Chapter 5: Audit Evidence

Audit evidence is all the information used by auditors to arrive at the conclusions
made in the audit report.
 Auditor must obtain evidence to support FS assertions.
 This evidence must be sufficient & appropriate (ISA 500).
 Audit evidence must be document sufficiently.
Sufficient – quantity of evidence is sufficient to support the audit opinion. This is
based on auditor’s professional judgement (based on materiality, high RoMM, weak
internal controls, first year audit).

Appropriate – Relevant (must cover FS assertions) in supporting the FS assertions &

reliable* (External better than internal).
*Reliability of the evidence maybe a matter of judgement for the auditor
- Original documents are more reliable than photocopies.
- Third party evidence is more reliable than client-generated.
-Written evidence as compared to oral.
- Audit evidence obtained directly by auditor rather than through indirect sources.

Factors to consider:
Procedures on obtain audit evidence:
1. Analytical procedures – Completeness
2. Enquiry – from management (written representations)
3. Inspection of assets/ documents
4. Observation – TEST OF CONTROL
5. Recalculation – arithmetic accuracy
6. Confirmation – written from third parties
7. Reperformance (stocktake – reconfirming the work done by client)
8. Physical verification – for tangible assets
FS assertions (ACCA COPER)
Assertions are used by auditors to consider different types of potential
misstatements that may occur when identifying, assessing & responding to the risks
of material misstatement.
1. Accuracy
2. Completeness
3. Cut off
4. Accuracy, valuation & allocation (compliance with accounting standards)
5. Classification
6. Occurrence
7. Presentation
8. Existence
9. Rights & Obligations
Completeness, rights & obligations, existence, classification, accuracy, valuation &
allocation and presentation relates to Assets, Liabilities & Related disclosures
(account balances).
Completeness, cut off, occurrence, accuracy, classification and presentation relate to
transactions and events and related disclosures (SOPL).

P&L (transactions)
1. Occurrence – Did the transaction actually happen?
2. Completeness – Whether all the transactions within the heading has been
recorded?? Is anything missing or voluntarily omitted.
3. Accuracy – Are the calculations correct?? Are the totals adding up??
4. Cut off – All transactions for this financial year are recorded & NO transaction
after the cut off are included?
5. Classification – whether the journal entries ( DR,CR) were correctly recorded
& that the are under the right heading of the statement??
6. Presentation – The way it looks on the statement is compliant with the
accounting standard??
Balance Sheet ( Account balances)
1. Existence – Does the balance actually exists in the name of the client??
 2. Rights & obligations- Does the client have the right over the asset & obligation
towards the liability?
7. Completeness - Whether all the transactions within the heading has been
recorded?? Is anything missing or voluntarily omitted.
3. Accuracy, valuation & allocations – are the numbers calculated correctly,
following the right estimates??
4. Classification – Are they under the right category on the BS??
5. Presentation & disclosures - The way it looks on the statement is compliant
with the accounting standard??

Substantive analytical procedures

1. Simple comparisons – a simple year on year comparison can be very
persuasive evidence that an expense have been corrected stated.
2. Comparisons with estimates prepared by Auditors – if the estimate was similar
to the actual transaction, it would go some way to allowing the auditor to
conclude that the charge was materially correct
Audit procedures – at the execution stage the actions done by the auditor to collect
the evidence.
Obtain debtors confirmation for a sample of receivables to confirm the existence.
Audit evidence – at the completion/review stage & it is the result of the procedure!!
Copy of the debtors confirmation to confirm the existence of receivables.
Audit Sampling

Initial audit engagements – auditors make special considerations at planning stage

when auditing clients for the first time due to lack of knowledge about the client
leading to specific risk.

Auditors report:
Whenever new auditor, Other Matters Paragraph should be prepared regardless of
the opinion.

Matters to be considered before placing reliance on an expert:

- Objectivity
- Competence
- Scope of work
- Relevance of conclusions

ISA 610 – Using the work on internal auditors

USING INTERNAL AUDITORS FOR DIRECT ASSISTANCE
the firm should:
1. obtain written agreement from an authorized representative of the entity that
the internal auditors will be allowed to follow the external auditor’s
instructions, and that the entity will not intervene in the work the internal
auditor performs for the external auditor; and
2. obtain written agreement from the internal auditors that they will keep
confidential specific matters as instructed by the external auditor and inform
the external auditor of any threat to their objectivity. If these confirmations
cannot be obtained, then the internal auditors should not be used to provide
direct assistance.
Not assign any work that includes significant judgements , high romm or anywhere
that internal auditors were involved in .
Before using the IA this way - external auditors must consider whether this
arrangement is acceptable under the jurisdiction.

ISA 402 Service Organizations

As per ISA 402 , auditors must obtain an understanding about the service
organization including -
1. Nature and materiality of the transactions or account balances handled by the
service organisation
[Link] of interaction between the service organisation and user entity
3. Nature of relationship between user entity and service organisation by verifying
the contractual terms between them.
The auditor should consider the following factors during the audit of service
organizations
▪ Gain an understanding of the services being provided.
▪ Assess how the service provider as designed and implemented internal controls.
▪ Visit the service provider to test the internal controls.
▪ Requesting the service provider to provide a report either
- the description and design of the internal controls -type 1 report.
- description, design and operating effectiveness of internal controls – type 2 report
. ▪ The service auditor’s professional competence and independence from the
service organization
▪ Assess whether sufficient and appropriate evidence has been gathered and impact
on the audit report.

ISA 550 Related Parties

Related party: A party that is either:
(a) A related party as defined in the applicable financial reporting framework; or
(b) Where the applicable financial reporting framework establishes minimal or no
related party requirements:
- A person or other entity that has control or significant influence, directly or
indirectly, through one or more intermediaries, over the reporting entity;
- Another entity over which the reporting entity has control or significant influence,
directly or indirectly, through one or more intermediaries; or
- Another entity that is under common control with the reporting entity through
having:
Common controlling ownership;
Owners who are close family members; or
Common key management
Management is responsible for the identification of related party transactions. Such
transactions should be properly approved as they are frequently not at arm’s length.
Management is also responsible for the disclosure of related party transactions.
The auditor should obtain a written representation from management concerning
the completeness of information provided concerning related parties and the
adequacy of disclosures in the financial statements.
From auditor’s perspective, related party is easy to conceal & the auditor has to rely
on the integrity of the management to disclose any information.
Audit procedures
- Review prior year working papers for the names of the known related party.
- Review the entity’s procedures for identification of related parties.
- Request from directors a list of related parties & transactions.
- Review shareholder records to determine the names of principal shareholders or
if possible, obtain a listing of principal shareholders from the share register.
- Review minutes of the meetings of the shareholders & other relevant statutory
records such as register of director’s interest.
- Look at the major customers and suppliers and ascertain any potential links with
the client’s management;
- Carefully review any transactions which appear unusual in nature or which
indicate the existence of unidentified related parties e.g. large discounts
offered/received;
- Obtain written representations from management concerning the completeness
of the information provided to the auditors.
If the auditor is unable to obtain sufficient appropriate audit evidence concerning
related parties and transactions with such parties, the auditor should modify the
auditor’s report due to inability to obtain sufficient appropriate evidence.
If the auditor concludes that their disclosure in the financial statements is not
adequate, the auditor should modify the auditor’s report due to material
misstatement.

Written Representations
Form of audit evidence.
They are contained in a letter, written by the company’s directors and sent to the
auditor, prior to the completion of audit work and before the auditor’s report is signed.

Written representations can be:

 1. General (e.g. “management has fulfilled its responsibility for the preparation
and presentation of the financial statements” and “management has provided
the auditor with all relevant information” or
2. Specific (e.g. “management considers the debt from company X to be fully
recoverable” – this would corroborate internal evidence such as the verbal
assurance of the credit controller that she is in oral communication with the
client).

AA Knowledge
1. IAS 8 Changes in Accounting policies and estimates:
Estimates : FS should be based on most recent and best estimates, any change in
estimates will have a prospective impact.
The estimates should be verified, especially if there are any unreasonable changes.
Any figure involving use of estimates need to be evaluated in more details as its
simple to manipulate these numbers.
Accounting policies should be selected and then used on consistent basis; changes
are allowed but there should be strong grounds when you change accounting
policies. Any change will have retrospective impact.
Changes in accounting policies
An entity is permitted to change an accounting policy only if the change:
▪ is required by a standard or interpretation;
▪ results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity's financial
position, financial performance, or cash flows
Key disclosures
(a) The nature of the change in accounting policy
(b) The reasons for the change
(c) The amount of the adjustment for the current and each prior period presented for
each line item affected
(d) The amount of the adjustment to periods before those presented
Disclosure is important to maintain the principle of comparability. Users should be
able to compare the financial statements of an entity over time and to compare the
financial statements of entities in the same line of business.

2. IAS 19 Employee Benefits

Short-term employee benefits – employee benefits (other than termination benefits)
that are expected to be settled wholly within 12 months after the end of the reporting
period in which the employees render the related service.
Accounting for Short-term Benefits
When an employee has rendered service during an accounting period, the entity
recognizes the amount of short-term employee benefits expected to be paid in
exchange for that service:
• as a liability (accrued expense), after deducting any amount already paid; and
• as an expense
Paid Absences
Short-term paid absences may be:
• accumulating (i.e. carried forward to another period if the current year’s entitlement
is not taken in full); or
• non-accumulating (i.e. lost if not taken).
The distinction is important:
• An accumulating absence is recognised as an expense when an employee
provides the service that entitles them to the leave. A liability must be recognised at
the period end for the estimated value of the unused entitlement.
• A non-accumulating absence is recognised as an expense when the absence
occurs.

Bonuses/Profit Shares
The expense related to bonus plans or profit sharing arrangements, and a related
liability, are recognised when:
• The entity has a legal or constructive obligation as a result of a past event to pay it;
and
• The amount can be estimated reliably.
A reliable estimate can only be made where:
• There is a profit-share or bonus formula;
• The amount payable has been determined before the financial statements are
authorised for issue; or
• Past practice provides evidence of the obligation.
Where a bonus is payable only if an employee remains in employment on a certain
date the estimated amount should take the expected number of leavers into account.
 3. IAS 20 Government Grant
Only recognize a grant:
- When there is reasonable assurance that it will comply with the conditions
attaching to the grant
- The grants will be received.
There are two types of grant:
1. Revenue Grant (eg. a grant towards training costs) - Grants relating to income are
shown in profit or loss either separately or as part of ‘other income’ or alternatively
deducted from the related expense.
2. Capital Grant (eg. a grant towards the purchase of a non-current asset) -
Government grants whose primary condition is that an entity qualifying for them
should purchase, construct or otherwise acquire non-current assets. Subsidiary
conditions may also be attached restricting the type or location of the assets or the
periods during which they are to be acquired or held.
Government grants relating to assets are presented in the statement of financial
position
either:
(a) As deferred income (Dr Cash, Cr Deferred income), this is then released to the
profit or loss account over the useful life of the asset (effectively over the same
period as the asset is being depreciated); or
(b) By deducting the grant in calculating the carrying amount of the asset.
Repayment of grants
This means when we are not allowed the grant anymore and so have to repay it
back.
This would be a change in accounting estimate (IAS 8) and so you do not change
past periods just the current one.
Accounting treatment (capital grant repayment):
Dr Any deferred Income Balance or Dr Cost of asset Dr Income statement with any
balance
Cr Cash with the amount repaid
The extra depreciation to date that would have been recognised had the grant not
been netted off against cost should be recognised immediately as an expense.
Accounting treatment – (Income Grant Repayment)
Dr Income statement Cr Cash
Audit Procedures:
1. Obtain the legal contract of the government grant to confirm terms and conditions,
value of the grant, duration of the grant.
[Link] the cash book or bank statement to confirm the receipt of [amount] grant.
[Link] the part related to the assets obtain any forecast information available to
confirm that the [use of the grant]
4. Discuss with the management if there are any issues in meeting the conditions of
the grant and whether they foresee any repayment of the same.

4. IAS 23 Borrowing Costs

Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset form part of the cost of that asset.
Other borrowing costs are recognized as an expense.
Commencement - Commencement of capitalization begins when:
(a) Expenditures for the asset are being incurred;
(b) Borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for its intended use or sale are
in progress.
Suspension- Capitalization is suspended during extended periods when
development is interrupted.
Cessation- Capitalization ceases when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete
The capitalization of borrowing costs should be calculated pro-rata if the
commencement or cessation occurs within the period, or there has been a
suspension within the period.
There are 2 scenarios here to worry about:
1. General Borrowings - You use current borrowings to pay for the asset
2. Specific Borrowings - You get a specific loan for the asset
1) Use current borrowings
This is looking at the scenario where we use funds we have already borrowed from
different sources. So, if the funds are borrowed generally – we need to calculate the
weighted average cost of all the loans we have generally.
Here's how you do it:
1. Calculate the total amount of borrowings
2. Calculate the interest payable on these in total
3. Weighted average of borrowing costs = Divide the interest by the borrowing
4. We then take this weighted average of borrowing costs and multiply it by any
expenditure on the asset.
5. The amount capitalized should not exceed total borrowing costs incurred in the
period.

5. IAS 36 Impairment of Assets

If an asset’s carrying amount in the financial statements is higher than its
‘recoverable amount’, which is the amount to be recovered through the asset’s sale
or use, the asset is judged to have suffered an impairment loss. It should therefore
be reduced in value, by the amount of the impairment loss.
The amount of the impairment loss should be written off against profit immediately.
The following are indicators of impairment:
External
(a) Observable indications that the asset’s value has declined during the period
significantly more than expected due to the passage of time or normal use
(b) Significant changes with an adverse effect on the entity in the technological or
market environment, or in the economic or legal environment
(c) Increased market interest rates or other market rates of return affecting discount
rates and thus reducing value in use
(d) Carrying amount of net assets of the entity exceeds market capitalization.
Internal
(a) Evidence of obsolescence or physical damage
(b) Significant changes with an adverse effect on the entity*:
(i) The asset becomes idle
(ii) Plans to discontinue/ restructure the operation to which the asset belongs
(iii) Plans to dispose of an asset before the previously expected date
(iv) Reassessing an asset's useful life as finite rather than indefinite
(c) Internal evidence available that asset performance will be worse than expected
Once the asset meets the criteria to be classified as ‘held for sale’, it is excluded
from the scope of IAS 36 and accounted for under IFRS 5 Non-current Assets Held
for Sale and Discontinued Operations.
Annual impairment tests, irrespective of whether there are indications of impairment,
are required for:
• Intangible assets with an indefinite useful life/not yet available for use
• Goodwill acquired in a business combination.

Recoverable amount is higher of : Value in Use[The PV of future cash flows] & FV

less Costs to sell
Costs of disposal are for example legal costs, stamp duties and similar transaction
taxes, costs of removing the asset and direct incremental costs to bring an asset into
condition for its sale.
In case of CGU revaluation is done on group basis.
If goodwill is a part of CGU, allocate impairment losses to goodwill to the extent
possible.
Impairment is done only when there are indicators (Except for goodwill and
intangible assets with indefinite life)
In case of audit risk question, if sales/ profits are going down- impairment can be a
risk. Reversal of past impairments
An entity should assess at each year end whether there is reversal of any past
impairments for assets other than goodwill. For individual assets and CGU , the
reversal is recognised in the SOPL except where reversing a loss recognised on
assets carried ta revalued amounts which are treated in accordance with the
applicable IFRS.
Note that the carrying amount of an asset cannot be increased above the lower of
a) Its recoverable amount (if determinable ) and
b) Its depreciated carrying amount had no impairment loss originally been
recognised.
c) Previous impairments to goodwill cannot be reversed.
WHEN DETERMINING VIU:
Cash flow projections should be based on reasonable and supportable assumptions,
the most recent budgets and forecasts, and extrapolation for periods beyond
budgeted projections
IAS 36 presumes that budgets and forecasts should not go beyond five years; for
periods after five years, extrapolate from the earlier budgets.
Management should assess the reasonableness of its assumptions by examining the
causes of differences between past cash flow projections and actual cash flows.
Cash flow projections should relate to the asset in its current condition – future
restructurings to which the entity is not committed and expenditures to improve or
enhance the asset’s performance should not be anticipated.
Estimates of future cash flows should not include cash inflows or outflows from
financing activities, or income tax receipts or payment.
Discount rate
In measuring value in use, the discount rate used should be the pre-tax rate that
reflects current market assessments of the time value of money and the risks
specific to the asset.
The discount rate should not reflect risks for which future cash flows have been
adjusted and should equal the rate of return that investors would require if they were
to choose an investment that would generate cash flows equivalent to those
expected from the asset.
6. IAS 37 Provisions, Contingent liabilities and Contingent assets
Provision
A provision shall be recognized when an entity has a present obligation (legal or
constructive) as a result of a past event, it is probable that an outflow of resources
embodying economic benefits will be required to settle obligation, and a reliable
estimate can be made of the amount of the obligation.
Provisions are reviewed each year and adjusted to reflect current best estimate. If it
is no longer probable that an outflow of resources embodying economic benefits will
be required, the provision is reversed.
Contingent liability:
• A possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the entity; or
• A present obligation that arises from past events but is not recognised because:
- It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
- The amount of the obligation cannot be measured with sufficient reliability
Contingent liabilities should not be recognised in financial statements but they should
be disclosed
Key Disclosures
(a) The nature of the contingent liability
(b) An estimate of its financial effect
(c) An indication of the uncertainties relating to the amount or timing of any outflow
(d) The possibility of any reimbursement.

Contingent asset:
A possible asset that arises from past events and whose existence will be confirmed
by the occurrence or non-occurrence of one or more uncertain future events not
wholly within control of the entity.
• A contingent asset must not be recognized.
• A contingent asset should only be disclosed when an inflow of economic benefits is
probable
• Only when the realization of the related economic benefits is virtually certain should
recognition take place. At that point, the asset is no longer a contingent asset.
Example – Legal dispute
A company is engaged in a legal dispute. The outcome is not yet known. A number
of possibilities arise:
▪ It expects to have to pay about $100,000. A provision is recognised.
▪ Possible damages are $100,000 but it is not expected to have to pay them. A
contingent liability is disclosed.
▪ The company expects to have to pay damages but is unable to estimate the
amount. A contingent liability is disclosed.
▪ The company expects to receive damages of $100,000 and this is virtually certain.
An asset is recognised.
▪ The company expects to probably receive damages of $100,000. A contingent
asset is disclosed.
▪ The company thinks it may receive damages, but it is not probable. No disclosure.
Types of provision examples :
▪ Restructuring provision
Restructuring is a plan of management to change the scope of business or a manner
of conducting a business.
In the case of restructuring, an obligation to restructure arises only if:
There is a detailed formal plan for restructuring with relevant information in it (about
business, location, employees, time schedule and expenditures)
A valid expectation related to restructuring has been raised in the affected parties.
Only INCREMENTAL costs that are directly associated with the restructuring should
be included in the provision. IAS 37 prohibits the recognition of a provision for costs
associated with ONGOING activities, such as the cost of training or relocating
continuing staff.
▪ Warranty provision
An entity that sells goods “under warranty” will have a legal obligation to repair those
goods should any faults occur. The entity should make a provision based on its best
estimate of the repair costs.
▪ Decommissioning costs
If there is an obligation to make these repairs, the entity should make a provision for
them. If the costs relate to a non-current asset, they can be included as part of the
cost of that asset.
▪ Future operating losses
Provisions are not recognised for future operating losses.
Future operating losses do not meet the definition of a liability or the Conceptual
Framework recognition criteria.
▪ Onerous contracts Cost of fulfilling contract exceeds the benefit from the contract
Where there is an onerous contract, the provision should be measured as the lower
of the net cost of fulfilling the contract and any penalties payable as a result of exiting
from it.
7. IAS 38 Intangible Assets
Recognize at cost if:
▪ Identifiable
▪ It is controlled by the entity
▪ It is expected to generate future economic benefits
▪ It can be measured reliably
Internally Generated Intangibles :
Research: ‘Original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.’
Development: ‘Application of research findings to a plan or design for the production
of new or substantially improved materials, products, processes, systems or services
before the start of commercial production or use.’
Recognition criteria
To assess whether an internally generated intangible asset meets the IAS 38
recognition criteria, an entity classifies expenditure into:
(a) A research phase - Recognize as an expense in the statement of profit or loss
(b) A development phase - Recognize as an intangible asset if
PIRATE
 Probable economic benefits
 Intention to complete the project
  Resources available to complete the project
 Ability to use or sell the item
 Technologically feasible
 Expenses on the project can be identified.
Advertising and promotional costs must not be recognized as intangible assets and
must be expensed.
If an intangible has a finite life, then it should be amortized over its useful economic
life.
Residual value is normally assumed to be zero unless there is a commitment from a
buyer or an active market exists.
An intangible could be considered to have an indefinite useful life should be tested
for impairment.
Subsequent measurement
After initial recognition, an intangible asset can either be measured using the cost or
the revaluation model.
Cost model
The carrying amount of an intangible asset measured using the cost model is cost
less accumulated amortisation and impairment losses
Revaluation model
The carrying amount of an intangible asset measured using the revaluation model is
its fair value at the date of the revaluation less subsequent accumulated amortisation
and impairment losses
Active market
If the revaluation model is followed, fair value shall be measured by reference to an
active market. All other assets in the same class must also be accounted for using
the revaluation model unless there is no active market for them in which case the
cost model is used for those assets.
Active market: ‘A market in which transactions for the asset or liability take place with
sufficient frequency and volume to provide pricing information on an ongoing basis.’
Derecognition
An intangible asset is derecognized:
(a) On disposal; or
(b) When no future economic benefits are expected from its use or disposal
Audit procedures & Evidence needed as follows
Basic procedures are:
- Inspect legal documents, confirming the length / type / cost of asset.
- Agree cash paid to the bank statement and the cash book.
- Inspect minutes of a discussion with management regarding amortization / non-
amortization.
- Recalculate the amortization to ensure it is as per accounting standards.
- Inspect forecast sales records to determine the future economic benefit to be
derived
Criteria Procedures
P- Probable economic benefits- Inspect any forecast / budgets to confirm that
probable future economic benefits will be generated and hence correct capitalization.
I- Intention to complete the project - Inspect board meeting minutes to confirm the
intention to complete and sell the asset and hence correct capitalization
R- Resources available to complete the project- Inspect the cash flow statement to
confirm if adequate resources to complete the development is available and hence
correct capitalization.
A- Ability to use or sell the item- Obtain any market research report to confirm the
ability to sell this product and hence correct capitalization.
T- Technologically feasible- Inspect the feasibility report to identify the technical
feasibility and hence correct capitalization
E- Expenses on the project can be identified - Obtain the invoices related to this
development to confirm the amounts are reliably measured hence correct
capitalization
Qn 1

You are the manager responsible for the audit of Osier Co, a jewellery
manufacturer and retailer. The final audit for the year ended 31 March
2017 is nearing completion and you are reviewing the audit working
papers. The draft financial statements recognize total assets of $1,919
million (2016 – $1,889 million), revenue of $1,052 million (2016 – $997
million) and profit before tax of $107 million (2016 – $110 million). Three
issues from the audit working papers are summarized below:

Cost of inventory
Inventory costs include all purchase costs and the costs of conversion of
raw materials into finished goods. Conversion costs include direct labour
costs and an allocation of production overheads.
Direct labour costs are calculated based on the average production time
per unit of inventory, which is estimated by the production manager,
multiplied by the estimated labour cost per hour, which is calculated using
the forecast annual wages of production staff divided by the annual
scheduled hours of production. Production overheads are all fixed and are
allocated based upon the forecast annual units of production. At the year
end inventory was valued at $21 million (2016 – $20 million).

Required:
Comment on the matters to be considered and explain the audit
evidence you should expect to find during your file review in
respect of each of the issues described above. (7 marks)
Qn 2

In April 20X5, a government grant of $10 million was received as part of a

government scheme to subsidize companies which operate in deprived
areas. Specifically, $2 million of the grant compensates the company for
wages and salaries incurred in the year to 30 September 20X5. The
remaining grant relates to the continued operations in the deprived area,
with a condition of the grant being that the manufacturing site in that area
will remain operational until April 20Y0.
Explain audit procedures in respect of recognition &
measurement of government grant (5 marks).
Qn 3
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 tax 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
receivables ledger is made up of a large number of customers with
balances ranging from $15,000 to $150,000. 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 receivables ledger at 31 March 20X5,
however the following exceptions were noted:

Nile Co $141,102 - No response

Congo Co $136,321 - $122,189

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.

(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 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)
qn 4

You are an audit manager in Rose & Co, responsible for the audit of
Cooper Co. You are reviewing the audit working papers relating to the
financial year ended 31 January 2014.

Cooper Co is a manufacturer of chemicals used in the agricultural

industry. The draft financial statements recognize profit for the year to 31
January 2014 of $15 million (2013 – $20 million) and total assets of $240
million (2013 – $230 million).

In October 2013, Cooper Co’s finance director, Hannah Osbourne,

purchased a car from the company. The carrying value of the car at the
date of its disposal to Hannah was $50,000, and its market value was
$75,000. Cooper Co raised an invoice for $50,000 in respect of the
disposal, which is still outstanding for payment.

Required:
Comment on the matters to be considered and explain the audit
evidence you should expect to find during your review of the
audit working papers in respect of each of the issues described
above.
Qn 5

Pigeon (sept/dec 2017) – QB pg 45

It is 1 July 20X5. You are a manager in the audit department of Pigeon &
Co, a firm of Chartered Certified Accountants. You are responsible for the
audit of Goldfinch Gas Co, a company which is the main supplier of gas to
business and residential customers across the country.
The audit fieldwork for the year ended 30 March 20X5 is nearing
completion. The draft financial statements recognise profit before tax of
$130 million (20X4 – $110 million), and total assets of $1,900 million
(20X4 – $1,878 million).

You are reviewing the audit files and the following matters have been
noted for your attention by the
audit senior:
(a) Decommissioning provision
A provision of $430 million (20X4 – $488 million) is recognised as a long-
term liability. The
provision is in respect of decommissioning a number of gas production
and storage facilities
when they are at the end of their useful lives. The estimate of the
decommissioning costs has
been based on price levels and technology at the reporting date, and
discounted to present
value using an interest rate of 8% (20X4 – 6%). The timing of
decommissioning payments is
dependent on the estimated useful lives of the facilities but is expected to
occur by 20A4
(ie in 30 years’ time), with the majority of the provision being utilised
between 20Y3 and 20Z8
(ie between 8 and 23 years from now).
The accounting policy note discusses the methodology used by
management for determining
the value of the decommissioning provision and states that this is an area
of critical accounting judgements including key areas of estimation
uncertainty. The estimate has been made by management. In previous
years, a management expert was engaged to provide the estimate but as
this was expensive, management decided to produce their own estimate
for the year ended 31 March 20X5. (13 marks)

(b) Trade receivables

The draft statement of financial position recognises total trade receivables
of $450 million
(20X4 – $390 million). The audit team has performed substantive
analytical procedures on trade receivables with the following results:
Receivables from business customers are generally reviewed for
impairment on an individual
basis when a customer changes their gas supplier, discontinuing their
relationship with the
Group. Receivables from residential customers are reviewed for
impairment where they are
more than 90 days late in paying their bill, or where customers have a
history of late payment.
Since a new customer billing system was introduced in June 20X4,
management has exercised additional judgement regarding the
appropriate level of allowance for these trade receivables. (7 marks)

Required:

Comment on the matters to be considered, and explain the audit evidence

you should expect to find during your file review in respect of each of the
issues described above.
You are NOT required to explain the potential impact of the matters on the
auditor’s opinion or
report.
Note: The split of the mark allocation is shown against each of the issues
above.
Professional marks will be awarded for the demonstration of skill in
analysis and evaluation,
professional scepticism and judgement and commercial acumen in your
answer. (5 marks)
(25 marks)
Qn 6

Qn 15- THURMAN CO (Q2, SEPT/DEC 2016) Pg 49

It is 1 July 20X5. You are the manager responsible for the audit of
Thurman Co, a manufacturing company which supplies stainless steel
components to a wide range of industries. The company’s financial year
ended on 30 March 20X4 and you are reviewing the audit work which has
been completed on a number of material balances and transactions:
assets held for sale, capital expenditure and payroll expenses. A summary
of the work which has been performed is given below and in each case the
description of the audit work indicates the full extent of the audit
procedures carried out by the audit team.

(a) Assets held for sale

Due to the planned disposal of one of Thurman Co’s factory sites, the
property and associated
assets have been classified as held for sale in the financial statements. A
manual journal has
been posted by the finance director to reclassify the assets as current
assets and to adjust the value of the assets for impairment and reversal of
depreciation charged from the date at which the assets met the criteria to
be classified as held for sale. The finance director asked the audit senior
to check the journal before it was posted on the basis of there being no
one with the relevant knowledge to do this at Thurman Co.
The planned disposal was discussed with management. A brief note has
been put into the audit working papers stating that in management’s
opinion the accounting treatment to classify the factory as held for sale is
correct. The manual journal has been arithmetically checked by a different
member of the audit team, and the amounts agreed back to the non-
current asset register. (10 marks)

(b) Payroll expenses

The payroll function is outsourced to Jackson Co, a service organisation
which processes all of Thurman Co’s salary expenses. The payroll
expenses recognised in the financial statements have been traced back to
year-end reports issued by Jackson Co. The audit team has had no direct
contact with Jackson Co as the year-end reports were sent to Thurman
Co’s finance director who then passed them to the audit team.
Thurman Co employs a few casual workers who are paid in cash at the
end of each month and
are not entered into the payroll system. The audit team has agreed the
cash payment made
back to the petty cash records and the amounts involved are considered
immaterial. (10 marks)
Required:

In respect of each of the matters described above:

(i) Comment on the sufficiency and appropriateness of the audit evidence
obtained;
 (ii) Recommend further audit procedures to be performed by the audit
team; and
(iii) Explain the matters which should be included in a report in
accordance with ISA 265
Communicating Deficiencies in Internal Controls to Those Charged with
Governance and
Management.
Note: The split of the mark allocation is shown against each of the
matters above.
Professional marks will be awarded for the demonstration of skill in
analysis and evaluation,
professional scepticism and judgement and commercial acumen in your
answer. (5 marks)
(25 marks)
Qn 7

THE GOODMAN GROUP (Q2, MARCH 2020)

It is 1 July 20X5. You work in the audit department of Saul & Co. The
Goodman Group (the Group) is an audit client of your firm and the audit
for the financial year ended 31 December 20X4 is in the completion stage.
The Group, which is not listed, installs and maintains security systems for
businesses and residential customers.

Materiality for the audit of the Group financial statements has been
determined to be $400,000. You are reviewing the audit working papers,
and have gathered the following information:

Development costs
In August 20X4, the Group commenced development of a new security
system, and incurred expenditure of $600,000 up to the financial year
end, which has been capitalised as an intangible non-current asset. The
only audit evidence obtained in relation to this balance is as follows:
- Agreement of a sample of the costs included in the $600,000 capitalised
to supporting
documentation such as supplier invoices.
- Cash flow projection for the project, which indicates that a positive cash
flow will be generated by 20X8. The projection has been arithmetically
checked.
- A written representation from management stating that ‘management
considers that the
development of this new product will be successful’.

You are aware that when the Group finance director was asked about the
cash flow projection which he had prepared, he was reluctant to answer
questions, simply saying that ‘the assumptions underlying the projection
have been agreed to assumptions contained in the Group’s business plan’.
He provided a spreadsheet showing the projection but the underlying
information could not be accessed as the file
was password protected and the Group finance director would not provide
the password to the audit team.
 Trade receivables
Trade receivables recognised in the Group’s current assets includes a
balance of $500,000 relating to a specific customer, Hamlyn Co. Audit
procedures indicate that at 31 December 20X4, the balance was more
than six months overdue for payment. In relation to this balance, the
following procedures have been performed:
- Agreement of the balance to invoices and original customer order.
- Discussion with the Group credit controller who states that ‘we are in
discussions with Hamlyn Co and we are confident that some or all of the
amount due to us will be paid. We have always allowed this customer
extended credit terms and they have always paid eventually.’

Hamlyn Co was included in the trade receivables direct confirmation audit

procedure, whereby a sample of customers were asked to confirm the
outstanding balance, but no reply was received.
Required:
(a) In respect of the development costs and trade receivables:
(i) Comment on the sufficiency and appropriateness of the audit evidence
obtained, and
(ii) Recommend the actions to be taken by the auditor, including the
further evidence which should be obtained. (12 marks)