Audit and Assurance December 2010 Marks Plan, ICAEW

Audit & Assurance – Professional Stage – December 2010MARK PLAN AND EXAMINER’S COMMENTARY General comments It was pleasing to note an improvement in candidates’ performance regarding the short-form questions, continuing the improvement identified in recent sessions. However, a significant number of candidates are failing to take advantage of the facility to present the short-form answers in note form. A small number of candidates failed to follow the instruction to answer each short-form question on a separate page and to submit the short-form questions in numerical order. It was also pleasing to note that there was evidence that candidates were managing their time better than in previous sessions as there were notably fewer unfinished last questions. SFQ1 Proposal represents “lowballing” Threat to the fundamental principle of professional competence and due care Risk that the firm may cut corners to stay within the budget If non-audit services obtained objectivity may be impaired due to:  self-interest/fee dependency threat - fear of losing fee may cause reluctance to report unfavourably  self-review threat - over reliance on colleagues’ work - reluctance to notify firm’s errors to client’s management  management threat - may be expected to make decisions ES4 (Revised) states that audit fee must not be influenced by the provision of other services. This question was generally well answered with most candidates identifying and adequately explaining selfinterest, self-review and management threats. Although many candidates identified that the firm may cut corners to stay within the budget, few cited that this posed a threat to the fundamental principle of professional competence and due care. Furthermore, the majority of candidates did not make the point that Ethical Standard 4 Fees Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality (Revised), states that the audit fee must not be influenced by the provision of other services. A minority of candidates wasted time citing safeguards for each of the threats which were not required. Maximum full marks Marks available 4 6 SFQ2 As the background information can be pooled (i.e. knowledge spillover) - services can be provided at a lower overall cost - convenient/less disruptive to client/one-stop shop As the firm has a greater knowledge and understanding of the client - services are likely to be of higher quality Client derives a greater degree of comfort from having the services provided by a trusted source. This question was well answered with the majority of candidates appreciating the benefits that a firm’s existing knowledge would bring when external auditors provide non-audit services to a client. Some candidates failed to read the question properly and gave benefits from the firm’s perspective (such as attracting higher calibre staff through offering a varied portfolio of work) or the general benefits of some non-audit or assurance services (such as increased credibility when raising finance). These points were outside the scope of the question and did not score any marks. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. 4 6 Page 1 of 15 Maximum full marks Marks available 4 10 SFQ4 Tasks Discussion of significant matters with engagement partner Review of financial statements and proposed audit report Review of selected documentation relating to significant judgements/conclusions Evaluation of conclusions reached and appropriateness of audit report For audits of listed entities consider Engagement teams evaluation of the firm’s independence Whether consultation has taken place on difficult or contentious matters Whether audit documentation selected for review reflects the work performed and supports the conclusions. rather than the auditor. 3 3. particularly given that this question tested candidates’ basic knowledge of external auditors’ rights and responsibilities when not being re-appointed. Others just listed the six elements of a system of quality control as set out in paragraph 16 of ISQC1. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010.to be deposited at Pisces’ registered office and copy to be sent to Registrar of Companies As Pisces is listed.make written representations and request directors to circulate to members . A significant minority of candidates included.5 Page 2 of 15 . the rights and responsibilities of the auditor on resignation.Audit & Assurance – Professional Stage – December 2010 SFQ 3 Rights Outgoing auditors may .specifying reasons for ceasing to hold office . Candidates did not appreciate that the written representation is circulated to shareholders by the directors. often scored full marks. Those candidates aware of the requirements of ISA 220 or ISQC1. the majority of candidates failed to distinguish the tasks associated with an engagement quality control review from those required by review procedures undertaken as part of routine engagement performance. or who knew where to look in the open text. However. many confused it with monitoring procedures (cold review) designed to provide an audit firm with assurance that its own system of quality control is operating effectively. there is no option to state there are no circumstances Obtain permission from client to reply to prospective auditor’s communication Return promptly all books and records of the company Maintain client confidentiality after ceasing to act Maintain money laundering identification records. In addition. This question was well answered but some answers were very disappointing. Quality Control for an Audit of Financial Statements (ISA 220) and International Standard on Quality Control 1(ISQC1). incorrectly. A few candidates misread the question and answered it from the perspective of the new firm of auditors about to be appointed.attend and speak at general meeting Responsibilities Prepare statement of circumstances . such as requisitioning an extraordinary general meeting. This was the most poorly answered short-form question. with only a minority of candidates appreciating that the answer could be found in International Standard on Auditing 220. Candidates often demonstrated an inability to distinguish between a written representation (a right) and the statement of circumstances (a responsibility) and often were unable to give these documents their correct titles. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. and the impact of adverse publicity on the going concern presumption.Audit & Assurance – Professional Stage – December 2010 SFQ 5 Increased risk of window dressing/misstatement/bias In order to increase purchase consideration Reduce materiality thresholds Increase the level of testing Emphasis on . Whilst the majority of candidates correctly identified that the pending purchase of shares increased the risk of material misstatement due to management bias.increase in provisions for warranties . many candidates did not appreciate the impact this would have on the overall audit strategy. the nature of the audit procedures that should be employed. This question was very well answered with many candidates scoring the full two marks available.5 SFQ 6 Likely to have material impact on financial statements .provisions/contingencies relating to legal claims Adverse publicity may impact on going concern status. reducing materiality thresholds and placing less reliance on management representations.testing assets and income for overstatement . A minority of candidates wasted time by going on to explain. 2 4 Page 3 of 15 . Answers to this question were mixed. This was not required within the two marks available for this question. Candidates correctly identified the impact the product recall would have on the financial statements.provision for faulty inventory . incorrectly. A number of candidates focussed.refunds for returns .testing liabilities and expenses for understatement Increase the level of professional scepticism Look carefully at judgement areas Place less reliance on management representations Use more experienced staff Arrange a quality control review. often in detail. such as provisions for legal claims and warranties. Maximum full marks Marks available 3 5. Points commonly missed by candidates included: arranging a quality control review. on the prospective owner of the business discussing issues such as client identification procedures and issuing new engagement letters and consequently scored no marks. Others failed to appreciate the distinction between doubt over the going concern status and the situation where a company was definitely ceasing to trade. ISA 570 Going Concern (ISA 570) requires the auditor to consider whether there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Weaker candidates were unable to explain the implications for the audit report when there are doubts over the going concern status of the company. Most candidates were able to explain why an auditor should consider whether a company is a going concern and the implications of this for the financial statements. If the note is adequate. but there should be a note in the financial statements explaining the situation. that the going concern basis should be used when a company was ceasing to trade.  assets may need to be written down to recoverable amounts. Weaker candidates strayed beyond the requirement and wasted time citing the audit work to be undertaken. Part (a) Explain why an auditor should consider whether a company is a going concern. In general. If the financial statements are prepared using an inappropriate basis the audit opinion will be modified with an adverse opinion. the financial statements should be prepared on the going concern basis. either with a qualified opinion (“except for”) if considered material but not pervasive or an adverse opinion if considered material and pervasive.Audit & Assurance – Professional Stage – December 2010 Question 7 Total marks: 40 General comments There were some very good answers to this question which attained the highest average mark on the written test section of the paper. If there is uncertainty about the going concern status. A small number of candidates confused the going concern and break-up basis and stated. they failed to appreciate as long as the basis of preparation was adequately disclosed in the financial statements the audit report would be modified with an emphasis of matter paragraph and the opinion would be unmodified. and  additional liabilities for losses/redundancies may arise. If the going concern basis of preparation of the financial statements is not appropriate. Your answer should consider the implications for both the financial statements and the audit report. If the note is inadequate. candidates provided strong answers to part (b) but struggled with part (d). A number of candidates incorrectly stated that when financial statements are prepared on a break-up basis then the audit opinion should be modified.  assets and liabilities should be reclassified as current. Although there were some very comprehensive answers to this part of the question. then the auditor can give an unmodified opinion but the audit report will be modified with an emphasis of matter paragraph. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. then the break-up basis will have to be used and this will have to be disclosed in the notes to the financial statements. fewer candidates were able to explain the implications for the audit report and some candidates provided very brief answers to this aspect of the question and consequently lost marks. The audit report will be modified with an emphasis of matter paragraph drawing the users’ attention to the basis of preparation and the note in the financial statements. 7 15 Page 4 of 15 . Consequently. then the audit opinion will be modified. This has implications for the amounts at which items are included in the financial statements. a number struggled with the requirement. the audit report will be issued with an unmodified opinion. However. If the auditor agrees with the use of the break-up basis and this is adequately disclosed in the notes to the financial statements. in particular. incorrectly. it could result in under or overstatement of work in progress.results of sensitivity analysis on key components of the forecasts.vouch entries for components to suppliers’ invoices  Trace payroll costs/invoices to job costing records  Ascertain the basis of overhead allocation and review it for reasonableness. In respect of the forecasts. including the arrears to HMRC  Review post year-end management accounts to assess the company’s performance  Inspect borrowing agreements and assess the company’s ability to comply with covenants and other terms and conditions  Obtain a written representation on the feasibility of management’s future plans  Enquire of the company’s legal advisors to assess the impact of potential fines imposed by the regulator  Inspect correspondence with regulators to assess the likely outcome of the investigation  Inspect bank correspondence for evidence of any deterioration in the relationship with the bank or alternative sources of finance  Inspect correspondence with HMRC to confirm the payments plan has been agreed Receivables Procedures  Inspect correspondence with the customer for evidence of a dispute  Discuss the situation with the directors and request a provision if recoverability in doubt  Examine cash book. the latter may seek to place the company into administration. describe the procedures that should be included in the audit plan in order to address those risks. There is a risk that the overdraft facility may not be extended. receivables may be overstated if a provision is not made. Going concern Procedures  Examine profit and cash flow forecasts for at least 12 months from the year end. Work in progress Justification The work in progress figure is extracted from the job costing records which are integrated with the purchases and payroll systems. bank statements or remittance advice up to audit completion to ascertain whether the amount is paid after date Work in progress Procedures  Evaluate and test the controls exercised over the posting of purchases and payroll costs  For a sample of contracts underway at the year end: . and . ensure only attributable overheads are included  Reperform overhead calculation based on the figures in the management accounts  Compare actual costs to budget to identify cost overruns which may indicate potential losses  Compare receipts after date to total costs for contracts in progress at the year end to ascertain whether provision for losses required © The Institute of Chartered Accountants in England and Wales 2010. Cost overruns on fixed-price contracts could result in losses which. The company is under investigation by the industry regulator and as a result may be subject to large fines or even have its licence to operate revoked. the delayed payments to HMRC and the overdue amount from a major customer. or even withdrawn. in particular. If the system is unreliable. The allocation of overheads involves the use of judgement which increases the risk of misstatement. Both of these have an adverse impact on profitability and impede the company’s ability to generate cash from operations. if not provided for.Audit & Assurance – Professional Stage – December 2010 Part (b) Justify why the items listed have been identified as key areas of audit risk and. If the company fails to meet its payments to HMRC. The cash flow problem is further exacerbated by a decline in demand from the construction sector coupled with undercutting of prices by competitors. . Page 5 of 15 .vouch entries for labour to payroll . consider the: . will result in the overstatement of work in progress.reasonableness of the assumptions upon which the forecasts are based.company’s ability to meet its debts as they fall due. for each item. Going concern Justification The company is experiencing cash flow difficulties as evidenced by the need to increase the overdraft facility. Receivables Justification A material amount is overdue and if its recoverability is in doubt. Non-current assets Procedures  Obtain a copy of the valuer’s report and consider the reliability of the valuation after taking account of: .experience/competence/expertise. the valuation may be deliberately overstated or all properties in the class may not be revalued). There is a risk that revaluation adjustments may not be accounted for correctly.Audit & Assurance – Professional Stage – December 2010 Non-current assets Justification The valuation of the property involves judgement which increases the risk of misstatement. Page 6 of 15 .qualifications. and . and in respect of the valuer: .no cherry picking) © The Institute of Chartered Accountants in England and Wales 2010. There is also a risk that management has used the revaluation to strengthen the statement of financial position by window dressing (for example.e. .the basis of valuation.independence/objectivity. .reputation  Compare the value attributed to Lagg’s property to the value of other similar properties in the locality  Reperform the calculation of the revaluation adjustments and ensure that they have been accounted for correctly  Ensure the depreciation is based on the revalued amount  Inspect the notes to the financial statements to ensure appropriate disclosures  Ensure all assets in the class are revalued (i. The point most commonly overlooked was that relating to the examination of post year-end management accounts. why raw materials inventory was a key audit risk and described procedures to verify such inventory instead of focusing on work in progress as required by the question. work in progress and property. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. a significant minority failed to appreciate that valuations involved judgement and that in itself posed a risk of misstatement. However.Audit & Assurance – Professional Stage – December 2010 This part of the question was very well answered in respect of going concern and trade receivables. However. As in previous exams. Receivables Generally well answered as most candidates appreciated that the overdue receivable may not be collectable and therefore receivables may be overstated if a provision is not made. candidates performed better on the justification of the risks identified in the question. a number of candidates lost marks by being too vague e. On the whole. many candidates cited “obtain cash flow forecasts” or “inspect correspondence” but did not specify what they should be looking for in the cash flow forecasts or why they should inspect the correspondence. inspecting evidence of payment after the year end.e. and included a number of general audit procedures in respect of receivables as a whole. plant and equipment were generally not well answered. almost all candidates followed the examiner’s guidance to use a columnar format to layout their answers. than on the procedures to be performed to address the risks. As noted by examiners in previous commentaries. lawyers and the industry regulator. Property. In addition. with a significant number scoring maximum marks. Work in progress Many candidates provided very weak answers to justify why work in progress had been identified as a key audit risk. Weaker candidates wasted time on income recognition which was beyond the scope of the requirement as revenue was not listed as an area of audit risk. plant and equipment Some answers dealing with the property. Some candidates discussed. However. Going concern The vast majority of candidates were able to justify why going concern was an area of audit risk and provide some relevant audit procedures involving examination of forecasts and correspondence with the company’s bank. Very few candidates described how to test the reliability of the job costing records used in the work in progress valuation by vouching payroll and component entries back to source documentation and tracing source documentation into the costing records. i. many candidates failed to identify procedures to address that specific risk.g. 20 44 Page 7 of 15 . Most candidates failed to appreciate that cost overruns on fixed price contracts could result in losses requiring provision and consequently affecting the work in progress valuation. plant and equipment risk were brief. many failed to consider inspecting the valuer’s report. Although the majority of candidates considered the competency and independence of the valuer. at length. Those candidates who worked methodically through the question justifying why each item had been identified as a key area of audit risk and then describing procedures to address that risk scored particularly well. particularly in relation to the audit procedures. a significant number of candidates overlooked the possibility that the revaluation adjustments may not have been recorded correctly. Many candidates appreciated that the valuation might have been overstated in order to strengthen the statement of financial position. The firm should ensure that the management of Lagg are “informed”. Any such services should be of a technical. International Standard on Quality Control 1 (ISQC1) and International Standard on Auditing 220 Quality Control for an Audit of Financial Statements (ISA 220) require the engagement partner to consider the integrity of the directors when deciding whether to continue with an existing engagement. who is not a member of the audit team. the staff member should not be involved in initiating transactions. Most candidates identified that there was an increased risk of misstatement in the financial statements arising from a failure to provide for fines and explained why the integrity of the directors needed to be considered.e. mechanical and informative nature. The management threat arises if members of the firm are expected to make decisions on behalf of management. Maximum full marks Marks available 6 10 Part (d) Identify and explain the principal threats to objectivity which arise from a member of your firm’s staff assisting with the preparation of the financial statements as requested by the finance director of Lagg. Mitigate threats The staff member assisting with the preparation of the financial statements must have no involvement in the audit of those financial statements. In light of this. This part of the question was generally well answered. few appreciated that this is a requirement of ISQC1 and ISA 220. therefore assistance with the preparation of the financial statements can be given as long as appropriate safeguards are in place. by you and your firm. i. with appropriate expertise. association with cavalier directors could impact adversely on the reputation of the audit firm.Audit & Assurance – Professional Stage – December 2010 Part (c) Explain the matters that should be considered. Audit staff may be reluctant to identify shortcomings in their colleagues’ work or may place too much reliance on that work without checking it. Breaking the law to save costs represents money laundering and as such needs to be reported to the firm’s money laundering reporting officer who should decide whether to report to the Serious Organised Crime Agency. The audit of the financial statements should be independently reviewed to ensure that the accounting services performed have been properly and effectively assessed in the context of the audit of the financial statements. The accounting services should be reviewed by a partner or other senior staff member. if during the course of the audit you discovered that the directors of Lagg had authorised the illegal disposal of hazardous waste in order to save costs. the firm should consider whether it is appropriate to offer itself for re-appointment. Stronger candidates went on to score full marks by explaining that the illegal dumping of hazardous waste to save costs represented money laundering and set out the actions that needed to be taken by themselves and their firm once money laundering is identified. Lagg’s management should take all decisions requiring the exercise of judgement and should have prepared the underlying accounting records. State how your firm should mitigate these threats. There is also an increased risk of misstatement as the directors may fail to provide for probable fines or disclose possible fines. Furthermore. The audit firm should take care not to tip-off the client. In addition. Threats The self-review threat arises when the results of a non-audit service performed by the engagement team or others within the firm are reflected in the amounts included or disclosed in the financial statements. Page 8 of 15 . The directors’ actions indicate a lack of integrity and cast doubt on the reliability of their representations and hence the degree of reliability that can be placed on them. The respective responsibilities should be set out in a separate engagement letter. designated members of the management have the capability to make management judgements and decisions on the basis of the information provided. Although many identified that the engagement partner should consider whether it was appropriate to continue to act. Assistance with the preparation of the financial statements is not prohibited in the UK as Lagg is not listed. The firm may become too closely aligned with the views and interests of management. © The Institute of Chartered Accountants in England and Wales 2010. including any actions to be taken. taking decisions or making judgements. 7 9 Page 9 of 15 . A number of candidates wasted time by discussing. having correctly identified the self-review threat most candidates stated. intimidation and self-interest that were not relevant to the answer. as this assignment was likely to be a one-off. A number of candidates stated that provision of accounting services is prohibited in the UK for listed companies but then failed to apply this to the question by stating that Lagg was not listed and therefore the services could be provided. Of those who did identify the management threat. Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. Most candidates correctly identified the threat of selfreview but fewer candidates identified the management threat. that it could be mitigated by the loan staff having no involvement on the audit and by independent review.Audit & Assurance – Professional Stage – December 2010 Answers to this part of the question were mixed. few were able to state how it could be mitigated. For example. at length. correctly. many cited the self-interest threat in respect of fee dependency and failed to appreciate that fee dependency only applied to regular income and. a number of other threats including familiarity. was not applicable in this situation. On the other hand. translation errors General The controls exercised over data transfer to the new IT system and whether the old and new systems were subject to parallel running.slow moving or obsolete items which need to be written down . answers to parts (c) were better than answers to parts (a) and (b). Operating margin The reason for the significant fall of 4%. © The Institute of Chartered Accountants in England and Wales 2010.leasing costs of the purpose-built warehouse facility (any up-front leasing costs accounted for incorrectly) .marketing costs of the new range and overseas expansion . Is the fall due to: . Would not have been surprised to see the margin fall.8% is out of line with previous years.depreciation relating to the new IT infrastructure . In general.understatement of payables due to unrecorded invoices . Page 10 of 15 .beneficial effect of movement in exchange rates . which is surprising in light of increase in gross margin. Is the increase due to: .translation errors in respect of items purchased from overseas suppliers Whether the book figure is supported by a physical count Payables days Payables days have fallen by 6 days.cheaper goods from Portuguese suppliers .possible understatement of purchases . Briefing notes on matters to be discussed with the management of Bambi Revenue Increase of 10.the new retail outlet in Paris .running expenses associated with the new Paris retail outlet .tighter credit terms with new suppliers . Part (a) Prepare briefing notes on matters which you wish to discuss with the management of Bambi in respect of the information provided in the scenario.the internet sales of items which are subject to stockouts Method used to translate sales made by the Paris retail outlet Gross profit margin Increase of 2% is significant in light of significant increase in revenue.increases in selling prices The point at which revenue is recognised in respect of: .misclassification of costs between cost of sales and operating expenses . Is this increase due to: . how much of this increase is due to: .the expansion of the product range .the accessories which have to be ordered .build up of new range of less expensive accessories . Is the fall due to: .Audit & Assurance – Professional Stage – December 2010 Question 8 Total marks: 20 General comments Answers to this question attained the second highest average mark on the written test section of the paper.misclassification of expenditure by expensing items which should have been capitalised Inventory days Inventory days have increased by 14 days which is surprising in view of the company’s policy of holding limited inventory for the more expensive items.possible overstatement of inventory.higher margin on accessories . Your notes should include reference to the results of your preliminary analytical procedures. that would be useful when undertaking analytical procedures in respect of Bambi’s performance for the six months ended 30 November 2010. many cited figures needed to calculate ratios such as the quick ratio and other liquidity ratios which would already be available in the interim statement of financial position. Maximum full marks Marks available 4 10 Part (c) Comment on the level of assurance provided by the report on the financial information of Bambi and explain how and why it differs from the level of assurance provided by an audit report on annual financial statements.mail order v retail outlets . The conclusion is expressed negatively in the form of “nothing has come to our attention that causes us to believe that the accompanying financial statements do not give a true and fair view.  Management accounts for the corresponding six-month period  Profit forecasts for the corresponding six-month period  Segmental information. level of assurance that the financial statements are free from material misstatement. Weaker candidates digressed into the consideration of the business risks such as failing to deliver goods or failing to comply with overseas laws and regulations. stating a plausible matter to be discussed with management. However. A limited assurance engagement reduces the risk to a level that is acceptable in the circumstances. industry information and full financial statements for the previous year. many lost marks by being too vague and just stating “obtain reason for the increase” instead of demonstrating an understanding of what might be the cause of the significant increase. It provides a high. The points most commonly overlooked were: in respect of gross profit margin. The conclusion is expressed positively in the form of “in our opinion the financial statements give a true and fair view of the state of the company’s affairs…” A review provides less assurance than an audit because the scope of the work is less. in addition to the interim financial information. only a minority of candidates appreciated that an increase in gross margin coupled with a fall in operating margin may result from a misclassification of costs. including: . A review of the financial statements provides limited/moderate assurance as to the credibility of the financial information. A reasonable assurance engagement reduces the risk to an acceptably low level.” A statutory audit provides reasonable assurance as to the credibility of the financial statements. Furthermore.outlet by outlet basis  Industry sector and competitor financial information  The full financial statements for the whole previous year  The cash flow statement for the corresponding six-month period Answers to this part of the question were mixed. Page 11 of 15 . For example. tended to score high or full marks. the possibility of understated purchases and cheaper suppliers.Audit & Assurance – Professional Stage – December 2010 Answers to this part were mixed.accessories v clothing . Strong candidates identified additional information such as management accounts. a breakdown in operating expenses. Some candidates ignored the requirement “in addition to the interim financial information” and identified items that would be available in the interim statement of financial position. the possibility of translation errors and in respect of payables days the possible understatement of payables. The following financial information would be useful when undertaking analytical procedures:  Schedules supporting the figures included in the financial statements for example. © The Institute of Chartered Accountants in England and Wales 2010. The points most commonly overlooked were those in respect of the segmental information. budgets and forecasts. but not absolute. in respect of inventory days. Maximum full marks Marks available 12 32 Part (b) Identify the financial information. Those candidates who dealt with each of the given ratios in turn. Audit & Assurance – Professional Stage – December 2010 This part was very well answered by the majority of candidates with many scoring full marks. incorrectly.5 Page 12 of 15 . Maximum full marks Marks available © The Institute of Chartered Accountants in England and Wales 2010. The point most commonly overlooked was that in respect of the scope of the work being less in an engagement to review financial information. A small minority of candidates stated. that the level of assurance provided by such a review engagement was low. 4 6. Recommendations Senior management should introduce a policy requiring a designated employee to undertake checks which involve comparison of the: . A progress report should be submitted to senior management on a monthly basis.assets recorded in the register which have been stolen. This may result in loss-making contracts which have an adverse impact on cash flow and could impede the company’s ability to continue to trade.inappropriate useful lives and consequently inappropriate depreciation charges Unrecorded acquisitions may result in incorrect claims for capital allowances. and . . you should outline the possible consequences of the deficiency and provide recommendations to remedy each of the deficiencies. For both internal control deficiencies identified. Contract managers should also be informed that disciplinary procedures will be implemented for breaches of company policy.assets recorded in the register to the physical asset to confirm existence and condition. © The Institute of Chartered Accountants in England and Wales 2010.assets which are impaired. This was mainly due to poor performance on Pembroke in part (b).acquisitions or disposals which have not been recorded. In general answers to part (a) were better than answers to part (b). . informing them of their responsibility to compare actual costs with budget on a weekly basis and that the comparison should be evidenced by signature. The lack of control may encourage the misappropriation of raw materials and failure to identify contracts behind schedule may trigger penalty clauses for late completion. . (i) Failure to compare costs with budgeted on fixed-price contracts Consequences Failure to compare actual costs to budgeted costs on a weekly basis may result in cost overruns on individual contracts not being identified at an early stage. A system of monitoring should be implemented to ensure that procedures are being followed. and .assets which are fully written down but still in use. Page 13 of 15 . Work in progress may be overvalued if provisions for losses are not recognised. (ii) Failure to reconcile non-current asset register Consequences Failure to reconcile the property plant and equipment register with the physical assets may result in failure to identify the following: . The reconciliation should be performed by an employee independent of the custodian of the assets and differences should be reported to senior management and investigated.Audit & Assurance – Professional Stage – December 2010 Question 9 Total marks: 20 General comments Answers to this question attained the lowest average mark on the written test section of the paper.physical assets to the register to ensure completeness of recording. Recommendations Senior management should write to contract managers. Part (a) Prepare extracts suitable for inclusion in your firm’s report to the management of Conco. A system of monitoring should be implemented to ensure that procedures are being followed. © The Institute of Chartered Accountants in England and Wales 2010. in turn. The recommendations were generally poorly covered as many candidates failed to provide recommendations in a manner that would be understood by the client. Failure to reconcile non-current asset register The consequences were generally well covered with the exception of the point relating to incorrect capital allowances. Failure to compare costs with budgeted Most candidates identified that failure to apply the company’s policy could result in failure to control costs and possibly result in losses which. As a result. In the matters on which auditors are required to report by exception section of the report. Statements such as “undertake physical checks on the assets on a regular basis” were common and too general to be awarded marks. state whether you would modify the audit opinion. for example physical controls. Immediately above the opinion. Snowdonia The opinion should be modified. to each audit report. as the auditor is unable to obtain sufficient appropriate evidence. Pembroke The opinion should be modified due to the limitation on scope imposed by the directors.5% of total assets and the depreciation of £40. Maximum full marks 10 Marks available 23 Part (b) In each of the two situations outlined.3% of profit before tax. the failure to compare costs against budget was dealt with better than the failure to reconcile the non-current asset register. As the equipment represents 14. due to disagreement over accounting treatment. Page 14 of 15 . the matter is material and the opinion should be qualified (except for). A number of candidates wasted time citing other control procedures in respect of non-current assets. Immediately above the opinion.000 represents 5. there should be an explanation of the reasons for the disclaimer of opinion. Most candidates identified the importance of making managers aware and disciplining those who failed to comply with company policy but only a minority identified the need to monitor company procedures. liabilities and depreciation are understated. which did not address the control deficiency identified.have not received all information and explanations considered necessary for the audit. Give reasons for your conclusions and describe the modifications. there should be an explanation of the issue including the reasons and the amounts involved. The transaction should be accounted for in the year ended 30 September 2010 because it was received and in use prior to the year end. A small number of candidates failed to score highly on recommendations as a result of simply reiterating that budgets should be reviewed regularly – this control was already in place but was not operating effectively and therefore did not address the issue. Consequently. The matter is not pervasive as it is confined to specific items in the financial statements and does not represent a substantial proportion of the financial statements. International Standard on Auditing 580 Written Representations (ISA 580) requires the auditor to disclaim an opinion on the financial statements when the directors refuse to provide representations regarding the fulfilment of their responsibilities in relation to the preparation of the financial statements. and . would have an adverse impact on cash flow. few candidates identified that work in progress may be overvalued if losses were not provided for or that contracts behind schedule may trigger penalty clauses for late completion.were unable to determine whether adequate accounting records had been kept. the auditors should refer to the fact that they: . non-current assets. However.Audit & Assurance – Professional Stage – December 2010 On the whole. as the matter is material and pervasive. the auditor should specify in the opinion section of the report that “we do not express an opinion” or “we are unable to express an opinion”. if any. failing to appreciate that it was the depreciation of £40. many students lost marks by hedging their bets and cited that if the matter is considered material. because ISA 580 paragraph 20 requires the auditor to disclaim the opinion on the financial statements if management refuses to provide written representations on the matters cited in the question. In addition. failing to appreciate that this term refers to a modified opinion in respect of a matter which is material but not pervasive. Page 15 of 15 . failing to appreciate that the matter was not pervasive as the issue was confined to specific items and did not represent a substantial proportion of the financial statements. Maximum full marks 10 Marks available 16.5 © The Institute of Chartered Accountants in England and Wales 2010. Pembroke The majority of candidates correctly identified the situation as a limitation on scope and many of those appreciated that it would warrant a disclaimer of opinion.000 that should have been benchmarked against profit before tax. the answers to Snowdonia were better than the answers to Pembroke. These candidates failed to appreciate that there was no choice regarding the type of modification. However. but not pervasive. Again. Snowdonia Many candidates correctly identified that the situation represented a material misstatement due to disagreement over accounting treatment and that it would warrant a qualified opinion (except for). but some candidates still struggle with distinguishing between modified reports and modified opinions.Audit & Assurance – Professional Stage – December 2010 It was pleasing to note an improvement in candidates’ understanding of the terminology used in respect of modified reports. candidates lost marks by hedging their bets and cited that if material and pervasive it would be an adverse opinion. a significant number of candidates continue to use the term “qualified opinion” to cover all types of modified opinion. Many candidates also failed to identify that these matters are required by the Companies Act 2006 to be reported on by exception. Some candidates considered the materiality of the non-current asset in the context of profit before tax. it would result in a qualified opinion (except for). In general.