FAU JJ 2024 MIDTERM SOLUTION

SECTION A

1. D
Tutorial note: Confirmation of completeness of recording in the company’s accounting records
is a particular problem for an auditor where the internal controls are not operating effectively.
This is because lack of adequate controls leads to systems objectives not being met and there is
often a lack of an audit trail to evidence the inception of transactions through to completion.
2. C
Tutorial note: As the auditor has concluded that the internal controls are not effective, the
approach to the final audit must be fully substantive. This will involve extensive testing of
transactions for the whole accounting period in addition to the verification of the items in the
statement of financial position and a review of the financial statements. The other options do
not allow the necessary substantive procedures to be carried out.
3. B
Tutorial note: The principal purpose of the engagement letter is to clearly define the extent of
the responsibilities of the auditor and so minimise the possibility of any misunderstanding
between the client and the auditor in this respect.
4. A
Tutorial note: Analytical procedures must be applied in risk assessment at the planning stage of
the audit. They must also be used in the overall review stage at the end of the audit when
forming an overall conclusion as to whether the financial statements are consistent with the
auditor’s knowledge of the business. Analytical procedures can be used as substantive
procedures to reduce detection risk, but this is not a requirement.

5. C
Tutorial note: A management representation letter contains confirmations from management
on matters relevant only to the audit of the financial statements subject to audit. It should
therefore be retained on the current audit file.
6. A
Tutorial note: ICEQs contain key control questions which focus on the objectives of the system
under review.Options B, C and D all focus on the objectives of a payroll system, whereas option
A focuses on a control procedure only.
7. C
Tutorial note: A wages master file must contain standing data which is of continuing importance
for the processing of information and updating of the wages data file for each employee. The
amount of cumulative statutory deductions to date is not of continuing importance; the other
data items are important.
8. D
Tutorial note: It is generally recognised that all three aspects should be reviwed by an internal
audit function.
9. B
Tutorial note: The risk of material misstatement is a function of inherent risk and control risk.
10. C
Tutorial note: Use of test data is essentially a test of controls because it is designed to test the
effectiveness of controls built into a specified computer programme. Test data is normally
processed separately from the client’s normal processing runs; however, it may be processed
simultaneously in certain circumstances.

11. B
Tutorial note: The auditor does not have the right to attend or speak at directors’ meetings and
should not make or take part in any executive decisions on behalf of the company.
12. C
Tutorial note: Control risk and inherent risk are components of the risk of material
misstatement, which is governed by the circumstances of the audit client and therefore is
outside the control of the auditor. Only detection risk is controlled by the auditor.
13. B
Tutorial note: The extent and quality of the communication with the audit client’s staff, will
depend on the personal attributes of audit staff and their individual ability to communicate
effectively. Standard audit programmes should facilitate all the other options
14. B
Tutorial note: Acting on behalf of a client in a dispute is an illustration of an advocacy threat.
Pressure on the performance of an audit is an intimidation threat. Owning shares in a client
company represents a self-interest threat.
15. C
Tutorial note: The same statistical probability is a feature of all random selection methods. The
selection of monetary units characterises value weighted selection. Stratification of the
population may improve audit efficiency regardless of the selection method.
SECTION B

1. (a) Components of audit risk

The components of audit risk are inherent risk, control risk and detection risk.

Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement which could be material (either individually or when aggregated with other
misstatements) before consideration of any related controls.

Control risk is the risk that a misstatement which could occur in an assertion about a class of
transaction, account balance or disclosure and which could be material (either individually or when
aggregated with other misstatements) will not be prevented, or detected and corrected, on a timely
basis by the entity’s internal control.

Detection risk is the risk that audit procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement which exists and which could be material (either
individually or when aggregated with other misstatements).

(b) Audit risks

Aquamarine has ordered $1.2m of plant and machinery, two-thirds of which may not have been
received by the year end. Only assets which physically exist at the year end should be included in
property, plant and equipment (PPE). If items not yet delivered have been capitalised, PPE will be
overstated.

Consideration will also need to be given to depreciation and when this should commence. If
depreciation is not appropriately charged when the asset is available for use, this may result in assets
and profit being over or understated.

The company has borrowed $1.2m from the bank via a five-year loan. This loan needs to be correctly
analysed between current and non-current liabilities in order to ensure correct presentation in the
statement of financial position.

Also, as the level of debt has increased, there should be additional finance costs. There is a risk that this
has been omitted from the statement of profit or loss leading to understated finance costs and
overstated profit.

The land and buildings are to be revalued at the year end; it is likely that the revaluation surplus/deficit
will be material. The revaluation needs to be carried out and recorded in accordance with IAS 16
Property, Plant and Equipment; otherwise non-current assets may be incorrectly valued.

Receivables for the year to date are considerably higher than the prior year. If this continues to the year
end, there is a risk that some receivables may be overvalued as they are not recoverable. If there is no
write off or allowance for credit losses, profit for the year will be overstated.

Aquamarine is planning to make approximately 60 employees redundant after the year end. The timing
of this announcement has not been confirmed; if it is announced to the staff before the year end, a
redundancy provision will be required at the year end (IAS 37 Provisions, Contingent Liabilities and
Contingent Assets). Failure to make adequate provision will result in an understatement of provisions
and expenses.

2. (a) Control objectives – purchases system

• To ensure that all purchases are recorded.

• To ensure that purchases are recorded accurately.
• To ensure that purchases are only made for a valid business use.
• To ensure that purchases represent the best value for money.
• To ensure that only goods ordered are received and paid for.
• To ensure that purchase invoices are paid when due.

(b)

Control Deficiency Control recommendation

A GRN is only raised if there is no supplier A sequentially numbered GRN should be
delivery note. [1 mark] Only GRNs are completed for all goods received by the stores
sequentially numbered, delivery notes are not department. [1 mark]
sequentially numbered. [1 mark] A sequence check should be performed on a
Some details of goods received may be omitted if weekly basis and any missing GRNs should be
not recorded in the standard form (i.e. of the investigated. [1 mark]
GRN). [1 mark] It may be difficult to trace/match
the goods to the corresponding purchase invoice.
[1 mark]
This increases the risk that liabilities for goods
received but not invoiced are not accrued. [1
mark]
Goods received are not checked to orders until All purchase invoices should be addressed to the
the delivery note/GRN is passed to the buying accounts department where they should be
department. [1 mark] recorded in receipt. [1 mark]
Goods may be accepted into stores that were not A copy of the purchase order and GRN should be
ordered. [1 mark] There will also be a delay in sent to the accounts department to be matched
identifying this. [½ mark] against the invoice before payment is approved.
[1 mark]
Invoices are not marked as paid when a bank Invoices should be marked as paid (e.g. with a
transfer payment is made. [1 mark] stamp and/or payment reference) when the bank
Invoices may be paid twice in error, resulting in transfer payment has been made. [1 mark]
lower cash balances until the money is recovered.
[1 mark] Late payments could lead to a loss of Invoices should be reviewed each week to
supplier goodwill and a reduction in credit confirm that they are shown to have been paid or
facilities. [1 mark] not yet due for payment, if unpaid. [1 mark]
Supplier statement reconciliations are not Supplier statements should be reconciled to the
performed regularly. [1 mark] payables ledger monthly. [1 mark]
Errors in recording purchases and/or payments in A responsible official should review
the purchase ledger may go undetected. [1 mark] reconciliations and ensure that any discrepancies
 This could result in overpayments, incurring identified are followed (e.g. requesting copies of
additional expense, or suppliers not being paid at missing invoices). [1 mark]
all leading to a loss of supplier goodwill. [1 mark]
Changes to supplier details in the purchase ledger Only the purchasing manager should have a
master file can be made by the purchasing clerk. password-protected access to make changes to
[1 mark] the master file. [1 mark]
Supplier details could be accidentally updated or The system should automatically generate an
fictitious suppliers set up, increasing the risk of exception report [1 mark] when changes are
error or fraud that could result in financial loss to made to the master data files. A responsible
the company. [1 mark] official should review the report to confirm that
changes are valid and sign the report to confirm
this. [1 mark]

3. (a) Engagement letters

Engagement letters for recurring/existing clients should be revised if any of the following factors are
present:

• Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
• Any revised or special terms of the audit engagement, as these would require inclusion in the
engagement letter.
• A recent change of senior management or significant change in ownership. The letter is signed
by a director on behalf of those charged with governance; if there have been significant changes
in management they need to be made aware of what the audit engagement letter includes.
• A significant change in nature or size of the entity’s business. The approach taken by the auditor
may need to change to reflect the change in the entity and this should be clarified in the
engagement letter.
• A change in legal or regulatory requirements. The engagement letter is a contract; hence if legal
or regulatory changes occur, the contract could be out of date.
• A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with
governance, it identifies the reporting framework of the financial statements and if this changes,
the letter requires updating.
• A change in other reporting requirements. Other reporting requirements may be stipulated in
the engagement letter; hence if these change , the letter should be updated.

(b) Matters to be included in an audit engagement letter

• The objective and scope of the audit

• The responsibilities of the auditor
• The responsibilities of management
• Identification of the applicable financial reporting framework for the preparation of the
financial statements
• Expected form and content of any reports to be issued
 • The form of any other communication of results of the audit engagement
• The fact that some material misstatements may not be detected
• The expectation that management will provide written representations
• The basis on which fees are computed and any billing arrangements
• A request for management to acknowledge receipt of the audit engagement letter and
agrees the terms
• Arrangements concerning the involvement of internal auditors
• Any restriction on the auditor’s liability

(c) Understanding an entity

• Prior year financial statements: Provides information in relation to the size of Milky Way Co as
well as the key accounting policies, disclosure notes and whether the audit opinion was
modified or not.
• Discussions with the previous auditors/access to their files: Provides information on key issues
identified during the prior year audit as well as the audit approach adopted.
• Prior year report to management: If this can be obtained from the previous auditors or from
management, it can provide information on the internal control deficiencies noted last year. If
these have not been rectified by management, they could arise in the current year audit as well
and may impact the audit approach.
• Milky Way’s accounting systems notes/procedural manuals: Provides information on how each
of the key accounting systems operates and this will be used to identify areas of potential
control risk and help determine the audit approach.
• Discussions with management: Provides information in relation to the business, any important
issues which have arisen or changes to accounting policies from the prior year.
• Review of board minutes: Provides an overview of key issues which have arisen during the year
and how those charged with governance have addressed them.
• Current year budgets and management accounts: Provides relevant financial information for the
year to date. It will help the auditor during the planning stage for preliminary analytical review
and risk identification.
• Milky Way’s website: Recent press releases from the company may provide background on the
business during the year as this will help in identifying the key audit risks.
• Financial statements of competitors: This will provide information about Milky Way’s
competitors, in relation to their financial results and their accounting policies. This will be
important in assessing Milky Way’s performance in the year and also when undertaking the
going concern review.

4. (a) Definition

Evaluations of financial information through analysis of plausible relationships among both financial and
non-financial data. Analytical procedures also encompass such investigation as is necessary of identified
fluctuations or relationships that are inconsistent with other relevant information or that differ from
expected values by a significant amount.
(b) Analytical procedures

Analytical procedures help identify inconsistencies, unusual transactions or events, and amounts, ratios
and trends that indicate matters that may have audit implications.

Unusual or unexpected relationships that are identified may assist the auditor in identifying risks of
material misstatement.

Analytical procedures performed as risk assessment procedures may therefore assist in:

• identifying and assessing the risks of material misstatement by identifying aspects of the entity
of which the auditor was unaware; or
• understanding how inherent risk factors, such as change, affect susceptibility of assertions to
misstatement.

5. Concept

Misstatements, including omissions, are considered to be material if they (individually or in aggregate)

could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements.

Judgements about materiality are affected by the size (quantity) or nature (quality) of a misstatement,
or a combination of both.

The determination of materiality is a matter of professional judgement, and it is affected by the

auditor’s perception of the financial information needs of users of the financial statements.

The concept of materiality is applied by the auditor both in planning and performing the audit and in
evaluating the effect of misstatements on the financial statements and in forming the opinion in the
auditor’s report.

The auditor determines materiality for the financial statements as a whole when establishing the overall
audit strategy.

Performance materiality

The auditor determines performance materiality for purposes of assessing the risks of material
misstatement and determining the nature, timing and extent of further audit procedures.

Performance materiality is the amount set by the auditor at less than materiality for the financial
statements as a whole to reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.

Performance materiality is used for testing individual transactions, account balances and disclosures.