Ques.

202 LAPIS

(b)

Audit risk Auditor’s response

1) Good in transit Audit team should undertake the detail cut off
Raw materials are purchased from overseas recorded may accurately. Review sample
suppliers and the goods are usually in transit purchase of raw material shipping documents
for up to six weeks and responsibility for goods at the before and after the year end related to
in transit from the point of dispatch by the goods from overseas supplier and ensure that
supplier. the cut off is recorded accurate and complete.
At the year end, there is a risk of cut-off may
not be recorded accurately and inventory,
purchases and payable are understated in the
financial statements.
2) Reliance on Internal audit Before using the work perform by the internal
External audit team may rely on control testing audit department, the auditor should discuss
carried by the internal audit department. with internal audit staff and read the reports
and review the documents prepared related to
If audit team rely on work of internal audit control testing of factories of companies.
department there is risk of incorrect And additionally Auditor should reperform the
conclusion is given on financial statements due work of internal audit to ensure that work is
to lack of substantive testing and which accurate and complete.
increased detection risk.
3) No allowance for receivables Auditor should discuss with the directors,
A wholesale customer has recently informed reason of not recording of allowance for
that it is experiencing financial difficulties, and receivables in financial statements, and also
directors indicated that no allowance for check the integrity and competence of
receivables is made in financial statements. management.
And review the post year end bank
There is risk that trade receivable is overstated statements, that any amount is received
and allowance for receivable is understated in related to this receivables.
financial statements.
4) Warranty Provision Discuss with the management related in which
Lapis Co changed one of its television speaker basics director the warranty provision are
suppliers to a cheaper alternative and this has same as prior year.
resulted in an increase in warranty claims for Review the before and after year end warranty
television speaker. claims made and compare with the warranty
Finance director has confirmed the warranty provisions are made accurately.
provision same as the prior year this may
increase the risk of warranty provision are
understated.

5) Director Remuneration Auditor should discuss with the directors

The finance director has informed the audit about the reason do not disclose of the name
manager that only the amount of of directors and auditor should check the
remuneration payable to each director in the integrity of directors. Ensure that Local
financial statements and local legislation is not legislation is override IFRS and directors name
allowed to disclose only amount. and remuneration should be disclosed.

There is risk that director manipulate their

remuneration. And local legislation is allowed
to disclose the name and remuneration of
directors in financial statements.
6) Development expenditures Obtain the proper breakdown of capitalised
Lapis Co incurred cost of all $1.6m capitalised cost in research expenditures and
within intangible assets in relation to development expenditures in financial
developing a new smart television model. statement according to IAS 38 Intangible
assets.
All the expenditure are capitalised with
intangible assets due this there is risk that
research cost is including in intangible assets
and intangible assets are overstated in Balance
sheet and expenses are understated in
statement of profit and loss account.
7) Bank loan Reperform the proper split of bank loan in
Lapis co secured a $2.5m interest bearing bank non-current liabilities and current liabilities in
loan related to development of the new smart statements of financial position. And proper
television model. calculation of finance cost.
There is risk of split of bank loan in non-
current liabilities and current liabilities in the
statement of financial position and risk of
finance cost is understated in statement of
profit or loss.
8) Dividend Discuss with the management about dividend
The directors of Lapis Co are intending to is not disclosed in liabilities of financial
propose a final dividend once the financial statement, and review the financial statement
statements are finalised. to ensure that dividend is disclosed in
According to IAS 10 Reporting after the year disclosures of financial statement of 20X5.
end, dividend is an non adjusting events, so
dividend will not including in liabilities in
financial statement of 20x5.
Que 203 MAGPIE

(b)

Ratio 20X5 20X4

Operating profit margin 1.8% 4.6%
Payables payment period 64 days 81 days

(c)

Audit risk Auditor’s response

1) New Client Crow & Co should appoint experienced audit
Magpie Co is new client of Crown & Co and team who has prior experience about similar
audit team is unfamiliar of balances, type of industries. And proper time should be
transactions and accounting policies of Magpie given to the audit team to understand the
Co. Magpie Co.
There is risk that opening balance is not
accurate and due to this detection risk is
increased.
2) New sales system Auditor should test the system by some
During the year Magpie Co installed a new dummy transactions and ensure that all
sales system which record all sales and controls are run accurately.
receivables, but old and new system are not
run parallel.
There is risk of misstatement in transfer of
opening balance to new sales system.
3) Cash shortages Auditor should discuss with management in
An increasing number of cash shortages at relation increasing number of cash shortages
each store and differences have not been at each store. And extend the substantive
investigated or reconciled because of small procedures on cash system.
amounts.
There is risk of fraud appear in the cash system
due to not reconciliation or investigation of
cash system and individual small amount
become material when they are aggregated.
4) Receivables valuation Discuss with the finance director and credit
Company has increased corporate customers controller about likelihood of will payment
which are overdue for payment, and made and request them to increase the
receivable days increase from 101 days to 149 allowance for receivables.
days in 20x5.
There is risk that receivables are overstated
and allowance are understated in the financial
statements.
5) Supplier statement reconciliation Auditor should review post year purchase
The payables ledger clerk has carried out invoices and ensure that they are recorded
supplier statement reconciliations during the accurately and significant difference should be
year and supplier statements have shown a discuss with the management.
balance owing by the company which is higher
than the balance on the list of individual
supplier balances.
Payable payment days decreased from 81 days
to 64 days.
There is risk of cut off is incorrected and by
which trade receivable are understated.
6) Inventories Auditor should discuss with finance director
Inventories cost price of $0.1m is why inventories days are increasing and
contaminated and goods may not be able to ensure that the aged or obsolete inventories
be sold. In addition inventories holding period are written down at NRV.
is increased from 101 days to 149 days.
According to IAS 2 Inventories contaminated
plant should be recorded to lower of cost or
NRV and if the contamination can not be
remedied than the inventories should be
recorded at NRV, if not inventories will
overstate, and expenses are understated.
7) Profit margin Compare the cost of sales and operating
Company’s gross profit margin has increases expenses amount with the prior year and
from 44% to 50% in 20x5 and operating profit investigate any significant difference with
margin is decrease from 4.6% to 1.8% in 20X5. management.
There is cost may be incorrect classified cost of
sales are understated and operating expenses
are understated.

Que 204 ESK

(b)

Ratio 20X5 20X4

Gross profit margin 27.2% 27.6%
Inventory holding period 135 days 117 days
Receivables collection period 85 days 65 days
Payables payment period 39 days 64 days

(c)

Audit risk Auditor’s response

1) New client Auditor should make enquiries and discuss
Esk Co is new client for the auditor so, there is with the management to obtain understanding
lack of understanding of transactions, balances of the Esk co. And increase substantive
and accounting policies of Esk co. procedures of opening balance.
There is risk that opening balance is not
accurate and misguided the auditor.
2) Patent cost There is should be proper breakdown between
Esk Co purchased a patent for $2.6m and all capitalised cost accordance with IAS 38
cost is capitalised in intangible assets. Intangible assets.
There is risk of patent is not recorded
according to IAS 38 Intangible assets, due to
this intangible asset is overstated.
3) Bank Loan Auditor should discuss with the management
Interest‐bearing bank loan of $2.5m during the and ensure that split between non-current
year and the bank loan is payable in five equal liabilities and current liabilities in statement of
annual instalments. financial position. And ensure that
There is risk of split between non-current management calculate accurate finance cost
liabilities and current liabilities. Also omitted in and proper recorded in Statement of Profit or
finance cost and this lead to understatement loss.
of finance cost in statement of profit and loss
account.
4) Damaged Inventories Auditor should discuss with management
Inventories damaged by fire which costing related to increasing the inventories holding
$1.1m required to be fully written off. period and if there is any aged or remain
Inventories holding period is increased from damaged inventories in current assets that
117 days to 135 days. should be written off completely.
There is risk that damaged inventories is not
fully written off or there also have aged
inventories in financial statement which lead
to overstatement of inventories in financial
statement.
5) Insurance claim Auditor must discuss with directors, of what
Insurance claimed of $1.1m will be received basis they are recording the claim before claim
and have included this amount as other received and review the post year end bank
receivables within current assets. statement to ensure that any amount received
As the confirmation regarding claim has not related to claim.
been received from insurance company,
recognising the claim led to overstatement of
current assets in financial statement.
6) Sales staff bonus Auditor must be alert regarding before and
Esk Co's sales staff receive bonuses if they after year end purchase return and accuracy of
meet sales targets each quarter which is cut off.
available for whole year.
There is risk that receivables and revenue are
overstated due to fictitious sales.
7) Discount to Customers Auditor should discuss with the management
Esk co offers 10% trade discounts to customers of the what reason and what accounting
which is separately recorded in cost of sales, treatment they recording discounts in cost of
but discounts are recorded as revenue as prior sales.
year.

There is risk that revenue and cost of sales are

overstated in financial statement.
8) Credit control Auditor should discuss with the management
Esk Co's credit control department has been and ensure that aged receivables should be
off work since December 20X4 due to ill health written off.
and has been replaced by an inexperienced
temporary manager.
The receivable collection period is increases
from 65 days to 85 days, which indicates that
no effective collection of receivable happened.
There is risk that credit customers are not
going to pay which indicates overstatement of
receivables.

Que 205 PEACH

(a)

Audit risk Auditor’s response

1) New accounting system Auditor must ensure that the opening balance
The new accounting system was introduced in accurately and completely transferred to new
March 20X5 and post-implementation is not accounting system.
tested.
There is a risk of incorrect opening balances
from the old accounting system has been
transferred to the new accounting system. If
the new accounting system is not tested post
implementation there is a risk of misstatement
of financial statement.
2) New production process Auditor must ensure that development cost
Development of a new production process should be capitalised according to IAS 38
which will helps to reduced sugar by 50%. And Intangible assets.
this development total amount was capitalised
by $0.8m.
There is risk that development cost contains
revenue expenditure which is also capitalized
in intangible assets in financial statement,
which causes overstatement of current assets
and understatement of expenses.
3) Inventories valuation Auditor should discuss with management their
Peach Co has inventories of high sugar drinks belief of inventories sold to international
costing $227,000 which it can no longer sell in customer, agree the selling price and
its home market due to lack of demand. Peach likelihood of sale is made.
co incurred other cost.
There is risk that NRV is greater than cost of
inventories. Risk of overstatement of
Inventories in financial statements.
4) Staff costs The audit team should discuss with the
Significant staff costs involved in preparing the management about what accounting
site for the new machinery. These costs have treatment is applied to record PPE.
been included within the wages and salaries
expense for the period.
All cost incurred to take the machinery to
factory should be capitalised. But the wages
cost is not recorded according to IAS 16 PPE
which indicate the expenses are overstated
and assets are understated in financial
statement.
5) Fraudulent Purchase of NCA The audit team should discuss with the
Fraudulently purchasing non‐current assets for management regarding fraud and what
personal use by the finance team member. treatment is made and process of detecting of
Reconciling all physical assets to the fraud.
non‐current asset register but will not have
completed before year end.
There is risk that undetected fraud is still
present in financial statement which causes
overstatement of Non-current assets.
6) New supplier Audit team should review the term of contract
New supplier of bottles of 150,000 bottles per and payable terms in which payments are
month and no costs have been accounted for likelihood to paid.
to date as no amounts are payable for the first
six months.
There is risk that cost incurred to date is not
recorded and the understatement of liabilities
and cost, overstatement of profits.
7) Legal claim Auditor should discuss with lawyer of peach
Peach Co’s previous supplier has legal claim co. regarding likelihood of payment made to
against Peach Co for breach of contract, Peach old supplier and review the method of
Co’s lawyers have indicated that it is likely to calculation of legal claim.
lose the case and payable of $0.3m.
There is risk that management has not
prepared the provision for legal claim and this
indicates understatement of liabilities.

8) New bank loan Auditor should undertake review of loan

Peach co obtain interest bearing bank loan agreement and confirm the breakdown of loan
repayable over the next three year. is accurate in current and non-current
There is risk that loan is not accurately spilt liabilities.
between current and non current liabilities
due to which liabilities are misstated.

Que 207 HART

(b)

Audit Risk Auditor’s response

1) New client Auditor should appoint experienced audit
Hart Co. is new client of auditors and there is team and proper time should be given to the
lack of understanding with accounting policies, audit team to understand the client.
transactions and balance.
There is risk of undetected error in opening
balance.
2) Directors bonus Audit team should maintain professional
Directors are paid a bonus based on a scepticism and be alert to increased risk
percentage of profit before tax. manipulation on profit.
There is a risk that directors try to
overstatement of profit which lead to increase
the bonus paid to directors.
3) Revenue recognition Auditor should obtain the copy of the contract
Customers pay a 25% deposit on signing the with the customer and review the revenue is
contract, with the balance payable when recorded accurately and deferred income is
control of the playground is transferred to the completely recorded in the financial
customer. statements.
There is risk that revenue is recorded
immediately instead of deferred income,
Revenue may be overstated, and current
liabilities are understated.
4) Work in progress (WIP) Audit team must attend the inventory count
Audit team only attend 5 of the work in where the balance is material and ensure that
progress count out of 16 sites. inventory count is made by accurate
There is risk of increase detection risk due to procedures.
only attend 5 sites WIP count, there is risk of
fraud is present in other 11 sites.
5) Warranty provision Auditor should discuss with the finance
The warranty provision for the current year director at what reason they decrease the
has been calculated as 2% of revenue. In the warranty provision from 6% prior year to 2%
previous year the warranty was based on 6% this year.
of revenue.
There is risk that warranty provision are
understated, leading to understatement of
liabilities and expenses.
6) Research and development Audit team should discuss with management
Expenditure of $1.8m relating to the research of correct breakdown of research in expense
and development of which $0.6m of the to profit or loss and development cost
expenditure is recorded as expenses and capitalised to intangible assets to balance
remaining $1.2m has been capitalised as an sheet accordance with IAS 38 intangible
intangible asset. assets.
There is risk that research expenditure is
incurred in development cost, which leading to
overstatement of intangible assets and
understatement of expenses.
7) Right issue of shares The audit team should recalculate the split of
Hart Co made a rights issue to existing share capital and share premium and then
shareholders at a price of $0.75 for each $0.50 compare with the right issue a/c journal entry.
share.
The right issue share contain both share
capital and share premium, there is risk
incorrect spilt between share capital and share
premium which lead to misstate the financial
statement.
8) Director’s remuneration Discuss should be made with the directors to
Directors correctly disclosed their disclose the complete information of
remuneration details in the forecast financial remuneration and auditor must review the
statements in line with IFRS Standards but not details carefully.
with local legislation.
Local legislation is more reliable than IFRS, so
directors should follow it.
There is risk that directors remuneration is not
completely disclosed.

Que 208 SCARLET

(c)

Audit risk Auditor responses

 1) New client Auditor should appoint experienced audit staff
Scarlet Co is new client to audit firm and there and proper time allocated to understand the
is lack of understanding of accounting policies, Scarlet company.
transaction and balances of the scarlet co.
There is risk of undetected error in opening
balance.
2) Temporary financial accountant The auditor should discuss with management
Temporary financial accountant is recruited in related to experience and competence of
place of company’s financial accountant who is temporary financial accountant and increase
on leave. the substantial procedures on work of
There is risk that temporary financial temporary financial accountant.
accountant has lack of understanding about
company’s activities.
3) Preparation of financial statement Auditor should obtain professional scepticism
Quickly finalising financial statement by the throughout the course of audit and increase
end of September 20X5 and to obtain secure the substantive procedures related to
loan management wants the strong and good estimates.
financial statement report.
There is risk that management may
manipulate the financial statement in form of
overstatement of assets and profit and
understatement of liabilities.
4) Training cost Auditor should discuss with management of
The training costs of $15,000 have been right accounting treatment is made for training
capitalised as part of the cost cost according to IAS 16 Property plant and
of the asset. equipment.
Training cost is related to revenue
expenditures which is recorded in expenses on
profit or loss account.
There is risk of overstatement of assets and
understatement of expenses.
5) Receivables valuation The auditor should extend the post year end
Preliminary analytical review which indicates testing of bank statement in which any aged
that the receivables collection period has receivables receipts.
increased from 38 days to 52 days and taking
longer to pay than in previous years.
There is risk that allowance are understated
and aged receivables are overstated.

6) Redundant provision Auditor should recalculate the amount of

On 29 May 20X5, the directors announced that redundant provision and ensure that provision
brands is being discontinued and this resulted would be recorded according to IAS 37,
in four staff members being made redundant. Provision, contingent assets and liabilities.
The redundancy and they will be paid in the
July 20X5 payroll run.
According to the IAS 37 Provisions, contingent
assets and liabilities, provision for redundant
must be made. If provision is not made profit
would be overstated and liabilities are
understated.
7) Director’s bonuses Auditor should discuss with the management
The directors each received a significant bonus and ensure that directors’ bonuses are
in the year which has been included in the disclosed according to Local legislation.
statement of profit or loss, but Local
legislation requires separate disclosure of
directors’ bonuses in the financial statements.
There is no complete disclosures of directors’
payroll and directors’ bonuses should be
disclosed in payroll charges in the statement of
profit or loss. But according to local legislation
it should be disclosed in separate disclosure in
financial statement.
8) Sales return Auditor should obtain the copy of credit note
A customer for $120,000 at the beginning of to make sure that revenue and receivables are
May 20X5, the customer returned faulty goods adjusted accurately and completely.
and credit note is yet to be issued.
If the credit notes is not issued before the year
end there is risk that revenue and receivables
are overstated.

Que 209 HARLEM

(a)

Ratios 20X5 20X4

Gross profit margin 19.4% 21%
Inventory holding period 41 days 34 days
Gearing 130% 116%
Interest cover 2.6 4.4

(b)

Audit risk Auditor’s response

1) Patents Auditor should discuss with the management
Purchased a patent on 30 September 20X4 for about the amortisation calculation and audit
$800,000 and its useful life is 4 years, which team ensure that amortization is calculate
was capitalised in the prior year as an accurately and completely recorded in
intangible asset. financial statement.
There is risk that amortisation is not charge
according to IAS 38 Intangible assets. And
overstatement of intangible assets and
understatement of expenses in profit or loss.
2) Fraudulent transaction Audit team should follow the professional
Financial controller had carried out a number scepticism and alert to risk of further frauds
of fraudulent transactions against the may happened.
company and company started to investigate
the extent of the fraud.
There is risk that financial controller carried
out material transaction frauds which leading
to misstatement of financial statement.
3) Plant and Machinery Auditor should recalculate the disposal of
Surplus items of plant and machinery were $160000 and compare with the suitable
sold, resulting in a loss on disposal of documentations.
$160,000.
Profit or loss on disposal indicates that
depreciation is not calculated correctly,
therefore depreciation is understated and
profit and assets are overstatement.
4) Faulty Goods Auditor should discuss with the management
A significant batch of tyres, which and ensure that Inventories is calculated o the
affected their quality. The issue was identified basis of lower of cost and NRV value according
prior to any goods being despatched. to IAS 2 Inventories.
There is risk that inventory is not written off
completely which lead to overstatement of
inventories in financial statement.

5) Dismissal claim Auditor should discuss with management and

The financial controller has threatened to sue request confirmation from Harlem companies
the company for unfair dismissal and disputes lawyer of likelihood of payment is being made.
the allegations.
According to IAS 37 Provision, Contingent
assets and Contingent liabilities, if probable
that company is will make payment to the
financial controller, a provision for claim is
made and if provision is not made than
liabilities are understated.

6) Increasing the receivables days Auditor should discuss with finance directors
The audit assistant has ascertained that the and review the controls by which irrecoverable
trade receivables collection period has and aged receivable identified.
increased from 38 to 51 days in this year.
There is a risk that aged receivables are not
written off and which lead to overstate the
receivables in the assets.
7) Deficiencies in Purchase cycle Auditor should increase the substantive
The report to management issued by Brooklyn procedure towards payables and purchase
& Co of prior year’s audit highlighted system.
significant deficiencies relating to Harlem Co’s
purchases cycle.
If deficiencies in purchase cycle is not rectified
than its causes to weaker of purchase and
payable system.
8) Bonus issue Auditor should ensure that bonus share issues
Harlem Co has not paid its shareholders a are recorded in shares register and adjustment
dividend this year and choosing instead to should be made in reserves.
undertake a bonus issue of its $0.50 equity
shares.
There is risk that bonus shares are not
accurately and completely recorded in
financial statement and may be treated as
share capital which overstated the share
capital.

Que 210 PEONY

(b)

Audit risk Auditor’s response

1) Reliance on Internal audit Auditor should review the reports and work
The audit manager has discussed with the prepared by the internal audit department
finance director that the external audit team related to control testing of stores.
may rely on the controls testing which is
undertaken by IA.
There is a risk that Internal audit work is not
accurate and if external audit is rely on
inappropriate work than there is high chances
of incorrect conclusion is given on financial
statement.
2) Misclassification of expenses Auditor should review the split of expenses
The gross profit margin is expected to increase between in cost of sales and operating
from 56% to 60% and the operating profit expenses and compare with the prior year.
margin is predicted to decrease from 21% to
18%.
There is risk of misclassification of expenses,
mean operating expenses are recorded in cost
of sales in profit or loss account. By which
operating expenses are understated, and cost
of sales are overstated.
3) Inventory valuation Auditor should discuss this issue with the
Peony Co values inventory in line which is to management and ensure that Net realisable
use selling price less average profit margin. value and cost should be used to valued the
The directors consider this to be a close inventory line.
approximation to cost.
Inventories should be valued at lower of cost
and Net realisable value (NRV) according to,
IAS 2 Inventories. If not than there is risk of
over or under statement of inventories.
4) Perpetual inventory counts Auditor should review the perpetual inventory
The company does not undertake a full timetable and ensure that count is conducted
year‐end inventory count and instead accurately with proper safeguards.
undertakes monthly perpetual inventory
counts, each of which covers one‐twelfth.
There is risk in perpetual inventory counts in
which some significant inventories is missing
from inventory count due to many breaks in
between counts.
5) Exception in Inventory counts Auditor should discuss as soon as possible
During the interim audit significant inventory with management regarding the exceptions in
count there were many exceptions where in inventory count and auditor should request
inventory records shows higher quantity than with the directors to conduct year end
physical inventory. inventory count.
There is fraud in inventory count which show
the overstated inventory.
6) Obsolete non-current assets The audit team should review depreciation
A few assets which had not been fully policies and recalculate sample of depreciation
depreciated were identified as obsolete by this of non-current assets and if any significant
review. difference must discuss with the management.
There is risk that depreciation policy are not
appropriate. And depreciation may be
understated, and assets are overstated.
7) Bank Loan Audit team should reperform the spilt of loan
The company obtained a $3m bank loan. This in current and non-current liabilities.
is repayable in arrears over five years in
quarterly instalments.
There may risk that bank loan is not
breakdown accurately in current and non-
current liabilities which indicates
misstatement in liabilities and in finance cost.
8) Redundant Auditor should ensure that provision is made
Company is planning to make approximately accurately and reperform the amount of
60 employees redundant after the year end, provision which is made for redundant.
but no decision has been made at year end.
Provision for redundant most made correctly,
according to IAS 37 Provisions, Contingent
assets and Contingent liabilities.
If provision is not made, than provision in
liabilities are understated.

Que 212 BLACKBERRY

(b)

Audit risk Auditor’s response

1) Purchase a patent Auditor should discuss with the management
Blackberry Co paid $1.1m to purchase a patent and request to correct treatment of patents in
which is for three years to customise their financial statements.
portable music players to gain a
competitive advantage in their industry. The
$1.1m has been expensed in statement of
profit or loss.
According to IAS 38 Intangible assets, patent
should be capitalised under the current assets
and amortisation is expenses to P&L account.
There is risk of understatement of profit.
2) Issue shares Auditor should confirm that $1.2m are
Blackberry Co raised $1.2m through issuing properly spilt between share capital and share
shares at a premium. premium and recorded accurately.
There should be proper and separate of share
capital and share primum in equity share.
If not, then share capital and share premium
are misstated in financial statement.
3) Fraud Auditor should maintain their professional
It was discovered that a significant teeming scepticism and be alert to the risk of further
and lading fraud had been carried out by four frauds and errors.
members of the receivables ledger
department who had colluded.
There is chance that many fraud may present
in the financial statements which is not been
detected yet.
And if they are not identified than financial
statement are misstated.
4) Outsourcing of receivables Audit should review the competence and
Blackberry Co decided to outsource its objectivity of the external services
receivables ledger processing to an external organisation and review the reports and
service organisation. procedures carefully which provided by
As receivables are outsource it may increase external service organisation.
the detection risk. There is a risk of
misstatement in receivables and sales ledger.
5) Financial accountant dismissal claim Auditor should discuss this matter with the
The financial accountant has threatened to sue management and request the confirmation
the company for unfair dismissal. from company’s lawyers.
According to IAS 37, Provision, Contingent
assets and Contingent liabilities, provision for
unfair dismissal should be made.
If provision is not made than there is a risk of
understatement of provision in liabilities.
6) No supplier’s reconciliations Auditor should request to management for
For this period no supplier statement completely and accurately reconciliation of
reconciliations or trade payables account supplier’s statement and trade payables
reconciliations will be performed. account at the year end.
No reconciliation of supplier’s and payables
account is made at year end, which leading to
over and under statement of payables.
7) Data transfer Auditor should discuss with the management
Blackberry Co ran its own receivables ledger about the process of transferring the data
processing and transferred to the service process and ensure that data is secure and
organisation. completely transfer to the service
There may risk of error in transferring the data organisation.
which cause the receivables and sales are over
or under stated.
8) Year-end inventory count Auditor should attend the inventory count and
The company plans to conduct full inventory ensure that all adjusting events related to
counts and any necessary adjustments and the inventory must be adjust correctly and
internal audit team will attend the counts. completely.
There is risk that adjustment is not completely
and accurately recorded and due to which
inventory shows over or understatement in
financial statement.
Que 213 PRANCER CONSTRUCTION

(c)

Audit Risk Auditor’s response

1) New client Audit firm should appoint experience staff for
Prancer Construction Co is a new client for audit and provide enough time to understand
Cupid & Co. the Prancer Construction Co.
Audit team has lack of understanding in
accounting policies, transactions and balance
of the Prancer Construction Co.
There is increased detection risk in audit.
2) Work in progress Auditor should discuss with the management
Prancer Construction Co, has material amount regarding the process of completion
of work in progress which comprised calculation of Work in Progress.
property construction in progress as well as
ongoing maintenance services for finished
properties.
The level of work in progress must be assessed
during the year end. If there is an error in work
in progress completion calculation this lead to
over or understatement of inventory.
3) Inventory count Audit team should attend those sites for the
A full year‐end inventory count will be inventory count which has material balance
undertaken at all of the 11 building sites and significant risk of misstatement.
where construction is in progress.
It is not possible for the audit team to
undertake the inventory count of all sites at
same date, and this will increase the risk of
insufficient of audit evidence and this increase
the detection risk.
4) Increased inventory Auditor should discuss with the management
The latest management accounts recognise regarding the aged inventories report and
$2.1m inventory of completed properties whether there is any need of write off.
compared to a balance of $1.4m in September
20X4.
There is risk that Prancer construction co is
struggling in selling the properties. This may
indicate overstatement of inventory.
5) Warranty provision Auditor should discuss with the management
The finance director anticipates this provision regarding the process of calculation warranty
will be lower than last year as the company provision and review that any provision is
has improved its building practices and claim post year end.
therefore the quality of the finished
properties.
Warranty claim is uncertain and there is risk of
understatement of Warranty provision.
6) Non-refundable deposit Auditor team should discuss with the
Customers who wish to purchase a property management regarding the recording advance
are required to place an order and pay a 5% deposit.
non-refundable deposit prior to the
completion of the building.
There is risk that non-refundable deposit is
recognised as revenue which indicates
overstatement of revenue and
understatement of liabilities.
7) Understated payable balance Audit team should increase the testing of
The payables period was 56 days for June payable balance at the year end and ensure
20X5, compared to 87 days for September that payables are complete and accurate.
20X4. The finance director anticipates that the
September 20X5 payables days will be even
lower than those in June 20X5.
There is risk of understatement of payables at
the year end.

Que 214 HURLING

(b)

Audit risk Auditor’s response

1) Upgradation of Website Auditor should review the breakdown of
The website was upgraded during the year at a upgradation cost in expenses recognised in
cost of $1.1 million. Profit or loss statement and capitalised
The cost incurred should be proper recorded expenditure in assets.
as expenses recognised in profit or loss
account and asset expenditure should be
capitalised in intangible assets. This lead to
increase the risk of completeness and
accuracy.
2) Warehouse acquisition Audit team should discuss with management
The company has recently entered into a that warehouse is acquired by the year end
transaction to purchase a new warehouse and review the title deep if acquired.
which will cost $3.2 million. Hurling Co’s legal
advisers are working to ensure that the legal
process will be completed by the year end.
According to IAS 16 Property plant and
equipment only physical exist assets should be
recorded in assets.
There is risk that assets is not acquired at year
end and recorded as acquired. This lead to
indicate overstatement of assets.
3) Irredeemable preference shares Auditor should ensure that irredeemable
The company issued $5 million of preference share are classified as equity rather
irredeemable preference shares to finance the than non-current assets.
warehouse purchase.
Irredeemable shares should be recorded in
Equity rather than non-current liabilities.
There is risk of overstatement of non-current
liabilities and understatement of equity.
4) Increase the assets life Auditor should discuss with the management
During the year the finance director has about the reason and procedures of increasing
increased the useful economic lives of fixtures the useful lives.
and fittings from three to four years as it was
considered to be a more appropriate period.
According to the IAS 16 Property, Plant and
Equipment, if the assets life is genuinely
increase than it is reasonable.
There is risk that reduction in depreciation has
intention to increase the profit and which lead
to overstatement of assets and profit.
5) Receivable valuation Auditor should review after the credit term
The finance director revised credit period has date any cash receipts from customer.
been agreed with one of its wholesale
customers, as they have been experiencing
difficulties with repaying the balance of $1.2
million owing to Hurling Co.
As customer is facing difficulties there is risk of
receivable balance is irrecoverable. This
indicates overstatement of receivables.
6) Bonus on sales target Increase the testing of after the date of cash
New bonus based on sales targets for its sales receipts and purchase returns.
staff, and this has resulted in a significant
number of new wholesale customer accounts
being opened by sales staff. As a result,
revenue has increased by 5% on the prior year.
There is risk of sales staff opening new
customers account without reviewing credit
terms and taking orders from them and this
indicates increasing irrecoverable receivables.
7) Audit timetable Audit team should follow professional
The finance director has asked auditor to scepticism and be alert of risk of error
complete the audit early than normal and occurring.
reported could be early.
There is increased detection risk and less time
to obtain sufficient appropriate audit
evidence.
8) Proposed Dividend Audit team should discuss with the
The company is intending to propose a final management related to dividend is not
dividend once the financial statements are included in 20X5 financial statement.
finalised.
Dividend should not be disclosed in 20X5
financial statement, due to obligation only
arises when dividend announce. If dividend is
included, this will indicates overstatement of
liabilities and understatement of equity.

Que 215 CENTIPEDE

(b)

Ratio 20X5 20X4

Gross profit margin 37.2% 33.8%
Inventory holding period 54 days 47 days
Payables payment period 81 days 73 days
Current ratio 0.97 1.26

(c)

Audit risk Auditor’s response

1) New client Audit firm should appoint more experienced
Centipede Co is new client for audit team and audit team members and provide enough time
there is lake of understanding of accounting to understand the Centipede Co.
policies, transactions and balance. There is a
risk of increase in detection risk.
2) Perpetual inventory counts Auditor should review the completeness of
Rather than undertaking a full year‐end perpetual inventory count and ensure that it is
inventory count, the company undertakes accurate.
monthly perpetual inventory counts.
All inventory must be count at least once a
year and perpetual inventory counts help to
cover all inventory count in a year.
But there is a risk if perpetual inventory count
is not complete, this causes over or
understatement of inventory.
3) Exceptions in inventory Discuss with the management as soon as
During the interim audit, there were a large possible and request for full year-end
number of exceptions where the inventory inventory count.
records were higher than the physical
inventory in the warehouse.
There is risk of missing inventory and this
indicates overstatement of inventory.
4) Inventory valuation Audit team should review the aged inventories
During the interim audit, the audit assistant report and discuss with management
noted that there were some lines of inventory regarding write off of aged inventories.
which, according to the records, were at least
90 days old.
And increasing inventory holding period from
47 days to 54 days this year.
This shows that aged inventory is increasing
and there is a risk of aged or obsolete
inventories are not written off which causes
overstatement of inventories.
5) Four sites are not visited Auditor should discuss with management
There are four additional sites where some regarding materiality of accounting records
accounting records are maintained, and these and should visit remaining sites during final
sites were not visited during the interim audit. audit and review the records.
The records for these sites are incorporated
monthly through an interface to the general
ledger.
There is increasing detection risk if audit team
does not visit those sites, and there is risk of
incomplete accounting reports.
6) Disposal of building Auditor should ensure that building is
The building was only sold in 20X5 at a loss of removed from non-current assets register.
$825,000.
There is a risk that disposal of building is not
remove from accounting records, which causes
assets are overstated.
7) Legal action Auditor should discuss with Centipede Co
The company has consistently failed to deliver lawyer’s regarding likelihood of payment to
goods on time, hence it has commenced legal customer.
action against Centipede Co for a loss of
profits claim.
There is risk that provision or contingent
liabilities is not made which causes
understatement of liabilities.
 8) Director’s remuneration disclosure Auditor should discuss with the directors to
The directors have not disclosed their ensure that local legislation has followed and
disclosed their name and payment in financial detailed is accurately and completely
statement. disclosed.
Local legislation required to disclosure of
names and payments of the directors. And
local legislation overrides IFRS, hence director
details are not disclosed accurately and
completely which cause misstatement of
financial statement.

Que 216 AQUAMARINE

(b)

Audit risk Auditor’s response

1) Work in progress Auditor should discuss with the management
The company undertakes continuous regarding cutoff of work in progress and
production in its factory, therefore at the year- ensure that cutoff is recorded accurately.
end it is anticipated that work‐in‐progress
(WIP) will be approximately $950,000.
There is risk of incorrect cutoff is calculated,
and inventory may over or understatement.
2) New Plant and machinery Auditor should ensure that only those assets
Aquamarine Co placed an order in April for are recorded as assets which are available to
$720,000 of new plant and machinery and one use and physical verify the assets.
third of this order was received in May with
the remainder expected to be delivered by late
July or early August.
If PPE are not delivered yet should not be
capitalised in assets and this causes
overstatement of assets. It only recorded
when assets are available to use.
3) Patent purchase Auditor should ensure that amortisation is
Patent recognised at a cost of $1.3 million accurately recorded and also review the live of
which was purchased at the beginning of the patent is accurate as five years.
year.
There is a risk that directors have not record
patent accurately and also no amortisation is
calculated which overstated of assets and
profit.
4) New Bank loan Auditor team should review the split of bank
In order to finance this purchase patent, loan between current and non-current
Aquamarine Co borrowed $1.2 million from liabilities is accurate and complete.
the bank which is repayable over five years.
There is a risk that bank loan is not split
accurately between current and non-current
liabilities.
5) Revaluation of land and building Discuss with management and ensure that
The company has a policy of revaluing land entire class of assets has been revalued and
and buildings, and the finance director has review related documents.
announced that all land and buildings will be
revalued at the year end.
According to IAS 16 Property, Plant and
Equipment non-current assets should be
revalued entire class of assets.
Non-current assets may be incorrectly valued.
6) Receivables valuation Auditor should review the aged receivable or
Receivables have increased significantly on the irrecoverable receivable should be write off
previous year end and against May 20X4. and ensure that provision should be made
There is a risk that aged receivables are not regarding irrecoverable receivables.
written off, and receivables are overstated.

Que 217 VENUS

(d)

Audit risk Auditor’s response

1) Assets life Audit team should discuss with the director of
During the year, the directors reviewed the what reason and procedure of which assets
useful lives and depreciation rates this life is increased and reduction in depreciation.
resulted in an overall increase in the asset lives
and a reduction in the depreciation charge for
the year.
There is a risk that director manipulate the
useful life of assets to achieve more profit and
this indicated overstatement of assets and
profit.
2) Inventory count Audit team should increase the cutoff testing
Due to a lack of available staff on 30 and ensure that inventories is accurately and
September, a full inventory count will completely recorded.
be held with adjustments for movements to
the year end. Inventories is not accurate and
complete.
There is a risk of over or understatement of
inventories.
 3) Fire damage of warehouse Audit team should ensure that damaged goods
In June, there was a fire in one of the are removed from inventories and also $0.2m
warehouses. Inventory of $0.9 million was scrap value is accurate.
damaged and this has been written down to
its scrap value of $0.2 million.
Damaged inventory is still recorded in
inventories and scrap value is overstated.
There is a risk that inventories are overstated.
4) Insurance claim Discuss with management regarding any
An insurance claim has been submitted for the information from insurance company about
difference of $0.7 million. insurance claim and review the post year bank
According to IAS 37 Provision, Contingent statement of any amount is received regarding
assets and Contingent liabilities, any balance insurance claim.
should not be recorded until it received.
There is risk of overstatement assets and
profit.

5) Unreconciled bank statement Audit team should be alert of any fraud occurs
The May and June bank reconciliations each in Bank balance and maintain professional
contained unreconciled differences, and it was scepticism.
considered that the overall differences
involved were immaterial.
If there is no reconciliation of bank statement,
it could be over or understatement of Bank
statement.
6) Director’s bonus scheme During the audit, audit team need to be alert
A directors’ bonus scheme was introduced of any fraud occurs and maintain professional
during the year which is based on achieving a scepticism.
target profit before tax.
There is risk that director’s may overstated
profit to achieving bonus intensives and this
causes misstatement in financial statement.

Que 218 SYCAMORE

(b)

Audit risk Auditor’s response

1) Profit on disposal Audit team should recalculate profit on
During the year, a review of plant and disposal and agree with supportive
equipment in the factory was undertaken and documents.
surplus plant was sold, resulting in a profit on
disposal of $210,000.
There is risk that profit on disposal is not
calculate correctly which causes
overstatement of profit.
2) Fraudulent expenses Audit team should be alert of any further
It was discovered that following discovery that frauds or errors occurs and maintain
fraudulent expenses had been claimed from professional scepticism.
the company for a significant period of time.
There is a risk that finance director may
conduct many more frauds and they are not
detected yet. This will misstated financial
statement.
3) Competence of new finance director Audit team should review the work of finance
A new finance director was appointed in director and ensure that any changes is made
January 20X5 who was previously a financial is proper.
controller of a bank.
Sycamore co is a pharmaceutical company and
new finance director has not experience about
these types of company.
There is risk of competence of new finance
directors.
4) Development cost Audit team should review the breakdown of
During the year Sycamore has spent $1.8 development cost between in, completed
million on developing several new products work is capitalised in intangible assets and
and these projects are at different stages of remain is recorded as expense in statement of
development and full amount of $1.8m is profit or loss.
capitalised in intangible assets.
According to IAS 38 Intangible assets, assets
should be capitalised when it completed and
remaining will be recorded as expenses.
There is a risk of overstatement of intangible
assets.
5) New Bank loan Audit team should discuss with the
In order to fund this development, $2.0 million management and ensure that new bank loan is
was borrowed from the bank and is due for accurately split between current and non-
repayment over a ten‐year period. current liabilities.
There is a risk of incorrect split between in
current liabilities and non-current liabilities.
This causes overstatement of profit and
understatement of finance cost.
6) Sales return Audit team should review sales return was
Since the year end there has been an accurately recorded and ensure that revenue
increased number of sales returns and that in and inventory are revised.
the month of May over $0.5 million of
goods sold in April were returned.
There is a risk if sales return is not correctly
recorded, then revenue is overstated, and
inventory is understated.
7) Bank loan covenants Audit team should be alert of any frauds and
The bank loan is due for repayment over a errors occurs in profit and maintain
ten‐year period and the bank has attached professional scepticism.
minimum profit targets as part of the loan
covenants.
There is a risk that directors overstated profit
to meet the loan covenants.
8) Outsource of payroll function Audit team should review the service
Sycamore decided to outsource its payroll organisation payroll report and ensure that
function to an external service organisation. they are accurate and complete.
There is increasing detection risk due to
unable to obtain sufficient appropriate audit
evidence related to the payroll. This cause to
misstatement in payroll records.

Que 219 RECORDER COMMUNICATION

(b)

Audit risk Auditor’s response

1) New client Audit firm should appoint more experienced
Recorder Communication Co is a new client for audit team members and provide enough time
audit team and there is lake of understanding to understand new client.
of accounting policies, transaction and balance
in Recorder Communication Co. And there is
risk of increased detection risk.
2) Perpetual inventory counts Auditor should review the Completeness of
Recorder does not undertake a year-end perpetual inventory count.
inventory count but carries out monthly
continuous perpetual inventory counts.
Inventory could be over or understated if
perpetual inventory is not complete.
3) Inventory valuation Auditor should reperform the inventory
The old models have to be sold at a significant valuation and ensure that they are accurately
discount to customers and Recorder has recorded as lower of cost or NRV.
a number of older models in inventory.
Inventories are overstated if inventories not
recorded according to lower of cost or NRV
value.
 4) Bonus based sales Audit should increase cutoff testing and review
During the year the company introduced a post year-end cancelled contract.
bonus based on sales for its salespersons.
There is a risk that salespersons fraudulent
create customer account and this indicated
overstatement of receivables and revenue.
5) Receivables valuation Audit team discuss with the management and
The level of receivables is considerably higher request to make allowance for irrecoverable or
than last year and there are concerns about aged receivables.
the creditworthiness of some customers.
There is risk of increasing irrecoverable
receivables and this indicates overstatement
of receivables.
6) Revaluation of property Auditor should discuss with directors related
Recorder has a policy of revaluing its land and to revaluation procedures and ensure that
buildings and this year has updated the entire class of assets should be revalued.
valuations of all land and buildings.
There is risk of understatement of non-current
assets, if revaluation is not completed this
year.
7) Director’s Bonus remuneration Auditor should ensure that the directors bonus
During the year the directors have each been remuneration is disclosed according local
paid a significant bonus, and they have legislation in financial statement.
included this within wages and salaries.
Separate disclosure of the bonus is required by
local legislation.
There is risk that directors have not been
disclosed bonus incentives in separate
disclosure and by this financial statement are
misstated.