Fundamentals Level – Skills Module

AUDIT & ASSURANCE

Paper F8
Time allowed: 3 hours 15 minutes

This question paper is divided into two sections:

Section A – ALL 15 questions are compulsory and MUST be attempted

Section B – ALL THREE questions are compulsory and MUST be attempted

Do NOT open this question paper until instructed by the supervisor.

Do NOT record any of your answers on the question paper.

This question paper must not be removed from the examination hall.
Section A – ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.

The following scenario relates to questions 1–5

You are the senior manager in the internal audit department of Fooz, a limited liability company. You
report to the chief internal auditor and have a staff of six junior auditors to supervise, although the
budget allows for up to ten junior staff.

In a recent meeting with the chief internal auditor, the difficulty of staff recruitment and retention was
discussed. Over the past year, five junior internal audit staff have left the company, but only two have
been recruited. Recruitment problems identified include location of Fooz’s head office in a small town
over 150 kilometres from the nearest major city and extensive foreign travel, often to cold climates.

Together with the chief internal auditor you believe that outsourcing the internal audit department may
be a way of alleviating the staffing problems. You would monitor the new outsourced department in a
part-time role taking on additional responsibilities in other departments, and the chief internal auditor
would accept the post of Finance Director (FD) on the board, replacing the retiring FD.

Two firms have been identified as being able to provide the internal audit service:
– The NFA Partnership, a local firm specialising in provision of accountancy and internal audit services.
NFA does not audit financial statements or report to members, and
– T&M, Fooz’s external auditors, who have offices in 75 countries and employ in excess of 65,000 staff.

1. Which of the following should NOT be a function of the internal audit department?
A. Reviewing accounting and internal control systems
B. Examining operating and financial information
C. Reviewing compliance with laws and regulations
D. Decision making regarding use of appropriate accounting policies

2. Which of the following statements relate to Internal Auditors?

i. They evaluate and improve the effectiveness of governance, risk management and control
processes.
ii. Their scope is decided by statute.
iii. They need to use specific formats for reporting their conclusions.
iv. They report to the board and senior management who are within the organisation’s governance
structure.
v. Their work includes assessing the tone and risk management culture of the organisation at one
level

A. 1,2 and 3
B. 3,4 and 5
C. 1,4 and 5
D. 2,4 and 5
3. Which TWO of the following are benefits of outsourcing internal audit to NFA?
i) They may be able to provide a broader range of expertise as they serve many different clients
therefore staff may be available for specialist work that Fooz could not afford to employ.
ii) Effectively training will be provided for ‘free’ as the outsourcing firm will be responsible for
keeping staff up-to-date with new auditing techniques and processes
iii) The NFA partnership may not be able to provide this service to Fooz as they are a local firm and
therefore the issue of travel and working away from home would remain.
iv) NFA will already have knowledge of Fooz. This will assist in establishing the internal audit
department as systems documentation will already be available and the firm will already be
aware of potential weaknesses in the control systems.

A. 1 and 2
B. 1 and 3
C. 2 and 3
D. 3 and 4

4. Which of the following statements is false regarding the issues T&M need to consider
before they accept appointment as internal auditors for Fooz?

A. T&M must ensure that separate staff are used to provide the internal and external audit functions.
B. Steps will need to be taken to avoid conflicts of interest or other independence issues such as close
personal relationships building up with staff in Fooz.
C. There may be fee pressure on T&M, either to maintain the cost effectiveness of the internal audit
department, or to maintain the competitiveness of the audit fee itself in order to keep the internal
audit work.
D. T&M will need to arrange special internal audit training for staff .This way they will become aware of
relevant best practice guidance for internal auditors.

5. When internal audit is outsourced, Fooz should apply control activities to ensure that the
outsourced internal audit service is being maintained to a high standard. Which of the
following control activities is not a relevant control activity?

A. The work plan for internal audit should be agreed prior to work commencing and this should be
followed by the outsourcing company.
B. Fooz should set and review of performance measures such as cost, areas reviewed etc. with
explanations obtained for any significant variances.
C. Fooz should ensure that appropriate audit methodology is being used, including clear documentation
of audit work carried out, adequate review, and appropriate conclusions drawn.
D. Fooz should carry out a cost benefit analysis for outsourcing internal audit in order to ensure it is
resulting in value addition for the company.
The following scenario relates to questions 6-10

TruOil operates in multiple countries and has earned a pre-tax profit of $4.6million. TruOil’s audit for the
year ended 31 December 2016 is being conducted by Brady Co. Brady Co. is reviewing audit work and
has identified the following issues related to the audit of TruOil.

Issue 1
One of the company’s oil tankers ran aground on the coast of SeeLand on 23 December 2016. There is a
risk of a serious oil spill which could have a significant effect on the future of the company. Further
information will not be available until after the auditors’ report has been signed. The Environmental
Regulatory Agency sent a notice on 14 January 2017 and has intimated a fine payable amounting to $3
million.
Issue 2
Brady was unable to conduct the audit of a part of payroll expense for the year due to a computer error
that has rendered the payroll for the month of May unverifiable. Payroll expense for the month of May
was $38,000.Brady has a written representation from the management verifying the number of
employees and the expense for the month.

6. Which of the following correctly describes a written representation?

A. A written statement by management provided to the auditor to confirm certain matters or to support
other audit evidence
B. A written communication from the auditor to the client stating the terms of engagement before the
appointment is accepted
C. A form of written evidence given by a third party to the auditor, which would allow the auditor to
conclude that the company is a going concern.
D. A written communication by the auditor to the management stating the significant deficiencies and
the actions to be taken to remove them in the future to make the system more effective

7. Regarding Issue 1, which if the following statements is correct?

A. The fine imposed by Environment Regulatory Body is a non-adjusting event as the notice was sent
post year end.
B. This is an adjusting event requiring a disclosure in the financial statements for the year ended 31
December 2016.
C. This is an adjusting event as the spill occurred before year end hence financial statements will also
be adjusted for the fine.
D. This is a contingent liability as the extent of damage will not be known until after the audit report is
issued.

8. Which of the following audit procedures would not be appropriate to gather sufficient
appropriate audit evidence in relation to Issue 1?

A. Obtain a copy of the notice to ensure it relates to the spill that occurred before year end.
B. Discuss with the management whether the issue affects going concern and ascertain whether
financial statements have been adjusted to reflect that.
C. Discuss the notice with an expert to check whether it is likely that the fine will have to be paid.
D. Review disclosures to ensure adequate disclosures have been made regarding the spill and the
uncertainty regarding going concern.
9. Which of the following statements correctly describe the actions that can be taken by the
auditor with regards to matters in Issue 2?

I. Discuss with the management to ascertain whether there are alternative procedures that can be
employed to verify payroll for the month of May.
II. Modify opinion in the audit report as the auditor was unable to gather sufficient appropriate audit
evidence in a material area.
III. Perform analytical analysis on the payroll figure for the month of May and investigate unusual
differences.

A. I only
B. I and III
C. II and III
D. I, II and III

10. If the management at TruOil fail to adjust the financial statements for matters
described in Issue 1, which of the following correctly describes courses of action available
to the auditor?

A. An unmodified opinion should be issued as the matter relates to year ending 2017 with an
emphasis of matter paragraph highlighting impact on the future of the company.
B. The audit opinion should be qualified since the amount of the fine imposed is material and
needs adjustment in financial statements.
C. The audit committee should be notified of the fact that financial statements are not being adjusted
and the auditor should consider withdrawing from the assignment.
D. The auditor should consider issuing an adverse opinion if it is verified that the going co
ncern assumption is incorrect.
 The following scenario relates to questions 11-15

Your firm has recently been appointed as the external auditor of Alpha Co, a public company as well
as for providing tax advisory services.

Alpha operates a chain of boutique coffee shops. Joe Brawley the engagement partner, met with
Alpha’s finance director, Paul Baldwin, last week. During the meeting Paul offered him the role of
financial controller once the current year audit is complete. Paul also suggested offering all the
members of the audit team an ‘Alpha Card’ which enabled them to have free coffee and pastries every
day for a year.

Paul asked Joe to request a meeting with the firm’s tax manager as he needs advice on whether to
challenge the local tax authority in respect of its assessment of Alpha’ carried forward tax losses.
Paul wants the firm to help make any challenge.

11. Which of the following options correctly identifies the ethical threat, if any, due to the
fact that audit firms often provide multiple services related to audit as well as assurance
to clients?

Ethical threat Description

A. Yes Professional competence and due care compromised
B. Yes Self-Interest and Self Review
C. No If work is reviewed by network firm
D. No If separate teams are ensured for all services

12. Which of the following statements is correct regarding the Paul’s offer of employment to
Joe?

A. Joe may accept the position as the offer will only be accepted once the current years audit
is completed independently
B. Joe cannot accept the offer as this may prejudice his opinion due to the fact that he would
be reviewing his own work as the Financial Controller.
C. Joe may accept the offer if he signs a contract not to disclose the audit plan to Alpha.
D. Joe may accept the offer after an appropriate time has passed after the audit to prevent
familiarity with the audit procedures and personnel.

13. Which of the following safeguards is most appropriate to address the fact that Paul has
asked the firm’s tax manager to prepare a challenge to contest the local tax authority’s
claim?

A. The audit firm may not prepare the challenge as the threat is so material that no other safeguard
would be suitable.
B. The audit firm can prepare the challenge if the audit work is reviewed by an independent partner to
ensure that audit opinion was not influenced.
C. The challenge may be prepared by the audit firm as long as audit and preparation of challenge are
undertaken by different teams.
D. The audit firm may prepare the challenge if the fee earned from the tax work combined with other
assignments does not exceed 15% of total fee earned.
14. Under what circumstances are gifts like the ‘Alpha Card’ are acceptable for an audit firm
under the ACCA’s Code of Ethics?

A. If the amount of the gift is nominal such that it may not or may not be seen as influencing the
auditor’s objectivity.
B. Gifts are only acceptable if given after the audit report is prepared such that the auditor’s opinion is
not prejudiced.
C. Gifts are not acceptable under any circumstances as they are given with the intention of influencing
the auditor’s independent opinion.
D. Gifts are acceptable as they are the client’s recognition of the auditor’s efforts in conducting the
assurance engagements.

15. Joe recently obtained the knowledge that Alpha was going to offer shares to general
public. Alpha has not made any public announcements yet. Joe came to know while
conducting the audit of financial statements that Alpha is forecasted to perform very well in
the upcoming 12 months and shares this information with the other partners of the audit
firm, none of whom have the shares of Alpha at the moment. In the above case, which of the
following fundamental principles is violated?

A. Integrity
B. Objectivity
C. Confidentiality
D. Professional behavior
 Section B – ALL THREE questions are compulsory and MUST be attempted

16. Your client, Hugh Co, is a manufacturer of machinery used in the coal extraction industry. You are
currently planning the audit of the financial statements for the year ended 30 November 2016. The draft
financial statements show profit before tax of $5·6 million and total assets of $95 million. Your firm was
appointed as auditor to Hugh Co for the first time in June 2016.

Hugh Co makes machinery for five key customers. Half payment is due when the order is confirmed and
the remaining half when the machinery is delivered.

At 30 November, there is an amount outstanding of $2·85 million from Jacks Mine Co. The amount is a
disputed payment. Jacks Mine Co is refusing to pay until the machinery, which was installed in August
2015, is running at 100% efficiency.

One customer, Sawyer Co, communicated in November 2016, via its lawyers with Hugh Co, claiming
damages for injuries suffered by a drilling machine operator whose arm was severely injured when a
machine malfunctioned. The CEO of Hugh Co, has told you that the claim is being ignored as it is
generally known that Sawyer Co has a poor health and safety record, and thus the accident was their
fault. Two orders which were placed by Sawyer Co in October 2016 have been cancelled.

Inventory included Work in progress valued at $8·5 million at 30 November 2016. A physical inventory
count was held on 17 November 2016. The chief engineer estimated the stage of completion of each
machine at that date.

All machines are supplied carrying a one year warranty. A warranty provision is recognised on the
balance sheet at $2·5 million.

At the beginning of the year, Hugh Co purchased a patent for $1·3 million which gives them the exclusive
right to manufacture specialised machinery for five years. In order to finance this purchase, Hugh Co
borrowed $1·2 million from the bank which is repayable over five years.

Required:

a) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning
the audit of Hugh Co.
(12 marks)

b) Describe substantive procedures you should perform to obtain sufficient and

appropriate audit evidence in relation to the warranty provision.
(5 marks)

c) Identify and describe FOUR quality control procedures that are applicable to the
individual audit engagement
(8 marks)

d) (i) State the aim of a test of control and the aim of a substantive procedure.
(ii) In respect of an auditor’s attendance at an inventory count, state one test of
control and one substantive procedure that the auditor should perform.
(5 marks)

(30 marks)
17. Wyatt Co is a wholesaler of electrical appliances selling to smaller retailers. You are an audit senior in
Reynolds & Co, a firm providing audit and assurance services. You are preparing the audit programme for
the income and receivables systems.

Audit documentation is available from the previous year’s audit, including internal control questionnaires
and audit programmes for the despatch and sales system. As far as you are aware, Wyatt’s system of
internal control has not changed in the last year and you have thus decided to use the approach adopted
last year to audit the area. You have gathered the following information on the system:

Wyatt only sells to authorized customers; following appropriate credit checks, each customer is given an
identification card to confirm their status. Customers visit Wyatt’s warehouse and load the goods they
require into their vans after showing their Wyattidentification card to the despatch staff.

A pre-numbered goods despatch note (GDN) is produced and signed by the customer and a member of
Wyatt’s despatch staff that is responsible for physically checking the goods being loaded in vans by
customers. One copy of the GDN is sent to the accounts department, the second copy is retained in the
despatch department. Error reports are produced showing breaks in the GDN sequence.

Accounts staff enter goods despatch information onto the computerized sales system. The GDN is then
signed by the accounts staff confirming entry into the system. The computer system produces the sales
invoice, with reference to the inventory master file for product details and prices, maintains the sales day
book and also the receivables ledger. The receivables control account is balanced by the computer. The
controls accounts are counter checked and signed by the Accounts Manager.

Invoices are printed out and sent to each customer in the post with paper copies maintained in the
accounts department. Invoices are compared to GDNs by accounts staff and signed. Paper copies of the
receivables ledger control account and list of aged receivables are also available to maintain follow up on
outstanding amounts.

a) Explain the benefits of documenting the transaction processes of the client. Give one
benefit and one disadvantage of the method of documentation identified in the scenario
above. (4 marks)

b) Using information from the scenario, list SIX tests of control that an auditor would
normally carry out on the despatch and sales system at Wyatt Co and explain the reason
for each test. (12 marks)

c) Reynolds sent confirmation letters to several receivables however certain receivables

confirmed balances that were significantly different from Wyatt’s records. The audit
senior has been asked to investigate reasons for these differences and pay close
attention to the audit of the value of receivables.

Describe substantive procedures you should perform to obtain sufficient and appropriate
audit evidence in relation to the matter above. (4 marks)

(20 marks)
 18.

a) ISA 701 related to Communicating Key Audit Matters in the Independent Auditor’s Report

i) Explain what Key Audit Matters (KAM) are. (2 marks)

ii) Describe TWO matters which the ISA requires the auditor to take into account when
determining Key Audit Matters (2 marks)

iii) Once the auditor has determined which matters will be included as KAM, the auditor
must ensure that each matter is appropriately described in the auditor’s report.
Explain what needs to be described in this section about each KAM.
(2 marks)

b) You are the manager responsible for the audit of MDamon Co( year ended 31 January 2016).
MDamon Co outsources its entire payroll, invoicing and credit control functions to Awtsorse Co. In
December 2015, Awtsorse Co suffered a computer virus attack on its operating system, resulting in
the destruction of its accounting records, including those relating to MDamon Co. You have therefore
been unable to perform the planned audit procedures on payroll, revenue and receivables, all of
which are material to the financial statements. Awtsorse Co has manually reconstructed the relevant
figures as far as possible, and has supplied a written statement to confirm that they are as accurate
as possible, given the loss of accounting records.’

i) Describe substantive procedures you would perform to obtain sufficient and appropriate
audit evidence in relation to the matter above. (2 marks)

ii) Describe the impact on the audit report if the above issue remains unresolved

(6 marks)

c) GoGone Co is an established manufacturing company that has for many years generated 95% of its
revenue through the sale of two products, A and B. In the recent past, there has been a growth in
the level of competition that it faces in its market and demand for its products has significantly
declined. In the past the company has not invested sufficiently in new product development.

The company needed to invest $2m in plant and machinery. The company wanted to borrow this sum
but was unable to agree suitable terms with the bank; therefore it used its overdraft facility, which
carried a higher interest rate. For three consecutive months, they have also used the overdraft
facility to pay the monthly salaries.

The directors have informed you that the bank overdraft facility is due for renewal next month, but
they are confident that it will be renewed. They also strongly believe that the new products which are
being developed will be ready to market soon and hence trading levels will improve and therefore
that the company is a going concern. Therefore they do not intend to make any disclosures in the
accounts regarding going concern

i) Describe substantive procedures you would perform to obtain sufficient and appropriate audit
evidence in relation to the matter above. (3 marks)
ii) The auditors have been informed that GoGone’s bankers will not make a decision on the overdraft
facility until after the audit report is completed. The directors have now agreed to include going
concern disclosures.

Required: Describe the impact on the audit report of GoGone if the auditor believes the
company is a going concern but a material uncertainty exists. (3 marks)

(20 marks)