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Application of SLAuSs and Other Pronouncements-Suggested Answers

Application of SLAuSs and Other Pronouncements

Suggested Answers

Important – The objective of this paper is test the application of technical standards in an open book environment. The structure and the type of questions are different from the normal structure of Advanced Audit & Assurance Paper.

Question 1

Part A

Required

Explain how fraud triangle is relevant in making the fraud risk assessment for Max Wealth Limited

                                                                                                                                    3   Marks

Applicability of SLAuSs – SLAuS 240- Appendix 1 page 242

1. Incentive/ Pressure

·     Excessive Management pressure to expectations of investors as the management in the process of finalizing an initial Public Offering.

·       Personal financial situation of management could be threatened by loan targets as they are linked to employee share ownership plan

2. Attitude/ Rationalization

·         Inappropriate changes to accounting policy given the attitude towards aggressive earning management

·         Ethical issues/ violation of laws

3. Opportunity

·         Ineffective monitoring because of domination of management by CEO

·         Significant related party transactions w

·         Significant deficiency in key controls- loan quality classification

State two general unpredictable testing that can be applied to the bank

                                                                                                                                    2    Marks

Applicability of SLAuSs – SLAuS 240- Para A36 Page 231

·         Select different branches on an unannounced basis for detailed testing

·         Select balances which are not otherwise tested for materiality or risk- e.g. zero balances

·         Change timing of confirmation

·         Use different sampling methods

State 3 procedures to address management override of controls

3    Marks

Applicability of SLAuSs – SLAuS 240- Para 32 Page 214

·         Test journal entries

·         Review accounting estimates for bias

·   Evaluate business rationale for significant transactions that are outside the normal course of the business

State two substantive audit procedures on loan impairment

                                                                                                                                    2    Marks

·       Test the methods used by management to identify impairment triggers, e.g. financial difficulties of   customers

·         Review the cash flow estimates for individually significant loans

·     Evaluate the reasonableness of the assumptions used in both individual and collective impairment review e.g. Probability of Default (PoD), Loss given the Defualt (LoD)

·         Check valuation reports supporting the value of collateral used in the impairment review

Part B

Audit senior has raised following issues in relation to Max Wealth Limited for your clearances. Explain the suitable cause of actions for the issues raised

1.      Can there be areas where materiality level be set for particular classes of transactions and account balances and disclosures (1 mark)

Applicability of SLAuSs – SLAuS 320- Para A10 Page 401

Yes areas such as related party disclosures, disclosure required by CB directives e.g. capital adequacy

2.      Mr Max Fenando has provided a written representation stating that loan given to related entities are recoverable, to what level reliance could be placed on this (1 Mark)

Applicability of SLAuSs – SLAuS 580- Para 4 Page 688

Written representation does not provide sufficient appropriate evidence on its own and does not affect the nature or extent of audit evidence that auditor should gather on valuation of loans

3.      Can we rely on only substantive analytical procedure in auditing loan and advances (2 Marks)?

Not advisable as this valuation of loan has been considered as a significant risk and controls on this area is appear to be weak

Applicability of SLAuSs – SLAuS 330- Para 22 Page 410

When the approach to a significant risk consists of only substantive procedures, those procedures shall include test of details

4.      State two general procedures to be performed to identify instances of non-compliance with CB regulations (1 Marks)?

Applicability of SLAuSs – SLAuS 250- Para 14 Page 264

Inquiry

Inspect correspondence with CB bank supervision division

Question 2

Required

Part A

Explain one business risk which could result in risk of material misstatements in relation to connectivity

                                                                                                                                    2    Marks

·         Management is under intense competitive pressure which has affected its ability to continue in the business as a going concern

·         Ability adopt to new technology

You have been asked to perform a risk assessment for connectivity, comment on the areas that should be covered through your risk assessment

                                                                                                                                    3    Marks

Applicability of SLAuSs – SLAuS 315- Para 11 Page 336

·         Telco industry, regulations (TRC), and other external factors including FRF

·         Nature of the entity; operations, ownership & governance, investments, structure and financing; type of business, mobile, broad band, TV etc

·         Selection & application of accounting policies and changes; there will be accounting policies which  are particularly relevant to Telco e.g. revenue recognition, decommissioning provision

·         Business objectives & strategies and business risk. E.g. technology change and impairmemt

·         Measurement of financial performance; KPIs which are linked to financial information

Part B

You have also been assigned to understand internal controls relent to audit & to assesses control environment of connectivity

List components of internal controls that you should assesses as a part of understating internal controls

                                                                                                                                    2 1/2    Marks

Applicability of SLAuSs – SLAuS 315- Para A 51 Page 359

List five main aspects of control environment which your assessment should focus on

                                                                                                                                    2 1/2    Marks

·         Control environment

·         The entity’s risk assessment process

·         The information system, including the related business processes, relevant to financial reporting, and communication

·         Control activities; and

·         Monitoring of controls.

SLAuSs – SLAuS 315- Appendix 1 Page 384

·         Communication & enforcement of integrity and ethical values

·         Commitment to competence

·         Participation by those charged with governance

·         Management’s philosophy and operating style

·         Organizational structure

·         Assignment of authority and responsibility

·         Human resource policies and practices

Part C

Amal, the senior auditor assigned to Telco has raised following matters for clarifications

Explain an appropriate testing strategy on revenue related assertions?

                                                                                                                                    2 1/2    Marks

·         Due to the large volume of revenue transactions, it will not be practicable to perform only substantive procedures, auditor should evaluate the internal controls relevant to important assertions such as occurrence/ completeness

·         Most of the controls could be automated application controls, therefore, auditor should first evaluate the effectiveness of IT General controls

·         Substantive analytical procedures along with test of details may be effective testing strategy

List four important quality control requirements which are particularly relevant to connectivity

·         Client Acceptance procedure- ability to handle, management integrity, independence

·         Assignment of personnel

·         Connectivity is a listed client and therefore, engagement quality control review to be undertaken

·         Consultation to be done on complex matters

                                                                                                                                    2 1/2  Marks

Part D

Explain whether there are events or conditions which may cast significant doubt about entity’s ability to continue as a going concern & state three additional procedures which you should perform on such events

                                                                                                                                    5    Marks

Events or conditions

·         Pressure on profitability

·         Operating losses for four consecutive years

·         Accumulated losses

Additional procedures

Refer Page 772, para 16

When events and conditions relating to going concerns were taken over with finance director, he mentioned that management had prepared financial statements on a going concern basis based on the undertaken given by its Parent Company Reality holding on the financial obligations of the company.

Explain additional considerations on the undertaken provided by the parent and impact on the audit opinion

·         Examine letter of financial support signed by the authorized personnel of Reliability & assess the enforceability of the letter

·         Assesse parent’ company’s ability to meet the debt of connectivity by reviewing the financial statements of Reality

Impact on the audit opinion

·         If the auditor is satisfied with the above areas with respect to financial support of the patent, adequate disclosures should be made in the financial statements with respect to the material uncertainty along with the mitigation plan (comfort letter).

·         Provided that the financial statements contain adequate disclose, auditor should issue an unmodified opinion with an emphasis of matter.

·         If adequate disclosure are not made qualified or adverse opinion may be issued

                                                                                                                                    5    Marks

Part A,B, C & D Total Marks                                                                                               25 Marks

Question 3

1. Explain the testing strategy that you would perform on completeness and valuation assertions of PPE

                                                                                                                                    3 Marks

Completeness- TOC

Auditor can test the effectiveness of the reconciliation process carried out by the management between the FAR and Smart Z

Substantive Procedures

Check the repair and expenses account for inclusion of items of capital nature

Valuation

·         Test controls over acquisition PPE

Auditor may undertake substantive procedures on construction of new plant, and major overhaul expenditure which Involved replacement of existing components of machineries.

·         Ensure that overhaul cost meet the capitalization criterial of LKAS 16

·         Cost of the existing components relating to replacements had been derecognized

Re-computation of depreciation

2. Testing performed on entity’s FAR reconciliation process showed that in two months there is an unreconciled differences between the GL and FAR.  State further procedures that you would perform

                                                                                                                                    3   Marks

·         Unless this is an isolated deficiency, it shows that the control is not operating effectively

·         Perform substantive testing on the reconciliation process, use of CAAT to compare Smart Z purchase/ GRN details with those of GRNs

·         For any discrepancies check the supporting documentation

·         Assesses the impact of discrepancies between Smart Z and FAR to financial statements.

·         e.g. delay in capitalization will affect the depreciation

3. Explain two main procedures that you would perform on sales cut-off

·        

      Obtain a detailed listing of items recorded in GDNI accounts and check whether such goods had been dispatched to the customer before the year end. (Check whether dispatch note had been acknowledged by the customer.

·         Select the invoices recorded in the sales ledger during the last one or two weeks before the year end (March) and invoices recorded during the first one or two weeks of the next financial year (April) & trace such invoices to dispatch notes acknowledged by the customer to determine whether revenue should be recorded during the current period.

                                                                                                                                     4 Marks

Question 4

Evaluate the work performed by an engagement team suggesting additional procedures required to conclude on the matters raised. 

5 Marks

Applicability of SLAuSs – SLAuS 620- Para A 33 Page 792

Written instructions should have been provided by the auditor to the expert prior to them carrying out the work. E.g. applicability of LKAS 39

Evaluation the adequacy of the auditor’s expert’s work.

Review the auditor’s expert’s working papers and reports to ensure that:

– the work meets the objectives of the audit

– the evidence contained in the report is consistent with other evidence obtained by the auditor

– the work is based on the correct period and takes into account events after the reporting date

 where necessary.

– Evaluate the appropriateness of models used by the expert to determine fair value.

– Compare the findings of the expert with results produced by management, eg compare the

    fair values determined by the expert with those determined by management.

– Reperform any calculations contained in the expert’s working papers, eg recalculate movements in fair value on the derivatives

Question 5

You are required to:

Comment on the additional considerations (if any) that should be taken into account in filing the Declaration of Independence on this audit.

Under Sarbanes Oxley Act, an auditor of a public entity is prohibited from providing certain non-

audit services to audit clients.

(1)        bookkeeping or other services related to the accounting records or financial statements of the audit client;

(2)        financial information systems design and implementation;

(3)        appraisal or valuation services, fairness opinions, or contribution-in-kind reports;

4)         actuarial services;

(5)        internal audit outsourcing services;

(6)        management functions or human resources;

(7)        broker or dealer, investment adviser, or investment banking services;

(8)        legal services and expert services unrelated to the audit; and

AUDIT PARTNER ROTATION

Audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the

5 previous fiscal years of that issuer.´´.

Question 6

Explain following matters in relation to the audit of Bentota Holding Ltd for the year ended 31 March 2014

Type of work to be performed on the financial information of the components described in the above table

6 Marks

Applicability of SLAuSs – SLAuS 600- Para 26 & 271 Page 715

Significant component based on the size of individual financial information

·         Royal Park Inn, represents more than 50% of the profit of the group

·         Flower Hotel  approximately 20% of the profit of the group

·         Royal Hills approximately 22% of the profit of the group

Type of work to be performed

An audit of the financial information of the component using component materiality

Significant component based on the significant risk or specific nature or circumstances

·         Hotel Palm Beach Bentota represents material uncertainty regarding the continuation as a going concern

Type of work to be performed

An audit of the financial information of the component using component materiality with a particular emphasis on the validity of the going concern assumption

Components which are not significant in relation to the financial statements of the group

·         Hill Top Property represents only 6% of the profit of the group

Type of work to be performed

The group engagement team shall perform analytical procedures at group level.

Further matters to consider in incorporating financial information of Flower Hotel in consolidated financial statements of  Bentota Holding

2 Marks

It appears that group has a joint arrangement with joint control over Flower Hotel, further evaluation to be done to assesses whether this joint arrangement is a joint venture or joint operation in terms of SLFRS 11, joint arrangements. (Page 50 Revision KiT).  Therefore, it may not be appropriate to recognize this as an AFS investments.

Joint operation

When parties have rights to the assets and obligations for the liabilities, the group should account for those assets and liabilities and not the net assets

Joint Venture

If the group has the rights only to the net assets, it could account this investment using the equity method

State maters to consider in evaluating the appropriateness, completeness and accuracy of

Consolidation adjustments

Applicability of SLAuSs – SLAuS 600- Para A56 746

·         Evaluate significant adjustments and determine whether they are authorized

·         Check the reconciliation and elimination of inter-group transactions and unrealized profits

2 Marks

  

Question 7

Part A

State the main source of information to obtain information about nature of the relationship

between the Fdel Apparel Limited & Fast Data Solution

1 Marks

Service Level Agreement between the company and Fast Data Solution

State the alternative procedures that you would perform If you are unable to obtain sufficient

understating about service organization and its effect on Controls from Fdel Apparel Limited,

Applicability of SLAuSs – SLAuS 402- Para 12 Page 439

·         Obtain type 1 or type 2 report

·         Contact Fast Data Solution to obtain specific information

·         Visit Fast Data Solution and perform procedures

·         Use another auditor to perform required procedures

3 Marks

State four main procedures that your team should perform in attending to the physical inventory

Count Fdel Apparel Limited

2 Marks

Applicability of SLAuSs – SLAuS 501- Para 4 Page 495

·         Evaluate management instructions and procedures for recording and couting of the result

·         Observe the performance of the count procedures

·         Inspect the inventory

·         Perform test counts

Part B

Applicability of SLAuSs – SLAuS 501- Para 13 Page 497

Obtain an understating of the methods used by the management in determining the segment information. This involve whether methods are likely to meet the disclosure requirement of SLAFRS 8

Perform analytical procedures or other procedures appropriate

State two main sources which auditor should inspect with respect to related party relationships or transactions not previously identified.

1 Marks

Applicability of SLAuSs – SLAuS 550- Para 15 Page 625

·         Bank and legal confirmation

·         Minutes of the meetings

State two procedures that you would perform on the assertions that related party transactions were conducted on arm’s length basis

Applicability of SLAuSs – SLAuS 550- Para A43 Page 648

·         Compare with identical or similar transactions

·         Engage external expert

·         Compare with broadly similar transactions

1 Marks

Total Marks                                                                                                                            10 Marks

Question 8

Explain additional consideration in planning for the audit of Bright Son (Pvt) Limited

5 Marks

·       Main consideration is that financial reporting framework used for Bright Son is SLFRS for SME. This means that accounting policies followed by the entity will be different from an entity that follows SLFRSs. E.g. Revaluation of assets, capitalization of borrowing costs are not applicable for a SME.

·         Further, due to the nature of the entity there may be limited segregation of duties, however, this may be compensated by close monitoring by owners

·         Internal controls may be operating in an informal manner

·         Team may place a greater emphasis on substantive procedures

Question 9

(a) The audit senior who has been working on the audit of Bradley Co made the following comment when discussing the completion of the audit with you:

Required:

Explain the quality control and other professional issues raised by the audit senior’s comment in relation to the completion of the audit. (5 marks)

Audit should have an adequate time to review the chairman’s report for the purpose of identifying any material inconsistency between the audited financial statements and chairman’s statements

Question 10

With respect to the information provided above I to iv, advice how the form should meet the requirement of the client (Your answer should include matters to consider regarding the above service and additional information that you may require)

Auditor may not be able to undertake one assignment in respect of the business plan.

Instead each of the above elements should be evaluated as a separate subject matter. Therefore, auditor should discuss with client which information requires an independent assurance.

·         SLAuS 810 deals with forming an opinion on summarized financial statements

·         SLAuS 3400 could be used to provide a limited assurance on profit/ cash flow forecast

·         SLSRE could be used to provide a limited assurance on un-audited financial information

·      SLSRS on agreed upon procedures could be used to check the information about the 

     governance