeking legal advice, believe that there is only a 20% chance of a successful claim being made against the company.
Figures extracted from the draft financial statements for the year ending 31 March 2011 are as follows: Nassau Group $million Profit before tax Total assets Required: Identify and explain the matters that should be considered, and actions that should be taken by the group audit engagement team, in forming an opinion on the consolidated financial statements of the Nassau Group. (10 marks) 20 85 Exuma Co $million 4 20
Answer to June2011 Q5: Matters to consider Significant component A significant component is defined as a component identified by the group audit engagement team that is of individual significance to the group. Exuma Co meets the definition of a significant component because it contributes 20% of group profit before tax, and 235% of group total assets. Exuma Co is therefore material to the group financial statements. Materiality The legal case involves a claim of $2 million. This is material to the Exuma Co financial statements as it is 50% of profit before tax, and 10% of total assets. This is also material to the group financial statements because its 10% of group profit before tax, and 24% of group total assets. Qualified opinion An except for qualification opinion is issued by auditors because they believe that the cash outflow for this is probable rather than possible and as long as there is enough audit evidence shows this is the case then this opinion is appropriate. Group auditors Because the individual financials statements are material to the group and so Jalousie&Cos work should be carefully reviewed by group audiotrs. The matters should be discussed with the group engagement audit team as well as those changed with governance about the impact on the group audit opinion as a result of this matter. If theres correct amendment in the Exuma Co financial statement then there would be unqualified audit opinion issued to that financial statement. If ExumaCos financial statements are not amended, an adjustment could be made on consolidation of the group financial statements to include the provision.So opinion on ExumaCos financial statements would be qualified, but the group audit opinion would not be qualified as the matter causing the material misstatement has been corrected. If no adjustment is made, either to ExumaCos financial statements, or as a consolidation adjustment in the group financial statements, and if the group engagement partner disagrees with this accounting treatment, then the group audit opinion should be qualified due to a material misstatement.
Actions Auditors should inspect copy of the actual claim showing the $2 million claimed against the company. Auditors should inspecta written representation from management detailing managements reason for believing that there is no probable cash outflow. The group engagement partner may consider engaging an external expert to provide an opinion as to the probability of the court case going against Exuma Co given the subjective nature of this matter.(ISA600 further procedures)
Non Audit Engagement Services
When talking about the assurance engagement it can be: 1. Audit engagement (6 stages) 2. Audit related services (which doesnt require a detailed standard to perform the work) * Review engagement including interim financial information; prospective financial information and due diligence review. * agree upon procedure including forensic investigation and due diligence investigation * Compilation service just to prepare the account for client or doing tax computation for client 3. other assurance engagement including social and environmental audit(verifying KPIs.)
Interim financial information DEC2012 Q5(b) (b) You are also responsible for the audit of Squire Co, a listed company, and you are completing the review of its interim financial statements for the six months ended 31 October 2012. Squire Co is a car manufacturer, and historically has offered a three-year warranty on cars sold. The financial statements for the year ended 30 April 2012 included a warranty provision of $15 million and recognised total assets of $275 million. You are aware that on 1 July 2012, due to cost cutting measures, Squire Co stopped offering warranties on cars sold. The interim financial statements for the six months ended 31 October 2012 do not recognise any warranty provision. Total assets are $30 million at 31 October 2012.
Required: Assess the matters that should be considered in forming a conclusion on Squire Cos interim financial statements, and the implications for the review report. (6 marks)
Answer to DEC2012 Q5(b):

Matters to be considered: General:
Reviews on interim financial statement for Squire Co are based on analytical procedures and enquiry. The IAS 37 provisions, contingent liabilities and contingent assets should be applied both on annual financial statements and interim financial statements here.
Materiality:
Warranty provision is 5.5% of total assets($1.5m/$27.5m) and hence it s material to the financial statements.
Accounting:
After 1 July 2012 there is no obligation for Squire to provide warranties on cars to customers but Squire has a liability for customers before 1 July 2012 and so Squire should recognize expenses and liability for those customers and here it s financial statements would understate liability and expenses.
Implications:
Before qualifying the conclusion auditor should communicate this to management or audit committee to require an adjustment. If this is not made then auditors should modified his/her conclusion like Based on our review, with the exception of the matter described in the previous paragraph, nothing has come to our attention that causes us to believe that the accompanying interim financial information does not give a true and fair view. Before qualification of opinion auditors should include the reasons about qualification in the basis of opinion paragraph which is before the actual opinion paragraph. Auditors would also consider whether to resign as an auditor for both review engagement and audit engagement if the above adjustments are not made.
Prospective financial information Chapter 2 June2012 Q2(a)

(a) You are a manager in Lapwing & Co. One of your audit clients is Hawk Co which operates commercial real estate properties typically comprising several floors of retail units and leisure facilities such as cinemas and health clubs, which are rented out to provide rental income. Your firm has just been approached to provide an additional engagement for Hawk Co, to review and provide a report on the companys business plan, including forecast financial statements for the 12-month period to 31 May 2013. Hawk Co is in the process of negotiating a new bank loan of $30 million and the report on the business plan is at the request of the bank. It is anticipated that the loan would be advanced in August 2012 and would carry an interest rate of 4%. The report would be provided by your firms business advisory department and a second partner review will be conducted which will reduce any threat to objectivity to an acceptable level. Extracts from the forecast financial statements included in the business plan are given below: Statement of profit or loss (extract) Note FORECAST 12 months to 31 May 2013 $000 Revenue UNAUDITED 12 months to 31 May 2012 $000
Operating expenses Operating profit

Profit on disposal of Beak Retail Finance costs Profit before tax
25,000 (16,550) 8,450 4,720 (2,650) 10,520
20,600 (14,420) 6,180 (1,690) 4,490
Statement of financial position FORECAST 31 May 2013 $000 Assets Non-current assets Property, plant and equipment Current assets Inventory Receivables Cash and cash equivalents Total assets Equity and liabilities Equity Share capital Retained earnings Total equity Non-current liabilities Long-term borrowings Deferred tax Current liabilities Trade payables Total liabilities Total equity and liabilities Notes: 1. Beak Retail is a retail park which is underperforming. Its sale is currently being negotiated, and is expected to take place in September 2012. 2. Hawk Co is planning to invest the cash raised from the bank loan in a new retail and leisure park which is being developed jointly with another company, Kestrel Co. 5,600 138,100 336,500 5,400 107,900 300,500 105,000 93,400 198,400 100,000 92,600 192,600 500 3,600 2,250 6,350 450 3,300 3,750 7,500 UNAUDITED 31 May 2012 $000
330,150
293,000
82,500 50,000
52,500 50,000
Required: In respect of the engagement to provide a report on Hawk Cos business plan: (i) Identify and explain the matters that should be considered in agreeing the terms of the engagement; and Note: You are NOT required to consider ethical threats to objectivity. (6 marks) (ii) Recommend the procedures that should be performed in order to examine and report on the forecast financial statements of Hawk Co for the year to 31 May 2013. (13 marks)
Answer to June2012 Q2(a) (a) you can add other points such as time to finish, time to build up knowledge, fees calculation, report to whom, follow which standards etc. Managements responsibilities It should set out managements responsibilities for the preparation of the business plan and forecast financial statements, including all assumptions used, and for providing the auditor with all relevant information and source data used in developing the assumptions. This is to clarify the roles of management and of Lapwing & Co, and reduce the scope for any misunderstanding. The intended use of the business plan and report It should be confirmed that the report will be provided to the bank and that it will not be distributed or made available to other parties. This will establish the potential liability of Lapwing & Co to third parties. The period covered by the forecasts This should be confirmed when agreeing the terms of the engagement, as assumptions become vague as the length of the period covered increases, eg, it should confirm whether a 12-month forecast period is sufficient for the banks purposes. The planned contents of the assurance report It should confirm the planned elements of the report avoid any misunderstanding with management. Eg, Lapwing & Co should clarify that their report will contain a statement of negative assurance as to whether the assumptions provide a reasonable basis for the prospective financial information, and an opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented according to the relevant financial reporting framework.
(b) General procedures Re-perform calculations to confirm the accuracy of the forecast financial statements. Agree the unaudited figures for the period to 31 May 2012 to management accounts, and agree the cash figure to bank statement or bank reconciliation. Confirm the consistency of the accounting policies used in the preparation of the forecast financial statements with those used in the last audited financial statements. Consider the accuracy of forecasts prepared in prior periods by comparing with actual results and discuss with management the reasons for any significant variances. Forecasted statement of profit or loss Discuss the reason for the 214% increase in revenue with management to verify its reasonableness. Discuss the reason for the increase in operating profit with management from 30% to 33.8% to verify its reasonableness. Request confirmation from the bank of the potential terms of the $30 million loan being negotiated, to confirm the interest rate is at 4%. Review relevant board minutes regarding the sale of BREAK RETAIL, to obtain understanding of the likelihood of the sale, and the main terms of the sale negotiation. Forecasted statement of financial position Agree the increase in property, plant and equipment to an authorised capital expenditure budget. Discuss the planned increase in equity with management to understand the reason for any planned share issue,its date and the nature of the share issue, ie, issue at full market price. Review a forecast statement of changes in equity to ensure that movements in retained earnings appear reasonable given forecasted profit is $10.52m but theres just an increase in retained earnings of $800,000 so there must be a planned to pay out dividend. Agree the increase in long-term borrowings to documentation relating to the new loan. Discuss the deferred tax liability with management to understand why no movement on the balance is forecast given theres a planned increase in capital expenditure.
Due diligence review Chapter 2 June2008 Q2

Rosie Co is the parent company of an expanding group of companies. The groups main business activity is the manufacture of engine parts. In January 2008 the acquisition of Dylan Co was completed, and the group is currently considering the acquisition of Maxwell Co, a large company which would increase the groups operating facilities by around 40%. All subsidiaries are wholly owned. The group structure is summarised below: Rosie Co Timber Co Acquired Jan 2001 Ben Co Acquired July 2005 Dylan Co Acquired Jan 2008
You are an audit manager in Chien& Co, a firm of Chartered Certified Accountants, and you are reviewing the working papers completed on the final audit of Rosie Co and the Rosie Group for the year ended 31 January 2008. Your firm has audited all current components of the group for several years, but the target company Maxwell Co is audited by a different firm. The management of Rosie Co has provided the audit team with some information about Maxwell Co to aid business understanding, but little audit work is considered necessary as the acquisition, if it goes ahead, will be after the audit report has been issued. Information provided includes audited financial statements for the year ended 31 January 2008, an organisational structure, several customer contracts, and prospective financial information for the next two years. This seems to be all of the information that the directors of Rosie Co have available. The finance director, Leo Sabat is hoping that the other directors will agree that an externally provided due diligence investigation should be carried out urgently, before any investment decision is made, however the other directors feel this is not needed, as the financial statements of Maxwell Co have already been audited. Leo has asked you to prepare a report to explain to the other directors the purpose of due diligence, and the difference between due diligence and an audit of financial statements, which will be presented at the next board meeting.
Goodwill on the acquisition of Dylan Co is recognised in the consolidated statement of financial position (balance sheet) at $750,000. The calculation provided by the client is shown below:
$000
Cost of Investment: Cash consideration Deferred consideration payable 31 January 2009 Contingent consideration payable 31 January 2012 if Dylan Cos revenue grows 5% per annum Net assets acquired Goodwill on acquisition 2,500 1,500 1,000 5,000 (4,250)
750
All of the figures in the schedule above are material to the financial statements of Rosie Co and the Rosie Group. Required: (a) Prepare a report to Leo Sabat (the finance director), in which you should: (i) Describe the purpose, and evaluate the benefits of a due diligence investigation to the potential purchaser of a company; and (10 marks) (ii) Compare the scope of a due diligence investigation with that of an audit of financial statements. (4 marks) Note: requirement (a) includes 2 professional marks.
Answer to June2008 Q2 (a) Report To: finance director From: auditor Date: exam date Subject: due diligence Introduction: The report details the objective and benefit of due diligence review as well as the comparison between it and audit. (i) purpose and benefit of due diligence Management representation By conducting such a due diligence investigation the management representation can be reviewed for its reasonableness. Eg, if the management representation said, the company isnt involved in the tax investigation and by conducting due diligence review we can subsequently find whether this representation is true. Information gathering By conducting such a due diligence investigation and gathering enough information as to whether or not to acquire the company any potential problems can be revealed. Reduce management involvement By allowing external audit firm to do the service then the management may save a lot of time by not checking the numbers themselves but focus more on their core operation of the business. Reveal operational problems By conducting due diligence review operational issues such as high rate of labour turnover can be revealed and it may help to form the decision by company of whether or not going to acquire this company. Increase confidence of investment decision By conducting due diligence this will increase shareholders confidence and investment decision to make subsequent acquisition easier.
Reveal assets and liabilities By conducting due diligence it will reveal potential liability such as contingent liability which may help company negotiate the price for the acquisition. Also goodwill and other intangible assets are not recognized separately in the financial statement but by conducting due diligence review the assets can be revealed as well. (ii) Comparison between due diligence investigation and audit Time Due diligence here relates to purchase another company so it may require it to be completed as soon as possible. The audit of financial statement may take a couple of months to complete. Assurance The due diligence review provides negative assurance or its just an agreed upon procedures, ie, checking what client asks for. Audit of financial statement would require positive assurance given and this requires auditors should follow ISA to do the audit work. Direction Due diligence requires forward looking by identifying any potential problems exist with the target company. Audit of financial statement requires backwards looking to identify any material misstatement in the financial statements. Systems Due diligence does not require auditors to test the client system. Audit assurance service would require auditors to test client system because this forms a basis of whether auditors would use system based approach to audit or full substantive testing approach. Conclusion Since due diligence provides a lot of benefit so you can reasonably consider that to happen before purchasing the target company.
Forensic audit Chapter 2 DEC2008 Q2

(a) Define the following terms: (i) Forensic Accounting; (ii) Forensic Investigation; (iii) Forensic Auditing. (6 marks) You are a manager in the forensic investigation department of your audit firm. The directors of a local manufacturing company, Crocus Co, have contacted your department regarding a suspected fraud, which has recently been discovered operating in the company, and you have been asked to look into the matter further. You have held a preliminary discussion with Gita Thrales, the finance director of Crocus Co, the notes of this conversation are shown below: Notes of discussion with Gita Thrales Four months ago Crocus Co shut down one of its five factories, in response to deteriorating market conditions, with all staff employed at the factory made redundant on the date of closure. While monitoring the monthly management accounts, Gita performs analytical procedures on salary expenses. She found that the monthly total payroll expense had reduced by 3% in the months following the factory closure not as much as expected, given that 20% of the total staff of the company had been made redundant. Initial investigations performed last week by Gita revealed that many of the employees who had been made redundant had actually remained on the payroll records, and salary payments in respect of these individuals were still being made every month, with all payments going into the same bank account. As soon as she realised that there may be a fraud being conducted within the company, Gita stopped any further payments in respect of the redundant employees. She contacted our firm as she is unsure how to proceed, and would like our firms specialist department to conduct an investigation. Gita says that the senior accountant, Miles Rutland, has been absent from work since she conducted her initial investigation last week, and it has been impossible to contact him. Gita believes that he may have been involved with the suspected fraud. Gita has asked whether your department would be able to provide a forensic investigation, but is unsure what this would involve. Crocus Co is not an audit client of your firm.
Required: (b) (i) Describe the objectives of a forensic investigation; and (ii) Explain the steps involved in a forensic investigation into the payroll fraud, including examples of procedures that could be used to gather evidence. (11 marks) (c) Assess how the fundamental ethical principles of IFACs Code of Ethics for Professional Accountants should be applied to the provision of a forensic investigation service. (6 marks) (23 marks)
Answer to Dec2008 Q2: (a) (i) Forensic accounting Forensic accounting uses investigative and auditing techniques to examine on the clients financial statements which would be used in court. Forensic accounting includes both forensic investigation ad forensic auditing. Forensic investigation A forensic investigation is a process whereby a forensic accountant carries out procedures to gather evidence. This involves planning stage, testing stage, review stage and report produced. Forensic auditing Forensic auditing is the specific use of audit procedures within a forensic investigation to gather evidence. This could include performing analytical procedure to determine the amount of an insurance claim. (b) (i) Fraud happened It should make sure that this is a fraud, ie, ghost employee not a mistake made within company. Obtain evidence Forensic investigation should obtain sufficient and appropriate evidence whether or not there are employees grouping together to commit the fraud. Prosecute the perpetrator This would involve interviewing with the suspected fraudster and if they are proved to commit the fraud then company should prosecute them. Quantify economic losses The investigation should quantify the financial loss suffered by Crocus Co as a result of the fraud which shows a detailed amount suffered by the firm.
(ii) Type of fraud Forensic investigation would firstly identify the types of fraud and in this case its ghost employee happened, eg, employee who has left company but still getting paid. How the fraud happened Forensic investigation would walk through the internal control system to see how the fraud would have happened. For example, there should be a control procedure to ensure that any amendments made to payroll data must be approved by a senior manager and its likely that this is breached. Evidence gathering The investigation needs to gather sufficient and appropriate evidence of a fraud has happened, who committed the fraud and the economic losses as well. For example forensic accountant would discuss with management relating to the fraud. Investigative skills This is to establish how the controls that should have been operating in the payroll system were breached. Skills would include: Review of authorisation of monthly payroll. Interview with the suspect(s), with the aim of extracting a confession Report produced This summarisesthe number of perpetrators and the losses suffered by company. Expert witness The investigator would likely be the expert witness to present the above findings in court and they may be asked questions regarding the investigation performed. Advice The investigator would give advice to company of how to avoid the same problems happening in the future by improving its internal control system.
(C) Professional behaiour Its likely that forensic investigation would be a matter of public interste and much of the media are focusing on this so forensic accountant should have a highly professional attitude towards this to avoid damanage the reputation of firm. Integrity The forensic accountant should not lie to court and his client and should remain highest integrity when carrying out the work. Competence and due care Forensic accountant should have cumulative knowledge in audit and in this area to carry out the work and they should follow reconigsed standards to do the work as well. Confidentiality During the court forensic accountant is required by the court to reveal information discovered during the investigation. But outside the court forensic accountant should remain faultless confidentiality by not disclosing clients information without its permission. Objectivity The outcome of the forensic investigation must be perceived as objective because it forms part of the legal evidence presented at court. The selfreview threat may arise because the investigation is likely to involve the estimation of an amount (i.e. the loss) and then forensic accountant find out whether this is true.
Social and environmental audit DEC2008 Q1(C)

A new internal auditor, Daisy Rosepetal, has recently joined Bluebell Co. She has been asked by management to establish and to monitor a variety of social and environmental Key Performance Indicators (KPIs). Daisy has no experience in this area, and has asked you for some advice. It has been agreed with Bluebell Cos audit committee that you are to provide guidance to Daisy to help her in this part of her role, and that this does not impair the objectivity of the audit. Recommend EIGHT KPIs which could be used to monitor Bluebell C os social and environmental performance, and outline the nature of evidence that should be available to provide assurance on the accuracy of the KPIs recommended. Your answer should be in the form of briefing notes to be used at a meeting with Daisy Rosepetal. (12 marks) Note: requirement (g) includes 4 professional marks.
Answer to DEC2008 Q1(c): Briefing note To: Bluebell co From: Auditor Date: exam date Subject: KPI Introduction: This briefing note will detail eight KPI and nature of evidence relating to KPIs. KPIs
Social-employees
Nature of evidence
Personnel files will show this leavers documentation from payroll records
% female employees accounts for total number of staff Reduction in Staff turnover of 25% from last year to this year
Social customers
Increase in Customer satisfaction rates of 30% with service provided from last year to this year Increase in Level of repeat bookings of 15% from last year to this year Decrease in level of complaints by customer by 20% from last year to this year.
Social community
Surveys or questionnaires completed by customers Customer account details from the sales system would indicate multiple bookings. Management log book of complaints received
Increase in donation of 35% from last year to this year expressed as value/profit.
Environment
Cash book will show value of any donations
35% decrease in water use from last year to this year. 35% decrease in carbon footprint from last year to this year.
Comparison of utilities costs using suppliers bills received. Board authorization of any payments made for carbon footprint.
Conclusion: Its very important to quantify every KPIs measures and keep control over them.
June2012 Q2(b)(ii): social and environmental audit

(b) You are also responsible for the audit of Osprey Co, which has a financial year ended 31 May 2012. The audit engagement partner, Bill Kingfisher, sent you the following email this morning: To: Audit manager From: Bill Kingfisher, audit engagement partner, Osprey Co Regarding: Environmental incident Hello Osprey Cos finance director called me yesterday to explain that unfortunately over the last few weeks, one of its four factories leaked a small amount of toxic chemicals into the atmosphere. The factorys operations were halted immediately and a decision has been taken to permanently close the site. Though this is a significant event for the company and will result in relocation and some restructuring of operations, it is not considered to be a threat to its going concern status. Costs of closure of the factory have been estimated to be $125 million, which is expected to be material to the financial statements, and a provision has been set up in respect of these costs. Osprey Co is keen to highlight its previous excellent record on socio-environmental matters. Management is preparing a report to be published with the financial statements which will describe the commitment of the company to socio-environmental matters, and state its target of reducing environmental damage caused by its operations. The report will contain a selection of targets and key performance indicators to show performance in areas such as energy use, water consumption and employee satisfaction. Our firm may be asked to provide an assurance report on the key performance indicators. I am asking you to prepare briefing notes for my use in which you: (ii) Discuss the difficulties in measuring and reporting on environmental and social performance. (4 marks) Thank you.
Answer to June2012 Q2(b) (ii): (ii) Measuring and reporting on social and environmental performance It is difficult to measure social and environmental performance for a number of reasons. Firstly, targets and KPIs are not always precisely defined. For example, Osprey Co may state a target of reducing environmental damage caused by its operations, but this is very vague. Secondly, targets and KPIs may be difficult or impossible to quantify, with Osprey Cos planned KPI on employee satisfaction being a good example. Thirdly, systems and controls are often not established well enough to allow accurate measurement, and the measurement of socio-environmental matters may not be based on reliable evidence. In Osprey Co it may not be possible to quantify how much toxic chemical has been leaked from the factory. Finally, It will also be difficult to make year on year comparisons for the same company, as targets may change in response to business activities. For example, if Osprey Co were to expand its operating, its energy and water use would increase, making its performance on environmental matters look worse.
Chapter 2 DEC2010 Q2(b) social and environmental audit
(b) Recommend procedures that could be used to verify the following draft KPIs: (i) The number of serious accidents in the workplace; and (ii) The average annual spend on training per employee. (6 marks)
Answer to DEC2010 Q2(b)
(i) (only 3points required) Review number and type of accidents in the workplace records held by human resources department. Review the accident log book for the location. Discuss the definition of a serious accident and establish criteria applied to an accident to determine whether it is serious. Review minutes of board meetings for discussions of any serious accidents.
(ii) Review Eastwood Cos approved training budget comparing to previous years to ascertain the overall level of planned spending on training. Agree significant components of the total training spend to supporting documentation such as contracts and invoice with training providers. Agree the total amount spent on training programmes to cash book and bank statements.
Chapter3 Current Issues

In this session we will be going through: 1. Joint audit where 2 or more firms perform audit services to clients company and they would have same responsibility to the opinion. 2. Transnational audit where the audited financial statements would be used by shareholders in the foreign country for raising money and legal purposes. 3. Audit guidance would include rules based to audit and if this is the case auditors need to follow detailed rules in every situations with no judgment. Another one would be principle based to audit where auditors follow the regulatory framework to audit rather than detailed rules and hence auditors would use their judgment in different situations for different clients. 4. Audit for small company would have its own advantages and disadvantages. Advantages would be to utilize expertise to help business growth by accepting advice from audit firm but the biggest disadvantage would be its very expensive for the small audit firm to have such audit services. 5. How to increase the auditors independence? Solution would include things like auditors rotation like key audit partners for one client should be rotated every 7 years. 6. Auditors liability. How auditors liability arises? 1.Auditors knows who use it and their plan. For example they know shareholders would use the audit report to make their investment decision so they are liable to shareholders. But if auditors dont know who are going to use their audit report and their plan then surely they are not liabile to those guys. 2. Auditors have done a poor quality work(negligence). 3. Users of the audit report would lose money as a result of using the audit report. If the above criteria are fulfilled then auditors are liable to those ones. Next question is how to minimize the liability? They can use: Disclaimers; Professional indemnity insurance (PII); Joint audit; Quality control.
Chapter3 June2009 Q2(d) transnational audit

The Dragon Group is a large group of companies operating in the furniture retail trade. The group has expanded rapidly in the last three years, by acquiring several subsidiaries each year. The management of the parent company, Dragon Co, a listed company, has decided to put the audit of the group and all subsidiaries out to tender, as the current audit firm is not seeking re-election. The financial year end of the Dragon Group is 30 September 2009. You are a senior manager in Unicorn & Co, a global firm of Chartered Certified Accountants, with offices in over 150 countries across the world. Unicorn & Co has been invited to tender for the Dragon Group audit (including the audit of all subsidiaries). You manage a department within the firm which specialises in the audit of retail companies, and you have been assigned the task of drafting the tender document. You recently held a meeting with Edmund Jalousie, the group finance director, in which you discussed the current group structure, recent acquisitions, and the groups plans for future expansion. Meeting notes Dragon Group Group structure The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the subsidiaries are located in the same country as the parent, and half overseas. Most of the foreign subsidiaries report under the same financial reporting framework as Dragon Co, but several prepare financial statements using local accounting rules. Acquisitions during the year Two companies were purchased in March 2009, both located in this country: (i) Mermaid Co, a company which operates 20 furniture retail outlets. The audit opinion expressed by the incumbent auditors on the financial statements for the year ended 30 September 2008 was qualified by a disagreement over the non-disclosure of a contingent liability. The contingent liability relates to a court case which is still on-going. (ii) Minotaur Co, a large company, whose operations are distribution and warehousing. This represents a diversification away from retail, and it is hoped that the Dragon Group will benefit from significant economies of scale as a result of the acquisition.
Other matters The acquisitive strategy of the group over the last few years has led to significant growth. Group revenue has increased by 25% in the last three years, and is predicted to increase by a further 35% in the next four years as the acquisition of more subsidiaries is planned. The Dragon Group has raised finance for the acquisitions in the past by becoming listed on the stock exchanges of three different countries. A new listing on a foreign stock exchange is planned for January 2010. For this reason, management would like the group audit completed by 31 December 2009.
Required: (d) (i) Define transnational audit, and explain the relevance of the term to the audit of the Dragon Group; (3 marks) (ii) Discuss TWO features of a transnational audit that may contribute to a high level of audit risk in such an engagement. (4 marks)
Answer to June2009 Q2 (d): (d) (i) Definition: Transnational audit is the audit of clients financial statement which would be relied on by investors outsider the home country for the purpose of raising finance, investment or regulatory issues. Relevance: Because Dragon is seeking listed on the stock exchange and clearly its audited financial statement would be used by investors outside the home country so this is a transnational audit. (ii) Features: Application of ISAs For some countries they are using their own auditing standards and these may be different from ISAs and hence when auditing those countries risks arises because different rules exist, ie, ISA requires to gain an understanding of client first to better identify risks within clients company while local auditing standards may not include this. Corporate governance rules In some countries there are very prescriptive corporate governance requirements, which the auditor must consider as part of the audit process. In this case the auditor may need to carry out extra work over and above local requirements in order to ensure group wide compliance with the requirements of the jurisdictions relevant to the financial statements. However, in some countries there is very little corporate governance regulation at all and controls are likely to be weaker than in other components of the group. Control risk is therefore likely to differ between the various subsidiaries making up the group.
Chapter3 DEC2009 Q4 As a result of the International Audit and Assurance Standards Boards Clarity Project, many revised and redrafted ISAs that have been issued will become effective for audits of financial statements for periods beginning on or after 15 December 2009. One of the objectives of the Clarity Project is to clarify mandatory requirements. This has been done by changing the wording used in the ISAs to indicate requirements which are expected to be applied in all audits. Some argue that this will introduce a more prescriptive (rules-based) approach to auditing, and that a principles-based approach is more desirable. Required: (i) Contrast the prescriptive and the principles-based approaches to auditing; and (2 marks) (ii) Outline the arguments for and against a prescriptive (rules-based) approach to auditing. (5 marks)
Answer to DEC2009 Q4:

(i) Prescriptive based to audit means auditor must follow detailed rules during the audit in every situations. Principle based to audit means auditors would follow a regulatory framework during the audit and auditors would have a choice of how to apply the rules in different situations. (ii) For: Because rules based to audit then auditors must follow detailed rules and hence this will improve clarity of auditing standards. This will improve audit quality as well since auditors follow all of the rules during the actual audit. Against: This will lead to over or under auditing because for small companies their transactions are relatively simple and hence there is no need to carry out a variety of procedures but just focus on those simple transactions. Under auditing means for some business because auditors just follow the rules and they may ignore to perform additional procedures to audit some more risky balances. Lack of judgment in auditing would lower down the audit quality as well because the rules are not applicable to every client.
June2008 Q2(c) Joint Audit

Maxwell Co is audited by Lead & Co, a firm of Chartered Certified Accountants. Leo Sabat has enquired as to whether your firm would be prepared to conduct a joint audit in cooperation with Lead & Co, on the future financial statements of Maxwell Co if the acquisition goes ahead. Leo Sabat thinks that this would enable your firm to improve group audit efficiency, without losing the cumulative experience that Lead & Co has built up while acting as auditor to Maxwell Co. Required: Define joint audit, and assess the advantages and disadvantages of the audi t of Maxwell Co being conducted on a joint basis. (7 marks)
Answer to June2008 Q2(c):
Definition: This means two or more audit firms would have the same responsibility in giving the audit opinion to the financial statements. Advantages: This will help two firms get together and build up knowledge of the new subsidiary especially for the high risk areas they have identified before. Two firms working together would mean resources would be shared and hence make audit more efficient and audit opinion given with better quality. Allowing two or more firms to work together and it should better complete the work before the deadline. Allowing two or more firms to work together and this would enable a new blood into the audit meaning this will help auditors find out more risky areas by holding a discussion among audit firms and hence increase the overall opinion given. Disadvantages: Its more expensive for client to pay these two audit firms rather than just one. Two audit firms would have different approaches to audit especially in materiality determination, risk assessment and actual substantive procedures and hence its difficult for them to work together effectively. When professional negligence happens then both audit firms would suffer equal liability and they may blame each other for negligence and making the litigation process more complicated as a result.
Chapter3 Q5 DEC2010 Neeson&Co(b) Q4

(b) You have set up an internal discussion board, on which current issues are debated by employees and partners of Neeson& Co. One posting to the board concerned the compulsory rotation of audit firms, whereby it has been suggested in the press that after a pre-determined period, an audit firm must resign from office, to be replaced by a new audit provider. Required: (i) Explain the ethical threats created by a long association with an audit client. (3 marks) (ii) Evaluate the advantages and disadvantages of compulsory audit firm rotation. (4 marks) (20 marks)
Answer to Dec2010 Q4(b): (i) Familiarity threat would be created because of the long association with audit client and this would be a threat to objectivity because auditors would lose professional skepticism when doing the audit, ie, failure to challenge the client. So key audit partners are required to be rotated every 7 years. Self-interest threat may arise to objectivity because auditors may become sympathetic to their clients interest after the long association with client. (ii) Advantages: It would eliminate the familiarity threat. By not only rotating the key partner, but the entire audit firm, it is argued that the auditors independence is not compromised, and that this adds credibility to auditors reports and to the profession as a whole. It can also be argued that clients would benefit from a fresh pair of eyes after a number of years. A new audit fi rm can offer different insights from a fresh point of view. Disadvantages: From the audit firms perspective, there will be a loss of fee income when forced to resign as auditor. Compulsory rotation undermines this accumulation of knowledge and experience and hence new audit firm will have to spend more time into auditing the client and hence it's more expensive to the client as well.
Chapter3 June2010 Q5(b) Auditors liability

(b) You are also responsible for providing direction to more junior members of the audit department of your firm on technical matters. Several recent recruits have asked for guidance in the area of auditors liability. They are keen to understand how an audit firm can reduce its exposure to claims of negligence. They have also heard that in some countries, it is possible to restrict liability by making a liability limitation agreement with an audit client. Required: (i) Explain FOUR methods that may be used by an audit firm to reduce exposure to litigation claims; (4 marks) (ii) Assess the potential implications for the profession, of audit firms signing a liability limitation agreement with their audit clients. (6 marks)
Answer to June2010 Q5(b): (b) (i) Disclaimers audit firms can include a disclaimer paragraph in the audit report. This is an attempt to restrict the duty of care of the audit firm to the shareholders of the company, thereby attempting to restrict legal liability to that class of shareholders. Professional indemnity insurance (PII) Auditors can buy the PII before providing the audit service in case something goes wrong then company can reimburse the expense from insurance company. Joint audit By engaging two audit firms to do the audit because they have same responsibility in giving the audit opinion so this reduce the risk exposure to litigation claims if it happened. Quality control Firms must ensure they have sufficient quality control procedures to do the audit and document the work, ie, staff would follow ISAs to do the work and so this would reduce the risk to litigation cliam. (ii) Audit quality Auditors could become less concerned with the quality of their work, in the knowledge that if there was a claim against them, the financial consequences are limited. Value of the audit opinion And once of the consequences would be users of the financial statements will place less reliance on the audit opinion, resulting in less credible financial statements. Reduction on audit fees Firms may be under pressure from clients to reduce their audit fees if the risk exposure is reduced. Reduce competition The ability to set a cap on auditors liability could distort the audit market because bigger audit firms may have the ability to set a high cap, which creates a disadvantage to smaller audit firms.
Congratulations! You have completed ACCA P7 Advanced Audit&Assurance(INT) study. I hope you find this course useful to you both in Exams and Real life working as an auditor. Please go to revision phase now practicing more past exam questions with us and the key to pass this paper is not only practicing them with us but also do them under exam condition on your own and compare to our tutors answer. Good luck with your future study. Steve

p7 Tuition Study Note DEC2013

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ACCA P7 ADVANCED AUDIT & ASSURANCE

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CHAPTER2 PERFORM AN ENGAGEMENT SERVICE:........................ 38

Chapter2 Q7: 6,IAS10 Events after the Reporting Period .......................... 71

Chapter2 Q7: 7,IAS 11 Construction Contracts ........................................ 75

Chapter2 Q7: 8,IAS12 Income Taxes ..................................................... 79

Chapter2 Q7: 11,IAS 18 Revenue .......................................................... 94

Chapter2 Q7: 12,IAS 19 Employee Benefit ............................................. 97

Chapter2 Q7: 15,IAS 23 Borrowing Costs ............................................. 106

Chapter2 Q7: 16,IAS 24 Related Party Transactions .............................. 110

Chapter2 Q7: 17,IAS28 Investments in Associates ................................ 116

Chapter2 Q7: 18, Financial instruments IAS32,37,39 IFRS9 ................... 119

Chapter2 Q7: 19,IAS33 Earnings Per share .......................................... 127

Chapter2 Q7: 21,IAS 36 Impairment of Assets ...................................... 131

Chapter2 Q7: 23,IAS38 Intangible Assets ............................................. 141

Chapter2 Q7: 24, IAS40 Investment Property ....................................... 147

Chapter2 Q7: 25, IFRS2 Share-based Payment ..................................... 152

Chapter2 Q7: 27, IFRS8 Operating Segments ....................................... 165

Chapter2 Q7 :28, IFRS10,11,12 .......................................................... 169

Chapter2 Q7 :29, IFRS13 Fair Value Measurement ................................ 173

Chapter2Group audit ............................................................................................................ 176

June2012 Q1(a(i+iii)): Group audit ............................................................... 177

STAGE 5 OF AUDIT FLOWCHART ................................................ 181

STAGE 6 AUDIT REPORT ............................................................ 193

NON AUDIT ENGAGEMENT SERVICES......................................... 199

CHAPTER3 CURRENT ISSUES ..................................................... 221

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Chapter1Before the engagement services:

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Chapter 1 (June 2004)Hawk Assocaite

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Chapter 1 tendering+Fees (June09 Q2)

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Answer to DEC2007 Q1(c):

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An external review service may be purchased.

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Chapter2 Perform an engagement service:

Chapter 2 Q1: What does an audit flowchart look like?

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