Section A

1.        Fundamentals  plc  is a  UK-listed company  providing training courses  in everything from accountancy to plumbing in many countries. The company currently has five subsidiaries based in France, Spain, Germany, Ireland and  Australia.  Fundamentals  plc’s  year  end  is  31st  January.  The  total revenue of Fundamentals plc and its subsidiaries for the year to 31st January

2023 is £150m and net profit is £15m.

Major changes in the year to 31st January 2023 are:

The company’s chief financial officer, Tseng, resigned having been in post for six years.  He was replaced through the internal promotion of the company’s financial controller who had worked under Tseng for five years. The reasons behind Tseng’s departure were said to be personal  but  the  financial  media  were  never  satisfied  by  this explanation and the company’s share price has suffered as a result of the uncertainty over the situation.

The company has expanded its customer base into Australia for the first  time  this  year.  Despite  some  teething  problems  the  move appears to have been a success with revenue equivalent to £10m and profit equivalent to £2m. However, the audit team found it difficult to obtain documentation from the Australian subsidiary company.     The company plans to expand into China and India. These plans will require a combination of rights issues to existing shareholders and bank loans to increase both forms of finance by 20%.

During a meeting held between the auditors, the audit committee and the chief executive officer just before the year end, the auditors were informed that the Board were very keen to work closely with the audit committee and the auditors to ensure a successful audit outcome this year.

The  subsidiary  companies  are  all  audited  by  local  auditors  not associated with the UK audit firm .

Required:

a)       When planning the audit of the Fundamentals plc group, what are the audit

risks that the auditor should consider and what audit work should be carried out in response to these risks? (15 marks)

b)       To  what  extent  can  the  parent  company  auditor  rely  on  the  work  of subsidiary auditors and what are the key factors to consider? (10 marks)

2.       You have just been appointed the auditor of Kite Books plc, a publishing house  which  commissions  literary  works  from  authors,  and  prints  and markets the books.  The authors are given an advance against their future royalties; for unknown authors this may be as little as £1,000.  Better known authors may demand and receive an advance of as much as £50,000.  The advance is paid before the writing begins.  Technically Kite can recover the advance from the author if he/she fails to deliver the completed book on time.  However, recovery has never been attempted since failed authors are unlikely to have any liquid assets. At December 31, 2022, Kite’s net assets totalled £750m including £100m accounts receivable balance of which £15m related to advances to authors.

Once a book is published and starts to sell, Kite records the amount of sales revenue for each title.  Under its standard terms of agreement with authors, Kite agrees to pay the author 10% of the sales proceeds as a royalty. A few well known authors have negotiated a rate of 15% which Kite agreed to pay rather than risk losing the author to a competitor.  Total revenue for sales of books amounted to £250m in the year to December 31, 2022. Total royalties paid to authors amounted to £20m.

Kite supplies books to a number of bookshops on a sale or return basis. The bookshop  has the opportunity of  returning any  unsold  books within  six months.   Kite accounts for such sales as if they were complete, on the grounds that in the past the return of unsold  books has been minimal. However, for reasons of ‘prudence’, royalties to the authors are not accrued until the end of the six month return period.

Kite’s sales and marketing staff have a lot of experience of the industry .  It has been a long time since they last had a bad year when several book titles all failed to produce expected sales volumes . They therefore argue that the inventories of printed but unsold books in the warehouse are as good as sold. On this basis the inventory is valued at selling price less the 10% owed in royalties to the author. The typical mark-up is 200% on the production cost.  However, when a book underperforms, it usually has to be shipped to discount stores which will only buy it at 5% of its full sales price.   Total inventory of books is included in the balance sheet at December 31, 2022 at £40m.  Net profit before tax is £5m.

Required:

a)       What are your concerns about Kite’s operations and accounting and how would you propose to investigate each matter or issue that you identify? (15 marks)

b)       In the context of Kite, give your estimate of an amount which you would regard as material and explain the factors which led to your assessment.  Identify which (if any) of the above items appear to be materially misstated. (10 marks)

3.       You are an audit partner in a Dragon & Co., a firm of registered auditors. The following extracts all relate to some of your audit clients:

i)       You are carrying out the audit of Vine Ltd in respect of the year ended 31st    January,  2023.   During  your  routine   review  of  the  company’s correspondence files you discover that the company has been in dispute with a customer over a warranty on one of its products. When you question the sales director about this issue he tells you that he is confident the complaint has no substance and is unlikely to be successful.

ii)      You have just completed the audit of Sloane Ltd in respect of the year ended 31st  December 2022. During the final audit meeting you receive an anonymous note informing you that since the year-end one of Sloane Ltd’s major clients has become insolvent. The note tells you that Sloane Ltd. ’s board had made the decision not to tell you about the issue due to the effect it would have on the financial statements.

iii)      Bond Ltd manufactures computer equipment. Inventory is a material area of its financial statements.  Your appointment as auditor to Bond Ltd was made just after its year-end. You were therefore not able to attend the company’s physical count of its inventory.

iv)     Leicester plc has a number of branches across the UK.  One branch is in a remote location in the far north of Scotland.  You have never visited this branch because it is relatively small and you could not justify incurring the travel cost.

v)      During the audit of the accounts receivable section of Mayfair plc, your  audit  team  were  unable  to  locate  a  file  containing  suppliers’ statements for the last two months of the year and the first month of the

new financial year.  All other records were in the correct place. Required:

a)       For each issue above explain why there might be a problem for you as auditor, what additional audit work you would need to do in response to the problem and how the outcome might affect your final audit opinion. (15 marks)

b)       In order for auditors to carry out an efficient and effective audit they are given certain legal rights in the UK under the Companies Act 2006.  Explain what these rights are. (10 marks)

4.       You are an audit senior in charge of the first audit of a new client, i-wear, an online wholesaler of a fashion brand of sunglasses.  You are reviewing the work of Libby, a first year trainee, involved in testing the sales cycle of i- wear, You had told the trainee to extract a random sample of 30 sales orders to test for the completeness of the sales figure.

The trainee began with the register of sequentially numbered sales orders. For each one, she had to trace from the entry in the register to the original contact from the customer, e.g. email, letter or its own requisition document. She also had to check evidence that the customer received the goods, i.e. the signed delivery note. Then she had to check that the customer had been invoiced and had paid the invoice within the 30 day stipulated time or had been included in the list of bad or doubtful debts.

Of the 30 items in her sample, Libby has found the following:

3 of the items on the register had no documented order but it was said that the orders had come in over the phone .

2 of the sales orders had blank delivery notes attached to them – customers, it had been suggested, often cannot be bothered to sign and the i-wear’s delivery driver is always under pressure to get to the next drop-off point so does not insist on the signature.

None of the customers placing orders appeared to have passed any credit checks – it had been explained that with the increase in sales recently no one had had the time to check the credit status of existing or new customers. 2 of the items had been purchased during a sales promotion when prices had been cut by 30% but the customers then returned the goods after the end of the promotion period and had received refunds at the full price.

5 of the items had gone to customers who still had not paid their invoices even though delivery had taken place more than 2 months before the tests were carried out.

Required:

a)       As an audit senior, what would be your concerns about each of the issues outlined above and what possible impact might each have on the financial statement amounts? (15 marks)

b)       Explain the extent to which  it  is the  responsibility of the auditor to tell management of weaknesses in a client’s control systems and what can auditors do if management refuse to take any corrective action? (10 marks)

Section B