Q.
Q.2
(a) 1. Ensure that criteria required by IAS - 38 to recognize development cost as intangible asset has
been met.
2. Discuss the feasibility of the project with management i.e.
3. For a sample of costs, inspect supporting documents e.g. development contracts, billing and
timesheets.
4. Test controls over documentation and safekeeping of scientists’ notes, discoveries and conclusions.
(b) 1. Review client’s procedures for comparing NRV with cost of each item of inventory.
2. During physical verification, also check for conditions of obsolescence, damage indicating that NRV
may be lower than Cost.
3. Review prices at which inventory has been sold subsequent to year end as evidence of NRV.
4. Review aged inventory reports and identify any damaged, slow moving or obsolete goods, and ensure
they have been recorded at lower of Cost and NRV in Balance Sheet.
5. Inquire management about estimated selling price of inventory, cost of completion and cost to make
sale.
(c)1. Inquire management regarding estimates used in calculation of provision for bad debts.
2. Obtain aged receivable ledger. Compare it with control account and test the aging. Review the aged
receivable ledger to identify any slow moving or old receivable balances. Discuss the status with the
credit controller to assess whether they are likely to pay.
3. Examine whether there are any cash recovery of doubtful debts or bankruptcy after balance sheet
date.
4. For large overdue balances, review financial statements of debtors and discuss with credit manager
likelihood of their collection.
5. Recalculate provision for bad-debts using sales, write-offs and current economic conditions of
customers.
6. Inquire management about any disputes with customers and review board minutes for disputed
receivables.
7. Review communication of client with customers, lawyers and collection agencies regarding debts
which are in dispute or unlikely to be paid.
Ans 3
(a)
: Fraud Risk Factors: Rapid Changes in Technology: Products like mobile phones are likely to become
obsolete very quickly, as more advanced products come on to the market. The company faces a threat
due to rapid changes in technology; therefore the management may be inclined to manipulate the
accounting records.
Lack of Segregation of Duties/ Dominance of management by a single person: As Anwar is the Chief
Executive and is also responsible for finance and operations of the company, this gives him a personal
motivation to misstate figures to show improved performance.
Long Term Loan: As the company has applied for long term loan, it may be inclined to manipulate the
figure to show better financial position to the bank.
Demand for early completion of audit: The demand by Anwar for early completion of audit creates
undue suspicion because such pressures are sometime applied to distract the auditor from his
responsibilities.
(b)
Matters that may be considered in establishing the overall audit strategy:
In establishing the overall audit strategy, the auditor shall:
• Identify the characteristics of the engagement that define its scope;
• Ascertain the reporting objectives of the engagement to plan the timing of the audit and the
nature of the communications required;
• Consider the factors that, in auditor’s professional judgment, are significant in directing the
engagement team’s efforts;
• Consider the results of the preliminary engagement activities and, where applicable,
whether knowledge gained on other engagement performed by the engagement partner for
the entity is relevant; and
• Ascertain the nature, timing and extent of resources necessary to perform the engagement.
Being the initial audit engagement following matters should also be considered in
establishing the overall audit strategy:
• Arrangements to be made with the predecessor auditor.
• Communicate major issues identified during discussion with the management, to those
charged with governance and consider that how these matters will affect the overall audit
strategy and audit plan.
• The audit procedures necessary to obtain sufficient appropriate audit evidence regarding
opening balances.
• Other procedures required by the firm’s system of quality control for initial audit
engagements (for example, the firm’s system of quality control may require the involvement
of another partner or senior individual to review the overall audit strategy prior to
commencing significant audit procedures or to review reports prior to their issuance).
Ans.4
The prospective audit risks are as follows:
Overstatement of Debtors:
Average period for outstanding debtors has reached to four months which is indicative of a risk
of inadequate provision against doubtful debts.
Overstatement/ Understatement of Inventories:
The inventories turnover rate has decreased to 3 times per year from 5 times in 2010. It is
indicative of the following types of risks:
(a) Obsolescence of inventories.
(b) Improper valuation of inventories.
Overstating of income as well as understating of expenses:
The income position has weakened and the company has suffered losses as the interest
coverage has moved below 1.0. In such a situation there is a risk that the management may like
to overstate its revenue, and understate its expenses.
Liquidity Problems:
The company is experiencing liquidity problems as are evidenced from the decline in current
ratio and quick asset ratio.
Decline in Gross Profit %:
The decline in GP % needs to be justified.
The absence of an appropriate explanation may be indicative of:
(a) Improper pricing and discounting policies
(b) Improper purchasing policies
(c) Other irregularities like unauthorized spending, intentional manipulation of profitability etc.
Going Concern:
Losses/significant decline in profitability and fast deteriorating liquidity position are financial
indicators of going concern issues, which should not be overlooked
Ans.5
Depreciation:
1. Review the reasonableness of the depreciation rates applied to the new leisure facilities and compare
to
industry averages.
2. Review profits and losses on disposal of assets disposed of in the year, to assess the reasonableness of
the
depreciation policies.
3. Review the capital expenditure budgets for the next few years to assess whether there are any plans
to replace
any of the new leisure equipment, as this would indicate that the useful life is less than 10 years.
4. Review the disclosure of the depreciation charges and policies in the draft financial statements.
5. Select a sample of leisure equipment and recalculate the depreciation charge to ensure that
depreciation has
been calculated correctly.
6. Recalculate depreciation expense (using analytical procedures) taking into account additions and
disposal.
Compare it with actual expense and investigate unusual difference.
Food poisoning:
1. Review the correspondence from the customers claiming food poisoning to assess whether Pineapple
has a
present obligation as a result of a past event.
2. Send an enquiry letter to the lawyers of Pineapple to obtain their view as to the probability of the
claim being
successful.
3. Review board minutes to understand whether the directors believe that the claim will be successful or
not.
4. Review the post year-end period to assess whether any payments have been made to any of the
claimants.
5. Discuss with management as to whether they propose to include a contingent liability disclosure or
not,
consider the reasonableness of this.
6. Obtain a written management representation confirming management’s view that the lawsuit is
unlikely to be
successful and hence no provision is required.
7. Review the adequacy of any disclosures made in the financial statements.