Chapter 15: Additional practice questions

Test your understanding 1

Some organisations conduct inventory counts once a year andexternal auditors attend those counts. Other organisations havecontinuous inventory counting procedures and do not conduct a year-endcount.


(a)Explain why year-end inventory counting isimportant to the auditors of organisations that do not have continuousinventory counting procedures.

(4 marks)

(b)Describe audit procedures you would performin order to rely on continuous inventory counting procedures in a large,dispersed organisation.

(4 marks)

(c)Snu is a family-owned company which retailsbeds, mattresses and other bedroom furniture items. The company'syear-end is 31 December 20X3. The only full inventory count takes placeat the year-end. The company maintains up-to-date computerised inventoryrecords.

Where the company delivers goods to customers, a deposit is takenfrom the customer and customers are invoiced for the balance after thedelivery. Some goods that are in inventory at the year-end have alreadybeen paid for in full – customers who collect goods themselves pay bycash or credit card.

Staff at the company's warehouse and shop will conduct theyear-end count. The shop and warehouse are open seven days a week exceptfor two public holidays during the year, one of which is 1 January. Thecompany is very busy in the week prior to the inventory count but theshops will close at 15.00 hours on 31 December and staff will work until17.00 hours to prepare the inventory for counting. The company has ahigh turnover of staff.

The following inventory counting instructions have been provided to staff at Snu:

(i)The inventory count will take placeon 1 January 20X4 commencing at 09.00 hours. No movement of inventorywill take place on that day.

(ii) The count will be supervised by MrSneg, the inventory controller. All staff will be provided withpre-printed, pre-numbered inventory counting sheets that are produced bythe computerised system. Mr Sneg will ensure that all sheets areissued, and that all are collected at the end of the count.

(iii)Counters will work on their own,because there are insufficient staff for them to work in pairs, but theywill be supervised by Mr Sneg and Mrs Zapad, an experienced shopmanager who will make checks on the work performed by counters. Staffwill count inventory with which they are most familiar in order toensure that the count is completed as quickly and efficiently aspossible.

(iv)Any inventory that is known to beold, slow-moving or already sold will be highlighted on the sheets.Staff are required to highlight any inventory that appears to be soiledor damaged.

(v) All inventory items counted will have a piece of paper attached to them that will show that they have been counted.

(vi)All inventory that has beendelivered to customers but that has not yet been paid for in full willbe added back to the inventory quantities by Mr Sneg.

Describe the weaknesses in Snu's inventory counting instructions and explain why these weaknesses are difficult to overcome.

(12 marks)
(Total: 20 marks)

Test your understanding 2

(a)There are a number of key procedures whichauditors should perform if they wish to rely on internal controls andreduce the level of substantive testing they perform. These include:

(i)Documentation of accounting and internal control systems;

(ii) Walk-through tests;

(iii)Audit sampling;

(iv)Testing internal controls;

(v) Dealing with deviations from the application of control procedures.


Briefly explain each of the procedures listed above.

(10 marks)

NB: (i) to (v) above carry equal marks

Flowers Anytime sells flowers wholesale. Customers telephone thecompany and their orders are taken by clerks who take details of theflowers to be delivered, the address to which they are to be delivered,and account details of the customer. The clerks input these details intothe company's computer system (whilst the order is being taken) whichis integrated with the company's inventory control system. The company'sstandard credit terms are payment one month from the order (all ordersare despatched within 48 hours) and most customers pay by bank transfer.An accounts receivable ledger is maintained and statements are sent tocustomers once a month. Credit limits are set by the credit controlleraccording to a standard formula and are automatically applied by thecomputer system, as are the prices of flowers.


(b)Describe and explain the purpose of theinternal controls you might expect to see in the sales system at FlowersAnytime over the:

(i)Receipt, processing and recording of orders.

(6 marks)

(ii) Collection of cash.

(4 marks)

(c)Describe how you would test each of the controls identified in part (b).

(10 marks)
(Total: 30 marks)

Test your understanding 3

Your firm is the external auditor of Bestwood Engineering, aprivately owned incorporated business, which manufactures components formotor vehicles and sells them to motor vehicle manufacturers andwholesalers. It has sales of $10 million and a profit before tax of$400,000.

The company has a new chief financial officer who has asked youradvice on controls in the company's purchases and accounts payablesystem.

Bestwood Engineering has separate accounts, purchasing and goodsreceived departments. Most purchases are required by the productiondepartment, but other departments are able to raise requisitions forgoods and services. The purchasing department is responsible forobtaining goods and services for the company at the lowest price whichis consistent with the required delivery date and quality, and forensuring their prompt delivery.

The accounts department is responsible for obtaining authorisationof purchase invoices before they are input into the computer which poststhem to the accounts payable ledger and the general ledger. Theaccounting records are kept on a microcomputer and the standardaccounting software was obtained from an independent supplier. Theaccounting software maintains the accounts payable ledger, accountsreceivable ledger, general ledger and payroll. The company does notmaintain inventory records, as it believes the costs of maintainingthese records outweigh the benefits.

The chief financial officer has explained that services includegas, electricity, telephone, repairs and short-term rental (hire) ofequipment and vehicles.

You are required to:

(a)describe the procedures which should be in operation in the purchasing department to control the purchase and receipt of goods.

(8 marks)

(b)describe the controls the accountsdepartment should exercise over obtaining authorisation of purchaseinvoices before posting them to the accounts payable ledger.

(6 marks)

(c)explain how controls over the purchase ofservices, from raising the purchase requisition to posting the invoiceto the accounts payable ledger, might differ from the procedures for thepurchase of goods, as described in your answers to parts (a) and (b)above.

(6 marks)
(Total: 20 marks)

Test your understanding 4

Your firm has recently been appointed as external auditor toEWheels. EWheels is a private ‘' company that operates aninternet auction service for the sale of used motor vehicles. You areplanning the audit of the financial statements. The company has been inexistence for four years and has grown rapidly. It was founded by threeindividuals who are a former car auctioneer, an internet specialist withan interest in cars, and an accountant. The company now has threeoffices and some 100 employees. The on-line car auction market is verycompetitive. The company is the biggest provider of the service in thesouth of the country, but the directors have ambitious plans whichinclude an aggressive marketing campaign, the take-over of a number oftarget competitors and additional office space and staff, all of whichwill require considerable additional finance.

The company is financed partly by private capital brought in by thethree founders, and partly by bank loans. The three founders were alldirectors, but the accountant resigned six months ago and has commenced alegal action against the company for a considerable amount of money,claiming that he has effectively been excluded from management by theother two directors. The company's statement of financial position showsnet liabilities. The company has not yet made a profit althoughpreliminary figures indicate that it has reached break-even point in thecurrent year. Your firm has discovered that the previous auditors werenot re-appointed because they refused to issue an unmodified auditopinion on the previous year's financial statements, and instead madereference to the going concern status of the company in their auditreport. Your firm has made it clear to the directors that it may benecessary to make reference to the going concern status of the companyagain in the current year, but they have indicated that they wouldprefer an unmodified report if at all possible. You are also aware thatloan facilities for this type of company are becoming more scarce, asthere are too many companies seeking such finance.

The director who resigned six months ago was responsible for theday to day accounting function and for the preparation of the financialand management accounts. The company has been unsuccessful in recruitinga permanent replacement and has used a number of temporary accountants.Your initial investigations have highlighted a number of weak-nesses inthe operation of the accounting and internal control systems.


(a)Explain your understanding of audit risk.

(4 marks)

(b)Describe the risks associated with the audit of EWheels.

(7 marks)

(c)List the enquiries you will make and theprocedures you will perform in deciding whether to make reference to thegoing concern status of Ewheels in your audit report on the financialstatements.

(5 marks)

(d)Describe the different ways in which your audit report might refer to the going concern status of the company.

(4 marks)
(Total: 20 marks)

Test your understanding 5

Professional ethics are relevant to both external auditors and internal auditors.

You work for a medium-sized firm of Chartered Certified Accountantswith seven offices and 150 employees. Your firm has been asked totender for the provision of statutory audit and other services toBillington Travel, a private company providing discounted packageholiday services in the Mediterranean. The company is growing fast andwould represent a substantial amount of fee income for your firm. Thefinance director has explained to you that the company would like thesuccessful firm to provide a number of different services. These includethe statutory audit and assistance with the preparation of thefinancial statements. The company is also struggling with a new computersystem and the finance director considers that a systems review by yourfirm may be helpful. Your firm does not have much experience in thetravel sector.


(a)Explain why it is necessary for external auditors to be and be seen to be independent of their audit clients.

(3 marks)

(b)With reference to the ACCA's Rules ofProfessional Conduct, describe the ethical matters that should beconsidered in deciding on whether your firm should tender for:

(i)the statutory audit of Billington Travel

(4 marks)

(ii) the provision of other services to Billington Travel

(4 marks)

You are a student Chartered Certified Accountant and you are one offour assistant internal auditors in a large manufacturing company. Youreport to the chief internal auditor. You have been working on thereview of the payables system and you have discovered what you considerto be several serious deficiencies in the structure and operation of thesystem. You have reported these matters in writing to the chiefinternal auditor but you are aware that none of these matters have beencovered in his final report on the system which is due to be presentedto management.


(c)List the actions you might take in these circumstances.

(6 marks)

(d)Explain the dangers of doing nothing in these circumstances.

(3 marks)
(Total: 20 marks)

Test your understanding 6

(a)Computer-Assisted Audit Techniques (CAATs)are used to assist an auditor in the collection of audit evidence fromcomputerised systems.


List and briefly explain four advantages of CAATs.

(4 marks)

(b)Porthos, a limited liability company, is areseller of sports equipment, specialising in racquet sports such astennis, squash and badminton. The company purchases equipment from avariety of different suppliers and then resells this using the Internetas the only selling media. The company has over 150 different types ofracquets available in inventory, each identified via a unique productcode.

Customers place their orders directly on the Internet site. Mostorders are for one or two racquets only. The ordering/sales softwareautomatically verifies the order details, customer address and creditcard information prior to orders being verified and goods beingdespatched. The integrity of the ordering system is checked regularly byArcherWeb, an independent Internet service company.

You are the audit manager working for the external auditors ofPorthos, and you have just started planning the audit of the salessystem of the company. You have decided to use test data to check theinput of details into the sales system. This will involve entering dummyorders into the Porthos system from an online terminal.


List the test data you will use in your audit ofthe financial statements of Porthos to confirm the completeness andaccuracy of input into the sales system, clearly explaining the reasonfor each item of data.

(6 marks)

(c)You are also considering using auditsoftware as part of your substantive testing of the data files in thesales and inventory systems of Porthos.

(i)List and briefly explain some of the difficulties of using audit software;

(4 marks)

(ii) List the audit tests that youcan program into your audit software for the sales and inventory systemin Porthos, explaining the reason for each test.

(6 marks)
(Total: 20 marks)

Test your understanding 7

Flylo is an airline. The company owns some of its fleet ofaircraft. Other aircraft are leased from third parties. Flylo has aninternal audit function that has recently been expanded. Your firm isthe external auditor to Flylo. Your firm has been asked to investigatethe extent to which it may be able to rely on the work of internal auditin the following areas:

  • sales and ticketing;
  • fleet acquisition and maintenance;
  • trade payables and long-term debt financing (borrowings).

The company outsources its in-flight catering and payroll functions to different service organisations.


(a)Explain why the work of the internalauditors, in the three areas noted above, is likely to be useful to youas the external auditor.

(9 marks)

(b)Explain how the quality of the internalaudit function is likely to influence the extent of your reliance oninternal audit work.

(5 marks)

(c)Describe the audit evidence you will seekrelating to internal controls over the out-sourced functions (in-flightcatering and payroll).

(6 marks)
(Total: 20 marks)

Test your understanding 8

Fraud and error present risks to an entity. Both internal andexternal auditors are required to deal with risks to the entity.However, the responsibilities of internal and external auditors inrelation to the risk of fraud and error differ.


(a)Explain how the internal audit function helps an entity deal with the risk of fraud and error.

(7 marks)

(b)Explain the responsibilities of external auditors in respect of the risk of fraud and error in an audit of financial statements.

(7 marks)

(c)Stone Holidays is an independent travelagency. It does not operate holidays itself. It takes commission onholidays sold to customers through its chain of high street shops. Staffare partly paid on a commission basis. Well-established tour operatorsrun the holidays that Stone Holidays sells. The networked reservationssystem through which holidays are booked and the computerised accountingsystem are both well-established systems used by many independenttravel agencies.

Payments by customers, including deposits, are accepted in cashand by debit and credit card. Stone Holidays is legally required to payan amount of money (based on its total sales for the year) into acentral fund maintained to compensate customers if the agency shouldcease operations.

Describe the nature of the risks to which Stone Holidays is subject arising from fraud and error.

(6 marks)
(Total: 20 marks)

Test your understanding 9

Ajio is a charity whose constitution requires that it raises fundsfor educational projects. These projects seek to educate children andsupport teachers in certain countries. Charities in the country fromwhich Ajio operates have recently become subject to new audit andaccounting regulations. Charity income consists of cash collections atfund raising events, telephone appeals, and bequests (money left to thecharity by deceased persons). The charity is small and the trustees donot consider that the charity can afford to employ a qualifiedaccountant. The charity employs a part-time bookkeeper and relies onvolunteers for fund raising. Your firm has been appointed as accountantsand auditors to this charity because of the new regulations. Accountshave been prepared (but not audited) in the past by a volunteer who is arecently retired Chartered Certified Accountant.


(a)Describe the risks associated with the audit of Ajio under the headings inherent risk, control risk and detection risk andexplain the implications of these risks for overall audit risk.

(10 marks)

(b)List and explain the audit tests to be performed on income and expenditure from fund raising events.

(10 marks)

Note: In part (a) you may deal with inherent risk andcontrol risk together. You are not required to deal with the detail ofaccounting for charities in either part of the question.

(Total: 20 marks)

Test your understanding 10

You are the audit manager of Hood Enterprises, a limited liability company. The company's annual turnover is over $10 million.


(a)Compare the responsibilities of the directors and auditors regarding the published financial statements of Hood Enterprises.

(6 marks)

(b)An extract from the draft audit report produced by an audit junior is given below:

Basis of opinion

‘We conducted our audit in accordance with Auditing Standards.An audit includes examination, on a test basis, of evidence relevant tothe amounts and disclosures in the financial statements. It alsoincludes an assessment of all the estimates and judgements made by thedirectors in the preparation of the financial statements, and of whetherthe accounting policies are appropriate to the company's circumstances,consistently applied and adequately disclosed.

‘We planned and performed our audit so as to obtain as muchinformation and explanation as possible given the time available for theaudit. We confirm that the financial statements are free from materialmisstatement, whether caused by fraud or other irregularity or error.The directors however are wholly responsible for the accuracy of thefinancial statements and no liability for errors can be accepted by theauditor. In forming our opinion we also evaluated the overall adequacyof the presentation of information in the company's annual report.'


Identify and explain the errors in the above extract.

Note: You are not required to redraft the report.

(10 marks)

(c)The directors of Hood Enterprises haveprepared a cash flow forecast for submission to the bank. They haveasked you as the auditor to provide a negative assurance report on thisforecast.


Briefly explain the difference between positive andnegative assurance, outlining the advantages to the directors ofproviding negative assurance on their cash flow forecast.

(4 marks)
(Total: 20 marks)

Test your understanding answers

Test your understanding 1

(a)Importance of inventory counting

(i)Inventory counting is important toauditors of manufacturers, wholesalers, retailers and many serviceorganisations. Inventory counting is the best way to establishquantities for valuation purposes and it assists management in makingappropriate provisions against obsolete, slow moving and damaged items.

(ii) Inventory counting provides theonly direct evidence in relation to the existence of inventory.Performed properly, counting also provides evidence on cut-off, certainfrauds and on the quality of internal controls over inventory.

(iii)Auditors should attend inventorycounts where inventory is material to the financial statements(statement of financial position or statement of comprehensive income).

(b)Perpetual inventory system

(i)The purpose of a perpetualinventory system procedure in practice is to control inventory. Such asystem involves cyclical counting procedures during the year. Suchprocedures avoid the need for reliance on a year-end count. If auditorswish to rely on the records rather than a year-end count for thepurposes of the financial statements they must ensure that the cyclicalcounting procedures are adequate and are being properly and consistentlyapplied, particularly in a large dispersed organisation.

(ii) I would expect all inventories tobe counted at least once a year and for the records to be up to dateand promptly corrected for any discrepancies discovered as a result ofcounting.

(iii)The auditors must assess the riskattaching to the different locations and seek to visit those locationswhere the value or volume of inventory is substantial, and wherecontrols are weak (i.e. where risk is greater).

(iv)It may be necessary to involveother offices of the same firm, or to engage staff from another firm toattend counts, and to co-operate with internal audit, who may wish toconduct their own counts (on which the auditor may wish to rely), or whomay lend staff to the external auditor.

(v) When using other firms of externalauditors, and when relying on internal audit work, it is particularlyimportant that the auditor is satisfied with the quality of that workand that the reporting auditors' involvement is sufficient for thereporting firm to be able to justify its audit opinion.

(vi)External auditors will oftenperform visits on a rotational basis throughout the year to ensureadequate coverage of all locations.

(c)Weaknesses in counting instructions – why they are difficult to overcome

Test your understanding 2

(a)Key procedures

(i)Documentation of accounting and internal control systems

Auditors document accounting and internal control systems inorder to evaluate them for their adequacy as a basis for the preparationof the financial statements and to make a preliminary risk assessmentof internal controls.

In very simple systems with few internal controls where auditorsdo not intend to perform tests of internal controls, it is not necessaryto document the internal control system in detail. It is alwaysnecessary, however, to have sufficient knowledge of the business toperform an effective audit.

For large entities, where the client has already documented thesystem, it is not necessary for the auditors to repeat the process ifthey can satisfy themselves that the client's documentation is adequate.

(ii)Walk through tests

The purpose of walk-through tests is for the auditors toestablish that their recording of the accounting and internal controlsystem is adequate.

Auditors trace a number of transactions from source todestination in the system, and vice versa. For example, customer orderscan be traced from the initial documentation recording the order,through to the related entries in the daybooks and ledgers.

It is common for walk-through tests to be performed at the sametime as tests of controls, where auditors are reasonably confident thatsystems are recorded adequately.

(iii)Audit sampling

Auditors perform tests of controls and substantive testing on asample basis in order to form conclusions on the populations from whichthe samples are drawn.

It is not possible in anything but the very smallest of entitiesto take any other approach, as testing 100% of a population may beimpractical, not cost effective and not accurate because populations aretoo large and because of human error.

Samples can be selected in a number of ways – eitherstatistically or on the basis of auditor judgement. In all cases, thesample selected must be representative of the population as a whole.

(iv)Testing internal controls

Auditors test internal controls in order to establish whetherthey are operating effectively throughout the period under review. Ifcontrols are operating effectively, auditors can reduce the level ofsubstantive testing on transactions and balances that would otherwise berequired.

In testing internal controls, auditors are checking to ensurethat the stated control has been applied. For example, auditors maycheck that there is a grid stamp on a sales invoice with varioussignatures inside it that show that the invoice has been approved by thecredit controller, that it has been checked for arithmetical accuracy,that the price has been checked, and that it has been posted to thesales ledger. The signatures provide audit evidence that the control hasbeen applied.

Auditors are not checking to ensure that the invoice is, in fact,correct. This would be a substantive test. Nevertheless, it is possibleto perform tests of control and substantive tests on the same documentat the same time.

(v) Dealing with deviations from the application of control procedures

Where it appears that an internal control procedure has not beenapplied, it is necessary to form an opinion as to whether the deviationfrom the application of the procedure is an isolated incident, orwhether the deviation represents a systematic breakdown in theapplication of the control procedure. This is usually achieved byselecting a further sample for testing.

If it cannot be shown that the non-application of the procedureis isolated (i.e. there are no further instances in which the controlhas failed), it is necessary either to find a compensating control thatcan be tested, or to abandon testing of controls and to take a whollysubstantive approach. Where there is a breakdown in internal controls itis also necessary to reassess the auditor's preliminary riskassessment. Abandoning tests of control may place strains on the budgetfor the audit and auditors should always consider the possibility ofcompensating controls before abandoning tests of controls.

Test your understanding 3

(a)Purchasing department – procedures to control the purchase and receipt of goods

The controls the purchasing department should exercise overordering and control over receipt of goods and services should include:

  • For all goods ordered, there should be a purchase requisition from a user department. The purchasing department should not be permitted to raise purchase requisitions, as this would create a weakness in the division of duties. For goods required by the purchasing department, they should request another department (e.g. the accounts department) to raise a purchase requisition. Before raising the purchase requisition, the accounts department should ensure it is for goods the purchasing department require and are authorised to order.
  • The purchasing department should check the purchase requisition is for goods the user department is authorised to buy or consume. If the value of the order is substantial, the purchasing department should ensure there is a need for such a large order, by checking current inventory levels and future orders to determine whether so large a quantity or value is required.
  • The purchase requisition should use a standard form and be signed by an authorised signatory.
  • The purchasing department should order the goods from an authorised supplier. Where there is a choice of supplier or a new supplier is required, the purchasing department should obtain the product from the supplier who provides the product or service at the best price, quality and delivery. For audit purposes, it is desirable for staff in the purchasing department to record details of the suppliers contacted, the price, delivery date and perceived quality, and the decision on which supplier was finally chosen.
  • The purchasing department should raise the purchase order which should be signed by the purchasing manager. For large value purchases, a director may be required to sign the purchase order. The purchase order should be sent to the supplier, the goods received department, the user department and the accounts department. The purchasing department should ensure the goods are received on time. This may require them to contact the supplier a week before the expected delivery date to ensure they are received on time, and allow action to be taken if the delivery date is later than specified on the purchase order.
  • When the goods are received, the purchasing department should receive a copy of the goods received note (GRN) from the goods received department. They should record the goods received against the order. From this information, they will be able to take action when there are short deliveries or the goods are received late. Frequently purchasing departments file purchase orders in three types of file:
    • where none of the goods have been received
    • where some of the goods ordered have been received
    • where all the goods ordered have been received (i.e. 'dead' purchase orders).
  • The purchasing department may be part of the system which authorises purchase invoices. They should check the goods on the invoice are consistent with the purchase order and the price per unit is correct.
  • The purchasing department should be informed about short deliveries (i.e. the quantity of goods received is less than on the purchase order or advice note) and when there are quality problems. From this information, they can contact the supplier so that corrective action is taken. Also, such details may be helpful in determining whether the supplier should be used for future orders.
  • The purchasing department should be informed of situations when goods or services are received but no purchase order has been raised. With this information, the purchasing department should contact the 'offending' department and ensure that in future a purchase order is raised for all the goods they order. The supplier should be contacted and informed that an authorised purchase order must be received by them (the supplier) before any goods or services are provided by the supplier.

(b)Controls over obtaining authorisation of purchase invoices

The procedures the accounts department should undertake before thepurchase invoice is input into the computer and posted to the accountspayable ledger and general ledger should include:

  • The accounts department will receive the purchase invoice, which they should record in a register.
  • The invoice expense will be included on the invoice (for posting to the general ledger). The expense analysis will be checked by an independent department (e.g. the purchasing or user department).
  • The accounts department will either match the purchase invoice to the goods received note and delivery note or ask the goods received department to check and authorise the purchase invoice.
  • The purchasing department will be asked to confirm the goods are as described on the purchase order and the price per unit is correct.
  • The user department may be asked to authorise the purchase invoice.
  • An appropriate responsible official will be asked to authorise the purchase invoice.
  • Provided these checks are satisfactory, the accounts department should input the invoice details into the computer which will post it to the accounts payable ledger and the general ledger.

Where there is a problem with the invoice (e.g. concerning thequantity, quality or price of the goods received) the accountsdepartment should put the invoice in a 'hold' file. They should contactthe supplier (sometimes with the help of the purchasing or userdepartment) and try to resolve the problem. When either a credit note isreceived or the correct quantity and quality of goods have beenreceived, the accounts department will get authorisation (e.g. from thepurchasing department) that the situation is resolved and they shouldinput the purchase invoice into the computer (and credit note if this isrequired).

Periodically, an independent person should check suppliers'statements against the balances on the accounts payable ledger.Differences between these two balances should be recorded. If thetransaction which created the difference is close to the date of thecheck, it is probable that no action will be taken. However, older itemsshould be investigated to ensure that action is being taken to resolvethe problem.

(c)Controls over the purchase of services

Frequently, procedures over receiving services are less strong and less effective than those over receiving goods.

For some types of service, such as receipt of electricity, gas,water and telephone charges there may be no system for raising purchaseorders. However there should be a system for reviewing these costs, bycomparing them with the previous year (or period), with budget and withamounts charged by alternative suppliers. In this way, the company canensure these services are received at the most economical cost.

For some of these services it may be possible to suggest ways inwhich these costs can be reduced (e.g. by turning off lights andreducing the temperature settings in winter).

Costs of gas, electricity and water can be monitored by checkingthe meter readings monthly and determining whether the consumption isreasonable. For telephone expenses, the system should provideinformation on the cost for each department, and each department managershould review his/her department's costs. A risk with telephone systemsis that they can be abused by staff, who make personal telephone callsusing the company's telephone system. The department managers should bemade responsible for checking this abuse is kept to a minimum.

For receipt of all other services, before the service isobtained, a purchase requisition should be raised by the userdepartment, and the purchasing department should raise a purchase order.In emergency situations, it may be acceptable to raise a purchaserequisition and order after the service has been received (e.g. therepair of a vehicle which has broken down). There should be a systemwhereby action is taken when no purchase order has been raised for aservice which has been received. In many situations when a service hasbeen received, it is probably appropriate that the department receivingthe service should issue a goods received note and send it to thepurchases accounts and the purchasing departments. In this way, the samesystem can be used for processing receipt of services as for receipt ofgoods.

Test your understanding 4

(a)Audit risk

(i)Audit risk is the product ofinherent risk, control risk and detection risk. Audit risk isestablished by the auditor and the nature and extent of testing in aparticular audit are determined by an assessment of the other elementsof risk.

(ii) Inherent risk is the risk thatmaterial errors will occur both at the entity level, and at the level ofindividual transactions and balances. Certain account balances andcertain entities are more inherently risky than others. For example,inventory is more inherently risky than cash, volatile businesses aremore inherently risky than stable businesses.

(iii)Control risk is the risk thatinternal controls will not prevent or detect material errors, both atthe entity level, and at the level of individual transactions andbalances.

(iv)Detection risk is the risk that auditors will fail to detect material errors (due to human error or sampling risk, for example).

(b)Risks associated with the audit

(i)In the case of EWheels, the level of inherent risk, control risk and detection risk all appear to be higher than normal.

(ii) EWheels is in a volatile sectorof the economy. It has grown rapidly and is planning further expansionwhich will require additional resources. There is a real risk of'over-trading', i.e. that the business will exhaust its cash resourcestoo soon as a result of rapid growth. In such circumstances, there is arisk that creditors will go unpaid and that the business will be forcedinto liquidation. This is risky for both the directors and for theauditors.

(iii)In a highly competitive sector,there is a possibility that the company itself will be vulnerable totake-over, particularly if it is in a weak financial position which itappears to be with net liabilities. The dispute between the ex-directorand the current directors means that the current directors do not haveoverall control of the company. It is particularly important intake-over situations for auditors to be cautious in the audit opinionthey give.

(iv)The overall control environment atEWheels is weak. There has been no proper control of the accountingfunction for six months and errors are appearing as a result. This maymean that the accounting records are unreliable and the financialstatements may be materially misstated.

(v) The attitude of the directors (whichis relevant to the overall control environment) is suspect, they haveindicated that they would prefer an unmodified opinion in circumstanceswhich may warrant a modified opinion. They also appear to be overlyambitious in their expansion plans.

(vi)EWheels is suffering from financialpressures; it wishes to expand but additional resources are needed andthey are becoming scarcer, loan finance may become more expensive. Theex-director is claiming a substantial amount of money from the company.It may be preferable for the company to seek further equity finance orto delay the expansion plans.

(vii)The audit is also risky for thefirm because this is the first year of audit (and mistakes are thereforemore likely to be made) and because there is pressure to issue anunmodified opinion. It will be important for the firm to ensure thatadequate time and resources are allocated to what is likely to be adifficult audit. Any pressure by the directors to complete the auditquickly should be resisted.

(c)Reference to going concern status

(i)It will be necessary to review theoverall financing position of the company in detail. This will involveexamining budgets and cash flow forecasts, and performance againstbudgets and cash flow forecasts. If this information is not availablefor whatever reason, it will probably be necessary for the directors toproduce it.

(ii) The relationship between thecompany and its bankers should be investigated thoroughly, because ifthe relationship is poor, additional finance is unlikely to beforthcoming.

(iii)It is likely that financialinformation will be sent to the bank on a regular basis and this shouldbe inspected. It will be necessary to inspect correspondence with thebank and possibly for the auditors to make their own enquiries of thebank, although banks do not normally provide much information toauditors in this context.

(iv)Enquiries should be made ofdirectors about that availability of additional equity and other financewhich will be necessary for the planned expansion. All statements inthis respect should be corroborated and supported by documentation.

(v) Enquiries should be made of thecompany's lawyers as to the nature and likely outcome of the disputewith the ex-director. It will be necessary to make either a provision ordisclosure in the financial statements unless it is very unlikely thatany amount will be payable to him.

(d)Audit reports

(i)The audit report would probably bemodified by means of the inclusion of an 'emphasis of matter' paragraph,highlighting the problem. This would only be possible however, if thematter were adequately disclosed in the financial statements.

(ii) If the matter were not adequatelydisclosed in the financial statements, it might be necessary to issuean 'except for' opinion, because the auditor would conclude that thefinancial statements were not free from material misstatement.

(iii)An 'adverse' opinion stating thatthe financial statements do not fairly present the position at allbecause of the lack of disclosure might be necessary if the auditorsconsidered the matter to be pervasive to the financial statements as awhole.

(iv)In extreme circumstances, where itwas clear that the company was not a going concern, and the financialstatements were still prepared on a going concern basis, it wouldprobably be necessary to issue an 'adverse' opinion.

Test your understanding 5


(i)It is important for externalauditors to be independent of their audit clients because externalauditors act on behalf of the owners of the business (normally theshareholders) and report on the financial statements prepared by themanagement for the benefit of shareholders.

(ii) If external auditors are notindependent of their clients, for example if they hold shares in thecompanies that they audit, their ability to form an objective opinion onthe financial statements is impaired.

(iii)External auditors must also beseen to be independent because if they are not, the owners of thebusiness will not have confidence in the audit reports that the auditorsissue.

(iv)The ACCA's Rules of ProfessionalConduct require that auditors are independent, and that they are seen tobe independent. The Rules cover a number of areas in which theauditors' independence may be, or be seen to be, impaired.

(v) National legislation also normally requires external auditors to be independent.

(b)Billington Travel

(i)The statutory audit

  • The Rules of Professional Conduct state that it is important that the firm is competent to undertake the audit; it must have adequate resources in terms of staff with sufficient experience in this sector. The fact that the services to be provided would constitute a substantial amount of fee income indicates that the firm might not, at present, have those resources.
  • It may be appropriate to consider whether experience in this sector can be brought in, by the recruitment of additional staff.
  • The firm should consider whether staff are available at the right time of year and whether the work fits in with the firm's existing obligations.
  • The Rules of Professional Conduct also state that the firm must be independent of its clients; in particular, this means that it must not take too much of its fee income from one client (or group of clients).
  • Generally, for non-public interest clients, the fee income (including income from additional services) should not exceed 15% of the gross practice income. If that figure is exceeded, it may be possible to consider providing some, but not all, of the services requested.

(ii)The provision of other services

  • Preparation of financial statements: it is generally acceptable under the Rules of Professional Conduct for auditors to provide assistance with the preparation of financial statements for private company clients, provided that the client takes full responsibility for the accounting records and financial statements.
  • It is important to know why the company needs assistance in this area and it would be preferable in the long run for the company to be able to prepare its own financial statements.
  • It is important that those preparing the financial statements are independent of those performing the audit as far as possible, in order that the firm is seen to remain independent.
  • Systems review: the external auditor is often well placed to provide assistance with such reviews as the firm obtains a working knowledge of systems during the course of the audit.
  • However, there is always the danger that the firm finds itself in the position of having to report on a system that it has helped to improve, and it may be difficult in such circumstances to be critical of the system. This detracts from the firm's ability to remain independent, and in this case, given that it is the first year of audit and that assistance is also needed with the preparation of financial statements, it seems preferable not to tender for the systems review, this year.

(c)Actions to be taken

(i)It may be appropriate to discussthe matter, discreetly, with other staff members to establish whether ornot it is of concern to them, as well as to you. It would be preferableto discuss the matter with persons who are known to be reliable.

(ii) If the concerns are shared, or ifthe other staff have no knowledge of the matter, or if you are stillconcerned about the matter, it may be appropriate to discuss the matterwith the chief internal auditor to try and establish why the matter hasnot been reported, as there may be a good reason. If other staff supportyou in your view, it may be appropriate to take another member of staffalong to the discussion.

(iii)If the chief internal auditor isable to reassure you (either that it is not necessary to report thematter, or that the matter will be reported), no further action will benecessary, although it may be useful to make a brief note of thediscussion.

(iv)If you are not satisfied, or ifthe chief internal auditor undertakes to report the matter but does notdo so within a reasonable time, the situation may be more serious and itis more important in such circumstances to make notes of anydiscussions. It may be appropriate to have further discussions with thechief internal auditor.

(v) If you are still not satisfied,and you consider that the matter is sufficiently serious, it may beappropriate to approach a more senior member of management to voice yourconcerns. You may wish to avoid this situation but it may be necessaryin order to protect yourself.

(vi)On the assumption that the matteris one of internal concern to the company and there is no question ofillegality, the question of reporting the matters to third partiesoutside the organisation does not arise.

(d)Doing nothing

(i)The principal danger in doingnothing lies in the possibility that you may be accused of not bringingattention to the matter or even of being actively involved in a'cover-up'.

(ii) Professional ethics do not permitchartered certified accountants to take no action at all where seriousmatters are concerned and to do nothing might, in extreme circumstances,involve you in disciplinary proceedings by the ACCA, even as a student.

(iii)To do nothing might also meanthat the business of the company you work for is damaged, and thereforeyour own employment prospects.

Test your understanding 6

(a)The advantages of Computer-Assisted Audit Techniques (CAATs) are that they:

  • Enable the auditor to test program controls – if CAATs were not used then those controls would not be testable.
  • Enable the auditor to test a greater number of items quickly and accurately. This will also increase the overall confidence for the audit opinion.
  • Allow the auditor to test the actual accounting system and records rather than printouts which are only a copy of those records and could be incorrect.
  • Are cost effective after they have been set up as long as the company does not change its systems.
  • Allow the results from using CAATs to be compared with 'traditional' testing – if the two sources of evidence agree then this will increase overall audit confidence.

(c)Audit software

(i)Difficulties of using audit software

  • Substantial setup costs because the client's procedures and files must be understood in detail before the audit software can be used to access and interrogate those files.
  • Audit software may not be available for the specific systems set up by the client, especially if those systems are bespoke. The cost of writing audit software to test those systems may be difficult to justify against the possible benefits on the audit.
  • The software may produce too much output either due to poor design of the software or using inappropriate parameters on a test. The auditor may waste considerable time checking what appear to be transactions with errors in them when the fault is actually in the audit software.
  • Checking the client's files in a live situation. There is the danger that the client's systems are disrupted by the audit program. The data files can be used offline, but this will mean ensuring that the files are true copies of the live files.

Test your understanding 7

(a)Use of the work of the internal auditors by external auditors

Sales and ticketing

(i)The sales function is likely to beintegrated with the accounting and internal control system used toproduce the figure in the financial statements for revenue, on which theexternal auditor reports.

(ii) The internal auditors' work onthe ticketing system is less likely to be useful because it relates toan operational area which does not have a direct impact on the financialstatements. There are, however, regulatory matters that may need to beconsidered by the external auditor. Ticketing may also have an indirecteffect because it is likely to be integrated with the sales system andthere is likely to be some crossover between the controls over ticketingand controls over sales generally. The work of the internal auditors istherefore likely to be of some use to the external auditor.

Fleet acquisition and maintenance

(iii)The internal auditors' work onthe fleet acquisition system is likely to be very relevant to theexternal auditors because owned aircraft and leased aircraft willconstitute a substantial element of statement of financial positionassets and liabilities, and depreciation and finance charges in thestatement of comprehensive income.

(iv)Much of the internal auditors'work is likely to relate to ensuring that company policy has beencomplied with. Policy will relate to the authorisation for andacquisition of aircraft, and accounting for aircraft in terms of thecorrect classification of leases (operating or financing) anddepreciation policy, for example. Company policy is likely to beextensive and detailed for such material items and external auditorswill be concerned to ensure that it is both appropriate and has beencomplied with.

(v) It is also possible that theinternal auditors' work may involve some verification of the statementof comprehensive income and statement of financial position entries atthe year-end. Given the likely materiality of the amounts involved, thiswork will also be of interest to the external auditors.

(vi)It is possible that the internalauditors' work may also relate to the quality of aircraft, and otheroperational aspects of fleet management. These issues may also berelevant to the external auditors, at least insofar as they relate tocompliance with laws and regulations.

(vii)In relation to maintenance, theinternal auditors' work is likely to relate to the authorisation andcorrect accounting for maintenance expenditure (capitalisation orexpensing), and on the operational side, to the quality thereof, as forfleet acquisition (above). Maintenance expenditure in the statement ofcomprehensive income may well be material and the work of the internalauditors is therefore of interest to external auditors.

Trade payables and long term debt financing

(viii)The extent of the externalauditor's interest in the internal auditors' work on trade payables andlong term financing will depend on the materiality of the amountsinvolved. Trade payables (for certain types of routine maintenance, andpayables due to the service organisations, for example) may be material.Long term debt financing is very likely to be material as many airlineshave substantial debt financing.

(ix) Internal audit work on tradepayables is likely to involve ensuring that routine internal controlsare properly designed and are operating. The external auditors may wellbe interested in the internal auditors' work in this area.

(x) There are substantial financialstatement disclosures required for debt financing. The internalauditors' assistance with ensuring that disclosures are properly made,as well as with ensuring that any covenants have been complied with andthat the accounting for the financing is appropriate, may also behelpful to the external auditors.

(b)Quality of internal audit function: extent of reliance

(i)The quality of the internal auditfunction will have a significant effect on the extent of the externalauditor's reliance. If the quality of work is not adequate, reliancewill not be possible, regardless of the extent and relevance of the workperformed.

(ii) The firm will seek to ensure thatthere is an appropriate structure within the department itself, withappropriate reporting lines outside the department, preferably reportingto the audit committee.

(iii)The internal audit function hasrecently been expanded and there are likely to be changes in the waythat it is organised. The function should have operational independencewithin the organisation and formal terms of reference that encompass therecent changes made.

(iv)The function should have a clearlydefined set of operating procedures, as well as a work program. Properdocumentation of all work performed is essential.

(v) Staff should be appropriatelytrained, experienced and qualified. The head of such an importantdepartment should preferably be professionally qualified.

(c)Audit evidence: outsourced functions

(i)Internal controls exercised by thecompany over in-flight catering and payroll must be properly designedand operated. The firm will seek to review documentation of controls andinternal audit reports. It will seek to obtain evidence that controlshave beenapplied.

(ii) A breach of regulations or adeterioration in the quality of catering could both have a significanteffect on the financial statements, particularly if fines were payableor adverse publicity was likely. Enquiries into both areas and a reviewof relevant documentation provided by, for example, food licensingauthorities to the company or the service organisation, and companylawyers (in relation to passenger complaints, perhaps), will benecessary.

(iii)Evidence of controls sought by the firm will include:

  • controls over the selection of the service organisations selected (by competitive tendering, for example);
  • evidence relating to the completeness, accuracy and timeliness of information provided to, and received from, the payroll organisation (batch summaries and exception reports, for example);
  • evidence relating to the security measures taken by the payroll organisation to ensure that confidential information is kept confidential;
  • evidence relating to the security measures taken by the catering organisation to ensure that health and safety standards are maintained and that no 'sabotage' of the food can take place.

Test your understanding 8

(a)Internal audit function: risk of fraud and error

(i)The internal audit function in anyentity is part of the overall corporate governance function of theentity. Corporate governance objectives include the management of therisks to which the entity is subject that would prevent it achieving itsoverall objectives such as profitability. Corporate governanceobjectives also include the overarching need for the management of anentity to exercise a stewardship function over the entity's assets.

(ii) A large part of the management ofrisks, and the proper exercise of stewardship, involves the maintenanceof proper controls over the business. Controls over the business as awhole, and in relation to specific areas, include the effectiveoperation of an internal audit function.

(iii)Internal audit can help management manage risks in relation to fraud and error, and exercise proper stewardship by:

  • commenting on the process used by management to identify and classify the specific fraud and error risks to which the entity is subject (and in some cases helping management develop and implement that process);
  • commenting on the appropriateness and effectiveness of actions taken by management to manage the risks identified (and in some cases helping management develop appropriate actions by making recommendations);
  • periodically auditing or reviewing systems or operations to determine whether the risks of fraud and error are being effectively managed;
  • monitoring the incidence of fraud and error, investigating serious cases and making recommendations for appropriate management responses.

(iv)In practice, the work of internalaudit often focuses on the adequacy and effectiveness of internalcontrol procedures for the prevention, detection and reporting of fraudand error. Routine internal controls (such as the controls over computersystems and the production of routine financial information) andnon-routine controls (such as controls over year-end adjustments to thefinancial statements) are relevant.

(v) It should be recognised however thatmany significant frauds bypass normal internal control systems and thatin the case of management fraud in particular, much higher levelcontrols (those relating to the high level governance of the entity)need to be reviewed by internal audit in order to establish the natureof the risks, and to manage them effectively.

(b)External auditors: fraud and error in an audit of financial statements

(i)External auditors are required byISA 240 The Auditor's Responsibility to Consider Fraud in an Audit ofFinancial Statements to consider the risks of material misstatements inthe financial statements due to fraud. Their audit procedures will thenbe based on a risk assessment. Regardless of the risk assessment,auditors are required to be alert to the possibility of fraud throughoutthe audit and maintain an attitude of professional scepticism,notwithstanding the auditors' past experience of the honesty andintegrity of management and those charged with governance. Members ofthe engagement team should discuss the susceptibility of the entity'sfinancial statements to material misstatements due to fraud.

(ii) Auditors should make enquiries ofmanagement regarding management's assessment of fraud risk, its processfor dealing with risk, and its communications with those charged withgovernance and employees. They should enquire of those charged withgovernance about the oversight process.

(iii)Auditors should also enquire of management and those charged with governance about any suspected or actual instance of fraud.

(iv)Auditors should consider fraudrisk factors, unusual or unexpected relationships, and assess the riskof misstatements due to fraud, identifying any significant risks.Auditors should evaluate the design of relevant internal controls, anddetermine whether they have been implemented.

(v) Auditors should determine anoverall response to the assessed risk of material misstatements due tofraud and develop appropriate audit procedures, including testingcertain journal entries, reviewing estimates for bias, and obtaining anunderstanding of the business rationale of significant transactionsoutside the normal course of business. Appropriate managementrepresentations should be obtained.

(vi)External auditors are onlyconcerned with risks that might cause material error in the financialstatements. External auditors might therefore pay less attention thaninternal auditors to small frauds (and errors), although they mustalways consider whether evidence of single instances of fraud (or error)are indicative of more systematic problems.

(vii)It is accepted that because ofthe hidden nature of fraud, an audit properly conducted in accordancewith ISAs might not detect a material misstatement in the financialstatements arising from fraud. In practice, routine errors are mucheasier to detect than frauds.

(viii)Where auditors encountersuspicions or actual instances of fraud (or error), they must considerthe effect on the financial statements, which will usually involvefurther investigations. They should also consider the need to report tomanagement and those charged with governance.

(ix)Where serious frauds (or errors)are encountered, auditors need also to consider the effect on the goingconcern status of the entity, and the possible need to report externallyto third parties, either in the public interest, for national securityreasons, or for regulatory reasons. Many entities in the financialservices sector are subject to this type of regulatory reporting andmany countries have legislation relating to the reporting of moneylaundering activities, for example.

(c)Nature of risks arising from fraud and error: Stone Holidays

(i)Stone Holidays is subject to all ofthe risks of error arising from the use of computer systems. Ifprogrammed controls do not operate properly, for example, theinformation produced may be incomplete or incorrect. Inadequate controlsalso give rise to the risk of fraud by those who understand the systemand are able to manipulate it in order to hide the misappropriation ofassets such as receipts from customers.

(ii) All networked systems are alsosubject to the risk of error because of the possibility of the loss orcorruption of data in transit. They are also subject to the risk offraud where the transmission of data is not securely encrypted.

(iii)All entities that employ staffwho handle company assets (such as receipts from customers) are subjectto the risk that staff may make mistakes (error) or that they maymisappropriate those assets (fraud) and then seek to hide the error orfraud by falsifying the records.

(iv)Stone Holidays is subject toproblems arising from the risk of fraud perpetrated by customers usingstolen credit or debit cards or even cash. Whilst credit card companiesmay be liable for such frauds, attempts to use stolen cards can causeconsiderable inconvenience.

(v) There is a risk of fraudperpetrated by senior management who might seek to lower the amount ofmoney payable to the central fund (and the company's tax liability) byfalsifying the company's sales figures, particularly if a largeproportion of holidays are paid for in cash.

(vi)There is a risk that staff mayseek to maximise the commission they are paid by entering falsetransactions into the computer system that are then reversed after thecommission has been paid.

Test your understanding 9

(a)Risks and implications for audit risk

Inherent and control risks

(i)Charities can be viewed asinherently risky because they are often managed by non-professionals andare susceptible to fraud, although many charities and the volunteersthat run them are people of the highest integrity who take a great dealof care over their work. The assessment of this aspect of inherent riskdepends on each individual charity, and the areas in which it operates.

(ii) Charities are also at risk ofbeing in violation of their constitutions which is important where fundsare raised from public or private donors who may well object stronglyif funds are not applied in the manner expected. Other charities andregulatory bodies supervising charities may also object. Again, theauditors will assess the level of risk. The involvement of a recentlyretired Chartered Certified Accountant in the preparation of accounts inthe past may lower the auditor's assessed inherent risk to an extent.

(iii)Most small charities have a highlevel of control risk because formal internal controls are expensive andare not often in place. This means that donations are susceptible tomisappropriation. Charities rely on the trustworthiness of volunteers.The auditors will assess the level of risk.

Detection risk

(iv)Detection risk comprises samplingrisk and non-sampling risk. It is possible in this case that alltransactions will be tested and therefore sampling risk (the risk thatsamples are unrepresentative of the populations from which they aredrawn) is not present.

(v) Non-sampling risk is the risk thatauditors will draw incorrect conclusions because, for example, mistakesare made, or errors of judgement are made in interpreting results, orbecause the auditors are unfamiliar with the client, as is the casehere.

Audit risk

(vi)Audit risk is the product ofinherent risk, control risk and detection risk and is the risk that theauditors will issue an inappropriate audit opinion. This risk can bemanaged by decreasing detection risk by altering the nature, timing andextent of audit procedures applied. Where inherent risk is high andcontrols are weak (as may be the case here) more audit work will beperformed in appropriate areas in order to reduce audit risk to anacceptable level.

(b)Audit tests – fund raising events

(i)Attend fund raising events andobserve the procedures employed in collecting, counting, banking andrecording the cash. This will help provide audit evidence that fundshave not been misappropriated and that all income from such events hasbeen recorded. Sealed boxes or tins that are opened in the presence oftwo volunteers are often used for these purposes.

(ii) Perform cash counts at the eventsto provide evidence that cash has been counted correctly and that thereis no collusion between volunteers to misappropriate funds.

(iii)Examine bank paying in slips,bank statements and bank reconciliations and ensure that these agreewith records made at events. This also provides evidence as to thecompleteness of income.

(iv)Examine the records of expenditurefor fund raising events (hire of equipment, entertainers, purchase ofrefreshments, etc.) and ensure that these have been properly authorised(where appropriate) and that receipts have been obtained for allexpenditure. This provides evidence as to the completeness and accuracyof expenditure.

(v) Review the income and expenditureof fund raising events against any budgets that have been prepared andinvestigate any significant discrepancies.

(vi)Ensure that all necessary licences(such as public entertainment licences) have been obtained by thetrustees for such events in order to ensure that no action is likely tobe taken against the charity or volunteers.

(vii)Obtain representations from thetrustees to the effect that there are no outstanding unrecordedliabilities for such events – again for completeness of expenditureand liabilities.

Test your understanding 10

(a)Preparation of financial statements

The directors are normally required to prepare the financialstatements of the company using the appropriate law of their country andin accordance with the International Accounting Standards (IASs). Theauditors are normally required to check or audit those financialstatements, again in accordance with the legislation of their countryand the International Standards on Auditing.

Fraud and error

The directors are responsible for preventing and detecting fraudand error in the financial statements, no matter how immaterial this maybe. Auditors are responsible for giving an opinion on whether thefinancial statements show a true and fair view; in other words that thefinancial statements are materially correct. Auditors are not requiredto detect immaterial fraud or error.


The directors must ensure that there is adequate disclosure ofall matters required by statute or IASs in the financial statements. Theauditor will check that disclosure provisions have been complied with,and where certain disclosures have not been made, provide thisinformation in the audit report.

Going concern

The directors are responsible for ensuring that the company willcontinue in operational existence for the foreseeable future, and reportto the members in the published financial statements if this isunlikely to be the case. The auditor will check the accuracy of thedirectors' workings and assumptions and if these are consideredincorrect or inappropriate, then the audit report may be modified orqualified to bring the situation to the attention of the members of thecompany.

(b)Review of audit report extract

The basis of opinion paragraph may not meet the requirements of ISAs 700-705 for the following reasons:

The use of the term Auditing Standards is not clear, because thereport does not state which auditing standards have been used. Thisprovides uncertainty regarding the actual standard of work performed.

The assessment of estimates and judgements made by the directorsnormally relates to significant amounts only, rather than all of thoseestimates and judgements. The use of the word all implies that the auditwas more thorough than it probably was. Replacing the word all with theword significant will show that there was some limit to the audittesting and that this was probably focused on material amounts only.

Stating that time was a factor in obtaining information andexplanations for the audit is not correct as this implies some factorwhich could have been avoided and that the audit may therefore beincomplete. The auditor has to plan the audit carefully and ensure thatall the information and explanations considered necessary are obtainedto form an opinion, not simply stop work when time runs out.

The auditor does not confirm that the financial statements arefree from material misstatement as this implies a degree of accuracythat the auditor simply cannot provide. Making the statement could alsoleave the auditor liable to claims from members or third parties shoulderrors be found in the financial statements later. Rather than make sucha categorical statement, the auditor provides reasonable assurance thatthe financial statements are free from material misstatement, whichclearly implies that audit techniques are limited.

The disclaimer regarding errors appears to be useful in that itlimits the auditor's liability. However, it does not belong in the basisof opinion paragraph as it appears to severely limit the basis of theauditor's opinion by stating that the directors are responsible for allerrors. Directors' responsibilities are also clearly outlined in anothersection of the report, and this statement also appears to extend thoseresponsibilities making the audit report overall less clear. This couldalso imply that the auditor has done little or no work.

As the auditor is not required to audit the whole of the annualreport of a company, it is inappropriate to refer to disclosure in thatreport when checking overall adequacy of presentation. Adequacy ofpresentation can only be confirmed regarding items actually audited,which is basically the financial statements.

(c)Positive v negative assurance

A positive assurance report means that the auditor has carriedout sufficient work to be able to state that financial information isfree from material error.

A negative assurance report means that nothing has come to theattention of the auditor, which indicates the financial informationbeing reported on has errors in it. However, the extent of the workcarried out is normally less, which means that less reliance can beplaced on this report.

The advantages of providing negative assurance include:

  • The user of the financial information receives some comfort that the information is correct, even though that assurance is less than positive assurance.
  • The report adds some credibility to the financial information because it has been reviewed by a professional accountant.
  • For the preparer, the report will be more cost effective than obtaining a full positive assurance report.

Created at 5/24/2012 2:41 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 5/25/2012 12:54 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London

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