KASNEB Advanced Auditing & Assurance - Question 1b

Explain SIX audit risks associated with the audit of financial instruments. ... [Click to view full question and step-by-step solution]

December 2023

1a

Audit evaluation and reviews

You are the Audit Manager of Baraka and Company LLP, who are the auditors of Miradi Ltd. for the year ended 30 June 2023. The company has net assets of Sh.150 million. The audit has been completed but there is a matter that has not yet been resolved on depreciation of buildings. The directors of Miradi Ltd. have resolved that depreciation on buildings will not be provided for in the financial statements. The buildings were acquired in the year 2020 and no depreciation has been provided since.

Required:

(i). Describe SIX additional audit procedures and actions that you could take with respect to the above matter.

(ii). Assume that, according to your workings, the depreciation charge on the buildings for the year ended 30 June 2023 should be Sh.4,200,000 based on the straight line method of depreciation at an annual rate of 5%.

Required:

Discuss the implications of the above on the financial statements, clearly indicating its effect on the audit report.

1b

Audit evaluation and reviews

Explain SIX audit risks associated with the audit of financial instruments.

2a

Audit related assurance services

The following is an extract from a speech presented in a recent professional forum:

“In the private sector, going concern is an area of interest to users of financial statements. Shareholders and lenders wish to know that a business will continue into the foreseeable future before they can make investment or lending decisions.

The going concern concept in the public sector differs from that in the private sector. This is because most public bodies, whether government departments, devolved administrations, local public bodies or national funds have a statutory existence that makes technical insolvency almost impossible.

Despite that, stakeholders in the public sector still have an interest in knowing whether these institutions are financially sustainable.”

Required:

In the context of the above statement, discuss EIGHT factors that an auditor would consider in determining the going concern assumption of a public entity.

2b

Audit evaluation and reviews

Describe FOUR procedures that an auditor might perform to identify subsequent events occurring after the financial year end in a company.

2c

Audit related assurance services

Your audit firm, KKCO LLP, has been the auditor of Express Ltd., a leading online retailer that was established a few years ago. At inception, the company had an average delivery time of a week, but has since grown to an average delivery time of between one and five days. The company started with three employees and has grown to 1,000 employees including a 150 customer service team who are available 7 days a week.

It has emerged that an employee stole Sh.20 million by manipulating vendor payment records pointing to the risk of fraud facing their trading platforms.

Required:

Prepare a proposal to the directors of Express Ltd. explaining:

(i). The need for an internal audit function in the company.

(ii). The benefits of outsourcing the internal audit function.

3a

Audit evaluation and reviews

Compumax Ltd. is one of your audit clients for the year ended 30 June 2023. The company has followed generally accepted accounting principles and had a conservative approach to recognising revenue from its software application sales. Revenue was recognised only when the product was delivered to the customer.

Due to increased competition leading to a declining market share, the Chief Executive Officer (CEO) of the company has put pressure on the Chief Finance Officer (CFO) to find ways to improve the company’s financial performance and boost revenue numbers. In reacting to the pressure, the CFO decided that the new policy will be that revenue from software application sales could be recognised as soon as the contract was signed, regardless of the product’s actual delivery to the customer. The CFO did not disclose the change in policy. With the new policy, the company started recognising revenue from software application sales immediately after contract signing, artificially inflating the company’s revenue figures. This allowed the company to present a more favourable financial status, potentially increasing the share price and attracting new investors.

Required:

With reference to the above scenario:

(i). Describe THREE circumstances under which a change in accounting policy is permissible.

(ii).Summarise THREE disclosures that could be made in the financial statements regarding the change in accounting policy.

(iii).Discuss FIVE audit procedures that are necessary where an entity has changed an accounting policy.

3b

Audit evaluation and reviews

The question on whether a change constitutes a change in policy or a change in estimate has been a major source of discussion among accountants and auditors.

Required:

Distinguish between a “change in accounting estimate” and a “change in accounting policy”.

4a

Audit evaluation and reviews

During the audit of the financial statements of WX Company Ltd. for the year ended 31 December 2022, the auditors realised that new information that had not been accounted for when the management prepared the financial statements had come to their notice as follows:

A court case in which a customer had sued the company for goods that got lost in transit from one of the company’s stores was decided against the company. Although the company had made a provision for a refund of the deposit paid on the goods, the court also awarded the customer the costs of the suit and general damages. The total amount payable now exceeds the provision.
A customer who owed the company a substantial amount of money and had been having problems paying has had to close business after his bank, from which he had obtained a loan, petitioned for liquidation of the business. Although he had invested the bank loan in a building project, the building had stalled before completion. The materials purchased from WX Ltd. had already been used in the project which the bank has attached as a collateral for their loan. WX Ltd. may never be paid the balance on this account.
Due to the rapid fluctuations in the foreign exchange rate, the directors feel that some of the inventory purchased earlier would not be replaceable if sold on the basis of their initial import cost and have suggested a revaluation of the inventory as a way of safeguarding the business from possible losses.

Required:

In each of the situations explained above, discuss the auditor’s advice to the management of WX Company Ltd. in order to minimise the risk of material misstatement resulting from these events.

4b

Assurance and non-assurance engagements

In conducting the audit of historical financial statements, the auditor’s objective is to obtain sufficient appropriate audit evidence on which he forms an opinion about the financial statements as a whole and report that opinion to the shareholders.

Required:

Describe the auditor’s objectives when undertaking:

(i). An examination of prospective financial information.

(ii). A financial due diligence assignment.

4c

Audit related assurance services

To succeed in business in the modern world, every company must consider investing in some form of Information Technology (IT). The companies that do not have their own systems still have to protect themselves from cyber criminals whenever they use computer systems even for simple communication within and without the organisation. To ensure the security of this computerised information, companies have had to invest in controls that ensure protection and integrity of their data. IT general controls are the most common controls because they are capable of preventing data theft, stop unauthorised access, reduce operational disruption and stop data breaches.

Required:

(i). Explain how the IT general controls protect the company and its information systems from risk.

(ii) Explain the best practice for implementing IT general controls.

5a

Audit evaluation and reviews

Solar Power Limited (SPL), an international company, sells solar panels subject to a warranty of one year. Included in the statement of financial position of SPL is a warranty provision of Sh.100,000,000. The director who owns 70% of the shares in the company is the one who estimates the cost of repairing defective solar panels reported by dissatisfied customers. The estimate from the director forms the basis of the provision.

This is your first audit of SPL whose turnover in the previous year was Sh.10 billion compared to Sh.15 billion this year.

Required:

Explain the audit procedures that you would perform during the year in respect to the estimated warranty provision included in the statement of financial position for the current year.

5b

Management of audit practice

(i) Explain TWO challenges that a small audit firm might face in implementing quality control procedures, recommending a measure that could be taken to overcome each challenge.

(ii) Describe FOUR quality control procedures that are applicable to an audit engagement.

December 2023

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