Audit and Internal
TUESDAY 10 DECEMBER 2002
This paper is divided into two sections
ALL THREE questions are compulsory and MUST
TWO questions ONLY to be answered
Section A – ALL THREE questions are compulsory and MUST be attempted
1 The objectivity of the external auditor may be threatened or appear to be threatened where: (i) There is undue dependence on any audit client or group of clients;
(ii) The firm, its partners or staff have any financial interest in an audit client;
(iii) There are family or other close personal or business relationships between the firm, its partners or staff and the audit client;
(iv) The firm provides other services to audit clients.
(a) For each of the four examples given above, explain why the objectivity of the external auditor may be threatened, or appear to be threatened, and why the threat is important. (12 marks)
(b) Describe ACCA’s requirements that reduce the threats to auditor objectivity for each of the four examples
given above. (8 marks)
NB: In part (a) all parts carry equal marks.
NB:In part (b) all parts carry equal marks.
2 (a) ISA 400 ‘Risk Assessments and Internal Control’ identifies a number of key procedures which auditors should perform if they wish to rely on internal controls and reduce the level of substantive testing they perform. These include:
(i) Documentation of accounting and internal control systems; (ii) Walk-through tests;
(iii) Audit sampling; (iv) Testing internal controls;
(v) Dealing with deviations from the application of control procedures.
Briefly explain each of the procedures listed above. (10 marks)
NB: (i) – (v) above carry equal marks.
(b) Flowers Anytime sells flowers wholesale. Customers telephone the company and their orders are taken by clerks who take details of the flowers to be delivered, the address to which they are to be delivered, and account details of the customer. The clerks input these details into the company’s computer system (whilst the order is being taken) which is integrated with the company’s inventory control system. The company’s standard credit terms are payment one month from the order (all orders are despatched within 48 hours) and most customers pay by bank transfer. An accounts receivable ledger is maintained and statements are sent to customers once a month. Credit limits are set by the credit controller according to a standard formula and are automatically applied by the computer system, as are the prices of flowers.
Describe and explain the purpose of the internal controls you might expect to see in the sales system at Flowers Anytime over the:
(i) Receipt, processing and recording of orders. (6 marks)
(ii) Collection of cash. (4 marks)
3 (a) Company A has a number of long and short-term payables, accruals and provisions in its balance sheet.
Describe the audit procedures you would apply to each of the three items listed below, including those relating to disclosure.
(i) A 10-year bank loan with a variable interest rate and an overdraft (a bank account with a debit balance
on the bank statement), both from the same bank. (5 marks)
(ii) Expense accruals. (4 marks)
(iii) Trade payables and purchase accruals. (6 marks)
(b) Company B has a provision in its balance sheet for claims made by customers for product defects under 1-year company warranties.
Describe the matters you would consider and the audit evidence you would require for the provision.
Section B – TWO questions ONLY to be attempted
4 Auditors obtain several different confirmations from various sources during the course of their audit.
Describe the audit evidence provided by each of the confirmations listed below, the practical difficulties in obtaining them and the alternative audit evidenceavailable when they are not provided:
(a) Management representations. (5 marks)
(b) Direct confirmation of receivables. (6 marks)
(c) Confirmation of inventory held by third parties. (5 marks)
(d) Reports provided by auditors of third party service organisations. (4 marks)
5 IAS 2 ‘Inventories’ requires that inventories are measured at the lower of cost and net realisable value.
(a) Explain why the audit of inventory is important to auditors. (5 marks)
(b) Define ‘cost’ and ‘net realisable value’ according to IAS 2 ‘Inventories’. (6 marks)
(c) Describe the audit evidence that you would obtain for the cost and net realisable value of finished inventory
in a company that manufactures household furniture. (9 marks)
NB: You are not required to deal with inventory quantities.
6 Risk management involves the classification of risks. Internal auditors sometimes classify risks as:
(i) high impact, high likelihood– such as the risk that contaminated foodstuffs will enter the production process in
a biscuit manufacturing business, or, that other entrants into the market will reduce the existing business’ market share or profit margins;
(ii) high impact, low likelihood– such as the risk of the non-availability of a basic element of production such as
sugar, for a biscuit manufacturing business, or, that there will be significant damage to property or injury to employees as a result of an earthquake in Northern Europe;
(iii) low impact, low likelihood– such as the risk that minor damage to property will be caused by snow in Australia;
(iv) low impact, high likelihood – such as the risk that drivers may be involved in vehicle accidents that will leave
the business temporarily without the vehicle, or, that production employees may be ill and unable to work temporarily.
Companies may transfer, reduce, or accept risks, or adopt some combination of these approaches to risk.
(a) For each of the examples given above, describe how the business might transfer, reduce or accept the risk.
(b) Explain how the work of internal auditors on the classification of risks, as described above, could be used by
external auditors. (8 marks)