ACFI301 Advanced Auditing 2023

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Question One

1.1 You are planning the audit of Repton Ltd (Repton), a company that owns and operates hotels throughout Europe, for the year ending 30 September 2023. The directors of Repton are planning a stock market listing in early 2024 and have requested that your firm complete the audit in a shorter time period than usual so that the audited financial statements can be included in the promotional material for the stock market listing.

Explain how the audit risk is increased due to the planned stock market listing, and identify any professional and ethical issues arising from the request to complete the audit in a shorter time period. 4 marks 

1.2 The UK government sued (brought a lawsuit against) accountancy firm KPMG over its audit of construction giant Carillion, which collapsed into administration in 2018. In response to this lawsuit, KPMG said: "We believe this claim is without merit and we will robustly defend the case. Responsibility for the failure of Carillion lies solely with the company's board and management, who set the strategy and ran the business."

Discuss the extent to which you agree with the statement that responsibility for the failure of Carillion lies solely with the company’s board and not with the auditor. 5 marks

1.3 You are the audit senior for the external audit of Munchie Ltd, a manufacturer of biscuits and cakes, for the year ended 31 March 2023. As part of your review of the board minutes, you identified that the company failed a routine health and safety inspection performed by industry regulators in February 2023.

Requirement
Explain why the auditor needs to consider this breach in health and safety regulations and outline the potential implications of this breach for the financial statements. 3 marks 

1.4 During the external audit of Roberts plc (Roberts), your firm is planning to use data analytics tests to gain assurance that inventory is fairly stated in the financial statements for the year ended 31 May 2023. The principal activity of Roberts is the retailing of outdoor clothing and camping equipment. Sales are made through Roberts’s 40 retail outlets, located in cities throughout the UK, and through its website. It distributes its products from a warehouse located in Glasgow.

Roberts maintains a perpetual inventory system, which records the quantities held and the cost price of inventory. The cost of inventory is updated from purchase invoices. Samples of inventory items are counted monthly at the warehouse and physical quantities are compared with those recorded in the accounting records.

Requirement
List three data analytics tests that your firm could perform on data from Roberts’s information systems. 3 marks

1.5 During the external audit of Lewis Ltd (Lewis), the audit senior discovered a cash transaction in the bank statement that did not have any supporting documentation and was not included in the accounting records. A member of the finance team explained that the Operations Director had requested the payment and instructed them not to include the payment in the accounting records.

The transaction involved cash being deposited into the company’s bank account and then the next day, the same amount being transferred into the bank account of a company owned by the Operations Director’s brother. The amount is below the materiality threshold set for the external audit.

Requirement
State, with reasons, how the audit senior should deal with this matter.  2 marks 

1.6 A senior partner at Vaughan LLP, an audit firm, conducted a cold review of the external audit of Carter Ltd (Carter) for the year ended 31 December 2022. The cold review identified that there wasn’t sufficient documentation to evidence that appropriate consultation had taken place where significant matters were identified.

Explain why the issue identified has been reported as part of the cold review. State the actions the senior partner should now take. 3 marks 

Total 20 marks

Question Two

Starsheep plc, a UK listed company, is an online retailer of greeting cards and gifts. Starsheep plc has two wholly-owned subsidiaries (which it has owned for several years) forming the Starsheep Group.

You are the audit senior of Addams and Ortega LLP (A&O) responsible for planning the audit of the consolidated financial statements of the Starsheep Group and the parent company Starsheep plc for the year ended 30 April 2023. The engagement partner has identified the following three areas as significant risk for this audit:

(1) Trade payables

(2) Capitalisation of development costs

(3) Carrying amount of investments in subsidiaries

Materiality for the audit has been set at £2,875,000.

The company buys cards and gifts from suppliers based overseas. All purchases are made on 30-day credit terms and are invoiced in the supplier’s local currency.

Following an increase in complaints from customers, Starsheep identified an issue with products purchased from one of its largest suppliers of gifts which resulted in a significant amount of returns during September 2022. Starsheep’s accounts department had paid the invoices relating to these products as it had not been notified of the returns. The returns were only identified by the finance team when they received the supplier’s credit notes. Starsheep do not routinely reconcile supplier statements with the payables ledger.

The subsidiaries of Starsheep Group at 30 April 2023 are:

Subsidiary name	Country of incorporation	Principal Activity
Starsheep.com Limited	England and Wales	Trading company: online retailer of greetings cards and gifts. Customers predominantly based in the UK
Salut SARL	France	Trading company: online retailer of greetings cards and gifts. Customers predominantly based in France

Each of the two trading companies has its own website and mobile app through which sales are made. Starsheep has a technology development team which works predominantly on maintaining and improving the mobile apps. Development costs are capitalised and amortised over the useful life of the asset.

During the year ended 30 April 2023, the technology development team conducted two main development projects:

· the development of a new app for Salut which is due to be launched in September 2023

· improvements to the Starsheep.com app including a more personalised experience for customers and the ability to include a photo of a handwritten message in greetings cards.

Development costs include a proportion of the salaries of employees working in the development team. This proportion is based on the IT Director’s estimate of time spent by staff on the relevant projects. The IT Director also estimates the relevant proportion of overheads to attribute to development costs.

The accountant responsible for recording the costs associated with technology development projects left Starsheep on 1 December 2022 and has not yet been replaced. One of the existing members of the finance team has taken on responsibility for recording the costs associated with technology development projects, in addition to their usual responsibilities, until a replacement can be found.

The Finance Director has enquired whether a member of the audit team could provide some advice to the Starsheep finance team regarding what costs can be capitalised as development costs for the year ended 30 April 2023 due to the finance team’s lack of experience in this area.   

In December 2022, Starsheep plc lowered its annual revenue guidance to the UK stock exchange, due to disruption from Royal Mail strikes as well as consumers choosing cheaper gifts from competitors. This resulted in the company’s share price falling 18%.

Salut SARL (Salut) has also experienced difficult trading conditions during the year as the current Salut app is less user friendly than the apps of Salut’s competitors. Starsheep’s technology development team are in the process of developing a new app for Salut which they expect to be the most innovative on the market when it is launched in September 2023.  

The carrying amount of the investment in subsidiaries in the Starsheep plc financial statements is dependent on the future performance of the two subsidiaries. The directors of Starsheep prepared an impairment assessment of each of the investments in subsidiaries at 30 April 2023. Through this assessment, the directors identified that the carrying amount of the investments was lower than the value in use of the trading entities within the Group, and concluded that no impairment was required.

The Finance Director has requested that the audit fee for the year ended 30 April 2023 be reduced by 18% due to the challenging economic conditions.

The engagement partner has provided you with the following extracts from the draft consolidated financial statements:

Consolidated statement of profit or loss for the year ended 30 April (extract)

	2023 (draft) £’000	2022 (audited) £’000
Revenue	356,768	388,265
Cost of sales	185,297	194,625
Gross profit	171,471	193,640

Consolidated statement of financial position as at 30 April (extract)

	2023 (draft) £’000	2022 (audited) £’000
Current liabilities
Trade and other payables	14,667	18,272

The investments in subsidiaries are recognised in the statement of financial position of the parent company Starsheep plc at £875,798,000 for the years ended 30 April 2022 and 30 April 2023.

Note to the consolidated financial statements: intangible assets (extract)

	Technology and Development Costs £’000
Cost
1 May 2022	17,296
Additions	8,714
Disposals	(3,659)
30 April 2023	22,351
Accumulated amortisation
1 May 2022	4,980
Amortisation charge	6,021
Disposals	(3,659)
30 April 2023	7,342
Carrying amount at 30 April 2023	15,009

Requirements

2.1 Justify why the three items listed (1) to (3) by the engagement partner have been identified as areas of significant risk for this audit. For each item, describe the audit procedures that should be included in the audit plan to address those risks.

Note. You are advised to present your answer in a two-column format using the headings:

(i) Justification; and

(ii) Procedures to address the risk. 28 marks 

2.2 For each of the two internal control deficiencies, outline the possible consequence(s) of the deficiency and provide recommendation(s) to remedy each deficiency.

You should present your answer under the following subheadings:

(a) Finance team not being informed about inventory returns

(b) Supplier statements not reconciled with the payables ledger. 6 marks 

2.3 Discuss the ethical and professional issues arising from the finance director’s request for a member of the audit team to advise on costs that can be capitalised as development costs and the request for the audit fee to be reduced. Outline the safeguards that your firm should have in place to address these issues. 6 marks 

Total 40 marks

Question 3

The directors of Pyjama Party Ltd (PP), an external audit client of your firm, are planning to expand the business. The expansion is to be funded by a loan from the company’s bank. The bank requires annual cash flow forecasts for the three years ending 31 March 2026 in support of the request for funding. The board of directors of PP has requested that your firm undertakes a limited assurance engagement to review this information.

PP designs and sells high quality matching pyjamas for all the family by mail order and online. Customers pay for goods at the time of order and the company operates a policy whereby customers who are not satisfied with any purchase are entitled to a full refund if they return the product, undamaged, within 60 days of receipt. In recent years, the level of returns has been approximately 10% of revenue. All products are designed by PP’s design team and made exclusively for PP by suppliers based overseas. All suppliers offer 30-day credit terms.

The directors are planning to expand the business by opening concessions (i.e. using an area of floorspace within large retail stores) throughout the UK. The directors of PP expect this to increase brand awareness as well as sales and so they are reducing their marketing budget for the next two years.

The directors of PP have reached a provisional agreement with a UK-based department store. This would be an exclusive deal for three years (meaning they could not operate concessions within any other stores during that time). PP will have concessions within 20 of the stores and are required to pay a deposit of 6 months’ rent for each concession. In addition, rent for each concession is payable quarterly in advance and the amount varies depending on the location of the store. The directors intend to have the concessions fitted out to a very high standard in line with the company’s image and will use specialist contractors to undertake this work. There will be electronic point-of-sales systems and customers will be able to pay by cash, credit cards or debit cards.

Concessions will not have members of staff employed directly by PP, instead staff from the department store will be trained by PP to be able to provide a high level of customer service. These employees will be paid a commission on all sales made at the concession. The commission will be payable quarterly in arrears.

PP currently operates from one site in Birmingham which includes both a warehouse and head office. To manage the additional demand, the directors are planning to lease a new warehouse in Leeds. They are yet to find suitable premises so have agreed a short-term lease arrangement with the owners of their current site to lease another warehouse in Birmingham on a month by month basis until they secure new premises. As the terms of this lease are very flexible, the rent is double the rent of their current warehouse, but the directors are hoping this is only for a short period of time.

Your firm is currently finalising its terms of engagement with PP for the review of the cash flow forecasts. The finance director has asked for an explanation of the following phrase used in your firm’s draft engagement letter:

“Our report will provide a limited level of assurance as to whether the assumptions provide a reasonable basis for the preparation of the forecasts.”

Requirements

3.1 From the information provided in the scenario, identify the key cash receipts and payments that you would expect to be included in the cash flow forecasts for the three years ending 31 March 2026 in respect of the expansion plans. For each receipt and payment, you should identify the specific matters you would consider when reviewing the reasonableness of the assumptions underlying that receipt or payment. 13 marks

3.2 Draft a note to the finance director which explains how and why the level of assurance provided by the assurance report on the cash flow forecasts differs from the level of assurance provided by an auditor’s report on annual financial statements.  4 marks

3.3 State, with reasons, the implications for your firm’s assurance report if it believes that significant assumptions in the cash flow forecasts do not provide a reasonable basis for the prospective financial information. 3 marks 

Total: 20 marks

Question 4

You are planning the external audit of Shankly Ltd (Shankly) for the year ended 31 December 2022. Shankly is a manufacturer of fashion jewellery.

Using data provided by Shankly, your firm’s data analytics software has produced the following visualisation relating to sales, purchases and inventories. The visualisation shows the sales per month, purchases per month and the inventory at the end of each month, all in £000s.

 

Shankly redesigned its products in October 2022.

All goods are sold at full cost plus 25%.

Shankly had a cash balance of £150,000 at 31 December 2022.  

Requirements

4.1 Identify and explain the key audit risks arising from the above visualisation and set out the key audit procedures to address each risk. (Ignore going concern issues).                            12 marks

4.2 You have reviewed the sales budget for Shankly, and it shows a continued decline of monthly sales throughout 2023 and 2024.  For the year ended 31 December 2022, explain the audit procedures you would carry out in respect of the going concern of Shankly.                                      8 marks

Total: 20 marks