QUESTION BANK

Section 2: Accepting and

managing engagements

8 Short form questions

1 What information should be included on every working paper originated by audit team members?
(2 marks)

2 An accountancy firm has previously used the services of an independent provider to conduct cold
reviews of its completed audit engagements. However, the partners have decided to undertake in-
house all aspects of monitoring the quality of audits carried out.
Set out the objectives of conducting cold reviews which the in-house system must achieve. (2 marks)

3 An audit partner has consulted a colleague on a question of judgement concerning the audit of his
client.
Explain the important features in respect of this matter that the working paper recording the
consultation should contain. (3 marks)

4 What are the three main considerations for an auditor when considering the acceptance and
continuance of client relationships and specific audit engagements? (2 marks)

5 List the principal items to be agreed in an engagement letter between an assurance firm and a person
commissioning an assurance engagement. (2 marks)

6 A prospective auditor is required to write to the client’s existing auditor to seek information which
could influence his decision as to whether he may accept the auditor appointment.
Give examples of relevant matters which could be within this letter and which would influence the
prospective auditor’s decision to accept the audit appointment. (2 marks)

7 Certain rights are conferred on an auditor by the Companies Acts when a company proposes to
remove him from office.
State the rights the auditor has in these circumstances. (2 marks)

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 Section 2: Accepting and managing engagements

8 The current auditors of Meldrew Ltd will not be proposed for re-appointment at the annual general
meeting to be held on 12 October 20X9. The directors were extremely unhappy at the additional
disclosures in the financial statements for the year ended 31 December 20X8 concerning the status of
the company as a going concern. The auditors had insisted upon these before they would express an
unqualified opinion.
As a result your firm has been asked to accept appointment as auditors of Meldrew Ltd. All the
shareholders of the company are directors.
Set out the matters your firm ought to consider and the procedures to follow before it should accept
appointment as auditors. (4 marks)

9 An audit partner has consulted a colleague regarding a question of judgement concerning the audit of
his client. The audit partner has prepared a working paper in respect of this matter, recording details
of facts known at the time, the reasoning for his conclusion and conclusion reached.
State why the partner should record this information in the working paper in respect of this matter.
(2 marks)

10 A mature student has recently joined your firm on a training contract. She has told you that in her
previous job, she was allowed to work on her own with little supervision and no review of her work.
She does not understand the importance of the review process in your firm.
State the reasons why assurance and audit work is reviewed by more senior staff and partners.
(3 marks)

11 List six functions of an audit committee. (3 marks)

9 Sleeper Ltd
Your audit firm has recently been invited to accept appointment as external auditor to Sleeper Ltd, a
company that owns and operates a number of mobile phone stores in the four major cities of Bangladesh.
You have not previously acted for Sleeper Ltd, but your firm is auditor to Zelig Ltd, a company which also
operates mobile phone stores in many of the same locations as Sleeper Ltd. Your audit firm has a total of
seven partners located in three offices which are situated in major cities within Bangladesh.
The current auditors of Sleeper Ltd have received notice from the company’s directors that they are not to
be re-appointed as auditors at the company’s forthcoming Annual General Meeting. The management has
given no reason for this course of action, although the auditors suspect that it is because they insisted on
modifying the audit report for the previous accounting year, despite substantial pressure from management
to issue an unmodified audit report.
The modification to the previous year’s audit report was in respect of inventory. It was discovered during
the audit that the year end inventory quantities at two of the company’s stores had been falsely inflated by
the managers of both stores in order to cover up a substantial theft of mobile phones immediately prior to
the year end. There were no satisfactory audit procedures that could be carried out to substantiate the
existence of the physical quantities of inventory at the year end.

12 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Requirements
(a) Identify and explain the professional ethical issues which you might need to consider in deciding
whether or not to accept appointment as external auditor to Sleeper Ltd. Recommend the possible
safeguards that could be put in place to resolve these issues. (6 marks)
(b) Set out the responsibilities and rights, including those under the Companies Acts, of the current
auditors of Sleeper Ltd in relation to the proposed change in professional appointment.
(3 marks)
(c) Set out the respective duties of both the management and external auditors of Sleeper Ltd in relation
to the prevention and detection of fraud, and outline how these duties are discharged.
(6 marks)
(d) List the financial statement assertions, other than existence, which are relevant to the audit of
inventory and, for each one listed, outline one relevant audit procedure to test that assertion in
respect of Sleeper Ltd. (6 marks)
(21 marks)

10 Gemini Ltd
Described below are situations that have arisen in companies which are external audit clients of your firm.
(1) During the year ended 31 May 20X2 your firm commenced a five-year contract to provide internal
audit services for Gemini Ltd. Over the course of the year the internal audit team carried out a risk
assessment exercise and an evaluation of the internal control systems supported by tests of control.
(2) Leo Starr, the managing director and majority (80%) shareholder of Taurus Ltd, received an offer from
Sagittarius Ltd, also an audit client, for the entire share capital of Taurus Ltd. Leo Starr has agreed in
principle to sell his shares to Sagittarius Ltd. The purchase consideration is likely to consist of an initial
cash payment based on the net assets of Taurus Ltd as at 31 August 20X2, and a deferred cash
payment contingent on the operating profit growing by an average of 5% over the next two years. Leo
Starr and the management of Sagittarius Ltd have requested, independently, that your firm acts as
advisors in respect of the negotiations and provides an assurance report on the calculation of the
amount of the net assets at 31 August 20X2.
Requirements
(a) Describe the purpose of quality control measures in respect of the provision of assurance and
advisory services. (6 marks)
(b) Discuss the ethical and professional issues raised by the situations described above, and identify the
quality control measures your firm should implement in order to mitigate any threats to objectivity
which might arise from the provision of the services described above. (12 marks)
(18 marks)

11 Hairsay Ltd
Hairsay Ltd is a company which operates six hairdressing salons. The company does not grant credit
facilities and customers pay by cash, cheque or debit or credit card. All branches have tills in which takings
are lodged, and receipts are issued when requested by customers.
Following a tip-off by one of the employees, the managing director discovered that another employee was
misappropriating cash takings by pocketing cash received from customers and deliberately failing to record
the related transactions. Although the amounts involved were immaterial in the context of the cash sales
and profit figures, it transpired that this had been going on for several years.
The managing director has expressed concern that the company’s auditors did not discover this fraud and
has requested that your firm undertakes an independent review of the company’s cash handling procedures.

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 Section 2: Accepting and managing engagements

He is worried that other cash handling irregularities may be occurring and is anxious to have a system in
place which will prevent any misappropriation of cash takings.
Requirements
(a) Outline the matters to be included in the letter of engagement which your firm should send to the
management of Hairsay Ltd prior to commencing the independent review of the company’s cash
handling procedures. (5 marks)
(b) Using Hairsay Ltd’s fraud as an example, compare and contrast the responsibilities of the auditors in
respect of fraud with the expectations of the managing director. (5 marks)
(c) Prepare a checklist of questions which you would ask in order to establish whether there are any
shortcomings in Hairsay Ltd’s policies and procedures which increase the risk of misappropriation of
cash. (6 marks)
(16 marks)

12 Wrapper Ltd
Your firm, which has six partners, has been invited by Mr Packer, the managing director and majority
shareholder of Wrapper Ltd, to accept appointment as auditor of the company and also provide assistance
with the preparation of the financial statements and the corporation tax computation.
The principal activity of Wrapper Ltd is the production of paper carrier bags, serviettes, coffee cups and lids
which are sold to customers operating in the fast food sector. Wrapper Ltd was incorporated on
1 October 20X4 and the financial statements will cover the 15 month period to 31 December 20X5.
Although the company's revenue and assets are below the thresholds for statutory audit purposes, the
company's bankers require the annual accounts to be subjected to a full audit.
Mr Packer started the business using a combination of money inherited from his grandfather and a bank
loan. The loan agreement includes a covenant specifying that the company's debt equity ratio should not
exceed parity (i.e. 1:1).
The accounting records are computerised and the company uses software which was developed by IT
Systems Ltd, a company owned by Mr Packer's brother. The software has been customised to integrate
inventory control with receivables and payables. IT Systems Ltd also provides support for the company’s
computer systems. The accounting records are maintained by Mrs Carlton, assisted by Mrs Biggs who
works one day a week and is responsible for payroll processing.
Requirements
(a) State, with reasons, the matters to be considered and procedures to be performed prior to your firm
accepting and commencing the audit of Wrapper Ltd for the period ending 31 December 20X5.
(8 marks)
(b) Identify, from the information provided above, the factors which should be taken into account when
assessing the risk of misstatement in the financial statements of Wrapper Ltd and explain why such
factors should be taken into account when conducting the audit. (10 marks)
(18 marks)

13 Waverley Ltd
The auditors of Waverley Ltd have resigned following a disagreement with the directors. The audit report
on the financial statements for the year ended 31 March 20X3 was qualified on the grounds that they did
not comply with accounting standards in some material respects.
Subsequently the directors have engaged your firm to review the accounting policies adopted by the
company and to investigate the application of the accounting policies in the financial statements for the year
ended 31 March 20X3. Your firm is required to report on the appropriateness of the policies adopted and
the extent to which they were properly applied in the financial statements.

14 © The Institute of Chartered Accountants in England and Wales, March 2009

 QUESTION BANK

Requirements
(a) Contrast this assurance engagement with the statutory audit of the annual financial statements with
respect to the scope of the work you would undertake and the report you would issue. (11 marks)
(b) If, after presenting the report, your firm were requested to accept appointment as auditors of
Waverley Ltd, identify the matters it should consider and the procedures it should follow before it
accepts the appointment. (7 marks)
(18 marks)

14 Wavenden Ltd
Your firm has been asked by the directors of two companies to accept appointment as auditors.
The directors of Wavenden Ltd have become dissatisfied with the service of the existing auditor,
mainly due to the lack of urgency that he appears to display in his dealings with the company. He has
been notified of their wish to replace him and has been asked for his resignation.
This has not been received and the directors now wish to remove him from office.
The financial statements for the year ended 30 September 20X0 showed inventories of CU25,000.
Inventories at cost were CU50,000. A review of obsolescence was not performed but, on the
recommendation of the company’s accountants, the cost was written down by 50% on the grounds of
prudence. The directors admit that obsolete inventories rarely exceed 10%, but there are no
satisfactory audit procedures that could be adopted to confirm the true figure at that date.
Requirements
(a) Set out the steps that both Wavenden Ltd and your firm should follow in order to complete the
process of the appointment of your firm as its auditors. (13 marks)
(b) In respect of the issue over inventory, reach a conclusion on whether you would modify your audit
report on Wavenden Ltd for the year ending 30 September 20X1, on the basis that no other matters
arise which affect the opinion. You should give reasons for your conclusion and describe any additional
statements which would need to be made in the audit report. (8 marks)
(21 marks)

15 Benson Ltd
Benson Ltd is a medium sized entity, managed by its owners who bought it out from a large limited
company six years ago. The share capital is owned by four directors. One of the original directors, Andrew
Fisher, has recently passed away and his shares and his place on the board have been taken up by his son,
John Fisher.
A large loan from the bank which helped to finance the management buy out was paid off in the previous
period. This year, the directors have negotiated another loan from the bank to help finance an expansion
into Europe.
You work for a firm of chartered accountants called Andrews, Baker and Co (ABC). ABC became involved
with Benson at the time of the buy out when they provided advice to two of the (current) directors. They
have been involved with the business ever since, acting in the capacity of tax advisers, management
consultants, and personal tax advisers for all the directors. They have also been involved in some special
projects for Benson, taking part in an investigation due to a suspected fraud two years after the MBO, and
putting together projections and budgets for the potential expansion into Europe.
ABC were invited to tender initially for the audit, but their tender had the highest fee, and Mr Fisher senior,
who was the managing director at the time, strongly believed that an audit was a statutory necessity which
the company should obtain as cheaply as possible. The audit was given to a smaller firm of auditors, XYZ,
but ABC were engaged to provide what Mr Fisher always termed, 'the useful stuff – worth paying for'.

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 Section 2: Accepting and managing engagements

The fee income from Benson has been considerable over the years. Two years ago, when the work was
done on the expansion, it represented 20% of the income of the firm for that year.
The increase in size of the business since the expansion has led to the current auditors, XYZ, resigning.
Rather than going through another tender, the directors have decided to offer the audit to their business
advisers, ABC, as they believe that it provides synergy to combine the two roles, and that synergy may
result in a lower overall cost to the company of accountancy and related services.
ABC have accepted the audit work. The first audit is due to start in three weeks’ time. At a recent board
meeting, attended by the partner who has been in charge of the work provided to Benson, and his
colleague, who has been appointed as the audit engagement partner, the directors discussed plans to float
the company on the Stock Exchange in the foreseeable future.
Requirements
(a) Explain the current ethical and legal considerations in connection with accepting appointment as an
auditor. (8 marks)
(b) Discuss whether the conduct of ABC has been ethical in its dealings with Benson Ltd during the
course of their relationship, and how Benson’s prospective listing might change the ethical situation.
(15 marks)
(c) ABC have appointed an audit engagement partner, who has not previously been involved with the
client, to the audit of Benson. What other quality control procedures and policies should ABC have in
place in relation to the audit of Benson to safeguard audit quality? (8 marks)
(31 marks)

16 Healey Ltd
Your firm has been invited by Mr Allard, the managing director of Healey Ltd, to accept appointment as
auditor of the company. Mr Allard owns 51% of the shares of the company and the remaining 49% is owned
by Mr Morgan, the sales director. The present firm of auditors will not be re-appointed when its term of
office expires as Mr Allard is dissatisfied with the cost of its services.
In addition, Mr Allard has requested that your firm takes on the following work.
(1) Advising both parties on the purchase consideration in respect of the sale of Mr Morgan’s shares in
Healey Ltd; Mr Morgan plans to retire and has agreed in principle to sell his shares to Mr Allard.
(2) Advising on an on-going basis in respect of Mr Allard’s plans to expand Healey Ltd’s operations by the
acquisition of other businesses; this will involve investigations and reports on businesses identified by
Mr Allard.
Requirements
(a) (i) State the matters, other than independence, that you would consider and the procedures you
would perform in deciding on the suitability of Healey Ltd as an audit client for your firm.
(8 marks)
(ii) Explain the six general threats to independence identified by ethical standards. (6 marks)
(iii) State, with reasons, the specific threats to the auditor’s objectivity which may arise out of
providing the additional services outlined above, and describe the safeguards which may offset
such threats. (7 marks)
(b) Outline the potential liability of the firm in respect of the three services requested by Mr Allard,
including suggestions related to how the firm might restrict its liability in respect of the services
provided. (15 marks)
(c) Identify four quality control policies or procedures the firm could implement to ensure that the
independence and quality of the audit was not impaired. (4 marks)
(40 marks)

16 © The Institute of Chartered Accountants in England and Wales, March 2009