The model answers to the questions are longer and more detailed than would be expected from a candidate in the examination. However, the model answer may not include all valid points mentioned by students – credit will be given to students mentioning such points.
The model answer may be used as guide to the form and standard of answer students should aim to achieve.
Monitoring Test MT1A
Audit and Assurance
Answers & Marking Scheme
Tutorial note: Watch out for the word “and” in the requirement.
To ensure professional independence:
−the proposed audit fee (together with fees from any other recurring work) should not be more than 10% of gross practice income and that of the engagement partner;
−any shares in Clover held by partners will need to be disposed of (at the earliest practicable date) if the appointment is accepted;
−any shares held by staff must be declared and such staff must not be engaged on the assignment (it may be the partnership’s policy that no shares can be held by any staff member) if the appointment is accepted; and
−potential conflicts of interest should be avoided (eg by not accepting the appointment if already acting (as auditor or consultant) for a competitor of Clover).
Family or other close personal or business relationships between employees of Clover and the staff of Future & Co must be identified and safeguards set up within the practice (eg staff are not involved in any work related to Clover). If such relationships involve a partner within Future & Co. it is highly unlikely that appointment can be accepted.
The duty of Future & Co to communicate with the existing auditor (Past & Co) should be explained to the prospective client (Clover). The purpose of this is to ascertain the reasons behind the proposed change, of which Future & Co should be aware, prior to accepting the nomination. The nomination should be declined if Clover refuses authority for such communication.
The resignation of Past & Co may have been prompted by disagreement (eg over the truth and fairness of the view shown by Clover’s accounts) or the loss of professional understanding between the two parties. This may cast doubt on the directors’ integrity and Future & Co. must carefully consider their involvement with the client.
Staff of appropriate experience and technical ability need to be available for the new audit
whilst maintaining an efficient and effective service to existing clients.
The timescale for the completion of the audit, as envisaged by the directors, must be feasible.
The reporting deadlines for the companies will need to be met.
Schedules and draft accounts to be produced by the client should be in formats suitable for
Any other services required (eg tax, company secretarial, management consultancy) must be
agreed. As Clover is a listed company, these will probably need to be dealt with through the company’s audit committee.
The involvement of specialists (experts) and other (or joint) auditors should be clearly
(a) Sources of information
The previous auditor may provide background information and information on
specific previous audit problems when replying to the “etiquette letter” sent by this firm prior to accepting nomination as auditors.
(Note that since this is a first year audit, it will not be possible to review prior year audit working papers or a permanent file for this client. It is highly unlikely that the previous auditor will allow you full access to their past working papers and permanent files.)
Any proposal document produced in order to pitch for the client’s audit should
contain information about the nature of the business.
Brochures produced by the hotel advertising its facilities and advertisements,
articles or features in the local press.
The members of the hotel management themselves and the management of Edco, if
Copies of previous financial accounts, as well as copies of the current year’s
Observation of the hotel’s activities from a visit to the site, possibly combined with
an overnight stay.
Hotel’s web site and relevant industry websites.
(b) Possible risk areas
Inherent risk derives from the characteristics of the enterprise that is being audited, or the circumstances of the particular audit assignment. It is the perceived risk that the financial statements will be materially misstated. Inherent risk can be considered at two levels: that of the financial statements themselves, and that of individual account balances.
The financial statements themselves
As this is a new audit client we do not have:
−prior knowledge or experience of the business;
−the relevant experience of management’s contribution;
−any specialised knowledge in this industry.
These factors contribute to a greater degree of inherent risk than would be the case in a long-established client.
The high degree of staff turnover (possibly at all levels of the organisation) may mean that the experience or calibre of management is not as high as the business requires, again leading to a higher inherent risk.
The individual account balances
The largely cash-based nature of the business gives rise to potential problems regarding completeness of recording of transactions. The cash-based nature of the business also gives rise to the greater risk of misappropriation.
The wide variety of discounts offered by the hotel may present problems in ensuring their proper accounting treatment, giving a greater risk of misstatements within the accounting records.
Inventory may constitute an area of specific inherent risk due to problems of valuation (especially foodstuffs) and its susceptibility to “shrinkage”.
Control risk is the risk that the client’s system of internal controls will fail to prevent or detect material misstatement in, or omission from, the financial statements.
Areas of control risk within Edco include the following:
High staff turnover (meaning few experienced employees).
A high number of part-time employees (which could mean a lack of motivation and
commitment on their part, as well as a poor degree of training).
Reliance on the microcomputer for processing bookings and accounting transactions
(especially given the levels of staff turnover and part-time staff).
The potential lack of controls over the microcomputers (especially the one in
reception which could be open to unauthorised access).
The use of electronic tills. These require strong controls over master files so that
the appropriate prices are charged and recorded.
A potentially weak control environment, unless strong controls over the receipt of
cash and the giving of discounts have been established.
(c) Internal control objectives
Tutorial note: The internal control objectives of the accounting systems as a whole are to ensure the complete and accurate processing of authorised transactions. To that end, each of the subsidiary accounting systems of the business should aim to record only bona fide
– to ensure that the financial statements as a whole are not materially misstated; and – to assist in safeguarding the assets of the business.
(i) Room lettings
To ensure that all lettings are recorded and charged at authorised rates.
To ensure that account is taken of any discounts, seasonal price variation, number of
occupants and any facilities/services enjoyed by the customer during his stay.
To ensure that, as far as possible, rooms are only let to creditworthy customers. To ensure that all room bookings are confirmed in writing by the customer. To ensure that any deposits payable are collected and accurately and completely
recorded in the accounts.
To ensure that booked rooms not claimed by a specified time are available for
To ensure that all room charges are received and completely and accurately
recorded in the accounts.
To ensure that room letting records are as up-to-date as possible to help ensure
maximum occupancy rate in the hotel.
To ensure that rooms cannot be let and not recorded or paid for at the correct rate.
(ii) Part-time employee wages
To ensure that wages should be computed for bona fide employees only and using
authorised rates of pay and conditions.
To ensure that wages are calculated in agreement with records of work actually
performed (eg time sheets or a staff signing-in register).
To ensure that claims for overtime, bank holidays and bonuses are authorised. To ensure that wages are paid to the appropriate employees.
To ensure that physical controls are present to ensure safe custody of cash and any
To ensure that all payroll transactions are accurately recorded within the accounting
records and correctly accumulated therein.
3 AUDIT COMMITTEES
(a) Roles and responsibilities
To monitor the integrity of the financial statements of the company, reviewing
significant financial reporting judgements contained in them;
To review the company’s internal financial controls and the company’s internal
control and risk management systems;
To monitor and review the effectiveness of the company’s internal audit function; To make recommendations to the board in relation to the appointment of the
external auditor and to approve the remuneration and terms of engagement of the external auditor;
To review and monitor the external auditor’s independence and objectivity and the
effectiveness of the audit process;
To develop and implement policy on the engagement of the external auditor to
supply non-audit services;
To report to the board, identifying any matters in respect of which it considers that
action or improvement is needed and making recommendations as to the steps to be taken;
To review arrangements by which staff of the company may, in confidence, raise
concerns about possible improprieties in matters of financial reporting or other matters.
(b) Communication with audit committee
Tutorial note: Consider the audit cycle and at what stages communication (eg verbal, written etc) is required.
At the commencement of each audit cycle, the auditor must establish that the terms
of engagement are appropriate. These should be discussed with the audit committee as should the remuneration to be paid in respect of audit services provided.
The auditor must be independent of the company. The audit committee will discuss
the independence of the audit firm and the audit team, review their independence policies and processes to maintain independence, and agree that the firm is complying with appropriate ethical guidelines, ie ACCA..
Before the start of any audit fieldwork (eg the interim audit) the audit committee
should ensure that appropriate plans are in place for the audit, eg the overall strategy, risk assessment, materiality, resources and work plans. This will involve meeting with the senior audit team members and discussing these matters;
After each audit fieldwork stage (eg interim, inventory observation and final audit)
meet with and review the findings of the auditor’s work, eg:
discussing major issues that arose during the audit (both resolved and
key accounting and audit judgements;
levels of error identified during the audit; and
discussing with management and auditors why certain errors remain
4 THREE SOURCES
Tutorial note: Considering the two components of “appropriateness” (ie “relevance” and “reliability”) breaks down the mark allocation.
(i) Initials on a grid stamp for quantity, prices and extensions on purchase invoices
Visual inspection of initials on a grid stamp provides evidence that an internal control has been performed. As a test of control it provides evidence that this area of the purchases system has operated effectively.
The evidence is not conclusive since the grid could be initialled without the check being performed. The auditor is more likely to rely on the checks having been performed if there is other evidence (eg quantities cross-referenced to goods received notes and “cast” symbols). If it is established that the check, though evidenced, is not being performed (eg if reperformance identifies an error not detected by the client) no reliance should be placed on it (unless isolation can be proven).
The auditor will usually reperform the checks to substantiate the transaction (since the test of control provides only indirect evidence regarding the completeness, accuracy and validity of purchases).
(ii) Year-end bank report for audit purposes (“confirmation letter”)
A bank report for audit purposes assists in ascertaining:
−the existence and amount of liabilities;
−the existence, amount, ownership and proper custody of assets.
It also provides other information relevant to disclosures in the financial statements (eg contingent liabilities).
Information given by a reputable bank is regarded as reliable (even if the bank attaches a responsibility disclaimer) unless it is clearly wrong, suspicious inconsistent in itself, or in conflict with other evidence. As documentary evidence received directly by the auditor from an independent third party, it is more reliable than third party evidence held by the client (eg monthly bank statements).
The confirmation will provide sufficient evidence of:
−accrued charges even where they are calculated on a provisional basis (unless they are material to the financial statements, which is unlikely);
−security and assets held.
(iii) Comparison of weekly till rolls and cash bankings
This is relevant to the completeness and accuracy of recorded cash receipts. The comparison should also reveal seasonal trends in sales revenue.
Analytical procedures carried out by the auditor provide most reliable evidence. Cash bankings per the bank statement (third party documentary evidence) are more reliable than till rolls generated by the client.
For most questions the marking scheme suggests you award 1 mark a point. However, the mark you award for each point will depend on its relevance and the depth of the student’s discussion. So, a brief point may be worth 1/2 mark or less while a point with a longer and deeper discussion could be worth 2 marks.
Also, marks are not allocated to specific points, as the student may mention a valid point which is not given in the model answer – obviously the student should be given credit for the point.
Many questions require the students to include a range of points in their answer, so an answer which concentrates on one (or a few) points should normally be given a lower mark than one which considers a range of points.
Generally 1 mark each point up to a maximum of 6
Generally 1 mark each point up to a maximum of __ 4 max 9
(a) Sources of information
Generally 1 mark each point up to a maximum of 5
(b) Inherent risk areas
Generally 1 mark a point up to a maximum of 5
Control risk areas
Generally 1 mark a point up to a maximum of __ 4 9
(c) Internal control objectives
Generally 1/2 mark a point up to a maximum
for each of (i) and (ii) __ 3 __ 6
3 AUDIT COMMITTEE
Generally 1 mark for each up to a maximum 5
Generally 1 mark a point up to a maximum of 2 marks for each element
Max of 7
4 THREE SOURCES
Generally 1 mark each point on relevance/reliability/sufficiency
Maximum for any one of (i), (ii) & (iii) 4 × 3
Ideas: Relevance – CAPER (balances) – CAVe (transactions)
Reliability – internal v oral, visual v documentary v oral – “generalisations”/“rules of thumb”
Sufficiency – risk, materiality, relevance, reliability, findings