MOCK FINAL EXAMINATION-SOLUTIONS

AUTUMN SESSION 2011

SCHOOL OF ACCOUNTING
Student Family Name:
Student Given Names:
Student Number:
Tutor’s name and tutorial time

Unit Name (In Full): Auditing and Assurance Services

Unit Number: 200535
Time Allowed: Two (2) hours inclusive of reading time.
Number of Questions: Six (6) questions
Total Number of Pages: 19 (including the cover sheet)
Unit Co-ordinator’s Name: Dr Kym Butcher
Assessor Associate Professor Philip Ross
INSTRUCTIONS
PLEASE READ CAREFULLY BEFORE PROCEEDING
1. Write your name and student number on the top of this examination paper and on the multiple choice
answer sheet.
2. All examinations include reading time, which allows you to spend some time at the start of the
examination composing yourself, reading the examination paper, and planning which questions to
answer, and how. We advise you to read the instructions and questions carefully, before you begin
writing. However, you are allowed to begin writing straight away if you wish.
3. This is a CLOSED BOOK examination. The Auditing and Assurance Standards Handbook 2011 is not
permitted to be used in this examination.
4. The value of each question is indicated at the start of each question.
5. Calculators are not permitted.
6. Attempt all questions.
7. Answer multiple choice questions in the answer sheet provided.. Answer all other questions in the
spaces provided within this examination paper. Answers outside the spaces will not be marked.
8. This assessment is worth 60% of the overall assessment mark.

Question Marks available Marks awarded

1 15
2 23
3 9
4 15
5 18
6 20
TOTAL 100
DO NOT TAKE ANY PART OF THIS PAPER FROM THE EXAMINATION ROOM

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Question 1 (Research question) [15 marks]

Background

Auditor Independence is essential for a quality and effective audit. Impairment of Auditor
Independence due to the joint provision of audit and non-audit services, contributed to the
global corporate collapses of the early Millenium such as WoldCom and Enron in the US and
HIH Insurance in Australia. Regulators both Internationally and locally responded to this
Independence concern by issuing regulation guiding the provision of non-audit services to
audit clients.

Required:
Assume that you have been asked to advise your audit partner about the independence issues
surrounding the joint provision of audit and non-audit services.
Using the IFAC Code of Ethics (2010), APES 110 (2010) and relevant academic literature
from 2008 onwards as the basis for your advice, prepare a briefing note for the audit partner
that explains (i) the specific threat to independence caused by joint provision of audit and
non-audit services, and (ii) whether audit firms are permitted to provide both audit and non-
audit services to clients.
You are NOT required to prepare a reference list, or use in-text referencing, as part of your
briefing note.

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Question 2 [23 marks]

(a) Explain the difference between independence in appearance and independence in

fact. (6 marks)

Independence in appearance, also known as perceived independence, is the belief of financial

report users that actual independence has been achieved. (3 marks)

Independence in fact, also known as actual independence, is described as independence of

mind, (3 marks )

(b) What procedures should the auditor use to confirm the appropriateness of the
going-concern basis when an entity is dependent on its parent entity for financial
support? (7 marks)

Obtain letter of comfort from parent. ( 2 mark)

Confirm legality, enforcability, and parents intention (3 marks)
and assess parent’s capacity to support (2 mark)

(c) What is the purpose of a substantive test? How does this differ to the
purpose of a test of control? (4 marks)

-Tests of controls: transactions selected to test whether related controls are

working effectively and consistently.
-Supports a control risk assessment of low or medium. Does not directly
measure monetary error in accounting records.

-Substantive test designed to determine whether monetary errors have

occurred.
-Supports planned level of detection risk. Low detection risk requires extensive
substantive tests. High detection risk requires limited substantive tests.

(d) Outline the conceptual framework approach to the application of the fundamental
principles of professional conduct. (6 marks)

The approach to be followed when seeking to apply the fundamental principles of

professional conduct are:
 Identify threats that may compromise compliance with the principles of professional
conduct.
 Apply safeguards to eliminate the threats or reduce them to an acceptable level.
 If the threat cannot be reduced to an acceptable level, consider resigning from the service,
client or employer.

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 Question 3 [9 marks]

Consider each of the following independent situations. In each case, assume the client is a
reporting entity and that a general purpose financial report has been prepared and audited for
the financial year ended 31 December 2010. For each case, the auditor an unqualified opinion
was expressed on the prior year’s financial report.

Required:

For each independent situation, (a) through (c) you need to decide:

(i) the type of audit report to be issued and,

(ii) if the audit report is to be modified, identify the nature of the matter that gives rise
to that type of audit modification.

Independent Situation Type of audit If modified, identify the nature of

report to be the matter giving rise to the type of
issued audit modification to be issued
(1 marks) (2 marks)
(a) Mr Peabeau, an Unqualified NO modification. Sufficient appropriate
independent auditor, was audit evidence was able to be obtained to
engaged to perform an audit of support the assertions underlying the
the financial report of Dogs R financial report.
Hence, clean audit report.
US, one month after its
financial year had ended.
Although the inventory count
was not observed by Mr
Peabeau, and accounts
receivable were not confirmed
by direct communication with
debtors, Mr Peabeau was able
to gain satisfaction by applying
alternative auditing
procedures.
(b) Miss Toots is an audit Qualified opinion Qualified opinion for the LIFO issue
partner of a middle-tier audit with an emphasis (financial report is materially
firm. At the end of the audit, of matter misstated)
Miss Toots has two matters AND
outstanding. The first is a EOM for the going concern
disagreement with uncertainty as disclosed
management regarding the use
of an inappropriate valuation
method for inventory (LIFO).
The second is significant
uncertainty as to whether the
entity will continue as a going
concern. The going concern
uncertainty is disclosed in the
notes to the accounts.

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(c) Mr Ralph is an audit Qualified Material (but not pervasive)
partner of a local audit firm. Insufficient audit evidence – client
He found when reviewing the denied auditor access to inventory, so
audit working papers, a note audit team could not verify whether
that said ‘the inventory the inventory balance was misstated
balance was unable to be or not.
confirmed’. He questioned the
audit manager who informed
him that the client would not
give the audit team permission
to attend the audit stock-take
and the audit team were
unable to verify the inventory
balance by any other means.

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Question 4: [15 marks]

You are the audit partner assigned to the audit of WhichBank Ltd (WhichBank). You issued
an unqualified audit report for the year ended 30 June 2009. In December 2009, four
employees of WhichBank were charged with systematically and deliberately entering
fictitious transactions and embezzling about $10 million. Your firm has been notified by the
legal representatives of WhichBank that they are taking legal action against your firm based
on the audit for the year ended 30 June 2009. They claim that you and your audit team were
negligent in conducting the audit due to your failure to identify fraudulent activities of the
employees of WhichBank.

Required:

(a) Outline the major questions that must be addressed in determining whether you, as
the auditor, have been negligent in performing the audit. Support your answer by
reference to case law and auditing standards (10 marks)

To determine whether you, as the auditor, have been negligent in performing the audit, the following
questions addressing the issues suggested by Pacific Acceptance Corporation Ltd v Forsyth and Others may
be considered:

 Did you and your audit team (you) perform your responsibilities with the reasonable care and skill
expected of a professional, that is, the work performed has been done in a professionally competent
manner, in accordance with the Australian Auditing Standards?
 Did you conduct audit procedures, check and see for yourself the relevant audit evidence, rather
than relying on independent sources or the client’s personnel only?
 Did you audit the whole year?
 Did you closely supervise and review the work of inexperienced audit staff?
 Did you properly document procedures in a written audit program?
 Did you discover any irregularities that indicated something is wrong or indicate the possibility of
fraud? If yes, were these communicated with the appropriate level of management during the
course of the audit and to the shareholders at the annual general meeting, in relation to any
material?

(b) Outline the major issues to be determined in deciding whether the company was
guilty of contributory negligence (5 marks)

In deciding whether the company was guilty of contributory negligence, the major issue to be determined is
whether WhichBank failed to meet the standard of care required for its own protection – in this case, a
sound internal control system - which contributed to bringing about its loss. The AWA case established for
the first time in Australia that contributory negligence by the client is acceptable as a reason for reducing the
damages attributable to an auditor.

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QUESTION 5 [18 marks]

Mick The-Monkey is an audit senior of TedsAndfriends Auditors, a large international audit firm. He has been asked by the audit partner, Green
Turtle, to evaluate the following audit risks of a major international client.
Required:
For each of the three (3) key audit risks described below complete the following:
(i) Identify the impact on the component (s) of audit risk affected and explain why it is an audit risk
(ii) Identify the key account balance (s) affected
(iii) Identify the prime audit assertion (s) to be tested
(iv) Identify the best audit procedure (s) audit procedure you would use in your audit program to address the reduce the risk of material
misstatement.

NB: The situations are independent of each other and are to be treated separately in your answers. For each component only your first answer (s) will receive
marks. Writing multiple answers may result in nil marks being awarded.

Description of audit risk Impact on the component of Key Account Prime Best audit
audit risk affected (1 mark) and Balance (s) Assertion procedure to
explanation as to why it is an Affected (1 mark) reduce risk
audit risk (1 mark) (1 mark) (2 marks)
(a) One of the stores new clothing franchises Increase inherent risk Sales revenue Occurrence Vouching from
has performed extraordinarily well, High likelihood of fraud – CEO’s sales sales journal to
increasing its profit by 40% since the bonus based on sales which have AND invoices
appointment of a new manager director. It increased substantially. Likely that ]
seems that the performance compensation sales staff are falsifying sales in Debtors existence of Confirmations with
system of bonuses based on sales is working at order to earn bonuses. debtors debtors
boosting employee morale.

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 Description of audit risk Impact on the component of Key Account Prime Best audit
audit risk affected (1 mark) and Balance (s) Assertion procedure to
explanation as to why it is an Affected (1 mark) reduce risk
audit risk (1 mark) (1 mark) (2 marks)
(b) One of the client’s soft drink factory Increase control risk Cash payments Occurrence Vouching from cash
warehouse reported large staff turnover in its Lack of segregation of duties in payments journal to
cash payment section. For two months, two cash payments section. Likely to supporting
employees were recording and authorising have fraud in the cash payments documents
batches of cheques for each other to overcome could be made to fictitious (matched order,
staff shortages. suppliers or themselves. invoice, receiving
notice)

(c) One of the client’s major boutique Increase inherent risk Inventory Valuation and Re-calculations of
chocolate stores reported a breakdown in allocation obsolete stock to
power and air-conditioning for the three Easter eggs are perishable. The (dramatic write ensure lower of cost
hottest days in summer. The heatwave forced quality of easter eggs would have down of stock and NRV rule
the store to close and workers were sent deterioriated during the period of required) applied
home. Once the air-conditioning was restored no-airconditioning.. The stock
it was business as usual although the should have been reduced to NRV. AND AND
customer complaints regarding stock quality Existence – if Physical stocktake
increased dramatically in the period following Easter eggs – vouch from
Easter. had melted inventory listing (of
completely Eggs) to actual
then the stock
inventory
balance would
be overstated.

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Question 6: Multiple Choice Questions [20 marks]

1. Which of the following would be suitable criteria for an assurance engagement?

A: An indicative list of corporate governance practices prescribed by ASIC for
providing assurance on corporate governance practices.
B: An organisation’s internal documents prescribing what constitutes satisfactory
internal control for providing assurance on internal controls.
C*: Both an indicative list of corporate governance practices prescribed by ASIC
for providing assurance on corporate governance practices, and an
organisation’s internal documents prescribing what constitutes satisfactory
internal control for providing assurance on internal controls.
D: Neither an indicative list of corporate governance practices prescribed by ASIC
for providing assurance on corporate governance practices, nor an
organisation’s internal documents prescribing what constitutes satisfactory
internal control for providing assurance on internal controls.

2. An auditor of a company finds that there are rare and exceptional circumstances
where they are unable to comply with a relevant requirement in an auditing
standard. They are however able to perform appropriate alternative audit
procedures. To whom do they have to report or document these circumstances?

A: The auditor must report these circumstances to either management or the audit
committee and obtain their agreement that the alternative procedures are
appropriate.
B: If the auditor can use appropriate alternative audit procedures, no reporting or
documentation required.
C: The auditor is required to document the circumstances in the audit report.
D*: The auditor is required to document the circumstances in the audit working
papers.

3. Which of the following bodies monitors the operation of the Auditing and
Assurance Standards Board?

A*: Financial Reporting Council.

B: Companies Auditors and Liquidators Disciplinary Board.
C: Australian Stock Exchange.
D: All of the given answers.

4. Which of the following is not one of the recommendations of the ASX Corporate
governance Council?

A*: All the Board should be independent directors.

B: The Board should establish a code of conduct for directors.
C: The roles of chairperson and chief executive should not be exercised by the
same person.
D: The Board should establish an audit committee.

5. A violation of the profession’s ethical standards would be least likely to occur

when an auditor:

A: Holds the position of company secretary with an audit client which is a public
company.
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 B: Refers life insurance assignments to the auditor’s spouse, who is a life
insurance agent.
C: Undertakes a management advisory engagement and decides on the most
appropriate computer system for a client.
D*: Is a member of the same golf club as the managing director.

6. Tegan Walker is about to begin a recurring annual audit engagement. As the

continuing auditor, her independence would ordinarily be considered to be
impaired if the previous year's audit fee:

A: Was only partially paid and the balance is being disputed.

B*: Has not been paid and will not be paid for at least twelve months.
C: Has not been paid and the client has filed voluntary bankruptcy.
D: Was settled by litigation.

7. The risk that an auditor’s procedures will lead to the conclusion that a material
misstatement does not exist in an account balance when, in fact, such a
misstatement does exist is:

A: Audit risk.
B*: Detection risk.
C: Control risk.
D: Inherent risk

8. As the acceptable level of detection risk decreases, an auditor may change the:

A: Timing of substantive tests by performing them at an interim date rather than

at year-end.
B*: Nature of substantive tests from less effective to more effective procedures.
C: Timing of tests of controls by performing them at several dates rather than at
one time.
D: Assessed level of inherent risk to a higher amount.

9. Which of the following is not a typical analytical procedure?

A: Study of relationships between financial and relevant nonfinancial information.

B: Comparison of recorded amounts of major disbursements with budgeted
amounts.
C*: Comparison of recorded amounts of major disbursements with appropriate
invoices.
D: Comparison of financial information with similar information regarding the
industry in which the entity operates.

10. For a reporting entity that has participated in related-party transactions that are
material, disclosure in the financial report should include:

A*: The nature of the relationship and the terms and manner of settlement.
B: Details of the transactions within major classifications.
C: A statement to the effect that a transaction was consummated on terms no less
favourable than those that would have been obtained if the transaction had
been with an unrelated party.
D: A reference to deficiencies in the entity's internal control.
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 11. In obtaining an understanding of the internal control policies and procedures
that are relevant to audit planning, the auditor should perform procedures to
provide sufficient knowledge of:

A: Design of the relevant policies, procedures and records and their operating
effectiveness.
B: Design of the relevant policies, procedures and records and their relationships
to assertions.
C: The complexity of the entity and the sophistication of its systems and
operations.
D*: Design of the relevant policies, procedures and records and whether they have
been placed in operation.

12. To determine whether internal control structure policies and procedures operated
effectively to minimise errors of failure to invoice a shipment, the auditor would
select a sample of transactions from the population represented by the:

A*: Bill of lading file.

B: Customer order file.
C: Sales invoice file.
D: Subsidiary customer accounts ledger.

13. Which of the following control activities is not usually performed in the vouchers
payable department?

A*: Controlling the mailing of the cheque and remittance advice.

B: Matching the receiving report with the purchase order.
C: Determining the mathematical accuracy of the vendor’s invoice.
D: Having an authorised person approve the voucher.

14. A common audit procedure in the audit of payroll transactions involves tracing
selected items from the payroll journal to employee time cards that have been
approved by supervisory personnel. This procedure is designed to provide evidence
in support of the audit proposition that:

A: Jobs on which employees worked were charged with the appropriate labour
cost.
B: Only bona fide employees worked and their pay was properly computed.
C*: All employees worked the number of hours for which their pay was computed.
D: Internal control structures relating to payroll disbursements are operating
effectively.

15. The primary purpose of sending a standard bank confirmation request to

financial institutions with which the client has done business during the year is to:

A: Detect kiting activities that may otherwise not be discovered.

B*: Corroborate information regarding bank account and loan balances.
C: Provide the data necessary to prepare a proof of cash.
D: Request information about contingent liabilities and secured transactions.

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16. When outside firms of non-accountants specialising in the taking of physical
inventories are used to count, list, price and subsequently compute the total dollar
amount of inventory on hand at the date of the physical count, the auditor will
ordinarily:

A*: Make or observe some physical counts of the inventory, recompute certain
inventory calculations and test certain inventory transactions.
B: Consider the report of the outside inventory-taking firm to be an acceptable
alternative procedure to the observation of physical inventories.
C: Consider the reduced audit effort with respect to the physical count of
inventory as a scope limitation.
D: Not reduce the extent of work on the physical count of inventory.

17. Taylor Ltd has disclosed the fact that they are being sued for $1,000,000. Taylor
Ltd reported a profit for the year of $10,000,000 and has total assets of $15,000,000.
You conclude that disclosure of the litigation is adequate. What type of opinion
should you express on the financial report of Taylor Ltd?

A: disclaimer of opinion
B*: unqualified opinion with an ‘emphasis of matter’
C: unqualified opinion
D: qualified opinion or adverse opinion

18. An auditor concludes that there is a material inconsistency in the other

information in an annual report to shareholders containing audited financial
statements. If the auditor concludes that the financial statements do not require
revision, but the client refuses to revise or eliminate the material inconsistency, the
auditor may:

A: Issue a qualified opinion after discussing the matter with the client's board of
directors.
B: Consider the matter closed since the other information is not in the audited
financial statements.
C: Revise the auditor's report to include an emphasis of matter paragraph
describing the material inconsistency.
D*: Revise the auditor's report to include an EOM paragraph describing the
material inconsistency.

19. FMC Electronics Ltd engaged the accounting firm of Crosby, Seals & Anderson
to perform its annual audit. The firm performed the audit in a competent, non-
negligent manner and billed FMC for $16,000, the agreed fee. Shortly after
delivery of the audited financial report, Robert Hightower, the assistant controller,
disappeared, taking with him $28,000 of FMC’s funds. It was then discovered that
Hightower had been engaged in a highly sophisticated, novel defalcation scheme
during the past year. He had previously embezzled $35,000 of FMC’s funds. FMC
has refused to pay the auditor’s fee and is seeking to recover the $63,000 that was
stolen by Hightower. Which of the following is correct?

A: The auditor cannot recover the audit fee and is liable for $63 000.
B*: The auditor is entitled to collect the audit fee and is not liable for $63 000.
C: FMC is entitled to recover the $28 000 defalcation, and is not liable for the
$16, 000 fee.
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 D: FMC is entitled to rescind the audit contract and thus is not liable for the
$16,000 fee, but it cannot recover damages.

20. Which of the following procedures would be most valuable in the performance
audit of a government transport department?

A*: Review procedures for selection of the most appropriate routes.

B: Obtain written confirmation from the regulatory agency that all carriers are
properly licensed.
C: Verify that dispatch dockets are pre-numbered.
D: Trace selected items from the transport payments register to supporting
documentation.

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