EAU2M05 CGA-Canada, 2005 Page 1 of 7

CGA-CANADA

AUDITING 2 EXAMINATION
March 2005

Marks Time: 4 Hours

30 Question 1
Select the best answer for each of the following unrelated items. Answer each of these items in your
examination booklet by giving the number of your choice. For example, if the best answer for item (a)
is (1), write (a)(1) in your examination booklet. If more than one answer is given for an item, that item will
not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.

Note:
1
1
/2 marks each

a. An attitude of professional scepticism is necessary if a CGA is to perform an audit engagement with
due care. Which of the following best describes how a CGA may display an attitude of professional
scepticism when performing an audit engagement?
1) By assuming that management is dishonest in the absence of evidence to the contrary
2) By not allowing clients staff to assist in the performance of an audit
3) By rejecting all management assertions in the absence of supporting evidence
4) By questioning all material assertions made by management

b. Which of the following steps or modifications to an audit program is likely to be the most appropriate
if an auditor assesses the risk of management fraud to be relatively high?
1) Performing relatively less audit work at interim dates
2) Placing greater reliance on managements representations
3) Performing less extensive tests of internal controls
4) Assigning less experienced personnel to the engagement

c. Generalized audit software, such as IDEA and ACL, can be used in a variety of ways during an audit
engagement. Which of the following audit steps is a CGA most likely to perform using generalized
audit software?
1) Test compliance with a clients internal controls.
2) Implement a strategic systems-based audit of financial statements.
3) Select a stratified random sample of the records in a file.
4) Verify the information in various record fields by reference to supporting documents.

d. Double-dating of an auditors report may be appropriate in which of the following circumstances?
1) A subsequent event occurs that is reflected in the financial statements.
2) A subsequent event occurs that is not reflected in the financial statements.
3) A principal auditor of a consolidated reporting entity relies on the work of a secondary auditor,
and the two auditors completed their fieldwork at different times.
4) An auditor of a company whose shares are publicly traded consents to a release of annual earnings
numbers by management, prior to the completion of the audit.






Continued...
EAU2M05 CGA-Canada, 2005 Page 2 of 7
e. Which of the following elements is most likely to be a source of value added by assurance
engagements?
1) Increasing the profitability of the firm
2) Increasing information risk
3) Reducing information asymmetry between preparers and users of financial statements
4) Reducing the likelihood of a firms bankruptcy

f. What level of assurance would a CGA normally provide when applying specified auditing-type
procedures (usually procedures agreed upon by the CGA and the client) to financial information other
than financial statements?
1) Audit level assurance
2) Moderate assurance
3) Limited assurance
4) No assurance

g. What level of assurance would a CGA normally provide when examining interim financial statements
issued by companies whose securities are publicly traded?
1) Audit level assurance
2) Moderate assurance
3) Limited assurance
4) No assurance

h. Which of the following techniques is most likely to be used by an auditor when performing analysis at
the planning stage of an audit engagement?
1) Statistical regression analysis
2) Cash flow analysis
3) Time series analysis
4) Analysis of account balance details

i. Which of the following audit opinions is most appropriate when a company faces a material loss
contingency that is not disclosed in the financial statements?
1) An unqualified opinion
2) A qualified (GAAP) opinion
3) A denial of opinion
4) A piecemeal opinion

j. Which of the following is a type of audit in the public sector that is, at least partially, concerned with
ascertaining the effectiveness and efficiency of operations of the audited entity?
1) Attest audit
2) Compliance audit
3) Comprehensive audit
4) Stakeholder audit

k. What effect (if any) is the fact that an audit client is a small business enterprise most likely to have on
the auditors business risk and the acceptable audit risk associated with the engagement?
1) No effect
2) Increase business risk and increase audit risk
3) Decrease business risk and increase audit risk
4) Decrease business risk and decrease audit risk



Continued...
EAU2M05 CGA-Canada, 2005 Page 3 of 7
l. Which of the following is most likely to be a characteristic of a small business enterprise?
1) Dispersed ownership
2) Limited segregation of duties
3) Strong internal controls
4) Use of custom-designed information technology (IT) systems

m. Which of the following elements is least likely to be a source of the expectations gap between how
auditors view their role and what clients and financial statement users expect of their auditors?
1) Auditors only investigate possible fraudulent situations that they stumble upon, whereas users
may expect auditors to actively search for fraudulent misstatements in financial statements.
2) Audits are designed to detect material misstatements, whereas users may expect auditors to detect
all misstatements.
3) An auditors opinion is based on test results and the examination of sample evidence, whereas
users may expect that all relevant evidence is examined.
4) Audits provide only reasonable assurance, whereas users may expect absolute assurance.

n. An essential feature of a valid statistical sampling plan is the auditors ability to make inferences from
the sample to the population using statistical concepts and calculations. Which of the following
sample selection methods is most consistent with statistical sampling?
1) Haphazard sample selection
2) Stratified sample selection
3) Block sample selection
4) J udgmental sample selection

o. An auditor using a statistical sampling plan encounters a situation in which the documentation
underlying an item selected for a sample is missing and cannot be located. What is the auditors best
response in this situation?
1) Ignore the missing sample item and select a different item for examination.
2) Discard the entire sample and select a new sample.
3) Treat the missing item as being correct.
4) Treat the missing item as an error.

p. Differential reporting options (sometimes referred to as little GAAP) are available to qualifying
enterprises and allow financial reporting for certain financial statement components to be simplified.
What type of audit opinion would normally be issued when the management of a qualifying enterprise
appropriately uses such differential reporting options?
1) An unqualified opinion using standard audit report wording
2) An unqualified opinion using modified audit report wording
3) An unqualified opinion but subject to the use of differential reporting options
4) A qualified opinion because the financial statements are not in accordance with GAAP

q. Which of the following tasks is most likely to be performed by a firms partner on an audit team?
1) Reviewing the clients internal controls
2) Performing analysis during the planning stages of the engagement
3) Evaluating the performance of the firms staff who completed the audit fieldwork
4) Sending confirmations to major debtors of the client






Continued...
EAU2M05 CGA-Canada, 2005 Page 4 of 7
r. Which of the following statements about the relationship between inherent risk (IR), control risk (CR),
and detection risk (DR) in the audit risk model is least likely to be true?
1) IR is high, CR is high, and DR is low.
2) IR is low, CR is high, and DR is medium.
3) IR is high, CR is medium, and DR is low.
4) IR is high, CR is low, and DR is low.

s. An auditor who encounters material related-party transactions by a client should take which of the
following steps?
1) Resign from the engagement.
2) Ensure that all such transactions are recorded at their fair market value in the financial statements.
3) Issue an adverse opinion on the financial statements.
4) Ensure that all such transactions are adequately disclosed in the financial statements.

t. Which of the following is not a valid sequence of steps an auditor would perform in assessing control
risk with respect to a material financial statement assertion?
1) Obtain an understanding of controls; perform tests of controls; make a preliminary assessment of
control risk.
2) Obtain an understanding of controls; document the preliminary assessment of control risk;
perform tests of controls.
3) Review control narratives, questionnaires, and/or flowcharts; make a preliminary assessment of
control risk; document the preliminary assessment of control risk.
4) Make a preliminary assessment of control risk; perform tests of controls; make a final assessment
of control risk.

15 Question 2
The following are five independent situations involving possible violations of the CGA-Canada Code of
Ethical Principles and Rules of Conduct (CEPROC) and/or standards for the performance of audits,
reviews, other forms of assurance engagements, and/or related services.

Required
For each situation, state whether the CGA has violated CEPROC and/or standards for the performance of
audits, reviews, other forms of assurance engagements, and/or related services. Explain your reasoning.

3 a. Frank, CGA, has a small computer system in his office that he uses to perform monthly accounting
services and tax return preparation for his clients. Franks client list does not include any audit clients.
However, a client who has never been audited wants to apply for a bank loan, and requests Frank to
perform an audit of the financial statements. Frank declines because of the potential risks involved,
but instead offers to perform a review of financial statements, which, he argues, will be much cheaper
than an audit and likely to be acceptable to the clients bank.

3 b. Ravi, CGA, received a letter from the president of a local company asking him to submit a proposal to
perform the audit of the company for the next fiscal year. The presidents letter explained that he was
dissatisfied with the services of his current audit firm, and that several CGA and CA firms would
probably be competing for the work. The next day, Ravi visited the potential clients offices, met with
the president, and then prepared a formal offer to perform the audit, including a fixed fee bid of
$10,000 and an outline of his planned audit approach. Two weeks later, Ravi was informed by the
president that his bid was successful, so Ravi immediately began planning and performing the audit
engagement.




Continued...
EAU2M05 CGA-Canada, 2005 Page 5 of 7
3 c. Alison, CGA, is performing interim audit work for a new client that operates in the forest industry in
British Columbia. Alison first prepared systems flowcharts describing the processing of the
companys major recurring transactions. She then observed the operation of the various systems,
discussed the problems she noted with the clients employees, and concluded by assessing control risk
for various financial statement assertions at values ranging from low to medium.

3 d. Hannah, CGA, owns a few shares of Alpine Resorts, a local ski operation, and also works in the
personnel department of that firm. The company is currently negotiating contracts with its unionized
employees, and the controller of Alpine Resorts asks Hannah to perform a review of the companys
financial statements to add credibility to the statements, which are being challenged by the union
negotiating team. Hannah agrees to do so, and accordingly computes a variety of financial ratios all
of which appear to be reasonable and consistent with other companies in the industry. She then issues
a review engagement report, without reservation, which concludes with the statement, Based on my
review, in my opinion, these financial statements are reasonable, in all material respects, and in
accordance with generally accepted accounting principles.

3 e. Lien, CGA, has recently opened a CGA practice as a sole practitioner. As part of her practice
development, Lien runs advertisements in the local newspapers that highlight her academic credentials
and practical experience in the hospitality industry. The advertisements also include a schedule of her
hourly billing rates for various types of services. In addition to these advertisements, she sends a
personal letter to the business offices of all the hotels and other lodging establishments in the area,
offering to perform assurance, tax, and/or management advisory services of high quality at very
reasonable rates.

14 Question 3
The following are seven independent statements concerning certain auditing issues.

Required
For each statement, indicate whether you agree or disagree. Explain your reasoning.

2 a. An attest engagement is a type of assurance engagement for which a practitioner provides an opinion
on a subject matter that consists of written assertion(s) by an accountable party.

2 b. Test data, an integrated test facility, and generalized audit software are all examples of
systems-oriented computer-assisted audit techniques.

2 c. A representative sample is any sample, whether selected statistically or judgmentally, in which every
potential sampling unit has an appropriate chance of selection, avoiding any systematic bias.

2 d. The concepts of audit assurance and audit risk are related in that audit assurance is 1 +audit risk level.

2 e. The appropriateness of audit evidence relates to the qualitative aspects of evidence and is primarily
determined by the relevance of the evidence to a specific client assertion(s).

2 f. A CGA can become associated with information simply through an assumption made by a third party
that the CGA was involved with the information issued by an enterprise.

2 g. Under current auditing standards, a CGA has no responsibility to detect violations of laws and
regulations and resulting illegal acts perpetrated by a client in the conduct of its business (for example,
violating pollution control laws).
EAU2M05 CGA-Canada, 2005 Page 6 of 7
15 Question 4
Kim, CGA, is auditing the financial statements of his client, Wheels Ltd., which sells and distributes
agricultural equipment across Canada. Kim has performed a preliminary evaluation of the companys
internal control over sales transactions, and has concluded that the quality of the system design is generally
good. However, because the system relies heavily on computer information technology, Kim decides that
performing tests of control would likely be more costly than performing substantive tests of the recorded
sales transactions. He therefore assesses control risk in the area at the maximum and will use dollar unit
sampling to test the accuracy of recorded sales. There were approximately 1,200 sales invoices issued
during the year, whose recorded total is $30,000,000. The companys income before taxes for the year is
$8,000,000.

Kim has decided that a misstatement of $750,000 or more in sales would be material to financial statement
users. In addition, on the basis of his prior experiences with the company and his professional judgment,
he has decided to examine a sample of 100 dollar units selected at random from the population of
$30,000,000.

Required
5 a. Explain whether Kims decision to ignore an apparently well-designed internal control system, assess
control risk at maximum, and proceed to substantive testing is consistent with generally accepted
auditing standards.

5 b. Explain the basic principles of sample selection for dollar unit sampling. Also discuss how
computer-assisted audit techniques could be used to assist in sample selection, assuming that the
population of recorded sales is available to Kim as a computer master file.

5 c. Assume that Kim examines a valid sample of 100 dollar units, finds three relatively minor
overstatement errors, and correctly calculates the upper bound for overstatement error to be $800,000
at a 10% risk of incorrect acceptance. Briefly explain the possible actions he can take.
EAU2M05 CGA-Canada, 2005 Page 7 of 7
26 Question 5
You are a partner in the CGA firm of Morris, Levy & Co. Among the clients of your CGA firm is an
attorney named Samuel Hughes. Hughes is an entrepreneur who has investments in numerous businesses,
and sometimes obtains a controlling shareholder position in businesses that he believes have outstanding
future prospects. Hughes works with a number of local public accounting firms, since he is a strong
believer in the economic benefits of competition. While he values an audit, he always tries to minimize the
impact that auditors might have on the operations of his businesses. He can also be very demanding, is
often arbitrary about deadlines, and has his own views on how work (including audits) should be done.

In February 2005, Hughes telephones you and asks if Morris, Levy & Co. would be interested in
performing an audit for the year ended December 31, 2005, of a company he has recently acquired. The
company, Fantastic Fashions Ltd., is a retailer of fine leather and fur clothing, with several stores in the
local metropolitan area. Fantastic Fashions has never been audited, but another local public accountant has
performed a review of the financial statements for the previous owner for a number of years.

Hughes would like your firm to undertake the engagement on a variable fee basis (actual audit hours
applicable billings rates per hour), subject to an upper limit on the audit fee of $25,000 in the first year.
Hughes is willing to negotiate a higher audit fee in later years if your firm can clearly document that the
minimum time needed to complete the engagement warrants a higher fee.

In addition, Hughes insists on the following conditions for the performance of the audit:
1. The audit must be completed and auditors report issued by the end of the first week of February 2006.
2. You dont confirm accounts receivable, since customers might be embarrassed by confirmation
requests sent to their homes, where the customers spouses are unaware of the purchases.
3. You should rely on the companys internal controls as much as possible to minimize the costs of the
audit. Hughes believes that, while Fantastic Fashions is a small business with relatively few office
employees, his indirect oversight of operations (he is not involved in day-to-day management) keeps
the employees off balance and on their toes... so there is very little chance anyone will be stealing
from me.
4. You are to concentrate your testing on the ending balance sheet accounts, as well as key accounts in
the income statement, such as income taxes. Also, Hughes does not want you to get involved in testing
the opening balance sheet accounts, since these have already been reviewed and Hughes relied on
these numbers in negotiating a purchase price for the business, so, he believes, they must be
reliable.

Finally, Hughes makes it clear to you that he will not accept a qualified audit opinion. If something is
wrong with the numbers, well change them, he says, and Ill have my managers and my accountant in
court the next day!

At the close of this conversation, youre unsure what to say. While Hughes has strong views on the matters
he raised, it seems to you that he may be persuaded to soften his position on some issues. You end the
conversation by telling Hughes that you will discuss his proposal with your partners, and then will write to
him within a week with your firms response.

Required
20 Write the letter to Mr. Hughes.
Note:
Limit your letter to about 1,000 words.
6 6 marks are allocated for clarity, logic, impact, and persuasiveness.
END OF EXAMINATION


100


AUDITING 2 [AU2]
EXAMINATION

Before starting to write the examination, make sure that it is complete and that there are no
printing defects. This examination consists of 7 pages. There are 5 questions for a total of
100 marks.


READ THE QUESTIONS CAREFULLY AND ANSWER WHAT IS ASKED.



To assist you in answering the examination questions, CGA-Canada includes the following glossary
of terms.

Glossary

From David Palmer, Study Guide: Developing Effective Study Methods (Vancouver: CGA-Canada, 1996).
Copyright David Palmer.

Compare Examine qualities or characteristics that
resemble each other. Emphasize similarities,
although differences may be mentioned.
Contrast Compare by observing differences. Stress
the dissimilarities of qualities or
characteristics. (Also Distinguish between)
Criticize Express your own judgment concerning the
topic or viewpoint in question. Discuss both
pros and cons.
Define Clearly state the meaning of the word or
term. Relate the meaning specifically to the
way it is used in the subject area under
discussion. Perhaps also show how the item
defined differs from items in other classes.
Describe Tell the whole story in narrative form.
Diagram Give a drawing, chart, plan or graphic
answer. Usually you should label a diagram.
In some cases, add a brief explanation or
description.
Discuss This calls for the most complete and detailed
answer. Examine and analyze carefully and
present both pros and cons. To discuss
briefly requires you to state in a few
sentences the critical factors.
Evaluate This requires making an informed judgment.
Your judgment must be shown to be based
on knowledge and information about the
subject. (Just stating your own ideas is not
sufficient.) Cite authorities. Cite advantages
and limitations.
Explain In explanatory answers you must clarify the
cause(s), or reasons(s). State the how and
why of the subject. Give reasons for
differences of opinions or of results.
Illustrate Make clear by giving an example, e.g., a
figure, diagram or concrete example.
Indicate Provide a short explanation.
Interpret Translate, give examples of, solve, or
comment on a subject, usually making a
judgment on it.
Justify Prove or give reasons for decisions or
conclusions.
List Present an itemized series or tabulation.
Be concise. Point form is often
acceptable. (Also Enumerate or Identify)
Outline This is an organized description. Give a
general overview, stating main and
supporting ideas. Use headings and
sub-headings, usually in point form. Omit
minor details.
Prove Establish that something is true by citing
evidence or giving clear logical reasons.
Relate Show how things are connected with each
other or how one causes another,
correlates with another, or is like another.
Review Examine a subject critically, analyzing
and commenting on the important
statements to be made about it.
State Present the main points in brief, clear
sequence, usually omitting details,
illustrations, or examples.
Summarize Give the main points or facts in condensed
form, like the summary of a chapter,
omitting details and illustrations.
Trace In narrative form, describe progress,
development, or historical events from
some point of origin.

SAU2M05 CGA-Canada, 2005 Page 1 of 7
CGA-CANADA

AUDITING 2 EXAMINATION
March 2005
SUGGESTED SOLUTIONS

Marks Time: 4 Hours

30 Question 1
Note:
1
1
/2 marks each

Sources:
a. 4) Topic 2.4 (Level 1)

b. 1) Topic 5.2 (Level 2)

c. 3) Topic 5.3 (Level 1)

d. 1) Topic 6.1 (Level 1)

e. 3) Topic 1.1 (Level 1)

f. 4) Topic 9.7 (Level 1)

g. 2) Topic 9.4 (Level 2)

h. 2) Topic 2.5 (Level 1)

i. 2) Topic 6.1 (Level 1)

j. 3) Topic 8.3 (Level 2)

k. 3) Topic 7.1 (Level 1)

l. 2) Topic 7.1 (Level 1)

m. 1) Topic 1.1 (Level 2)

n. 2) Topic 4.1 (Level 1)

o. 4) Topic 4.1 (Level 1)

p. 2) Topic 6.1 (Level 1)

q. 2) Topic 7.2 (Level 1)

r. 4) Topic 2.6 (Level 1)

s. 4) Topic 5.4 (Level 1)

t. 1) Topic 3.1 (Level 1)
SAU2M05 CGA-Canada, 2005 Page 2 of 7
15 Question 2
Source: Topic 1.4 (Level 1); CGA-Canada Code of Ethical Principles and Rules of Conduct (CEPROC);
Topic 1.1 (Level 1); Topic 2.1 (Level 1); Topic 3.1 (Level 1)

3 a. No Violation. The fact that Frank performs accounting and tax services for a client and is then asked to
perform an assurance service is not of concern since, in Canada, joint performance of these services is
allowed. Also, Franks desire not to perform audits to avoid the risk associated with such engagements
is reasonable. Finally, Franks suggestion that a less expensive review service be performed, rather
than an audit, is reasonable. However, before agreeing to a review, the client should verify that the
bank will accept a review engagement in lieu of an audit.

3 b. Violation. Ravis response to a request from a potential client to bid on an engagement is acceptable.
Also, Ravi can agree to perform the audit for a fixed fee, so long as the fee arrangement does not lead
him to compromise audit quality. While Ravi spent only a short time at the potential clients offices,
this may be adequate to obtain a sufficient understanding of what is required in performing the audit
so as to determine a reasonable fee bid. However, after being informed that his bid was successful but
prior to his final agreement to perform the audit, Ravi must first contact the predecessor auditor and
inquire whether there is any reason why he should not accept the engagement. Failure to do so violates
CEPROC and legislation such as the Canada Business Corporations Act.

3 c. Violation. Alison violated generally accepted auditing standards by assessing control risk for various
financial statement assertions at less than maximum without performing adequate tests of controls.
Although Alison observed the operation of various systems and discussed problems with employees,
many, if not most, control activities will also leave a document trail. These documents can be
examined as part of tests of control. Also, since Alison assessed control risks at values ranging from
low to medium, she must perform reasonably extensive (and costly) tests of control to justify these
assessments.

3 d. Violation. Hannah violated CEPROC by performing a review engagement when she was not
independent of the client since she owns company shares and is an employee of the company. In
addition, Hannahs review engagement report is improperly worded since it contains a form of
positive assurance (...in my opinion, these financial statements are reasonable...). Note that in a
review engagement, a CGA would only give moderate assurance through an expression of negative
assurance (that is, ...nothing has come to my attention that causes me to believe that these financial
statements...are not in accordance with GAAP). However, irrespective of the wording, Hannah
cannot issue any form of review engagement report since she lacks independence from the client.

3 e. No Violation. Lien can advertise her CGA practice and include factual information, such as her
academic credentials, practical experience, and billing rates. Also, under the current rules of
CEPROC, she can send a personal letter to the business offices of hotels and similar businesses so
long as the letter does not contain false or deceptive information, is not deemed to be harassing
conduct, does not create an unjustified expectation of favourable results, and does not contain
self-laudatory statements that are not verifiable. These same restrictions apply to her newspaper
advertisements.
SAU2M05 CGA-Canada, 2005 Page 3 of 7
14 Question 3
2 a. Source: Topic 1.3 (Level 1)
Agree. An attest engagement is a form of assurance engagement for which a practitioner opines on a
subject matter that consists of one or more written assertions by an accountable party.

2 b. Source: Topic 3.8 (Level 1)
Disagree. While test data and an integrated test facility are examples of systems-oriented
computer-assisted audit techniques, generalized audit software is a data-oriented computer-assisted
audit technique.

2 c. Source: Topic 4.1 (Level 1)
Disagree. Two requirements are needed for a sample to be representative: 1) that the sample be
selected, either statistically or judgmentally, avoiding any systematic bias, and 2) that the sample size
be sufficiently large so as to reduce sampling error to an acceptably low level.

2 d. Source: Topic 2.3 (Level 1)
Disagree. While the concepts of audit assurance and audit risk are related, the relationship is: Audit
assurance =1 audit risk (not 1 +audit risk, as stated in the question).

2 e. Source: Topic 5.1 (Level 1)
Disagree. While the appropriateness of audit evidence does relate to the qualitative aspects of
evidence, appropriateness is not only determined by the relevance of the evidence to assertion(s), but
also by its objectivity and reliability, where the reliability of evidence depends upon both its nature
and its source.

2 f. Source: Topic 1.4 (Level 1)
Agree. A simple assumption by a third party (whether warranted or unwarranted) is one way that a
CGA can become associated with information issued by an enterprise.

2 g. Source: Topic 2.3 (Level 1)
Disagree. Under current auditing standards, fraudulent material misstatements and material
misstatements arising from a clients illegal acts are treated similarly auditors must assess the
inherent risk of material misstatements arising from illegal acts (and fraud) and adjust the nature,
extent, and/or timing of their substantive testing to reduce audit risk to an acceptably low level.
SAU2M05 CGA-Canada, 2005 Page 4 of 7
15 Question 4
5 a. Source: Topic 2.4 (Level 1)
Kims decision to assess control risk at the maximum with respect to internal control over sales
transactions and then to perform substantive tests of sales transactions is appropriate. Generally
accepted auditing standards require that an auditor obtain a sufficient understanding of internal control
in order to plan an audit. When control risk is assessed below maximum, an auditor must perform tests
of control to support the assessment. Kim has acquired an understanding of the control system design,
but chooses not to perform tests of control because, he believes, the cost of testing would exceed the
benefits, given the clients information technology. Thus, Kim has properly used his professional
judgment to evaluate this cost-benefit trade-off.

5 b. Source: Topics 4.1 and 5.3 (Level 1)
In order to obtain a valid dollar unit sample, each dollar in the population must have an equal
probability of being selected. Once a particular dollar is identified, it is then traced to the appropriate
physical unit (here a sales invoice), which is audited using appropriate procedures.

There are several ways that computer-assisted audit techniques could be used to assist in sample
selection. If the sample is selected randomly, the recorded amounts in the sales population can be
arrayed as a list with cumulative subtotals. A particular random number would then identify a dollar in
the cumulative total and a corresponding sales invoice in the list. Note that computer software (such as
ACL or spreadsheet software) can be used to generate the random numbers used in sample selection.
Alternatively, the sample could be selected systematically. In that case, Kim could choose a random
start, here a number between 0 and $30,000,000 / 100 or 300,000, and then choose each successive
300,000th dollar in the cumulative total. Details concerning the corresponding sales invoices could
then be printed for audit examination.

5 c. Source: Topics 4.4 and 4.5 (Level 1)
Since the computed upper error bound exceeds the amount deemed material ($800,000 >$750,000),
the recorded sales population must be rejected. At this point, Kim could do the following:
Increase the sample size. Depending on the pattern of errors in the expanded sample, this could
result in a reduction of the upper error bound.
Perform additional audit tests only in certain areas, if the errors were clustered in terms of their
characteristics (that is, certain types of mistakes were found, such as invoice extension errors).
Request the client to adjust (reduce) the recorded sales balance to make the amount acceptable.
Request the client to correct or rework the entire accounting population, again if the errors tend to
be of a certain type.
Refuse to give an unqualified opinion on the financial statements.
SAU2M05 CGA-Canada, 2005 Page 5 of 7
26 Question 5
Source: Topics 2.1, 2.2, 2.4, 2.6 and 2.7 (Level 1)

Note:
Candidates will provide different solutions. The major issues to be addressed and allocation of marks are shown in this sample letter. Not
all points need to be made to receive full marks. The word count is longer for exposition purposes.

Morris, Levy & Co., CGAs
(letterhead)

February 15, 2005

Mr. Samuel Hughes
Hughes Enterprises
21 Bench Ave.
Halifax, NS B3M 2J 2

Dear Mr. Hughes:

As we agreed during our telephone conversation last week, I am writing to you concerning the possibility
of our firm serving as the auditors for Fantastic Fashions Ltd. for the year ended December 31, 2005.
During our conversation, you made a number of requests and raised a variety of issues related to the audit.
I have carefully considered these matters and discussed them with my partners, and will summarize our
views regarding these matters in this letter.

2 Timing of the audit
You indicated that the audit must be completed and our auditors report issued by the end of the first week
of February 2006. We believe that a five-week period after the close of the companys fiscal year for the
performance of an audit is reasonable, and we agree to meet this deadline unless we encounter significant,
unanticipated problems that are outside the control of our firm. If any such major problems impede our
performance, we will inform you and the companys management as soon as possible so that appropriate
corrective action can be taken in a timely manner.

Note:
A complete answer would 1) address the reasonableness of the deadline, and 2) raise the possibility that uncontrollable events could
delay completion.

5 Confirmation of accounts receivable
You have stated that we should not confirm accounts receivable through direct correspondence with
customers because of concerns that this could cause embarrassment to some customers, and therefore harm
your business. While we understand this concern, direct confirmation of a sample of accounts receivable is
an important audit procedure. This is particularly true in a small business environment, such as yours,
where there are few employees and internal controls over accounts receivable transactions and balances
may not be strong. Consequently, an inability to confirm any customer account balances during our audit
would constitute a material scope restriction and would not allow us to issue an unqualified opinion. Since
you have indicated that only our unqualified opinion on the financial statements would be of value to you,
we must decline to perform the engagement under this material scope restriction.







Continued...
SAU2M05 CGA-Canada, 2005 Page 6 of 7
However, we are prepared to work with you and company management to identify specific customers that
should best be excluded from our confirmation procedures, so as to avoid any risk of embarrassment to
them. So long as reasonable criteria are used to identify such customers, and we are able to satisfy
ourselves that any or all of the excluded balances are free of material misstatement using alternative audit
procedures, this more-limited scope restriction would not affect our audit opinion.

Note:
A complete answer would 1) acknowledge the reasonableness of clients concern regarding potential harm to the business; 2) note that
confirmation is particularly necessary in a (likely) weak internal control situation; 3) note that a material scope restriction would not allow
for the issuance of an unqualified opinion; 4) mention that a more modest scope restriction could be acceptable; 5) indicate that
alternative procedures could be used with a more modest scope restriction; and 6) explain that an unqualified report could be issued if
these were successful.

5 Reliance on internal controls to minimize audit costs
You have expressed a desire that we minimize the costs of the audit by relying on the internal controls of
the company wherever possible. We fully agree with your objective that we minimize audit time and costs.
As a normal part of an audit performed in accordance with generally accepted auditing standards, we will
obtain an understanding of the companys internal controls that is sufficient to plan our audit. Since, as
noted earlier, the company is a small business with a limited number of employees, the areas where
internal controls are sufficiently strong to allow us to reduce the assessed level of control risk below the
maximum are likely to be limited. Whenever this is possible, we will use a minimum cost combination of
control risk assessment and substantive testing. In areas where internal controls are not strong, we will use
appropriate substantive testing as we deem necessary. Finally, as a normal part of our service, at the
conclusion of our audit, we will communicate to you and to management about specific weaknesses in
controls that we have noted, and which we believe can be improved at a reasonable cost. We will also
make specific suggestions for such control improvements.

During our conversation, you indicated that you monitor the companys operations sufficiently so that
employee theft of assets is unlikely to occur. While this may be true, you should be aware that our audit
cannot be relied upon to detect immaterial theft of assets by management or other employees, and will
provide only reasonable assurance that the financial statements are free of material misstatements, whether
arising from fraud or from simple errors.

Note:
A complete answer would 1) mention that minimizing audit cost is a mutual client and auditor objective; 2) note that the auditor must
obtain a sufficient understanding of controls to plan the audit; 3) note that internal controls in a small business are likely to be weak in
many (most) areas; 4) as a result, a combined audit approach (control risk below maximum and reduced substantive testing) may only be
possible in limited areas; 5) mention the role of a management letter in this context; and 6) explain the role of an audit in the detection of
fraud.
















Continued...
SAU2M05 CGA-Canada, 2005 Page 7 of 7
5 Audit of opening balances
A normal approach in an audit of financial statements is to concentrate substantive testing on the major
asset and liability account balances at year end, and on important elements of the income statement, such
as the provision for income taxes. This is consistent with your suggestions. However, in this initial audit
engagement where the previous years financial statements have not been audited, it is also necessary for
us to audit the opening balance sheet accounts of the company as of January 1, 2005. This is so because
the opening balances will affect the results of operations and cash flows for the year ended
December 31, 2005. In our conversation last week, you stated that no audit of opening balances is
necessary since those financial statements have been reviewed by another accountant. While a review does
provide moderate assurance that the opening balances are free of material misstatement, a review does not
constitute an audit and does not provide a sufficiently high level of assurance concerning the opening
balances to form a basis for our audit opinion, even if we were able to rely on the other accountant. As a
result, if we are restricted in our ability to audit opening balances, we could not provide an unqualified
opinion on the financial statements for the year ended December 31, 2005. Since you have said that a
qualified opinion would not be of value to you, we would decline to undertake the engagement under this
material scope restriction.

Note:
A complete answer would 1) agree that an auditor would normally focus on ending balance sheet; 2) indicate that opening balances must
be audited; 3) mention that opening balances affect the results of operations for the year; 4) note that a review only provides moderate
assurance and does not constitute an audit of opening balances; 5) explain that failure to audit opening balances is a material scope
restriction that would not allow for the issuance of an unqualified opinion.

3 Audit fee arrangement
Finally, you have asked that we perform an audit on the basis of a variable fee arrangement (actual audit
hours applicable billing rates per hour), with an upper fee limit of $25,000 this year, but subject to
upward adjustment in future years, if warranted and mutually agreed. While we are largely comfortable
with this arrangement, we would like an opportunity to spend some time obtaining a better understanding
of your business and the likely time and staffing requirements for this years audit, prior to committing our
firm to the fee limit of $25,000. A visit to obtain a better understanding of your business would also
provide an opportunity for us to discuss other ways that our firm may be of service to you, now and in the
future.

Note:
A complete answer would 1) acknowledge that the fee arrangement is reasonable; 2) indicate that it would be helpful to seek additional
knowledge of the business prior to agreeing to a upper bound on fees; 3) mention that other services may affect the amount of the
acceptable audit fee.

Conclusion
I would be pleased to visit with you and the management of the company at your convenience to discuss
these various issues, or to discuss any of the above matters with you by phone. I look forward to hearing
from you.

Sincerely,

Anna Knecht

Partner, Morris, Levy & Co., CGAs

6 The final six marks are allocated for clarity, logic, impact, and persuasiveness.

END OF SOLUTIONS

100

CGA-Canada, 2005
CGA-CANADA

AUDITING 2 EXAMINATION
March 2005
EXAMINERS COMMENTS
General Comments
Overall performance on this examination was satisfactory and generally consistent with results in prior
sessions. Candidates who had difficulty with the examination typically had problems with the examination
as a whole. However, the lowest marks were generally on the case question (Question 5). This may
partially be explained by the fact that this type of question is new to this examination. Difficulties included
both analyzing the case and crafting an appropriate answer (that is, a thoughtful, well-organized letter to a
prospective client discussing various issues surrounding a proposed audit engagement).
Specific Comments
Question 1 Multiple choice (Levels 1 and 2)
Performance on the multiple-choice questions was satisfactory. No particular pattern of errors was noted.

Question 2 The application of professional standards to five independent situations (Level 1)
Performance on this question was satisfactory. Candidates who lost marks generally did so because their
answers did not completely address the key issues in the case. In part (a), many candidates erroneously
believed that a CGA would be violating professional standards if the CGA felt that performance of an
audit for a client could be too risky and instead offered to perform a review engagement. A CGA can
ethically protect his or her own business interests and make suggestions to a client suggestions which
the client is free to accept or reject. Also in part (a), some candidates erroneously stated that because
engagement risk was higher for a review than for an audit, a review was more risky to the CGA than an
audit. That answer confuses engagement risk with an auditors business risk. These are two distinct
concepts. Finally, in part (e), many candidates believed that a CGA who sent a personal letter to
prospective clients was violating the rules of ethics. Although this is a form of solicitation, which was not
allowed in the past, recent changes to the CGA-Canada Code of Ethical Principles and Rules of Conduct
allow business solicitation.

Question 3 Independent auditing statements (Level 1)
This question covered a variety of auditing issues through seven independent statements with which the
candidate had to agree or disagree and then explain his or her reasoning. Overall performance on the
question was satisfactory. With respect to common errors, many candidates did not correctly answer
part (c) because they equated a random sample with a representative sample. But a representative sample
is more than just a random sample. It must also be large enough so that inferences from the sample have a
high probability of reflecting the true state of the population. Also, in part (d), the majority of candidates
did not understand the nature of the link between audit assurance and audit risk. Simply put, audit risk and
audit assurance are two sides of the same coin, as one is the complement of the other. That is, audit
assurance +audit risk =1. This is true whether or not the concepts are explicitly measured; they are still
both probabilities that sum to one.

Question 4 Trade-off between tests of control and substantive audit tests; dollar unit sampling (Level 1)
Overall performance on this question was satisfactory. In part (a), most candidates correctly described the
logic underlying the trade-off between tests of control and substantive tests, but some candidates
erroneously said that purportedly good internal controls must be tested by an auditor. Others argued that an
auditor cannot choose not to test controls because the cost of such tests is perceived to be too high. At this
time, in Canada, these are simply economic decisions that an auditor is free to make based on his or her
own professional judgment. Finally, for part (c), many candidates did not fully describe the CGAs choices
when a computed upper bound for error exceeds materiality. In particular, most did not discuss the
possibility of studying the underlying details of the errors found so that subsequent audit tests could be
focused on specific error types and conditions.
Continued...
AU2M05 CGA-Canada, 2005
Question 5 Case question (Level 1)
This long case question involved a request by a prospective client that an audit be performed, subject to a
variety of conditions and circumstances. As noted in the question and suggested solution, most marks (20)
were awarded for addressing the auditing issues raised in the case, with some marks (6) awarded for the
clarity, logic, impact, and persuasiveness of the candidates answer. Overall performance on the
question was unsatisfactory. Candidates who did not do well almost always lost significant marks both for
deficiencies in content and deficiencies in clarity, logic, impact, and persuasiveness. That is, the marks
for the two aspects of the solution were highly correlated. While no clear pattern of errors was noted with
respect to the auditing issues in the case, some candidates were willing to allow the prospective client to
impose a scope restriction on the confirmation of receivables. In their letters, they simply agreed to
perform alternative procedures. This is not an acceptable audit approach, unless a scope restriction is
deemed to have a valid business purpose which seems lacking in this case. Also, some candidates were
willing to rely on the previously performed review engagement to satisfy themselves regarding opening
balances. This is not acceptable since a review has a much higher engagement risk than an audit. Finally,
many candidates were unwilling to perform the audit under a fee cap of $25,000 in the first year. While
accepting such an arrangement is a matter of professional judgment, research indicates that the majority of
real world audit engagements are performed under fixed fee arrangements, generally subject to a provision
that fees can be adjusted upward if unexpected problems are encountered.