ZAMBIA INSTITUTE OF CHARTERED ACCOUNTANTS CHARTERED ACCOUNTANTS EXAMINATIONS PROFESSIONAL LEVEL P4: AUDIT AND ASSURANCE SERIES: DECEMBER

2012 TOTAL MARKS: 100 TIME ALLOWED: THREE (3) HOURS INSTRUCTIONS TO CANDIDATES 1. You have fifteen (15) minutes reading time. Use it to study the examination paper carefully so that you understand what to do in each question. You will be told when to start writing. This paper is divided into TWO sections: Section A: Section B: 3. One compulsory question. Four Optional Questions. Attempt any three (3).

2.

Enter your student number and your National Registration Card number on the front of the answer booklet. Your name must NOT appear anywhere on your answer booklet. Do NOT write in pencil (except for graphs and diagrams). The marks shown against the requirement(s) for each question should be taken as an indication of the expected length and depth of the answer. All workings must be done in the answer booklet. Present legible and tidy work. Graph paper (if required) is provided at the end of the answer booklet.

4. 5. 6. 7. 8.

SECTION A
QUESTION ONE This question is compulsory and must be attempted. You are the Audit Manager of Small & Large Chartered Accountants an audit firm with three offices in the country and a total number of five partners. Heavy Equipment Supplies Plc is one of your recently acquired clients. Heavy Equipment Supplies is based in Kitwe and the company supplies earthmoving equipment largely to the mines. The company imports heavy equipment spares and assembles heavy duty equipment at its assembly plant in Kitwe. You are currently planning the audit of the financial statements for the year ended 31 December 2011. Your firm was appointed as auditor of Heavy Equipment Supplies for the first time in July 2011. The following figures were extracted from the financial statements of Heavy Equipment Supplies: 2011 Km 673 750 13 475 30 184 2010 Km 555 170 12 936 27 489

Revenue Warranty provision Profit before tax

Heavy Equipment Supplies assembles equipment for its customers on receipt of a signed contract from the customer. On average it takes the company three months to finish assembling each unit. The company does not wish to stock finished equipment which has no customer and, therefore, has a policy that on signing the contract of sale, the customer makes a 50% down payment and the balance is due one month after delivery of the equipment. The company raises sales invoices for the initial deposit amount received and a final invoice is raised at the time of delivery. At 31 December 2011, there is an amount outstanding of K243million from Mukuba Mines one of the customers of Heavy Equipment Supplies. The amount is in relation to the final payment after delivery of the equipment. The mine has refused to pay this amount because the equipment supplied did not meet the specification requested by the mine and was not performing to expectation. Mugodi Mine another one of Heavy Equipment Suppliess customers, in November 2011, lodged a claim against the company for an accident involving equipment recently supplied to it which resulted in the injury of the operator. Investigations by Mugodi mine suggest that the accident was as a result of poor workmanship on the part of Heavy Equipment Supplies Plc. You have been told by the Chief Executive of Heavy Equipment Supplies that they have not made any provision for damages because this is not the first time that Mugodi Mine has had an accident.

On 31 December 2011, Heavy Equipment Supplies had equipment being assembled and this is classified as work in progress. The valuation of work in progress is undertaken by the Chief Engineer of Heavy Equipment Supplies Plc. At the year end the company owed a foreign supplier for parts and components that it had ordered and not yet paid for. The amount owing and payable in US$ is $1.5m and the liability is included in payables at the kwacha equivalent of the original invoice value converted at the exchange rate on the date of receipt of the spares three months earlier. The company holds large quantities of spares and components used in the assembly of equipment. The inventory count of the materials was conducted seven days before the period end. The book record inventory value at the period end was used as the closing inventory value in the financial statements of Heavy Equipment Supplies at 31 December 2011. When equipment is sold to customers, it is supplied with a one year warranty. A warranty provision has been recognized in the statement of financial position amounting to the figures in the extract financial statements. The warranty provision is computed based on the sales made during the year and based on previous experience of claims made by customers. Heavy Equipment Supplies Plc. sells equipment to another company, Nshimbi Light Equipment Ltd, which is jointly owned with it. As on 31 December 2011, a total value of K121m was due from Nshimbi Light Equipment Ltd and this amount is included in the receivables figure and there is no other mention of this amount anywhere else in the financial statements. The reporting timetable for the group financial statements is tight and the Chief Executive of Heavy Equipment Supplies has indicated that you should finalize the audit by 28 January 2012 as the deadline for submission of financial statements to the group auditors is 5 February 2012. You feel this is a very tight timetable especially in view of the fact that this is the first year to audit Heavy Equipment Supplies Plc. Required: a) b) Discuss the reasons why your firm will concern itself with risk before undertaking the audit of the financial statements of Heavy Equipment Supplies Plc. (5 marks) Using the information given, identify and explain the principal audit risks, and any other matters to be considered when planning the final audit for Heavy Equipment Supplies Plc for the year ended 31 December 2011. (14 marks) Explain the audit procedures to be performed during the final audit in respect of the estimated warranty provision in the statement of financial position of Heavy Equipment Supplies Plc as at 31 December 2011. (5 marks) Identify and describe four (4) quality control procedures that can be applied to an individual audit engagement such as that of Heavy Equipment Supplies Plc. (8 marks)

c)

d)

e)

(i) (ii)

Discuss why the identification of related parties, and material related party transactions can be difficult for auditors. (4 marks) Recommend the audit procedures to be performed by your firm in relation to related party transactions. (4 marks) (Total: 40 marks)

SECTION B There are four questions in this section. Attempt any three questions only. QUESTION TWO a) Your firm CMM Chartered Accountants is the auditor of Salim Transport Plc a listed company on the Lusaka Stock Exchange (LUSE). Your firm has been the auditor of Salim Transport for the past five years and the audit for the year ended 30 September 2011 is about to be concluded. The following review points have been extracted from the current audit file of Salim Transport: 1) The company did not renew its license to transport dangerous goods for the year under review. It is a legal requirement that all transporters of dangerous goods obtain a license allowing them transport dangerous goods. Non compliance attracts heavy penalties and continued breach of this requirement can result in the withdrawal of the license to operate. The company obtained a loan to acquire a fleet of new trucks two years ago and due to the fact that the customer who necessitated the acquisition of new trucks has turned to using rail transport there has been a significant drop in revenue resulting in the company being in arrears in paying back the loan. The loan is secured on the tangible non current assets of the company. The most recent cash flow forecast shows that the company will be in deficit for the next fifteen months and it is considering obtaining a bridging loan from another bank which loan will be secured by a floating charge on the receivables of the company. On 30 September 2011 there is an ongoing court case where a former senior member of management has sued the company for wrongful dismissal. Management of Salim Transport is of the view that the company will be held liable and as such they have made a provision in the financial statements and this has been adequately disclosed as required.

2)

3)

4)

An extract of the Report of the Directors reads as follows: There are reasonable grounds to believe that the company will be able to pay its debts as and when they fall due. The engagement partner of this audit has not returned from a trip overseas and he has asked Chandra the audit manager to complete the review of the working papers and also draft the audit report based on the evidence obtained.

You are one of the partners of your firm and you have not been involved in the audit of Salim Transport. The engagement partner has requested you to review the audit file and make your review notes and pass them on to Chandra to resolve. Below is the full draft audit report prepared by the audit manager.
INDEPENDENT AUDITORS REPORT TO THE BOARD OF DIRECTORS OF SALIM TRANSPORT PLC Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of Salim Plc as at 30 September 2011 and its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards. Directors responsibility for the financial statements The directors of Salim Plc are responsible for the preparation and fair presentation of the financial statements in accordance with relevant legislation and laws. Other matter paragraph We wish to draw attention to note 10 of the financial statements which describes the uncertainty of the outcome of the legal suite filed against the company by one former employee who sued for wrongful dismissal. Our opinion is not qualified in respect of this matter.

Required: Evaluate whether the audit managers proposed audit report is appropriate, and if you disagree with the proposed report, state the amendments to the draft report. (8 marks) b) You are a firm of Chartered Accountants and the auditors of Luangwa Ltd. Luangwa Ltd. is a fast growing company which has grown largely through the acquisitions of medium size companies. Luangwa Ltd has resolved to acquire Kafue Ltd a company in the same industry as Luangwa Ltd. At a board meeting at which a final decision was to be made whether or not to go ahead with the acquisition, one of the independent non executive directors raised a concern about the viability of Kafue Ltd. The Board Chairman agreed with the independent board member and stated that the consequences of acquiring a company that might fail are high due to the huge amounts involved in an acquisition. There are audited financial statements for Kafue Ltd but the two directors are not comfortable with relying on these financial statements. The Chairman of the Audit Committee suggests that it will be in the interest of the shareholders if a due diligence investigation is carried out. He further suggests that the due diligence investigation should be conducted by independent auditors and not the existing auditors. He says that the current auditors may not disclose any issues that should have been picked by them in the previous audits for fear of being sued for professional negligence. The current auditors have issued unmodified audit reports in the last five years.

The management of Luangwa Ltd have requested your firm to prepare a briefing for the Board members to explain the meaning of a due diligence investigation and the benefits to Luangwa Ltd of having a due diligence investigation conducted before going ahead with the acquisition. Required: i. Discuss the measures that a firm of chartered accountants such as yours can take in order to restrict liability arising from being found guilty of professional negligence in the performance if its duties. (7 marks) Prepare notes for presentation to the Board of Luangwa Ltd in which you describe the purpose and evaluate the benefits of a due diligence investigation to Luangwa Ltd. (5 marks) (Total: 20 marks) QUESTION THREE Your firm, Financial Solutions Chartered Accountants has been offering consultancy services to Rex & Co Ltd for the past ten years. The services offered include the provision of internal audit services and the preparation of the financial statements of Rex & Co. You have been in charge of all the work carried out at Rex & Co. The income that Financial Solutions Chartered Accountants gets from the provision of the current non audit services is 13% of the total revenue of your firm. Another firm of accountants, Young & Partners has been providing external audit services to Rex & Co. Rex & Co has grown from a small company with two shareholders to one that has been listed on the Lusaka Stock Exchange. The financial year end of Rex & Co is 30 September and the financial statements for the year ended 30 September 2011 will be the second ones to be audited after obtaining the listing. It is now 20 October 2010 and Young & Partners have tendered their resignation as auditors of Rex & Company. They have indicated that they will not seek re election at the next AGM at which the financial statements for 2010 will be presented. The Managing Director of Rex & Co Ltd Pickson Grill is worried that the company will not have statutory auditors to audit the financial statements for the year ended 30 September 2011. Your firm has responded to the advertisement by Rex & Co for reputable firms of Chartered Accountants to offer audit services. Your firm has been shortlisted for consideration as auditors of Rex & Co. Pickson Grill has e mailed Chris Banda, the engagement partner, informing him of the fact that your firm has been shortlisted to be the auditors of Rex & Co. In his e mail, he has requested Chris to treat this as a matter of urgency and that he expects a response from Chris before the end of October 2010 so that the matter is taken to the Annual General Meeting slated for 15 November 2010.

ii.

Pickson has suggested that Chris immediately prepares an engagement letter and he has expressed his happiness that your firm will be the auditors because of the vast experience you have gained from the other services that you have been offering. He would like you to continue offering the other services as this will be cost effective for Rex & Co. Chris responded to the email from Pickson and sought for permission from him to communicate with Young & Partners before he could respond. Pickson responded in the negative and stated that there is no need for your firm to communicate with the outgoing auditors as they resigned of their own will and if Chris wanted he could obtain a copy of the letter of resignation from him. You receive the following e mail from Chris, the engagement partner, who is away in RSA on a business trip.
To: chintu@yahoo.com From: chrisbanda@yahoo.com Date: 27 October 2010 Subject: REX & CO AUDIT APPOINTMENT

Hi Chintu, remember the bid for audit services to Rex & Co that we submitted a few weeks ago. I have just received an e mail from Pickson the Managing Director of Rex & Co informing me that our firm has been shortlisted and that we need to respond and confirm our willingness to provide audit services to Rex & Company in a few days time. I will only be back in the office after the deadline and so please get the file for Rex & Co from my secretary and go through the correspondence. I would like to deal with all ethical and other matters that should be looked into before we reply. I will appreciate your early response to enable me send a reply to Pickson by close of business tomorrow. I have forwarded the e mail from Pickson to you for your information.

Chris.

Required: a) b) c) Discuss the ethical matters that you wish to bring to the attention of Chris to help him reply to the e mail from John. (10 marks) Describe four (4) possible matters that would have caused Young & Co to resign as auditors of Rex & Co. (4 marks) Recent years have seen an increasing debate on whether assurance providers should offer other services in addition to carrying out the statutory audit. In the United States the Sarbanes Oxley Act prohibits auditing firms from carrying out other services for their audit clients.

Required: Evaluate the arguments for and against the prohibition of auditors providing non audit services for their audit clients. (6 marks) (Total: 20 marks) QUESTION FOUR Your firm has just won a tender for the audit of the financial statements of Minsale Plc. Minsale Plc is in the agriculture and manufacturing industry. The company has its own sugar plantations in Kasama and also supports a number of small scale sugarcane growers through an out grower scheme. Under this scheme, Minsale Plc provides the inputs to the small scale farmers and then buys off the sugarcane from them. Your firm does not have auditing experience in the agriculture industry and specifically sugar plantations and the refining of sugar. Minsale Plc prepares its financial statements to 31 December and your firm is required to audit the financial statements for the year ended 31 December 2011. The audit of the financial statements of Minsale Plc is expected to commence in the first week of January 2012. You have just realized that you may experience a staff crisis because the contracts for three senior audit assistants are ending on 31 December 2011. They have just completed their mandatory three year attachment which is part of their professional training after completing the final examinations of the ZICA qualification. All three have been offered permanent jobs by a leading bank and they are not willing to take on a permanent job with your firm. To bridge the gap left by the three audit assistants your firm has recruited five recently qualified audit assistants. It is your intention that three out of these five newly recruited audit assistants will be assigned to the audit of Minsale Plcs financial statements. In addition to your having been appointed the audit manager for the Minsale audit, you are also the manager in charge of training in the office. At a recent training seminar held for new staff the following matters came up: 1. Chanda, one of the newly recruited audit assistants wanted to know the relevance and use of professional skepticism in the conduct of an audit such as that of Minsale Plc and he wants you to give him practical examples of the application of professional judgment in an audit. During the training, you emphasized the need for understanding the entity and its environment. You specifically mentioned the need to assess the integrity of management in order to satisfy yourselves that the management is not involved in fraudulent activities including money laundering. None of the trainees could show a good understanding of what money laundering is.

2.

Required: a) ISA 300(Redrafted) Planning an audit of financial statements states that the auditor shall plan the audit so that the audit is performed in an effective manner. (i) (ii) b) With particular reference to the audit of Minsale Plc, explain why it is important to plan for the forthcoming audit. (3 marks) State four (4) matters that you may wish to consider as you prepare the audit strategy of the audit of Minsale Plcs financial statements. (4 marks)

Arising from the training held: (i) (ii) Discuss the concern raised by Chanda. (4 marks)

Describe what is meant by money laundering and state the procedures specific to money laundering that should be considered before the acceptance of an audit appointment. (4 marks)

c)

The objective of the statutory auditors is to form an opinion on the financial statements of a client company. This is achieved by gathering sufficient appropriate audit evidence that the financial statements are not materially misstated. The gathering of evidence is by way of carrying out appropriate audit procedures to test the financial statement assertions made by management. Required: Discuss the above statement on financial statement assertions using any three (3) financial statement assertions pertaining to the figure of tangible non current assets in the statement of financial position. (5 marks) (Total: 20 marks)

QUESTION FIVE You are the audit manager in your firm of Chartered Accountants and you were assigned to the audit of Zambezi Ltd. This is the first time your firm is auditing the financial statements of Zambezi Ltd and the audit is about to be concluded. You are reviewing the working papers for the audit for the year ended 31 March 2010. The audit was supervised by Chansa who is audit senior in your firm. An extract of the figures for non current assets and revenue sections of the audit file contains the following information: 2010 K000 545 000 132 000 254 000 2009 K000 324 000 98 000 214 000

Revenue Profit before tax Property plant and equipment

You have made the following observations from a review of the working papers: 1. In the audit procedures for sales revenue you note that there is no evidence of work on cut off having been carried out. You are concerned about the 68% increase in revenue from 2009 to 2010. Chansa conducted a physical inspection of selected tangible non current assets for the purposes of testing the assertion of valuation of non current assets. You come across a note on the results of the physical inspections which states that equipment valued at K64m is in an unusable condition and based on his enquiries Chansa concluded that the equipment does not have any use to Zambezi Ltd. The recoverable amount for this equipment is estimated at K43m. The equipment was previously revalued and there is an amount of K9m relating to this equipment included in the balance of the revaluation account at the period end. 3. The schedule of uncorrected errors indicates that a total of K13m remains uncorrected at the conclusion of the audit. The performance materiality level for this audit is K15m and the Chief Finance Officer of Zambezi Ltd has refused to make corrections in the ledger and the financial statements. He is concerned that any correction of the errors will result in a reduction in the profit for the year. You observe that there is no evidence of any work performed on the opening balances for 2010. This is despite the fact that the previous years financial statements were not audited by your firm. Required: a) b) Describe what is meant by impairment and why companies such as Zambezi Ltd are required to conduct impairment reviews. (3 marks) Discuss the importance of reviews of audit working papers explaining how this is achieved in your firm of Chartered Accountants. (5 marks)

2.

4.

10

c)

For each of items 1 to 3 above, state your review points clearly stating the work that Chansa should perform and where relevant, possible action that should be taken if the matters remain unresolved at the conclusion of the audit. (8 marks) Discuss the importance and relevance of your firm performing audit procedures on the opening balances for 2010 clearly describing the audit procedures that should be conducted as required by ISA 510 Initial Audit Engagements Opening Balances (4 marks) (Total: 20 marks) END OF PAPER

d)

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P4 AUDIT AND ASSURANCE SUGGESTED SOLUTIONS

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SOLUTION ONE: a) Heavy Equipment Supplies Plc Why concern for risk of Heavy Equipment Supplies: The auditor carries out an audit with a view to forming an opinion on the financial statements. The auditor only tests a sample of items and concludes on the whole population based on the sample results. The auditor faces the risk that he may issue an inappropriate audit opinion at the conclusion of the audit. For example he may conclude that the financial statements of Heavy Equipment Supplies Plc show a true and fair view when in fact they do not and vice versa. The auditor can face litigation for giving an inappropriate audit opinion. It is therefore important that before carrying out an audit, the auditor carries out a risk assessment on the client entity. If the risk of giving an inappropriate audit opinion is too high and cant be reduced to acceptable levels then the auditor should decline the appointment or resign when he is already the auditor. Having assessed the risk the auditor: o Will decide whether or not to continue with the audit. o Will pay more attention to areas that are riskier. o Will assign staff with suitable skills and experience to audit the areas that are assessed as high risk. b) Principle audit risks of Heavy Equipment Supplies: The timing and recognition of revenue: Heavy Equipment Supplies Plc raises invoices and recognizes revenue at the time when customers pay the initial deposit on signing the sales contract. It takes approximately three months to complete the assembly of the equipment and deliver. There is a risk that at the period end there will be equipment not completed and delivered but for which deposits have been received and included in revenue for the current year as per company policy. IAS 18 Revenue requires that revenue of Heavy Equipment Supplies should only be recognized when the company has the right to receive it and this is when the company has performed its part of the contract. In this case this does not appear to be the case as regards equipment not delivered at the period end. According to IAS 18 the initial deposits received should be treated as a liability representing the obligation Heavy Equipment Supplies has under the contract. There is therefore a risk that revenue will be overstated and liabilities understated at the period end. Disputed accounts receivable of K243m The amount of K243m owed and disputed by Mukuba mines is material in the financial statements. There is a risk that the receivables balance is overstated in view of no impairment being recognized for this disputed amount. Legal claim of K219m by Mugodi Mine:

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This is a case that is in court at the period end and the fact that the Chief Executive feels that the company will not be held liable because of the poor safety record of Mugodi Mine is not conclusive enough that the courts will rule in favor of Heavy Equipment Supplies. If it is proved that the fault is with Heavy Equipment Supplies then the company may be found liable. There is a risk that Heavy Equipment Supplies has not provided for damages in the financial statements in the current year. The fact that the warranty provision in each year is substantial means that the company recognizes that it does have poor workmanship in some cases and hence could be found liable. IAS 37 Provisions, Contingent Liabilities and Contingent Assets provides thus: o o If the conditions in the accounting standard are met then a provision should be made by Heavy Equipment Supplies in the financial statements. If on the other hand the liability of Heavy Equipment Supplies is considered to only be a possibility, then disclosure should be made in the financial statements.

There is a risk that no provision has been made or any provision that has been made may be misstated due to the fact that its determination is largely subjective. Legal costs arising from defending legal suite: There is a risk that Heavy Equipment Supplies may not have accrued for any legal expenses that may arise in defending the legal suite by Mugodi Mine. Since the litigation began in the current year and at the period end the case is still on, an estimate of the related legal costs should be recognized in the current year. There is a risk that expenses and liabilities are misstated in view of the fact that legal costs have not been provided for. Work in progress at the period end: There is a risk that work in progress valuation at the period end is not done correctly. This is dependant on the person valuing WIP and in particular depends on the costing method in use. For example the absorption of labor costs and overheads into each uncompleted machine could be a complex matter. There is a risk that work in progress may be misstated at the year end. Inventory count of parts: There is a risk that the valuation of parts and components at the period end is wrong. The inventory value at the year-end should represent inventory held on 31 December 2011. The fact that inventory count was conducted seven days earlier poses a risk that stock movements in the intervening period may not have been correctly done resulting in an over or understatement of inventory and current assets. There is a risk the inventory value in the financial statements at the year-end may be misstated. Liability in foreign currency:

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According to IAS 21 The Effects of Changes in Foreign Exchange Rates, the foreign trade payable should be retranslated at the exchange rate ruling at the period end. There is a risk that Heavy Equipment Supplies has not done so resulting in trade payables being significantly over or under valued depending on the movement of the exchange rate between the date of purchase and the year end. Warranty provision: There is a risk that the warranty provision in the financial statements of Heavy Equipment Supplies is misstated. The increase in the warranty provision from 2010 to 2011 is only 4% whereas revenue has increased significantly by 21%. There is supposed to be a relationship between the increase in revenue and the warranty provision. The warranty provision is expected to move in line with the increase in sales. The fact that the warranty provision has not increased as expected could be indicative of the understatement of the warranty provision. Related party transactions: There is a risk that not all related party transactions have been disclosed by the management of Heavy Equipment Supplies. Further, any disclosures made may not be at the correct values. IAS 24 Related Party Disclosures requires that transactions between related parties should be disclosed in the financial statements. Details of the dealings between Heavy Equipment Supplies and Nshimbi Light Equipment Ltd should be disclosed in the notes to the financial statements. Timetable of completing the audit: The request by the Chief Executive that the audit be concluded by 28 January 2012 will put pressure on the audit team to finish the work. The audit team may not manage to complete the assignment within this time and complete all the necessary procedures or there may not be time for adequate reviews to be carried out on the work that has been performed. As a result of this pressure, the detection risk may increase resulting in the overall audit risk increasing. c) Audit of warranty provision: ISA 540 Audit of Accounting Estimates requires that auditors obtain sufficient audit evidence as to whether accounting estimates, such as warranty provision, are reasonable given the circumstances at hand. The following audit procedures may be applied in auditing warranty provisions: o Review the contracts signed between Heavy Equipment Supplies and the customers so that you understand the obligations of Heavy Equipment Supplies. Review any correspondence with customers so that you gain an understanding of any claims that may have been made already.

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o o o o o o o

Carry out analytical procedures to compare the level of warranty provision year on year, and compare actual and budgeted provisions. Recalculate the amount of provision at the period end based on assumptions used by the entity. If a percentage is used to arrive at the provision, agree the percentage applied in the calculation to the stated accounting policy of Heavy Equipment Supplies. Review the board minutes for any discussions on warranty claims and provisions and the approval of the amount provided. Use the management accounts of Heavy Equipment Supplies to ascertain the normal level of warranty rectification costs during the year. Confirm that the assumptions used in determining the provision are in line with the auditors understanding of the business. Compare the prior year provision with the actual expenditure on warranty claims in the accounting period. This will help determine the accuracy of managements estimates. Compare the current year provision with the prior year and discuss any significant fluctuations with management. Review subsequent events in the following accounting period which confirm the estimate made and specifically: Review the rectification works carried out post year end on specific faults that were provided for. Ensure that all costs are included in the year end provision. Go through any customer correspondence received after year end for any claims received since the year end which may not have been provided for.

o o

d) Quality control procedures at the individual audit level: ISA 220 Quality Control for Audits of Historical Financial Information provides guidance in this area. Procedures include the following: Client acceptance procedures: There should be full documentation, and conclusion on, ethical and client acceptance issues in each audit assignment. The engagement partner should consider whether members of the audit team have complied with ethical requirements, for example, whether all members of the audit team are independent of the client. Additionally, the engagement partner should conclude whether all acceptance procedures have been followed, for instance, that the audit firm has considered the integrity of the principal owners and key management of the client. Also ensure that: Obtained professional clearance from the previous auditors. Consideration of any conflict of interest. Money laundering procedures.

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Engagement team: There must be procedures in place to ensure that the engagement team on the audit of Heavy Equipment Supplies has the skills, competence and time to perform the audit engagement. For example the engagement partner should assess that the audit team has: o o o o The appropriate level of technical knowledge The experience of the audit engagements of a similar nature and complexity The ability to apply professional judgment Understands the professional standards and regulatory and legal requirements.

Direction of the audit: The engagement partner should direct the engagement team. For example a planning meeting should be undertaken to ensure that the team understands: o o o o o o Their responsibilities The objectives of the work they are to perform The nature of the business of the client Risk related issues How to deal with any problems that may arise and The detailed approach to the performance of the audit

This planning meeting should be led by the partner and all people involved with the audit should attend. There should be a discussion of the key issues identified at the planning stage. Supervision of the audit: Supervision should be continuous during the assignment. Any problems that arise during the audit should be rectified as soon as they arise. Attention should be focused on ensuring that members of the audit team are carrying out their work in accordance with the planned approach to the engagement. Significant matters should be brought to the attention of senior members of the audit team. There should be documentation of key decisions made during the audit engagement. Review of work carried out: The review process of work carried out is one of the key quality control procedures. All work performed must be reviewed by a more senior member of the audit team. The following should be considered during the review: o o o Whether work has been performed in accordance with professional standards. Whether the objectives of the procedures performed have been achieved. Whether the work supports the conclusions drawn and is appropriately documented.

The actual review process must be documented and evidenced in writing. Consultation:

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The engagement partner should arrange consultation on difficult or contentious matters. Consultation can start within the engagement audit team and there should be procedures whereby the matters can be discussed with a professional outside the engagement team, and at times even outside the audit firm. Any consultations must be documented to show: o o e) (i) The issue on which the consultation was sought and The results of the consultation which must be documented. Difficulties of identifying related parties: Related parties and associated transactions are often difficult to identify, because it can be hard to establish exactly who, or what, are the related parties of an entity. IAS 24 Related Party Disclosures contains the definitions which theoretically provide a framework for identifying related parties, but deciding whether a definition is met can be complex and subjective. For example related party status can be obtained via significant interest, but in reality it can be hard to establish the extent of influence that potential related parties can actually exert over a company. The directors may be reluctant to disclose to the auditors the existence of related parties or transactions. This is an area of the financial statements where knowledge is largely confined to management, and the auditors often have little choice but to rely on full disclosure by management in order to identify related parties. Identification of material related party transactions: Related party transactions may not be easy to identify from the accounting systems. Where accounting systems are not capable of separately identifying related party transactions, management need to carry out additional analysis, which if not done make the transactions extremely hard for auditors to find. For example sales to a related party may not be differentiated from normal sales in the accounting systems. Related party transactions may be concealed in whole or in part, from auditors for fraudulent purposes. A transaction may not be motivated by normal business considerations, for example, a transaction may be recognized in order to improve the appearance of the financial statements by window dressing. Where management deliberately conceals the true nature of these items it will be extremely difficult for the auditor to discover the rationale behind the transaction and to consider the impact on the financial statements. Other reasons why it is hard to identify related parties and related party transactions: o o Related party transactions may take place without any charge and as such will not be recorded in the financial statements. Related party transactions may be with a party that auditors could not reasonably be expected to know is a related party.

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o (ii)

In situations where the corporate structure to which the entity belongs is complex.

ISA 550 Related parties gives guidance in this area. The auditors are expected to carry out the following procedures in relation to related parties and related party transactions: o o Enquire from management and those charged with governance whether related party transactions have taken place. Ensure that any related party transactions identified have been disclosed as required in the financial statements. In the case of Heavy Equipment Supplies ensure that management makes full disclosure of the existence of Nshimbi as a related party and also disclosed separately in the financial statements its dealings with the related party and the amount involved. Review prior year working papers as they may contain names and details of known related parties. Review minutes of meetings of shareholders and directors and other relevant statutory records such as the register of directors interests. This review may reveal related parties. Review third party confirmations such as the bank confirmation. They may reveal details of guarantors for loans to the entity which can help determine relationship with Heavy Equipment Supplies. Enquire as to the affiliation of directors and officers with other entities. Review invoices and correspondence from lawyers for indications of the existence of related parties or related party transactions. Obtain representations from management confirming that they have: - Disclosed to the auditors the identity of the entitys related parties. - Disclosed the related party transactions that they are aware of. - Appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements.

o o

o o o

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SOLUTION TWO: a) Salim Transport Plc A critical review of the points raised from the audit working papers indicates that Salim Transport has serious going concern issues. The following points should be noted: Non-renewal of license to transport dangerous goods: o o o Non-renewal may result in heavy penalties being imposed on Salim Transport which is already facing serious cash flow problems. The worst case is that the regulator may decide to withdraw the license and the company will have to close. It is unlikely that Salim Transport will get away with this breach bringing into question its ability to continue operating.

Loss of business from major customer: The switch from road to rail transport by the company that necessitated the acquisition of more trucks by Salim Transport creates serious cash flow problems for Salim Transport. With reduced levels of operations the company is unlikely to be able to repay the loan and at the same time support the limited operations. Further, the bank may enforce its security and recover the trucks on which the loan is secured so as to recover its debt. This too brings into question the going concern assumption of Salim Transport. Poor cash flow forecasts: The only way the company can come out of this financial distress is by obtaining additional funding by way of more loans. It is unlikely that Salim will be able to find a financier to give it additional loans because of its serious cash flow position and the lack of collateral. Conclusion: It is clear from the above that Salim is not a going concern. The Chairmans statement that it is a going concern is misleading and discussions should be held with the chairman so that the statement is withdrawn. Due to the seriousness of the cash flow problem it is concluded that Salim Transport is not a going concern and an adverse audit opinion is appropriate. Revised audit report: ISA 700 (Redrafted) Forming an opinion and reporting on financial statements provides guidance on the format of the auditors report. The standard gives the format hat reports should take and the elements that make up the audit report. The following comments are made as regards the draft report by the audit manager:

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o o

The draft report is wrongly addressed to the Board of Salim Ltd. The audit report should be addressed to the shareholders who appoint the auditors. The report is supposed to have an introductory paragraph which specifies the financial statements being audited and the relevant financial reporting framework. The draft report does not have this paragraph. The draft report only has a paragraph containing the responsibilities of management. There should also be a paragraph specifying the responsibilities of the auditors. The other matter paragraph is generally used in the auditors report to refer to a matter other than those presented or disclosed in the financial statements that, in the auditors judgment, is relevant to the users understanding of the audit and the financial statements. The matter included in the draft report has been correctly presented and disclosed and as such should have been included in an emphasis of matter paragraph and not in the other matter paragraph. The auditors objective is simply to emphasize the matter because of its importance to the users of the financial statements. The report should be modified with an adverse opinion. As such there will be a paragraph before the opinion paragraph titled Basis for adverse opinion. The opinion paragraph will be renamed to read Adverse opinion. The report should be signed and dated. Professional negligence: Auditors have a fiduciary relationship with their clients and they therefore owe a fiduciary duty to their clients. If found to have performed their work in a negligent manner the auditors risk being used for professional negligence. If it is proved that the auditors were negligent in the performance of their duties they could be charged damages and such damages may be huge and could result in the firm having cash flow problems and hence going concern fears. For a long time audit firms were run as partnerships meaning that if the firm could not meet the liabilities of the partnership then the individual partners risked their personal belongings being taken. Options available to auditors to restrict their liability: Audit firms have a number of options that they can take in order to reduce their liability in the event of being found guilty of professional negligence: Professional indemnity insurance: This is insurance that the audit firm can take against liability that can arise from claims made by clients and third parties arising from work undertaken by the auditor. If found guilty, the client can be compensated for the damage suffered as a result of the auditors negligence. If no insurance is taken, the liability will be placed on the partners. In some situations, the liability could be far greater than the firms resources therefore taking indemnity insurance restricts the liability.

o o o b) (i)

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Incorporation: This is where the firm of accountants incorporates like a limited liability company. This requires that the firm registers as such with the registrar of companies. Liability is restricted in that the partners will only be liable only to the extent of unpaid capital by the shareholders. The personal property of the partners will not be touched in trying to settle liabilities arising out of litigation from professional negligence. In the UK the Companies Act 1989 allows audit firms to incorporate and to this effect KPMG one of the big audit firms incorporated. Limited liability partnerships: Under the Limited Liability Partnership Act of 2000 UK firms can establish limited liability partnerships as separate legal entities. Under this arrangement, the partnership will be liable to third parties and not the members. Liability limitation agreement: This is an agreement between the client company and the audit firm to limit the liability of the firm if found guilty of professional negligence. This agreement can only be made with the authority of the members in general meeting and is usually for a one year period only. The agreement can also be withdrawn by the company by passing an ordinary resolution. In the UK the Companies Act 2006 allows auditors to limit their liability to a client company. (ii) Due diligence: Before purchasing a company, it is essential that the purchasing company such as Luangwa Ltd in this case undertakes a comprehensive survey of the business in order to avoid any operational or financial surprises after the acquisition. Due diligence can be seen as simply a fact finding exercise in order to minimize the risk of making a bad investment. Purpose of due diligence investigation:

Information gathering:
o This is a process by which information is gathered about the target company, Kafue Ltd in this case. This is to ensure that Luangwa Ltd the acquiring company has full knowledge of the operations, financial performance and position, legal and tax situation as well as general commercial background. This way any hidden issues are identified and any potential problems are identified before Luangwa Ltd goes ahead with the acquisition. For example the acquired company may have obtained debt finance and the terms of such finance may only be obvious when a due diligence investigation is carried out.

Verification of specific management representations:

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The representations made by the management of the acquired company in this case Kafue Ltd. It is essential that these representations are verified by the acquiring company. The acquired company may state that it has never been subject to investigations say for tax investigations or that it is compliant with relevant legislation when this is not the case. These representations should undergo a due diligence investigation.

Identification of assets and liabilities:

o It is important that all assets of the acquired company are identified. This is because there may be intangible assets such as customer databases and brand names which will not appear in the statement of financial position but need to be identified and valued for purposes of calculating goodwill on acquisition. These assets will only be uncovered through a due diligence investigation. These assets are important in negotiating the acquisition price. Contingent liabilities: - Should be identified - Acquiring company will need to understand the likelihood of the liability crystallizing and the potential financial consequence.

Operational issues:
o o o A key benefit of due diligence investigation is the possibility of discovering problems or risks in the entity. These could include matters such as high staff turnover or need to renegotiate contracts with customers or suppliers. Such risks identified could be used in negotiating a reduction in the price or the acquired company may be asked to provide assurance that these problems will be resolved pre acquisition.

Acquisition planning:
o The due diligence investigation will give the benefits and possible drawbacks of the acquisition. On the positive side it will highlight matters such as the expected synergies to be created post acquisition and possible economies of scale. On the negative side there are acquisition expenses to be paid, costs in terms of reorganization and possible redundancies and issues about changes in management.

Credibility of due diligence investigation:

o An external investigation will also provide an independent, impartial view of the situation, enhancing the credibility of the investment decision and the amount paid for the investment.

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SOLUTION THREE: a) Rex & Company: Ethical matters that should be considered before acceptance of appointment: Long association with Rex & Co: The firm has been performing non audit services to Rex & co for ten years now. The same person has been responsible for this work and as such has most likely lost his independence. The long association may create self-interest and self-review threats. It is necessary that appropriate safeguards are put in place such as assigning to the audit individuals who have had no dealings with Rex & Co. Self-review threat: Financial Solutions have provided consultancy to Rex & Co and through this they may have been involved in setting up systems and internal controls. To have the firm carry out the audit as suggested by the managing director may result in a self-review threat. This threat may be overcome by assigning to the audit staff who were not involved in the consultancy work for Rex & Co. Communication with Young & Co: It is an ethical requirement that incoming auditors communicate with the outgoing auditors. In this case Financial Solutions Chartered Accountants are supposed to communicate with Young & Co to find out if there are any reasons that Young & Co has which could cause Financial Solutions Chartered Accountants to decline the appointment. In this case the Managing Director has not given Financial Solutions permission to communicate to Young & Co. There is need to tell the Managing Director of the ethical requirement that should be fulfilled and that it is part of the client acceptance procedures. If the Managing Director refuses to grant permission then Financial Solutions Chartered Accountants should decline the appointment. Self-interest threat due to over dependence on this client: Currently the income from Rex & Co forms 13% of the total revenue of Financial Solutions Chartered Accountants. Guidance states that a firm should not depend on income from one client as this will result into a self-interest threat. Guidance provides that income from one client should not exceed 15 %( 10% for listed companies) of total income. Currently the income from Rex & Co is marginally below 15%. In the event that the firm is appointed as auditor of Rex & co it may just result in the income from Rex & Co exceeding the threshold and hence result in fee dependence.

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The firm may need to establish the impact on income of providing both audit and non-audit services to Rex & Co. The firm may have to decide on which service to provide in the event that the threshold is reached if both services are provided. The firm will have to decide whether to continue providing consultancy services and decline the audit appointment or accept the audit appointment and give up the consultancy work. Proposed engagement letter: The Managing Director has suggested that the partner prepares an engagement letter immediately. It should be pointed out that auditors are appointed by the shareholders at the Annual General meeting. In this case the AGM has not yet voted to appoint Financial Solutions Chartered Accountants as auditors and so an engagement letter will not be appropriate at this stage. Before issuing an engagement letter the firm should ensure that it has been appointed as per requirement and this can only be confirmed by getting a copy of the resolution of the AGM appointing Financial Solutions as auditors of Rex & Co Conclusion: The matters stated above should be resolved before accepting appointment as auditors of Rex & Co. b) Matters that may have caused the resignation of Young & Company: Lack of resources: This could be that the firm does not have the necessary resources to continue with the audit. The firm may opt to resign and carry on the audits that it can manage. Lack of skills: As the clients grow the scope of the audit work may also change. It may happen that the existing auditors lack the skill to continue auditing the client and in order to avoid the risk of issuing inappropriate audit opinion, the firm may opt to resign from the engagement. Conflict of interest: The firm may find itself in a situation where there is a conflict of interest which it can no longer manage effectively. It may be that in the first instance the firm had applied suitable safeguards to manage the situation but it can no longer do so. The firm may have to give up one of the audits to avoid the conflict of interest. Loss making clients: In a situation where the audit is being conducted at a loss the auditor may opt to walk away and use the capital saved on other audits where it will be profitable. Fee exceeding the recommended thresholds: The audit firm is offering other non-audit services to its audit client. It may happen that as a result the income from a particular client may exceed the recommended

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thresholds of 15 %( 10% for listed companies) for income from one client. This may bring about a threat to the independence of the auditor. In the event that the income from the non-audit services is higher than that from the audit, the audit firm may decide to give up the audit. Personality: This is more evident in small client audits where the audit is an almost personal service. If the relationship between the client and the auditor breaks it may be necessary for the audit relationship to discontinue. Audit rotation: This may arise where the firm has been offering audit services to the same client for a long time. The partners of the firm may conclude that the firm as a whole has been associated with a client for too long and therefore independence has been impaired greatly. The firm may opt to divest the audit. c) Non audit services to audit clients: The issue of auditors providing non audit services to audit clients has been a topical issue for many years, and there are many arguments for and against their outright prohibition. Arguments in favor of prohibition of provision of non-audit services to audit clients: o This is a simple way to eliminate the threats to objectivity, which the provision of non-audit services to audit clients creates. Typically, self-interest and self-review threats arise, which result in the perception that the auditor cannot be objective when performing the audit service. Non audit services can be very lucrative to the auditor leading to a selfinterest threat. The greater the volume and financial significance of the nonaudit services provided, the greater the risk that the auditor will have relationship and economic reasons not to challenge managements views and positions with the necessary degree of professional skepticism. Argued that outright prohibition will benefit the market for professional accountants. This will allow smaller audit firms to provide the services which larger firms would no longer be able to offer to their audit clients. In the USA there are tougher regulations introduced by the Sarbanes Oxley Act which prohibits outright the provision of non-audit services to audit clients.

Arguments against prohibition: o By having the same firm audit and provide non audit services, the client benefits: - The firm already has knowledge and understanding of the client resulting in deeper insight and better quality service offered.

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This will lead to cost benefits as the non-audit service will be provided in a more efficient manner. Audit firms argue that by carrying out due diligence reviews and forensic investigations, they understand the clients business and risks better and also to obtain insights into managements objectives and capabilities which are useful in an audit context. Argued that audit services can safely be provided as long as steps are taken to assess potential threats to objectivity, and to adequately address those risks for example by using separate teams to provide audit and non-audit services. In the UK audit committees review and monitor the external auditors independence and objectivity. This includes the audit committee evaluating and approving the provision of non-audit services by the audit firm.

SOLUTION FOUR: a) Minsale Plc (i) Why planning an audit is important: Planning helps in setting out how the audit objectives will be met. It is an important aspect of an audit as it sets the direction for the audit. If the audit is planned then the audit engagement is likely to be performed in an effective manner. Planning helps to ensure that: o Appropriate attention is devoted to important areas of the audit. o Potential problems/risks are identified and resolved on a timely basis. o The engagement is properly organized and managed in order to be performed in an effective and efficient manner. o There is proper assignment of work among the engagement team members. o The direction and supervision of the work by audit team members and the review of the work is done as required. o Assist in the coordination of work done by component auditors and experts where necessary. (ii) Matters that may be included in the audit strategy: Characteristics of the engagement including: o o o o o The financial reporting framework Any industry specific reporting requirements The scope of the audit Nature of the business Availability of internal audit department

Reporting objectives, timing of the audit and nature of communication:

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o o o

The timetable of the entity for reporting Organization of meetings with management and those charged with governance. Expected communication with third parties.

Significant factors, preliminary engagement activities and knowledge gained on other engagements: o o o o Determination of the materiality level Volume of transactions Significant business developments Significant changes in financial reporting framework.

Nature, timing and extent of resources: o o o b) The selection of engagement team members Assignment of work to team members Engagement budget.

Concerns raised by Chanda: (i) Professional sckepticism and Professional Judgment Professional skepticism: The term professional skepticism is defined by ISA 200 Overall Objectives of

the Independent Auditor and the Conduct of an Audit in Accordance with ISAs as:

An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatements due to error or fraud, and a critical assessment of audit evidence. Professional skepticism means for instance being alert to contradictory or unreliable audit evidence, and conditions that may indicate the existence of fraud. If professional skepticism is not maintained, the auditor may overlook unusual circumstances, use unsuitable audit procedures, or reach inappropriate conclusions when evaluating the results of work that has been carried out. It is important that all audit team members maintain professional skepticism throughput the audit in order to reduce audit risk. Professional judgment: In carrying out his work the auditor is expected to use his professional judgment in a number of instances. This is based on experience and possession of relevant skills. There are instances when the auditor is required to use his judgment such as the following: o In deciding on the sufficiency and appropriateness of audit evidence gathered the auditor should use his professional judgment.

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o o o o o (ii)

In arriving at an appropriate conclusion based on work conducted the auditor should apply his professional judgment. When assessing the accounting estimates made in the financial statements by management the auditor applies his professional judgment In determining the materiality level to be used in the conduct of the audit, the auditor uses his professional judgment. In determining the risk levels of a client company based on the understanding of the entity and its environment. In determining the nature, timing and extent of audit procedures the auditor will use his professional judgment.

Money Laundering: This is the process by which criminals attempt to conceal the true origin and ownership of criminal activity, allowing them to maintain control over the proceeds, and ultimately providing a legitimate cover for their sources of income. The objective of money laundering is to break the connection between the money and the crime that it resulted from. Could include: o o Possession of, or concealment of, the proceeds of any crime. Examples include proceeds of fraud, tax evasion and benefits of bribery and corruption.

Client procedures should include the following: Client identification: o o Establish the identity of the entity and its business activity by say obtaining registration certificate. If client is an individual, obtain official documentation including a name and address e.g. by looking at photographic identification such as a passport, NRC or driving license. Consider whether the commercial activity of the client makes business sense and is not just a front for other illegal activities. Establish the current list of principal shareholders and the directors.

o o

Client understanding: o o c) Possible communication with the directors before acceptance on the nature of the client acceptance procedures. Possible that the engagement letter should include a paragraph outlining the auditors responsibilities in relation to money laundering.

Financial statement assertions: Financial statement assertions can be described as the representations that the directors make in the financial statements. It is managements responsibility to prepare financial statements and by approving the financial statements, the directors

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are making representations or strong statements about the information contained in the financial statements. The financial statement assertions can be classified into three main categories as follows: o o o Assertions about classes of transactions and events for the period under audit. Assertions about account balances at the period end Assertions about presentation and disclosure

The above categories cover the details comprised in the financial statements. The auditor will design the audit procedures with a view to determining whether the stated assertions hold true and there are no material misstatements that could mislead the users of the financial statements. Examples of financial statement assertions using tangible non-current assets:

Existence:
The assertion of existence as regards tangible non-current assets implies that the relevant tangible non-current assets actually existed at the period end. The auditor will test this assertion by carrying out a physical check of selected tangible noncurrent assets at the period end.

Valuation:
Is an assertion that the tangible noncurrent assets are valued in accordance with generally accepted accounting principles and any impairment would have been carried out in line with the guidelines of IAS 36 Impairment.

Rights and obligations:

Is a management representation that the tangible non-current assets included in the financial statements belong to the client company. The auditor will design audit procedures to confirm this assertion. This could be done for, example, by inspecting relevant documents such as title deeds for property, white books for vehicles and supplier invoices for other tangible non-current assets.

Completeness:
Is a representation by management that all tangible non-current assets that should have been recorded have been recorded. This assertion could be tested by tracing items that are physically inspected to the related accounting records.

Classification:
A representation that transactions relating to tangible non-current assets have been recorded in the correct accounts. Note: Marks will be awarded for any other assertions explained but not included above as long as they are clearly explained.

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SOLUTION FIVE: a) Zambezi Ltd Impairment of assets: In accordance with IAS 36 Impairment of assets an asset is impaired if its recoverable amount is less than the carrying value of the asset in the statement of financial position. This is a matter of acting in a prudent manner so that the asset is carried at a value expected to be recovered. Carrying the asset at a higher value than the recoverable amount may be misleading to the users of financial statements as a stronger position than is the case will be presented. Why company should carry out impairment review: The standard provides that if there is any indication of impairment of an asset at the period end then an impairment review should be carried out. If the auditors in gaining an understanding of an entity or during the course of the audit come across any signs of impairment of assets falling under this standard, they will request management to conduct an impairment review. Therefore, when there are indications of impairment of tangible non-current assets, management should carry out impairment review so that it follows the guidance in IAS 36. By writing down the tangible non-current asset to its recoverable amount, the financial statements will present a fair view. If the asset which has been impaired it left at a higher carrying value this will be misleading to the users of the financial statements. b) Importance of the review of audit working papers: Audit working papers are the only evidence of the work that has been carried out by the audit team. The working papers form the basis upon which the audit opinion is arrived at. It is therefore important that the working papers provide sufficient appropriate audit evidence. The review of audit working papers is important because it allows senior members of the audit team to evaluate the evidence that has been obtained during the course of the audit for sufficiency and reliability. This will ensure that more evidence that can be relied upon can be obtained to support the audit opinion. The reviewer who will be senior to the one who prepared the working paper will consider among other things whether: o o o o o The work has been performed in accordance with the audit program. The work performed and the results obtained have been adequately documented Any significant matters have been resolved or are reflected in the audit conclusions reached. The objectives of the audit procedures have been achieved. The conclusions expressed are consistent with the results of the work performed and support the audit opinion.

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How audit work review is carried out: Work is assigned to staff in the audit team. Most of the work is carried out with the supervision of the audit senior who delegates to the audit assistants. Reviews are conducted as follows: o The work carried out by the audit assistants is reviewed by the audit senior and any matters arising are resolved before passing on the file to more senior members of the audit team. The work that has been reviewed by the audit senior and any work that the audit senior performs is reviewed by the audit manager. After resolving any matters arising with the audit senior, the audit manager will pass on the file to the audit partner for review of the work carried out by the audit manager and by the other audit team member for further review. Some firms will have quality control policies in place which may require that the work carried out by an engagement team be reviewed by another partner who was not part of the audit team on a particular assignment.

o o

c)

Cut off tests for sales revenue: Audit procedures on cut off are important for the auditor. The audit objective is to ensure that revenue for the audit client is recorded in the correct accounting period. If revenue is recorded in the wrong accounting period the financial statements will be misstated depending on extent of wrong cut off procedures. The tendency at the period end will be for management to try and show a better picture than is real the case. This might be by way of including in the current years revenue that relates to the following financial accounting period. In this case the action to be taken: o o o Require that Chansa performs appropriate audit procedures relating to the cut off of sales. If the results of the audit procedure indicate that there was no problem on cut off then the matter can be put to rest. If on the other hand evidence suggests that there were cut off problems at the period end, then management will be requested to correct such errors. If management makes the adjustments then that is fine. If management refuses to adjust the financial statements in view of any material misstatement arising due to wrong cut off procedures, the auditor will need to assess the impact of the refusal to his audit report.

Impairment of equipment: According to IAS 36 Impairment, if the auditor has evidence that an asset has been impaired, he will confirm whether an impairment review has been undertaken by the management in the financial statements. In the event that impairment review has not been carried out the auditor will request management to conduct one.

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In this case management will be requested to carry out the review and the auditor will carry out necessary audit procedures to ensure that the review and accounting for any impairment loss has been done in accordance with the accounting standards. The impairment loss compares the carrying amount with the recoverable amount. Carrying value K64m Recoverable amount K43m Impairment to be recognized K21m Since the asset had been revalued upwards previously by K9m, part of the total impairment amount of K9miillion should be debited to the revaluation account and the balance of K12m debited to the income statement. In the event of refusal by management to write down the asset: o o The auditor will assess how pervasive this matter is to the financial statements. If the auditor is of the view that not writing down the asset will affect the judgment of the users of financial statements he will consider modifying his audit report.

Materiality of uncorrected errors: This is an amount that the auditor establishes at the planning stage of the audit. If uncorrected errors amount to the materiality amount set then it means that such misstatement would affect the judgment of the users of financial statements. The auditor will be concerned if the errors that are not corrected are near or above the set level. In this case the auditor will request management to make corrections in the financial statements. Performance materiality is normally set at a figure lower than the materiality level for the financial statements as a whole. This is so as to reduce the risk of not detecting any misstatements of financial statements which would exceed the materiality level for the financial statements as a whole. The uncorrected errors of K13m are close to the performance materiality level of K15m. The auditor will need to assess the possibility that total errors in the financial statements may exceed the materiality level set for the financial statements as a whole. The auditor will request management to correct these errors. In the event that the Finance Manager refuses to make corrections, the auditor will consider the impact of this to his audit report. If in the opinion of the auditor the effect of the uncorrected errors is pervasive to the financial statements he will modify the audit report. d) Importance of performing audit procedures on opening balances: It is important to perform audit procedures on the opening balances brought forward into the current year. The opening balances have a bearing on closing balances for the year under review and so if they are misstated then the current year closing balances will equally be misstated. Depending on the extent of the misstatements, the current year financial statements may be materially misstated.

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ISA 510 Initial audit engagements opening balances gives guidance in this regard: In this situation the previous years financial statements were audited by a different firm of accountants. It is, therefore, expected that audit procedures will be necessary on the opening balances for the auditors to satisfy themselves that the opening balances are not misstated. Any misstatement of opening balances will result in the misstatement of current year figures. The audit procedures that will be carried out include the following: o o o o o Determining whether the prior years closing balances have been correctly brought forward to the current period. Determining whether the opening balances reflect the application of appropriate accounting policies. Review the working papers of the previous auditors to obtain evidence regarding opening balances. Confirm the audit report for the previous year and confirm if it was modified. Review transactions in the first few months of the current year as they may give evidence on the opening balances for instance: - The collection of the opening accounts receivables during the current period will provide evidence of their existence and valuation at the previous period end.

END OF SOLUTIONS

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