PAA 4 – 1

The following scenario relates to questions 1 to 5.

You are the audit manager in the firm of MSD & Co, an audit firm. You are planning the audit of

Cruse Co, which operates as a high street retailer and has 15 shops.

All of the shops are owned by Cruse Co and have always been included in the financial

Statements at cost less depreciation. The shops are depreciated over 50 years. However, you

Know from discussions with management that the company intends to include one of the shops, the flagship store, at a revalued amount rather than cost in the current accounting period. The revalued amount is expected to be materially above the carrying value of the shop. The valuation will be based on a management estimate.

Management has explained that the reason for the revaluation is because the flagship store is located in an area where property prices have risen much more quickly compared to other shop locations They consider the flagship store to be significantly undervalued on the statement of financial position.

Management will not depreciate the revalued amount allocated to the flagship store’s building because they maintain the building to a high standard.

1. In his notes for the audit planning meeting, the audit junior made several statements in relation to the valuation of the shops.

Which TWO of the below statements are correct?

2. Indicate whether the following assertions are relevant to the audit of tangible non-current assets.

A. Existence

B. Occurrence

C. Classification

D. Presentation

3. Which of the following procedures will provide appropriate audit evidence in respect of the completeness of non-current assets?

4. At the planning meeting, it was decided that an auditor’s expert should be sought in relation to the valuation of Cruse Co’s properties as the company has not used an independent valuer.

ISA 620 Using the Work of an Auditor’s Expert states that the nature, timing and extent of audit procedures to evaluate the work of the auditor’s expert depend on the circumstances of the engagement.

Which of the following matters should the audit team NOT consider in determining the nature, timing and extent of these audit procedures?

5. The audit junior has been assigned to the audit of the bank and cash balances of Cruse Co. He has noted down the audit evidence he plans to obtain in respect of the bank and cash balances

Rearrange the four options below to show the order of reliability of the audit evidence, starting with the most reliable first.

A. Bank reconciliation carried out by the cashier
B. Bank confirmation report from Cruse Co’s bank
C. Verbal confirmation from the directors that the overdraft limit is to be increase
D. Cash count carried out by the audit junior himself

The following scenario relates to questions 6 to 10.

You are an audit senior in Smith & Co and are currently performing the final audit of Stand Co for the year ended 31 October 20X6. The company is a manufacturer and retailer of shoes and boots. The current audit senior is ill and you have been asked to complete the audit of payroll and revenue in their absence.

 Payroll

You determine the following information from a review of the current year and prior year audit files:

• As at 31 October 20X5, Stand Co had 500 employees
• On 1 November 20X5, 10% of staff were made redundant, effective immediately, due to discontinuation of a product line
• On 1 January 20X6, all remaining staff received a 6% pay rise
• Over the course of the year, sales levels met performance targets which resulted in a fixed bonus of $1,500 being paid to each employee on 31 October 20X6

 Revenue

The following audit procedures are included in the revenue section of the audit plan:

1. Review the treatment of a sample of post year‐end returns
2. Select a sample of goods despatched notes and agree to invoices in the sales day book

• Select a sample of invoices from the sales day book and agree to goods despatched notes

1. Select a sample of invoices and recalculate the invoiced amount agreeing to price list

6. Which of the following statements explains the CUT‐OFF assertion for wages and salaries?

7. The following audit evidence has been gathered relating to the accuracy of wages and salaries for Stand Co:

• Proof in total calculation performed by an audit team member
• Written representation from the directors of Stand Co confirming the accuracy of wages and salaries
• Verbal confirmation from the finance director of Stand Co confirming the accuracy of wages and salaries
• Recalculation of the gross and net pay for a sample of employees by an internal audit team member of Stand Co

What is the order of reliability of the audit evidence starting with the MOST RELIABLE first?

8. The prior year financial statements for Stand Co included $17 million for wages and salaries in the statement of profit or loss.

What would be the estimated current year wages and salaries expense, ignoring redundancy costs, based on the data gathered from the review of the audit files?

9. Select which TWO of the following are substantive ANALYTICAL PROCEDURES for wages and salaries.

10. In respect of the revenue procedures included in the audit plan, select the assertion being tested.

1.

2.

3.

4.

The following scenario relates to questions 11 to 15.

You are an audit manager, auditing the financial statements of Newtrend Engineering Co, a listed company, for the year ended 30 April 20X7.

Newtrend’s management has provided you with a schedule of the realisable values of the inventories. A full inventory count was carried out at 30 April 20X7. Audit tests have confirmed that the inventory counts are accurate and there are no purchases or sales cut-off errors.

One of the company’s factories was closed on 30 April 20X7. The plant and equipment and inventories were to be sold. By the time the audit work commenced in June 20X7, most of the inventory had been sold.

You have instructed the audit junior to evaluate the valuation of the inventory related to the closing factory at the year end. The audit junior has sent you a list of planned audit procedures. On 17 March 20X7, Newtrend’s managing director was dismissed for gross misconduct. It was decided that the managing director’s salary should stop from that date, and that no redundancy or compensation payments should be made.

The managing director has claimed unfair dismissal and is taking legal action against the company to obtain compensation for loss of his employment. The managing director says he has a service contract with the company which would entitle him to two years’ salary at the date of dismissal. The directors believe that there is a 35% chance of the managing director succeeding in his claim.

The financial statements for the year ended 30 April 20X7 record the resignation of the director. However, they do not mention his dismissal and no provision for any damages has been included in the financial statements.

11. Which TWO of the following statements are true regarding the auditor’s attendance at the inventory count?

12. Which of the audit procedures below is NOT appropriate in auditing the valuation assertion for Newtrend’s inventory?

13. Using the drop down lists, complete the sentence below to show the correct accounting treatment for the legal claim made by the managing director for unfair dismissal and the reason for this treatment.

The legal claim should ______A______ because ______B______.

A.

B.

14. Which of the following audit procedures is likely to provide the auditor with the MOST reliable audit evidence regarding the legal claim?

15. The dismissal of Newtrend’s managing director has alerted you to the possibility that the company may not have complied with employment regulations. You therefore need to determine the impact that such non-compliance may have on the audit.

ISA 250 (Revised) Consideration of Laws and Regulations in an Audit of Financial Statements sets out the responsibilities of the auditor in relation to the entity’s compliance with laws and regulations.

Which of the following responsibilities is CORRECT regarding the responsibilities of Newtrend’s auditors in relation to compliance with employment regulations?

The following scenario relates to questions 16 to 20.

It is 1 July 20X5. You are an audit supervisor in Seashell & Co and you are currently performing the audit of an existing client, Snow Heating Co (Snow), for the year ended 31 May 20X5. Snow manufactures and sells heating and plumbing equipment to a number of home improvement stores across the country.

The following information has been obtained during discussions with the finance director.

Unpaid receivable

One of Snow’s key customers has been experiencing financial difficulties. Snow has agreed that the customer can take a six‐month payment break, after which payments will resume. The finance director does not believe that any allowance is required against this receivable. Your review of industry journals has identified several articles that suggest the key customer may soon cease trading.

Inventory

Snow has experienced increased competition. In order to maintain its current levels of sales, it has decreased the selling price of its products significantly. Despite the reduction in selling price, inventory levels are significantly higher this year compared to the prior year. In addition to Snow’s inventory, there is inventory stored on behalf of a third party at the year‐end. Audit staff attended the year‐end inventory count of Snow which was held three days before the year end due to staff availability of Snow. A reconciliation has been performed to determine the year‐end inventory quantities.

Lawsuit

A customer has filed a claim against the company regarding a heating system that Snow installed two months before the year end. The customer claims the installation was not done properly resulting in an explosion which caused damage to his home. The customer is claiming compensation of $50,000 which is material to the financial statements. The finance director believes that the claim is not probable to succeed so has not referred to it in the financial statements.

16. Which of the following substantive procedures will provide the MOST reliable evidence as to the recoverability of the outstanding balance from Snow’s key customer?

17. Which TWO of the following substantive procedures will provide evidence over the EXISTENCE of Snow’s other trade receivables?

18. Which TWO of the following factors may indicate overvaluation of inventory at Snow?

19. Select whether the following are tests of control or substantive procedures in relation to Snow’s inventory balance.

A. Observe the client’s staff to ensure they are following the inventory count instructions

B. Inspect the inventory for evidence of damage or obsolescence

C. Re‐perform the reconciliation from the inventory count date to the year‐end date for inventory to assess the accuracy of the inventory quantities.

20. Which of the following are appropriate audit responses to the lawsuit?

1) Ask the finance director to include a provision in the financial statements

2) Inspect correspondence between the client and their legal advisers

3) Review board minutes to understand management’s view about the claim

4) Contact the customer to understand the details of the claim

The following scenario relates to questions 21 to 25.

Your audit firm Pal & Co has just gained a new audit client, Cereal Co, in a tender in which Pal & Co offered competitively low audit fees. You are the manager in charge of planning the audit work. Cereal Co’s year end is 30 June 20X9 with a scheduled date to complete the audit of 15 August 20X9. The date now is 3 June 20X9.

Cereal Co provides repair services to motor vehicles from 25 different locations. All inventory, sales and purchasing systems are computerised, with each location maintaining its own computer system. The software in each location is the same because the programs were written specifically for Cereal Co by a reputable software house. Data from each location is amalgamated on a monthly basis at Cereal Co’s head office to produce management and financial statements.

You are currently planning your audit approach for Cereal Co. One option being considered is to rewrite Pal & Co’s audit software to interrogate the computerized inventory systems in each location of Cereal Co (except for head office) as part of inventory valuation testing. The testing will need to take place while the system is live. You are aware that July is a major holiday period for Cereal Co.

21. The audit junior is concerned about various circumstances of the audit, which are likely to increase audit risk. He has written to you with some suggestions.

Which TWO of the following suggestions are valid?

22. Which TWO of the following are benefits of using audit software in auditing the inventory of Cereal Co?

23. It has been decided that systematic sampling would be applied to the audit of Cereal Co’s inventory.

Which of the following sampling methods correctly describes systematic sampling?

24. Cereal Co’s internal audit department is going to assist with the statutory audit. The chief internal auditor will provide you with documentation on the computerized inventory systems at Cereal Co. The documentation provides details of the software and shows diagrammatically how transactions are processed through the inventory system. This documentation can be used to significantly decrease the time needed to understand the computer systems and enable audit software to be written for this year’s audit.

Which of the following is NOT a matter the audit team should consider in determining whether or not the internal auditor’s work is adequate for the purposes of the audit?

25. The audit junior has obtained the following extract of the aged inventory report:

What is the impact on the value of inventory if no adjustments are made to the carrying amounts above?

The following scenario relates to questions 26 to 30

It is 1 July 20X5. You are an audit senior in Stair and Co and you are preparing the audit procedures in respect of the audit of inventory for Floss Co for the year ending 31 August 20X5. Floss Co is a paint manufacturer and has been trading for over 50 years. It operates from one central site, which includes the production facility, warehouse and administration offices.

To avoid the disruption of a year‐end inventory count, Floss Co has this year introduced a continuous/perpetual inventory counting system. A timetable of inventory counts is maintained and regularly reviewed.

The following inventory counting processes have been implemented by Floss Co:

1) The team prints the inventory quantities and descriptions from the system and these records are then compared to the inventory physically present.

2) Any discrepancies in relation to quantities are noted on the inventory sheets, including any items not listed on the sheets but present in the warehouse area.

3) Any damaged or old items are noted and they are removed from the inventory sheets.

4) During the counts there will continue to be inventory movements with goods arriving and leaving the warehouse.

5) Inventory belonging to third parties is removed from the warehouse before the count commences and kept in a separate location.

26. Which of the following statements are TRUE in respect of inventory counts?

1) The external auditor will perform the inventory count to ensure the inventory figure is accurate for the financial statements

2) The inventory count is used to ensure inventory is valued appropriately in the financial statements

3) All companies must cease production on days an inventory count is performed

4) The external auditor must attend the inventory count if inventory is a material balance

27. What is the primary reason for maintaining an inventory count timetable?

28. Select whether the following statements are true or false in respect of Floss Co’s perpetual inventory system.

A. Stair & Co must attend at least one count to ensure adequate controls are applied

B. Cut‐off testing will only need to be performed if a full count is carried out at the year‐end

C. All lines of inventory must be counted at least twice during the year

D. Stair & Co should visit the client’s premises at least once a year and request a surprise inventory count

29. Select whether the inventory count processes described represent strengths or deficiencies

1.

2.

3.

4.

5.

30. During the inventory count you perform test counts agreeing inventory quantities on the count sheets to the physical inventory present in the warehouse and from the physical inventory to the count sheets.

Which financial statement assertions do these two procedures address?

The following scenario relates to questions 31 to 35

Metal, a limited liability company, is a retailer of sports equipment, specializing in racquet sports such as tennis, squash and badminton. The company purchases equipment from a variety of different suppliers and then resells this online. Customers place their orders directly on the company website. The ordering/sales software automatically verifies the order details, customer address and credit card information prior to orders being verified and goods dispatched. Once the order has been verified the system produces a pre-numbered picking note. The order is then picked in the warehouse and a goods dispatched note (GDN) is produced. A copy of this is scanned in to the system and a sequentially numbered invoice is automatically produced and sent to the customer.

You are the audit senior working on the audit of Metal for the year ended 31 December 20X7.

As the sales system is highly automated the audit manager has decided that computer-assisted audit techniques (CAATs) should be used where possible in the audit of the sales account. You identified the key steps to be taken in planning the application of CAATs, as follows:

(1) Define the types of transactions to be tested

(2) Set the objective of the CAAT application

(3) Define the procedures to be performed on the data

(4) Determine the content and accessibility of the entity’s files

The manager has also decided that test data would be used to test the input of details into the ordering system. You identified the following test data which could be used:

(i) Orders for unusually large quantities

(ii) Orders with fields left blank

(iii) Orders with invalid inventory codes

(iv) Orders with complete and valid details

In addition to the sales income generated from the sale of sports equipment Metal earns a small amount of rental income by renting out surplus warehouse space to a local company. The rental agreement shows that the annual rent from 1 March 20X7 was $24,000, increased from $21,600 per annum.

31. Which of the following identifies the correct order in which the steps to be taken in planning the application of CAATs should be performed?

32. Which of the test data identified by the audit junior should be used to confirm the completeness and accuracy of input into the sales system?

33. Which of the following procedures would provide evidence that sales cut-off for Metal has been applied correctly?

34. As part of substantive audit procedures, you perform a sequence check on the sales invoice numbers issued by Metal over the year.

What is the purpose of the sequence check you have performed on the sales invoice numbers?

35. You are using a proof in total calculation to assess the accuracy of the rental income.

Which of the following correctly shows the calculation which would be used?

The following scenario relates to questions 36 to 40.

It is 1 July 20X5. You are an audit senior in Hand & Co assigned to the audit of Dolphin Co for the year ended 31 May 20X5. You are due to commence the audit of trade receivables. For the first time at this client, you have decided to use audit software to assist with the audit of the receivables balance.

Dolphin Co is a wholesaler of furniture such as chairs, tables and cupboards. Dolphin Co buys the furniture from six major manufacturers and sells them to over 600 different customers ranging from large retail chain stores to smaller owner‐controlled businesses.

All financial information is stored on Dolphin Co’s computer systems, although previous audits have tended to adopt an ‘audit around the computer’ approach. Computer staff at Dolphin Co are happy to help the auditor by providing access to the systems, although they cannot confirm completeness of systems documentation, and have warned that the systems have very old operating systems in place which limits file compatibility with more up‐to‐date programs. As the system is old, the auditor will be provided with copy files and not be allowed any direct access to Dolphin Co’s computer system.

36. Select whether the following explanations provide a valid explanation why audit risk increases when auditing ‘around the computer’.

A. The actual computer files and programs are not tested therefore the auditor has no direct evidence that the programs are working as expected

B. Where errors are found in reconciling inputs to outputs, it may be difficult or even impossible to determine why those errors occurred

37. Which of the following is NOT a limitation of using audit software at Dolphin Co?

38. Assuming that audit software can be developed for use on Dolphin Co’s systems, which of the following procedures could be carried out on the receivables balance?

1. Cast the receivables ledger to ensure it is arithmetically correct
2. Compare the balance on each receivable account with its credit limit to ensure this has not been exceeded
3. Stratify the receivables balances and select an appropriate sample for testing
4. Produce an aged receivables analysis to assist with the identification of irrecoverable receivables

39. Which THREE of the following statements are TRUE in relation to audit software?

40. Dolphin Co has informed you that they plan to implement a new computerized accounting system within the next year.

Which of the following would represent an appropriate audit response in respect of the new computerized accounting system?

1. The audit firm should delay the use of audit software to ensure it is designed to effectively work with the new system
2. The audit engagement partner should provide advice to Dolphin Co on which system to implement
3. The external audit team must be present during the installation and testing of the new system

The following scenario relates to questions 41 to 45.

You are an audit manager who specializes in the audit of not‐for‐profit (NFP) organizations. You are currently assigned to two clients, Downup and Star. Both audit teams include audit juniors who have only been involved with audits of companies and have not audited NFP organizations before. As the manager, you will be responsible for explaining the differences between the audits of NFPs and companies. The following information is to be communicated to the audit teams of each client.

 Downup

Downup is a local government authority which receives an allocation of tax payer money from central government. Downup has been notified by central government of a significant cut in its funding for the following financial year.

 Star

Star is a local charity which operates several charity shops. People make donations of goods which the shop sells to customers. All sales are paid for in cash as transaction amounts are usually small and credit card charges incur too great a cost.

Star employs one administrative assistant. All other staff and trustees are volunteers who commit between 1 and 5 hours per week to the charity. The administrative assistant is responsible for paying the bills, including their own wages, and recording the transactions in a spreadsheet. The administrative assistant is also responsible for preparing the financial statements and charity’s tax return. Tax rules for charities are different to those for companies and individuals. Once prepared, they are sent to the trustees for approval. None of the trustees have any specific financial expertise.

41. Which TWO of the following statements is TRUE in relation to the audit of Downup?

42. Which of the following statements is FALSE in respect of the notification regarding the cut in funding for Downup?

43. Completeness of income has been identified as a significant audit risk for the audit of Star. Select THREE procedures which will help identify if income is understated.

44. Which of the following risks require specific consideration for the audit of Star?

1. Less segregation of duties
2. Uncertainty over future funding
3. Complexity of taxation rules
4. Competence of volunteer staff

45. Select whether the following statements are ALWAYS true, NEVER true or MAY be true in respect of the audit of a charity such as Star.

A. Management will have no financial qualifications therefore there is a greater risk of material misstatement

B. Internal control systems will not be as sophisticated as those for profit making companies

C. There are fewer auditing standards applicable to audits of charities

D. Charities such as Star s will have different objectives to a profit making company therefore the auditors’ assessment of materiality will consider different factors

The following scenario relates to questions 46 to 50.

You are an audit senior of Beach & Co and are currently conducting the audit of Lobster Co (Lobster) for the year ended 30 September 20X1. You are reviewing the work of your audit assistant.

Trade receivables

Your audit assistant has carried out a direct confirmation (a receivables circularization) on trade receivables at Lobster. She selected the 10 largest balances, representing 85% of the sales ledger at year end, including 2 items that were individually material. Seven customers agreed the sales ledger balance, two replied noting discrepancies which she has followed up and one has not replied.

The audit working papers contain the following work in respect of the two balances with discrepancies.

Allowance for doubtful accounts

The company has an accounting policy of creating an allowance for doubtful accounts at 2% of year-end sales ledger balance.

46. You are analyzing the sample selection with regard to the direct confirmation.

Which of the following statements in relation to the sample selection is TRUE?

47. The audit assistant has identified further procedures to be carried out in respect of the customer who has not responded to the circularisation request as follows.

(1) Send out a follow-up request.

(2) Inspect the sales invoices in the customer account at year end.

(3) Ask the credit controller whether the customer exists.

(4) Reconcile cash receipts after date with pre year end invoices in the customer account.

Which of these procedures would provide audit evidence of the EXISTENCE of this receivable?

48. You are reviewing the work carried out on the disputed balances.

What is the misstatement arising from the above issues and the resultant impact on current assets?

49. Your audit assistant has heard that auditing accounting estimates can be problematic and has asked you to explain why this is the case.

Which of the following statements concerning auditing accounting estimates is INCORRECT?

50. The audit junior has suggested the following tests could be carried out to test the allowance for doubtful accounts:

(1) Review cash receipts after year end

(2) Review an aged debt analysis of the sales ledger

(3) Ask the credit controller what debts are considered to be doubtful

(4) Review sales invoices relating to overdue accounts

Which of the following correctly ranks these tests in terms of their appropriateness to the VALUATION assertion (most appropriate being listed first)?