Audit and Assurance

Suggested Answer
Certificate in Accounting and Finance – Spring 2023

A.1 S. No Business Risk Audit Risk

1. Growth available in the FMCG sector Increased competition and any
results in a fierce competition which restrictions on imports can lead to
may lead to price wars and a decline in lower prices, lower sales, and lower
profitability. profitability. AL might overstate the
revenue or understate the expenses for
Government may place restrictions on
maintaining its share price on the stock
import of raw material which would exchange.
affect its sales.
2. FMCG sector always needs to adapt to Since consumer preferences are rapidly
consumer preferences and generally changing and products have a short
these products have a short shelf life, shelf life, there is a risk that the
which may cause certain products cross products which have crossed their
their expiry date or not being expiry date might not be recognized at
profitable. a lower of cost or net realizable value.
3. Raw material for one of the products is There is a risk that the inventory may
imported, therefore, it is subject to not have been recognized using the
changes in currency exchange rates and exchange rate of that date when the risk
can impact the cost of imports. and rewards were transferred.
There is also a risk that the closing
payables in foreign currency may not
be re-translated using the exchange rate
of the year-end date. Similarly, the
same effect also needs to be taken in the
foreign exchange gain or loss.
Since the raw material is being
imported, there is a risk that the raw
material which has departed from the
foreign country and has not reached
Pakistan, is not recorded as stock in
transit.
4. In case, expired raw material is used There is a risk that an incident might
after its expiration date, it could have occurred which needs to be
severely affect its consumers. disclosed as a contingency or a
provision might need to be recorded.
5. AL has obtained borrowing facilities Since borrowing facilities have been
for the expansion of its production used for the expansion of AL’s
facility. There is a risk that the demand production facility, there is a risk that
has not been correctly estimated which borrowing cost might not have been
may result in underutilization of the correctly capitalized in the cost of the
facility. asset.
There is also a risk of incorrect
AL has also obtained borrowings for
estimation of useful life of assets
this expansion project which might
resulting in an incorrect depreciation
cause liquidity issue or effect the
charge.
profitability and earning ratios of the
shareholders. There is also a risk that costs that
should have been charged as revenue
expenditure have been recognized as
capital expenditure.
There is a risk that the bank covenants
might be breached and the loan might
not be properly classified.
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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2023

S. No Business Risk Audit Risk

6. Improper or incomplete There is a risk that ERP might not be
implementation could affect the correctly capitalized and amortized.
business decision taken on the basis of
the data generated by the ERP. Due to improper implementation
account balances may not be correctly
brought forward and there may be
misstatements in the overall
accounting records.

A.2 (a) There is an intimidation threat to professional competence and professional behavior.
Since the audit team is facing pressure because of tight deadlines, this may lead the
audit team to compromise on the audit quality. The audit team may reduce the sample
size, increase the materiality level or adopt other ways to meet the deadline.

Preparation of the fixed asset schedule is the responsibility of the management. A self-
review threat to objectivity will be created if the audit team member prepares the fixed
asset schedule himself. The audit team member will have to review his own schedule
which will be part of the financial statements and his professional judgment would be
biased due to this fact.

(b) The insurance industry is markedly different from other businesses and requires a
specific knowledge base that the audit team must possess. In addition, the financial
statements of an insurance company are distinct from those of other companies,
making it necessary for the audit team to possess specialized knowledge in this area.
Furthermore, insurance transactions and their accounting are inherently complex in
nature, necessitating a thorough understanding on the part of the audit team.

Since only two personnel have experience auditing insurance clients, there is a self-
interest threat to compliance with the principles of professional competence and due
care. Despite this, the firm may accept the client due to financial and reputational
interests, and may subsequently be unable to deliver competent services based on
professional standards, potentially discrediting the profession.

Given the current situation, it is necessary to assess:

 whether the knowledge possessed by the two experienced personnel can be
effectively transferred to other team members to ensure a successful audit.
 that only one partner has relevant experience and consequently, it is unclear who
will conduct the mandatory quality control review. It should be noted that the
engagement cannot proceed without an effective quality control review.

Given the high level of threat posed by these factors, the firm should not accept this
engagement. However, if the firm decides to accept the engagement, the following
safeguards should be implemented:
 Providing adequate training to the staff to ensure that only personnel with the
necessary competencies are assigned to the engagement.
 Hiring staff members who possess experience and knowledge of the insurance
industry.
 Agreeing upon a realistic time frame for the completion of the engagement.
 Using experts where necessary.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2023

A.3 (a) Audit efficiency may be improved if the auditor stratifies a population by dividing it
into discrete sub-populations which have an identifying characteristic. The objective
of stratification is to reduce the variability of items within each stratum and therefore
allow sample size to be reduced without increasing sampling risk.

If a class of transactions or account balance has been divided into strata, the
misstatement is projected for each stratum separately. Projected misstatements for
each stratum are then combined when considering the possible effect of misstatements
on the total class of transactions or account balance.

(b) The financial statement level refers to risks that are pervasive to the financial
statements as a whole and which potentially affect many assertions.

Following are the examples:

 Management having a tendency to override internal controls – this would affect
all areas of the accounting systems.
 Lack of management competence or lack of oversight over the preparation of the
financial statements may have a pervasive effect on the financial statements and
may require an overall response by the auditor.

(c) After the assembly of the final audit file has been completed, the auditor shall not
delete or discard audit documentation of any nature before the end of its retention
period.

The partner shall only do so if exceptional circumstances arise after the date of the
audit report, such that the auditor has to perform new or additional procedures, or
reaches new conclusions.

A.4 (a) Evaluation of the transaction:

Since there is common directorship in BL and SPL, both these entities are related
parties. Secondly, it also seems that management had not disclosed this related party
relationship as the auditor came to know about it after inquiries from the management.
Thirdly, this receivable has been outstanding for the last seven months which may
indicate that it may not have been conducted under normal market terms.
Furthermore, since BCL is a manufacturer of active wear, providing management
consultancy may be considered as a transaction outside normal course of business.
Auditor’s course of action:
 Inspect the underlying contracts or agreements, if any, and evaluate:
 whether the terms of the transactions are consistent with management’s
explanations.
 the transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework.
 Promptly communicate the relevant information to the other members of the
engagement team.
 Request management to identify all transactions with the newly identified related
parties for the auditor’s further evaluation.
 Remain alert, when inspecting records or documents, for arrangements or other
information that may indicate the existence of further related party relationships
or transactions that management has not previously identified or disclosed to the
auditor.
 Inquire as to why the entity’s controls over related party relationships and
transactions failed to enable the identification or disclosure of the related party
relationships or transactions.
 Compare the credit period given to SPL with one or more unrelated parties.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2023

 Comparing the terms of the related party transaction to those of an identical or

similar transaction with one or more unrelated parties.
 Obtain audit evidence that the transactions have been appropriately authorized
and approved.
 Send confirmation to the newly identified related party to confirm the
transactions conducted and the outstanding balance.
 Review minutes of meetings of shareholders and of those charged with
governance.
 If the non-disclosure by management appears intentional (and therefore
indicative of a risk of material misstatement due to fraud), evaluate the
implications for the audit as per ISA.
(b) Following representation should be obtained:
 Whether BL has disclosed to the auditor the identity of the entity’s related parties
and all the related party relationships and transactions of which they are aware;
 Whether BL has appropriately accounted for and disclosed such relationships
and transactions in accordance with the requirements of the framework;
 Whether those charged with governance have financial or other interests in the
related parties or the related party transactions;
 Whether the transactions have been carried out at arm’s length;
 Whether those charged with governance have approved the related party
transactions that materially affect the financial statements;
 Whether those charged with governance have made specific oral representations
to the auditor on details of the related party transaction.

A.5 (a) Evaluation:

Depreciation needs to be recorded despite the production unit being shut down for two
months. Furthermore, the shut down of the production unit due to a reduction in
demand may be an indicator of impairment.
Audit procedures:
 Obtain the management working of depreciation and impairment and verify its
accuracy.
 Obtain an understanding of management process related to identifying,
estimating and recording impairment for fixed assets.
 Obtain the management working and verify the authenticity of the source data
used by the management.
 Assess the reasonableness of the assumptions used by the management for the
working of the impairment.
 Obtain the management fair valuation report of the production unit.
 Consider involving the auditor’s expert for valuation of the production unit.
 Review the disclosures prepared by the management related to impairment of
plant.
(b) Reporting implications:
Although depreciation only amounts to 2% of the profit before tax, and may not be
material individually, we would still ask the management or those charged with
governance to record the depreciation for the last two months. However, being
immaterial, an unqualified opinion would be issued.
Additionally, the misstatements must be aggregated with other misstatements to
determine if the total amount of misstatement is material in the aggregate.
It should also be evaluated whether the impairment of the production unit exceeds the
materiality threshold. If it does, the audit report would be qualified and a basis of
qualified opinion paragraph would be added, which would describe the reasons for the
qualification.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2023

A.6 Evaluation:
Revenue and production records generally constitute a significant portion of financial
records, unavailability of these records could impede the auditor’s the ability to obtain
sufficient appropriate audit evidence, and could result in a scope limitation. It is necessary to
assess the availability of electronic records, and to consider verifying these records through
alternate audit procedures.

Implication of fraudulent financial reporting would also be relevant if the management is

involved in tax evasion. In addition, a contingency related to this matter may need to be
disclosed in the financial statements, or a provision could be recognized.

Reporting implication:
Since the records of a significant portion of revenue have been seized by FBR in order to
probe an allegation of tax evasion, the auditor will consider the scope limitation imposed by
circumstances beyond management control on the sufficiency and appropriateness of audit
evidence.

Since revenue and production records constitute a significant portion of the accounting
records, the auditor’s inability to obtain sufficient appropriate audit evidence will have a
pervasive effect. Therefore, a disclaimer of opinion will be expressed. We will discuss the
reason for disclaiming the opinion in basis of opinion paragraph. However, a qualified
opinion will be expressed if inability to obtain sufficient appropriate audit evidence has a
material impact.

If we are able to obtain sufficient appropriate audit evidence through alternate audit
procedures, we will also evaluate whether management has adequately disclosed the
contingency or recorded additional taxes and fines that the entity may face as a result of the
probe. If appropriate accounting/disclosures have not been made, we will have to express a
qualified opinion.

If it is determined that the evasion was intentional, the auditor should consider its earlier
assessment regarding the integrity of the management and consider informing the fact to
those charged with governance. The auditor should also consider resigning from the
assignment and obtain a legal opinion in this regard and shall determine whether there is a
responsibility to report to the regulatory authorities.

A.7 (a) An emphasis of matter paragraph is included in the auditor’s report to appropriately
refer to a matter presented or disclosed in the financial statements that, in the auditor’s
judgment, is of such importance that it is fundamental to users’ understanding of the
financial statements.

An other matter paragraph included in the auditor’s report refers to a matter, other
than those presented or disclosed in the financial statements, that, in the auditor’s
judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities
or the auditor’s report.

(b) The auditor may require any of the following persons to provide him the information
for the purpose of audit:
 Any director, officer or employee of the company;
 Any person holding or accountable for any of the company‘s books, accounts or
vouchers;
 Any subsidiary undertaking of the company; and
 Any officer, employee or auditor of any such subsidiary undertaking of the
company or any person holding or accountable for any books, accounts or
vouchers of any such subsidiary undertaking of the company.

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 Audit and Assurance
Suggested Answer
Certificate in Accounting and Finance – Spring 2023

(c) The objectivity of the internal audit function can be evaluated by inquiring the
following:
 To whom does it report? Does it have access to those charged with governance?
 Is it free of any conflicting responsibilities (e.g. any operational responsibilities)?
 Do those charged with governance oversee employment decisions regarding the
internal audit function?
 Does the internal audit function team have a membership of professional bodies?
Does it comply with the professional standards of any professional body?
 Do those charged with governance determine the appropriate remuneration
policy?
 Are there any restrictions in place in communicating the finding to the external
auditor?

A.8 (a) Control Test of controls

Inventory is counted and  When performing onsite test counts during the
matched to a PO on audit, observe the inventory receipt process as
arrival at the warehouse. explained by the management.
 Select a sample of inventory received throughout
the year and agree to the PO.
Inventory counts are  Attend a sample of counts throughout the audit to
performed on a weekly observe the client process.
basis.  During attendance, verify the selection of areas,
the instructions given, and the process of the
recounts performed.
 Select previous weekly recounts performed during
the year and review the documentation of the
counts performed.
Each area is counted once  Select a sample of areas and verify that they were
in every quarter. counted at least once in each quarter.
 Inquire whether there is a process to ensure that
each area is counted once in each quarter.
Inventory adjustments are  Select a sample of adjustments throughout the
approved by the year and ensure that revision in the system has
warehouse manager and been made after the approval of the warehouse
finance manager. and the finance manager.
 Review whether the adjustments are backed with
the supporting documentation of inventory count.

(b)  List out all items over a pre-set amount (at least the materiality threshold) (for
subsequent physical verification).
 For each item on the schedule, multiply the lower of cost and selling price
quantity, and list any items where this figure does not agree with the year-end
valuation.
 Compare prices to those on the current sales price master file.
 List any items where the date of the last purchase was more than, say, one month
ago (as this may indicate that the product is obsolete/damaged/no longer in
vogue and may need to be written down).
 List any items where the date of the last sale was more than, say, one month ago
(as, again, this may indicate that the product is obsolete/no longer in vogue and
may need to be written down).
 List any items which do not appear on the post year-end sales listing for the, say,
first month of the year (again, may indicate that a provision is needed).
 Obtain the purchases made at 31 December 2022 and perform cut-off.
(THE END)
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