Section 2

PRACTICE QUESTIONS – SECTION B

PLANNING AND RISK ASSESSMENT

201 GREEN CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Teal & Co, which has recently been
appointed as auditor to Green Co, and you are planning your first audit which will be for the
year ending 31 July 20X5. Green Co sells a variety of plants, garden equipment and garden
furniture to wholesale customers and to retail customers via a network of stores. The
company was formed 13 years ago by Aidan White who is the Chief Executive Officer (CEO)
and is the company's only shareholder. Aidan is planning to retire within the next year and is
intending to sell his shares in the company.
The audit engagement partner had a meeting with Aidan White and has advised you of the
following:
In August 20X4, the company began to refurbish the retail stores in order to incorporate cafes
into each one. Refurbishment costs of $14.2m were recognised within property, plant and
equipment and this was partly financed by a loan of $10m, which is to be repaid in five annual
instalments commencing in September 20X5. In November 20X4, Green Co spent $400,000
on an advertising campaign and the cafes were opened in December 20X4. The advertising
expenditure has been included within intangible assets and is being amortised over 24
months as Aidan White expects the advertising to generate additional revenue for that
period of time. In May 20X5, Green Co received notification that the building authority had
received a complaint that the refurbishments had not been performed in accordance with
building regulations. The building authority is currently investigating and, if found to be in
breach of the regulations, Green Co would be required to remedy any deficiencies in addition
to paying a fine.
Green Co sells a range of tropical plants. In August 20X4, Green Co began a project to develop
new technology for maintaining the correct temperature and humidity in its greenhouses.
The project is expected to be completed in August 20X5 and Green Co has incurred costs of
$350,000 which are recognised within intangible assets.
In May 20X5, a flood caused water damage to inventories of plants which had cost $425,000.
The company believes that the plants can still be sold but at a reduced selling price.
The financial statements for the year ending 31 July 20X5 are expected to show revenue of
$88.2m (20X4: $85.1m), gross profit of $23.3m (20X4: $16.9m) and operating profit of $6.3m
(20X4: $9.4m).

KAPLAN PUBLISHING 83
A A : A UDIT AN D ASS URAN CE

As part of your planning, you have calculated the following ratios:

Forecast 20X5 Actual 20X4

Gross profit margin 26% 20%
Operating profit margin 7% 11%
Receivables collection period 67 days 40 days

Aidan White has attributed the increase in the receivables collection period to the absence
of the credit controller, who has been on long-term sick leave since April 20X5.

Required:
(a) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Green Co. (16 marks)
Audit risk Auditor's response

(b) Explain the responsibility of Teal & Co under ISA 250 Consideration of Laws and
Regulations in an Audit of Financial Statements.
Note: You do not need to refer to the scenario to answer this requirement.
(4 marks)
(c) Describe substantive procedures which Teal & Co should perform in order to obtain
sufficient and appropriate audit evidence in respect of ADDITIONS to Green Co's
property, plant and equipment. (4 marks)
It is now 2 November 20X5 and the audit of Green Co has been completed. The auditor’s
report was signed in October and, in line with Teal & Co’s quality management procedures
for new clients, a post-issuance review has been carried out. During the review of Green Co’s
audit files, the engagement quality reviewer noted the following:
The members of the audit engagement team who carried out the audit of Green Co had
previously audited educational organisations, not retail or manufacturing companies.
The audit engagement partner held a planning meeting with the engagement team.
However, several junior team members were unable to attend due to a training course which
was held on the same day. No additional briefing on key audit risks associated with Green Co
was held for these team members.
The audit supervisor was absent due to illness during the last two weeks of the final audit.
The audit assistants continued their work but no other senior team members were assigned
to Green Co’s audit.
Due to the audit supervisor’s illness and absence, the audit of intangible assets was
reallocated from the audit supervisor to a junior member of the team who had never audited
intangible assets before.
(d) Identify and explain THREE quality management deficiencies in the approach
adopted by Teal & Co and provide a recommendation which would have addressed
each deficiency to ensure compliance with quality management requirements.
(6 marks)
Deficiency Recommendation

(Total: 30 marks)

84 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

202 KNIGHT ELECTRONICS CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Your firm, Hercules & Co, has recently won the audit of a new client, Knight
Electronics Co, for the year ending 30 September 20X5. Knight Electronics Co sells products
enabling 'smart building' systems which allow customers to efficiently control their security,
lighting and networking needs. The audit manager held a preliminary meeting with the
finance director and has provided you with the following notes:
Planning meeting notes
Since its launch five years ago, Knight Electronics Co has experienced high levels of growth
such that the founder and CEO, William Knight, is considering a stock exchange listing next
year.
Knight Electronics Co has both corporate and domestic customers. On 1 October 20X4 Knight
Electronics Co began to offer customers the option to purchase a three-year servicing
agreement. This provides three annual services for products purchased. Customers pay for
the servicing agreement in full at the start of the agreement.
Component parts are purchased from a number of suppliers. Prices of components have
been steadily increasing over the past two years leading to a reduction in the gross profit
margin. The forecast financial statements for the year ending 30 September 20X5 show
inventory valued at cost.
In June 20X5, Knight Electronics Co decided to revalue its premises, which had previously
been accounted for using the historic cost model. Properties with a carrying amount under
the cost model of $3.8m were revalued to $8.4m based on a valuation performed by
management. The finance director also carried out an extensive review of non-current asset
lives and decided to extend the useful life of plant and equipment from five years to eight
years.
In May 20X5, defective equipment used by Knight Electronics Co resulted in a small fire at its
premises. The company has commenced legal action against the supplier of the equipment.
Knight Electronics Co's lawyers have advised that the legal action is likely to be successful
and, as a result, the finance director has included a receivable for the damages likely to be
received from the supplier in the forecast financial statements.
During the year the company's credit controller was ill and was absent from work for four
months. Due to staff shortages, no replacement credit controller was appointed. The
receivables collection period has increased from 45 days to 75 days.
An instance of payroll fraud was also discovered during the year. A payroll clerk had set up a
number of fictitious employees and the wages were then paid into the clerk’s own bank
account. Controls have now been implemented to prevent this from re-occurring and the
clerk involved no longer works for the company. However, the audit manager is concerned
that additional fraud may have taken place in the payroll department prior to the controls
being implemented.
William Knight would like the audit to be completed by 31 October 20X5.

KAPLAN PUBLISHING 85
A A : A UDIT AN D ASS URAN CE

Requirements:
(a) Briefly explain how each of the following sources of information will be used by
Hercules & Co to gain an understanding of Knight Electronics Co at the planning stage
of the audit: prior year audited financial statements, current year budgets and
management accounts, prior year report to management, board meeting minutes
and company website.
Note: You do not need to refer to the scenario to answer this requirement. (5 marks)
(b) Describe EIGHT audit risks and explain the auditor's response to each risk in planning
the audit of Knight Electronics Co. (16 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Knight Electronics Co's revenue. (5 marks)
ISA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements
provides guidance for auditors regarding fraud and error. Auditors must obtain sufficient
appropriate audit evidence regarding the assessed risks of material misstatement due to
fraud through designing and implementing appropriate responses.
(d) Describe procedures which should be undertaken during the audit of Knight
Electronics Co as a result of the payroll fraud. (4 marks)
(Total: 30 marks)

203 LAPIS Walk in the footsteps of a top tutor

This scenario relates to two requirements.

It is 1 July 20X5. You are an audit supervisor with Indigo & Co and are planning the audit of
your client, Lapis Co, for the year ending 30 September 20X5. Forecast profit before income
taxes for the year is $68.9m and forecast revenue is $192.3m. The audit manager has
attended a planning meeting with the finance director and has provided you with the
following notes of the meeting:
Planning meeting notes
Lapis Co manufactures televisions at six factories located across Europe and purchases most
of its raw materials from overseas suppliers. These raw materials are shipped directly to one
of the company’s factories and the goods are usually in transit for up to six weeks. Lapis Co
has responsibility for goods in transit from the point of dispatch by the supplier.
The company’s internal audit department undertakes controls testing across all factories,
visiting each site at least once every year. The audit manager has discussed with the finance
director that the external audit team may rely on the controls testing which is carried out by
the internal audit department.
The company sells televisions to wholesale customers and directly to individual members of
the public via the company’s website. A significant wholesale customer has recently informed
Lapis Co that it is experiencing financial difficulties, however the finance director indicated
that an allowance for receivables is not required in the year-end financial statements.

86 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Lapis Co offers customers a three-year warranty on any new televisions purchased. The
finance director has confirmed that the warranty provision for the year ended 30 September
20X5 will remain at a similar level to the prior year. In December 20X4 Lapis Co changed one
of its television speaker suppliers to a cheaper alternative. This has resulted in an increase in
warranty claims for television speaker deficiencies.
In May 20X5, a payroll clerk was dismissed after it was discovered that they had carried out
a number of fraudulent transactions. Controls have since been implemented to prevent this
reoccurring.
The finance director has informed the audit manager that the intention I to disclose only the
amount of remuneration payable to each director in the financial statements. Local
legislation in the country in which Lapis Co is based requires disclosure of the names of the
directors as well as the total amount of remuneration payable to each director.
One of Lapis Co’s suppliers is offering the company an annual rebate on the condition that it
purchases a minimum number of units by 30 September 20X5. The amount of the rebate will
be claimed in November 20X5. It is likely from orders placed to date and forecast orders that
Lapis Co will exceed the minimum volume required to claim this rebate, therefore, it is
anticipated that the draft financial statements will include a receivable of $0.8m.
Lapis Co is developing a new smart television model. All $1.6m of costs incurred to date will
be capitalised within intangible assets by the year end. The model is still under development
and it is not anticipated that it will be available for commercial production until 20X6.
In order to finance the development of the new smart television model, Lapis Co secured a
$2.5m interest-bearing bank loan in April 20X5. This is repayable in arrears over four years in
quarterly instalments.
The directors of Lapis Co are intending to propose a final dividend once the financial
statements are finalised.

Required:
(a) In line with ISA 220 Quality Management for an Audit of Financial Statements,
describe the auditor's responsibilities in relation to supervising and reviewing the
work performed during the external audit of Lapis Co.
Note: You do not need to refer to the scenario to answer this requirement. (4 marks)
(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Lapis Co. (16 marks)

Audit risk Auditor’s response

(Total: 20 marks)

KAPLAN PUBLISHING 87
A A : A UDIT AN D ASS URAN CE

204 MAGPIE Walk in the footsteps of a top tutor

This scenario relates to three requirements.

It is 1 July 20X5. You are the audit supervisor at Crow & Co and are finalising the planning for
your new client Magpie Co for the forthcoming audit for the year ending 31 July 20X5.
Magpie Co is a retailer of garden supplies which operates from 20 stores across the country
and employs 400 staff. The audit manager has attended a meeting with the finance director
and has provided you with the following notes of that meeting and financial statement
extracts:
Notes of planning meeting
During the year the company spent $0.75m on refurbishing its stores to improve the
customer experience. All of this expenditure has been recognised in the statement of
financial position as property, plant and equipment. In addition, the company also installed
a new sales system during the year which records all sales and receivables. The system
enables daily sales from each store to be automatically reported to the centralised finance
department at the end of each working day. As the system is from a market leading provider,
it was not felt necessary to run the old and the new systems in parallel.
Customers are able to pay for their goods using either cash or credit card. At the end of the
working day, the store manager generates a report from each cash register which confirms
the cash takings. The cash is then counted and compared to the report. Since the new sales
system was installed, head office now receives daily cash takings reports which have shown
an increasing number of cash shortages at each store. These differences have not been
investigated or reconciled on the basis that they have only been small amounts.
The company has a number of corporate customers who buy goods on 90-day credit terms
and the level of receivables which are overdue for payment has increased from the prior year.
However, the finance director does not intend to make any further allowance for receivables
as overdue payments are becoming common in the industry.
The payables ledger clerk has carried out supplier statement reconciliations during the year
and in a number of instances the supplier statements have shown a balance owing by the
company which is higher than the balance on the list of individual supplier balances. These
differences have been included as reconciling items on the supplier statement reconciliations
by the payables ledger clerk, but no further work has been performed on these differences.
It has been discovered that the soil relating to a batch of plants with a cost price of $0.1m is
contaminated, meaning that the plants may not be able to be sold. Tests are currently being
carried out to determine whether the contamination can be remedied.
The report to management issued following the 20X4 audit indicated a significant number of
deficiencies noted in the payroll cycle of the business.

88 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Financial statement extracts for the year ending 31 July are as follows:
Forecast Actual
20X5 20X4
$m $m
Revenue 22 26
Cost of sales (10.9) (14.5)
Gross profit 11.1 11.5
Operating profit 0.4 1.2

Inventories 1.6 1.1

Receivables 9.0 7.2
Cash in hand 1.3 4.2
Trade payables 1.9 3.2
The audit assistant has already calculated some key ratios for Magpie Co which you have
confirmed as accurate.
Ratio 20X5 20X4
Gross profit margin 50% 44%
Inventory holding period 54 days 28 days
Receivables collection period 149 days 101 days

Required:
ISA 210 Agreeing the Terms of Audit Engagements requires an auditor to issue an audit
engagement letter.
(a) Explain the PURPOSE of an audit engagement letter and list FOUR items which should
be included in an audit engagement letter. (4 marks)
(b) Using the table below, calculate the following TWO ratios, for BOTH years, to assist
you in planning the audit of Magpie Co. (2 marks)
Note: Formulas are NOT required to be shown.
Ratio 20X5 20X4
Operating profit margin
Payables payment period
(c) Using the information provided and the ratios calculated, describe SEVEN audit risks
and explain the auditor's response to each risk, in planning the audit of Magpie Co.
(14 marks)

Audit risk Auditor’s response

(Total: 20 marks)

KAPLAN PUBLISHING 89
A A : A UDIT AN D ASS URAN CE

205 ESK Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Bannock & Co and are responsible for
planning the audit of a new client, Esk Co, for the year ending 31 August 20X5. Your audit
manager recently met with the finance director of Esk Co and has provided you with the
following planning meeting notes and financial statement extracts.
Planning meeting notes
Esk Co is a manufacturer and wholesaler of plumbing supplies. It operates from two
warehouses which are situated in the north and south of the country. Extracts from the
forecast financial statements for the year ending 31 August 20X5 and the final financial
statements for 20X4 are as follows:
Forecast Final
20X5 20X4
$m $m
Revenue 30.9 27.5
Cost of sales (22.5) (19.9)
Gross profit 8.4 7.6

Inventories 8.3 6.4

Receivables 7.2 4.9

Trade payables 2.4 3.5

In September 20X4, Esk Co purchased a patent for $2.6m which gives it the exclusive right to
manufacture a waste disposal system for a four-year period. The purchase cost capitalised
comprises the cost of the patent and other costs such as legal fees and administrative costs
incurred in negotiating the contract. In order to finance this purchase, Esk Co obtained an
interest-bearing bank loan of $2.5m during the year. The bank loan is payable in five equal
annual instalments, with the first instalment due to be paid on 1 September 20X5.
The payables ledger clerk has recently discovered a batch of supplier invoices that had been
mis-coded and therefore had not been recorded as trade payables. This error has now been
corrected but investigations are still ongoing to determine how this happened and whether
any other batches of invoices have been mis-coded.
There was a fire in the south warehouse in June 20X5 which resulted in damaged inventory.
An inventory count immediately following the fire identified that inventory costing $1.1m
required to be fully written off. The damaged inventory has not yet been replaced as there is
sufficient inventory in the north warehouse to satisfy demand. The directors have raised a
claim against Esk Co's insurance company to cover the full extent of the lost inventory.
Although no confirmation has been received from the insurance company, the directors are
confident that the full amount claimed of $1.1m will be received and have included this
amount as other receivables within current assets.

90 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Esk Co's sales staff receive bonuses if they meet sales targets each quarter. A higher level of
sales bonus is available in the quarter to 31 August each year as a reward for efforts during
the year as a whole. Esk Co offers its regular customers discounts of up to 10%, which are
negotiated and documented by the sales director. This year, in order to easily monitor the
amount of the customer discounts, they have been recorded separately as an expense in cost
of sales. In previous years, revenue has been recorded net of the discount.
The manager in Esk Co's credit control department has been off work since December 20X4
due to ill health and has been replaced by an inexperienced temporary manager. As a result,
Esk Co has not been monitoring the ageing of its receivables and only follows up on
outstanding invoices when the system alerts credit control that a customer invoice has been
outstanding for 90 days or more. The standard credit terms are 30 days.
During the year, Esk Co was informed by the tax authorities that it was under investigation
for a breach of legislation relating to sales tax. Esk Co has appointed a tax consultant who has
advised that there does appear to have been a breach of tax legislation and has estimated
that a fine and penalty totalling $0.6m will be payable. The directors do not intend to record
anything in the financial statements until final notification is provided by the tax authority,
which is due to be received on 31 January 20X6.

Required:
ISA 210 Agreeing the Terms of Audit Engagements requires an auditor to establish whether
the preconditions for an audit are present prior to accepting an audit engagement.
(a) Describe the PRECONDITIONS for an audit that Bannock & Co should have
established prior to accepting the audit of Esk Co. (4 marks)
(b) Using the table below, calculate the following FOUR ratios, for BOTH years, to assist
you in planning the audit of Esk Co. (4 marks)
Note: Formulas are NOT required to be shown.
Ratio 20X5 20X4
Gross profit margin
Inventory holding period
Receivables collection period
Payables payment period
(c) Using the information provided and the ratios calculated, describe EIGHT audit risks
and explain the auditor's response to each risk, in planning the audit of Esk Co.
(16 marks)

Audit risk Auditor’s response

(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Esk Co’s trade receivables. (6 marks)
(Total: 30 marks)

KAPLAN PUBLISHING 91
A A : A UDIT AN D ASS URAN CE

206 PEACH Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor with Apricot & Co and have been assigned to the
audit of Peach Co, a soft drinks manufacturer which sells to wholesale customers. You are
currently planning the audit for the year ending 31 August 20X5 and have received the
following notes from the audit engagement partner. Materiality for the draft financial
statements has been calculated as $153,000, which is 5% of profit before income taxes.
Planning meeting notes
A new accounting system was introduced via direct changeover in March 20X5. It had been
successfully tested prior to its implementation and management had such confidence in the
new system that they did not consider it necessary to undertake further testing after
implementation.
Peach Co has been developing a new production process which will help to reduce sugar in
its drinks by 50%. Development commenced on 1 November 20X4 and the total amount
capitalised was $0.8m. On 1 May 20X5, the food safety authority approved the process and
production of the new reduced-sugar soft drinks commenced.
Peach Co has inventories of high sugar drinks costing $227,000 which it can no longer sell in
its home market due to lack of demand. The directors believe Peach Co can sell the remaining
inventories to an international customer at a price that marginally exceeds cost but Peach Co
will be responsible for all costs relating to the delivery and shipping of the drinks.
Peach Co replaced two items of machinery in its production line to accommodate a change
in the type of bottles used. There were significant staff costs involved in preparing the site
for the new machinery and in testing that the new machinery was operating correctly. These
costs have been included within the wages and salaries expense for the period. Despite the
old machinery being sold at a significant loss, during the year the directors of Peach Co
decided to extend the useful lives of plant and machinery by an average of five years.
A member of the finance team was dismissed by Peach Co in May 20X5 after it was discovered
that they had been fraudulently purchasing non-current assets for personal use. Peach Co
started to investigate the fraud at the beginning of June 20X5 by reconciling all physical assets
to the non-current asset register but will not have completed the reconciliation by the year-
end date.
Peach Co entered into a contract on 1 May 20X5 with a new supplier of bottles. Peach Co has
committed to a minimum order quantity of 150,000 bottles per month for a period of
12 months commencing 1 May 20X5. No costs have been accounted for to date as no
amounts are payable for the first six months. Three equal instalments are then payable across
the remainder of the contract term. Peach Co’s previous supplier has launched a legal claim
against Peach Co for breach of contract, stating that Peach Co did not have the right to exit
the agreement early. Peach Co’s lawyers have indicated that it is likely to lose the case and
have estimated the amount payable to be in the region of $0.3m.
In order to fund the development of the new production process and the purchase of new
machinery, Peach Co obtained an interest-bearing bank loan of $1.2m on 1 March 20X5
repayable over the next three years in arrears. In order to secure the bank loan, Peach Co
agreed to maintain a minimum operating profit margin and meet specific sales targets.

92 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
(a) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Peach Co. (16 marks)

Audit risk Auditor’s response

(b) Describe Apricot & Co’s responsibilities in relation to the prevention and detection
of fraud and error. (4 marks)
Peach Co has been an audit client of Apricot & Co for the last 15 years. The audit staff of
Apricot & Co and the client staff of Peach Co have always enjoyed a meal together at the start
of the final audit. Alan Edward, the managing director of Peach Co has this year suggested
that instead of a meal, all the audit staff and client staff go away for the weekend to a luxury
hotel at Peach Co’s expense.
Alan Edward has also suggested that the current year audit fee is renegotiated to be based
on a percentage of Peach Co’s operating profit for the year.
This year, for the first time, Apricot & Co has been approached by Peach Co to help identify
potential acquisition targets. Discussions are currently at an early stage and no work has been
undertaken at present. The total fees in relation to the audit and other work would fall within
acceptable levels in line with ACCA’s Code of Ethics and Conduct.

Required:
(c) (i) Identify and explain TWO ethical threats which may affect the independence
of Apricot & Co audit of Peach Co; and
(ii) For each threat, recommend an appropriate safeguard to reduce the threat to
an acceptable level. (4 marks)

Ethical threat Appropriate safeguard

(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Peach Co’s development expenditure.
(6 marks)
(Total: 30 marks)

207 CORLEY APPLIANCES Walk in the footsteps of a top tutor

This scenario relates to three requirements.

It is 1 July 20X5. You are an audit supervisor with Woodward & Co and you are in the process
of planning the audit of Corley Appliances Co, a company which sells domestic electrical
appliances such as fridge freezers, TVs and washing machines. The company’s year end is
31 August 20X5 and forecast revenue for the year is $12.2m, total assets are $6.8m and profit
before income taxes is $2.8m. The audit manager held a meeting with the finance director
and the notes from that meeting are provided below:
Notes from meeting with finance director
The company operates nationwide with 20 branches located across the country and sells
goods to members of the public and to retailers.
KAPLAN PUBLISHING 93
A A : A UDIT AN D ASS URAN CE

The company has a returns policy which allows a customer to return goods within 28 days of
purchase if they are not satisfied with the product. Historically, 5% of customers return goods
within the return period. The company also provides a six-month warranty on its products
which requires Corley Appliances Co to repair any defects, at its own cost, which arise within
the warranty period. It is anticipated that the warranty provision in the draft financial
statements will be lower than the prior year as the directors are confident the products sold
by the company are built to a very high standard.
The company is based in Europe and its main supplier of appliances is based in Asia. Goods
are shipped to the company’s central warehouse by sea and are usually in transit for up to
one month. Corley Appliances Co has responsibility for goods in transit from the point of
despatch by the supplier. The central warehouse and all 20 branches will be carrying out a
full year-end inventory count on 31 August 20X5 and it is expected that the value of inventory
in Corley Appliances Co’s financial statements will be $0.95m.
Over the last six months, the finance director has noticed that the company's receivables
collection period is now an average of 55 days, whereas the company’s target is 42 days. The
credit controller is confident that all receivables will eventually pay as increases in receivables
collection periods are starting to become common in the industry and has informed the
finance director of this. The finance director believes it is unlikely that any increase in the
allowance for credit losses/receivables will be necessary at the year end as compared to the
prior year.
In June 20X5, a fraud was uncovered in the finance department. A payables ledger supervisor
had diverted funds from the company’s bank account using a fictitious supplier set up in the
payables system. The employee was immediately dismissed, and the value of the fraud will
be recognised as an expense in the statement of profit or loss. Since the dismissal of the
supervisor, purchase invoices have not been recorded in the individual supplier accounts and
it is unlikely that this backlog of invoices will be cleared by the year end.
During the year, the company purchased and installed a new automated despatch system for
its central warehouse. The cost of the despatch system was $0.9m and has been recognised
as an addition to property, plant and equipment. These capitalised costs include the purchase
price of $0.6m, installation costs of $0.2m and staff training costs of $0.1m.
Due to the costs incurred in purchasing the new despatch system and the increase in the
receivables collection period, the company’s overdraft facility has increased significantly and
at one point went over the agreed limit of $0.7m in early June 20X5. The bank has expressed
concern about the way that the company is operating its bank overdraft and a decision will
be made in November 20X5 as to whether the bank will continue to provide this overdraft
facility, which the company is dependent on. The auditor’s report is due to be signed in
October 20X5.
Required:
ISA 210 Agreeing the Terms of Audit Engagements states that auditors should only accept, or
continue an existing audit engagement, if the preconditions for an audit are present.
(a) Describe the PRECONDITIONS required for an audit. (3 marks)
(b) Describe SEVEN audit risks and explain the auditor’s response to each risk in planning
the audit of Corley Appliances Co. (14 marks)
Audit risk Auditor’s response

(c) Define the term ‘professional scepticism’ and explain TWO examples from the audit
of Corley Appliances Co where the auditor should apply professional scepticism.
(3 marks)
(Total: 20 marks)

94 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

208 HART Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Morph & Co responsible for planning the
final audit of a new client, Hart Co, for the year ending 30 September 20X5. Hart Co
specialises in the design and construction of customised playgrounds. The audit manager
recently met with Hart Co’s finance director and has provided you with the following notes.
Planning meeting notes
Hart Co has a forecast profit before income taxes of $12.2m (20X4: $9.8m) and total assets
are expected to be $28.5m (20X4: $24.3m). The finance director has indicated that the
directors are very pleased with the forecast performance for the year as the directors are
paid a bonus based on a percentage of profit before income taxes.
Hart Co is undertaking the construction of playgrounds at 16 sites in various locations across
the country. All playgrounds are constructed to specific customer specifications. Customers
pay a 25% deposit on signing the contract, with the balance payable when control of the
playground is transferred to the customer.
The balance of work-in-progress (WIP) at 30 June 20X5 is $7.6m in respect of the playgrounds
under construction. A WIP count and valuation will be carried out at all sites on 30 September
20X5. Arrangements have been made for the audit team to attend only five of the WIP
counts. Hart Co offers its customers a warranty at no extra cost, which guarantees that the
playgrounds will function as expected for a period of three years. The warranty provision for
the current year has been calculated as 2% of revenue. In the previous year the warranty was
based on 6% of revenue. The finance director has made this change despite no significant
difference in construction techniques or the level of claims in the year.
Hart Co has incurred expenditure of $1.8m relating to the research and development of a
new type of environmentally-friendly building material. $0.6m of the expenditure to date has
been written off to the statement of profit or loss. The remaining $1.2m has been capitalised
as an intangible asset. No amortisation has been recognised to date as the material has not
yet been brought into use.
In June 20X5, the company contracted to purchase new machinery costing $2.4m. It paid $1m
on signing the contract to secure the machinery, which was due to be delivered in July 20X5.
Due to a supplier problem, the delivery is delayed and is now scheduled to be delivered in
October 20X5.
In order to finance the research and development costs and the machinery purchase, Hart Co
made a rights issue to existing shareholders at a price of $0.75 for each $0.50 share.
Hart Co's payroll function is outsourced to an external service organisation, Chaz Co, which
is responsible for all elements of payroll processing and maintenance of payroll records.
Hart Co’s directors correctly disclosed their remuneration details in the forecast financial
statements in line with IFRS Standards, however, local legislation in the country in which
Hart Co is based, requires more extensive disclosure. The directors have stated that they
consider this onerous and so do not intend to provide the additional information.

KAPLAN PUBLISHING 95
A A : A UDIT AN D ASS URAN CE

Required:
ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in
planning an audit.
(a) Explain the benefits of audit planning. (4 marks)
(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Hart Co. (16 marks)

Audit risk Auditor’s response

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Hart Co’s directors’ bonuses. (5 marks)
At the end of the planning meeting, the finance director of Hart Co mentioned to the audit
manager that one of the key reasons Morph & Co was appointed as auditor was because of
its knowledge of the industry. There were some concerns however, as to how Morph & Co
would keep information obtained during the audit confidential as it audits three other
construction companies specialising in environmentally-friendly building materials, including
Hart Co’s main competitor.
(d) Explain the safeguards which Morph & Co should implement to ensure that this
conflict of interest is appropriately managed. (5 marks)
(Total: 30 marks)

209 SCARLET Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor of Orange & Co planning the audit of a new client,
Scarlet Co, for the year ended 31 May 20X5. Scarlet Co manufactures chemicals for use in
domestic and commercial cleaning products.
The company’s financial accountant was taken ill suddenly in May 20X5 and is unable to
undertake the preparation of the year-end draft financial statements. As a result, the
company recruited a temporary financial accountant in early June 20X5 who will prepare the
draft financial statements.
The year-end financial statements need to be finalised quickly as the company is looking to
raise finance through a bank loan to replace three machines in the production facility. The
bank has asked for a copy of the audited year-end financial statements by the end of
September 20X5 before they will agree to the loan and the directors are keen to report strong
results in order to obtain this financing.
In the year, the company also purchased a specialised machine to develop a new range of
chemicals for a major customer. Only trained staff are allowed to operate this machine and
staff members had to undertake two days of training, followed by an assessment at the end
of the training period. The training costs of $15,000 have been capitalised as part of the cost
of the asset.
The company sources many of its raw materials to be used in the chemical manufacturing
process from an international supplier and goods can be in transit for up to three weeks.

96 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

The agreement with the international supplier contains a clause which states that Scarlett Co
is responsible for the goods as soon as they leave the suppliers warehouse.
You have carried out a preliminary analytical review which indicates that the receivables
collection period has increased from 38 days to 52 days. The credit controller has confirmed
that some customers are currently taking longer to pay than in previous years as they are
awaiting payment from their customers.
On 29 May 20X5, the directors announced that one of its brands was being discontinued due
to a fall in demand for the product. This resulted in four staff members being made
redundant. The payroll department has calculated the levels of termination costs associated
with the redundancy and they will be paid in the July 20X5 payroll run.
The directors each received a significant bonus in the year which has been included in the
payroll charge for the year in the statement of profit or loss. Local legislation requires
separate disclosure of directors’ bonuses in the financial statements.
During the year the company sold a batch of chemicals to a customer for $120,000. At the
beginning of May 20X5, the customer returned these chemicals because the chemical mix
was not in line with the customer’s specifications. A credit note is yet to be issued to the
customer and the chemicals have been written down to their scrap value within inventory.
The company usually pays its suppliers by the end of each month. However, due to the
financial accountant’s illness, the payment run for May 20X5 was not performed until 1 June
20X5. The finance director has informed you that in order to show consistent results with
the prior year, this payment run is shown as an unpresented item on the year-end bank
reconciliation.

Required:
ISA 210 Agreeing to the Terms of Audit Engagements requires auditors to issue an
engagement letter.
(a) Explain the PURPOSE of an audit engagement letter and list FOUR items which should
be included in an audit engagement letter. (4 marks)
(b) Explain WHY the following factors should have been considered by Orange & Co prior
to accepting Scarlet Co as a new audit client. (5 marks)
Pre-acceptance factors Explanation
The outgoing auditor’s response
Management integrity
Pre-conditions for an audit
Independence and objectivity
Resources available at the time of the audit
(c) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Scarlet Co. (16 marks)

Audit risk Auditor’s response

(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in respect of the redundancy costs. (5 marks)
(Total: 30 marks)

KAPLAN PUBLISHING 97
A A : A UDIT AN D ASS URAN CE

210 HARLEM Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor of Brooklyn & Co and are planning the audit of
Harlem Co for the year ending 30 September 20X5. The company has been a client of your
firm for several years and manufactures car tyres, selling its products to wholesalers and
retailers. The audit manager attended a planning meeting with the finance director and has
provided you with the following notes of the meeting and financial statement extracts.
Planning meeting notes
Harlem Co sells approximately 40% of its tyres to wholesale customers. These customers
purchase goods on a sale or return basis. Under the terms of the agreement, wholesale
customers have 60 days during which any returns can be made without penalty. The finance
director has historically assumed a return rate of 10%, however, but now feels that this is
excessive and intends to change this to 5%.
The company purchased a patent on 30 September 20X4 for $800,000, which was capitalised
in the prior year as an intangible asset. This patent gives Harlem Co the exclusive right to
manufacture specialised wet weather tyres for four years. In preparation for the manufacture
of the wet weather tyres, this year the company conducted a review of its plant and
machinery. As part of this review, surplus items of plant and machinery were sold, resulting
in a loss on disposal of $160,000.
In May 20X5, the financial controller of Harlem Co was dismissed after it was alleged that the
financial controller had carried out a number of fraudulent transactions against the company.
The financial controller has threatened to sue the company for unfair dismissal and disputes
the allegations. The company has only recently started to investigate the extent of the fraud
in order to quantify the required adjustment.
A problem occurred in June 20X5, during production of a significant batch of tyres, which
affected their quality. The issue was identified prior to any goods being despatched and
management is investigating whether the issues can be rectified and the tyres can
subsequently be sold.
Harlem Co’s finance director has informed you that in March 20X5 a significant customer was
granted a payment break of six months, as it has been experiencing financial difficulties.
Harlem Co maintains an allowance for credit losses/trade receivables and it is anticipated
that this will remain at the same level as the prior year.
The report to management issued by Brooklyn & Co following last year’s audit highlighted
significant deficiencies relating to Harlem Co’s purchases cycle.
The finance director has informed you that the company intends to restructure its debt
finance after the year end and will be looking to consolidate its loans to reduce the overall
cost of borrowing. As a result of the planned restructuring of debt, Harlem Co has not paid
its shareholders a dividend this year, choosing instead to undertake a bonus issue of its
$0.50 equity shares.
You have been asked by the audit manager to complete the preliminary analytical review and
has provided you with the following information:

98 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Financial statement extracts for year ending 30 September

Forecast Actual
20X5 20X4
$000 $000
Revenue 23,200 21,900
Cost of sales 18,700 17,300
Gross profit 4,500 4,600
Interest expense 290 250
Profit before income taxes 450 850

Intangible asset 800 800

Inventories 2,100 1,600

Long and short-term borrowings 13,000 11,000

Total equity 10,000 9,500
The audit assistant has already calculated some key ratios for Harlem Co which you have
confirmed as accurate. The audit assistant has ascertained that the trade receivables
collection period has increased from 38 to 51 days.

Required:
(a) Using the table below, calculate the following FOUR ratios, for BOTH years, to assist
you in planning the audit of Harlem Co. (4 marks)
Note: Formulas are NOT required to be shown.
Ratio 20X5 20X4
Gross profit margin
Inventory holding period
Gearing
Interest cover

(b) Using the information provided and the ratios calculated, describe EIGHT audit risks
and explain the auditor’s response to each risk in planning the audit of Harlem Co.
(16 marks)

Audit risk Auditor’s response

(c) In line with ISA 220 (Revised) Quality Management for an Audit of Financial
Statements, describe the audit supervisor’s responsibilities in relation to supervising
and reviewing the audit assistants’ work during the audit of Harlem Co. (4 marks)
(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of trade receivables in the
current year. (3 marks)
(e) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the DISPOSAL of plant and machinery in the
current year. (3 marks)
(Total: 30 marks)

KAPLAN PUBLISHING 99
A A : A UDIT AN D ASS URAN CE

211 PEONY Walk in the footsteps of a top tutor

This scenario relates to two requirements.

It is 1 July 20X5. You are an audit supervisor of Daffodil & Co and are planning the audit of
Peony Co for the year ending 30 September 20X5. The company is a food retailer with a large
network of stores across the country and four warehouses. The company has been a client
of your firm for several years and the forecast profit before income taxes is $28.9m. The audit
manager has attended a planning meeting with the finance director and has provided you
with the following notes of the meeting.
Planning meeting notes
Peony Co has an internal audit (IA) department which undertakes controls testing across the
network of stores. Each store is visited at least once every 18 months. The audit manager has
discussed with the finance director that the external audit team may rely on the controls
testing which is undertaken by IA.
During the meeting, the finance director provided some forecast financial information.
Revenue for the year is expected to increase by 3% as compared to 20X4; the gross profit
margin is expected to increase from 56% to 60%; and the operating profit margin is predicted
to decrease from 21% to 18%.
Peony Co values inventory in line with industry practice, which is to use selling price less
average profit margin. The directors consider this to be a close approximation to cost. The
company does not undertake a full year-end inventory count and instead undertakes
monthly perpetual inventory counts, each of which covers one-twelfth of all lines in stores
and the warehouses. As part of the interim audit which was completed in May, an audit junior
attended a perpetual inventory count at one of the warehouses and noted that there were a
large number of exceptions where the inventory records showed a higher quantity than the
physical inventory which was present in the warehouse. When discussing these exceptions
with the financial controller, the audit junior was informed that this had been a recurring
issue.
During the year, IA performed a review of the non-current assets physically present in around
one third of the company’s stores. A number of assets which had not been fully depreciated
were identified as obsolete by this review.
The company launched a significant TV advertising campaign in May 20X5 in order to increase
revenue. The directors have indicated that at the year end a current asset of $0.7m will be
recognised, as they believe that the advertisements will help to boost future sales in the next
12 months. The last advertisement will be shown on TV in early September 20X5.
Peony Co decided to outsource its payroll function to an external service organisation. This
service organisation handles all elements of the payroll cycle and sends monthly reports to
Peony Co which detail wages and salaries and statutory obligations. Peony Co maintained its
own payroll records until 30 April 20X5, at which point the records were transferred to the
service organisation.
Peony Co is planning to expand the company by opening three new stores during November
20X5 and in order to finance this, in June 20X5 the company obtained a $3m bank loan. This
is repayable in arrears over five years in quarterly instalments. In preparation for the
expansion, the company is looking to streamline operations in the warehouses and is
planning to make approximately 60 employees redundant after the year end. No decision has
been made as to when this will be announced, but it is likely to be in September 20X5.

100 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
(a) Define and explain materiality and performance materiality. (4 marks)
(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Peony Co. (16 marks)

Audit risk Auditor’s response

(Total: 20 marks)

212 DARJEELING Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor of Earl & Co and are planning the audit of
Darjeeling Co for the year ending 30 September 20X5. The company develops and
manufactures specialist paint products and has been a client of your firm for several years.
The audit manager has attended a planning meeting with the finance director and has
provided you with the following notes of the meeting and financial statement extracts. You
have been asked by the audit manager to undertake preliminary analytical procedures using
the financial statement extracts.
Planning meeting notes
During the year Darjeeling Co has spent $0.9m, which is included within intangible assets, on
the development of new product lines, some of which are in the early stages of their
development cycle.
Additionally, as the company is looking to expand production, during the year it purchased
and installed a new manufacturing line. All costs, incurred in the purchase and installation of
that asset, have been included within property, plant and equipment. These capitalised costs
include the purchase price of $2.2m, installation costs of $0.4m and a five-year servicing and
maintenance plan costing $0.5m. In order to finance the development projects and the new
manufacturing line, the company borrowed $4m from the bank which is to be repaid in
instalments over eight years and has an interest rate of 5%. Developing new products and
expanding production is important as the company intends to undertake a stock exchange
listing in the next 12 months.
The company started a number of initiatives during the year in order to boost revenue.
It offered extended credit terms to its customers on the condition that their sales order
quantities were increased.
In addition, Darjeeling Co made an announcement in October 20X4 of its ‘price promise’: that
it would match the prices of any competitor for similar products purchased. Customers who
are able to prove that they could purchase the products cheaper elsewhere are asked to
claim the difference from Darjeeling Co, within one month of the date of purchase of goods,
via its website. The company intends to include a refund liability of $0.25m, which is based
on the monthly level of claims to date, in the draft financial statements.

KAPLAN PUBLISHING 101

A A : A UDIT AN D ASS URAN CE

The finance director informed the audit manager that a problem arose in June 20X5 in
relation to the mixing of materials within the production process for one particular product
line. A number of these faulty paint products had already been sold and the issue was
identified following a number of complaints from customers about the paint consistency
being incorrect. As a precaution, further sales have been stopped and a product recall has
been initiated for any of these specific paint products sold since June.
Management is investigating whether the paint consistency of the faulty products can be
rectified and subsequently sold.
Financial statement extracts for year ending 30 September
Forecast Actual
20X5 20X4
$000 $000
Revenue 19,850 16,990
Cost of sales (12,440) (10,800)
––––––– –––––––
Gross profit 7,410 6,190
––––––– –––––––
Inventories 1,850 1,330
Trade receivables 2,750 1,780
Bank (810) 560
Trade payables 1,970 1,190

Required:
(a) Explain why analytical procedures are used during THREE stages of an audit.
(3 marks)
(b) Calculate THREE ratios, for BOTH years, which would assist you in planning the audit
of Darjeeling Co. (3 marks)
(c) Using the information provided and the ratios calculated, describe EIGHT audit
risks and explain the auditor’s response to each risk in planning the audit of
Darjeeling Co. (16 marks)

Audit risk Auditor’s response

(d) Describe substantive procedures the auditor should perform in relation to the faulty
paint products held in inventory at the year end. (3 marks)
(e) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Darjeeling Co’s revenue. (5 marks)
(Total: 30 marks)

102 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

213 BLACKBERRY Walk in the footsteps of a top tutor

This scenario relates to two requirements.

It is 1 July 20X5. You are an audit senior of Loganberry & Co and are planning the audit of
Blackberry Co for the year ending 30 September 20X5. The company is a manufacturer of
portable music players and your audit manager has already had a planning meeting with the
finance director. Forecast revenue is $68.6m and profit before income taxes is $4.2m.
Planning meeting notes
Inventory is valued at the lower of cost and net realisable value. Cost is made up of the
purchase price of raw materials and costs of conversion, including labour, production and
general overheads. Inventory is held in three warehouses across the country.
The company plans to conduct full inventory counts at the warehouses on 2, 3 and 4 October,
and any necessary adjustments will be made to reflect post-year-end movements of
inventory. The internal audit team will attend the counts.
During the year, Blackberry Co paid $1.1m to purchase a patent which allows the company
the exclusive right for three years to customise their portable music players to gain a
competitive advantage in their industry. The $1.1m has been expensed in the current year
statement of profit or loss. In order to finance this purchase, Blackberry Co raised $1.2m
through issuing shares at a premium.
In May 20X5, it was discovered that a significant teeming and lading fraud had been carried
out by four members of the receivables ledger department who had colluded. They had
stolen funds from wholesale customer receipts and then to cover this, they allocated later
customer receipts against the older receivables. These employees were all reported to the
police and subsequently dismissed. As a result of the vacancies in the receivables ledger
department, Blackberry Co decided to outsource its receivables ledger processing to an
external service organisation. This service organisation handles all elements of the
receivables cycle, including sales invoicing and chasing of receivables balances and sends
monthly reports to Blackberry Co detailing the sales and receivable amounts. Blackberry Co
ran its own receivables ledger processing until 30 June 20X5, at which point the records were
transferred to the service organisation.
In June 20X5, the financial accountant of Blackberry Co was dismissed, having been employed
by the company for nine years. The financial accountant has threatened to sue the company
for unfair dismissal. As a result of this dismissal, and until a replacement commences work in
October, the financial accountant’s responsibilities have been adequately allocated to other
members of the finance department. However, for this period no supplier statement
reconciliations or trade payables account reconciliations will be performed.
During the year, a receivable balance of $0.9m was written off by Blackberry Co as it was
deemed irrecoverable as the customer had declared itself bankrupt. In June 20X5, the
liquidators handling the bankruptcy of the company publicly announced that it was likely that
most of its creditors would receive a pay-out of 40% of the balance owed. As a result,
Blackberry Co plans to recognise $360,000 within the 20X5 financial statements in respect of
the payout.

KAPLAN PUBLISHING 103

A A : A UDIT AN D ASS URAN CE

Required:
(a) Describe Loganberry & Co’s responsibilities in relation to the prevention and
detection of fraud and error. (4 marks)
(b) Describe EIGHT audit risks and explain the auditor’s response to each risk in planning
the audit of Blackberry Co. (16 marks)
Audit risk Auditor’s response

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to COMPLETENESS of Blackberry Co’s trade
payables. (4 marks)
It is now 1 December 20X5 and the final audit has commenced. The audit manager assigned
to the audit has been taken ill and you have been informed you will have to take on the role
of audit manager as well as audit senior. There is no one available to review your work until
the day before the auditor’s report is due to be signed. Due to the reduction in resources
assigned to the audit, the audit engagement partner has instructed you to reduce the number
of procedures performed and reduce sample sizes to ensure the audit is completed by the
deadline originally agreed with Blackberry Co.
(d) Describe THREE quality management deficiencies and provide a recommendation to
address each deficiency to ensure compliance with quality management standards.
Note: The marks will be split equally between each part. (6 marks)
Quality management deficiency Recommendation

(Total: 30 marks)

214 PRANCER CONSTRUCTION Walk in the footsteps of a top tutor

This scenario relates to three requirements.

It is 1 July 20X5. You are an audit supervisor of Cupid & Co, planning the final audit of a new
client, Prancer Construction Co, for the year ending 30 September 20X5. The company
specialises in property construction and providing ongoing annual maintenance services for
properties previously constructed. Forecast profit before income taxes is $13.8m and total
assets are expected to be $22.3m, both of which are higher than for the year ended 30
September 20X4.
You are required to produce the audit strategy document. The audit manager has met with
Prancer Construction Co’s finance director and has provided you with the following notes, a
copy of the latest management accounts to June 20X5, and the prior year financial
statements.
Meeting notes
The prior year financial statements recognise work-in-progress of $1.8m, which comprised
property construction in progress as well as ongoing maintenance services for finished
properties. The latest management accounts recognise $2.1m inventory of completed
properties compared to a balance of $1.4m in September 20X4. A full year-end inventory
count will be undertaken on 30 September at all of the 11 building sites where construction
is in progress. There is not sufficient audit team resource to attend all inventory counts.

104 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

In line with industry practice, Prancer Construction Co offers its customers a five-year
building warranty, which covers any construction defects. Customers are not required to pay
any additional fees to obtain the warranty. The finance director anticipates this provision will
be lower than last year as the company has improved its building practices and therefore the
quality of the finished properties.
Customers who wish to purchase a property are required to place an order and pay a 5% non-
refundable deposit prior to the completion of the building. When the building is complete,
customers pay a further 92.5%, with the final 2.5% due to be paid six months later. The
finance director has informed you that although an allowance for credit losses/receivables
has historically been maintained, it is anticipated that this can be significantly reduced.
Information from management accounts
Prancer Construction Co’s prior year financial statements and latest management accounts
contain a material overdraft balance. The finance director has confirmed that there are
minimum profit and net assets covenants attached to the overdraft.
A review of the management accounts shows the payables period was 56 days for June 20X5,
compared to 87 days for September 20X4. The finance director anticipates that the
September 20X5 payables days will be even lower than those in June 20X5.

Required:
(a) Describe the process Cupid & Co should have undertaken to assess whether the
PRECONDITIONS for an audit were present when accepting the audit of Prancer
Construction Co. (3 marks)
(b) Identify THREE main areas, other than audit risks, which should be included within
the audit strategy document for Prancer Construction Co, and for each area provide
an example relevant to the audit. (3 marks)
(c) Using all the information provided describe SEVEN audit risks, and explain the
auditor’s response to each risk, in planning the audit of Prancer Construction Co.
(14 marks)

Audit risk Auditor’s response

(Total: 20 marks)

215 HURLING Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor of Caving & Co and you are planning the audit of
Hurling Co, a listed company, for the year ending 30 September 20X5. The company
manufactures computer components and forecast profit before income taxes is $33.6 million
and total assets are $79.3 million.
Hurling Co distributes its products through wholesalers as well as via its own website. The
website was upgraded during the year at a cost of $1.1 million. Additionally, the company
has recently entered into a transaction to purchase a new warehouse which will cost
$3.2 million.

KAPLAN PUBLISHING 105

A A : A UDIT AN D ASS URAN CE

Hurling Co’s legal advisers are working to ensure that the legal process will be completed by
the year end. The company issued $5 million of irredeemable preference shares to finance
the warehouse purchase.
During the year the finance director has increased the useful economic lives of fixtures and
fittings from three to four years as it was considered to be a more appropriate period. The
finance director has informed the engagement partner that a revised credit period has been
agreed with one of its wholesale customers, as they have been experiencing difficulties with
repaying the balance of $1.2 million owing to Hurling Co.
In June 20X5, Hurling Co introduced a new bonus based on sales targets for its sales staff.
This has resulted in a significant number of new wholesale customer accounts being opened
by sales staff. The new customers have been given favourable credit terms as an introductory
offer, provided goods are purchased within a two-month period. As a result, revenue has
increased by 5% on the prior year.
The company has launched several new products this year and all but one of these new
launches have been successful. Feedback on product Luge, launched four months ago, has
been mixed, and the company has just received notice from one of their customers, Petanque
Co, of intended legal action. They are alleging the product sold to them was faulty, resulting
in a significant loss of information and an ongoing detrimental impact on profits. As a
precaution, sales of the Luge product have been halted and a product recall has been initiated
for any Luge products sold in the last four months.
The finance director is keen to announce the company’s financial results to the stock market
earlier than last year and in order to facilitate this, has asked if the audit could be completed
in a shorter timescale. In addition, the company is intending to propose a final dividend once
the financial statements are finalised.
Hurling Co’s finance director has informed the audit engagement partner that one of the
company’s non-executive directors (NEDs) has just resigned, and has enquired if the partners
at Caving & Co can help Hurling Co in recruiting a new NED.
Specifically, the finance director requested that the engagement quality reviewer, who was
until last year the audit engagement partner on Hurling Co, assist the company in this
recruitment. Caving & Co also provides taxation services for Hurling Co in the form of tax
return preparation along with some tax planning advice. The finance director has
recommended to the audit committee of Hurling Co that this year’s audit fee should be based
on the company’s profit before income taxes. At today’s date, 20% of last year’s audit fee is
still outstanding and was due to be paid three months ago.

Required:
(a) Define audit risk and the components of audit risk. (4 marks)
(b) Describe EIGHT audit risks, and explain the auditor’s response to each risk, in
planning the audit of Hurling Co. (16 marks)

Audit risk Auditor’s response

106 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(c) (i) Identify and explain FIVE ethical threats which may affect the independence
of Caving & Co’s audit of Hurling Co, and
(ii) For each threat, recommend an appropriate safeguard to reduce the threat to
an acceptable level.

Ethical threat Appropriate safeguard

(10 marks)
(Total: 30 marks)

216 CENTIPEDE Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor of Ant & Co and are planning the final audit of
Centipede Co, which is a listed company, for the year ended 30 June 20X5. The company
purchases consumer packaged goods and sells these through its website and to wholesalers.
This is a new client for your firm and your audit manager has already had a planning meeting
with the finance director and has provided you with the following notes along with financial
statement extracts.
Client background and notes from planning meeting
Rather than undertaking a full year-end inventory count, the company undertakes monthly
perpetual inventory counts, covering one-twelfth of all lines monthly. As part of the interim
audit which was completed earlier in the year, an audit assistant attended a perpetual
inventory count in March and noted that there were a large number of exceptions where the
inventory records were consistently higher than the physical inventory in the warehouse.
When discussing these exceptions with the finance director, the assistant was informed that
this had been a recurring issue all year. In addition, the audit assistant noted that there were
some lines of inventory which, according to the records, were at least 90 days old.
Centipede Co has a head office where the audit team will be based to conduct the final audit
fieldwork. However, there are four additional sites where some accounting records are
maintained and these sites were not visited during the interim audit. The records for these
sites are incorporated monthly through an interface to the general ledger. A fifth site was
closed down in 20X4, however, the building was only sold in 20X5 at a loss of $825,000.
One of Centipede Co’s wholesale customers is alleging that the company has consistently
failed to deliver goods in a saleable condition and on time, hence it has commenced legal
action against Centipede Co for a loss of profits claim. The directors have disclosed their
remuneration details in the financial statements in line with International Financial Reporting
Standards, which does not require a separate list of directors’ names and payments.
However, in the country in which Centipede Co is based, local legislation requires disclosure
of the names of the directors and the amount of remuneration payable to each director.

KAPLAN PUBLISHING 107

A A : A UDIT AN D ASS URAN CE

Financial statement extracts for the year ended 30 June:

Draft Final
20X5 20X4
$000 $000
Revenue 25,230 21,180
Cost of sales (15,840) (14,015)
––––––– –––––––
Gross profit 9,390 7,165
Operating expenses (4,903) (3,245)
––––––– –––––––
Operating profit 4,487 3,920
––––––– –––––––
Inventories 2,360 1,800
Trade receivables 1,590 1,250
Cash – 480
Trade payables 3,500 2,800
Overdraft 580 –
Required:
(a) Describe the matters which Ant & Co should have considered prior to accepting the
audit of Centipede Co. (5 marks)
(b) Using the table below, calculate the following FOUR ratios, for BOTH years, to assist
you in planning the audit of Centipede Co. (4 marks)
Note: Formulas are NOT required to be shown.
Ratio 20X5 20X4
Gross profit margin
Inventory holding period
Payables payment period
Current ratio
(c) Using the information provided and the ratios calculated, describe EIGHT audit risks
and explain the auditor's response to each risk, in planning the audit of Centipede
Co. (16 marks)

Audit risk Auditor’s response

The finance director of Centipede Co informed Ant & Co that one of the reasons they were
appointed as auditors was because of their knowledge of the industry. Ant & Co audits a
number of other consumer packaged goods companies, including Centipede Co’s main rival.
The finance director has enquired how Ant & Co will keep information obtained during the
audit confidential.
(d) Explain the safeguards which Ant & Co should implement to ensure that this conflict
of interest is properly managed. (5 marks)
(Total: 30 marks)

108 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

217 AQUAMARINE Walk in the footsteps of a top tutor

This scenario relates to three requirements.

It is 1 July 20X5. You are an audit supervisor of Amethyst & Co and are currently planning the
audit of your client, Aquamarine Co which manufactures elevators. Its year end is 31 July
20X5 and the forecast profit before income taxes is $15.2 million.
The company undertakes continuous production in its factory, therefore at the year end it is
anticipated that work-in-progress (WIP) will be approximately $950,000. In order to improve
the manufacturing process, Aquamarine Co placed an order in April for $720,000 of new plant
and machinery; one third of this order was received in May with the remainder expected to
be delivered by the supplier in late July or early August.
Included within intangible assets is a patent recognised at a cost of $1.3 million which was
purchased at the beginning of the year. The patent gives Aquamarine Co the exclusive right
to manufacture specialised elevator equipment for five years. In order to finance this
purchase, Aquamarine Co borrowed $1.2 million from the bank which is repayable over five
years.
In January 20X5 Aquamarine Co outsourced its payroll processing to an external service
organisation, Coral Payrolls Co (Coral). Coral handles all elements of the payroll cycle and
sends monthly reports to Aquamarine Co detailing the payroll costs. Aquamarine Co ran its
own payroll until 31 December 20X4, at which point the records were transferred over to
Coral.
The company has a policy of revaluing land and buildings and the finance director has
announced that all land and buildings will be revalued at the year end.
During a review of the management accounts for the month of May 20X5, you have noticed
that receivables have increased significantly on the previous year end and against May 20X4.
The finance director has informed you that the company is planning to make approximately
65 employees redundant after the year end. No decision has been made as to when this will
be announced, but it is likely to be prior to the year end.

Required:
(a) Define audit risk and the components of audit risk. (5 marks)
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning
the audit of Aquamarine Co. (12 marks)

Audit risk Auditor’s response

(c) Explain the additional factors Amethyst & Co should consider during the audit in
relation to Aquamarine Co’s use of the payroll service organisation. (3 marks)
(Total: 20 marks)

KAPLAN PUBLISHING 109

A A : A UDIT AN D ASS URAN CE

218 VENUS Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor of Pluto & Co and are currently planning the
audit of your client, Venus Magnets Co (Venus) which manufactures decorative magnets. Its
year end is 30 September 20X5 and the forecast profit before income taxes is $9.6 million.
During the year, the directors reviewed the useful lives and depreciation rates of all classes
of plant and machinery. This resulted in an overall increase in the asset lives and a reduction
in the depreciation charge for the year.
Inventory is held in five warehouses and on 27 and 28 September a full inventory count will
be held with adjustments for movements to the year end. This is due to a lack of available
staff on 30 September. In June, there was a fire in one of the warehouses. Inventory of
$0.9 million was damaged and this has been written down to its scrap value of $0.2 million.
An insurance claim has been submitted for the difference of $0.7 million. Venus is still waiting
to hear from the insurance company with regards to this claim, but has included the
insurance proceeds within the statement of profit or loss and the statement of financial
position.
The finance director has informed the audit manager that the May and June bank
reconciliations each contained unreconciled differences; however, it was considered that the
overall differences involved were immaterial.
A directors’ bonus scheme was introduced during the year which is based on achieving a
target profit before income taxes. In order to finalise the bonus figures, the finance director
of Venus would like the audit to commence earlier so that the final results are available
earlier this year.

Required:
(a) Identify and explain TWO factors which would indicate that an engagement letter
for an existing audit client should be revised. (2 marks)
(b) List FOUR matters which should be included within an audit engagement letter.
(2 marks)
You have been asked by the audit engagement partner to gain an understanding about the
new client as part of the planning process.
(c) Identify FOUR sources of information relevant to gaining an understanding and
describe how this information will be used by the auditor. (4 marks)
(d) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning
the audit of Venus Magnets Co. (12 marks)

Audit risk Auditor’s response

(Total: 20 marks)

110 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT ION 2

219 SYCAMORE Walk in the footsteps of a top tutor

Answer debrief

This scenario relates to five requirements.

It is 1 July 20X5. You are the audit supervisor of Maple & Co and are currently planning the
audit of an existing client, Sycamore Science Co (Sycamore), whose year end was 30 April
20X5. Sycamore is a pharmaceutical company, which manufactures and supplies a wide range
of medical supplies. The draft financial statements show revenue of $35.6 million and profit
before income taxes of $5.9 million.
During the year, a review of plant and equipment in the factory was undertaken and surplus
plant was sold, resulting in a profit on disposal of $210,000.
Sycamore’s previous finance director left the company in December 20X4 after it was
discovered that following discovery that fraudulent expenses had been claimed from the
company for a significant period of time. A new finance director was appointed in
January 20X5 who was previously a financial controller of a bank, and the new appointee
expressed surprise that Maple & Co had not uncovered the fraud during last year’s audit.
During the year Sycamore has spent $1.8 million on developing several new products. These
projects are at different stages of development and the draft financial statements show the
full amount of $1.8 million within intangible assets. In order to fund this development,
$2.0 million was borrowed from the bank and is due for repayment over a ten-year period.
The bank has attached minimum profit targets as part of the loan covenants.
The new finance director has informed the audit partner that since the year end there has
been an increased number of sales returns and that in the month of May over $0.5 million of
goods sold in April were returned.
Sycamore decided to outsource its payroll function to an external service organisation. This
service organisation handles all elements of the payroll cycle and sends monthly reports to
Sycamore which detail wages and salaries and statutory obligations. Sycamore maintained
its own payroll records until January 20X5, at which point the records were transferred to the
service organisation.
Maple & Co attended the year-end inventory count at Sycamore’s warehouse. The auditor
present raised concerns that during the count there were movements of goods in and out
the warehouse and this process did not seem well controlled.

Required:
(a) State Maples & Co’s responsibilities in relation to the prevention and detection of
fraud and error. (5 marks)
(b) Describe EIGHT audit risks, and explain the auditor’s response to each risk, in
planning the audit of Sycamore Science Co. (16 marks)

Audit risk Auditor’s response

KAPLAN PUBLISHING 111

A A : A UDIT AN D ASS URAN CE

(c) Explain the quality management procedures that Maple & Co should have in place
during the engagement performance. (5 marks)

Sycamore’s new finance director has read about review engagements and is interested in the
possibility of Maple & Co undertaking these in the future. However, the finance director is
unsure how these engagements differ from an external audit and how much assurance would
be gained from this type of engagement.
(d) (i) Explain the purpose of review engagements and how these differ from
external audits, and (2 marks)
(ii) Describe the level of assurance provided by external audits and review
engagements. (2 marks)
(Total: 30 marks)

Calculate your allowed time, allocate the time to the separate parts……………

INTERNAL CONTROLS

220 FRANCISCO CO Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor with Canyon & Co, preparing the draft audit
programmes and reviewing extracts from the internal control documentation in preparation
for the audit of your client, Francisco Co. The company’s year-end is 30 September 20X5, and
it is a wholesale food operator with 18 distribution depots and one central warehouse.
Payroll
Francisco Co employs distribution depot staff who are paid monthly based on the number of
hours worked. Each employee has a staff identity card which they use to sign in and out of
the depot at the beginning and end of each shift to record their hours worked, and this
process is supervised by security staff as well as CCTV cameras. The hours worked per
employee are automatically transferred from the signing-in system into the payroll system.
The hourly wage rate is pre-set, and the payroll system automatically calculates the gross and
net pay along with relevant statutory deductions and produces pay slips which are
immediately emailed to employees.
Access to employees' standing data in the payroll system is restricted to payroll managers
through the use of a password, which the system requires to be changed on a monthly basis.
Distribution depot employees are paid by bank transfer on a monthly basis. The senior payroll
manager reviews the list of bank payments and agrees this to the payroll records. If any
discrepancies are noted, these are investigated by the senior payroll manager who then
makes the required adjustment in the payroll records.
Purchases
Francisco Co has a central purchasing department based at its head office. When goods are
required, a production supervisor submits a request to the purchasing department. A multi-
part purchase order is then generated. The purchasing manager authorises all orders below
$3,000 and the purchasing director authorises orders of $3,000 and above.

112 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

On receipt of goods, the quality and quantities received are checked by a warehouse team
member against the supplier's delivery note, and a goods received note (GRN) is produced.
A copy of the GRN is sent to both the finance and purchasing departments.
When purchase invoices are received from the suppliers, they are logged into an invoices
received file and the accounting system assigns each invoice a unique number based on the
supplier’s code and date of input. The finance clerk then matches the invoices to a copy of
the relevant purchase order and passes those two documents to the finance director for
authorisation prior to the invoice being input into payables.
Non-current assets
Francisco Co owns approximately 55% of its distribution depots and the remainder are leased
premises, which have been confirmed as correctly capitalised in line with relevant accounting
standards. The lease agreements and ownership documents are held in the finance
department. Earlier in the year, members of the company’s internal audit department
undertook a review of the lease agreements and ownership documents but were unable to
locate a number of the relevant documents.
Each distribution depot is set up as a separate cost centre and is given an annual capital
expenditure budget, but some cost centres have already significantly exceeded their annual
budgets. When new equipment is purchased, the finance manager classifies the purchase
order as capital or revenue expenditure. The classification is made with reference to formal
company policy established by the finance director, who sample checks that the capital or
revenue expenditure allocation has been correctly applied and then evidences this review by
way of signature.

Required:
ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance
and Management, provides guidance on communicating significant deficiencies in internal
control.
(a) (i) Define a significant deficiency in internal control; and
(ii) Describe THREE matters the auditor may consider in determining whether a
deficiency in internal control is significant.
Note: You do not need to refer to the scenario to answer this requirement.
(4 marks)
(b) In respect of the system of internal control of Francisco Co:
(i) Identify and explain THREE DIRECT CONTROLS which the auditor may seek to
place reliance on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (6 marks)

Direct control Test of control

KAPLAN PUBLISHING 113

A A : A UDIT AN D ASS URAN CE

(c) Identify and explain FIVE DEFICIENCIES in Francisco Co’s system of internal control
and provide a control recommendation to address each of these deficiencies.
(10 marks)
Initial Response:

Control deficiency Control recommendation

(Total: 20 marks)

221 SILVER CO Walk in the footsteps of a top tutor

This scenario relates to two requirements.

It is 1 July 20X5. You are an audit senior with Golden & Co and you are in the process of
reviewing the inventory count arrangements for your audit client, Silver Co, in preparation
for attendance at the full year-end inventory count on 30 September 20X5. The company
manufactures household furniture such as tables, sofas and beds and has a factory and a
large warehouse which are located on a single site.
Inventory count arrangements
The company manufactures goods 24 hours a day, seven days a week to meet customers’
demands. Production will still be continuing during the inventory count as it is not possible
for the company to stop producing goods. Movements of goods in and out of the factory and
warehouse will also have to continue for operational reasons.
The count will be undertaken by 20 teams of two counters from the warehouse, and the
warehouse supervisor will be overseeing the inventory count. Each team will be given a
specific area of the warehouse to count using sequentially numbered inventory sheets which
detail the items of inventory together with quantities held at the date of the count as per the
inventory system. It has been left to the individuals within each team to decide how to
allocate the responsibilities between them.
All goods present in the warehouse on 30 September 20X5 will be allocated into separate
warehouse bays (designated areas of the warehouse) in preparation for counting. When a
warehouse bay has been counted, it is crossed out on the warehouse map which is held in
the office by the warehouse supervisor. The warehouse supervisor is confident that the 20
teams are familiar with the warehouse and the location of the inventory and concluded that
that each bay only needs to be counted by one team. One area of the warehouse, which
includes a large quantity of spare parts left over from production, will be segregated so that
this inventory will not be counted, as the warehouse supervisor has stated that these items
are unusable.
A numerical sequence check of the sheets will be carried out by the warehouse supervisor
once the count is finished. The inventory sheets will then be passed to a warehouse assistant
to update the inventory records to reflect the inventory physically present as per the
inventory sheets.
Work in progress valuations have previously been carried out by an external inventory valuer.
However, the warehouse supervisor has offered to undertake this valuation this year due to
being having a detailed knowledge of the company’s products. The directors have agreed to
this on the basis that it will save costs.

114 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Last week the company agreed to store 30 sofas belonging to a third party in its warehouse
for the next four months as the third party’s storage facilities became flooded. For
convenience, these sofas have been stored alongside similar products which belong to Silver
Co.

Requirements:
Auditors have a responsibility under ISA 265 Communicating Deficiencies in Internal Control
to Those Charged with Governance and Management to communicate significant deficiencies
in internal controls to those charged with governance.
(a) Describe FOUR matters the auditor should consider in determining whether a
deficiency in internal controls is significant.
Note: You do not need to refer to the scenario to answer this requirement (4 marks)
(b) Identify and explain EIGHT deficiencies in Silver Co’s inventory count arrangements
and provide a control recommendation to address each of these deficiencies.
(16 marks)
(Total: 20 marks)

Control deficiency Control recommendation

222 PETRA Walk in the footsteps of a top tutor

This scenario relates to six requirements.

It is 1 July 20X5. Petra Co is a company listed on a stock exchange. It manufactures handbags
which it supplies to retailers across the country. The company’s year end is 30 September
20X5. You are an audit supervisor with Babylon & Co, preparing the draft audit programmes
and reviewing the internal controls documentation in preparation for the forthcoming
interim audit.
Payroll
Petra Co employs factory staff, who are paid based on the number of hours worked. They are
paid in cash on a weekly basis due to commercial reasons. These staff each have a unique
clock card which they use to enter and exit the factory at the beginning and end of their shift,
and this process is supervised by security staff. The clock card system and the payroll system
are linked.
The payroll system automatically calculates the gross and net pay along with relevant
deductions and generates employee payslips. The payroll supervisor selects a sample of the
payslips, reperforms the gross to net pay calculations and investigates any discrepancies. The
sampled payslips are then signed as evidence of this review.
Factory staff receive an annual inflation-based pay increase every April. The revised hourly
wage rates are communicated to the payroll department. The revised pay rates are entered
into the system in April by a payroll clerk and each entry is checked by a senior clerk for input
errors prior to processing that week’s wages. The senior clerk signs a payroll listing of factory
staff employees, which includes the revised hourly wage rates as evidence of undertaking
this review.

KAPLAN PUBLISHING 115

A A : A UDIT AN D ASS URAN CE

Two members of the payroll department produce the cash pay packets. One member is
responsible for preparing the pay packets by reference to the payslips generated by the
system. The second member recounts the contents of the finished pay packets and confirms
that this agrees to the payslips. Both members of staff are required to sign the weekly payroll
listing on completion of this task.
Sales
Petra Co carries out credit checks for all new customers. Upon passing these checks, new
customers are set up by an accounting clerk in the receivables ledger master file and a credit
limit is set by the finance director. The credit limits are only reviewed if an increase is
requested by the customer.
Petra Co generates revenue through visits by members of its sales department to customers'
premises. When a customer places an order, sales staff check that the customer is within its
credit limit and that the inventory is available and then complete a three-part pre-printed
order form. One copy is left with the customer, the second is sent to the warehouse and the
third to the finance department. The sales staff have monthly sales targets and are able to
use their discretion in granting discounts up to a maximum of 8%. No review is undertaken
of discounts granted.
Purchases
The company has a purchasing department based at its head office. All members of this
department have full access to the supplier master file data and are able to make changes.
When goods are received from a supplier they are processed by the warehouse team, who
agree the delivery to the purchase order, checking the quantity and the quality of goods, and
complete a sequentially numbered goods received note (GRN). The GRNs are matched to the
purchase orders and are filed in the warehouse.
On receipt of the purchase invoice from the supplier, a payables ledger clerk, logs them into
the payables ledger using document count controls to ensure that the correct number of
invoices has been input.

Required:
(a) List FOUR control objectives of Petra Co’s sales system. (4 marks)
(b) In respect of the PAYROLL system of Petra Co:
(i) Identify and explain THREE DIRECT CONTROLS on which the auditor may seek
to place reliance, and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (6 marks)

Direct control Test of control

116 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(c) Identify and explain FIVE DEFICIENCIES in Petra Co’s SALES and PURCHASES systems
and provide a recommendation to address each of these deficiencies.

Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Petra Co's purchases and other expenses.
(4 marks)

Petra Co has been a listed company for six years and the directors are aware of the need for
compliance with corporate governance principles. The finance director has requested that
the audit team undertakes a review of whether the company complies with the principles.

The board of Petra Co is appropriately comprised of executive and independent non-

executive directors (NEDs). The Chair is planning to retire at the end of the financial year, and
it is proposed by the nomination committee that the current marketing director is appointed
into this role and that a new marketing director is recruited. Two directors are subject to re-
election at each annual general meeting.

The NEDs are all members of the audit committee and are highly experienced in the industry
in which Petra Co operates. Before joining Petra Co they were all previously involved in sales
or purchasing roles. The level of executive directors' pay is set by the remuneration
committee, comprised of independent NEDs. The remuneration for the NEDs is in the form
of an annual bonus based on profit growth over the prior year.

(e) Describe THREE corporate governance deficiencies faced by Petra Co and provide a
recommendaƟon to address each deficiency to ensure compliance with corporate
governance principles.

Note: The marks will be split equally between each part. (6 marks)

Deficiency Recommendation

(Total: 30 marks)

KAPLAN PUBLISHING 117

A A : A UDIT AN D ASS URAN CE

223 DALEY Walk in the footsteps of a top tutor

This scenario relates to six requirements.

It is 1 July 20X5. Daley Co, a listed company, manufactures double glazed windows and doors.
The company's year end is 30 September 20X5. You are an audit supervisor with Cooper &
Co and you are in the process of reviewing the following extracts from the internal controls
documentation in preparation for the forthcoming audit:
Payroll
The company employs 210 staff in its factory who are paid on a weekly basis by bank transfer.
Factory staff have key cards and are required to swipe in and out at the beginning and end
of their shift. This process is supervised. Hours worked by employees are recorded
electronically using the key card system which is linked to the payroll system. Each week the
hours worked are automatically transferred to the payroll system. As the process is
automated, no checks over this transfer are performed.
The payroll is run on a weekly basis and the system automatically calculates the wages to be
paid. On a sample basis, a payroll clerk checks gross to net pay calculations and compares
these to the system-generated balances to ensure the accuracy of the payroll system. If any
changes to the payroll data are required, the payroll clerk makes the amendment. An edit
report of any amendments is produced weekly by the system but is not reviewed.
Non-current assets
Daley Co has a head office and ten factories, with a warehouse included at each factory. The
company has an internal audit (IA) department which carries out a comparison between all
of the assets recorded on the non-current asset register to those physically present in each
of Daley Co's 21 sites. This year's programme of visits, which has been planned and carried
out on the same basis as previous years, means that by 30 September 20X5, IA will only have
completed this comparison at one factory and one warehouse.
During the year, the financial controller changed the company’s capitalisation accounting
policy. In accordance with the revised policy, only items of a capital (asset) nature exceeding
$20,000 are accounted for as additions to non-current assets in the statement of financial
position. Any non-current assets purchased below $20,000 are written off to the statement
of profit or loss as an expense.
Bank and cash
On a weekly basis, a bank payments list is generated for supplier payments. The finance
director reviews the total amount of the bank payments list and authorises it. The finance
director then passes it to the financial controller who processes it for payment.
Daley Co incurs a lot of petty cash expenditure and the finance department maintains a petty
cash float of $500 which is kept in the safe. It is used for making any sundry purchases by the
company. When staff wish to purchase sundry items, the required sum of cash is given to the
staff member who signs for it. The staff member is required to return any excess money to
the finance department but there is currently no requirement for receipts to be provided.
The cashier reconciles the main current account on a monthly basis as this contains the
highest levels of activity and reconciles the remaining three bank accounts every three
months. The reconciliations are reviewed by the finance director who evidences this review.

118 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement states
that an entity's system of internal control consists of five components: control environment,
the entity's risk assessment process, the entity's process to monitor the system of internal
control, the information system and communication and control activities.
(a) Using the table below, describe the five components of an entity's system of internal
control. (5 marks)
Note: You do not need to refer to the scenario to answer this requirement.

Component of internal control Description

Control environment
Entity’s risk assessment process
Entity’s process to monitor the system of
internal control
Information system and communication
Control activities

(b) In respect of system of internal control of Daley Co:

(i) Identify and explain FIVE deficiencies
(ii) Recommend a control to address each of these deficiencies, and
(iii) Describe a TEST OF CONTROL the external auditors should perform to assess if
each of these controls, if implemented, is operating effectively.
Note: The marks will be split equally between each part. (15 marks)

Control deficiency Control recommendation Test of control

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Daley Co’s bank balances. (4 marks)

During the year, the Chair of Daley Co resigned due to other commitments and Fred Johnson,
who is the chief executive of the company, took over this role. Fred has recently written to
all shareholders to inform them that any questions or comments they may have could only
be raised at the company’s annual general meeting and that any other communication with
the board is not possible.

The executive directors' remuneration is set by the remuneration committee. The non-
executive directors’ remuneration is set by the board and is based on pre-tax profit targets
which are agreed by the board at the start of each financial year. As the board is of the view
that the internal control environment is very effective, an audit committee has not been
established.

KAPLAN PUBLISHING 119

A A : A UDIT AN D ASS URAN CE

(d) Describe THREE corporate governance deficiencies faced by Daley Co and provide a
recommendation to address each deficiency to ensure compliance with corporate
governance principles.
Note: The marks will be split equally between each part. (6 marks)

Deficiency Recommendation

(Total: 30 marks)

224 WHITTAKER Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Walsh & Co. You are currently reviewing
notes in relation to the internal controls in place at your client, Whittaker Co. Whittaker Co
manufactures and sells luxury bed linen wholesale to the hotel trade and direct to the public
from its factory store. It has a year ending 31 August 20X5.
Sales
Whittaker Co implemented a new sales system in May 20X5. The new system was fully tested
prior to its implementation and will be run in parallel with the old system until the year end.
Whittaker Co's internal audit (IA) department is responsible for comparing the output from
the old and new systems, investigating any discrepancies and making recommendations for
further action.
The company operates a fully automated credit check process for all its new hotel customers.
The automated system generates a credit limit for each new customer which the sales
director approves before the customer can place any orders. The sales director evidences
approval of the credit limit in the system.
On a monthly basis, the receivables ledger clerk downloads the aged receivables report and
reviews it for outstanding debts. In line with Whittaker Co's credit control policy, any debts
which are greater than 30 days overdue are then passed to the credit control department
which contacts the customers to resolve any issues and recover the debt.
Also, on a monthly basis, the accounts clerk reconciles the trade receivables account to the
list of individual customer balances in order to verify the month-end receivables balance. Any
reconciling items are documented, errors are corrected on a timely basis and then the
reconciliations are reviewed and approved by the financial controller.
Payroll
Whittaker Co has a human resources (HR) department which is responsible for processing
joiners and leavers, including preparing and sending authorised joiners forms to the payroll
department so that new employees can be set up correctly on the payroll system. However,
when additional staff are required at short notice, joiners’ forms are not completed and
instead, the production supervisor notifies the payroll department by email on the day they
commence employment.

120 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Staff are required to work overtime on a regular basis in order to meet production targets.
Overtime is paid monthly in arrears, at the end of the month in which it is worked. All
overtime reports are reviewed on a quarterly basis by the production supervisor after the
overtime has been paid. Reviews of overtime reports are evidenced by signature of the
production director.
The payroll system automatically calculates wages and deductions for all employees based
on standing data. The standing data is reviewed regularly to ensure it is still accurate however
no checks are performed on the monthly payroll calculations.
In May each year, all employees receive a bonus, the amount of which varies depending upon
their performance. The payroll department receives written notification from the HR
manager of the bonus, based only on the HR Manager’s view of the employees' performance
in the year. The bonuses for 20X5 were input into the payroll system by the payroll clerk.
After May's payroll had been processed, a small number of employees notified the payroll
department that the bonus they had been paid did not agree to their bonus confirmation
letter. This was corrected in June 20X5.
Bank
Whittaker Co uses an internet banking system which requires a two-step verification process.
A password is required to log on to the system. An additional passcode is then required to
set up new payees or to withdraw funds. The login details including the password and the
passcode are saved in a shared file which is accessible to all payables ledger staff in the
accounts department.
The accounts clerk undertakes the bank reconciliations on a weekly basis. The reconciling
items are documented and sent to the financial controller for review. The financial controller
only investigates the reconciling items if the sum of these items is significant.

Required:
Auditors are required, under ISA 265 Communicating Deficiencies in Internal Control to Those
Charged with Governance and Management, to communicate in writing to those charged
with governance any significant deficiencies in internal control.
(a) Describe FOUR matters the auditor may consider in determining whether a
deficiency in internal control is significant.
Note: You do not need to refer to the scenario to answer this requirement. (4 marks)
(b) In respect of the SALES system of Whittaker Co:
(i) Identify and explain THREE DIRECT CONTROLS on which the auditor may seek
to place reliance, and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (6 marks)

Direct control Test of control

KAPLAN PUBLISHING 121

A A : A UDIT AN D ASS URAN CE

(c) Identify and explain FIVE DEFICIENCIES in Whittaker Co’s PAYROLL and BANK systems
and provide a control recommendation to address each of these deficiencies.

Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

(Total: 20 marks)

225 POMERANIAN Walk in the footsteps of a top tutor

This scenario relates to two requirements.

It is 1 July 20X5. Pomeranian Co is a manufacturer of fizzy drinks and operates across the
country. The company’s year end is 30 September 20X5. You are an audit supervisor with
Poodle Co and you are reviewing extracts from the internal controls documentation in
preparation for the forthcoming audit.
Sales
All new customers of Pomeranian Co are required to pass suitable credit checks. Upon
passing the credit check, customers are set up in the customer master file and a credit limit
is set by the sales director. The credit limits are only then changed when a customer requests
an increase.
Customer orders are processed by Pomeranian Co’s sales ordering department and goods
are despatched from one of the company’s warehouses. Sequentially numbered multi-part
goods despatch notes (GDNs) are completed and a copy is filed in the warehouse when the
goods are despatched. Copies of the GDNs are sent to the sales ordering department and the
finance department on a weekly basis.
Pomeranian Co’s credit controller is currently on maternity leave for six months and no one
has taken over the credit controller’s duties. As part of the month-end procedures, a clerk
reconciles the trade receivables account to the list of individual customer balances and the
reconciliations are only reviewed by the financial controller if there are any unreconciled
differences.
Non-current assets
An annual asset expenditure budget is set for each department within Pomeranian Co and is
referred to as part of the approval process. Board approval is required for any assets costing
more than $0.5m. Asset expenditure below this level can be authorised by the relevant head
of department.
Pomeranian Co has a head office and five factories, each of which includes a warehouse. The
company has an internal audit (IA) department which is required, over a three-year cycle, to
carry out a comparison between all the assets recorded on the non-current asset register to
those physically present in each of the company’s 11 sites. The programme of visits for the
current year means that by the year end, IA will only have completed this comparison at one
factory and one warehouse.
Purchases and inventory
Pomeranian Co maintains a perpetual inventory system in which finished goods and raw
materials, stored in the warehouses, are counted monthly throughout the year rather than
just being counted at the year end. Each of the five warehouse managers are responsible for
supervising the inventory counts at their sites and ensuring that the counting teams are
following the issued instructions.

122 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

The company calculates the cost of its inventory using standard costs, both for internal
management reporting and for inclusion in the year-end financial statements. The basis of
the standard costs was reviewed by the production department approximately two years
ago. The company has a central purchasing department which is based at its head office. All
members of this department have full access to the supplier master file data and a monthly
exception report of any changes to master file data is automatically generated and then filed
by a purchasing clerk.
Sequentially numbered goods received notes (GRNs) are produced by the company’s
warehouse department when goods are received, a copy of which is promptly sent to the
purchasing and finance departments. On receipt of the purchase invoices, the finance clerk
matches the invoices to the relevant purchase order and then passes the documents to the
finance director for authorisation prior to input.

Required:
In order to obtain sufficient and appropriate audit evidence, an auditor cannot place
complete reliance on an entity’s system of internal control. In addition to performing tests of
controls, auditors must always perform some substantive procedures due to the limitations
of internal control.
(a) Describe the LIMITATIONS of internal control.
Note: You do not need to refer to the scenario to answer this requirement. (4 marks)
(b) Identify and explain EIGHT deficiencies in Pomeranian Co’s internal control system
and provide a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (16 marks)

Control deficiency Control recommendation

(Total: 20 marks)

226 CASTLE COURIER Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor of Apple & Co and are in the process of reviewing
extracts of the systems documentation which has been completed on the payroll cycle of
Castle Courier Co, as well as preparing the audit programmes for the forthcoming final audit
for the year ending 30 September 20X5. Castle Courier Co is a package delivery company
which operates from a large distribution centre.
Payroll
The company employs 200 staff of whom 120 of these staff are delivery drivers. All staff work
a standard eight-hour shift each day and are paid monthly. All staff members are required to
clock-in and out using a sequentially numbered key card which contains their unique
employee number and name. Sequence checks on the key cards and the data recorded in the
clocking-in system are carried out by the human resources (HR) supervisor on a regular basis.
The clocking-in process is monitored by a camera on entry to the distribution centre and
weekly checks are carried out by the HR department who review the video footage to ensure
that no staff member clocks-in for someone else. Recordings are kept in date order in the HR
department and logged on a spreadsheet together with the name of the person who has
reviewed the footage.

KAPLAN PUBLISHING 123

A A : A UDIT AN D ASS URAN CE

The clocking-in system is directly linked to the payroll system and information regarding the
hours worked by the staff is automatically transferred into the payroll system. The payroll
system then automatically calculates gross pay, deductions and net pay. The payroll clerk
confirms that the transfer of hours and calculations has been done correctly by recalculating
a sample of employees’ gross to net pay. A payroll supervisor then reviews this check which
is evidenced by the supervisor’s signature.
All staff are entitled to 22 days holiday a year. Employees are paid for any holiday which has
not been taken at the end of the year. Department managers are required to approve all
holiday requests by authorising employees' holiday forms, however this does not always occur.
The payroll system is password-protected, and the password is changed on a monthly basis
by the payroll manager using a random password generator.
Once the payroll has been agreed by the payroll supervisor, the payroll clerk provides details
of the net pay due to each employee to the financial controller who then prepares and
authorises the bank transfer to be paid to the employees’ bank accounts.
Each month, as part of the month-end procedures, the finance director undertakes a payroll
account reconciliation and investigates any differences to ensure that the payroll figures have
been posted into the accounting records correctly.
The company’s HR department is responsible for processing starters and leavers using a
joiner/leaver form to notify the payroll department of the change. On receipt of the
joiner/leaver form a payroll clerk updates the payroll system. An edit report is generated
which records the changes made but this report is not reviewed. Two staff members from
the HR department have been absent for some time due to illness. As a result, the operations
manager has processed six newly recruited temporary delivery drivers and instructed the
payroll department to set up the new employees.
Delivery drivers are sometimes required to work overtime, particularly in busy periods.
Where overtime is necessary, the operations manager has to authorise overtime in excess of
five hours per week.
Some temporary delivery drivers receive their wages in cash. The delivery driver collects their
pay packet from the finance department when it is ready. The member of staff in the finance
department will ask for the delivery driver’s name to check that there is a pay packet
prepared and, if there is, they provide the delivery driver with their pay packet.
The company has to pay employment taxes to the tax authority by the end of each month.
Each month the payroll supervisor calculates the total liability due to the tax authority and
this is then passed to the financial controller who checks the calculations prior to the
payment being made.
To encourage delivery drivers to make deliveries on time, the company pays a discretionary
bonus to delivery drivers on a quarterly basis. The operations manager decides on the bonus
to be paid and notifies the payroll clerk in writing every quarter as to who will receive a bonus
and how much it will be.
As delivery drivers spend the majority of their day driving the company vehicles, they are
required by law to take a 15-minute paid break in the morning and afternoon, as well as a
one-hour lunch break. The company has no way of monitoring the length of these breaks as
the delivery drivers are out on deliveries.

124 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
(a) Describe the following methods for documenting internal control systems and for
each explain a DISADVANTAGE of using this method.
Note: The marks will be split equally between each part. (4 marks)

Description Disadvantage
Narrative notes
Internal control questionnaires

(b) (i) Identify and explain FOUR DIRECT CONTROLS in Castle Courier Co’s payroll
system which the auditor may seek to place reliance on, and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (8 marks)

Direct control Test of control

(c) Identify and explain SIX DEFICIENCIES in Castle Courier Co’s payroll system and
provide a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (12 marks)

Control deficiency Control recommendation

(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Castle Courier Co’s payroll expense.
(6 marks)
(Total: 30 marks)

KAPLAN PUBLISHING 125

A A : A UDIT AN D ASS URAN CE

227 SWIFT Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Swift Co prints books which it sells online and supplies to retailers across the
country. The company’s year end is 30 September 20X5. You are an audit supervisor with
Toucan & Co, preparing the draft audit programmes and reviewing the internal controls
documentation in preparation for the interim audit.
Payroll
Swift Co employs factory staff who are required to work a standard shift of eight hours per
day. No staff members are required to work overtime. All staff members are paid monthly by
bank transfer. The company has a human resources (HR) department which is responsible
for setting up all new joiners and a payroll department which processes wages and salaries.
When a new employee joins the company, HR completes a joiners’ form which includes a
unique employee number for each new employee. The joiners’ form is then sent to the
payroll department so that the new employee can be set up for payment. The unique
employee number must be entered into the payroll system before the employee can be
added to payroll. On a monthly basis, an exception report relating to changes to the payroll
standing data is produced and reviewed by the payroll manager who evidences this review.
Employee hours worked and their hourly wage rates are preset into the system, which
automatically calculates the gross and net pay along with relevant deductions and generates
employee payslips. The payroll supervisor selects a sample of the payslips, reperforms the
gross to net pay calculations and investigates any discrepancies. The sampled payslips are
then signed as evidence of this review.
Purchases
The company has a purchasing department based at its head office. When raw materials are
required, the production supervisors submit a requisition form to the purchasing
department. A multi-part purchase order is generated and the purchasing manager
authorises all orders up to $5,000. Orders over $5,000 are authorised by the purchasing
director.
The warehouse team processes goods received from suppliers. They agree the goods
received to the purchase order and check the quantity and the quality of the goods. On
completion of those checks a goods received note (GRN) is produced. One copy of the GRN
is then signed and filed in the warehouse. Another copy of the GRN is sent to the finance
department.
A payables ledger clerk logs the purchase invoices in batches of 20 into the detailed purchase
listing utilising control totals. A batch control sheet is completed for each set of 20 invoices
and the clerk signs to evidence the checks undertaken.
Supplier statement reconciliations are performed on a monthly basis. All differences are fully
investigated, and the financial controller reviews these reconciliations. Invoices are paid in
accordance with the supplier’s credit terms. The finance director authorises the bank transfer
payment list for suppliers having first agreed the amounts to be paid to supporting
documentation and having reviewed the list for duplicate payments.

126 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
Auditors are required to document a company’s accounting and internal control systems as
part of their audit process. Three methods available for documenting internal control
systems are narrative notes, flowcharts and questionnaires.
(a) For each of the THREE methods identified in the table:
(i) Describe the method for documenting internal control systems, and
(ii) Explain an ADVANTAGE of using this method.

Note: The marks will be split equally between each part. (6 marks)

Description Advantage
Narrative notes
Flowcharts
Questionnaires

(b) In respect of the internal control system of Swift Co:

(i) Identify and explain SEVEN DIRECT CONTROLS which the auditor may seek to
place reliance on, and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (14 marks)

Direct control Test of control

(Total: 20 marks)

228 SNOWDON Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Rocky & Co, reviewing extracts from the
internal controls documentation in preparation for the interim audit of Snowdon Co. The
company’s year end is 30 September 20X5. The company provides training services for
individuals looking to become qualified engineers. Snowdon Co’s customers are the
employers that send their employees for training on a weekly basis. Snowdon Co runs classes
in its 45 training centres across the country.
The company has a small internal audit (IA) department, which has experienced significant
staff shortages and is currently under-resourced. This has resulted in a reduction in their
programme of work for the year in many areas.
Non-current assets
Snowdon Co’s training centres are either owned by the company or are held under a long-
term lease. The company also has a head office and central warehouse for storage of training
materials. Each training centre is set up as a separate department and is given an annual
asset expenditure budget but some departments have already significantly exceeded their
annual budgets.

KAPLAN PUBLISHING 127

A A : A UDIT AN D ASS URAN CE

When new equipment is acquired, the finance department classifies the expenditure
between assets and expenses, noting the classification on the purchase order. The
classification is made with reference to guidelines established by the finance director, who
sample checks that the expenditure allocation has been correctly applied.
Part of the work which Snowdon Co’s IA department is required to carry out is a comparison
of the assets per the non-current asset register and those physically present in each of the
centres. This year’s programme of visits, which has been planned and carried out on the same
basis as previous years, means that by the year end IA will only have visited the four largest
centres and five of the other centres randomly selected.
Payroll
Snowdon Co has a human resources (HR) department, responsible for setting up all new
joiners. Pre-printed joiners’ forms, which require all necessary data, are completed by HR for
new employees and once verified, a copy is sent to the payroll department so that the
employee can be set up for payment. The joiner’s form includes the staff member’s assigned
employee number and the system requires the new joiner’s employee number to be entered
before they can be added to payroll.
All members of the payroll department can amend employees’ standing data in the payroll
system as they have access to the password, which is changed by the payroll director on a
quarterly basis.
On a monthly basis the employees are paid by bank transfer. The senior payroll manager
reviews the list of bank payments and agrees this to the payroll records. If any discrepancies
are noted, the senior payroll manager always makes the adjustment in the payroll records.
Sales and bank
After passing a credit card check, new customers are set up in the individual customer master
file and a credit limit is set by the sales director. The credit limits then remain unchanged in
the system unless a review is requested by the customer.
Each new customer is allocated a client services manager from Snowdon Co, who is
responsible for managing the customer relationship and maximising sales. Standard credit
terms for customers are 30 days and on a monthly basis sales invoices which are over 90 days
outstanding are notified to the relevant client services manager to chase payment directly
with the customer.
Every month, the cashier reconciles the bank statements to the bank ledger account. The
reconciliations are reviewed by the financial controller, who also investigates all reconciling
items and evidences that review by way of a signature.

Required:
Auditors are required, under ISA 265 Communicating Deficiencies in Internal Control to Those
Charged with Governance and Management, to communicate in writing to those charged
with governance any significant deficiencies in internal control.
(a) Describe FOUR matters the auditor may consider in determining whether a deficiency
in internal control is significant. (4 marks)

128 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(b) In respect of the internal control system of Snowdon Co:

(i) Identify and explain THREE DIRECT CONTROLS on which the auditor may seek
to place reliance, and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (6 marks)

Direct control Test of control

(c) Identify and explain FIVE DEFICIENCIES in Snowdon Co’s internal control system and
provide a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

(Total: 20 marks)

229 AMBERJACK Walk in the footsteps of a top tutor

This scenario relates to three requirements.

It is 1 July 20X5. You are an audit manager of Pinfish & Co and you are reviewing extracts of
the documentation describing Amberjack Co’s sales and despatch system following
completion of the interim audit. Amberjack Co manufactures and distributes car tyres to a
wide customer base both in its country and across the rest of the continent. Its year end was
30 April 20X5.
Amberjack Co has grown in size over the previous 18 months. All new customers undergo
credit checks prior to being accepted and credit limits are subsequently set by the receivables
ledger clerks who record the new customer details, assign a unique customer number and
set credit limits in the master data file.
The company’s credit controller is currently on secondment to the internal audit department
for six months and no replacement has been appointed.
Customers wishing to order goods, telephone the company’s sales order department and
provide their unique account details. Sequentially numbered four-part sales orders are
generated for all orders, after checking available inventory levels. One copy is retained by the
sales ordering team to enable them to monitor progress of the sales orders, one copy is sent
to the customer, one copy is sent to one of the company’s warehouses for despatch and the
final copy is sent to the finance department. Upon despatch, a three-part goods despatch
note (GDN) is completed which is assigned the same sequential number as the order number;
one copy is sent with the goods, one remains with the warehouse and one is sent to the
finance department.
Due to the recent growth of the company, and as there are a large number of sales invoices,
additional temporary staff members have been appointed to help the sales clerks to produce
the sales invoices. The sales invoices are prepared using quantities from the GDNs and prices
from the authorised sales prices list, which is updated every six months.

KAPLAN PUBLISHING 129

A A : A UDIT AN D ASS URAN CE

This year, in line with its main competitors, the company offered a 10% discount on all orders
placed during one weekend in late November. Where a discount has been given, this has to
be manually entered by the sales clerks onto the sequentially numbered invoice.
Customer statements are no longer being generated and sent out. The company only
reconciles the trade receivables account at the end of April in order to verify the year-end
balance.

Required:
(a) List FOUR limitations of internal control components. (4 marks)
(b) As the external auditor of Amberjack Co, write a report to management in respect of
the sales and despatch system described which:
(i) Identifies and explains SEVEN deficiencies in the sales and despatch
system and recommends a control to address each of these deficiencies, and
(ii) Includes a covering letter
Note: The marks will be split equally between each part. Two marks will be awarded
within this requirement for the covering letter. (16 marks)

Control deficiency Control recommendation

(Total: 20 marks)

230 FREESIA Walk in the footsteps of a top tutor

This scenario relates to seven requirements.

(a) Auditors are required to document a company’s accounting and internal control
systems as part of their audit process. Two methods available for documenting internal
control systems are narrative notes and questionnaires.

Required:
For each of the two methods, NARRATIVE NOTES and QUESTIONNAIRES:
(i) Describe the method for documenting internal control systems; and
(ii) Explain an ADVANTAGE of using this method.
Note: The marks will be split equally between each part. (4 marks)

Description Advantage
Narrative notes
Questionnaires

It is 1 July 20X5. You are an audit supervisor with Zinnia & Co, preparing the draft audit
programmes and reviewing extracts from the internal controls documentation in preparation
for the interim audit. Freesia Co is a company listed on a stock exchange. It manufactures
furniture which it supplies to a wide range of retailers across the region. The company has an
internal audit (IA) department and the company’s year end was 30 June 20X5.

130 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Sales
Freesia Co generates revenue through visits by its sales staff to customers’ premises. Sales
ledger clerks, who work at head office, carry out credit checks on new customers prior to
being accepted and then set their credit limits. Sales staff visit retail customers’ sites
personally and orders are completed using a four-part pre-printed order form. One copy is
left with the customer, a second copy is returned to the sales ordering department, the third
is sent to the warehouse and the fourth to the finance department at head office. Each sales
order number is based on the sales person’s own identification number in order to facilitate
monitoring of sales staff performance.
Retail customers are given payment terms of 30 days and most customers choose to pay their
invoices by bank transfer. Each day Lily Shah, a finance clerk, posts the bank transfer receipts
from the bank statements to the bank ledger account and updates the list of individual
customers. On a monthly basis, Lily performs the bank reconciliation.
Purchases and inventory
Receipts of raw materials and goods from suppliers are processed by the warehouse team at
head office, who agree the delivery to the purchase order, check the quantity and quality of
goods and complete a sequentially numbered goods received note (GRN). The GRNs are sent
to the finance department daily. On receipt of the purchase invoice from the supplier, Camilla
Brown, the purchase ledger clerk, matches it to the GRN and order and the three documents
are sent for authorisation by the appropriate individual. Once authorised, the purchase
invoices are logged into the suppliers’ individual accounts by Camilla, who utilises document
count controls to ensure the correct number of invoices has been input.
The company values its inventory using standard costs, both for internal management
reporting and for inclusion in the year-end financial statements. The basis of the standard
costs was reviewed approximately 18 months ago.
Payroll
Freesia Co employs a mixture of factory staff, who work a standard shift of eight hours a day,
and administration and sales staff who are salaried. All staff are paid monthly by bank
transfer. Occasionally, overtime is required of factory staff. Where this occurs, details of
overtime worked per employee is collated and submitted to the payroll department by a
production clerk. The payroll department pays this overtime in the month it occurs. At the
end of each quarter, the company’s payroll department sends overtime reports which detail
the amount of overtime worked to the production director for their review.
Freesia Co’s payroll package produces a list of payments per employee which links into the
bank system to produce a list of automatic bank transfer payments. The finance director
reviews the total to be paid on the list of automatic payments and compares this to the total
payroll amount to be paid for the month per the payroll records. If any issues arise, then the
automatic bank transfer can be manually changed by the finance director.

KAPLAN PUBLISHING 131

A A : A UDIT AN D ASS URAN CE

Required:
(b) In respect of the internal controls of Freesia Co:
(i) Identify and explain SIX deficiencies
(ii) Recommend a control to address each of these deficiencies, and
(iii) Describe a TEST OF CONTROL the external auditors should perform to assess if
each of these controls, if implemented, is operating effectively to reduce the
identified deficiency.
Note: The marks will be split equally between each part. (18 marks)

Control deficiency Control recommendation Test of control

Freesia Co deducts employment taxes from its employees’ wages and salaries on a monthly
basis and pays these to the local taxation authorities in the following month. At the year end,
the financial statements will contain an accrual for employment tax payable.

Required:
(c) Describe the substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in respect of Freesia Co’s year-end accrual for
employment tax payable. (4 marks)
The listing rules of the stock exchange require compliance with corporate governance
principles and the directors of Freesia Co are confident that they are following best practice
in relation to this. However, the chair recently received correspondence from a shareholder,
who is concerned that the company is not fully compliant. The company’s finance director
has therefore requested a review of the company’s compliance with corporate governance
principles.
Freesia Co has been listed for over eight years and its board comprises four executive and
four independent non-executive directors (NEDs), excluding the chair. An audit committee
comprised of the NEDs and the finance director meets each quarter to review the company’s
internal controls.
The directors’ remuneration is set by the finance director. NEDs are paid a fixed fee for their
services and executive directors are paid an annual salary as well as a significant annual bonus
based on Freesia Co’s profits. The company’s chair does not have an executive role and
therefore has sole responsibility for liaising with the shareholders and answering any of their
questions.

Required:
(d) Describe TWO corporate governance deficiencies faced by Freesia Co and provide a
recommendation to address each deficiency to ensure compliance with corporate
governance principles.
Note: The marks will be split equally between each part. (4 marks)

Deficiency Recommendation

(Total: 30 marks)

132 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

231 CAMOMILE Walk in the footsteps of a top tutor

This scenario relates to three requirements.

(a) ISA 260 Communication with Those Charged with Governance provides guidance to
auditors in relation to communicating with those charged with governance on matters
arising from the audit of an entity’s financial statements.

Required:
(i) Explain why it is important for auditors to communicate throughout the audit
with those charged with governance; and
(ii) Identify TWO examples of matters which the auditor may communicate to
those charged with governance.
Note: The marks will be split equally between each part. (4 marks)
Camomile Co operates six restaurant and bar venues which are open seven days a week. The
company’s year end is 31 July 20X5. It is 1 July 20X5. You are the audit supervisor reviewing
the internal controls documentation in relation to the cash receipts and payments system in
preparation for the interim audit, which will involve visiting a number of the venues as well
as the head office. The company has a small internal audit (IA) department based at head
office.
The purchasing department based at the company’s head office is responsible for ordering
food and beverages for all six venues. In addition, each venue has a petty cash float of $400,
held in the safe, which is used for the purchase of sundry items. When making purchases of
sundries, employees are required to obtain the funds from the restaurant manager, purchase
the sundries and return any excess money and the receipt to the manager. At any time the
petty cash sum held and receipts should equal the float of $400 but it has been noted by the
company’s IA department that on some occasions this has not been the case.
Each venue has five cash tills (cash registers) to take payments from customers. Three are
located in the bar area and two in the restaurant area. Customers can pay using either cash
or a credit card and for any transaction either the credit card vouchers or cash are placed in
the till by the employee operating the till. To speed up the payment process, each venue has
a specific log on code which can be used to access all five tills and is changed every two weeks.
At each venue at the end of the day, the tills are closed down by the restaurant manager who
counts the total cash in all five tills and the sum of the credit card vouchers and these totals
are reconciled with the aggregated daily readings of sales taken from each till. Any
discrepancies are noted on the daily sales sheet. The daily sales sheet records the sales per
the tills, the cash counted and the total credit card vouchers as well as any discrepancies.
These sheets are scanned and emailed to the cashier at head office at the end of each week.
Approximately 30% of Camomile Co’s customers pay in cash for their restaurant or bar bills.
Cash is stored in the safe at each venue on a daily basis after the sales reconciliation has been
undertaken. Each safe is accessed via a key which the restaurant manager has responsibility
for. Each key is stored in a drawer of the manager’s desk when not being used. Cash is
transferred to the bank via daily collection by a security company.
The security company provides a receipt for the sums collected, and these receipts are
immediately forwarded to head office. The credit card company remits the amounts due
directly into Camomile Co’s bank account within two days of the transaction.

KAPLAN PUBLISHING 133

A A : A UDIT AN D ASS URAN CE

At head office, on receipt of the daily sales sheets and security company receipts, the cashier
agrees the cash transferred by the security company has been banked for all venues and also
agrees the cash per the daily sales sheets to bank deposit slips and to the bank statements.
The cashier updates the bank ledger account with the cash banked and details of the credit
card vouchers from the daily sales sheets. On a monthly basis, the credit card company sends
a statement of all credit card receipts from the six venues which is filed by the cashier.
Every two months, the cashier reconciles the bank statements to the bank ledger account.
The reconciliations are reviewed by the financial controller who evidences the review by
signature and these are filed in the accounts department. All purchases of food and
beverages for the venues are paid by bank transfer. The finance director is given the total
amount of the payments list to authorise at the relevant payment dates.

Required:
(b) Identify and explain EIGHT DEFICIENCIES in Camomile Co’s cash receipts and
payments system and provide a control recommendation to address each of these
deficiencies.
Note: The marks will be split equally between each part. (16 marks)

Control deficiency Control recommendation

(Total: 20 marks)

232 RASPBERRY Walk in the footsteps of a top tutor

Answer debrief

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit manager of Grapefruit & Co, the auditor of Raspberry Co.
The interim audit has been completed and you are reviewing the documentation describing
Raspberry Co’s payroll system. Raspberry Co operates an electric power station, which
produces electricity 24 hours a day, seven days a week. The company’s year end was 30 June
20X5.
Systems notes – payroll
Raspberry Co employs over 250 people and approximately 70% of the employees work in
production at the power station. There are three shifts every day with employees working
eight hours each. The production employees are paid weekly in cash. The remaining 30% of
employees work at the head office in non-production roles and are paid monthly by bank
transfer.
The company has a human resources (HR) department, responsible for setting up all new
joiners. Pre-printed forms are completed by HR for all new employees and, once verified, a
copy is sent to the payroll department for the employee to be set up for payment. This form
includes the staff member’s employee number and payroll cannot set up new joiners without
this information.

134 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

To encourage staff to attend work on time for all shifts, Raspberry Co introduced a
discretionary bonus, paid every three months, for production staff. The production
supervisors determine the amounts to be paid and notify the payroll department. This
quarterly bonus is entered into the system by a clerk and each entry is checked by a senior
clerk for input errors prior to processing. The senior clerk signs the bonus listing as evidence
of undertaking this review.
Production employees are issued with clock cards and are required to swipe their cards at
the beginning and end of their shift. This process is supervised by security staff 24 hours a
day. Each card identifies the employee number and links into the hours worked report
produced by the payroll system, which automatically calculates the gross and net pay along
with relevant deductions. These calculations are not checked.
In addition to tax deductions from pay, some employees’ wages are reduced for such items
as repayments of student loans owed to the central government. All employers have a
statutory obligation to remit funds on a timely basis and to maintain accounting records
which reconcile with annual loan statements sent by the government to employers. At
Raspberry Co student loan deduction forms are completed by the relevant employee and
payments are made directly to the government until the employee notifies HR that the loan
has been repaid in full.
On a quarterly basis, exception reports relating to changes to the payroll standing data are
produced and reviewed by the payroll director.
No overtime is worked by employees. Employees are entitled to take 28 holiday days
annually. Holiday request forms are required to be completed and authorised by relevant
line managers, however, this does not always occur.
On a monthly basis, for employees paid by bank transfer, the senior payroll manager reviews
the list of bank payments and agrees this to the payroll records prior to authorising the
payment. If any errors are noted, the payroll senior manager amends the records.
For production employees paid in cash, the necessary amount of cash is delivered weekly
from the bank by a security company. Two members of the payroll department produce the
pay packets, one is responsible for preparing them and the other checks the finished pay
packets. Both members of staff are required to sign the weekly payroll listing on completion
of this task. The pay packets are then delivered to the production supervisors, who distribute
them to employees at the end of the employees’ shift, as they know each member of their
production team.
Monthly management accounts are produced which detail variances between budgeted
amounts and actual. Revenue and key production costs are detailed, however, as there are
no overtime costs, wages and salaries are not analysed.

Required:
(a) In respect of the payroll system of Raspberry Co:
(i) Identify and explain FIVE DIRECT CONTROLS which the auditor may seek to
place reliance on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (10 marks)

Direct control Test of control

KAPLAN PUBLISHING 135

A A : A UDIT AN D ASS URAN CE

(b) Identify and explain FIVE DEFICIENCIES in Raspberry Co’s payroll system and provide
a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

The finance director is interested in establishing an internal audit department (IAD). In the
company the financial director previously worked for the IAD carried out inventory counts,
however, as this is not relevant for Raspberry Co, has asked for guidance on what other
assignments an IAD could be asked to perform.

Required:
(c) Compare and contrast the role of external and internal audit. (5 marks)
(d) Describe assignments the internal audit department of Raspberry Co could carry out.
(5 marks)
(Total: 30 marks)

Calculate your allowed time, allocate the time to the separate parts……………

233 COMET PUBLISHING Walk in the footsteps of a top tutor

This scenario relates to six requirements.

It is 1 July 20X5. You are an audit supervisor of Halley & Co and you are reviewing the
documentation describing Comet Publishing Co’s purchases and payables system in
preparation for the interim and final audit for the year ending 30 September 20X5. The
company is a retailer of books and has ten stores and a central warehouse, which holds the
majority of the company’s inventory.
Your firm has audited Comet Publishing Co for a number of years and as such, audit
documentation is available from the previous year’s file, including internal control flowcharts
and detailed purchases and payables system notes. As far as you are aware, Comet Publishing
Co’s system of internal control has not changed in the last year. The audit manager is keen
for the team to utilise existing systems documentation in order to ensure audit efficiency. An
extract from the existing systems notes is provided below.
Extract of purchases and payables system
Store managers are responsible for ordering books for their shop. It is not currently possible
for store managers to request books from any of the other nine stores. Customers who wish
to order books, which are not in stock at the branch visited, are told to contact the other
stores directly or visit the company website. As the inventory levels fall in a store, the store
manager raises a purchase requisition form, which is sent to the central warehouse. If there
is insufficient inventory held, a supplier requisition form is completed and sent to the
purchase order clerk, Oli Dancer, for processing. Oli sends any orders above $1,000 for
authorisation from the purchasing director.

136 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Receipts of goods from suppliers are processed by the warehouse team, who agree the
delivery to the purchase order, checking quantity and quality of goods and complete a
sequentially numbered goods received note (GRN). The GRNs are sent to the accounts
department every two weeks for processing.
On receipt of the purchase invoice from the supplier, an accounts clerk matches it to the
GRN. The invoice is then sent to the purchase ordering clerk, Oli, who processes it for
payment. The finance director is given the total amount of the payments list, which is then
authorised and bank payments are processed. Due to staff shortages in the accounts
department, supplier statement reconciliations are no longer performed.

Required:
(a) Explain the steps the auditor should take to confirm the accuracy of the purchases
and payables flowcharts and systems notes currently held on file. (5 marks)
(b) In respect of the purchases and payables system of Comet Publishing Co:
(i) Identify and explain FIVE deficiencies
(ii) Recommend a control to address each of these deficiencies, and
(iii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these controls, if implemented, is operating effectively to reduce the identified
deficiency.
Note: The marks will be split equally between each part. (15 marks)

Control deficiency Control recommendation Test of control

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Comet Publishing Co’s purchases and other
expenses. (5 marks)
Other information – conflict of interest
Halley & Co has recently accepted the audit engagement of a new client, Edmond Co, who is
the main competitor of Comet Publishing Co. The finance director of Comet Publishing Co
has enquired how Halley & Co will keep information obtained during the audit confidential.
(d) Explain the safeguards which Halley & Co should implement to ensure that the
identified conflict of interest is properly managed. (5 marks)
(Total: 30 marks)

234 EQUESTRIAN Walk in the footsteps of a top tutor

This scenario relates to five requirements.

Equestrian Co manufactures smartphones and tablets. Its main customers are retailers who
then sell to the general public. The company’s manufacturing is spread across five sites and
goods are stored in its nine warehouses located across the country.
It is 1 July 20X5. You are an audit supervisor in Baseball & Co, and in preparation for the
forthcoming audit for the year ended 30 June 20X5, you are reviewing the following notes
your audit manager has provided you with in relation to the company’s internal controls.

KAPLAN PUBLISHING 137

A A : A UDIT AN D ASS URAN CE

Equestrian Co has a small internal audit (IA) department. During the year, IA started a
programme of physically verifying the company’s assets and comparing the results to the
non-current asset register, as this type of reconciliation had not occurred for some time. To
date only 15% of assets have had their existence confirmed as IA has experienced significant
staff shortages.
During the year, Equestrian Co conducted an extensive reorganisation of its manufacturing
process to improve efficiency. Due to the significant number of employee changes required,
the human resources department (HR) has been very busy and to ease their workload during
this period, the payroll department has assisted by setting up any new employees who have
joined the company. In January 20X5, the wage rate paid to employees was increased by the
HR director. The change in wage rate was communicated to the payroll department by email.
A new receivables system was introduced in May 20X5 and will continue to be run in parallel
with the old system until IA has completed its checks between the two systems. New
customers obtained by the sales team are required to undergo a full credit check. On the
basis of this, a credit limit is proposed by sales staff and approved by the sales director via
email. Credit limits are reviewed every six months by the sales managers and any
amendments are made via a credit limit review form which must be authorised by the sales
director.
Sales invoices are raised by the accounts department using the approved company price list,
which is updated quarterly. Equestrian Co offers discounts to customers depending on the
volume of orders, with an approved discount range of 2% to 10%. Discounts must be
requested by a sales manager and authorised by the sales director to allow the accounts team
to raise an invoice.
Monthly perpetual inventory counts are undertaken at each of the nine warehouses, as a full
year-end inventory count is too disruptive for the company. High value items are stored in a
secure area in each warehouse. Access is via a four-digit code, which for convenience is the
same across all sites. Due to the company’s reorganisation programme, some of the monthly
inventory counts were not performed.
Bank reconciliations are undertaken monthly by an accounts clerk and details of all
reconciling items are included. Where the sum of the reconciling items is significant, the
reconciliation is sent to the financial controller for review.
In order to maximise cash balances, the finance director approves all purchase invoices for
payment 75 days after receipt of the invoice. Payments are made by the cashier’s office by
bank transfer. Invoices are stamped as ‘paid’, and returned to the purchase ledger team who
record the payment and file the invoices separately from invoices not yet paid.

Required:
(a) Describe FOUR different types of control activities as given in ISA 315 (Revised 2019)
Identifying and Assessing the Risks of Material Misstatement and, for each type,
provide an example control a company may implement. (4 marks)
(b) In respect of the internal control systems of Equestrian Co:
(i) Identify and explain FIVE DIRECT CONTROLS which the auditor may seek to
place reliance on; and
(ii) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these direct controls is operating effectively.
Note: The marks will be split equally between each part. (10 marks)
Direct control Test of control

138 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(c) Identify and explain FIVE deficiencies in Equestrian Co’s internal controls and provide
a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

The directors feel that the internal audit team needs to increase in size and specialist skills
are required, but they are unsure whether to recruit more internal auditors, or to outsource
the whole function.
(d) Explain the advantages and disadvantages for Equestrian Co of outsourcing the
internal audit department. (6 marks)
(Total: 30 marks)

235 CATERPILLAR Walk in the footsteps of a top tutor

This scenario relates to three requirements.

Caterpillar Co is a clothing retailer which operates 45 stores throughout the country. The
company’s year end was 30 June 20X5. Caterpillar Co has an internal audit department which
has undertaken a number of internal control reviews specifically focusing on cash controls at
stores during the year. The reviews have taken place in the largest 20 stores as this is where
most issues arise. It is 1 July 20X5. You are an audit supervisor of Woodlouse & Co and are
reviewing the internal controls documentation in relation to the cash receipts system in
preparation for the interim audit which will involve visiting a number of stores and the head
office.
Each of Caterpillar Co’s stores has on average three or four cash tills to take customer
payments. All employees based at the store are able to use each till and individuals do not
have their own log on codes, although employees tend to use the same till each day.
Customers can pay using either cash or a credit card and for any transaction either the credit
card payment slips or cash are placed in the till by the cashier. Where employees’ friends or
family members purchase clothes in store, the employee is able to serve them at the till point.
At the end of each day, the tills are closed down with daily readings of sales taken from each
till. These are reconciled to the total of the cash in the tills and the credit card payment slips
and any discrepancies are noted. Once this reconciliation has taken place, the cash is stored
in the shop’s safe until it is transferred to the bank via collection by a security company the
same day. If the store is low on change for cash payments, a junior sales clerk is sent by a till
operator to the bank with money from the till and asked to change it into smaller
denominations.
The daily sales readings from the tills along with the cash data and credit card payment data
are transferred daily to head office through an interface with the sales and cash receipts
records. A clerk oversees that this transfer has occurred for all stores. On a daily basis, the
clerk agrees the cash transferred by the security company has been banked in full by agreeing
the cash deposit slips to the bank statements, and that the credit card receipts have been
received from the credit card company. On a monthly basis, the same clerk reconciles the
bank statements to the bank ledger account. The reconciliations are reviewed by the financial
controller if there are any unreconciled amounts.

KAPLAN PUBLISHING 139

A A : A UDIT AN D ASS URAN CE

Required:
(a) State FOUR control objectives of Caterpillar Co’s cash receipts system. (4 marks)
(b) Identify and explain THREE DIRECT CONTROLS in Caterpillar Co’s cash receipts system
which the auditor may seek to place reliance on and describe a TEST OF CONTROL
the auditor should perform to assess if each of these controls is operating effectively.
Note: The marks will be split equally between each part. (6 marks)

Direct control Test of control

(c) Identify and explain FIVE DEFICIENCIES in Caterpillar Co’s cash receipts system and
provide a control recommendation to address each of these deficiencies.
Note: The marks will be split equally between each part. (10 marks)

Control deficiency Control recommendation

(Total: 20 marks)

236 BRONZE Walk in the footsteps of a top tutor

This scenario relates to seven requirements.

It is 1 July 20X5. You are an audit supervisor in Scarlet & Co and you are in the process of
reviewing the systems testing completed on the payroll cycle of Bronze Industries Co
(Bronze), as well as preparing the audit programmes for the final audit for the year ending
31 July 20X5.
Bronze operate several chemical processing factories across the country, it manufactures
24 hours a day, seven days a week and employees work a standard shift of eight hours and
are paid for hours worked at an hourly rate. Factory employees are paid weekly, with
approximately 80% being paid by bank transfer and 20% in cash; the different payment
methods are due to employee preferences and Bronze has no plans to change these
methods. The administration and sales teams are paid monthly by bank transfer.
Factory staff are each issued a sequentially numbered clock card which details their
employee number and name. Employees swipe their cards at the beginning and end of the
eight-hour shift and this process is not supervised. During the shift employees are entitled to
a 30-minute paid break and employees do not need to clock out to access the dining area.
Clock card data links into the payroll system, which automatically calculates gross and net
pay along with any statutory deductions. The payroll supervisor for each payment run checks
on a sample basis some of these calculations to ensure the system is operating effectively.
Bronze has a human resources department which is responsible for setting up new
permanent employees and leavers. Appointments of temporary staff are made by factory
production supervisors. Occasionally overtime is required of factory staff, usually to fill gaps
caused by staff holidays. Overtime reports which detail the amount of overtime worked are
sent out quarterly by the payroll department to production supervisors for their review.

140 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

To encourage staff to attend work on time for all shifts Bronze pays a discretionary bonus
every six months to factory staff; the production supervisors determine the amounts to be
paid. This is communicated in writing by the production supervisors to the payroll
department and the bonus is input by a clerk into the system.
For employees paid by bank transfer, the payroll manager reviews the list of the payments
and agrees to the payroll records prior to authorising the bank payment. If any changes are
required, the payroll manager amends the records. For employees paid in cash, the pay
packets are prepared in the payroll department and a clerk distributes them to employees
who knows most of these individuals and therefore does not require proof of identity.

Required:
(a) Explain why the auditor needs to obtain an understanding of the components of
internal control relevant to the preparation of financial statements. (3 marks)
(b) In respect of the payroll system of Bronze Industries Co:
(i) Identify and explain FIVE internal control deficiencies
(ii) Recommend a control to address each of these deficiencies, and
(iii) Describe a test of control Scarlet & Co should perform to assess if each of these
controls is operating effectively.
Note: The marks will be split equally between each part. (15 marks)

Control deficiency Control recommendation Test of control

(c) Describe substantive ANALYTICAL PROCEDURES you should perform to confirm

Bronze Industries Co’s payroll expense. (4 marks)
(d) Explain the factors to be considered in determining the suitability of using analytical
procedures as a substantive procedure. (4 marks)
The directors of Bronze Industries Co are considering establishing an internal audit
department next year, and the finance director has asked what impact, if any, establishing an
internal audit department would have on future external audits performed by Scarlet & Co.

Required:
(e) Explain the potential impact on the work performed by Scarlet & Co during the
interim and final audits, if Bronze Industries Co was to establish an internal audit
department. (4 marks)
(Total: 30 marks)

KAPLAN PUBLISHING 141

A A : A UDIT AN D ASS URAN CE

237 TROMBONE Walk in the footsteps of a top tutor

This scenario relates to six requirements.

Trombone Co operates a chain of hotels across the country. Trombone Co employs in excess
of 250 permanent employees and its year end is 31 August 20X5. It is 1 July 20X5. You are an
audit supervisor of Viola & Co and you are currently reviewing the documentation of
Trombone Co’s payroll system, detailed below, in preparation for the interim audit.
Trombone Co’s payroll system
Permanent employees work a standard number of hours per week as specified in their
employment contract. However, when the hotels are busy, staff can be requested by
management to work additional shifts as overtime. This can either be paid on a monthly basis
or taken as days off.
Employees record any overtime worked and days taken off on weekly overtime sheets which
are sent to the payroll department. The standard hours per employee are automatically set
up in the system and the overtime sheets are entered by clerks into the payroll package,
which automatically calculates the gross and net pay along with relevant deductions.
These calculations are not checked at all. Wages are increased by the rate of inflation each
year and the clerks are responsible for updating the standing data in the payroll system.
Employees are paid on a monthly basis by bank transfer for their contracted weekly hours
and for any overtime worked in the previous month. If employees choose to be paid for
overtime, authorisation is required by department heads of any overtime in excess of 30% of
standard hours. If employees choose instead to take days off, the payroll clerks should check
back to the ‘overtime worked’ report; however, this report is not always checked.
The ‘overtime worked’ report, which details any overtime recorded by employees, is run by
the payroll department weekly and emailed to department heads for authorisation. The
payroll department asks department heads to only report if there are any errors recorded.
Department heads are required to arrange for overtime sheets to be authorised by an
alternative responsible official if they are away on annual leave; however, there are instances
where this arrangement has not occurred.
The payroll package produces a list of payments per employee; this links into the bank system
to produce a list of automatic payments. The finance director reviews the total list of bank
transfers and compares this to the total amount to be paid per the payroll records; if any
issues arise then the automatic bank transfer can be manually changed by the finance
director.

Required:
(a) ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement
describes the five components of an entity’s internal control.
Identify and briefly explain the FIVE components of an entity’s internal control.
(5 marks)

142 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(b) In respect of the payroll system of Trombone Co:

(i) Identify and explain FIVE deficiencies
(ii) Recommend a control to address each of these deficiencies, and
(iii) Describe a test of control Viola & Co should perform to assess if each of these
controls is operating effectively.
Note: The marks will be split equally between each part. (15 marks)

Control deficiency Control recommendation Test of control

(c) Describe substantive procedures the auditor should perform at the final audit to
obtain sufficient and appropriate evidence in relation to COMPLETENESS and
ACCURACY of Trombone Co’s payroll expense. (6 marks)
Trombone Co deducts employment taxes from its employees’ wages on a monthly basis and
pays these to the local taxation authorities in the following month. At the year end the
financial statements will contain an accrual for income tax payable on employment income.
You will be in charge of auditing this accrual.

Required:
(d) Describe the audit procedures required in respect of the year-end accrual for tax
payable on employment income. (4 marks)
(Total: 30 marks)

238 LILY WINDOW GLASS Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit senior in Daffodil & Co and you are responsible for the audit
of inventory for Lily Window Glass Co (Lily), including attending the year end inventory count.
Lily is a glass manufacturer, which operates from a large production facility, where it
undertakes continuous production 24 hours a day, seven days a week. Also on this site are
two warehouses, where the company’s raw materials and finished goods are stored. Lily’s
year end is 31 July 20X5.
Lily is finalising the arrangements for the year-end inventory count, which is to be undertaken
on 31 July 20X5. The finished windows are stored within 20 aisles of the first warehouse. The
second warehouse is for large piles of raw materials, such as sand, used in the manufacture
of glass. The following arrangements have been made for the inventory count.
The warehouse manager will supervise the count as due to being the individual who is most
familiar with the inventory. There will be ten teams of counters and each team will contain
two members of staff, one from the finance and one from the manufacturing department.
None of the warehouse staff, other than the manager, will be involved in the count.
Each team will count an aisle of finished goods by counting up and then down each aisle. As
this process is systematic, it is not felt that the team will need to flag areas once counted.

KAPLAN PUBLISHING 143

A A : A UDIT AN D ASS URAN CE

Once the team has finished counting an aisle, they will hand in their sheets and be given a
set for another aisle of the warehouse. In addition to the above, to assist with the inventory
counting, there will be two teams of counters from the internal audit department and they
will perform inventory counts.
The count sheets are sequentially numbered, and the product codes and descriptions are
printed on them but no quantities. If the counters identify any inventory which is not on their
sheets, then they are to enter the item on a separate sheet, which is not numbered. Once all
counting is complete, the sequence of the sheets is checked and any additional sheets are
also handed in at this stage. All sheets are completed in ink.
Any damaged goods identified by the counters will be too heavy to move to a central location,
hence they are to be left where they are but the counter is to make a note on the inventory
sheets detailing the level of damage.
As Lily undertakes continuous production, there will continue to be movements of raw
materials and finished goods in and out of the warehouse during the count. These will be
kept to a minimum where possible.
The level of work-in-progress in the manufacturing plant is to be assessed by the warehouse
manager. It is likely that this will be an immaterial balance. In addition, the raw materials
quantities are to be approximated by measuring the height and width of the raw material
piles. In the past this task has been undertaken by a specialist; however, the warehouse
manager feels confident enough to perform this task.
Approximately 10% of the space in the finished goods warehouse has been rented out to
third parties with similar operations. For completeness, the counters have been asked to
count the inventory for all bays noting the third-party inventories on separate blank
inventory sheets, and the finance department will make any necessary adjustments.

Required:
(a) Identify and explain SEVEN DEFICIENCIES in Lily Window Glass Co’s inventory count
arrangements and provide a control recommendation to address each of these
deficiencies
Note: The marks will be split equally between each part. (14 marks)

Control deficiency Control recommendation

(b) Describe the procedures to be undertaken by the auditor DURING the inventory
count of Lily Window Glass Co in order to gain sufficient appropriate audit evidence.
(6 marks)
Your manager wishes to utilise automated tools and techniques for the first time for controls
and substantive testing in auditing Lily Window Glass Co’s inventory.
Required:
(c) For the audit of the inventory cycle and year-end inventory balance of Lily Window
Glass Co, describe FOUR audit procedures that could be carried out using automated
tools and techniques. (4 marks)
(d) Explain the potential advantages and disadvantages of using automated tools and
techniques, including data analytics. (6 marks)
(Total: 30 marks)

144 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

SUBSTANTIVE PROCEDURES, COMPLETION AND REPORTING

239 COOKIT CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Cookit Co owns ten shops selling kitchen equipment. Your firm, Beeny & Co,
is about to commence the final audit for the year ended 31 May 20X5. Draft profit before
income taxes is $22.8m (20X4: $19.7m) and net assets are $84.3m (20X4: $77.7m). The
following matters have been brought to your attention:
Inventory
Cookit Co sells a range of cookery products endorsed by a famous TV chef, Remy Gusteau. In
February 20X5, the TV company that produced his show cancelled the programme which led
to a reduction in demand for Remy Gusteau products. Cookit Co stopped purchasing these
goods in March 20X5. Total inventory in the draft financial statements for the year ended
31 May 20X5 is $4.25m. Cookit Co's system-generated inventory valuation report shows that
this includes Remy Gusteau products at a cost of $1.7m. A member of the audit team
attended the year-end inventory count of Cookit Co.
Decrease in trade payables
The accounts payable clerk left the company in January 20X5 and no replacement has
yet been hired. The following information has been provided by the finance director of
Cookit Co:

31 May 20X5 31 May 20X4

Trade payables $2.8m $3.5m
Payables payment period 53 days 72 days

The finance director also mentioned that no reconciliations of supplier statements had been
performed since December 20X4. The audit team has decided not to perform a year-end
payables circularisation as response rates in previous years were low.
Redundancy provision
In May 20X5, the management of Cookit Co decided to close down one of the shops as it is
unprofitable. An announcement of this decision was made on the company’s website on
28 May 20X5 and staff informed of the timetable for closure. All 32 staff employed in the
shop are to be made redundant and a redundancy provision of $1.8m is included in the draft
financial statements for the year ended 31 May 20X5. The closure is expected to take place
in September 20X5.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Cookit Co’s inventory.
(5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Cookit Co's trade
payables. (5 marks)

KAPLAN PUBLISHING 145

A A : A UDIT AN D ASS URAN CE

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Cookit Co’s redundancy provision.
(5 marks)
The final audit is now nearing completion and you are reviewing the financial statements.
The directors have told you that they have decided against including the redundancy
provision of $1.8m in the financial statements for the year ended 31 May 20X5 as the closure
of the shop will not take place until September 20X5.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

240 LATTE CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Macchiato & Co currently working on the
final audit of Latte Co, a supplier of catering equipment, for the year ended 31 March 20X5.
Latte Co is a listed company with total assets of $22.7m and profit before income taxes of
$3.2m. You are responsible for finalising the audit fieldwork in respect of the following:
Trade receivables
Latte Co's net trade receivables balance is $5.1m which comprises trade receivables of $5.5m
and an allowance for receivables of $0.4m at 31 March 20X5 (20X4: receivables of $4.4m and
an allowance of $0.6m). As a result of a lack of responses in prior years, the audit engagement
partner has decided that a trade receivables circularisation will not be performed this year.
Instead, the adut engagement partner has asked you to identify alternative substantive
procedures to confirm the existence and valuation of trade receivables.
Provision for legal claim
A former employee of Latte Co has made a claim for $0.6m against the company in respect
of an injury suffered while operating equipment which did not have the correct safety
equipment installed. The directors have recognised a provision of $0.25m in the current year
financial statements which is the maximum amount they are willing to pay to settle the claim.
Bank loan
Latte Co obtained a new three-year bank loan of $1m on 1 October 20X4 to finance the
purchase of new equipment. The loan attracts an interest rate of 5%. Under the terms of the
loan, 10 payments of $105,000, comprising capital and interest, are due to be made on a
quarterly basis commencing 31 December 20X4. Latte Co did not make the quarterly
payment due on 31 March 20X5 until 15 April 20X5.

Requirements
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to the EXISTENCE and VALUATION of Latte Co’s
trade receivables. (6 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Latte Co’s provision for the legal claim.
(4 marks)

146 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate evidence in relation to Latte Co’s bank loan. (5 marks)
It is now 12 August 20X5. During the audit of the legal claim against Latte Co, the audit team
concluded that a provision of $0.6m should be recognised, rather than the $0.25m originally
provided for. A significant increase in the provision was required, in order to comply with
IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The audit engagement
partner has determined that the provision is now appropriately valued and that this issue
should be communicated as a key audit matter (KAM) in accordance with ISA 701
Communicating Key Audit Matters in the Independent Auditor's Report.
(d) (i) Describe the factors which the audit engagement partner would have
considered in determining that this issue is a KAM; and
(ii) Describe the content of the KAM section of the auditor’s report for Latte Co.
(5 marks)
(Total: 20 marks)

241 HERON Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor of Owl & Co, responsible for the final audit of
Heron Co for the year ended 31 May 20X5 which is due to commence shortly. Heron Co is a
manufacturer of colour dyes used in the texƟle industry. Its draŌ financial statements show
total assets of $65.4m and profit before income taxes of $8.9m. The following maƩers have
been brought to your aƩenƟon:
Additions to plant and equipment
Heron Co incurred significant asset (capital) expenditure in the year as it purchased a new
manufacturing line. All costs incurred in the purchase and installation of the manufacturing
line have been recognised as plant and equipment within non-current assets. The amount
capitalised of $3.6m includes the purchase price of $2.7m, delivery and installation costs of
$0.3m, refundable purchase tax of $0.5m and $0.1m incurred in training staff on how to
operate the new plant and equipment.
In addition to the $3.6m capitalised, Heron Co incurred costs of $0.2m testing the quality of
the dye being produced by the new manufacturing line. The finance director has also
capitalised this cost within plant and equipment. Heron Co started using the new
manufacturing line in December 20X4 and it has a useful life of eight years.
Bank balances
The bank figure included in Heron Co’s draft financial statements comprises four bank
account balances: an overdraft of $2.4m which is the company’s main current account and a
total of $0.6m relating to three savings accounts. The finance director has informed the audit
team that all four accounts have been reconciled as at the year end.

KAPLAN PUBLISHING 147

A A : A UDIT AN D ASS URAN CE

Provision for legal claim

Parrot Co, a customer of Heron Co, has made a claim for $0.8m against the company. Parrot
Co is claiming that a customised yellow dye purchased from Heron Co in March 20X5 was
substandard and that, as a result, Parrot Co had to scrap a large batch of clothes it was
producing. The finance director has included a provision of $0.6m in the draft financial
statements for the year ended 31 May 20X5 due to the belief that this is the likely sum to be
paid to settle the claim. The yellow dye was not sold to any other customers and Heron Co
does not hold any inventory of the dye at the year end.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the matters identified regarding Heron Co’s
ADDITIONS to plant and equipment. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Heron Co’s bank balances. (5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Heron Co’s provision for the legal claim.
(5 marks)
It is now 28 August 20X5 and the audit of Heron Co is almost complete. The auditor's report
is due to be signed shortly. The following matter has been brought to your attention:
On 14 July 20X5, Sparrow Co, a customer of Heron Co with a receivables balance of $692,000
at 31 May 20X5, notified Heron Co that it was experiencing significant cash flow difficulties
and would be unable to make any payments for the foreseeable future. The finance director
of Heron Co believes that as Sparrow Co is a long-standing customer and has been trading
for many years, the outstanding amount will be received in full in due course, and has
therefore not adjusted the receivable balance in the financial statements for the year ended
31 May 20X5.
(d) (i) Explain whether the 20X5 financial statements of Heron Co require
amendment in relation to the outstanding balance with Sparrow Co; and
(ii) Describe TWO audit procedures which should be performed in order to form a
conclusion on any required amendment. (5 marks)
(Total: 20 marks)

148 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

242 PACIFIC Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Pacific Co operates a chain of 14 retail stores across the country, selling its
own range of cosmetic products. You are the audit supervisor of Caribbean & Co and the final
audit is due to commence shortly for the year ended 31 May 20X5. Draft financial statements
show revenue of $45.2m and profit before income taxes of $4.1m. The following three
matters have been brought to your attention:
Trade payables and accruals
As part of the year-end process, Pacific Co’s payables ledger is closed at the end of the day
on 31 May. Any invoices received after this date, relating to goods received before the year
end, are recorded in the goods received not invoiced (GRNI) accrual.
This year, the payables ledger was kept open in error until 1 June 20X5. As a result, a
significant payment run for suppliers made by bank transfer on 1 June 20X5 was recorded in
the 20X5 payables ledger. The finance director has confirmed that the year-end trade
payables balance was corrected using a journal.
Provision for legal claims
In March 20X5, a number of claims were received by the company from customers who
suffered severe allergic reactions after using one of Pacific Co's products. They allege that the
product ingredients listed on the label were incorrect. An internal investigation has suggested
that one batch of the product had been incorrectly labelled. The finance director has
recognised a provision in the draft financial statements of $0.5m.
Revenue
The company’s revenue has increased by $3.9m during the year (20X4: total revenue
$41.3m). The management accounts record information for revenue by key product line, of
which there are eight, and also by store. In August 20X4, Pacific Co opened a new retail store,
bringing the number of stores to 14. In addition, it launched a number of new products across
most of the key product lines.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Pacific Co’s trade
payables and accruals. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Pacific Co’s provision for the legal claims.
(6 marks)
(c) Describe SUBSTANTIVE ANALYTICAL procedures the auditor should perform to
obtain sufficient and appropriate audit evidence in relation to Pacific Co's revenue.
(4 marks)
During the audit of Pacific Co's provision for the legal claims, the audit team gathered audit
evidence showing that the provision should amount to $0.8m. The finance director has
suggested that no adjustment is made in the 20X5 financial statements due to the belief that
$0.5m is a reasonable estimate and that the difference of $0.3m is not material.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

KAPLAN PUBLISHING 149

A A : A UDIT AN D ASS URAN CE

243 SPINACH Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor with Sweetcorn & Co and are responsible for the
final audit of your existing client Spinach Co, which is due to commence in September 20X5.
Spinach Co is a listed company which manufactures garden furniture. Its draft financial
statements for the year ending 31 July 20X5 show revenue of $65.1m and profit before
income taxes of $18.2m. The following matters have been brought to your attention:
Revenue
Spinach Co’s revenue is generated through sales to individual customers via its website and
also to wholesale customers such as garden centres and stores. Price increases in line with
inflation were applied across all products in September 20X4. Spinach Co successfully
launched three new product lines in February 20X5.
Wholesale customers place their orders on credit via Spinach Co’s sales ordering department.
Individual customers place their order online and immediately pay the full amount owing.
The goods are normally despatched within seven days of the customer placing the order.
Inventory count
Spinach Co is forecasting a year-end inventory balance of $9.3m. The company undertakes
continuous production and full year-end inventory counts will be carried out on 31 July 20X5.
Spinach Co’s raw materials and finished goods inventory are stored in its six warehouses
which are located across the country. The company has one factory site and it is expected
that there will be no significant work-in-progress held at the year end. Each inventory count
will be supervised by a member of Spinach Co’s internal audit department. There will be no
movements of goods in and out of the warehouses during the counts. Sweetcorn & Co will
only attend some of the counts.
The largest warehouse is located at the factory site and around 10% of this warehouse space
is rented out to a third-party company, which stores its inventory of cleaning products there.
The finance director has explained that the third-party inventory is located in one specific
area of the warehouse.
Issue of share capital
The company is looking to expand its operations by securing an additional factory site in
January 20X6. In order to raise sufficient capital to fund the factory purchase, Spinach Co
issued ordinary shares at a premium in May 20X5, raising a sum of $4.3m.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Spinach Co’s revenue. (5 marks)
(b) Describe the audit procedures the auditor should perform as part of the audit of
Spinach Co BEFORE and DURING the inventory count. (6 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Spinach Co’s issue of share capital.
(4 marks)

150 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

It is now 12 November 20X5. During the audit of Spinach Co’s inventory, the audit team
identified five product lines which were very slow moving and concluded that the net
realisable value of these goods was below cost. A significant write down of inventory was
required in order to comply with IAS® 2 Inventories. The audit engagement partner has
determined that inventory is now appropriately valued and that this issue should be
communicated as a key audit matter (KAM) in accordance with ISA 701 Communicating Key
Audit Matters in the Independent Auditor's Report.
(d) (i) Describe the factors which the audit engagement partner would have
considered in determining that this issue is a KAM, and
(ii) Describe the content of the KAM section of the auditor’s report for Spinach Co.
(5 marks)
(Total: 20 marks)

244 DANUBE Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. Danube Co is listed on a stock exchange and sells consumer goods to
wholesale customers. The company has a large head office and 18 warehouses. You are an
audit supervisor of Mississippi & Co and the final audit for the year ended 31 March 20X5 is
due to commence shortly. The draft financial statements show total assets of $198.5m and
profit before income taxes of $56.1m. The following three matters have been brought to your
attention.
Land and buildings
Danube Co historically recorded all property, plant and equipment (PPE) at cost less
accumulated depreciation. However, during the year, management decided to change the
accounting policy for land and buildings from the cost model to the revaluation model. The
finance director hired an external independent valuer to undertake the valuation of all land
and buildings, and this took place in July 20X4. Depreciation is calculated monthly on a pro-
rata basis. Danube Co’s year-end balance for PPE includes land and buildings of $79.2m
(20X4: $64m).
Trade receivables circularisation
Danube Co’s year-end trade receivables balance of $9.3m (20X4: $7.7m) has significantly
increased compared to the prior year. Danube Co’s list of individual customers is made up of
a large number of customers with balances ranging from $15,000 to $50,000. A positive trade
receivables circularisation has been undertaken by the audit team based on the year-end
balances. The majority of responses from customers agreed to the balances as per
Danube Co’s list of individual customers at 31 March 20X5, however the following exceptions
were noted.
Customer Balance per Danube Co Response from customer
Nile Co $141,102 No response
Congo Co $136,321 $122,189

KAPLAN PUBLISHING 151

A A : A UDIT AN D ASS URAN CE

Provision and receivable arising from the sale of defective goods

In December 20X4 Danube Co sold a number of hoverboards to a customer, Kalama Kids Co.
It is alleged by Kalama Kids Co that these hoverboards are faulty, as there have been a few
instances of the hoverboards overheating and catching fire. As a result, Kalama Kids Co is
suing Danube Co for $3.9m. The court case is due to take place in August 20X5 and
management believes that Kalama Kids Co’s claim is likely to be successful. No hoverboards
remain in Danube Co’s inventory at the year end.
Danube Co purchased the hoverboards from a supplier, Thames Co. In February 20X5 Danube
Co contacted Thames Co and requested that they reimburse Danube Co for damages which
may become payable as a result of the sale of defective hoverboards. Danube Co is
requesting a sum of $3.9m from Thames Co. The draft financial statements contain a
provision of $3.9m in respect of the customer’s claim and a receivable of $3.9m in respect of
Danube Co’s counter-claim against its supplier.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Danube Co's land and buildings. (6 marks)
(b) Describe the procedures the auditor should perform in relation to the exceptions
noted during the trade receivables circularisation in respect of Nile Co and Congo Co.
Note: The total marks will be split equally between each customer. (4 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the PROVISION and the RECEIVABLE arising
from the sale of defective goods. (5 marks)
The audit engagement partner has determined that the issue relating to the provision and
receivable arising from the sale of defective goods should be communicated as a key audit
matter (KAM) in accordance with ISA 701 Communicating Key Audit Matters in the
Independent Auditor’s Report.
(d) (i) Describe the factors which the audit engagement partner would have
considered in determining that this issue is a KAM, and
(ii) Describe the content of the KAM section of the auditor’s report for Danube Co.
(5 marks)
(Total: 20 marks)

245 PURRFECT CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Purrfect Co manufactures and sells a variety of food for dogs and cats. Your
firm, Kirano & Co, has audited the company for a number of years. You are about to
commence the final audit for the year ended 31 March 20X5 and the draft financial
statements show profit before income taxes of $23.1m and total assets of $99.2m.
Vego Dog – inventory valuation
Purrfect Co launched a new brand of vegan dog food, Vego Dog, in December 20X4 but sales
have been lower than expected and the directors are considering a discounted sales price.
Vego Dog products are valued using a standard costing method and the standard cost
comprises raw materials, labour costs and production overheads. As at 31 March 20X5,
Vego Dog products with a standard cost of $2.4m were included as finished goods in
inventory.
152 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Receivable – Ellah Co
One of Purrfect Co’s major customers, Ellah Co, operates a chain of pet stores with 23 stores
across the country. There have been reports in the press for several months that Ellah Co’s
sales and profits have been falling and, in March 20X5, Ellah Co announced that 11 of its
stores were to close in May 20X5. As at 31 March 20X5, Purrfect Co’s trade receivables
included $2.6m outstanding from Ellah Co and no allowance has been included for this
balance at the year end.
Contamination – legal claims
On 25 February 20X5, it was discovered that a batch of canned cat food had been
contaminated with insecticide, which could be harmful to cats. This batch had been
despatched in November 20X4 to 247 retail stores. By 31 March 20X5, Purrfect Co had
received legal claims totalling $1.9m from consumers whose cats had eaten the
contaminated food.
Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the matters identified regarding the
inventory valuation of Vego Dog products. (6 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the receivable balance due from Ellah Co.
(4 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the legal claims following the
contamination. (5 marks)
The final audit is now nearing completion. The audit team is satisfied that legal claims
received to date have been appropriately reflected in the financial statements.
However, Purrfect Co’s lawyer has advised you that it is possible that significant additional
legal claims may be made by customers in future in respect of the contamination. The audit
engagement partner has confirmed that this is a contingent liability that requires disclosure.
The finance director has agreed to disclose some detail of the potential claims in the financial
statements but the audit team is yet to confirm the adequacy of these disclosures.
(d) Discuss the issue and describe the impact on the auditor’s report of Purrfect Co of
both adequate AND inadequate disclosure of the contingent liability. (5 marks)
(Total: 20 marks)

246 SAGITTARII & CO Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit manager of Sagittarii & Co and you are in charge of two final
audits which are due to commence shortly. Vega Vista Co and Canopus Co are both existing
clients with a financial year ended 31 March 20X5. Vega Vista Co is a not-for-profit charitable
organisation which raises funds for disadvantaged families and the draft financial statements
show revenue of $0.8m. Canopus Co manufactures paint products in seven factories across
the country and the draft financial statements show total equity and liabilities of $11.6m.
The following matters have been brought to your attention for each company.

KAPLAN PUBLISHING 153

A A : A UDIT AN D ASS URAN CE

Vega Vista Co
Income
Vega Vista Co generates income in a number of ways. The main source of income is via an
annual food and music festival held in September every year. Tickets, which cost $35, are
sold in the nine-month period prior to the event and can be purchased in advance online or
on the day of the event for cash.
Approximately 15,000 people attended the September 20X4 event and more are anticipated
for 20X5. At the event there are a number of stalls selling food and the charity receives a
fixed percentage of these sundry sales. Also, during the festival, volunteers of the charity sign
up individuals to make monthly donations, and these are paid by bank transfer to the charity.
During the audit planning, the completeness and cut-off of income was flagged as a key audit
risk.
Canopus Co
Restructuring provision
Canopus Co recently announced plans to fundamentally restructure its production processes
due to a change in the focus of the company’s operations. It has included a $2.1m
restructuring provision in the draft financial statements. The restructure involves a
refurbishment of the factories, the purchase of new plant and equipment and retraining of
existing staff. These plans were finally agreed at a board meeting in March 20X5 and
announced to shareholders and employees just before the year end.
Bank loans
In readiness for the operational changes, the directors of Canopus Co decided to restructure
the company’s bank loans. As a result, several long-term loans were repaid early and a new
ten-year bank loan of $4.8m was taken out on 1 January 20X5. Repayments of $150,000 are
due quarterly in arrears which includes interest.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Vega Vista Co's income.
Note: You should assume that the charity adopts International Financial Reporting Standards.
(5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Canopus Co's restructuring provision.
(5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Canopus Co's bank loans. (5 marks)
During the audit of Canopus Co's restructuring provision, the audit team discovered that
$270,000 of costs included did not meet the criteria for inclusion as per IAS 37 Provisions,
Contingent Liabilities and Contingent Assets. The finance director has suggested that no
adjustment is made in the 20X5 financial statements as the provision is a matter of
judgement and the provision has been deemed reasonable by the board.
(d) Discuss the issue and describe the impact on the auditor's report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

154 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

247 ENCORE Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit supervisor with Velo & Co and you are working on the final
audit of Encore Co for the year ended 30 April 20X5. Encore Co is a waste management
company, supplying its services to a variety of governmental and business organisations.
Encore Co’s draft profit before income taxes is $5.3m (20X4: $4.6m) and total assets are
$40.1m (20X4: $33.9m). You have been provided with the following information regarding
the draft financial statements.
Vehicle additions and disposals
On 1 February 20X5, Encore Co replaced 20 of its recycling vehicles. The old vehicles had a
carrying amount of $1.8m, as recorded in the non-current asset register and were given in
part-exchange against new vehicles costing $4.6m. Cash consideration of $3.9m was also
paid.
Trade receivables
Encore Co’s credit controller left the company in January 20X5 and has only recently been
replaced. The trade receivables collection period increased from 49 days as at 31 December
20X4 to 66 days as at 30 April 20X5. Year-end trade receivables amounted to $9.1m
(20X4: $7.1m) and an allowance for credit losses/receivables of $182,000 (20X4: $142,000)
has been made.
Potential breach of transport regulations
In March 20X5, a former employee of Encore Co made a complaint to the transport authority,
alleging that Encore Co has breached the regulations concerning maximum driving hours and
compulsory rest breaks for drivers on a number of occasions. The transport authority has
launched an investigation but the directors of Encore Co are not intending to disclose this
issue or make any provision as they do not believe that the potential fine, which is $50,000
per breach, is material.
Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Encore Co’s vehicle additions and disposals.
(6 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Encore Co’s trade
receivables. (5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the potential breach of transport
regulations by Encore Co. (4 marks)
It is now 26 August 20X5 and the auditor’s report for Encore Co is being finalised. On
12 August 20X5, the transport authority announced that it was taking legal action against
Encore Co in respect of 17 breaches of the regulations. Encore Co’s lawyers have advised that
it is probable Encore Co will be found guilty of all of the breaches. Encore Co’s directors have
informed you that no provision will be made in respect of this matter, as the decision by the
authority to take legal action was made after the year end, but they have agreed to disclose
the issue in the notes to the financial statements.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

KAPLAN PUBLISHING 155

A A : A UDIT AN D ASS URAN CE

248 SPADEFISH Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5 and you are an audit manager of Spadefish & Co and you are currently
responsible for the audits of two existing clients:
Triggerfish Co manufactures hair products and its year ended on 31 May 20X5. You are
finalising the audit programmes for the forthcoming audit.
Marlin Co is a distributor of electronic goods and its year ended on 30 April 20X5. The audit
is almost complete and the auditor's report is due to be signed shortly.
The following matters have been brought to your attention for each company.
Triggerfish Co – Receivables
Triggerfish Co’s draft year-end trade receivables are $3.85m (20X4: $2.45m) and revenue for
the year is slightly increased on 20X4. Triggerfish Co has a large number of customers with
balances ranging from $5,000 to $45,000. A positive receivables circularisation has been
undertaken based on the year-end balances. The majority of responses from customers
agreed to the balances as per Triggerfish Co’s list of individual customers, however, the
following exceptions were noted:
Balance per Triggerfish Response from customer
Albacore Co $36,558 Nil response
Flounder Co $24,115 $18,265
Menhaden Co –$5,360 (Credit) $3,450
Due to the increase in receivables, Triggerfish Co has recently recruited an additional credit
controller to chase outstanding receivables. As a result of the additional focus on chasing
outstanding receivables the finance director thinks it is not necessary to continue to maintain
a significant allowance for credit losses/receivables and has reduced the closing allowance
from $125,000 to $5,000.
Marlin Co – Going concern
During the year under audit Marlin Co has consistently paid a number of its suppliers
significantly later than usual and only after several reminders. As a result, some of its
suppliers have withdrawn credit terms meaning the company must pay cash on delivery. The
company has also just received notification that its main supplier who provides the company
with over 60% of its specialist electrical equipment has ceased to trade.
The overdraft has increased significantly over the year and the directors have informed you
that the overdraft facility is due for renewal next month, and they are confident it will be
renewed. The directors have decided that in order to conserve cash, no final dividend will be
paid in 20X5.

Required:
(a) Describe the procedures the auditor should perform to resolve the exceptions noted
for each customer during the positive receivables circularisation for Triggerfish Co.
(8 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the allowance for credit losses/receivables
in the current year. (4 marks)

156 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

(c) Identify and explain THREE potential indicators that Marlin Co is NOT a going
concern. (3 marks)
(d) Describe the audit procedures the auditor should perform in assessing whether or
not Marlin Co is a going concern. (5 marks)
(Total: 20 marks)

249 HYACINTH Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. Hyacinth Co develops and manufactures computer components and its year
end was 30 April 20X5. The company has a large factory, and two warehouses, one of which
is off-site. You are an audit supervisor of Tulip & Co and the final audit is due to commence
shortly. Draft financial statements show total assets of $23.2m and profit before income
taxes of $6.4m. The following three matters have been brought to your attention:
Inventory valuation
Your firm attended the year-end inventory count for Hyacinth Co and confirmed that the
controls and processes for recording work-in-progress (WIP) and finished goods were
acceptable. WIP and finished goods are both material to the financial statements and the
audit team was able to confirm both the quantity and stage of completion of WIP.
Before goods are despatched, they are inspected by the company’s quality control
department. Just prior to the inventory count, it was noted that a batch of product line
‘Crocus’, which had been produced to meet a customer’s specific technical requirements, did
not meet that customer’s quality and technical standards. This inventory had a production
cost of $450,000. Upon discussions with the production supervisor, the finance director
believes that the inventory can still be sold to alternative customers at a discounted price of
$90,000.
Research and development
Hyacinth Co includes expenditure incurred in developing new products within intangible
assets once the recognition criteria under IAS 38 Intangible Assets have been met. Intangible
assets are amortised on a straight-line basis over four years once production commences.
The amortisation policy is based on past experience of the likely useful lives of the products.
The opening balance of intangible assets is $1.9m.
In the current year, Hyacinth Co spent $0.8m developing three new products which are all at
different stages of development.
Sales tax liability
Hyacinth Co is required by the relevant tax authority in the country in which it operates to
charge sales tax at 15% on all products which it sells. This sales tax is payable to the tax
authority. When purchasing raw materials and incurring expenses in the manufacturing
process, the company pays 15% sales tax on any items purchased and this can be reclaimed
from the tax authority.
The company is required to report the taxes charged and incurred by completing a tax return
on a quarterly basis, and the net amount owing to the tax authority must be remitted within
four weeks of the quarter end. The draft financial statements contain a $1.1m liability for
sales tax for the quarter ended 30 April 20X5.

KAPLAN PUBLISHING 157

A A : A UDIT AN D ASS URAN CE

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Hyacinth Co’s inventory.
(6 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Hyacinth Co’s research and development
expenditure. (4 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Hyacinth Co’s year-end sales tax liability.
(4 marks)
The audit is now almost complete and the auditor’s report is due to be signed shortly. The
following matter has been brought to your attention:
On 3 June 20X5, a flood occurred at the off-site warehouse. This resulted in some damage to
inventory and property, plant and equipment. However, there have been no significant
delays to customer deliveries or complaints from customers. Hyacinth Co’s management has
investigated the cause of the flooding and believes that the company is unlikely to be able to
claim on its insurance. The finance director of Hyacinth Co has estimated that the value of
damaged inventory and property, plant and equipment was $0.7m and that it now has no
scrap value.
(d) (i) Explain whether the 20X5 financial statements of Hyacinth Co require
amendment in relation to the flood, and
(ii) Describe audit procedures which should be performed in order to form a
conclusion on any required amendment.
Note: The total marks will be split equally between each part. (6 marks)
(Total: 20 marks)

250 JASMINE Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Jasmine Co manufactures motor vehicle components and its year end was
30 April 20X5. You are an audit supervisor of Peppermint & Co and the final audit is due to
commence shortly. Total assets are $43.2m and profit before income taxes is $7.2m. The
following matters have been brought to your attention.
Trade receivables
Jasmine Co’s list of individual customers comprises a large number of customers. In previous
years, the audit team has undertaken a positive trade receivables circularisation to confirm
year-end balances. However, the customer response rate has historically been low and so
alternative audit procedures have been undertaken. A decision has been made that for the
current year audit a circularisation will not be performed.
The year-end trade receivables balance is $3.9m (20X4: $2.8m) and the allowance for credit
losses/trade receivables is $410,000 (20X4: $300,000).

158 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Bank balances
The bank and cash figure included in Jasmine Co’s draft financial statements is comprised of
a number of bank account balances: an overdraft of $5.1m which is the company’s main
current account and $0.2m relating to several savings accounts. The finance director has
informed the audit manager that all accounts have been reconciled as at the year end.
The overdraft of $5.1m has increased significantly since the prior year (20X4: $1.2m). The
directors have informed you that the overdraft facility, which the company requires in order
to operate on a daily basis, is due for renewal in August 20X5 and that they are confident it
will be renewed.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Jasmine Co’s trade receivables. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Jasmine Co’s bank balances. (5 marks)
(c) Describe the audit procedures the auditor should perform in assessing whether or
not Jasmine Co is a going concern. (5 marks)
During the final audit, the finance director has informed the audit team that Jasmine Co’s
bankers will not make a decision on the renewal of the overdraft facility until after the
auditor’s report is signed. The audit engagement partner is satisfied that the use of the going
concern basis is appropriate.
The directors have agreed to include some brief going concern disclosures in the draft
financial statements and the audit team still have to assess the adequacy of these disclosures.
(d) Discuss the issue and describe the impact on the auditor’s report of Jasmine Co of
adequate AND inadequate going concern disclosure. (5 marks)
(Total: 20 marks)

251 GOOSEBERRY Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit manager of Cranberry & Co and you are currently
responsible for the audit of Gooseberry Co, a company which develops and manufactures
health and beauty products and distributes these to wholesale customers. Its draft profit
before income taxes is $6.4m and total assets are $37.2m for the financial year ended 30
April 20X5. The final audit is due to commence shortly and the following matters have been
brought to your attention.
Research and development
Gooseberry Co spent $1.9m in the current year developing nine new health and beauty
products, all of which are at different stages of development. Once they meet the recognition
criteria under IAS® 38 Intangible Assets for development expenditure, Gooseberry Co
includes the costs incurred within intangible assets. Once production commences, the
intangible assets are amortised on a straight-line basis over three years.
Management believes that this amortisation policy is a reasonable approximation of the
assets’ useful lives, as in this industry there is constant demand for innovative new products.

KAPLAN PUBLISHING 159

A A : A UDIT AN D ASS URAN CE

Depreciation
Gooseberry Co has a large portfolio of property, plant and equipment (PPE). In June 20X5,
the company carried out a full review of all its PPE and updated the useful lives, residual
values, depreciation rates and methods for many categories of asset. The finance director
felt the changes were necessary to better reflect the use of the assets. This resulted in the
depreciation charge of some assets changing significantly for this year.
Bonus
The company’s board is comprised of seven directors. They are each entitled to a bonus
based on the draft year-end net assets, excluding intangible assets. Details of the bonus
entitlement are included in the directors’ service contracts.
The bonus, which related to the 20X5 year end, was paid to each director in May 20X5 and
the costs were accrued and recognised within wages and salaries for the year ended
30 April 20X5. Separate disclosure of the bonus, by director, is required by local legislation.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Gooseberry Co’s research and development
expenditure. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the matters identified regarding
depreciation of property, plant and equipment. (5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the directors’ bonuses. (5 marks)
During the audit, the team discovers that the intangible assets balance includes $440,000
related to one of the nine new health and beauty products development projects, which does
not meet the criteria for capitalisation. As this project is ongoing, the finance director has
suggested that no adjustment is made in the 20X5 financial statements. The finance director
s confident that the project will meet the criteria for capitalisation in 20X6.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

252 DASHING Walk in the footsteps of a top tutor

This scenario relates to six requirements.

It is 1 July 20X5. Dashing Co manufactures women’s clothing and its year end was 30 April
20X5. You are an audit supervisor of Jaunty & Co and the final audit for Dashing Co is due to
commence shortly.
The draft financial statements recognise profit before income taxes of $2.6m and total assets
of $18m. You have been given responsibility for auditing receivables, which is a material
balance, and as part of the audit approach, a positive receivables circularisation is to be
undertaken.
At the planning meeting, the finance director of Dashing Co informed the audit engagement
partner that the company was closing one of its smaller production sites and as a result, a
number of employees would be made redundant. A redundancy provision of $110,000 is
included in the draft financial statements.

160 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Required:
(a) Describe the steps the auditor should perform in undertaking a positive receivables
circularisation for Dashing Co. (4 marks)
(b) Describe substantive procedures, other than a receivables circularisation, the
auditor should perform to obtain sufficient and appropriate audit evidence to verify
EACH of the following assertions in relation to Dashing Co’s receivables:
(i) Accuracy, valuation and allocation
(ii) Completeness, and
(iii) Rights and obligations.
Note: The total marks will be split equally between each part. (6 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the redundancy provision at the year end.
(5 marks)
A few months have now passed and the audit team is performing the audit fieldwork
including the audit procedures which you recommended over the redundancy provision. The
team has calculated that the necessary provision should amount to $305,000. The finance
director is not willing to adjust the draft financial statements.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

253 AIRSOFT Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. Airsoft Co is a listed company which manufactures stationery products. The
company’s profit before income taxes for the year ended 30 April 20X5 is $16.3 million and
total assets as at that date are $66.8 million. You are an audit supervisor of Biathlon & Co and
you are currently finalising the audit programmes for the final audit of your existing client
Airsoft Co. You attended a meeting with your audit manager where the following matters
were discussed:
Trade payables and accruals
Airsoft Co purchases its raw materials from a large number of suppliers. The company’s policy
is to close the payables account just after the year end and the financial controller is
responsible for identifying goods which were received pre year end but for which no invoice
has yet been received. An accrual is calculated for goods received but not yet invoiced (GRNI)
and is included within trade payables and accruals.
The audit strategy has identified a risk over the completeness of trade payables and accruals.
The audit team will utilise automated tools and techniques, in the form of audit software
while auditing trade payables and accruals.
Bank overdraft and savings accounts
Airsoft Co’s draft financial statements include a bank overdraft of $2.6 million, which relates
to the company’s main current account. In addition, Airsoft Co maintains a number of savings
accounts. The savings account balances are classified as cash and cash equivalents and are
included in current assets. All accounts have been reconciled at the year end.

KAPLAN PUBLISHING 161

A A : A UDIT AN D ASS URAN CE

Directors’ remuneration
Airsoft Co’s board comprises eight directors. Their overall remuneration consists of two
elements: an annual salary, paid monthly and a significant annual discretionary bonus, which
is paid in a separate payment run on 20 April. All remuneration paid to directors is included
within wages and salaries. Local legislation requires disclosure of the overall total of
directors’ remuneration broken down by element and by director.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Airsoft Co’s trade
payables and accruals. (4 marks)
Excluding procedures included in part (a):
(b) Describe audit software procedures which could be carried out during the audit of
Airsoft Co’s trade payables and accruals. (3 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Airsoft Co’s year-end bank balances.
(5 marks)
(d) Describe substantive procedures the auditor should perform to confirm the directors’
remuneration included in the financial statements at the year end. (3 marks)
A member of your audit team has asked for information on ISA 701 Communicating Key Audit
Matters in the Independent Auditor’s Report having heard that this standard is applicable to
listed clients such as Airsoft Co.
(e) Identify what a key audit matter (KAM) is and explain how the auditor determines
and communicates KAM. (5 marks)
(Total: 20 marks)

254 INSECTS4U Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. You are an audit manager of Snail & Co and you are in charge of two audits
which are due to commence shortly. Insects4U Co is a registered charity which promotes
insect conservation and has been an audit client for several years. Spider Spirals Co, also an
existing audit client, manufactures stationery products and its draft total liabilities are
$8.1 million. Both clients’ financial year ended on 30 April 20X5. The following matters have
been brought to your attention for each company.
Insects4U Co
Insects4U Co is a not-for-profit organisation which generates income in a number of ways. It
receives monthly donations from its many subscribers and these are paid by bank transfer to
the charity.
In addition, a large number of donations are sent through the post to the charity. Insects4U
Co also sells tickets for their three charity events held annually. During the audit planning,
completeness of income was flagged as a key risk.
Note: Assume that the charity adopts International Financial Reporting Standards.

162 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Spider Spirals Co
Trade payables
The finance director of Spider Spirals Co has informed you that at the year end the individual
supplier accounts were kept open for one week longer than normal as a large bank transfer
and cheque payment run was made on 3 May 20X5. Some purchase invoices were received
in this week and were recorded in the 20X5 accounts as well as the payment run made on
3 May.
Trade receivables
Spider Spirals Co has a large number of small customers; the normal credit terms offered to
them is 30 days. However, the finance director has informed you that the average trade
receivables days have increased quite significantly this year from 34 days to 55 days. This is
partly due to difficult trading conditions and also because for six months of the year the role
of credit controller was vacant. The company has historically maintained on average an
allowance for credit losses/trade receivables of 1.5% of gross trade receivables.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the COMPLETENESS of Insect4U Co’s
income. (4 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Spider Spiral Co’s trade payables.
(6 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Spider Spiral Co’s trade receivables.
(5 marks)
The finance director of Spider Spirals Co has informed you that there is no intention to make
an adjustment for the trade payables payment run made on 3 May, as the total payment of
$490,000 would only require a change to trade payables and the bank overdraft, both of
which are current liabilities.
(d) Discuss the issue and describe the impact on the auditor’s report, if any, should this
issue remain unresolved. (5 marks)
(Total: 20 marks)

255 ELOUNDA Walk in the footsteps of a top tutor

This scenario relates to four requirements.

It is 1 July 20X5. Elounda Co manufactures chemical compounds using a continuous
production process. Its year end was 30 April 20X5 and the draft profit before income taxes
is $13.6 million. You are the audit supervisor and the final audit is due to commence shortly.
The following matters have been brought to your attention.
Revaluation of property, plant and equipment (PPE)
At the beginning of the year, management undertook an extensive review of Elounda Co’s
non-current asset valuations and as a result decided to update the carrying amount of all
PPE. The finance director, Peter Dullman, contacted a sibling, Martin, who is a valuer and
requested that Martin’s firm undertake the valuation, which took place in May 20X4.
KAPLAN PUBLISHING 163
A A : A UDIT AN D ASS URAN CE

Inventory valuation
Your firm attended the year-end inventory count for Elounda Co and ascertained that the
process for recording work-in-progress (WIP) and finished goods was acceptable. Both WIP
and finished goods are material to the financial statements and the quantity and stage of
completion of all ongoing production was recorded accurately during the count.
During the inventory count, the count supervisor noted that a consignment of finished goods,
compound E243, with a value of $720,000, was defective in that the chemical mix was
incorrect. The finance director believes that compound E243 can still be sold at a discounted
sum of $400,000.
Bank loan
Elounda Co secured a bank loan of two years ago. Repayments of $200,000 are due quarterly,
with a lump sum of $800,000 due for repayment in October 20X5. The company met all loan
payments in 20X4 on time, but was late in paying the January and April 20X5 repayments.

Required:
(a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the revaluation of Elounda Co’s property,
plant and equipment. (5 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the VALUATION of Elounda Co’s inventory.
(6 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Elounda Co’s bank loan. (4 marks)
(d) Describe the procedures which the auditor of Elounda Co should perform in assessing
whether or not the company is a going concern. (5 marks)
(Total: 20 marks)

256 ANDROMEDA Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. Andromeda Industries Co (Andromeda) develops and manufactures a wide
range of fast-moving consumer goods. Its year end is 31 July 20X5 and the forecast profit
before income taxes is $8.3 million. You are an audit supervisor in Neptune & Co and the final
audit is due to commence next month. The following information has been gathered during
the planning process:
Inventory count
Andromeda’s raw materials and finished goods inventory are stored in 12 warehouses across
the country. Each of these warehouses is expected to contain material levels of inventory at
the year end. It is expected that there will be no significant work-in-progress held at any of
the sites. Each count will be supervised by a member of Andromeda’s internal audit
department and the counts will all take place on 31 July, when all movements of goods in
and out of the warehouses will cease.

164 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT ION 2

Rights issue
In order to fund ongoing research and development, Andromeda invited shareholders to
participate in a 2 for 1 rights issue at a share price of $2.50 for each $1 share. The rights issue
was taken up by the majority of the shareholders raising $10 million.
Research and development
Andromeda spends over $2 million annually on developing new product lines. This year it
incurred expenditure on five projects, all of which are at different stages of development.
Once they meet the recognition criteria under IAS 38 Intangible Assets for development
expenditure, Andromeda includes the costs incurred within intangible assets. Once
production commences, the intangible assets are amortised on a straight-line basis over five
years.

Required:
(a) Explain FOUR factors which influence the reliability of audit evidence. (4 marks)
(b) Describe the procedures to be undertaken by the auditor BEFORE and DURING the
inventory count of Andromeda Industries Co in order to gain sufficient appropriate
audit evidence. (5 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Andromeda Co’s rights issue. (3 marks)
(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Andromeda Co’s research and development
expenditure. (4 marks)
The final audit is now nearing completion. During the audit, the team discovered that one of
the five development projects, valued at $980,000 and included within intangible assets,
does not meet the criteria for capitalisation. The finance director does not intend to change
the accounting treatment adopted as the amount is considered to be immaterial.
(e) Discuss the issue and describe the impact on the auditor’s report, if any, if the issue
remains unresolved. (4 marks)
(Total: 20 marks)

257 HAWTHORN Walk in the footsteps of a top tutor

Answer debrief

This scenario relates to five requirements.

It is 1 July 20X5. Hawthorn Enterprises Co manufactures and distributes fashion clothing to
retail stores. Its year end was 30 April 20X5. You are the audit manager and the final audit is
due to commence shortly. The following three matters have been brought to your attention.
Supplier statement reconciliations
Hawthorn Enterprises Co receives monthly statements from its main suppliers and although
these have been retained, none have been reconciled to the individual supplier accounts as at
30 April 20X5. The engagement partner has asked the audit senior to recommend the
procedures to be performed on supplier statements.

KAPLAN PUBLISHING 165

A A : A UDIT AN D ASS URAN CE

Bank reconciliation
During last year’s audit of Hawthorn Enterprises Co’s bank and cash, significant cut off errors
were discovered with a number of post-year-end cheques being processed prior to the year
end to reduce payables. The finance director has assured the audit engagement partner that
this error has not occurred again this year and that the bank reconciliation has been carefully
prepared. The audit engagement partner has asked that the bank reconciliation is
comprehensively audited.
Receivables
Hawthorn Enterprises Co’s receivables balance has increased considerably during the year, and
the year-end balance is $2.3 million compared to $1.4 million last year. The finance director
has requested that a receivables circularisation is not carried out as a number of their
customers complained last year about the inconvenience involved in responding. The
engagement partner has agreed to this request, and tasked you with identifying alternative
procedures to confirm the existence and valuation of receivables.

Required:
(a) (i) Identify and explain FOUR assertions relevant to classes of transactions and
events for the year under audit; and
(ii) For each identified assertion, describe a substantive procedure relevant to the
audit of REVENUE. (8 marks)
(b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the supplier statement reconciliations of
Hawthorn Enterprises Co. (3 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the bank reconciliation of Hawthorn
Enterprises Co. (4 marks)
(d) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the EXISTENCE and VALUATION of
Hawthorn Enterprises Co’s receivables. (5 marks)
(Total: 20 marks)

Calculate your allowed time, allocate the time to the separate parts……………

258 PINEAPPLE BEACH HOTEL Walk in the footsteps of a top tutor

This scenario relates to five requirements.

It is 1 July 20X5. Pineapple Beach Hotel Co is a national hotel chain with 10 hotels around the
country. Its year end was 30 April 20X5. You are the audit senior of Berry & Co and are
currently preparing the audit programmes for the final audit of Pineapple Beach Hotel Co.
You are reviewing the notes of last week’s meeting between the audit manager and finance
director where two material issues were discussed.

166 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT I ON 2

Revenue
Pineapple Beach Hotel Co’s main source of revenue is generated from hotel bookings. Each
hotel has its own leisure facilities which hotel guests can use for free. Memberships to the
leisure centres are available to non-hotel guests on a monthly or annual contract with no
joining fees. Each hotel also has a restaurant which offers meals to hotel guests and the
general public. Business is seasonal due to the hotels being situated in beach resorts. Unlike
many of their competitors, the hotels remain open all year round.
Depreciation
Pineapple Beach Hotel Co incurred significant asset expenditure during the year on updating
the leisure facilities for the hotel. The finance director has proposed that the new leisure
equipment should be depreciated over 10 years using the straight-line method.
Food poisoning claim
Pineapple Beach Hotel Co’s directors received correspondence in March from a group of
customers who attended a wedding at the hotel. They have alleged that they suffered severe
food poisoning from food eaten at the hotel and are claiming substantial damages. The
company’s lawyers have received the claim and believe that the lawsuit against the company
is unlikely to be successful.

Required:
(a) List and explain the purpose of FOUR items that should be included on every working
paper prepared by the audit team. (4 marks)
(b) Describe substantive ANALYTICAL PROCEDURES the auditor should perform to
should perform to confirm Pineapple Beach Hotel Co’s revenue. (4 marks)
(c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to Pineapple Beach Hotel Co’s depreciation.
(4 marks)
(d) Excluding written representation, describe substantive procedures the auditor
should perform to obtain sufficient and appropriate audit evidence in relation to the
food poisoning claim. (4 marks)
The date is now 1 September 20X5 and the audit is nearly complete. Suggested wording for
the written representation letter has been given to the directors of Pineapple Beach Hotel,
including a point confirming that the directors believe the food poisoning claim is
appropriately accounted for and disclosed in the financial statements and all information in
respect of the claim has been provided to the auditor. The directors have stated that they
will not sign the written representation this year on the grounds that they believe the
additional evidence that it provides is not required by the auditor.
(e) Discuss the issue and describe the impact on the auditor’s report, if any, if the issue
remains unresolved. (4 marks)
(Total: 20 marks)

ADDITIONAL QUESTIONS
THE FOLLOWING QUESTIONS ARE EXAM STANDARD BUT DO NOT REFLECT THE
CURRENT EXAM FORMAT. THESE QUESTIONS PROVIDE VALUABLE PRACTICE FOR
STUDENTS NEVERTHELESS.

KAPLAN PUBLISHING 167

A A : A UDIT AN D ASS URAN CE

259 ORANGE FINANCIALS Walk in the footsteps of a top tutor

You are the audit manager of Currant & Co and you are planning the audit of Orange
Financials Co (Orange), who specialise in the provision of loans and financial advice to
individuals and companies. Currant & Co has audited Orange for many years.
The directors are planning to list Orange on a stock exchange within the next few months
and have asked if the engagement partner can attend the meetings with potential investors.
In addition, as the finance director of Orange is likely to be quite busy with the listing, the
finance director has asked if Currant & Co can produce the financial statements for the
current year.
During the year, the assistant finance director of Orange left and joined Currant & Co as a
partner. It has been suggested that due to familiarity with Orange, the new partner should
be appointed to provide an independent partner review for the audit.
Once Orange obtains its stock exchange listing it will require several assignments to be
undertaken, for example, obtaining advice about corporate governance best practice.
Currant & Co is very keen to be appointed to these engagements, however, Orange has
implied that in order to gain this work Currant & Co needs to complete the external audit
quickly and with minimal questions/issues.
The finance director has informed you that once the stock exchange listing has been
completed, the engagement team would be invited to attend a weekend away at a luxury
hotel with the Orange team, as a thank you for all their hard work. In addition, the finance
director has offered a senior member of the engagement team a short-term loan at a
significantly reduced interest rate.

Required:
(a) (i) Identify and explain FIVE ethical threats which may affect the independence
of Currant & Co’s audit of Orange Financials Co, and
(ii) For each threat, recommend an appropriate safeguard to reduce the threat to
an acceptable level.
Note: The marks will be split equally between each part. (10 marks)
Ethical threat Appropriate safeguard

(b) Orange’s finance director has asked your firm to undertake a non-audit assurance
engagement later in the year. The audit junior has not been involved in such an
assignment before and has asked you to explain what an assurance engagement
involves.

Required:
Explain the five elements of an assurance engagement. (5 marks)
(Total: 15 marks)

168 K A P LA N P UB L I S H I N G
 PRA CTICE QUES TIO NS – SECTION B : SE CT ION 2

260 VIOLET & CO Walk in the footsteps of a top tutor

Answer debrief

You are the audit manager of Violet & Co and you are currently reviewing the audit files for
two of your clients for which the audit fieldwork is complete. The audit senior has raised the
following issues.
Daisy Co
Subsequent to the year end, the company’s sales ledger has been corrupted by a computer
virus. Daisy Co’s finance director was able to produce the financial statements prior to this
occurring; however, the audit team has been unable to access the sales ledger to undertake
detailed testing of revenue or year-end receivables. All other accounting records are
unaffected and there are no backups available for the list of individual customers. Daisy Co’s
revenue is $15.6m, its receivables are $3.4m and profit before income taxes is $2m.
Fuchsia Co
Fuchsia Co has experienced difficult trading conditions and as a result it has lost significant
market share. The cash flow forecast has been reviewed during the audit fieldwork and it
shows a significant net cash outflow. Management are confident that further funding can be
obtained and so have prepared the financial statements using the going concern basis with
no additional disclosures; the audit senior is highly sceptical about this.
The prior year financial statements showed a profit before income taxes of $1.2m; however,
the current year loss before income taxes is $4.4m and the forecast net cash outflow for the
next 12 months is $3.2m.

Required:
For each of the two issues:
(i) Discuss the issue, including an assessment of whether it is material.
(ii) Discuss whether a written representation is appropriate.
(iii) Recommend procedures the audit team should undertake at the completion stage
to try to resolve the issue.
(iv) Describe the impact on the auditor’s report if the issue remains unresolved.
Notes: 1 The total marks will be split equally between each issue.
2 Report extracts are NOT required.
(12 marks)

Calculate your allowed time, allocate the time to the separate parts……………

KAPLAN PUBLISHING 169

A A : A UDIT AN D ASS URAN CE

170 K A P LA N P UB L I S H I N G