Topic: Audit evidence

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  • 20 Marks

AAA – July 2023 – L3 – Q3 – The audit approach | Audit evidence | Reporting

Evaluate quality control issues and their implications for audit completion, including actions to be taken.

The audit of Nkwa Ltd’s financial statements for the year ended 30 November 2022 is nearing completion, and the auditor’s report is due to be signed next week. Nkwa Ltd manufactures parts and components for the aviation industry. You are conducting an engagement quality control review on the audit of Nkwa Ltd, which is a listed entity and a significant new client of your firm. The draft financial statements recognize revenue of GH¢8.7 million, assets of GH¢15.2 million, and profit before tax of GH¢1.8 million.

You have identified the following issues as a result of your review:

a) The planned audit approach to trade payables was to place reliance on purchasing controls and keep substantive tests to a minimum. During control testing on trade payables, from a random statistical sample, the audit team identified three purchase orders that had not been authorized by the procurement manager. On review of the supporting documentation, the audit team concluded that the items were legitimate business purchases and therefore decided that no additional procedures were required. (4 marks)

b) Following a review of petty cash transactions, the audit assistant identified that the petty cashier paid for taxi fares for personal, non-business journeys with a total value of GH¢175. Following discussions with the Audit Assistant, you have ascertained that he did not report the matter as the amount is immaterial. The audit assistant also commented that the petty cashier is his brother, and that he did not want to get him into trouble. (6 marks)

c) Cut-off testing on revenue has identified two goods despatch notes, dated 2 December 2022, for items sent to Chinn Co, with a combined sales value of GH¢17,880, which had been included in revenue for the year ended 30 November 2022. The client’s financial controller, David Mount, has explained that Chinn Co does not order on a regular basis from Nkwa Ltd. In the absence of a regular payment history with Chinn Co, and in order to minimize the receivables collection period from this particular customer, the sales invoice was raised and sent to the customer on the same day that the sales order was received. The average time period between the receipt of an order and despatching the goods to the customer is approximately one to two weeks. The audit working papers have concluded that no further investigation is necessary. (6 marks)

d) The Finance Director, Leslie Gray, has not completed the tax computation for the year ended 30 November 2022. He has recently asked the audit assistant to compute the company’s tax payable for the year on the basis that as a newly qualified chartered accountant, the audit assistant was more up to date with recent changes in tax legislation. (4 marks)

Required:
Evaluate the quality control issues and the implications for the completion of the audit, including any further actions that should be taken by your audit firm. Your answer should include the matters to be communicated to management and those charged with governance in relation to the audit of Nkwa Ltd.

a) Controls Testing on Payables:

The absence of authorization by the procurement manager for three purchase orders is an indication of a deficiency in internal control over purchasing. The audit team’s conclusion that the items were legitimate business expenses does not mitigate the fact that the control was not operating effectively. This raises concerns about the reliability of the purchasing process and the possibility of further unauthorized transactions that may not have been legitimate.

Actions to be taken:

  • The audit team should extend the sample size and perform additional substantive tests to assess the extent of the control deficiency.
  • The issue should be reported to those charged with governance as a significant finding in line with ISA 260.

b) Petty Cash Fraud:

The payment for personal expenses by the petty cashier represents a breach of trust and is indicative of weak internal controls over petty cash. Although the amount is immaterial, the fact that the audit assistant did not report the issue due to a personal relationship with the petty cashier raises concerns about professional integrity and objectivity.

Actions to be taken:

  • Conduct a thorough review of the petty cash transactions to identify any other irregularities.
  • Discuss the matter with management and recommend strengthening petty cash controls.
  • The relationship between the audit assistant and the petty cashier should be considered a familiarity threat, and appropriate safeguards should be implemented to maintain audit quality.

c) Cut-off Testing on Revenue:

The recognition of revenue for goods despatched after the year-end violates the revenue recognition principles under IFRS 15, which require that revenue is recognized when control of the goods has passed to the customer. Including this revenue in the financial year under audit results in an overstatement of revenue and receivables.

Actions to be taken:

  • Extend the cut-off testing to ensure that no further instances of early revenue recognition have occurred.
  • Communicate this significant audit finding to those charged with governance and recommend a correction to the financial statements.

d) Tax Advice:

The request for the audit assistant to calculate the company’s tax payable represents a self-review threat, particularly as Nkwa Ltd is a listed company. The auditor’s independence could be compromised by being involved in preparing figures that will be audited.

Actions to be taken:

  • The audit firm should decline the request to prepare the tax computation and advise the Finance Director to seek assistance from a separate tax advisor.
  • Report the situation to those charged with governance as it indicates a lack of sufficient resources and expertise within the client’s finance function, which may have broader implications for the audit.
  • 20 Marks

AAA – Dec 2023 – L3 – Q3 – Audit Evidence | Evaluation and Review

Assess the risk of material misstatement and audit implications related to goodwill impairment, accounting policies, auditor’s opinion, and going concern.

As the Audit Manager for Grep & Co., you are currently overseeing the audit of Kellwin Ltd., a company operating in the food processing industry. The audit for the financial year ended 31 October 2023 is nearing completion. However, several issues have been brought to your attention by the audit team, requiring your review and further action.

a) Goodwill Impairment
Kellwin Ltd. acquired a subsidiary, Fresh Foods Plc, on 1 November 2021. The purchase consideration for the acquisition was GH¢18 million. The goodwill arising on the acquisition was recognized at GH¢3 million in Kellwin Ltd.’s consolidated financial statements for the year ended 31 October 2022. The directors have conducted an impairment review of goodwill and have concluded that no impairment is necessary, with the carrying amount of goodwill remaining at GH¢3 million as at 31 October 2023. The directors have explained that the recoverable amount of the cash-generating unit (CGU) to which the goodwill has been allocated exceeds the carrying amount. (8 marks)

b) Accounting Policies
During the audit, it was identified that Kellwin Ltd. changed its accounting policy for recognizing revenue from contracts with customers. Previously, revenue was recognized when goods were delivered to customers. However, from 1 January 2023, the company started recognizing revenue when the goods were dispatched from the warehouse. This change was applied retrospectively, and the comparative figures in the financial statements were restated. The impact of this change is an increase in revenue by GH¢1.5 million for the year ended 31 October 2023. The directors have justified the change by stating that it provides more relevant information to users of the financial statements. (6 marks)

c) Auditor’s Opinion and Going Concern
Kellwin Ltd. has experienced significant financial difficulties during the year due to adverse economic conditions. As a result, the company has incurred a net loss of GH¢2 million and has breached its loan covenants. The directors have initiated discussions with the company’s bank to secure a waiver of the covenant breaches and to obtain additional funding. The financial statements have been prepared on a going concern basis, and the directors are confident that they will secure the necessary funding. However, the negotiations with the bank are still ongoing, and there is significant uncertainty regarding the company’s ability to continue as a going concern. (6 marks)

Required:
i) Assess the risk of material misstatement in relation to each of the issues described above.
ii) For each issue, state the audit procedures that should be performed to address the risks identified.

a) Goodwill Impairment

Risk of Material Misstatement:

  • Goodwill Valuation: The carrying amount of GH¢3 million represents a significant portion of the assets of Kellwin Ltd., and there is a risk that the recoverable amount of the CGU may have been overstated, leading to an overstatement of goodwill in the financial statements. The directors’ assertion that no impairment is required may be based on optimistic assumptions, particularly in light of the challenging economic conditions that could impact the cash flows of the CGU.
  • Subjectivity in Estimates: The impairment review involves significant judgment, especially in estimating the recoverable amount based on future cash flows, discount rates, and growth rates. There is a risk that these estimates may not be reasonable, leading to a material misstatement if the goodwill is not impaired when it should be.

Audit Procedures:

  1. Review Impairment Calculation: Obtain and review the directors’ impairment calculation, including the key assumptions used in determining the recoverable amount of the CGU. Ensure that the calculation complies with the requirements of IAS 36.
  2. Evaluate Cash Flow Projections: Assess the reasonableness of the future cash flow projections used in the impairment review, considering historical performance, current economic conditions, and industry trends. Compare the projections to actual results and other budgets or forecasts.
  3. Test Discount Rate: Evaluate the appropriateness of the discount rate used in the impairment test by comparing it to market data, including the cost of capital and risk premiums for similar entities in the industry.
  4. Perform Sensitivity Analysis: Conduct a sensitivity analysis on the key assumptions (e.g., cash flow growth rates, discount rates) to determine the impact on the recoverable amount and assess whether any reasonable changes in these assumptions would result in an impairment.
  5. Consider Use of an Expert: If the impairment review involves complex or highly judgmental estimates, consider involving a valuation expert to assist in evaluating the appropriateness of the methodology and assumptions used.

b) Accounting Policies

Risk of Material Misstatement:

  • Revenue Recognition: The change in the accounting policy for revenue recognition from delivery to dispatch may result in the premature recognition of revenue, leading to an overstatement of revenue and profits in the financial statements. The retrospective application and restatement of comparatives add further complexity and increase the risk of error.
  • Justification for Change: The directors’ justification for the change in accounting policy must be thoroughly evaluated to ensure that it provides more relevant information and that the change is in accordance with the applicable financial reporting framework (IFRS 15 Revenue from Contracts with Customers).

Audit Procedures:

  1. Review Policy Change: Review the rationale provided by the directors for the change in accounting policy and assess whether it is appropriate under IFRS 15. Confirm that the change results in more relevant and reliable information for users of the financial statements.
  2. Test Restatement of Comparatives: Verify that the restatement of comparative figures has been performed accurately and in accordance with the applicable accounting standards. Ensure that the impact of the policy change has been correctly reflected in the financial statements.
  3. Examine Revenue Recognition: Test a sample of revenue transactions before and after the policy change to ensure that revenue has been recognized in accordance with the new policy. Confirm that the timing of revenue recognition is appropriate and that no premature revenue has been recognized.
  4. Evaluate Disclosures: Review the disclosures in the financial statements related to the change in accounting policy, ensuring that they are clear, complete, and in compliance with IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors.

c) Auditor’s Opinion and Going Concern

Risk of Material Misstatement:

  • Going Concern: There is a significant risk that the financial statements may be misstated if the going concern assumption is not appropriate. The ongoing negotiations with the bank and the uncertainty surrounding the waiver of loan covenants create a material uncertainty that may cast significant doubt on the company’s ability to continue as a going concern.
  • Management Bias: The directors may be overly optimistic about the likelihood of securing additional funding, which could lead to the inappropriate use of the going concern basis of accounting. If the company is not a going concern, the financial statements should be prepared on a break-up basis, and appropriate disclosures should be made.

Audit Procedures:

  1. Review Cash Flow Forecasts: Obtain and review management’s cash flow forecasts for the next 12 months, assessing their reasonableness and consistency with other budgets or forecasts. Evaluate the assumptions used, including revenue growth, cost projections, and the timing of cash inflows and outflows.
  2. Examine Correspondence with the Bank: Review correspondence between Kellwin Ltd. and its bank regarding the waiver of loan covenants and the potential for additional funding. Assess the likelihood of securing the necessary waiver and funding, and consider the implications for the going concern assessment.
  3. Discuss with Management: Discuss the going concern assessment with management, including the plans to mitigate the risks identified, such as cost-cutting measures or asset disposals. Evaluate the feasibility of these plans and their impact on the company’s ability to continue as a going concern.
  4. Review Subsequent Events: Perform a review of subsequent events up to the date of the auditor’s report to identify any developments that may affect the going concern assessment, such as changes in the company’s financial position or the outcome of negotiations with the bank.
  5. Assess Adequacy of Disclosures: Review the disclosures in the financial statements related to going concern, ensuring that they adequately describe the material uncertainties and management’s plans. If significant doubt remains, consider the need for an emphasis of matter paragraph or a qualified opinion in the auditor’s report.
  6. Consider the Auditor’s Report: Based on the findings from the above procedures, consider the appropriate form of the auditor’s report. If the going concern assumption is deemed inappropriate, or if there is insufficient evidence to support management’s assessment, a qualified opinion or an adverse opinion may be necessary.
  • 20 Marks

AAA – Dec 2023 – L3 – Q2 – Audit Evidence | Evaluation and Review

Evaluate the accounting treatment of cash-settled share-based payments, regulatory penalties, and property valuation, and outline relevant audit procedures for each.

You are the Manager responsible for the audit of Rail Expert Plc, a listed entity whose principal activity is the operation of a regional railway network. The audit for the year ended 28 February 2021 is the first year your firm is auditing Rail Expert Plc. The draft financial statements received from your client indicated a total asset of GH¢58 million and a profit before tax of GH¢7.4 million. The detailed audit fieldwork has started, and the audit supervisor has brought the following matters to your attention in relation to the testing of key accounting estimates:

a) Cash-settled share-based payment scheme
On 1 March 2020, Rail Expert Plc granted 550,000 share appreciation rights to 55 executives and senior employees of the company, with each eligible member of staff receiving 10,000 of the rights. The fair value of the rights was estimated on 28 February 2020 by an external expert using an options pricing model at GH¢4.50 each. Rail Expert Plc prides itself on good employee relations, and the senior management team has estimated that all 55 staff will qualify for the rights when they vest three years after the granting of the rights on 1 March 2020. The company recognized an expense of GH¢825,000 with its associated liability in the draft accounts. (7 marks)

b) Regulatory penalties
Rail Expert Plc has been subject to a review by the national railways regulator following a complaint from a member of staff with safety concerns. The regulator identified breaches in safety regulations and issued a penalty notice on 30 September 2020. Rail Expert Plc has appealed against the initial penalty payable. Negotiations with the regulator are still ongoing, and the amount payable has not yet been finalized. Rail Expert Plc currently estimates that the total penalty payable as a result of the breach will be GH¢1.3 million, which it expects to repay in equal annual installments over the next ten years, with the first payment falling due on 1 March 2021. The company’s draft statement of profit or loss for the current year recognizes an expense of GH¢1.3 million, and the draft statement of financial position includes a liability for the same amount. (7 marks)

c) Property development
Rail Expert Plc owns an industrial property which it has historically used as a maintenance depot for its engines and carriages. The company has an accounting policy of revaluing its properties to fair value, and at the interim audit, it was noted that the depot was recorded at a carrying amount of GH¢2.5 million in the non-current asset register. During the first week of the audit fieldwork, the audit supervisor identified a year-end journal which has uplifted the depot to a fair value of GH¢4.9 million in this year’s statement of financial position as at 28 February 2021. Management has advised that this represents the estimated sales value of the building following Rail Expert Plc’s plan to develop the building as a residential property. The client has confirmed that the property is suitable for conversion into residential apartments at an estimated cost of GH¢1.2 million and has negotiated secured finance for the development with their bank. The development will be subject to the payment of fees to the local council’s building regulator of GH¢173,000. (6 marks)

Required:
Evaluate the client’s accounting treatments above and state THREE (3) audit procedures you will undertake when auditing each of the transactions.

a) Cash-Settled Share-Based Payment Scheme

  • The expense recognized this year of GH¢825,000 in respect of the cash-settled share-based payment scheme represents 11.1% of profit before tax and is therefore material to Rail Expert Plc’s statement of profit or loss for the year. The related liability of GH¢825,000, which would be recognized on the statement of financial position, is on the borderline of materiality to assets at 1.4%.
  • IFRS 2 Share-Based Payment requires that for cash-settled share-based payment transactions, the entity should measure the services acquired and the liability incurred at the fair value of the liability. Moreover, it states that until the liability is settled, the entity should remeasure the fair value of the liability at the end of each reporting period and at the date of settlement, with any changes in fair value recognized in profit or loss for the period. In the case of Rail Expert Plc, the expense and the associated liability have been calculated based on the fair value of the rights as at the reporting date, and the treatment therefore complies with the requirements of IFRS 2 (GH¢4.50 x 550,000 x 1/3 = GH¢825,000).
  • IFRS 2 also requires that the amount recognized as an expense for cash-settled share-based payments should be based on the best available estimate of the number of awards that are expected to vest. The entity must therefore estimate the number of awards that are expected to vest. In this case, management’s estimate that all 55 staff will qualify for the rights appears to be based on a perception of good historic staff relations, which may be inaccurate, and the expectation that none of the eligible staff will leave over the three-year vesting period may prove to be unrealistic. The predictive nature of management’s estimate in this regard represents a challenge to the auditor as it is difficult to obtain reliable evidence.
  • The fair value estimate of GH¢4.50 is based on an options pricing model, which is an example of a complex valuation model which, according to ED-540, is built on significant estimates and assumptions and is therefore challenging to audit. The initial choice of which option-pricing model to use is also a matter of judgment and whichever model is selected, it will incorporate judgmental inputs such as the current risk-free interest rate and measures of share price volatility.

Audit Procedures:

  1. Obtain a copy of the contractual documentation for the share-based payment scheme and supporting file notes detailing principal terms, and confirm:
    • Grant date and vesting date.
    • Number of executives and senior employees awarded share appreciation rights.
    • Conditions attaching to the share appreciation rights.
  2. Perform an assessment of the appropriateness of the model used to value the share appreciation rights and confirm that it is in line with the requirements of IFRS 2.
  3. Obtain details of the external expert used and assess the appropriateness of their appointment by considering their professional certification, experience, reputation, and objectivity.

b) Regulatory Penalties

  • The expense recognized in this year’s statement of profit or loss for the year of GH¢1.3 million is material to both profit (17.6%) and assets (2.2%). According to IAS 37 Provisions, Contingent Liabilities, and Contingent Assets, the fine should be measured at its present value at the reporting date. IAS 37 states that where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation and that the discount rate used in the calculation should be a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. The cash flows for the repayment of the fine over the ten years should therefore be discounted at an appropriate rate to present value as at 28 February 2021.
  • The audit of the provision represents a challenge for the auditor in a number of respects. First, it is difficult to estimate the amount payable as it has not yet been finalized, and the amount currently recognized is an estimate based on management’s judgment. These difficulties are compounded by IAS 37 requirements to measure the provision at present value. The measurement process therefore also requires management to predict the payment dates and to identify an appropriate pre-tax rate to be applied as the discount factor. Both of these will require a significant level of management judgment which will be a challenge for the auditor to obtain sufficient relevant and reliable evidence on. Moreover, there is also the possibility of other provisions being needed in relation to the costs of remedying the safety issues which the regulator has identified and in relation to other potentially unidentified safety problems. Here, addressing the completeness assertion will represent a key challenge to the auditor as it is inherently difficult to predict all of the costs to be incurred in the future especially when they have not yet been determined.

Audit Procedures:

  1. Obtain a copy of the regulator’s notice detailing the date of the issue and any indication of the amount of the penalty to be paid by Rail Expert Plc.
  2. Obtain a copy of any draft installment agreement detailing the timing and amount of each repayment.
  3. Review Rail Expert Plc’s correspondence with the regulator for evidence of the amount payable and details of the repayment schedule.

c) Property Development

  • The proposed valuation of the property at GH¢4.9 million represents 8.4% of assets and is material to Rail Expert Plc’s statement of financial position as at 28 February 2021. According to IFRS 13 Fair Value Measurement, the fair value measurement of a non-financial asset should take into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant who would use the asset in its highest and best use.
  • The audit of the property development will be challenging for the auditor first because judgment will be required in order to identify the property’s highest and best use per IFRS 13. The auditor must ensure, for example, that the valuation is compared to the property’s fair value in its existing use as well as in any other potential uses. Indeed, there may be other potential uses which have not been considered.
  • IFRS 13 also states that the highest and best use of a non-financial asset such as a property must be:
    • Physically possible: This will therefore require independent expert confirmation that the conversion can be successfully undertaken.
    • Legally permissible: This will require obtaining confirmation of formal permission from the local planning authority.
    • Financially feasible: This will require a detailed assessment of whether Rail Expert Plc will have sufficient cash flows in order to fund the development through to completion.
  • According to IFRS 13, when considering alternative uses for non-financial assets, the valuation should include all costs associated with the alternative uses. Hence, if the proposed development does represent the highest and best use of the property, the valuation should be adjusted for all of its associated costs. The proposed valuation at GH¢4.9 million is not therefore in compliance with IFRS 13 and on the basis of the information available, the valuation should be GH¢3,527,000 (i.e., GH¢4.9 million – GH¢1.2 million – GH¢173,000). If the additional costs are fairly stated, therefore, the property is currently overstated by GH¢1.373 million (GH¢4.9 million – GH¢3,527,000). The auditor will, however, need external confirmation of the GH¢173,000 in fees from the local building regulator and will also need to obtain sufficient appropriate audit evidence that the conversion costs of GH¢1.2 million are fairly stated. The conversion costs will present a particular challenge to the auditor as they will be based on the estimation of industry experts and the amounts will be inherently uncertain. There may be unforeseen additional costs payable to complete the conversion which will be difficult for the auditor to identify and quantify.

Audit Procedures:

  1. Obtain a copy of the development plans and confirm that the property is physically suitable for conversion into residential apartments.
  2. Review the approval documentation from the local planning authority confirming that the development is legally permissible.
  3. Assess the reasonableness of the estimated conversion costs, possibly by obtaining an independent valuation or expert confirmation.
  4. Review the loan agreement with the bank to confirm that secured financing has been arranged and assess the company’s cash flow forecasts to ensure they can meet these costs.
  5. Confirm the GH¢173,000 fee payable to the local council’s building regulator by reviewing the agreement with the local authority or an invoice from the regulator.
  • 10 Marks

AAA – Nov 2020 – L3 – Q3b – Audit Evidence | Evaluation and Review

Describe the auditor’s responsibility for subsequent events that occur before and after the auditor's report is signed.

Describe your responsibility for subsequent events;
i) Assuming the events occurred before your report is signed (5 marks)

ii) Assuming the events occurred after signing your report but before the report was issued. (5 marks)

i) Events Occurring Before the Auditor’s Report is Signed:

    • The auditor has an active duty to perform audit procedures to identify subsequent events up to the date of the auditor’s report. These procedures should provide sufficient and appropriate evidence that all events requiring adjustment or disclosure have been identified.
    • Audit procedures include:
      • Reviewing management procedures for identifying subsequent events.
      • Reading board minutes and inquiries to management.
      • Reviewing correspondence with legal counsel regarding pending litigation.
    • The auditor should ensure all relevant events are properly accounted for or disclosed in the financial statements.

ii) Events Occurring After the Auditor’s Report is Signed but Before It Is Issued:

    • The auditor does not have a responsibility to perform audit procedures or make any inquiries about the financial statements or subsequent events after the report date. However, if the auditor becomes aware of a fact that could materially affect the financial statements, they should:
      • Discuss the matter with management.
      • Determine whether the financial statements need amendment.
      • Consider the implications for the audit report if management refuses to amend.
    • If the financial statements are amended, the auditor should perform additional procedures and issue a new report. If not amended, the auditor might need to modify their opinion.
  • 10 Marks

AAA – Nov 2020 – L3 – Q3a – Audit Evidence | Evaluation and Review

Discuss whether financial statements require amendment for specific events and describe related audit procedures and audit report implications.

a) For each of the three events below:
i) Discuss whether the financial statements require amendment. (3 marks)
ii) Describe audit procedures that should be performed in order to form a conclusion on the amendment. (4 marks)
iii) Explain the impact on the audit report should the issues remain unresolved. (3 marks)

  • Warehouse Flood:
    • Amendment: The flood event occurred after the year-end, making it a non-adjusting event under IAS 10. The financial statements should not be adjusted, but if the impact is material, a disclosure note should be made.
    • Audit Procedures:
      • Discuss the event with management.
      • Review the insurance claim and correspondence with insurers.
      • Obtain a written representation confirming that the company’s going concern status is not impacted.
      • Review other warehouses’ inventory levels for reasonableness.
    • Audit Report Impact: If management refuses to disclose the event and it is material, a qualified opinion would be required with an ‘except for’ paragraph regarding the lack of disclosure.
  • Lawsuit Settlement:
    • Amendment: The lawsuit settlement amount agreed after year-end provides evidence of the condition that existed at the balance sheet date, so the financial statements should be adjusted to reflect a provision of GHS 0.9 million instead of a contingent liability.
    • Audit Procedures:
      • Contact the company’s legal counsel for confirmation of the settlement likelihood and amount.
      • Review the correspondence from the supplier confirming the settlement amount.
      • Discuss the provision with management and obtain written representation.
    • Audit Report Impact: If management refuses to adjust the provision, a qualified opinion would be required due to non-compliance with IAS 37.
  • Receivable with Going Concern Issues:
    • Amendment: The event provides evidence about conditions existing at the balance sheet date, indicating that the receivable may not be collectible. An allowance for doubtful debts should be considered, but as the amount is immaterial, no adjustment may be necessary.
    • Audit Procedures:
      • Review correspondence with the customer regarding their financial difficulties.
      • Discuss with management why no allowance has been made.
      • Check post-year-end payments from the customer.
    • Audit Report Impact: As the receivable is immaterial, the lack of adjustment does not warrant a modification to the audit opinion.
  • 3 Marks

AAA – Nov 2020 – L3 – Q2b – Audit Evidence | Evaluation and Review

Explain significant audit procedures to be performed in the final audit regarding the warranty provision as at 31 March 2019

Explain the significant audit procedures to be performed during the final audit in respect of the estimated warranty provision in the statement of financial position of Manuf Co. as at 31 March 2019. (3 marks)

  • Review and test the process used by management to develop the estimate.
  • Review contracts or orders for the terms of the warranty to gain an understanding of the obligation of Manuf Co.
  • Perform analytical procedures to compare the level of warranty provision year on year, and compare actual to budgeted provisions.
  • Re-calculate the warranty provision.
  • Compare prior year provision with actual expenditure on warranty claims in the accounting period.
  • Compare the current year provision with prior year and discuss any fluctuation with Odo Pa Nye.
  • 20 Marks

AAA – May 2021 – L3 – Q2 – Audit evidence | Evaluation and review

Recommend audit procedures for validating accounting estimates, evaluate the appropriateness of written representations, and assess the impact of management's refusal to provide representations on the audit report.

Oliso Private Company Ltd has been operating in the manufacturing sector for over a decade. One of its major products is manufacturing equipment, which can reduce toxic emissions in the production of chemicals. The company recently employed a new marketing manager who introduced a series of marketing initiatives. This has resulted in significant growth of the company since the appointment of the marketing manager. One of the initiatives is the warranties that the company gives to its customers. The company guarantees its products for three years, and if problems arise within the period, it undertakes to fix them or provide a replacement for the product.

You are the Senior Manager recently engaged by Integrity Audit Consult responsible for Oliso Private Company Ltd’s audit. You are performing the final review as required by ISA 520 Analytical procedures for the audit and have come across the following issues.

Receivable balance due from Obey Company Ltd: Oliso Private Company Ltd has a material receivable balance due from a customer named Obey Company Ltd. During the year-end audit, your team reviewed the ageing of this balance and found that no payments had been received from Obey Company Ltd for over eight months. Oliso Private Company Ltd however would not allow this balance to be included in the list of balances to be circulated. Instead, management has assured your team that they will provide a written representation confirming that the balance is recoverable.

Warranty provision: The warranty provision included in the statement of financial position is material. The audit team has performed testing over the calculations and assumptions, which are consistent with prior years. The team has requested a written representation from management confirming the basis and amount of the provision. Management is yet to confirm acceptance of the need to issue this representation.

Required:

a) Recommend THREE (3) audit procedures to validate the accounting estimates. (5 marks)

b) For each of the two issues above:

i) Evaluate the appropriateness of written representations as a form of audit evidence. (4 marks)

ii) Describe TWO (2) additional procedures the auditor should perform to conclude on the balances to be included in the financial statements. (6 marks)

c) The directors of Oliso Private Company Ltd have decided not to provide the audit firm with the written representation for the warranty provision as they feel it is unnecessary.

Required:

Explain the steps the auditor of Oliso Private Company Ltd should take to assess the impact of management’s refusal to provide a written representation on the auditor’s report. (5 marks)

a) Audit Procedures to Validate Accounting Estimates:

  1. Inquire of Management: Inquire how the accounting estimate is made and the data on which it is based.
  2. Post-Year-End Events: Determine whether events occurring up to the date of the auditor’s report (after the reporting period) provide audit evidence regarding the accounting estimate.
  3. Review Measurement Methods: Review the method of measurement used and assess the reasonableness of assumptions made.
  4. Test Controls: Test the operating effectiveness of the controls over how management made the accounting estimate.
  5. Estimate Comparison: Develop an expectation of the possible estimate (point estimate) or a range of amounts to evaluate management’s estimate.
  6. Review Management’s Judgments: Review the judgments and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias.
  7. Evaluate Overall Reasonableness: Evaluate overall whether the accounting estimates in the financial statements are either reasonable or misstated.
  8. Disclosure Review: Obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates and estimation uncertainty are reasonable.
  9. Written Representations: Obtain written representations from management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.

b)

Receivables Balance Owing from Obey Company Ltd:

i) Appropriateness of Written Representations as Audit Evidence:

  • The written representation proposed by management is intended to verify the valuation, existence, and rights and obligations of a material receivables balance. However, as management has refused to allow the auditor to circularize the balance and there has been little activity on the account for the past eight months, there is very little evidence that the auditor has obtained.
  • This representation would constitute entity-generated evidence, which is less reliable than auditor-generated evidence or evidence from an external source. However, if related control systems operate effectively, then this evidence becomes more reliable. In addition, if the representation is written as opposed to oral, this will increase the reliability as an evidence source.
  • Overall, this representation is a weak form of evidence, as there were more reliable evidence options available, such as the circularization, but this was not undertaken.

(2 marks)

ii) Additional Procedures to Conclude on the Receivable Balance:

  1. Discuss with Management: Discuss with management the reasons why a circularization request was refused.
  2. Post-Year-End Payments: Review the post-year-end period to identify whether any cash has now been received from Obey Company Ltd.
  3. Correspondence Review: Review correspondence with Obey Company Ltd to assess reasons for the continued non-payment.
  4. Legal Review: Review board minutes and legal correspondence to assess whether any legal action is being taken to recover the amounts due.
  5. Provision Consideration: Discuss with management whether a provision or write-down is now required.
  6. Audit Opinion Impact: Consider the impact on the audit opinion if the balance is considered to be materially misstated.

(3 points for 3 marks)

Warranty Provision:

i) Appropriateness of Written Representations as Audit Evidence:

  • In this case, the auditor has performed some testing of the provision to obtain auditor-generated evidence. The team has tested the calculations and assumptions. None of this is evidence from an external source.
  • The very nature of this provision means that it is difficult for the auditor to obtain a significant amount of reliable evidence as to the level of future warranty claims. Hence, the written representation, whilst being an entity-generated source of evidence, would still be useful as there are few other alternatives.

(2 marks)

ii) Additional Procedures to Conclude on the Warranty Provision:

  1. Post-Year-End Claims: Review the post-year-end period to compare the level of claims actually made against the amounts provided.
  2. Historical Comparison: Review the level of prior year provisions with the amounts claimed to assess the reasonableness of management’s forecasting.
  3. Board Minutes Review: Review board minutes to assess whether any changes are required to the level of the provision as a result of an increased or decreased level of claims by customers.

(3 points for 3 marks)

c) Steps if Written Representation on Warranty Provision is Not Provided:

  1. Discuss with Management: ISA 580 “Written Representations” guides the auditor when written representations are requested from management, but they refuse to provide. If management does not provide the requested written representation on the warranty provision, the auditor should discuss the matter with management to understand why they are refusing.
  2. Reevaluate Integrity: Reevaluate the integrity of Oliso Private Company Ltd’s management and consider the effect that this may have on the reliability of other representations (oral or written) and audit evidence in general.
  3. Determine Audit Opinion: Determine the possible effect on the audit opinion. If the auditor cannot obtain sufficient appropriate evidence to conclude that the warranty provision is free from material misstatement, a modified audit opinion will be required.
  4. Modify Audit Opinion: The warranty provision is material but not pervasive, and therefore a qualified opinion would be appropriate. The opinion paragraph will be amended to state ‘except for’ the lack of evidence on the warranty provision, the financial statements show a true and fair view.
  5. Basis for Opinion Paragraph: The audit report will require an additional paragraph known as the basis for the qualification paragraph after the opinion paragraph, which will describe the reason for the modification, namely management’s refusal to provide a written representation in relation to the warranty provision and hence the reason for the except-for opinion. The materiality of the warranty provision will be stated in the basis for the opinion paragraph.
  • 10 Marks

AAA – May 2017 – L3 – Q5b – Audit evidence | Reporting

Discuss the audit considerations related to inventory valuation at lower of cost and net realizable value and the implications of a refund policy on the audit report.

You are an audit senior in Patampa and Associates, and nearing the end of the audit of Duakor Ltd. for the year ended 30 June 2016. Duakor Ltd owns a chain of clothing stores and also has a manufacturing division where it makes its own label brand “Dumas.” Own label clothing represents 50% of the inventory and sales of Duakor Ltd. The financial statements show a profit before tax of GH¢14m (2015 GH¢6m) and a statement of financial position total of GH¢46m (2015 GH¢30m). The following points have arisen on the audit:

i) Duakor Ltd. values its inventory at the lower of cost and net realizable value. Cost is determined by deducting a suitable estimated profit margin from the selling price. Inventory in the statement of financial position as at 30 June 2016 was GH¢2,530,000.

ii) Duakor Ltd. has a refund policy which states that a customer who is not satisfied with their purchase may return their goods within 28 days of purchase and obtain an exchange or a cash refund. Experience has shown that exchanges and refunds are common, as Duakor Ltd’s shops do not provide fitting rooms, space being at a premium. Duakor Ltd. does not make any provision in the financial statements for refunds.

Required:

Comment on the matters you will consider in relation to the implications of the above points on the audit report of Duakor Ltd. (10 marks)

i) Inventory Valuation:

  • Compliance with IAS 2: The valuation of inventory at the lower of cost and net realizable value (NRV) is in accordance with IAS 2. However, the method of determining cost by deducting an estimated profit margin from the selling price is typically acceptable only in the retail industry where a more precise costing method is not available.
  • Reasonableness of Method: Given that 50% of Duakor’s inventory is manufactured in-house, it may be expected that the company can establish the actual cost of inventory using methods such as First-In, First-Out (FIFO) or Weighted Average Cost. Relying on a method that deducts profit margins from selling prices could lead to inaccuracies if the estimated margins are not reflective of actual costs.
  • Consistency and Materiality: If the company has used this method consistently over time, it may be less likely to impact the audit opinion unless the difference between the estimated cost and actual cost is material. The auditor should consider whether this method results in a reasonable approximation of cost.
  • Audit Conclusion: If the method provides a reasonable estimate of cost and the difference is immaterial, the auditor may not modify the audit report. However, if there is a significant discrepancy that could materially misstate the financial statements, the auditor might need to consider issuing a modified opinion.

ii) Refund Policy and Provisions:

  • Provision for Refunds: Given that the refund policy is well-established and refunds are common, IAS 37 requires that a provision be made for expected returns, as it represents an obligation that the company must settle.
  • Materiality of Refunds: The auditor should assess the materiality of the refunds. If a significant portion of sales in June could be refunded, this could have a material impact on the revenue and profit recognized in the financial statements. The lack of a provision may result in the financial statements not presenting a true and fair view.
  • Audit Evidence: The auditor should review the historical data on refunds, particularly for sales in the last month of the year, to determine whether a material provision is required. If the potential refund amount is significant, this may necessitate an adjustment to the financial statements.
  • Audit Conclusion: If the financial statements do not include a material provision for refunds, the auditor might issue a qualified opinion on the grounds of material misstatement. However, if the provision is made and adequately disclosed, an unmodified opinion may be appropriate.

Overall Conclusion:

  • The audit report would likely remain unmodified if both the inventory valuation method is deemed reasonable and consistent, and if the provision for refunds is adequately addressed. However, any material misstatements or omissions in these areas could lead to a modified audit opinion.
  • 20 Marks

AAA – May 2017 – L3 – Q1 – Planning | Audit evidence | Evaluation and review

Assess the audit implications of subsequent events involving bad debt and legal actions, describe subsequent events review, and recommend audit procedures for identifying material subsequent events.

You are the audit manager in charge of the audit of Serwah Ghanaba Ltd for the year ended 31 December 2014. The partner in charge of the audit instructs you to carry out a review of the company’s activities during the financial year end. The following issues came up during the review.

i) On 28 February 2015, Jessica Mensah, who owed the company GH¢500,000.00, was killed by some robbers on her way to Accra after a visit to her hometown. The amount was part of the GH¢800,000.00 debtors appearing on the statement of financial position for the year end 31 December 2014. It was realized that it will not be possible to recover the amount from the family of Jessica Mensah.

ii) In another development, the marketing director of the Company, Stephen Odoi, who was due to retire on 31 March 2015, embarked on a 6-month leave prior to retirement with effect from 1 October 2014. Investigation instituted in May 2015 revealed that Mr. Stephen Odoi took a contract appointment with another company from 1 November 2014. As a result of the investigation, the company decided to bring an action against Mr. Stephen Odoi to recover the salary paid to him from 1 November 2014 to 31 March 2015.

Required:

a) Assess the audit implications of issues (i) and (ii) above. (10 marks)

b) Describe the nature and purpose of subsequent events review. (5 marks)

c) Recommend the audit procedures which would be carried out in order to identify any material subsequent events. (5 marks)

a)

i) Subsequent Events – Bad Debt

  • The issue under consideration is an adjusting event – that is, the event provides further evidence of conditions that existed at the end of the reporting period. The GH¢500,000.00 appeared on the statement of financial position for the year ended 31 December 2014. In addition, the amount is material. There is a need for the debt to be written off in the December 2014 financial statement since there is no hope for the amount to be recovered.
  • If the client refuses to make the write-off, the auditor should consider the type of modified opinion to issue—Qualified opinion or adverse opinion depending on the pervasiveness of the auditor.

ii) Legal Action Against Marketing Director

  • The auditors should first ascertain from the board minutes that the board intends to proceed with the lawsuit and should then attempt to assess the outcome by consulting the directors and the company’s legal advisors. Only if it seems probable that the salary paid to Stephen Odei will be recovered should a contingent gain be disclosed in the notes to the accounts along with a summary of the facts of the case. A prudent estimate of legal cost should be deducted.
  • It could be argued that the breach of contract by Mr. Stephen Odei existed at the year-end, and therefore the salary for November and December 2014 should be treated as contingent assets, and that for January – 31st March 2015 should be disclosed in notes to the accounts.

(10 marks)

b) Subsequent Events Review:

  • The auditor’s active responsibility extends to the date on which they sign their audit report. As this date is inevitably after the year-end, it follows that in order to discharge their responsibilities, the auditor must extend the audit work to cover the period after the year-end.
  • The objective of this review is to ascertain whether management has dealt correctly with any events, both favorable and unfavorable, which occurred after the end of the reporting period and which need to be reflected in the financial statements if those statements are to show a true and fair view.
  • The general rule is that, in the preparation of year-end financial statements, no account should be taken of subsequent events unless to do so is required by statute or to give effect to retrospective legislation, or to take into account an event that provides information about a condition existing at the end of the reporting period, for example, realizable values of inventory, or indicates that the going concern concept is no longer applicable. Additionally, certain events may have such a material effect on the company’s financial condition, for example, a merger, that disclosure is essential to give a true and fair view.

(5 marks)

c) Audit Procedures to Identify Material Subsequent Events:

  • Ask management if there have been any material subsequent events.
  • Identify and evaluate procedures implemented by management to ensure that all events after the end of the reporting period have been identified, considered, and properly evaluated as to their effect on the financial statements.
  • Review relevant accounting records to identify subsequent cash received in relation to accounts receivable, to check items uncleared at the year-end on the bank reconciliation, and to check NRV of inventories from sales invoices.
  • Review budgets, profit forecasts, cash flow projections, and management accounts for the new period to assess the company’s trading position.
  • Consider known ‘risk’ areas and contingencies, whether inherent in the nature of the business or revealed by previous audit experience or by lawyers’ letters.
  • Read minutes of shareholders and management meetings, and correspondence and memoranda relating to items included in the minutes to identify any matters arising.
  • Consider relevant information which has come to the auditors’ attention from sources outside the entity, including public knowledge of competitors, suppliers, and customers.
  • Obtain written representations concerning subsequent events from management.
  • 10 Marks

AAA – May 2016 – L3 – Q5b – Audit evidence | Current issues

Discuss factors affecting audit quality according to the IAASB’s recent publication on Audit Quality.

Audit Quality has been a topical issue for discussion in the accountancy profession in recent times. The International Auditing and Assurance Standards Board (IAASB) has recently issued a publication on the Framework for Audit Quality. The objectives of this publication are to raise awareness of the key elements of audit quality; to encourage key stakeholders to explore ways to improve audit quality; and to facilitate greater dialogue between key stakeholders on the topic. Although audit quality is principally the responsibility of auditors, there are many factors that contribute to it. The IAASB describes these other factors as contextual, inputs, outputs, and key interactions.

Required:
Discuss with examples what factors affect Audit Quality according to the recent publication of the IAASB on Audit Quality. (10 marks)

The recent publication by the IAASB on audit quality describes several factors that contribute to audit quality, categorized as contextual factors, input factors, output factors, and key interaction factors. Below is a discussion of these factors:

1. Contextual Factors:

  • Business Practices and Commercial Law:
    • The environment in which the entity operates, including business practices and the legal framework, impacts the quality of the audit. For instance, weak legal enforcement in a jurisdiction may hinder auditors’ ability to access necessary information.
  • Laws and Regulation Relating to Financial Reporting:
    • Compliance with financial reporting laws and regulations affects the quality of the audit. For example, different financial reporting frameworks require different levels of disclosures, impacting how auditors assess financial statements.
  • Corporate Governance:
    • The quality of corporate governance within an entity, including the effectiveness of those charged with governance, influences audit quality. Strong governance can provide auditors with reliable information and proper oversight.

2. Input Factors:

  • Values, Ethics, and Attitudes of Auditors and the Audit Firm:
    • The integrity and professional ethics of the audit team and firm contribute significantly to audit quality. A culture of professionalism and adherence to ethical standards ensures that auditors conduct thorough and unbiased audits.
  • Knowledge, Experience, and Time Allocated to Perform the Audit:
    • The competence of the audit team, including their industry knowledge and experience, as well as the time allocated for the audit, directly impacts the quality of the audit. For instance, complex audits require more experienced auditors and more time for proper execution.

3. Output Factors:

  • Outputs from the Auditor:
    • The quality of the auditor’s report, including clear communication of audit findings and conclusions, affects audit quality. A well-prepared report that addresses key risks and issues adds value to stakeholders.
  • Outputs from the Audit Firm:
    • The firm’s audit methodology and tools, as well as its internal review processes, contribute to the consistency and quality of audits conducted.

4. Key Interaction Factors:

  • Auditors and Management, Those Charged with Governance, Users, and Regulators:
    • Effective communication and interaction between auditors and key stakeholders (management, governance bodies, regulators) ensure that audit issues are identified and resolved promptly, enhancing audit quality.
  • Management and Governance Interaction:
    • The level of cooperation and transparency between management and those charged with governance, as well as their interaction with auditors, plays a crucial role in ensuring the audit process is effective and comprehensive.

These factors collectively influence the overall quality of the audit, and understanding them helps in improving audit practices and outcomes.

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