QUESTION 1:

Part A

When planning a financial statement audit, an audit manager must understand audit risk as well as its components. The firm of Jack and Jackie calculates the risk of material misstatement (RMM) by disaggregating RMM into its two components- control risk and inherent risk.

Required:

For every illustration select the component of audit risk that is most directly illustrated.

The components of audit risk may be utilized once more than once, or not at all.

Components of Audit Risk-

a. Control risk

b. Detection risk

c. Inherent risk                                        

Part B

Henry Clarke is auditing Atkison Hardware Company, a fast-growing retail hardware chain in the Ontario area. While Clarke has previously worked on this engagement, this is his first year as the audit manager. As he planned the engagement, Clarke identified a number of risk factors (such as strong interest in maintaining the company's earnings and stock price, unrealistic forecasts, and high dependence on debt financing for expansion) that indicated that fraud might exist.

Required:

How should Clarke respond to the possibility of fraud at the planning stage?

Part C

Required:

(i) Explain briefly what is meant by management assertions about financial statements.

(ii) Define audit risk.

(iii) For the following situation, explain how risk of material misstatement should be assessed and what effect the assessment will have on detection risk.

Wyatt Halliwell is a fast-growing trucking company. The company is publicly held, but Wyatt Halliwell and his sons control 55% of the shares. Mr Halliwell is chairman of the board and Chief Executive officer (CEO). He personally makes all major decisions with little consultation with the board of directors. Most of the directors, however, are either members of the Halliwell family or long-standing friends. The board basically rubberstamps Mr Halliwell's decisions.

Part D

(i) List the three main steps in applying materiality to an audit.

(ii) Mathews and Jackson is a manufacturer of small motors for lawnmowers and tractors. The components of its financial statements are:-

a. Net profit = Rs 21 million

b. Total assets = Rs 550 million

c. Total revenue = Rs 775 million

During the course of the audit Mathews and Jackson's audit firm detected two misstatements that aggregated to an overstatement of net profit of Rs 1.25 million.

Required:

Determine planning materiality and evaluate the audit findings.

QUESTION 2:

Part A

(i) Define the three broad objectives management has when designing an effective internal control system.

(ii) What is the relationship among the five components of internal control?

Part B

The Art Appreciation Society operates a museum for the benefit and enjoyment of the community. During hours when the museum is opened to the public, two clerks are positioned at the entrance to collect Rs 50 admission fee from each non-member patron. Members of the Art Appreciation Society are permitted to enter free of charge upon presentation of their membership cards. At the end of each day, one of the clerks delivers the proceeds (receipts) to the treasurer. The treasurer counts the cash in the presence of the clerk and places it in a safe. Each Friday afternoon, the treasurer and one of the clerks deliver all cash held in the safe to the bank and received an authenticated deposits slip which provides the basis for the weekly entry in the cash receipts journal.

The board of directors of the Art Appreciation Society has identified a need to improve its control procedures for cash admission fees. The board has determined the cost of installing turnstiles, sales booths or otherwise altering the physical layout of the museum will greatly exceed any benefits which may be derived. Nevertheless the board has agreed that the sale of admission tickets must be an integral part of its improvement efforts. The auditing firm "Black & White Company" has been asked by the board of directors of the Art Appreciation Society to review the internal control structure for cash admission fees and provide suggestions for improvement.

Required:

Indicate five weaknesses in the existing procedures for cash admission fees which Black & White should identify and recommend one improvement for each of the weaknesses identified.

Organize your answer as in the following illustrative example:-

QUESTION 3:

Part A

For each of the following specific audit procedures mentioned below, indicate the type of audit procedures it represents:

• Inspection of records or documents
• Inspection of tangible assets
• Observation
• Inquiry
• Confirmation
• Recalculation
• Re-performance
• Analytical procedures
• Scanning

Audit procedures:-

a. Sending a written request to the client's customers requesting that they report the amount owed to the client.

b. Examining large sales invoices for a period of two days before and after the year-end to determine if sales are recorded in the proper period.

c. Discussing the adequacy of the allowance for doubtful accounts with the credit manager.

d. Comparing the current year gross profit percentage with the gross profit percentage of the last four years.

e. Examining a new machine to ensure that this major acquisition was received.

f. Watching the client's warehouse personnel count the raw materials inventory. Reviewing the general ledger for unusual adjusting entries.

Part B

Evidence comes in various types and has different degrees of reliability. Following are certain statements that compare various types of evidence.

a. A bank confirmation versus observation of the segregation of duties between cash receipts and recording payment in the accounts receivable subsidiary ledger.

b. An auditor's recalculation of depreciation versus examination of raw material requisitions.

c. A bank statement included in the client's records versus shipping documents.

d. Physical inspection of share certificates held for investment versus physical examination of inventory components for a personal computer.

Required:

For each situation, indicate whether the first or second type of evidence is more reliable. Deliver a rationale for your choice.

QUESTION 4:

Part A

The most critical question for an organisation to answer is what function(s) to include in an Operational / performance review. Does it execute the review for all functions of the organisation or only for selected areas? One way to elect which functions to review is to determine how critical each function is to the overall organisational operation.

Required:

Identify and discuss five criteria for determining an organisation critical areas.

Part B

With respect to a main contract suggest ten audit checks to verify efficiency and effectiveness of the administration of the contract.