THE GENERAL AUDIT ENVIRONMENT

QUIZ

1. List the objectives of an audit.

2.List the benefits of an audit to a public limited company.

3.List the properties of a statutory audit that are different from a private audit.

EXAM QUESTIONS

QUESTION ONE

Restmount Kenya Ltd. was formed on 1 October 2006 in order to export tea and coffee to
European markets. The Directors are unsure as to their responsibilities and the nature of their
relationship with the external auditors. The audit partner has asked you to visit the client and
explain to the directors, the fundamental aspects of the accountability of the directors and their
relationship with the auditor.

Required:

Explain to the directors of Restmount Kenya Ltd.

a. The need for an audit.

b. Procedures for the appointment of an auditor of a public company under the Companies Act.

c. Director’s responsibilities in relation to the accounting function of the Company.

d. Auditors’ statutory responsibilities in relation to the audit of the company’s financial

QUESTION TWO
Your firm is the newly appointed external auditor to a large company that sells, maintains and
leases office equipment and furniture to its customers and you have been asked to co-operate
with internal audit to keep total audit costs down. The company wants the external auditors to
rely on some of the work already performed by internal audit. The internal auditors provide the
following services to the company:

(i) A cyclical audit of the operation of internal controls in the company’s major functions
(Operations, finance, customer support and information services)

(ii) A review of the structure of internal controls in each major function every four years;

(iii) An annual review of the effectiveness of measures put in place by management to minimize
the major risks facing the company.

During the current year, the company has gone through a major internal restructuring in its
information services function and the internal auditors have been closely involved in the
preparation of plans for restructuring, and in the related post-implementation review.

Required:

(a) Explain the extent to which your firm will seek to rely on the work of the internal
auditors in each of the areas noted above.
(b) Describe the information your firm will seek from the internal auditors in order for you
to determine the extent of your reliance.
(c) Describe the circumstances in which it would not be possible to rely on the work of the
internal auditors.
(d) Explain why it will be necessary for your firm to perform its own work in certain audit
areas in addition to relying on the work performed by internal audit.

QUESTION THREE

List and describe SIX financial statement assertions, other than completeness, used by auditors in
the audit of financial statements.

QUESTION FOUR

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The purpose of an external audit and its role are not well understood. You have been asked to
write some material for inclusion in your firm’s training materials dealing with these issues in
the audit of large companies. Draft explanation dealing with the purpose of an external audit and
its role in the audit of large companies, for inclusion in your firm’s training materials.

THE AUDITOR AND THE COMPANIES ACT

QUIZ

1. List the professional ethics that the auditor is expected to adhere to.
2. What is the purpose of an engagement letter?

EXAM QUESTIONS

QUESTION ONE

Your firm has been approached by the directors of UB Bank Ltd. a newly formed commercial
bank to undertake the audit for its first complete financial year ended 31 December 1996. Your
manager has assigned you the responsibility for leading the team. You have had various
discussions with the directors about the timetable and the respective responsibilities of
management and the auditor. You have drafted a letter of engagement and have sent it to the
managing director for approval and acceptance but the management has not yet responded to
your letter.

Required:

a) Explain why a letter of engagement is sent before any new audit appointment is accepted.

b) Set out the main contents of a letter of engagement.

c) Itemize the actions you would take in response to the non-reply by the management to your
draft engagement letter.

d) State when it might be necessary to re-draft an engagement letter and have it reaffirmed by the
client’s management.

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QUESTION TWO

The objectivity of the external auditor may be threatened or appear to be threatened where:

i. There is undue dependence on any audit client or group of clients.

ii. The firm, its partners or staff have any financial interest in an audit client.

iii. There are family or other close personal or business relationships between the firm, its
partners or staff and the audit client.

iv. The firm provides other services to audit clients.

Required:

a) For each of the four examples given above, explain why the objectivity of the external auditor
may be threatened, or appear to be threatened, and why the threat is important.

b) Describe requirements that reduce the threats to auditor objectivity for each of the four
examples given above.

QUESTION THREE

a) Describe the matters to consider within your firm and the other procedures that must be
undertaken before accepting the appointment as auditor to a new client.

b) Explain why it would be inappropriate to commence the audit before consideration of the
matters and the procedures referred to in (a) above have been completed.

c) Explain the purpose of an engagement letter and list its contents.

QUESTION FOUR

You are a recently qualified Chartered Certified Accountant in charge of the internal audit
department of ZX, a rapidly expanding company. Turnover has increased by about 20% p.a. for
the last five years, to the current level of Kshs50 million. Net profits are also high, with an
acceptable return being provided for the four shareholders. The internal audit department was

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established last year to assist the board of directors in their control of the company and to prepare
for a possible listing on the stock exchange. The Managing Director is keen to follow the
principles of good corporate governance with respect to internal audit. However, he is also aware
that the other board members do not have complete knowledge of corporate governance or
detailed knowledge of International Auditing Standards.

Required:

Write a memo to the board of ZX that:

a) Explains how the internal audit department can assist the board of directors in fulfilling

their obligations under the principles of good corporate governance.

b) Explains the advantages and disadvantages to ZX of an audit committee.

QUESTION FIVE

a) Explain the situations where an auditor may disclose confidential information about a client.

b) You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants.

You are preparing the engagement letter for the audit of Ancients; a public limited liability
company, for the year ending 30 June 2006.Ancients has grown rapidly over the past few years,
and is now one of your firm’s most important clients. Ancients has been an audit client for eight
years and McKay & Co has provided audit, taxation and management consultancy advice during
this time. The client has been satisfied with the services provided, although the taxation fee for
the period to 31 December 2005 remains unpaid. Audit personnel available for this year’s audit
are most of the staff from last year, including Mr. Grace, an audit partner and Mr. Jones, an audit
senior. Mr. Grace has been the audit partner since Ancients became an audit client. You are
aware that Allyson Grace, the daughter of Mr. Grace, has recently been appointed the financial
director at Ancients. To celebrate her new appointment, Allyson has suggested taking all of the
audit staff out to an expensive restaurant prior to the start of the audit work for this year.
Required:

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Identify and explain the risks to independence arising in carrying out your audit of Ancients for
the year ending 30 June 2006, and suggest ways of mitigating each of the risks you identify.

AUDIT PLANNING, CONTROL & RECORDING (ISA 300)

EXAM QUESTIONS

QUESTION ONE

Audit planning process allows the audit senior to acquire adequate knowledge about the entity.
This process ensures an effective control and review of audit work. Required;

a) Explain the auditor’s planning process when planning for an audit of a new client.

b) How does audit planning assist in the conduct of an audit?

c) Explain the following controlling procedures in a well-planned audit:

• Direction and supervision of work

• Review and co-coordination of work

• Quality controls

QUESTION TWO

You are an audit senior responsible for understanding the entity and its environment and
assessing the risk of material misstatements for the audit of Rock for the year ending 31
December 2004. Rock is a company listed on a stock exchange. Rock is engaged in the
wholesale import, manufacture and distribution of basic cosmetics and toiletries for sale to a
wide range of stores, under a variety of different brand names. You have worked on the audit of
this client for several years as an audit junior.

Required:

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(a) Describe the information you will seek, and procedures you will perform in order to
understand the entity and its environment and assess risk for the audit of Rock for the year
ending 31 December 2004.

(b) You are now nearing the completion of the audit of Rock for the year ending 31 December
2004. Draft financial statements have been produced. You have been given the responsibility of
performing a review of the audit files before they are passed to the audit manager and the audit
partner for their review. You have been asked to concentrate on the proper completion of the
audit working papers. Some of the audit working papers have been produced electronically but
all of them have been printed out for you. Describe the features of those working papers that
show that they have been properly completed.

QUESTION THREE

ISA 230 Audit Documentation (Revised) establishes standards and provides guidance regarding
documentation in the context of the audit of financial statements. Required:

a) List the purposes of audit working papers. (3 marks)

b) The time is now towards the end of the audit, and you are reviewing working papers
produced by the audit team. An example of a working paper you have just reviewed is shown
below.

Client Name Specs4You Co

Working paper Payables transaction testing

Year end 30 April 2007

Prepared by ……………………..

Reviewed by ……………………

Audit assertion: To make sure that the purchases day book is correct.

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Method: Select a sample of 15 purchase orders recorded in the purchase order system. Trace
details to the goods received note (GRN), purchase invoice (PI) and the purchase day book
(PDB) ensuring that the quantities and prices recorded on the purchase order match those on the
GRN, PI and PDB.

Test details: In accordance with audit risk, a sample of purchase orders were selected from a
numerically sequenced purchase order system and details traced as stated in the method. Details
of items tested can be found on another working paper.

Results: Details of purchase orders were normally correctly recorded through the system. Five
purchase orders did not have any associated GRN, PI and were not recorded in the PDB. Further
investigation showed that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as the internal controls do
not allow for changes in specification.

Conclusion: Purchase orders are completely recorded in the purchase day book.

Required:

Explain why the working paper shown above does not meet the standards normally expected of a
working paper.

QUESTION FOUR

International Standard on Auditing 300, (Planning an Audit of Financial Statements) states that
an auditor must plan the audit. Explain why it is important to plan an audit.

THE ACCOUNTING AND INTERNAL CONTROL SYSTEMS (ISA 400)

QUIZ

1. What is the difference between internal audit and external audit?

2. List the five elements of internal control.

3. What are the factors that are responsible to the growth of the internal audit function?

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4. List the approaches used to record the internal control system by the auditor.

5. Differentiate control environment from control procedures

EXAM QUESTIONS

QUESTION ONE

List down internal control procedures for raw material purchasing system of a large
manufacturing firm.

QUESTION TWO

Rhapsody Co supplies a wide range of garden and agricultural products to trade and domestic
customers. The company has 11 divisions, with each division specializing in the sale of specific
products, for example, seeds, garden furniture, and agricultural fertilizers. The company has an
internal audit department which provides audit reports to the audit committee on each division on
a rotational basis.

Products in the seed division are offered for sale to domestic customers via an Internet site.
Customers review the product list on the Internet and place orders for packets of seeds using
specific product codes, along with their credit card details, onto Rhapsody Co’s secure server.
Order quantities are normally between one and three packets for each type of seed. Order details
are transferred manually onto the company’s internal inventory control and sales system, and a
two-part packing list is printed in the seed warehouse. Each order and packing list are given a
random alphabetical code based on the name of the employee inputting the order, the date, and
the products being ordered.

In the seed warehouse, the packets of seeds for each order are taken from specific bins and
dispatched to the customer with one copy of the packing list. The second copy of the packing list
is sent to the accounts department where the inventory and sales computer is updated to show
that the order has been dispatched. The customer’s credit card is then charged by the inventory
control and sales computer. Bad debts in Rhapsody are currently 3% of total sales.

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Finally, the computer system checks that for each charge made to a customer’s credit card
account, the order details are on file to prove that the charge was made correctly. The order file is
marked as completed confirming that the order has been dispatched and payment obtained.

Required:

a) In respect of sales in the seeds division of Rhapsody Co, prepare a report to be sent to the
audit committee of Rhapsody Co which:

i. Identifies and explains four weaknesses in that sales system.

ii. Explains the possible effect of each weakness.

iii. Provides a recommendation to alleviate each weakness.

(b) Explain the advantages to Rhapsody Co of having an audit committee.

QUESTION THREE

ISA 400 (Risk Assessments and Internal Control) deals with internal control objectives and
internal controls. ISA 500 (Audit Evidence) deals with audit objectives and audit procedures. A
proper understanding of internal controls is essential to auditors in order that they understand the
business and are able to effectively plan and execute tests of controls and an appropriate level of
substantive procedures.

You are the auditor of a small manufacturing company, Dinko, that pays its staff in cash and by
bank transfer and maintains its payroll on a small stand-alone computer.

Required:

(a) For the payroll department at Dinko, describe the:

i. Internal control objectives that should be in place.

ii. Internal control environment and internal control procedures that should be in place to

achieve the internal control objectives.

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(b) For the payroll charges and payroll balances (including cash) in the financial statements of
Dinko:

i. Describe the external auditor audit objectives.

ii. List the tests of control and substantive procedures that will be applied in order to achieve the
audit objectives identified in (b) (i) above.

QUESTION FOUR

Ajio is a charity whose constitution requires that it raises funds for educational projects. These
projects seek to educate children and support teachers in certain countries. Charities in the
country from which Ajio operates have recently become subject to new audit and accounting
regulations. Charity income consists of cash collections at fund raising events, telephone appeals,
and bequests (money left to the charity by deceased persons). The charity is small and the
trustees do not consider that the charity can afford to employ a qualified accountant. The charity
employs a part-time bookkeeper and relies on volunteers for fund raising. Your firm has been
appointed as accountants and auditors to this charity because of the new regulations. Accounts
have been prepared (but not audited) in the past by a volunteer who is a recently retired
Chartered Certified Accountant.

Required:

a. Describe the risks associated with the audit of Ajio under the headings inherent risk, control
risk and detection risk and explain the implications of these risks for overall audit risk.

b. List and explain the audit tests to be performed on income and expenditure from fund raising
events.

QUESTION FIVE

You are the audit manager for Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions: mail order and on-line ordering on the Internet. Parker is a
new audit client. You are commencing the planning of the audit for the year-ended 31 May 2005.
An initial meeting with the directors has provided the information below. The company’s

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turnover is in excess of Kshs85 million with net profits of Kshs4 million. All profits are currently
earned in the mail order division, although the Internet division is expected to return a small net
profit next year. Turnover is growing at the rate of 20% p.a. Net profit has remained almost the
same for the last four years. In the next year, the directors plan to expand the range of goods sold
through the Internet division to include toys, garden furniture and fashion clothes. The directors
believe that when one product has been sold on the Internet, then any other product can be as
well.

The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Parker’s computer systems.
Recently errors have been known to occur, in the input of orders, and in the invoicing of goods
following dispatch. The directors maintain that the accounting system produces materially
correct figures and they cannot waste time in identifying relatively minor errors. The company
accountant, who is not qualified and was appointed because he is a personal friend of the
directors, agrees with this view, The directors estimate that their expansion plans will require a
bank loan of approximately Kshs30 million, partly to finance the enhanced web site but also to
provide working capital to increase inventory levels. A meeting with the bank has been
scheduled for three months after the year end. The directors expect an unmodified auditor’s
report to be signed prior to this time.

Required:

Identify and describe the matters that give rise to audit risks associated with Parker.

FRAUD AND ERROR

QUIZ

a. Define an error and a fraud.

b. List the different types of errors.

c. List the ways in which internal control systems are used to prevent fraud.

QUESTION ONE
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Fraud and error present risks to an entity. Both internal and external auditors are required to deal
with risks to the entity. Required:

a) Explain how the internal audit function helps an entity deal with the risk of fraud and error.

b) Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes
commission on holidays sold to customers through its chain of high street shops. Staff are partly
paid on a commission basis.

Well-established tour operators run the holidays that Stone Holidays sells. The networked
reservations system through which holidays are booked and the computerized accounting system
are both well-established systems used by many independent travel agencies.

Payments by customers, including deposits, are accepted in cash and by debit and credit card.
Stone Holidays is legally required to pay an amount of money (based on its total sales for the
year) into a central fund maintained to compensate customers if the agency should cease
operations.

Describe the nature of the risks to which Stone Holidays is subject arising from fraud and error.

QUESTION TWO

The responsibilities of internal and external auditors in relation to the risk of fraud and error
differ. Explain the responsibilities of external auditors in respect of the risk of fraud and error in
an audit of financial statements.

QUESTION THREE

Compare the responsibilities of the directors and auditors regarding the published financial
statements.

AUDIT EVIDENCE

QUIZ

1.What is audit evidence?

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2. List the ways of gathering audit evidence.

3. List qualities of a good sample

EXAM QUESTIONS

QUESTION ONE

The Auditors Operational Standard requires the auditor to obtain ‘relevant and reliable audit
evidence sufficient to enable him to draw reasonable conclusions therefrom.

Required:

a. What is audit evidence?

b. Explain the meaning of the following terms;

• Relevant audit evidence

• Reliable audit evidence

c. Explain whether the following types of audit evidence meets the standards of relevancy,
reliability and sufficiency as required by the auditor’s operational standards regarding:

• Written confirmation of a trade debtor circularized at year end

• Work-in-progress stocks identified during the annual physical stock count

• Solicitor’s letter confirming pending legal action

QUESTION TWO

The external audit process for the audit of large entities generally involves two or more
recognizable stages. One stage involves understanding the business and risk assessment,
determining the response to assessed risk, testing of controls and a limited number of substantive
procedures.

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This stage is sometimes known as the interim audit. Another stage involves further tests of
controls and substantive procedures and audit finalization procedures. This stage is sometimes
known as the final audit.

Describe and explain the main audit procedures and processes that take place during the interim
and final audit of a large entity.

QUESTION THREE

Curdco is a company that runs a chain of fast-food restaurants. The company has a centralized
operating style and managers of individual restaurants have very limited decision-making powers
on day-to-day operational matters. The company’s centralized administration is responsible for
the buying of food, the payment of staff, the maintenance and cleaning of restaurants by staff
employed by a national agency, and all other matters relating to the running of the business. The
company has good internal controls over purchasing. Inventory counts are conducted at each
restaurant at the year-end. Your firm has recently been appointed as auditor to Curdco.

Required:

a. List the account headings you would expect to find in Curdco’s schedule of accounts payable
and accrued expenditure.

b. Describe and give reasons for the audit tests you would carry out to obtain audit

evidence for Curdco’s accounts payable and accrued expenditure.

c. Explain the difficulties faced by auditors, and the decisions that auditors have to make,

in conducting direct confirmations of accounts payable.

QUESTION FOUR

There are a number of different methods of obtaining audit evidence. Methods include:

• Analytical procedures.

• Audit sampling

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• Tests of controls.

• Detailed testing of transactions and balances.

• Computer assisted audit techniques (CAATs)

These methods overlap and may be used for different purposes during an audit of financial

statements.

Required:

a. Explain the advantages and disadvantages of each of the five methods of evidence gathering
listed above.

b. Describe the relationship between the five methods of evidence gathering described above.

QUESTION FIVE

(a) Explain the purpose of a management representation letter.

(b) A suggested format for the letter of representation has been sent by the auditors to the
directors of a client company. The directors have stated that they will not sign the letter of
representation this year on the grounds that they believe the additional evidence that it provides
is not required by the auditor.

Required:

Discuss the actions the auditor may take as a result of the decision made by the directors not to
sign the letter of representation.

AUDITORS REPORT

QUIZ

1. List the different types of Audit opinions.

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2. List the basic elements of the audit report.

3. List the factors that lead to the qualification of an audit Report

EXAM QUESTIONS

QUESTION ONE

Going concern concept is a fundamental assumption underlying the preparation of the financial
statements. What are the procedures you would perform to ensure that the going concern is
appropriate for you audit client.

QUESTION TWO

a) In respect of the going concern concept:

i. Define ‘going concern’ and state two situations in which it should NOT be applied in the
preparation of financial statements.

ii. Explain the directors’ responsibilities and the auditors’ responsibilities regarding financial
statements prepared on the going concern principle.

b) List the audit procedures that should be carried out to determine whether or not the going
concern basis is appropriate for Green Co.

QUESTION THREE

The Companies Act (Cap.486) sets out the duties of the auditors for a company in respect of his
report and other matters.

Required:

a. State four situations under which the Act requires auditors to qualify their report.

b. State two circumstances in which the auditors may qualify their report owing to inherent
uncertainty.

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c. State four types of circumstances in which the auditors may qualify their report as a result of
disagreement with the directors

QUESTION FOUR

An extract from the draft audit report produced by an audit junior is given below:

Basis of Opinion

‘We conducted our audit in accordance with Auditing Standards. An audit includes examination,
on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of all the estimates and judgments made by the directors in the
preparation of the financial statements, and of whether the accounting policies are appropriate to
the company’s circumstances, consistently applied and adequately disclosed.

‘We planned and performed our audit so as to obtain as much information and explanation as
possible given the time available for the audit. We confirm that the financial statements are free
from material misstatement, whether caused by fraud or other irregularity or error. The directors
however are wholly responsible for the accuracy of the financial statements and no liability for
errors can be accepted by the auditor. In forming our opinion, we also evaluated the overall
adequacy of the presentation of information in the company’s annual report.’

Required:

Identify and explain the errors in the above extract.

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