PAA 2 – 1

The following scenario relates to questions 1 – 5.

You are an audit senior of Oval & Co and your firm has recently been appointed as the auditor to Fine store Products (Fine Store), a large company which sells televisions, DVD players and Bluray

Disc players to electrical retailers.

You are planning the audit for the year ended 31 January 20X8 and your audit manager has asked you to produce both the audit strategy document and the detailed audit plan, including an assessment of materiality.

In order to assist you in your planning work you have visited Fine Store, where you obtained the following information.

Sales have increased during the year ended 31 January 20X8 following a move to attract new customers by offering extended credit. The new credit arrangements allow customers three months’ credit, rather than the one-month credit period allowed previously. As a result of this change, you have calculated that the receivables collection period has increased from 49 days to 127 days.

Fine Store installed a new computerized inventory control system, which began operating on 1 June 20X7. Since the inventory control system records both inventory movements and current inventory quantities, Fine Store is proposing to use the inventory quantities on the computer to value the inventory at the year-end rather than carrying out an inventory count.

The production director informed you that in the last month or so there have been reliability problems with the company’s products which have resulted in some customers refusing to pay for the products.

As part of the planning process you also undertake a risk assessment. Based on the information you have obtained to date you have identified several audit risks which you feel your team will need to address. The first risk relates to the extended credit terms offered by Fine Store to its customers, and the recent product reliability problems resulting in customers’ refusal to pay.

A second audit risk relates to the computerized inventory control system which was implemented on 1 June 20X7. You are concerned about whether data was accurately transferred into the new system, and whether it is sufficiently reliable to determine the quantity of inventory for the yearend financial statements.

1. The audit manager has requested that you cover a number of specified areas in the audit planning documentation.

For each area, indicate whether the information would be included in the audit strategy document or in the detailed audit plan.

A. The availability of the client’s data and staff (including internal audit)

B. The allocation of responsibility for specific audit procedures to audit team members

C. The audit procedures to be undertaken for each area of the financial statements

D. The potential for using automated tools and techniques to gather evidence

2. You have set the level of materiality for the financial statements as a whole, and now need to determine performance materiality.

Which of the following statements about performance materiality is NOT true?

3. ISA 520 Analytical Procedures states that where analytical procedures identify fluctuations or relationships that are inconsistent with other relevant information or that differ significantly from the expected results, the auditor shall investigate the reason for this.

Which of the following auditor responses to the increase in the receivables collection period of Fine Store is the LEAST relevant?

4. Which of the following statements summarizes your key concern regarding the risk relating to the extended credit terms and refusal of certain customers to pay?

5. Which TWO of the following procedures are relevant responses to the risk that inventory quantities are misstated by the new computerized inventory system?

The following scenario relates to questions 6 – 10.

It is 1 July 20X7. You are planning the audit of Verbal Co for the year ending 31 July 20X7. Verbal Co is a new audit client which operates in the oil & gas exploration industry. Companies wishing to operate in this industry require a license which is valid for 20 years. Licensing authorities take into account public health and safety, protection of the environment and protection of biological resources when granting licenses. Verbal Co.’s activities are geographically spread across three continents in 35 locations.

Verbal Co has been in existence for 30 years and has grown its revenue at an average of 12% per annum. This is in line with the industry average. During your planning meeting with the finance director you were informed that the forecast profit before tax for this financial year is $9.5 million (20X6: $6 million) based on revenues of $124 million (20X6: $100 million).

You have completed the audit strategy and the risk assessment section identifies the following as areas of significant risk of material misstatement:

• Overstatement of receivables due to long outstanding debts
• Misstatement of intangible assets (licenses) due to incorrect amortization
• Overstatement of non‐current assets due to impairment of exploration areas which have been decommissioned
• Overstatement of inventory due to the inherent difficulty of establishing the quantity of oil and gas reserves

6. Which of the following is the LEAST significant audit risk to be considered when planning the audit of Verbal Co?

7. Which TWO of the following are appropriate responses to address the increased detection risk due to Verbal Co being a new audit client?

8. Which of the following is the LEAST appropriate materiality level to be used in the audit of Verbal Co?

9. Select whether the following statements are consistent or not consistent with the movement in revenue.

A. Cut‐off of revenue is an audit risk

B. Completeness of revenue is an audit risk

C. Occurrence of revenue is an audit risk

10. Match the audit risks given with the MOST appropriate response the auditor of Verbal Co should take.

Audit Risk
1. Receivables
2. Non‐current assets
3. Intangible assets (licenses)

Auditor’s response
A. Physically inspect a sample of exploration areas
B. Contact a sample of customers to confirm the year‐end balance
C. Ask management to adjust the financial Statements
D. Inspect the license agreement
E. Review correspondence with customers
F. Calculate the expected amortization
G. Review the depreciation charge for adequacy

The following scenario relates to questions 11 – 15.

It is 1 July 20X5. You are an audit manager in Sand & Co and you are planning the audit of

Trumpet Co, a new audit client for your firm which has a year ended of 30 June 20X5. Trumpet Co is a large mobile phone company which operates a network of stores in countries across Europe. You have been provided with planning notes from the audit engagement partner following his meeting with the finance director.

During the year the company introduced a bonus based on sales for its sales team. The bonus target was based on increasing the number of customers signing up for 24‐month phone line contracts. This strategy has been successful and revenue has increased by 15% compared with 20X4. In particular, there has been a significant increase in sales in May and June 20X5.

Technology companies which supply Trumpet Co with mobile phones release new versions with updated features every twelve months. When new phones are released, Trumpet & Co offers significant discounts on older versions.

You are to undertake a preliminary analytical review of the draft financial statements and have been provided with the following information:

Overvaluation of inventory and receivables are considered to be significant risks for this year’s audit.

11. Which of the following statements is TRUE in relation to Trumpet Co being a new audit client of Sand & Co?

12. Which of the following is an appropriate explanation of the audit risk relating to the bonus for Trumpet Co’s sales team?

13. Using the financial information provided, calculate the following ratios for both years.

Calculate your answers to the nearest round number and enter the answer into the relevant box.

A. Receivables collection period (2015)

B. Receivables collection period (2014)

C. Inventory holding period (2015)

D. Inventory holding period (2014)

14. Which of the following is NOT an appropriate audit response to the significant risks relating to inventory and receivables?

A. Inventory

B. Receivable

15. Which TWO of the following statements BEST describe the purpose of using analytical procedures during the planning stage of Trumpet Co’s audit?

The following scenario relates to questions 16 – 20.

You are an audit senior of SBA & Co and are responsible for planning the audit of Slike for the year ended 30 September 20X6.

Slike is a charity which was established over five years ago. The charity’s aim is to provide support to children from disadvantaged backgrounds who wish to take part in sports such as tennis, badminton and football.

Slike has a detailed constitution which explains how the charity’s income can be spent. The constitution also notes that expenditure relating to the administration of the charity cannot exceed 10% of the charity’s income in any year. Slike currently employs 3 permanent members of staff. At present, 100 volunteers work for Slike: some commit up to 3 days a week and others help out on an ad hoc basis. The organization, including its finance department, is primarily run by volunteers.

The charity’s income is derived wholly from voluntary donations. Sources of donations include the public in the form of cash collected in buckets by volunteers in shopping areas, and from generous individuals.

16. Based on your understanding of the nature of Slike, you have identified that income is received primarily in the form of cash and this will affect audit risk.

By clicking on the relevant box indicate whether the following statements regarding the effect on audit risk are true or false.

A. Detection risk will increase due to the increased risk of cash donations being misappropriated and revenue being overstated

B. Inherent risk will increase as the nature of Slike’s transactions means that income may be misstated either in error or deliberately.

C. Control risk will increase as internal controls may be weak due to the large number of volunteers used by Slike

D. Business risk will increase due to the level of volunteers used by Slike

17. Your audit partner has highlighted to you that it is imperative that SBA & Co acts in line with ISA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment. This means it must identify and assess the risks of material misstatement at both the financial statements level and the assertion level, for classes of transactions, events and their related disclosures, and account balances and their related disclosures.

Indicate which of the following statements gives a true explanation of why ISA 315 requires a risk assessment to be carried out at the planning stage?

A. The risk assessment will help the audit team gain an understanding of the entity for audit purposes

B. The risk assessment will enable the audit senior to produce an accurate budget for the audit assignment

C. The risk assessment will form the basis of the audit strategy and the detailed audit plan

D. Once the risks have been assessed, SBA & Co can select audit team members with sufficient skill and experience to maximize the chance of those risks being addressed

18. You have identified several audit risks which you feel your team will need to address. One such audit risk relates to the risk that income may be understated in the financial statements. You are concerned that not all income may be recorded.

Which of the following statements is NOT a valid response to this audit risk?

19. Another identified audit risk is the susceptibility of Slike’s business to fraud due to the high levels of cash involved.

Use the drop down lists to complete the following sentence to correctly describe the auditor’s responsibilities in accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements.

A. The auditor is not responsible for the ______________ of fraud or error.

B. However, they are responsible for obtaining ____________ that the financial statements are free from material misstatement whether caused by fraud or error.

20. The audit manager has noted in the detailed audit plan that Slike’s control environment may be weak.

Which TWO of the following statements are valid reasons as to why Slike may have a weak control environment?

The following scenario relates to questions 21 – 25.

It is 1 July 20X6. You are the audit manager responsible for the audit of Sword Co, a company with a financial year ending 31 July 20X6. You are planning the audit and payroll has been identified as a significant audit risk this year.

• You have designed the following procedures for inclusion in the audit plan.
• For a sample of employees recalculate the gross and net pay and agree to the payroll records.
• Perform a proof in total of wages and salaries and compare the expected total to actual wages and salaries in draft financial statements.
• Select a sample of hourly paid employees and verify hours worked have been authorized by their line manager.
• Review the payroll report for evidence of authorization by the financial director before any payments are made to employees.

 Payroll fraud

During the year, it was discovered that a payroll clerk had been setting up fictitious employees on the payroll system with the wages being paid into the clerk’s own bank account. This clerk has subsequently left the company but you are concerned that additional frauds may have taken place in the wages department due to a lack of adequate and effective internal controls.

21. Which TWO of the procedures included in the audit plan describe substantive procedures to confirm the completeness and accuracy of Sword Co’s payroll expense?

22. Select which section of the audit strategy of Sword Co the following matters would appear. Audit strategy areas may be selected more than once or not at all.

Matter
1. Risk of material misstatement including the risk of fraud
2. Use of professional Skepticism
3. Selection of the audit team
4. Use of computer‐assisted audit techniques

Audit strategy section
A. Characteristics of the engagement
B. Reporting objectives, timing of the audit and nature of communications
C. Significant factors, preliminary engagement activities, and knowledge gained on other engagements
D. Nature, timing and extent of resources

23. With respect to the fraud at Sword Co, which of the following statements is TRUE?

24. Which of the following additional controls is most effective at preventing fraud of this type occurring again?

25. Which THREE of the following procedures would assist in the detection of further frauds of this type at Sword Co?

The following scenario relates to questions 26 – 30

You are an audit senior of SMS & Co, and your firm has recently been appointed as the auditor to Family, a private company that runs seven supermarkets in the UK. You are currently planning your firm’s audit of Family and are shortly due to make a preliminary visit to Family’s head office.

Four months before the year end, the company installed a new till system in all supermarkets. The new till system is linked to the accounting system at head office and automatically posts transactions to the accounting system. Previously journals were made manually based on totals on till rolls. The cost of the new till system which Family has capitalized as a non-current asset.

The audit engagement partner has also said that she has is concerned that the new till system may not be reliable, and that consequently not all sales have been recorded, resulting in an understatement of revenue. She is also concerned that staff may not yet be familiar with the system, leading to an increased risk of errors relating to data entry.

Finally, after a number of people living close to one of Family’s stores became seriously ill, the source of the illness was traced back to meet the customers had purchased from Family. Legal proceedings were commenced against Family by a number of customers during the financial year, demanding $1m in compensation.

26. Indicate which TWO of the following statements describe the objectives of planning the audit of Family.

27. You are about to begin work on the share capital section of the Family audit file.

Match each of the following audit procedures to the financial statement assertion to which it is most closely related.

Procedure
1. Recalculate the closing balance on the share capital account
2. Review financial statement notes
3. Review Memorandum and Articles of Association and compare their requirements with issued share capital
4. Read minutes of board meetings for evidence of share issues

Assertion
A. Presentation
B. Completeness
C. Accuracy, valuation and allocation
D. Existence

28. In relation to the capitalized costs of the new till system, you are concerned that Family may have included within the capitalized costs some items which are revenue in nature, leading to the overstatement of non-current assets.

Which of the following statements is a valid response to this audit risk?

29. The audit engagement partner has stated that the new till system may not be reliable.

Which TWO of the following statements represent valid responses to this audit risk?

30. You plan to review the legal correspondence relating to the claims made by those customers to whom Family sold contaminated meat.

Which TWO of the following are valid objectives of this audit procedure?

The following scenario relates to questions 31 – 35

It is 1 July 20X8. You are an audit manager in Bat & Co responsible for the audit of Eagle Co. Eagle Co manufacture kites which it sells via its website directly to customers. You are currently planning the audit for the year ending 31 July 20X8.

Two issues have been brought to your attention during a planning meeting with the finance director.

Dismissal of financial controller

The financial controller of Eagle Co was dismissed in May 20X8. He had been employed by the company for over 20 years and he has threatened to sue the company for unfair dismissal. The role of financial controller has not yet been filled and his tasks have been shared between the existing finance department team.

Payables ledger supervisor

The payables ledger supervisor left in March 20X8 and a replacement has only been appointed in the last week. However, for this period no supplier statement reconciliations or payables ledger control account reconciliations were performed.

The finance director has also provided you with the most recent management accounts to enable you to perform preliminary analytical procedures. Using that information you have calculated the following ratios:

31. Which of the following are appropriate auditor responses to the increased audit risk created by the finance team being allocated the work of the financial controller?

1. The audit team should be fully briefed and be alert throughout the audit for additional errors
2. The auditor should appoint an expert to properly assess the risks of misstatement
3. The finance director should be requested to provide the audit team with assistance for matters that cannot be addressed by the remaining finance function
4. The auditor should consider resigning from the engagement as audit risk cannot be managed to an acceptable level

32. Which THREE of the following statements are TRUE in relation to the lack of supplier statement reconciliations?

33. In respect of the unfair dismissal claim, which of the following audit procedures is NOT appropriate?

34. Which audit risks can be identified from the preliminary analytical procedures performed?

35. Which of the following are reasons why analytical procedures will be performed during the planning of Eagle Co?

1. To help identify areas of potential risk
2. To help obtain an understanding of Eagle Co
3. To help detect material misstatements in the financial statement figures

The following scenario relates to questions 36 – 40

It is 1 July 20X5. You are an audit senior in North & Co. You are planning the audit of Huga Co for the year ending 31 July 20X5. The audit manager has held a planning meeting with the finance director and has provided you with the following notes of his meeting and financial statement extracts.

Huga Co has experienced difficult trading conditions this year which has resulted in sales prices being reduced. Despite this, revenue has continued to fall. In an attempt to improve profit, Huga Co has switched to a cheaper supplier which has resulted in lower quality goods being purchased and a corresponding increase in returns from customers.

During the year the directors performed a review of asset lives which has resulted in an increase in the useful life of the majority of tangible non‐current assets. Accordingly, the depreciation charge has reduced from $1 million in 20X4 to $0.8 million in 20X5.

 Financial statement extracts for year ending 31 July

36. Using the financial information provided, calculate the following ratios for both years.

Calculate your answers to ONE decimal place and enter the answer into the relevant box.

A. Gross margin (2015)

B. Gross margin (2014)

C. Current Ratio (2015)

D. Current Ratio (2014)

37. In relation to the movement in the payables payment period, which of the following statements is most relevant to the auditor’s consideration of audit risk?

38. Which THREE of the following describe audit risks that should be addressed during the audit of Huga Co?

39. Which TWO of the following describe appropriate auditor responses to the audit risk related to the increase in the useful life of tangible non‐current assets of Huga Co?

40. Which of the following correctly describes the term performance materiality?

The following scenario relates to questions 41 – 45

You are an audit senior of NDH & Co and you are planning the audit of Monson Wind Services Co

(Monson) for the year ended 31 December 20X3.

Monson is a company that provides specialist helicopter support to public services, such as the police force and the ambulance service. Monson has four of these contracts, which contain very similar terms and are equal in value. Monson owns and maintains the helicopter fleet which is held at cost. Each aircraft carries specialist equipment and is operated by a highly skilled specialist pilot. Under the terms of these contracts Monson charges the customer an annual fee to cover the maintenance, storage and testing of the aircraft and equipment. The annual fee is payable in advance each year with the first annual payment being paid on the date the contract commences.

Monson has not purchased any new helicopters during the year to 31 December 20X3; however, there has been a lot of refitting, replacement and adding of specialist equipment to some of the existing aircraft. This has been necessary to keep up with the latest developments in search and rescue, and to maintain the aircraft to the high standard required under the contracts in place.

The original purchase of each aircraft was funded with a secured loan carrying substantial interest charges. The loan is in the process of being renegotiated and the bank has indicated that finance costs will increase further. Furthermore, the directors have told you that Monson’s contract with the police force expires in March 20X4, at a time when, in the wake of government cuts, the police are trying to substantially reduce the amount they pay. It is thought that the contract will be put out to tender, and it is possible that another aircraft provider may also bid for the contract.

Monson also holds around $2 million of aircraft spares which are included within inventory. Monson sells the aircraft spares to amateur flying associations. Aircraft spares which are not sold after three years are scrapped.

Approximately one-quarter of this value is made up of specialist equipment taken out of aircraft when it was replaced by newer or more advanced equipment. Such specialist equipment is transferred from non-current assets to inventory without adjustment, and continues to be recognized at amortized cost.

41. In relation to the specialist helicopter support contracts, which of the following statements summarizes a key audit risk?

42. Given the large amount of refitting of existing aircraft, you are concerned that property, plant and equipment may be overstated in the financial statements.

Indicate which TWO of the following statements represent valid responses to this audit risk?

43. In relation to Monson’s secured loan, which is the MOST important audit risk that should be documented in the detailed audit plan?

44. Which TWO of the following are valid responses to the fact that Monson’s contract with the police force is due for renewal?

45. In relation to the aircraft spares held by Monson, indicate which of the following correctly describe areas of audit concern?

A. Non-current assets

B. Inventory

C. Completeness

D. Accuracy, valuation and allocation

The following scenario relates to questions 46 – 50

You are an audit manager of Water & Co. Your firm has been invited to tender for the audit of Eight Co, a listed company. Your firm does not have any other listed clients, and Eight Co will represent the biggest client of your firm (by client annual revenue) if your tender is successful.

A member of the audit committee of Eight Co informed your audit engagement partner that the current auditors were not being invited to stand for re-election as the audit committee felt that the relationship between the firm and the company had begun to lose objectivity due to overfamiliarity. You have reviewed past financial statements of Eight Co and have noted that the company applies IFRS, and that the audit committee reports on its responsibilities with regard to internal control annually. The director confirmed that the board would be happy to confirm their responsibilities in writing with Water & Co as they are aware of the relevant audit requirements.

46. The audit engagement partner has asked you to prepare some information ready for the tender.

Identify, by clicking on the relevant box in the table below, if the following items should be included in, or excluded from, the tender for the audit of Eight Co.

A. The proposed fee for the initial audit of Eight  Co

B. Overall level of materiality to be used in the audit

C. A summary of potential other services Water & Co could provide to Eight Co

47. You have identified a number of issues which should be considered prior to tendering for a new client.

Given what you already know of Eight Co, which TWO of these are most important to consider further prior to tendering for the audit?

48. Your firm has tendered for the engagement and has been successful. You have been asked to follow through the acceptance procedures for the firm.

You are reappraising whether it is appropriate for the firm to accept the engagement.

Which of the following issues arising would cause Water & Co to decline the engagement?

49. You are drafting an engagement letter in respect of Eight Co, and are aware that ISA 210 Terms of Audit Engagements requires certain issues to be included.

Indicate which of the following issues must be included in the engagement letter?

A. Scope of the audit

B. Responsibilities of management of Eight Co

C. Timetable for the provision of accounting information by Eight Co

D. Fees and billing arrangements

50.

A. Before accepting the audit of Eight Co, Water & Co should __________

B. Once the audit has been accepted, then Water & Co should begin to __________

The following scenario relates to questions 51 – 55

You are an audit manager in DAB & Co, a large audit firm which specializes in the audit of retailers. The firm currently audits Spoofy Co (Spoofy), a food retailer, but Spoofy’s main competitor, Mize Co (Mize), has approached the audit firm to act as auditors. Both Spoofy and Mize are listed companies. Spoofy is concerned that if DAB & Co audits both companies then confidential information could pass across to Mize.

The audit engagement partner for Spoofy has been in place for approximately six years and her daughter, Emi, has just accepted a job offer from Spoofy as a warehouse manager. Emi ‘s employment contract states that if a bonus is to be paid it will be awarded as shares in Spoofy rather than in cash. Spoofy is offering DAB & Co a 5% bonus on top of the audit fee if this year’s audit can be completed three weeks earlier than last year. This is to reduce the demands on the finance director’s time as he is busy working on other projects.

51. The ACCA Code of Ethics and Conduct requires that an external auditor implement appropriate safeguards to ensure that a conflict of interest is properly managed.

Which TWO of the following actions should DAB & Co take regarding the potential confidentiality issue?

52. From a review of the information above, your audit assistant has highlighted some potential risks to independence in respect of the audit of Spoofy.

Indicate the appropriate category to which each of the threats to independence should be allocated.

A. Audit engagement partner has been in the position for six years

B. Audit engagement partner’s daughter works for Spoofy

C. Audit engagement partner’s daughter’s bonus would be in the form of shares

D. 5% bonus offered if audit is completed three weeks earlier than last year

53. DAB & Co has decided that it would like to accept nomination as Mize’s auditors and Mize’s existing auditors have agreed to resign rather than be removed from office.

The audit manager in charge of the tender has set out a list of procedures that the firm must undertake before Mize can be approved as an audit client.

(1) Ensure that the existing auditor’s resignation has been properly conducted

(2) Communicate with Mize’s existing auditors

(3) Submit an engagement letter to Mize’s management

(4) Perform client screening procedures, including an assessment of Mize’s risk profile

Show the correct order in which the above procedures should be undertaken.

54. Before DAB & Co can accept appointment as Mize’s auditors it must determine whether the preconditions for an audit are met and obtain management’s agreement that it acknowledges and understands its responsibilities.

Which of the following is NOT included in the agreement obtained by the auditor?

55. Indicate which of the following statements are true regarding the regulation of the audit profession?

A. The auditor has the right of access to the books, records and vouchers of the company

B. The auditor has the right to be heard at general meetings on matters relating to the audit

C. The auditor is appointed by, and answerable to, those charged with governance of the company

D. An auditor can be removed by a simple oral resolution in line with the common law