Series: NOV 2018

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  • 20 Marks

QT – Nov 2018 – L1 – Q7 – Probability

Calculate expected returns for investments, determine optimal strategy, and analyze student error distribution.

Royal Driving School is considering investing in a profitable project. The school is given the following investment alternatives and percentage rates of return.

Over the past 300 days, market conditions have been moderate for 150 days and good for 60 days.

Required:
i) Calculate the expected return for each type of investment. (4 marks)
ii) Determine the optimum investment strategy for Royal Driving School. (3 marks)

b) The number of errors made by 294 students of Royal Driving School in their first attempt at a driving test is grouped in the following frequency distribution:

Number of Errors Number of Students
7 – 13 3
14 – 20 12
21 – 27 23
28 – 34 44
35 – 41 54
42 – 48 56
49 – 55 43
56 – 62 24
63 – 69 23
70 – 76 12

Required:
i) Compute an estimate of the mean and mode for the distribution. (3 marks)
ii) Construct an ogive for the distribution. (4 marks)
iii) Using the ogive in (ii) above, estimate the median for the distribution. (3 marks)
iv) Use the ogive in (ii) above to estimate the percentage of errors within one standard deviation of the mean. (3 marks)

a

i)

 

ii) Optimum investment strategy:

Since the expected return of 6% is the highest and it is for property, the school
should invest in Property.

 

b

i) Estimate of the mean and mode for the distribution:

The mean:

Mean =

 

The mode (using the formula for grouped data):

Mode =

Where:
L = 41.5L 
D1 = 56 − 54 = 2
D2 = 56 − 43 = 13
C = 7

Mode =

 

ii) Graph for the distribution:

 

iii) Estimate of the median:

The median position is 294/2, which corresponds to the 43rd percentile. From the graph, the estimated median is approximately 43 errors.

 

iv) Percentage of errors within one standard deviation of the mean:

SD =

SD =

The range of errors within one standard deviation of the mean is 43.43 ± 14.3 i.e., between 29 and 58 errors.
From the graph, the percentage of errors within this range is approximately 64%.

 

  • 18 Marks

QT – Nov 2018 – L1 – Q6b – Forecasting

Calculate the moving average, trend values, seasonal variation, and forecast membership.

Membership of Pro Amalion, a network of professional volunteers, has grown over the years but in the months of the second quarter, there was always a decline. The table below shows membership records for a period of four years:

Year 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Year 1 713 694 735 755
Year 2 767 733 766 780
Year 3 787 755 798 814
Year 4 816 790 826 843

Required:
i) Calculate the centered four-quarterly moving average of membership. (4 marks)
ii) Using a least squares trend equation based on (i) above, calculate the trend values. (5 marks)
iii) Using (ii) above, calculate the percentage seasonal variation and the average seasonal variation of membership. (5 marks)
iv) Determine the seasonally adjusted forecast of membership for each of the four quarters of Year 5. (4 marks)

i) Centered four-quarterly moving average of membership:

Quarter Membership yy 4 Moving Total 8 Moving Total 4 CMA Trend TT S=yTS = \frac{y}{T}
1 713 719.52 0.991
2 694 726.83 0.955
3 735 2897 731 734.15 1.005
4 755 2951 5848 742.63 741.46 1.017
5 767 2990 5941 751.38 748.77 1.024
6 733 3021 6011 758.38 756.08 0.969
7 766 3046 6067 764 763.39 1.003
8 780 3066 6112 769.25 770.71 1.012
9 787 3088 6154 776 778.02 1.013
10 755 3120 6208 784.25 785.33 0.961
11 798 3154 6274 792.13 792.64 1.007
12 814 3183 6337 800.13 799.95 1.018
13 816 3218 6401 808 807.27 1.011
14 790 3246 6464 815.13 814.58 0.970
15 826 6521 821.89 1.005
16 843 829.20 1.017

(4 marks)

 

ii) Least squares trend equation:

The least squares trend line is of the form T=a+bx

 

iii) Average Seasonal Variation

Adjustment factor of 0.00125 (4-3.995=0.005 and 0.005/4=0.00125) must be added to
each average to make the total average 4. Since this is insignificant, the difference of
0.005 is arbitrarily added to the average of Quarter 2.

 

iv) Seasonally adjusted forecast for Year 5:

T=712.21+7.312x

The forecasted membership: Quarter 1 is 845 members, Quarter 2 is 818 members;
Quarter 3 is 855 members and Quarter 4 is 872 members.

 

 

 

  • 14 Marks

QT – Nov 2018 – L1 – Q5b – Probability

Solve normal distribution problems related to spending habits of residents in Kojokrom.

In a study commissioned by Ofo Stores, the researcher examined the spending habits of the residents of Kojokrom. He found the spending habits to be normally distributed with a mean of GH¢700 and a standard deviation of GH¢70.

Required:
i) Determine the probability that a resident selected at random spends:

  • Less than GH¢620 (3 marks)
  • More than GH¢1,000 (3 marks)
  • Between GH¢800 and GH¢900 (4 marks)

ii) Calculate the amount:

  • Above which 80% of the residents will spend in a week (2 marks)
  • Below which 30% of the residents will spend in a week (2 marks)

a)

i)

 

 

ii)

 

iii)

 

b)

 

Thus 80% of the residents will spend above GH₵ 700.50 in a week.

 

ii)

Thus 30% of the residents will spend below GH₵ 722.90 in a week

 

  • 6 Marks

QT – Nov 2018 – L1 – Q5a – Probability

Define properties of normal distribution and examples of phenomena that follow it.

The normal distribution is a probability distribution which usually applies to continuous variables.

Required:

i) State FOUR (4) properties of the Normal Distribution. (4 marks)

ii) State TWO (2) examples of phenomena which closely follow a Normal Distribution. (2 marks)

i) Properties of the Normal Distribution:

  • It is a continual distribution.
  • The mean, median, and mode lie in the center of the distribution and have the same value.
  • It is symmetrical and bell-shaped.
  • The area under the curve equals 1.
  • The curve is asymptotic to the horizontal axis.
  • The distribution can be defined completely by two parameters: the mean and the standard deviation.

(Any 4 points for 4 marks)

ii) Examples of phenomena that closely follow a Normal Distribution:

  • Heights of people.
  • Size of things produced by machines.
  • Errors in measurements.
  • Blood pressure.
  • Marks on a test.

(Any 2 points for 2 marks)

  • 15 Marks

AA – Nov 2018 – L2 – Q5 – Completion Procedures and Reporting

Evaluates the use of an adverse opinion and the inclusion of an emphasis of matter paragraph in audit reports.

The auditors of ABC Ltd issued an adverse opinion on the financial statements of the company for the year ended 31 December 2017. This was due to the fact that management could not make available the cash book, general ledger, and debtors ledger to the auditors for examination.

Some of the engagement team members may not agree to the issue of an adverse opinion and are suggesting an unmodified report with an emphasis of matter paragraph.

Required:
a. Comment on the action of the auditors to issue an adverse opinion. (10 marks)
b. Explain to your team members the circumstances that will make auditors include an emphasis of matter paragraph in the Independent Auditor’s report. (5 marks)

(Total: 15 marks)

a. Comment on the Auditors’ Action to Issue an Adverse Opinion:

  1. Justification for Adverse Opinion: An adverse opinion is issued when the financial statements are materially misstated and do not provide a true and fair view of the company’s financial position. In this case, management’s failure to provide key documents, such as the cash book, general ledger, and debtors ledger, severely limits the auditor’s ability to gather sufficient appropriate audit evidence.
  2. Impact on Financial Statements: The absence of these key records means that the financial statements cannot be substantiated, and the figures provided by management could be materially misstated. This makes it impossible for the auditor to conclude that the financial statements are free from material misstatement, justifying the adverse opinion.
  3. Pervasive Effect: The issue is pervasive as it affects multiple areas of the financial statements, including cash, revenue, receivables, and possibly other balances. A pervasive issue affects the overall reliability of the financial statements, making the adverse opinion the appropriate course of action.
  4. Limitation of Scope vs Adverse Opinion: Although some team members suggest issuing a modified opinion with an emphasis of matter paragraph, the situation represents a significant limitation in the scope of the audit. An emphasis of matter paragraph would be inappropriate in this case because it is typically used when highlighting matters already disclosed in the financial statements, not when there is an inability to obtain sufficient audit evidence.
  5. Conclusion: The adverse opinion issued by the auditors is appropriate and justified under the circumstances, as the lack of essential financial records makes it impossible to verify the accuracy of the financial statements. (10 marks)

b. Circumstances for Including an Emphasis of Matter Paragraph:

  1. Definition of Emphasis of Matter: An emphasis of matter paragraph is included in the audit report to draw users’ attention to a matter that is appropriately disclosed in the financial statements but is of such importance that it is fundamental to users’ understanding of the financial statements.
  2. Uncertainty or Significant Event: An emphasis of matter paragraph may be included if there is an uncertainty relating to the outcome of significant litigation, regulatory actions, or major events such as natural disasters that have a significant impact on the company’s financial position but are properly disclosed.
  3. Application of New Accounting Standard: If a company applies a new accounting standard early, and the application has a material impact on the financial statements, the auditor may include an emphasis of matter paragraph to highlight this fact to users of the financial statements.
  4. Going Concern: If there is material uncertainty about the entity’s ability to continue as a going concern, and this uncertainty is appropriately disclosed in the financial statements, the auditor may include an emphasis of matter paragraph to highlight this to the users.
  5. Importance of Disclosure: It is important to note that the inclusion of an emphasis of matter paragraph does not modify the audit opinion. It is included to highlight key matters already presented in the financial statements. (5 marks)

(Total: 15 marks)

  • 7 Marks

AA – Nov 2018 – L2 – Q4b – Audit and Assurance Evidence

Explains audit procedures for verifying the valuation of land and buildings in the financial statements.

b. At a meeting to deliberate with management on the draft financial statement of E.T Company Ltd, the external auditors, Sampson Amarty and Co., a firm of Chartered Accountants, demanded that management should explain how an amount of GH¢200,000 for land and building in the financial statements had been arrived at. The Managing Director asked the Director of Finance to explain how the amount of GH¢200,000 was arrived at. The Director of Finance explained that the amount of GH¢200,000 was given to them by an external valuer, S.K. Valuation Experts.

Required:
Explain the audit procedures that would be adopted in verifying the land and building value in the financial statements. (7 marks)

  1. Obtain the Valuation Report: Request and review the external valuation report from S.K. Valuation Experts to confirm the basis of the GH¢200,000 valuation. Ensure that the valuation is appropriately supported by evidence.
  2. Assess the Competence of the Valuer: Evaluate the qualifications, independence, and experience of S.K. Valuation Experts to determine whether they are suitably qualified to provide a reliable valuation.
  3. Verify Supporting Documents: Inspect supporting documents such as land titles, deeds, or registration certificates to confirm the ownership of the land and buildings.
  4. Compare with Market Values: Compare the valuation amount with current market values for similar properties in the same geographical area to assess the reasonableness of the valuation.
  5. Review Assumptions Used in the Valuation: Evaluate the assumptions used by the valuer, such as the condition of the building, future market trends, and any significant events that may impact the property’s value.
  6. Inspect for Physical Existence: Conduct a physical inspection of the land and building to ensure that the assets exist and are in good condition, as reflected in the valuation.
  7. Check Financial Statement Disclosure: Verify that the valuation of land and buildings is correctly disclosed in the financial statements in accordance with applicable accounting standards (e.g., IAS 16 – Property, Plant, and Equipment).

(Total: 7 marks)

  • 8 Marks

AA – Nov 2018 – L2 – Q4a – Audit and Assurance Risk Environment

Identifies audit problems likely to be encountered when a client shifts from manual to computer-based accounting systems.

a. All Souls Ltd is the audit client of Objectivity Auditors, a firm of Chartered Accountants. All Souls Ltd has been operating a manual system of accounting for the past 10 years. All Souls Ltd is contemplating the acquisition of a new accounting software to facilitate the preparation of its accounting records.

Required:
As an audit senior of Objectivity Auditors, advise your audit team on the problems which are likely to be encountered by auditors while a client is moving from manual-based accounting records to computer-based accounting records. (8 marks)

  1. Lack of Audit Trail: In a computerized system, transactions may be recorded electronically without generating physical source documents, making it harder for auditors to trace individual transactions.
    Solution: Auditors need to ensure that sufficient electronic logs or records are maintained to provide a complete audit trail.
  2. High Speed of Data Processing: Computer-based systems process data at a much higher speed than manual systems, increasing the risk of errors being amplified and quickly spread throughout the system.
    Solution: Auditors should implement automated audit procedures and increase their focus on internal controls to prevent errors from affecting large volumes of data.
  3. Concentration of Duties: In a computerized system, fewer staff are needed to perform accounting functions, leading to a higher concentration of duties, which can weaken internal controls.
    Solution: Auditors should assess segregation of duties in the new system and ensure that key tasks are not concentrated in the hands of one person.
  4. Errors in Software Configuration: If the software is improperly set up or configured, it could lead to significant misstatements in financial records, such as incorrect classifications of accounts or automated calculations.
    Solution: Auditors should review the setup and configuration of the accounting software to ensure that it complies with accounting standards and best practices.
  5. Data Integrity and Security: The switch to a computerized system introduces risks related to data integrity and security, such as the potential for data corruption, hacking, or unauthorized access.
    Solution: Auditors should evaluate the company’s IT security measures and data backup procedures to ensure that data is protected and recoverable in case of a system failure.
  6. Impact of System Failures: A failure in the new system could lead to loss of data, interruptions in accounting processes, or delays in financial reporting.
    Solution: Auditors should assess the company’s contingency plans and IT support systems to mitigate the risk of system downtime or failure.
  7. Increased Complexity: The new system may be more complex to audit, requiring auditors to have specialized knowledge of the software and its internal workings.
    Solution: The audit team may need to bring in IT specialists or undergo additional training to understand the system and its controls.

(Total: 8 marks)

  • 5 Marks

AA – Nov 2018 – L2 – Q3d – Professional and Ethical Considerations

Explains safeguards to manage conflicts of interest when auditing competitors.

The Finance Director of the Company informed the audit partner that the reason for appointing Add Consult as auditors was because they audit other similar companies, including the Company’s main competitor. The Finance Director doubts how Add Consult keeps information (obtained during the audit) confidential.

Required:
Explain the safeguards which your firm should implement to ensure that this conflict of interest is properly managed. (5 marks)

  1. Notify Both Clients: The firm should inform both International Training Center (ITC) and its competitor that it is acting as auditor for each of them. If necessary, obtain consent from both parties to proceed with the audits.
  2. Use Separate Engagement Teams: Establish different engagement teams for the audits of ITC and its competitor to prevent any overlap of personnel or knowledge between the two audits. This ensures that there is no sharing of sensitive information.
  3. Implement Physical Barriers (Chinese Walls): The firm should ensure strict physical and electronic separation between the teams handling the two audits. This may involve setting up separate offices, secure data systems, and access controls to safeguard confidential information.
  4. Confidentiality Agreements: All members of the engagement teams should sign confidentiality agreements to reaffirm their commitment to keeping client information private and not sharing it across teams.
  5. Regular Monitoring of Safeguards: The firm should assign a senior auditor, not involved in either engagement, to regularly review and monitor the application of these safeguards to ensure that the conflict of interest is properly managed.

(Total: 5 marks)

  • 20 Marks

AA – Nov 2018 – L2 – Q3a, b & c – Audit and Assurance Risk Environment

Identifies audit risks at International Training Center and outlines appropriate auditor responses.

International Training Center (ITC) is a large company limited by shares that operates a network of teaching centers in countries across West Africa. The Company was incorporated under the requirements of the Companies Act, 1963 (Act 179), on 19 January 1990 and domiciled in Ghana. Students who register with the Center pay 30% during initial registration and the remaining 70% over the course period. You are the senior Associate of Add Consult. ITC is a new client, and you are currently planning the audit with the audit manager to audit the company for the year ended 31 December 2017.

You have been provided with the following planning notes from the audit partner following his meeting with the Finance Director.

  • ITC purchases stationery from a supplier in China, and these goods are shipped to the company’s central warehouse. The goods are usually in transit for a fortnight, and the company correctly records the goods when received. ITC does not undertake a year-end inventory count but carries out monthly continuous (perpetual) inventory counts, and any errors identified are adjusted in the inventory system for that month.
  • During the year, the directors of the Company have each been paid a significant bonus, and they have included this in wages and salaries expenses. Separate disclosure of the bonus is required by the Companies Act.
  • ITC has a policy of revaluing its land and buildings, and this year has updated the valuations of all land and buildings.
  • During the year, the company introduced a bonus-based scheme on sales for its salespersons. The bonus target was based on increasing the number of students signing up for 6-month courses by the school for individuals running accountancy examinations. This has been successful, and revenue has increased by 25%, especially in the last few months of the year. The level of receivables is considerably higher than last year, and there are concerns about the creditworthiness of some students.

Required:
a. Describe FIVE (5) audit risks, and explain the auditor’s response to each risk, in planning the audit of International Training Center. (10 marks)

b. Identify FIVE (5) audit procedures Add Consult should perform in order to place reliance on the continuous (perpetual) counts for year-end inventory. (5 marks)

c. Describe substantive procedures Add Consult should perform to confirm the directors’ bonus payments included in the financial statements. (5 marks)

a)

Audit Risk 1: New Client

  • Risk: ITC is a new client for Add Consult, and the team is not familiar with the company’s accounting policies, transactions, and balances, increasing detection risk.
  • Auditor’s Response: The audit team should ensure they have a suitably experienced team, and adequate time should be allocated for team members to obtain an understanding of the company and the risks of material misstatement.

Audit Risk 2: Goods in Transit

  • Risk: The company purchases goods from China, and these goods are in transit for a fortnight. There is a risk that cut-off for inventory, purchases, and payables may not be accurate.
  • Auditor’s Response: The audit team should undertake detailed cut-off testing of goods in transit from suppliers to ensure that cut-off is complete and accurate.

Audit Risk 3: Perpetual Inventory Counts

  • Risk: ITC undertakes continuous (perpetual) inventory counts at its central warehouse. Inventory could be under or overstated if counts are incomplete or adjustments are not accurately made.
  • Auditor’s Response: The audit team should review the completeness of the continuous inventory counts and the level of adjustments made to inventory to assess the reliability of inventory records.

Audit Risk 4: Sales-Based Bonus Scheme

  • Risk: A bonus scheme was introduced for salespersons based on increased student sign-ups, which could lead to sales cut-off errors.
  • Auditor’s Response: Increased sales cut-off testing should be performed, along with a review of any post-year-end cancellations of contracts.

Audit Risk 5: Receivables Valuation

  • Risk: Receivables are considerably higher than the previous year, and concerns exist about the creditworthiness of some students, raising the risk of overvalued receivables.
  • Auditor’s Response: Extended post-year-end cash receipts testing and a review of the aged receivables ledger should be performed to assess receivables’ valuation.

(Total: 10 marks)

b)

  1. Attend Continuous Inventory Counts: The audit team should attend at least one of the continuous (perpetual) inventory counts to observe and assess the adequacy of internal controls over the counting process. This ensures that proper procedures are followed during each count.
  2. Review Inventory Count Schedules: The auditor should verify that all inventory items are counted at least once during the year by reviewing the schedule of inventory counts. This ensures that no inventory items are missed or undercounted.
  3. Reconcile Adjustments to Inventory Records: Review the adjustments made to the inventory records following each monthly count. This helps to ensure that any discrepancies identified during the counts are accurately reflected in the inventory records.
  4. Test Inventory Movements: Perform test counts at the year-end by selecting a sample of items and tracing them from the records to the physical inventory (and vice versa). This will help verify the existence and completeness of inventory.
  5. Review Internal Control Over Inventory Counts: Assess the adequacy of the internal controls in place to monitor the perpetual inventory system, including checks on count accuracy, segregation of duties, and proper documentation of inventory adjustments.

(Total: 5 marks)

 

c)

  1. Obtain a Schedule of Directors’ Remuneration: Request a detailed schedule of directors’ remuneration, including the bonus payments, and verify the accuracy of the figures by casting the totals.
  2. Agree to Payroll Records: Trace the individual bonus payments from the schedule to the payroll records to ensure that the amounts paid are accurate and in line with approved remuneration.
  3. Verify Payments to Bank Statements: Cross-check the actual payments made to directors by agreeing the bonus amounts to the cash book and corresponding bank statements to ensure that the payments were made.
  4. Review Board Minutes for Approval: Inspect the board minutes to confirm that the bonus payments were authorized by the board in accordance with company policy and were properly recorded.
  5. Review Disclosure Compliance: Ensure that the directors’ bonuses are correctly disclosed in the financial statements, as required by the Companies Act, ensuring full compliance with relevant regulations.

(Total: 5 marks)

 

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