ACFI301 Advanced Auditing May Examination Paper 2022

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Question One

1.1 Island Ltd (Island) and Flint Ltd (Flint) are both external audit clients of your firm. Each company has a year end of 30 September. In April 20X8, Flint contracted with Island for the provision of services. Flint is dissatisfied with the quality of services provided by Island and is currently taking legal action against Island.

The outcome of the legal action will not be known before the conclusion of both external audits for the year ending 30 September 20X8.

Requirement

Identify and explain the ethical issues arising from the situation outlined above and state how your firm should address these issues.

(4 marks) 

1.2 Your firm is the external auditor of Blackett Ltd (Blackett), an unlisted company, and its wholly-owned subsidiary Coniston Ltd (Coniston). The audit fees for Blackett and Coniston are £4.2 million and £2.7 million respectively. Your firm also provides annual tax services to both companies for a total fee of £1.6 million.

During the current year, your firm performed a oneoff IT engagement for Blackett for a fee of £1.1 million. Your firm’s total annual fee income from all its clients is £74.8 million.

Requirement

Explain what is meant by the self-interest threat in relation to the fee income, arising from the circumstances outlined above, and state how your firm should address this threat.

(4 marks)

1.3 Your firm is the external auditor of Captain Ltd (Captain) for the year ending 31 December 20X8. Your firm plans to use data analytics routines relevant to the audit of inventory. Captain sells fashion goods from 3,000 retail stores located in 36 countries. The goods are purchased from around the world and are invoiced in each supplier’s local currency.

Requirement 

Describe three data analytics routines relevant to the audit of Captain’s inventory.

(3 marks)

1.4 Your firm has been the external auditor of Parrot Ltd (Parrot) for three years. Using data analytics routines, you have produced the following payables dashboard.

         

Parrot’s suppliers have credit terms of 30 days.

Requirements 

List the audit procedures you would include in the audit plan for the year ended 30 June 20X8 given the changes in trade payables days.

 (3 marks) 

1.5 Outline how the planned procedures for an engagement to review financial statements will differ from the planned procedures in respect of an external audit performed under the Companies Act 2006. Give reasons for the differences.

(2 marks)

1.6 Your firm is the external auditor of Pirate Ltd (Pirate). During the current year, Pirate acquired 100% of the share capital of Oar Ltd (Oar), a company incorporated in the UK. The year end for both companies is 30 June 20X8. Oar’s financial statements are being audited by Turner LLP (Turner) and your firm intends to use the audit evidence obtained by Turner for the group audit. Oar is a significant component of Pirate.

Requirement 

Outline the procedures that your firm should undertake because of its intention to use the audit evidence obtained by Turner for the year ended 30 June 20X8. 

(4 marks) 

Total: 20 marks

Question Two

Pattinson LLP (Pattinson) was appointed on 1 May 2021 as the external auditor of Soundscape Ltd (Soundscape), an unlisted company, for the year ended 30 April 2022. Soundscape manufactures a range of sound equipment. The product range consists of:

· high specification equipment sold to entities operating in the music industry; and

· standard equipment sold to retailers for sale to the public.

You are the audit senior responsible for planning the audit.

The engagement partner has asked you to consider the following key areas of audit risk:

(1) Revenue

(2) Trade receivables

(3) Inventory

You have been provided with the following financial information:

Summary statement of profit or loss for the year ended 30 April

	2022 £’000 (Draft)	2021 £’000 (Audited)
Revenue	52,790	40,150
Cost of Sales	25,215	16,915
Gross Profit	27,575	23,235
Operating Expenses	23,995	21,440
Profit from Operations	3,580	1,795

Extracts from statement of financial position as at 30 April

	2022 £’000 (Draft)	2021 £’000 (Audited)
Current Assets
Inventory	5,750	4,015
Trade receivables	6,190	4,250

Standard equipment sold to retailers is invoiced upon despatch. Payment is due within 30 days.

Due to the specialist nature of the high specification equipment, customers for these items are required to pay a 50% deposit upon ordering, the remaining amount is required to be paid within one week of delivery. Sales are invoiced in either £ sterling or euro depending on the location of the customer.

On 25 April 2022, Soundscape invoiced one of its customers, Crinkle Ltd (Crinkle) for the outstanding 50% payment of £425,000. The equipment for Crinkle was ready to despatch to this customer just before the year end but, due to a mix up in the warehouse, it was despatched shortly after the year end.

Soundscape received a formal complaint from one of its customers, Osman Sounds Ltd (Osman) regarding the quality of an order supplied to it by Soundscape in January 2022. Osman claims that the equipment was unfit for use and is refusing to pay the £350,000 outstanding amount. This is currently included within the year-end trade receivables balance. The directors are refusing to adjust the financial statements for the year ended 30 April 2022 in respect of Osman’s complaint.

Soundscape is currently experiencing strong competition. In September 2021, in order to reduce costs, it changed to cheaper suppliers for the components of the standard equipment. During the year, Soundscape received a significant number of complaints about its equipment malfunctioning and an increase in the number of returns from retail customers.

Inventory comprises components, work in progress and finished goods. Inventory is valued at standard costs for labour, overheads and components, which are set at the beginning of the financial year. The company operates a perpetual inventory system supported by periodic counting throughout the year and does not perform a full inventory count at the year end. Following attendance at one of the periodic inventory counts during the year, two internal control deficiencies were noted on the audit file. It was reported that:

(1) There was a large quantity of one type of equipment, the XP324 model, which appeared to be old with damaged packaging. The warehouse manager said that he had not had time to review the aged inventory report for several months.

(2) There were several discrepancies identified between the perpetual inventory records and the quantity of physical inventory counted at the warehouse. The warehouse manager explained that when discrepancies are found, adjustments are made to the perpetual inventory records without further investigation.

During the audit planning meeting with the finance director, Alex Pope, he told you that the trade receivables clerk had left several months ago and had not yet been replaced. The finance team are therefore understaffed so Alex has asked whether your firm could provide someone to assist with the preparation of the financial statements. Alex also mentioned that Soundscape is searching for a new supplier of components, given the quality issues they have experienced during the year.

The audit assistant, Quinn David, a trainee ICAEW Chartered Accountant, previously worked on the external audit of Huck Ltd (Huck), a supplier of electrical components. Quinn has proposed that your audit firm recommends Huck to Soundscape in return for a fee from Huck for the recommendation.

Requirements

2.1 Justify why the items listed as (1) to (3) above have been identified as key areas of audit risk and, for each key area, describe the audit procedures that should be included in the audit plan to address those risks.

  You may present your answer using a two-column format headed ‘Justification’ and ‘Procedures’.   

(28 marks) 

2.2 In respect of the internal control deficiencies identified during attendance at one of the periodic inventory counts, draft points for inclusion in the report to those charged with governance and management of Soundscape.

You should outline the possible consequence(s) of the deficiencies and provide recommendations to address them.

(6 marks) 

2.3 Identify and explain the threats to the auditor’s objectivity that arise in respect of Quinn’s proposal and in respect of Alex’s request for assistance from your firm with the preparation of the year-end financial statements. Outline the safeguards, if any, which should be put in place to mitigate these threats.

(6 marks)

Total 40 marks 

Question 3

Your firm has recently been appointed as the external auditor of Idea Furniture Ltd (Idea) for the year ended 30 April 2022. Idea operates a chain of 60 retail stores throughout the UK, supplying customers with household furniture as well as soft furnishings such as curtains and cushions.

Customers pay for purchases using cash or debit/credit cards. Employees at each store are paid monthly and receive an annual bonus if profit targets are met. Furniture and soft furnishings are purchased, ready for sale, from a variety of specialist suppliers in the UK and overseas. Overseas suppliers invoice Idea in their local currency.  

The directors are planning to diversify the business by introducing, in July 2022, a gourmet food hall and restaurant into each store. In order to fund the proposed diversification, a new loan application has been submitted to the company’s bank. The bank wishes to examine the audited financial statements for the year ended 30 April 2022 together with the profit and cash flow forecasts in respect of the proposed diversification, for the three years ending 30 April 2025. The bank requires an independent examination of, and a report on, the profit and cash flow forecasts and Idea’s directors have requested that your firm perform this engagement.

If the loan is approved by the bank, Idea will invest the funds in fixtures and fittings in each store as well as an initial purchase of inventories of gourmet foods and gifts.

The engagement partner for the external audit has provided you with the following information:  

Inventories of a range of garden furniture with a carrying amount of £3.7 million at 30 April 2022 were sold in bulk to a discount retailer for £1.1 million on 23 May 2022. The directors have refused to amend the financial statements as the amendment will cause the profit to fall below the level required for the payment of directors’ bonuses.

Your subsequent events review performed during the external audit of Idea for the year ended 30 April 2022, included reading the minutes of board meetings held after the year end. Minutes of the board meeting held on 14 May 2022 identified that the company failed a routine health and safety inspection performed by industry regulators on 1 May 2022

Requirements

 3.1 From the information provided, identify the key receipts and payments that you would expect to be included in the cash flow forecast prepared by the directors of Idea in respect of the diversification plans for the three years ending 30 April 2025.

For each key receipt and payment, identify the specific matters you would consider when reviewing the reasonableness of the assumptions in forecasting that receipt or payment.

(13 marks) 

3.2 In respect of the matter regarding the directors’ refusal to amend the value of the range of garden furniture sold to a discount retailer in the year-end financial statements, state whether or not you would modify the audit opinion. Give reasons for your conclusion and outline the modifications, if any, to the auditor’s report.

(7 marks) 

Total 20 marks

Question 4

4.1 “The auditors from KPMG, earning around £1.5m a year for vouching that Carillion’s accounts gave a “true and fair view” of its business, were in fact rubber-stamping figures that ‘misrepresented the reality of the business’. In March 2017, the firm expressed no concern over reported profits of £150m even though just four months later these proved to be illusory.

“Nobody says accounting is easy. Estimating profits and losses on long-term contracts before they finish, for example, involves fine judgment. But this should be exercised by managers and auditors with ‘professional scepticism’.

“This failure, which included ‘accounting for revenue for work that [had] not even been agreed’, enabled Carillion to present the healthy results that justified the lavish dividends and boardroom bonuses that drove the company into insolvency.”

Requirement

  Critically appraise the above quote, assessing the validity of the opinions expressed.

  Explain how proposed reforms to auditing may prevent a recurrence of audit failures such as Carillion.

(12 marks) 

4.2 Described below are situations which have arisen at two unrelated clients of your firm.

Lake

Lake Ltd (Lake) Your firm is performing an engagement to examine and provide assurance on Lake’s cash flow forecast for the three years ending 30 September 20Y1. The forecast has been prepared by Lake’s directors in support of a loan application. Lake’s bank requires the forecast to be examined and reported on by independent accountants. The cash flow forecast has been prepared on the assumption that revenue will grow by 8% pa. Your firm believes this is highly unrealistic because current revenue growth for Lake and the industry in which it operates is 2% pa and 3% pa respectively.

Sail

Sail plc (Sail) Sail is a listed company. Your firm has accepted an assurance engagement to provide an opinion on Sail’s greenhouse gas (GHG) statement for the year ended 30 June 20X8. Sail has estimated the emissions figures for the period February to June 20X8 and is required to disclose this fact in the GHG statement. Your firm is satisfied with the basis of the estimate and that it has been appropriately disclosed by Sail. The inclusion of estimates is fundamental to users’ understanding of the GHG statement. Requirement For each of the four situations above, state, with reasons, the implications for your firm’s audit or assurance reports. 

(8 marks)

Total 20 marks