f8int 2013 Jun a (Bpp's Answers)

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F8 ACCA June 2013 Exam: BPP Answers

1

Question 1

Text reference. ISA 260 is covered in Chapter 3. Controls over the purchasing system are discussed in Chapter 10.

Reports to management are covered in Chapter 19. Application controls can be found in Chapter 9. Substantive

audit procedures relating to bank and cash are set out in Chapter 15.

Top tips. The requirements for this question are typical for question 1 of the F8 paper, with the scenario beingabout control deficiencies within a particular system. There is a lot to do in this question, so there is a risk of over-

running on the time. Make sure you stick to time for each part of the question and move on to the next requirement

once the time is up.

Part (b) should be presented in a tabular format for the deficiencies, impacts and recommendations but do note the

requirement for a covering letter – this is relatively unusual for this type of question. Note also that there are two

presentation marks available, so make sure your covering letter is addressed and dated appropriately and that you

use a ruler for the table and headings. These two marks could be the difference between passing and failing. You

must ensure that you identify deficiencies from both the purchases system and the payments system – go through

the scenario line-by-line and make notes on areas where there are weaknesses. Your recommendations need to be

sufficiently detailed and useful to the organisation. Imagine that you are drafting a real report to management to a

real client. Saying things like ‘Discuss with management’ or ‘Reconciliations’ will not score many marks.

Part (c) is on application controls. This is a notorious area of weakness for F8 students. Make sure you know the

difference between application and general IT controls and that the controls you describe are relevant to the

scenario in the question.

Easy marks. Part (a) on ISA 260 is knowledge-based for five marks and relatively straightforward. Part (d) asks for

substantive procedures for bank and cash. This is worth seven marks and provided your procedures are adequately

detailed, you should be able to score well here.

Marking scheme

Marks

(a) (i) Up to 1 mark per well explained point

– Assists the auditor and those charged with governance in

understanding matters related to the audit

– Obtains information relevant to the audit

– Helps those charged with governance in fulfilling their

responsibility to oversee the financial reporting process 2

(ii) Up to 1 mark for each example matter to be communicated to

those charged with governance 3

(b) Up to 1 mark per well explained deficiency, implication and

recommendation. If not well explained then just give ½ mark for each.

Overall maximum of 4 marks each for deficiencies, implications and

recommendations.

2 marks for presentation: 1 for address and intro and 1 for conclusion.

– No approved suppliers list

– Purchase orders not sequentially numbered

– Orders below £5,000 are not authorised by a responsible official

– No application controls over input of purchase invoices

– Purchase ledger manually posted to general ledger

– Saving (deposit) bank accounts only reconciled every two months

– Payments to suppliers delayed

– Finance director only reviews the total of the payment list prior topayment authorising 14




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Marks

(c) Up to 1 mark per well explained application control

– Document counts

– Control totals

– One for one checking

– Review of output to expected value

– Check digits

– Range checks– Existence checks 4

(d) Up to 1 mark per substantive procedure

– Check additions of bank reconciliation

– Obtain bank confirmation letter

– Bank balance to statement/bank confirmation

– Cash book balance to cash book

– Outstanding lodgements

– Unpresented cheques review

– Old cheques write back

– Agree all balances on bank confirmation

– Unusual items/window dressing– Security/legal right set-off

– Review reconciliations for saving (deposit) accounts

– Cash counts for significant cash balances

– Review disclosure of bank and cash in financial statements 7 30

(a) ISA 260 requirements

(i) It is important that auditors communicate throughout the audit with those charged with governance

for the following reasons:

It assists the auditor and those charged with governance to understand audit-related matters

in context and allows them to develop a constructive working relationship.

It allows the auditor to obtain information relevant to the audit.

It assists those charged with governance to fulfil their responsibility to oversee the financial

reporting process, thus reducing the risks of material misstatement in the financial

statements.

(ii) Examples of matters that the auditors may communicate with those charged with governance:

The auditor's responsibilities in relation to the audit of the financial statements, including that

the auditor is responsible for forming and expressing an opinion on the financial statements

and that the audit does not relieve management or those charged with governance of theirresponsibilities

The planned scope and timing of the audit

Significant deficiencies in internal control

The auditor's views about significant qualitative aspects of the entity's accounting practices,

including accounting policies, accounting estimates and financial statement disclosures

Significant difficulties encountered during the audit

Significant matters arising from the audit that were discussed or subject to correspondence

with management

Written representations requested by the auditor




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Other matters that, in the auditor's professional judgement, are significant to the oversight of

the financial reporting process

For listed entities, a statement that the engagement team and others in the firm, the firm, and

network firms have complied with relevant ethical requirements regarding independence, any

relationships between the firm and entity that might affect independence, and safeguards

applied to eliminate identified threats to independence or reduce them to an acceptable level

(Note : Only three matters were required.)

(b) Purchasing and payments system

ABC Auditors

Any Street

Any Town

AB1 2YZ

1 June 20X3

Board of Directors

Fox Industries Ltd

Trading Estate

Any Town

AB1 3DE

To the Board of Directors, Fox Industries Ltd,

Financial statements for the year ended 30 April 20X3

Please find enclosed in an Appendix to this letter the report to management detailing deficiencies in internal control

found within the purchases and payments system during our recent external audit. This details only the significant

deficiencies identified during our audit. If more extensive procedures on internal control had been carried out, we

might have identified and reported more deficiencies.

This report to management is solely for the use of Fox Industries Co. It must not be disclosed to a third party, or

quoted or referred to, without our consent. No responsibility is assumed by us to any other person.

Yours faithfully,

ABC Auditors

Appendix

Deficiency Implication Recommendation

Purchase orders are not

reviewed by a second person

before the order is sent out

unless the amount is greater

than £5,000.

Orders can be made for

unauthorised goods up to a

value of £5,000.

All orders should be reviewed before the

order is placed and signed off and dated

as authorised by a more senior team

member. Delegated levels of authority

should be in place.

The purchase order clerk

chooses the supplier based

on the supplier who candeliver the goods fastest.

Goods of poor quality could be

ordered or a higher price may

be paid for goods fromparticular suppliers.

An approved suppliers list should be in

place so that the company knows

exactly who the supplier is and howmuch the goods cost.

Purchase orders are not

sequentially numbered.

Purchase orders can be lost and

there is no way of keeping track

of unfulfilled orders.

Purchase orders should be sequentially

numbered and multi-part. Order forms

should be filed in sequential order and

reviewed on a weekly basis to flag any

unfulfilled orders for chasing up.

Purchase invoices are not

matched back to the purchase

order before being input onto

the system.

Invoices for incorrect amounts

and incorrect goods may be

entered onto the system and

paid for.

Purchase invoices should be matched

back to the purchase order to ensure

they tally up before being input onto the

system. A copy of the order should be

attached to the invoice and filed away.




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Deficiency Implication Recommendation

The purchase ledger clerk

does not use any application

controls over the input of

purchase invoices to the

ledger.

The lack of application controls

increases the risk of errors

being made during the input of

invoices to the ledger. This

could result in misstatements in

the financial statements and

also errors in amounts paid tosuppliers and a consequent loss

of goodwill.

There should be some application

controls in place over the input of

invoices to the system, such as control

totals and document totals.

The purchase ledger clerk

posts the purchase ledger to

the general ledger manually.

Errors may be made during the

posting process as it is done

manually.

The system should be set up so that the

purchase ledger is posted automatically

to the general ledger. A reconciliation

between the two should be performed

each week by the purchase ledger clerk

and this should be signed off and dated

as reviewed by the finance director.

Deposit accounts are not

reconciled on a timely basis,only every two months.

Unreconciled differences may

go unnoticed for a long periodof time. The length of time

between reconciliations may

also increase the risk of fraud

being perpetrated by

employees.

Deposit accounts should be reconciled

at the same time as the current account.All reconciliations should be signed off

and dated to evidence review by a more

senior person, with all differences fully

investigated and resolved on a timely

basis.

Payment to suppliers is

delayed for as long as

possible.

Prompt payment discounts are

not taken advantage of and

suppliers may not look

favourably on the company if it

takes too long to pay and

therefore may refuse credit later

on, if the company is viewed as

unreliable.

Suppliers should be paid as soon as

possible to take advantage of early

settlement discounts and to promote

and maintain good relations with

suppliers.

The finance director

authorises the total amount of

the payment list, without a

review of the detail.

Unauthorised amounts may be

missed as the finance director

does not see the detail of the

payments on the list. This opens

the company up to the risk of

fraud and error.

The finance director should review the

detailed list of payments and query any

amounts and supplier names that

appear erroneous or suspicious. The

review should be evidenced by the

finance director’s signature and date.

(Note: only four deficiencies were required.)

(c) Application controls

Daily reconciliation between purchase ledger and general ledger by the purchase ledger clerk, which should

be reviewed and signed and dated as reviewed by the finance director

Control totals agreeing the amount per purchase day book, purchase ledger and general ledger totals

Agreement of amounts on purchase invoices back to the purchase orders

Document counts of the number of invoices entered onto the system

One-for-one checking of output from the system against the original invoices to ensure completeness and

accuracy of input

Programmes to check data fields which could include digit verification on reference numbers,

reasonableness checks, existence checks on supplier names, character checks in reference numbers

(Note: only four application controls were required.)






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Question 2

Text reference. Professional ethics is covered in Chapter 4 of the Study Text. Going concern is covered in Chapter

18, and emphasis of matter paragraphs are covered in Chapter 19.

Top tips. Although question 2 of the paper is usually the most straightforward, being knowledge-based, the danger

is spending too long on your answer to the detriment of subsequent questions. You have 18 minutes to completethis question so for each part, make sure you stick to the time allocation. Stay focussed on the requirements in

each part – it is so easy to be tempted to write down all you know about a particular topic. For example, in (a) you

are asked to ‘list’ the five ethical threats – this means you do not need to explain them. You are also only asked for

one example per threat so do not include any more than one as you won’t get credit for doing so.

Easy marks. Question 2 of the paper generally provides easy marks as the requirements are knowledge-based.

Although this question tests your knowledge from across the syllabus, the requirements are pretty straightforward

and should not prove too problematic.

Marking scheme

Marks

(a) ½ mark for each threat and ½ mark per example of a threat:

– Self-interest

– Self-review

– Advocacy

– Familiarity

– Intimidation 5

(b) Up to 1 mark per well explained responsibility

– Management assessment of the company’s ability to continue as a

going concern and to make appropriate disclosures

– Auditor’s responsibility to obtain evidence about theappropriateness of management’s going concern assumption

– Auditor consider whether the period of management’s going

concern assessment is adequate; no less than 12 months from

the date the auditor’s report signed

– Auditor should conclude whether there is a material uncertainty

about going concern and consider the reporting implications 3

(c) Up to 1 mark per well described point

– Emphasis of matter 2 10




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(a) Ethical threats to independence and objectivity

Threat Example

Self-interest Close business, family or personal relationships

Undue fee dependency on one client

% or contingent fees

Lowballing to win lucrative other work Overdue fees

Gifts and hospitality

Employment with an assurance client

Partner on client board

Loans and guarantees

Financial interests in a client

Holding client assets

Self-review Provision of other non-audit services such as

tax, internal audit, valuation services, corporatefinance, IT systems services

Preparing financial statements and accounting

records

Recent service with an audit client

Advocacy Promoting shares in a listed audit client

Acting as an advocate in a legal dispute

Commenting publicly on future events in

particular circumstances

Familiarity Long association with an audit client

Close business, family or personal relationships

Gifts and hospitality

Intimidation Being threatened with removal as auditor

Dominant person in senior position within the

client

Threat of litigation

Threat of other lucrative non-audit work not

being awarded

(Note: only one example per threat was required.)






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Marking scheme

Marks

(a) Up to 1 mark per well explained point:

– Materiality for financial statements as a whole and also

performance materiality levels

– Definition of materiality

– Amount or nature of misstatements, or both– 5% profit before tax or 1% revenue or total expenses

– Judgement, needs of users and level of risk

– Small errors aggregated

– Performance materiality 5

(b) (i) ½ mark per ratio calculation per year.

– Gross margin

– Operating margin

– Inventory days

– Inventory turnover

– Receivable days

– Payable days– Current ratio

– Quick ratio 5

(ii) Up to 1 mark per well described audit risk and up to 1 mark per

well explained audit response

– Receivables valuation

– Inventory valuation

– Depreciation of plant and machinery

– Management manipulation of profit to reach bonus targets

– Completeness of warranty provision

– Disclosure of bank loan of £1 million

– Going concern risk 10 20

(a) Materiality and performance materiality

Materiality is not specifically defined in ISA 320 Materiality in planning and performing an audit but it does

state that misstatements are material if they could reasonably be expected to influence the economic

decisions of users (either individually or in aggregate). ISA 320 also states that judgements about materiality

are affected by the size and/or nature of a misstatement. Auditors set their own materiality levels, based on

their judgement of risk. During audit planning, the auditor will set materiality for the financial statements as a

whole and this involves the exercise of professional judgement. Benchmarks and percentages are often used

to calculate a materiality level for the financial statements as a whole, eg 5% of profit before tax or 1-2% of

total assets, but ultimately, the level of materiality set is down to the auditor’s professional judgement, and

may be revised during the course of the audit.

The auditor also has to set performance materiality, which is lower than materiality for the financial

statements as a whole. Performance materiality is defined in ISA 320 as the amount or amounts 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.




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(b) (i) Ratios

Ratio 20X3 20X2

Gross profit margin

(gross profit/sales x 100)

5.5/12.5 100 = 44% 7.0/15.0 100 = 47%

Operating margin

(profit before interest andtaxation/sales x 100)

0.5/12.5 100 = 4% 1.9/15 100 = 13%

Inventory turnover (cost of

sales/inventory)

7/1.9 = 3.7 8/1.4 = 5.7

Inventory days

(inventory/cost of sales x

365)

1.9/7 365 = 99 days 1.4/8 365 = 64 days

Receivables days

(receivables/sales x 365)

3.1/12.5 365 = 91 days 2/15 365 = 49 days

Payables days

(payables/cost of sales x

365)

1.6/7 365 = 83 days 1.2/8 365 = 55 days

Current ratio

(current assets/current

liabilities)

(1.9 + 3.1 + 0.8)/(1.6 + 1.0) = 2.2 (1.4 + 2.0 + 1.9)/1.2 = 4.4

Quick ratio

(current assets except

inventory/current

liabilities)

(3.1 + 0.8)/(1.6 + 1.0) = 1.5 (2.0 + 1.9)/1.2 = 3.3

(Note: only five ratios were required.)

(ii) Audit risk and responses

Audit risk Auditor’s response

The company offers a five year building warranty

on its houses. During the year, as a result of

switching to a cheaper supplier, some

customers have claimed on their guarantees.

There is a risk that the warranty provision is

understated in the financial statements.

As this is a judgemental area, the auditors need

to discuss the basis of calculating the provision

with the directors and assess the reasonableness

of any assumptions made. They should also

review a sample of guarantees claimed during the

year and vouch amounts to repairs invoices. They

should review the level of claims made in the

year and assess whether the provision needs

revising in light of this.The company has had a difficult year due to a fall

in house prices. Gross profit margin has fallen

by 3% and operating margin has fallen

significantly from 13% to 4%. In addition, the

company has had to take out a loan of £1m

during the year to help with operating cash flow.

Payables days have also increased from 55 days

to 83 days, indicating that the company is having

problems paying suppliers. The current and

quick ratios have also fallen significantly from

the prior year. There is therefore a risk that the

company may not be a going concern.

The auditors must discuss with directors whether

they believe that the company is still a going

concern in light of the results of the ratio

analysis, and review cash flow forecasts and

budgets for the forthcoming year.




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Audit risk Auditor’s response

Receivables days have increased from 49 days

to 91 days as a result of the directors increasing

the credit terms offered to customers. There is a

risk that the receivables’ balance at year-end is

materially misstated as customers may not be

able to pay.

The auditors should carry out post year-end

testing and cut-off testing on receivables’

balances to verify the accuracy of the year-end

balance. The auditors should also review the

aged receivables listing to identify any balances

that need writing off.

There is a risk that inventory is overstated in thefinancial statements as there may be some

houses whose selling price is less than cost.

Inventory days have also increased from 64 days

to 99 days, and inventory turnover has fallen

from 5.7 to 3.7. Inventory should be valued at

the lower of cost and net realisable value.

Detailed audit work on inventory should becarried out as this is likely to be a material

balance. An auditor’s expert may need to be used

to independently verify the value of inventory at

the year-end.

There is a risk that revenue and costs have been

deliberately misstated in the financial statements

in order for the directors to meet the target profit

before interest and taxation figure of £0.5m so

as to get their bonuses (window dressing). Thisis also indicated by the fact that the directors

have changed the useful economic life of plant

and machinery from three to five years to reduce

the depreciation charge for the year and hence

inflate the profit figure to attain the minimum

target figure.

The auditors need to maintain professional

scepticism throughout the audit and carry out

detailed cut-off testing on revenue and expenses

to confirm that the figures are correctly stated.

There is a risk that the depreciation charge for

the year is understated and non-current assets

on the statement of financial position are

overstated as the directors have amended the

useful economic life of plant and machinery from

three to five years.

The auditors should discuss the change and the

reasons for it with the directors and assess

whether it is reasonable or not. They should also

examine a sample of plant and machinery assets

to assess whether the change is appropriate.

The company has taken out a loan of £1m from

the bank which is repayable within a year. There

is a risk that this loan has been incorrectly

disclosed in the financial statements. It should

be disclosed as a current liability as it is

repayable within a year.

The auditors should review the terms of the loan

agreement to verify the repayment date and the

amount borrowed. They should review the draft

financial statements to confirm the correct

disclosure of the loan.

(Note: only five audit risks were required.)

Question 4 Text reference. Audit procedures are described in Chapters 8 and 11 of the Study Text. Tests of controls relating to

non-current assets can be found in Chapter 10 and substantive audit procedures for non-current assets can be

found in Chapter 12. Internal audit is covered in Chapter 5.

Top tips. Part (a) is knowledge-based but make sure that you adequately describe the procedures and examples

required. This part of the question would best be answered using a columnar format. Parts (b), (c) and (d) are more

challenging and you need to make sure your answers are relevant to the scenario in the question – think about the

type of industry that Bush-Baby Hotels operates in and tailor your answer accordingly.

Easy marks. Part (a) offers easy marks – you can score ten marks here as long as your answer is sufficiently

detailed. Vague example audit procedures will not score full marks.




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Marking scheme

Marks

(a) Up to 1 mark per well described procedure and up to 1 mark for a valid

audit test, overall maximum of 2 marks per type of procedure and test,

maximum of 5 marks for procedures and maximum of 5 marks for tests.

– Inspection– Observation

– Analytical procedures

– Inquiry

– Recalculation

– External confirmation

– Reperformance 10

(b) Up to 1 mark per well explained point

– Internal audit (IA) can assess fraud risk and develop controls to

mitigate fraud

– Regular reviews of compliance with these controls

– Where fraud suspected, IA can undertake detailed fraudinvestigation

– Existence of IA department acts as a fraud deterrent 3

(c) Up to 1 mark per well described limitation

– Lack of independence as employees of the company

– No requirement to be professionally qualified

– Cost of establishing department

– Possible resistance from existing employees to idea of being

audited 2

(d) Up to 1 mark per well described point

– Monitoring asset levels

– Cash controls testing

– Customer satisfaction levels

– Financial/operational controls

– IT system review

– Value for money review

– Regulatory compliance 5 20

(a) Audit procedures

Audit procedure Example for non-current assets

Inspection can relate to the examination of

documents and records in paper, electronic or other

forms, and it can also relate to the physical

examination of an asset. Inspection provides audit

evidence of existence and completeness.

Select a sample of non-current assets from the non-

current asset register and physically inspect them to

provide evidence that they actually exist. Select a

sample of non-current assets from the client sites

and trace back to the non-current asset register to

provide evidence of completeness.

Inspect purchase order requisitions for a sample of

property, plant and equipment purchased in the year

to confirm that they were properly authorised.








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Marks

(b) Up to 1 mark per valid point, overall maximum of 6 marks per event

Event 1 – Defective chemicals

– Provides evidence of conditions at the year end

– Inventory to be adjusted to lower of cost and net realisable value

– Calculation of materiality

– Review board minutes/quality control reports

– Discuss with the directors, adequate inventory to continue totrade

– Obtain written representation re going concern

– Obtain schedule of defective inventory, agree to supporting

documentation

– Discuss with directors basis of the scrap value 6

Event 2 – Explosion

– Provides evidence of conditions that arose subsequent to the year

end

– Non-adjusting event, requires disclosure if material

– Calculation of materiality

– Obtain schedule of damaged property, plant and equipment andagree values to asset register

– Obtain latest inventory records to confirm damaged inventory

levels

– Discuss with the directors if they will make disclosures

– Discuss with directors why no insurance claim will be made 6

(c) Up to 1 mark per well explained valid point

– Disclosure required in 2013 financial statements and adjustment

to the assets in 2014 financial statements

– Material but not pervasive misstatement, modified audit report,

qualified opinion

– Basis for qualified opinion paragraph required

– Opinion paragraph – except for 3 20

(a) Elements of an assurance engagement

There are five elements of an assurance engagement and these are explained below.

A three party relationship

The three parties are the intended user, the responsible party and the practitioner. Intended users are the

person, persons or class of persons for whom the practitioner prepares the assurance report. The

responsible party is the person (or persons) responsible for the subject matter (in a direct reportingengagement) or subject matter information of the assurance engagement.

The practitioner is the individual providing professional services that will review the subject matter and

provide the assurance.

A subject matter

This is the data to be evaluated that has been prepared by the responsible party. It can take many forms

including financial performance (eg historical financial information), non-financial performance (eg key

performance indicators), processes (eg internal control) and behaviour (eg compliance with laws and

regulations).

Suitable criteria

The subject matter is evaluated or measured against criteria in order to reach an opinion.




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Evidence

Sufficient appropriate evidence needs to be gathered to support the required level of assurance.

Assurance report

A report containing the practitioner's opinion is issued to the intended user.

(b) Event 1: Defective chemicals

A batch of chemicals produced before the year-end, costing £0.85m to produce, has been found to bedefective after the year-end. Its scrap value is £0.1m. Inventory should be valued at the lower of cost and net

realisable value in accordance with IAS 2 Inventories . This is an adjusting event in accordance with IAS 10

Events after the reporting date . As it stands, the inventory is overstated by £0.75m. This represents 13.4%

of profit before tax and 1.4% of revenue and is therefore material to the financial statements.

Audit procedures to be performed:

Obtain a schedule to confirm the cost value of the defective batch of £0.85m and documentary proof

of the scrap value of £0.1m.

Discuss with management whether this is the only defective batch or whether there are likely to be

other batches affected.

Review quality control reports to assess the likelihood of other batches being affected and discussresults of testing with technical team members at Panda.

Event 2: Explosion

An explosion shortly after the year-end has resulted in damage to inventory and property, plant and

equipment. The amount of inventory and property, plant and equipment damaged is estimated to be £0.9m.

It has no scrap value. Inventory and property, plant and equipment are therefore overstated by £0.9m. This

represents 16.1% of profit before tax and 1.6% of revenue, and is therefore material. The explosion

represents a non-adjusting event in accordance with IAS 10 Events after the reporting date . It therefore does

not require adjustment in the financial statements but should be disclosed as it is material.

Audit procedures to be performed:

Obtain a schedule of the inventory and property, plant and equipment damaged in the explosion toverify the value of £0.9m.

Visit the site where the explosion took place to assess damage.

Discuss with directors the need to make disclosure in the financial statements and review any draft

disclosure note drafted.

Inspect insurance agreement to assess whether any claim can be made on the insurance.

(c) Effect on auditor’s report of the explosion

The directors should make disclosure in the financial statements about the explosion and the effect on

inventory and property, plant and equipment as the amount involved is material and affects the value of

opening inventory and property, plant and equipment in the following financial year.If the directors refuse to make the disclosure, then the auditors would modify the opinion on the financial

statements on the basis of a material misstatement. The opinion would be ‘except for’ as the matter is

material but unlikely to be pervasive.

Documents

f8int 2013 Jun a (Bpp's Answers)