Series: MAY 2020

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  • 10 Marks

AA – May 2020 – L2 – Q5b – Regulatory Framework and Audit Responsibilities

Outline the procedures for communicating deficiencies in internal controls to those charged with governance.

You have completed the audit of ABC Ltd for the year ended October 31, 2019.

Required:
i) Outline the procedures for communicating deficiencies in internal controls to those charged with governance and management. (6 marks)

ii) Illustrate how the deficiencies are reported. (4 marks)

The procedures for communicating deficiencies in internal controls to those charged with governance and management are as follows:

Identification of Deficiencies:

During the audit, the auditor should document all identified deficiencies in internal control, noting the area affected and the potential impact on financial reporting.
Preliminary Discussion with Management:

Before formal communication, the auditor should discuss the identified deficiencies with management to confirm their understanding and obtain management’s initial responses.
Prepare a Written Communication:

The auditor must prepare a formal written report outlining the deficiencies identified, the implications for the financial statements, and any potential risks to the entity’s operations.
Content of Communication:

The communication should clearly explain the nature of the deficiency, its potential impact, and recommendations for improvement. It should also include any responses provided by management.
Formal Presentation to Governance:

The report should be addressed to those charged with governance (e.g., the audit committee or board of directors) and presented in a formal meeting where the deficiencies and recommendations can be discussed.
Acknowledgment and Action Plan:

Management and those charged with governance should acknowledge receipt of the communication and provide a response outlining actions taken or planned to rectify the deficiencies.
(6 marks)

ii)
Deficiencies in internal controls are reported as follows:

Identification of the Internal Control Cycle:

The report should begin by identifying the specific internal control cycle (e.g., procurement, sales, or cash handling) where the deficiency was found. This provides context for understanding the deficiency.
Description of the Deficiency:

Provide a clear and detailed description of the deficiency, explaining how the control failed or was inadequate. For example, “Lack of segregation of duties in the cash handling process.”
Impact of the Deficiency:

Explain the effect of the deficiency on the organization’s financial statements or operations. This could include increased risk of fraud, misstatement, or operational inefficiency.
Recommendation for Improvement:

Provide a specific recommendation to address the deficiency. For example, “Implement segregation of duties by assigning cash handling and record-keeping tasks to different individuals.”
(4 marks)

  • 10 Marks

AA – May 2020 – L2 – Q5a – Planning and Approach for Audit and Assurance Engagements

Discuss three factors the auditor must consider before accepting or continuing an audit engagement.

ISA 220 – Quality Control for an Audit of Financial Statements deals with the specific responsibilities of the auditor regarding quality control procedures for an audit of financial statements. It also addresses, where applicable, the responsibilities of the engagement quality control reviewer. According to ISA 220, the auditor should consider certain factors before accepting a new engagement or continuing an existing engagement.

Required:
Discuss THREE (3) of such factors. (10 marks)

The three factors that an auditor must consider before accepting or continuing an audit engagement are:

Integrity of the Client:

The auditor must assess the reputation of the client, including its management and key personnel. The client’s history of compliance with regulations, ethical conduct, and any legal disputes should be carefully evaluated. If the client has a poor reputation or history of non-compliance, it may not be in the auditor’s interest to take on the engagement.
Examples include concerns over money laundering activities or aggressive interpretation of accounting standards.
Competence to Perform the Engagement:

The audit firm must evaluate whether it has the technical knowledge, expertise, and sufficient resources to perform the engagement. The firm should assess if it has personnel with the right skills and experience, particularly in the industry of the client.
This also includes ensuring the availability of time and capacity to meet deadlines and the ability to engage specialists if needed.
Compliance with Ethical Requirements:

The audit firm must ensure compliance with ethical standards, including independence. The auditor must be free from any conflicts of interest that could impair objectivity. For example, the firm should verify that none of its personnel hold financial interests in the client.
The firm must also ensure that no ongoing or prior disputes with the client could impair their ability to remain impartial and independent.
(10 marks)

  • 10 Marks

AA – May 2020 – L2 – Q4b – Audit and Assurance Risk Environment

Identify and describe two major categories of services provided by internal audit.

AA&A Chartered Accountants have been auditing ABC Company Ltd for the past four years. The company intends to list on the Ghana Stock Exchange, which requires the establishment of an internal audit department if the company does not have one already. Management has asked your firm to brief them about internal audit, and you have been asked to assist in the briefing.

Required:
i) Outline TWO (2) major categories of services that the internal audit function undertakes. (5 marks)

ii) Outline the scope of internal audit function. (5 marks)

The two major categories of services that the internal audit function undertakes are:

Assurance Services: These services involve an objective examination of evidence to provide an independent assessment on risk management, control, and governance processes. Examples include financial performance audits, compliance audits, and systems security reviews. The primary goal is to give assurance that the company’s processes are effective and aligned with its objectives.

Consulting Services: These are advisory and related services, the nature and scope of which are agreed upon with management, and are designed to improve the organization’s operations. Consulting services may include counsel, advice, facilitation, and training, aimed at enhancing risk management and control without assuming management’s responsibilities.

(5 marks)

ii)
The scope of the internal audit function typically includes the following areas:

Risk Management: Evaluating whether the organization’s risk management processes are adequate and functioning as intended, ensuring that risks are appropriately identified and managed.
Governance Processes: Ensuring that interactions with governance bodies are effective and that the organization complies with applicable laws, regulations, and internal policies.
Accuracy of Financial and Operational Information: Verifying that financial and operational data is accurate, reliable, and timely.
Resource Management: Assessing whether the organization’s resources are acquired and used economically, efficiently, and are adequately protected from misuse or loss.
Achievement of Objectives: Reviewing whether programs, plans, and objectives are achieved, and fostering continuous improvement in operations.
(5 marks)

  • 10 Marks

AA – May 2020 – L2 – Q4a – Audit and Assurance Evidence

Identify who is responsible for ensuring the going concern basis in preparing financial statements.

Your audit firm has almost completed the audit of SG Ltd. At the review stage, the audit manager assembled the engagement team and wanted to find out whether the audit evidence obtained shows that the company is a going concern.

Required:
i) Outline whose responsibility it is to ensure that the going concern basis used in the preparation of the financial statements is reasonable and acceptable.
(7 marks)

ii) Outline with examples the THREE (3) broad classifications of going concern indicators. (3 marks)

Management’s Responsibility: The responsibility for preparing the financial statements, including the assessment of whether the going concern basis is appropriate, lies with the management of the company. Management must perform a thorough assessment to ensure that the entity can continue its operations for the foreseeable future.

Assessment of Going Concern: Management must evaluate the entity’s ability to continue as a going concern, considering both internal and external factors that could impact the company’s financial health. This involves projecting future cash flows, profitability, and operational risks.

Auditor’s Responsibility: The auditor is responsible for evaluating the reasonableness and acceptability of the going concern basis used in preparing the financial statements. While the auditor does not prepare the financial statements, they must assess whether management’s evaluation is reasonable and sufficient to support the going concern assumption.

Impact on Audit Opinion: If the auditor concludes that the going concern assumption is inappropriate and management has not adopted an alternative basis for presenting the financial statements, the auditor may need to express a modified opinion.

(7 marks)

ii)
The three broad classifications of going concern indicators are:

Financial Indicators: Examples include the company’s inability to pay debts as they fall due, recurring losses, negative cash flows, and breaching loan covenants.

Operational Indicators: Examples include the loss of key management personnel or technical staff without suitable replacements, significant labor disputes, or substantial interruptions in operations.

Other Indicators: Examples include government actions or regulations, such as expropriation or new laws that make the entity’s operations illegal, as well as natural disasters or environmental catastrophes.

(3 marks)

  • 7 Marks

AA – May 2020 – L2 – Q3b – Audit and Assurance Risk Environment

Describe how you would verify the patents appearing in the financial statements of Tamale Pharma.

Tamale Pharma specializes in the development of drugs for the pharmaceutical industry.

Required:
i) State how you could verify the following item appearing in the statement of financial position of Tamale Pharma as at 31 December 2018:

Patents.
(3.5 marks)

ii) State how you could verify the following item appearing in the statement of financial position of Tamale Pharma as at 31 December 2018:

Research and development.
(3.5 marks)

To verify patents in the financial statements of Tamale Pharma, the auditor would:

Examine Patent Documentation: Review the patent documents to verify ownership and the cost associated with the acquisition.
Check Patent Register: Ensure that a register of patents is maintained, detailing descriptions, costs, and net book values of the patents. Test a sample of patents from the register against the patent documentation.
Review Additions: For any additions during the year, verify the purchase documentation, such as board minutes or senior management approval, if applicable.
Amortization: Ensure that patents are amortized over their useful life, and recalculate the amortization for accuracy.
Impairment Consideration: Consider whether there are any circumstances that might require an impairment write-off of the patents and ensure any impairment has been correctly recorded.
(3.5 marks)

To verify research and development (R&D) costs in the financial statements of Tamale Pharma, the auditor would:

Verify Supporting Documentation: Examine supporting documents such as invoices and timesheets to ensure that only development costs are capitalized, and they meet the criteria specified in IAS 38.
Compliance with IAS 38 Criteria: Confirm that the development costs capitalized meet the IAS 38 criteria, including:
Probable economic benefits.
Intention to complete the asset.
Availability of resources to complete the project.
Ability to use or sell the asset.
Technical feasibility.
Reliable measurement of expenditure.
Project Evaluation Reports: Review project evaluation reports and consider consulting an independent expert for highly technical information.
Non-Current Assets Used: Verify that any non-current assets used in research and development have been properly capitalized and depreciated according to IAS 16.
(3.5 marks)

  • 13 Marks

AA – May 2020 – L2 – Q3a – Audit and Assurance Evidence

Explain the main assertions about account balances and give examples from the audit of trade receivables.

Audit Evidence requires the auditor to obtain sufficient, appropriate evidence to be able to draw reasonable conclusions on which to base the audit opinion. That evidence should be relevant to the financial statement assertions.

Required:
i) Explain the main assertions about account balances and provide an example of each one by reference to the audit of trade receivables. (8 marks)

ii) Identify FIVE (5) of the seven main audit testing procedures (e.g., inspection) and give an example of how each might be used in the audit of plant and machinery. State the assertion being tested in each case. (5 marks)

The main assertions about account balances are:

Completeness: All assets, liabilities, and equity interests that should have been recorded have been recorded. Example: Ensuring that all trade receivables are included in the financial statements by reconciling the trade receivables listing to the general ledger.

Accuracy, Valuation, and Allocation: Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts. Example: Verifying that trade receivables are stated at their net realizable value by reviewing subsequent cash receipts or evaluating the adequacy of the allowance for doubtful accounts.

Rights and Obligations: The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. Example: Confirming that the receivables are the entity’s legal rights by sending direct confirmations to customers.

Existence: Assets, liabilities, and equity interests exist at the reporting date. Example: Verifying the existence of trade receivables by sending confirmations to customers to confirm balances at the year-end date.

Classification: Assets, liabilities, and equity interests have been recorded in the proper accounts. Example: Ensuring that trade receivables are classified as current assets in the financial statements.

Presentation: Assets, liabilities, and equity interests are appropriately aggregated or disaggregated and clearly described in the financial statements. Example: Using a disclosure checklist to verify that trade receivables are properly disclosed in accordance with IFRS/IAS requirements.

(8 marks)
ii)
The five main audit testing procedures and examples related to plant and machinery are:

Inspection: Physically inspecting plant and machinery to confirm their existence (testing the existence assertion).
Observation: Observing the maintenance of plant and machinery to confirm their condition and allocation (testing the accuracy, valuation, and allocation assertion).
Inquiry: Inquiring of management regarding useful lives and profitability of the plant (testing the valuation and allocation assertion).
Confirmation: Writing to third parties that hold the company’s plant to confirm its existence (testing the existence assertion).
Recalculation: Recalculating depreciation of plant and machinery to verify that the depreciation charge is correct (testing the accuracy, valuation, and allocation assertion).
(5 marks)

  • 3 Marks

AA – May 2020 – L2 – Q2d – Audit and Assurance Evidence

Describe the rights of an auditor in the event of a disagreement and threat of removal.

Your client Abeka Ltd is threatening to remove your firm as auditors as a result of disagreement on account of the use of inappropriate accounting policies.

Required:
Describe THREE (3) rights as an auditor in relation to the disagreement and subsequent threat of removal. (3 marks)

The auditor has the following rights in the event of a disagreement and subsequent threat of removal:

Right to Receive Written Resolution: The auditor has the right to receive a copy of any written resolution proposal concerning their removal or any disagreements related to the audit.
Right to Attend and Speak at Meetings: The auditor has the right to attend and be heard at any meetings where a resolution regarding their removal is being discussed.
Right to Make Written Representations: The auditor has the right to make written representations to the company’s shareholders, explaining their position in the event of a proposed removal. These representations must be circulated to shareholders before any resolution for removal is passed.
(3 marks)

  • 7 Marks

AA – May 2020 – L2 – Q2c – Regulatory Framework and Audit Responsibilities

Comment on the powers of the Registrar General regarding auditor appointments in the scenario.

The auditors of Obuasi Ltd resigned on 21 August 2019 after they had been validly appointed and accepted. The directors of Obuasi Ltd appointed Ofori Ansong and Co. Chartered Accountants as their new auditors on 10 October 2019. The Registrar General refused to accept Ofori Ansong and Co as auditors on the grounds that the directors had acted beyond their powers since the Registrar General has the power to appoint auditors.

Required:
Comment on the action of the Registrar General. (7 marks)

According to Section 134, Subsection 3 of the Companies Act 1963 (Act 179):

The first auditors of a company must be appointed within three months of incorporation or prior to delivering the particulars required under Section 27 of the Act to the Registrar.
Every existing company without auditors must appoint auditors within three months of the Act’s commencement.
Subsection 4(a) empowers the directors to appoint the first auditors or to fill a casual vacancy in the office of auditor.
Subsection 4(b) states that if a company does not have auditors for a continuous period of three months, the Registrar may appoint auditors.
Since the resignation of the previous auditors occurred on 21 August 2019 and Ofori Ansong and Co were appointed on 10 October 2019, the period between the resignation and the new appointment is less than three months. Therefore, the directors acted within their powers, and the Registrar General’s refusal to accept Ofori Ansong and Co was incorrect, as the directors had the right to fill the vacancy within the three-month period.

(7 marks)

  • 4 Marks

AA – May 2020 – L2 – Q2b – Types of Audit and Assurance Engagements

Describe audit procedures to obtain sufficient evidence regarding inventory.

ISA 501 – Audit Evidence – Specific Considerations for Selected Items deals with three specific items that may be contained within a set of general-purpose financial statements and for which the auditor may need to obtain sufficient appropriate audit evidence. It deals with specific considerations for inventory, litigation and claims, and segment information.

Required:
i) What should an auditor do to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory where inventory is material to the financial statements? (2 marks)

ii) What should an auditor do when physical inventory counting is conducted on a date other than the date of the financial statements? (2 marks)

 

To obtain sufficient appropriate audit evidence regarding the existence and condition of inventory, the auditor should:

  • Attend the physical inventory count unless it is impracticable.
  • Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting.
  • Observe the performance of management’s count procedures.
  • Inspect the inventory and verify its condition.
  • Perform test counts to ensure the inventory quantities are accurate.

(2 marks)

ii)

When physical inventory counting is conducted on a date other than the date of the financial statements, the auditor should perform audit procedures to obtain evidence about whether the changes in inventory between the count date and the reporting date have been properly recorded. This includes reconciling the physical count to the financial statement date and verifying that any movements in inventory after the count have been appropriately reflected in the accounting records.

(2 marks)

  • 6 Marks

AA – May 2020 – L2 – Q2a – Audit Failure and Expectation Gap

Define the concept of materiality in the context of an audit.

ISA 320: Materiality in Planning and Performing an Audit explains the concept of materiality and how it is used by the auditor in engagement to reach important conclusions regarding procedures and evidence obtained. The concept of materiality is a core concept in risk-based audit approaches.

Required:
i) Explain materiality. (2 marks)

ii) Briefly assess FOUR (4) ways materiality impacts an audit. (4 marks)

i)

Misstatements or omissions are generally considered material, individually or in aggregate, if they can reasonably be expected to influence the economic decisions of users based on the financial statements. Materiality depends on the size of the omission or misstatement, judged in its particular circumstances. It provides a threshold or cutoff point rather than being a primary qualitative characteristic that information must have to be useful.

(2 marks)

ii

The four ways materiality impacts an audit are as follows:

  • Selection of Audit Items: Materiality helps auditors determine which items to test, as material items must undergo substantive procedures.
  • Sampling Decisions: Materiality helps auditors decide whether to use sampling; for example, if all items in a population are material, sampling may not be appropriate.
  • Audit Opinion Formation: Materiality assists in determining what level of misstatement will result in a modified audit opinion.
  • Reassessment During Audit: Materiality is calculated during the planning stage and must be reassessed throughout the audit to ensure it reflects the conditions at the reporting date.

(4 marks)

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