CONFIDENTIAL 1 AUD589 –JUNE 2017

SOLUTION – AUD 589

JUNE 2017

SUGGESTED SOLUTION

QUESTION 1

a) Identify TWO (2) advantages and disadvantages of monetary sampling.

ADVANTAGES DISADVANTAGES

1. Design an efficient sample 1. Possibility bias

2. Measure of sufficiency of evidence 2. Additional cost – training of

obtained auditors

3. Can be drawn quickly 3. Other consideration of non-

financial matters will not be a basis
of choosing a sample
4. Ease of use 4. Need to have knowledge or
experience to perform the
sampling method
(Identify 2 advantages & 2 disadvantages x 1 mark each = 4 marks)

b) Briefly discuss the THREE (3) steps in applying materiality to an audit procedures.

3 steps in applying materiality:

1. Determine overall materiality – Overall materiality is the maximum amount by
which the auditor believes the financial statements could be misstated and
still not affect the decisions of users. Materiality is a relative not an absolute
concept.

2. Determine performance materiality – in practice auditors commonly set

performance materiality for each account at between 50 and 75 percent of
overall materiality. The firms also provide guidance to assist their auditors in
determining the appropriate percentage to use within the range.

3. Evaluating audit evidence – The auditor evaluates all the evidence that has
been gathered. Based on the results of the audit procedures conducted, the
auditor aggregates misstatements from each account or disclosure. In
evaluating misstatements relating to accounting estimates, the auditor should
careful in considering the risk of material misstatement in accounts.
(Briefly discuss 3 steps x 2 marks = 6 marks)
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B.

a. Define the meaning of ‘Audit Risk’ Audit risk means that the auditor accepts some
level of uncertainty in performing the audit function/. The auditor recognizes for
examples that there is uncertainty about the reliability of evidence, uncertainty
about the effectiveness of the client’s internal control system/.
(2/ x 1 mark= 2 marks)

b. Describe the component of audit risks

- Component of audit risks – a) inherent risk, b) Control risk, c) Detection risk
(Explanation for each of the audit risks)
((Describe 3 components x 1 mark each = 3 marks)

c. Explain how these components and interrelated to each other.

- Detection risk is determined by the effectiveness of audit procedure/ and how
well the procedure is applied by the auditor. Detection risk has an inverse
relationship to inherent risk and control risk/. If an auditor judges a client’s
inherent risk and control risk to be high, the auditor would set a lower level of
detection risk in order to achieve the planned level of audit risk/. If inherent
risk and control risk are low, the auditor can accept higher detection risk/.

Audit model: AR = IR X DR X CR
(5/ x 1 mark = 5 marks)
(Total: 20 marks)

QUESTION 2

A.

a. FOUR (4) factors that affect the reliability of confirmations.

1. Independent source outside the entity

2. Effectiveness of internal control
3. Auditor’s direct personal knowledge
4. Documentary evidence
5. Original document
(List any 4 x 1 mark each = 4 marks)

b.
i) A bank confirmation is more reliable as compared to observation of
segregation of duties between cash receipts and recording payment in the
accounts receivable subsidiary ledger. The reason is because a confirmation
is a document received from a third party and therefore the reliability is higher
than observation.
(Briefly discuss the evidence = 2 marks)
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ii) An auditor’s recalculation of depreciation is more reliable as compared to

examination of raw material requisitions because the auditor himself
recalculates and confirms the amount of depreciation. Therefore,
recalculation is more reliable as compared to examination.
(Briefly discuss the evidence = 2 marks)
B.

Audit procedures Type of audit procedures Audit assertions

a. Sending a written request Debtor’s confirmation√ Existence√

to the company’s
customers requesting that
they report the amount
owed to the entity.
b. Examining large sales Cut-off test√ Completeness/detail-tie in√
invoices for a period of
two days before and after
year end to determine if
sales are recorded in the
proper period.
c. Agreeing the total of the Tracing Accuracy/posting and
accounts receivable
summarization√
subsidiary ledger to the
accounts receivable
general ledger account.

d. Discussing the adequacy Reconfirmation/Interview√ Accuracy√

of the provision for
doubtful debts with the
credit managers.
e. Comparing the current- Analytical procedures√ Accuracy/completeness√
year gross profit
percentage with the gross
profit percentage for the
last four years.
f. Reviewing the general Review of unusual Presentation and disclosure√
ledger for unusual
adjusting entries. balances√

(12√ x 1 mark each = 12 marks)

(Total: 20 marks)

QUESTION 3

a. (i) Identify five (5) elements of internal control

Five components - Control Environment, Risk Assessment, Control Activities,
Information and Communication, and Monitoring
(Identify 5 components x ½ mark each = 2 ½ marks)
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(ii) Explain any two elements of internal control that has been identified above

The control environment-sets the tone of an institution and influences the control
consciousness of its people. Leaders of each department, area or activity establish a
local control environment. This is the foundation for all other components of internal
control, providing discipline and structure. Control environment factors include:

 Integrity and ethical values;

 The commitment to competence;

 Leadership philosophy and operating style;

 The way management assigns authority and responsibility, and organizes and
develops its people;

Policies and procedures of internal control – are internal rules established to

ensure smooth business operation i.e. efficient and company is able to achieve its
goal such as making profit.

Control activities are the policies and procedures that help ensure management
directives are carried out. They help ensure that necessary actions are taken to
address risks to achievement of the entity's objectives. Example of Control activities
are: approvals, authorizations, verifications, reconciliations, reviews of operating
performance, security of assets and segregation of duties.

(Explain 2 points x 1 ¼ = 2 ½ marks)

b.

1. Small number of staff limits the proper segregation of duties. Errors or fraud can
be reduced through the implementation of compensating controls to ensure that
objectives are achieved. 

2. Limitation that relates to the element of human error, misunderstandings, fatigue

and stress. The way to reduce error is to encourage employees to take earned
vacation time in order to improve operations through cross training while enabling
employees to overcome or avoid stress and fatigue.

3. Management override - may cause poor or sub-standard performance. The way

to reduce is to make the management aware of the importance of certain
procedural controls to ensure quality performance
(Discuss 3 points x 2 marks = 6 marks)

c.

No. Types of error and fraud Types of internal controls to implement

1 Misappropriate inventory Have an individual in charge of inventory of the

business and ensure another individual maintains
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its records and keeps the record its movement in

and out of the company. This is to make sure that if
there is any loss of inventory the person in charge
can be made accountable.

2 Misappropriate cash from Have strict access to the cash till machine and
cash till machine allow only certain individual to open and close the
till machine. Use password and regularly change it.
This is to make sure there is no unauthorized
access to the cash till so that the money is not lost.

3 Came late for work Keep a good system of recording the attendance
and time come for work, for example use punch
card or thumb print. This will avoid fraudulent
claiming of wages.

4 Fraudulently understate Issue a receipt whenever sales take place and put
sales a notice stating the importance of customers to
obtain a receipt for any purchase. This is to make
sure no money is stolen from sales and is properly
recorded in the ledger.

5 Fraudulent entry in books Ensure segregation of duties of the individual who

of the company record transactions in the books and the person
who is in charge of inventory and authorization of
sales (cashier in this case). This is to avoid
individual stealing the inventory and make a
fraudulent record in the books of the business.

Any 3 types of error and fraud.

One type of error and fraud =1 mark and 2 marks for explanation on the
type of internal controls to implement
Total = 9 marks

(Total = 20 marks)

QUESTION 4

a.
Current asset = cash, money at bank, has intention of sale and resale and other
assets that are easily realisable to cash except prepayments within one year.

Non-current asset = used by the business to generate income and has no intention
for resale
(Briefly explain CA & NCA X 1 mark each =2 marks)

b.
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No. Substantive procedures for non- Balance related audit

current asset objective

1 Physical examination of property Existence

2 Obtain listing of assets (asset Completeness

register) and discuss with
management if there is any new
acquisition and disposal during
the financial year.

3 Inspect the policy regarding Valuation (net realizable

depreciation of asset and enquire value)
about the market valuation of the
asset (from estate valuer)

4 Determine the nature of the asset Classification

investment and inspect whether it
has been properly classified and
disclosed in the financial
statements.

Any 3 points with explanations

One point 2 marks and 1 mark for relevant audit objective
Total = 9 marks

c.

No. Management Substantive procedures to confirm the

assertion assertion

1 Completeness Examine all sales invoices issued are

recorded in the relevant journal and
ledger

2 Occurrence Check that all sales transactions are

approved by the sales manager and
sales invoices have been raised

3 Presentation and Examine the documents that rlates to sales

disclosure whether they are sales of inventory and
disposal of asset

4 Measurements Examine the amount of sales whether

discounts allowed or returns have been
taken into considerations

Any 3 points with elaborations

One management assertion 1 mark and 2 marks for
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substantive procedures to confirm the assertion

Total = 9 marks

(Total = 20 marks)

QUESTION 5

A. The elements for unmodified audit reports.

 The auditors have obtained sufficient appropriate audit evidence (1). The
sufficiency and appropriateness of the audit evidence enable the auditors to give an
opinion on the validity of the individual assertions (1) embodied in the components
of the financial report.
 The auditors have concluded that any uncorrected misstatements are immaterial,
both individually and in aggregate (1). The objective of an audit is to obtain
reasonable assurance that the financial report as a whole is free from material
misstatement (1), whether due to fraud or error.
 The financial report is prepared, in all material respects, in accordance with the
requirements of the applicable financial reporting framework. Malaysian entities other
than private entities are subject to the Malaysian Financial Reporting Standards
framework (MFRS) (1).
(Explain 3 elements x 2 marks each = 6 marks)

B. The errors that have been made by the audit junior in drafting the opinion paragraph.
 Auditors do not “certify” financial statements (1). The auditors’
opinion derived from the degree of reasonable assurance obtained
by the auditors. Here, certify indicated that the auditors’ opinion is a
guarantee (1) that the financial statements as a whole are free
from material misstatements, whether due to fraud or error.
 Auditors’ opinion does not give a “correct view” on the financial statements (1). The
auditors give a fair opinion which implies that the financial statements present the
information faithfully without any element of bias. However, correct view give the
indication that the financial statements have been measured with absolute no error or
fraudulent transactions (1).
 Auditors do not specify the components of the attached financial statements (1). In
the opinion paragraph, the auditors should mention the financial statements as the
financial position as of the year end and the financial performance and cash flows for
the year ended (1).
 Auditors do not specify the accounting framework (1). Here, the opinion paragraph
should clearly state the accounting framework as the Malaysian Financial Reporting
Standards and International Financial Reporting Standards (1).
 In the second opinion paragraph, although the wording did not follow the standard
wording, but it did make some sense by stating the essential elements. Here, the
auditors do not state the name of the law which they are required to comply with
(1). Hence, for the second paragraph the auditors should mention the Companies
Act 1965 in Malaysia has been complied with (1).
(Discuss 4 errors x 2 marks each = 8 marks)
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C. The types of audit report that should be issued.

Reason
Type of Audit Report
Circumstances Effect

i. Modified audit report with Financial statements are materially Material

except for opinion (1) misstated (1). The disagreement of
the directors to approve the write-off in
order to reflect the fair value of the
inventories had misstated the validity
of the assertion on the valuation (1).

ii. Unmodified audit report (1) The auditors able to obtain sufficient Not
appropriate audit evidence (1). The applicable
audit supervisor was allowed to have
accessed the personnel record, hence
able to complete the procedures for
the tests of controls over the payroll
and personnel cycle (1).

(Suggest 2 independent situations x 3 marks each = 6 marks)

(Total: 20 marks)

END OF SOLUTION