Advanced Auditing-p Ii - Nov 08

Advanced Auditing Time allowed-3 hours Total Marks-100 [N.B.- Questions must be answered in English. The figures in the margin indicate full marks. All workings are to be submitted. Examiner will take account of the quality of the language and of the ways in which the answers are presented. Different parts, if any, of the same question must be answered in one place in order of sequence. Answer all the questions.]

1. (a) “Computer systems give rise to such possibilities as a lack of visible evidence and systematic errors” – Explain each of the phrases ‘lack of visible evidence’ and ‘systematic errors’. (b) State briefly TWO computer-assisted audit techniques (CAATs) which the auditor can use in an enterprise’s audit. (c) State and explain FIVE factors which the auditor will need to take into account in choosing the appropriate combination of computer-assisted audit techniques and manual procedures. 2.

Marks 5

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ECM Motors deals in motor vehicles, sells spare parts, provides after-sales servicing and undertakes car body repairs. During the financial year to 30 June 2008, the company expanded its operations from one to three sites. Each site has a car showroom, service workshop and parts storage. In May 2008, management appointed an experienced chartered accountant to set up an internal audit department. New cars are imported every three months from one supplier. ECM pays the purchase price of the cars three months after taking delivery. ECM does not return unsold cars, although it has a legal right to do so. ECM offers ‘trade-ins’ (i.e. part exchange) on all sales of new and used cars. New car sales carry a three year manufacturer’s warranty and used cars carry a six month guarantee. Many used cars are sold for cash. An extensive range of spare parts is held for which perpetual inventory records are kept. Storekeepers carry out continuous checking. Mr. Reza, the sales executive, selects a car from each consignment to use for all his business and personal traveling until the next consignment is received. Such cars are sold at a discount as ex-demonstration models. Car servicing and body repairs are carried out in workshops by employed and sub-contracted service engineers. Most jobs are started and finished in a day and are invoiced immediately on completion. In may 2007 ECM purchased a brand name, ‘Uni-fit’, which is now applied to the parts which it supplies. Management has not amortized this intangible asset as it believes its useful life to be indefinite. Required: (a) Using the information provided, identify and explain the audit risks to be addressed when planning the final audit of ECM Motors for the year ending 30 June 2008. (b) Identify and briefly explain the principal matters to be addressed in ECM Motor’s instructions for the conduct of its physical inventory count as at 30 June 2008.

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[Please turn over]

2 (c) Describe the audit work to be carried out in respect of the useful life of the ‘Uni-fit’ brand name as at 30 June 2008.

Marks 6

3. You are the auditor of Dhaka limited, a trading company. The profits have been declining in recent years, but dividends paid have been maintained at a consistent level by drawing on the balance in the profit & loss account built up in previous years. The position for the last three years has been: Year to 30 June (In million Tk.)

Profit after tax Balance brought forward Dividend paid Balance carried forward

Yr. 2005 10 150 50 110

Yr. 2006 5 110 50 65

Yr. 2007 2 65 50 17

The projection for the year 2008 shows the following: i. ii.

Loss after taking into account tax refund Tk. 3,500,000 Profit on sale of property for Tk. 23,500,000

In addition, the company has the following capital reserves: a) Capital redemption reserve fund Tk. 5,000,000 b) Revaluation reserve (un-realized) Tk. 10,000,000 The Directors wish to pay another dividend of Tk. 50,000,000 drawing on the capital reserves, if necessary. Required: Draft a letter setting out briefly the principles that must be considered when determining whether profits are available for dividend, together with your comments on the directors’ proposal. 4.

You are the audit Manager in the audit firm of Karim & Co. One of your audit clients is Sportszone Co., a company specializing in the manufacture and supply of sporting equipment. Sportszone have been an audit client for five years and you have been audit manager for the past three years while the audit partner has remained unchanged. You are now planning the audit for the year ending 31 December 2007. Following an initial meeting with the directors of Sportszone, you have obtained the following information. (i) Sportszone is attempting to obtain a listing on a recognized stock exchange. The directors have established an audit committee, as required by corporate governance regulations, although no further action has been taken in this respect. Information on the listing is not yet in public knowledge. (ii) You have been asked to continue to prepare the company’s financial statements as in previous years. (iii) As the Company’s auditors, Sportszone would like you and the audit partner to attend an evening reception in a hotel, where Sportszone will present their listing arrangements to banks and existing major shareholders. (iv) Sportszone has indicated that the fee for taxation services rendered in the year to 31 December 2005 will be paid as soon as the taxation authorities have agreed

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3 Marks the company’s taxation liability. You have been advising Sportszone regarding the legality of certain items as ‘allowable’ for taxation purposes and the taxation authority is disputing these items. Finally, you have just inherited about 5% of Sportszone’s share capital as an inheritance on the death of a distant relative. Required: (a) Identify, and explain the relevance of, any factors which may threaten the independence of Karim & Co’s audit of Sportszone Co’s financial statements for the year ending 31 December 2007. Briefly explain how each threat should be managed. (b) Explain the actions that the board of Directors of Sportszone Co. must take in order to meet corporate governance requirements for the listing of Sportszone Co. (c) Explain why your audit firm will need to communicate with Sportszone Co’s audit committee for this and future audits. 5.

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You are the auditor of Anupam Ltd. The draft financial statements for the year ended 31 march 2008 show revenue Tk. 422 million (2007-Tk. 418 million). Profit before taxation of Tk. 18 million (2007-Tk. 22 million) and total assets of Tk. 307 million (2007-Tk. 234 million). You are currently reviewing two matters that have been left for your attention on Anupam’s audit working paper file for the year ended 31 March 2008. (i) Anupam’s management board decided to revalue properties for the year ended 31 March 2008 that had previously all been measured at depreciated cost. At the Balance sheet date three properties had been revalued by total of Tk. 17 million. Another nine properties have since been revalued by Tk. 54 million. The remaining three properties are expected to be revalued later in 2008. (ii) On 1 July 2007 Anupam introduced a 10 year warranty on all sales of its entire range of products. Sales for the year ended 31 March 2008 totalled Tk. 182 million. The notes to the financial statements disclose the following: “Since 1 July 2007, the company’s products are guaranteed to be free from defects in materials and workmanship under normal use within a 10 year guarantee period. No provision has been recognized as the amount of the obligation cannot be measured with sufficient reliability.” Required: Identify and comment on the implications of these matters for your auditor’s report on the financial statements of Anupam for the year ended 31 March 2008.

6.

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You are the auditor of Highrise, a limited company. The main activity of the company is the construction of buildings ranging in size from individual houses to large offices and blocks of flats. Under the laws Highrise must add VAT to all buildings sold and they pay tax to the government at the end of each month. The largest non-current asset on Highrise balance sheet is the plant and machinery used in the construction of buildings. Due to the variety of different assets used, four different subclasses of plant and machinery are recognized, each with its own rate of depreciation. You are now reaching the audit work for the year ended 30 September 2007. There are two specific matters where additional audit work is required: [Please turn over]

4 Marks (i) The VAT for the month of August was not paid to the government. This appears to have been an error and the amount involved is not material to the financial statements. (ii) The complicated method of calculating depreciation for plant and machinery appears to have resulted in depreciation being calculated incorrectly, with the result that depreciation may have been under provided in the financial statements.

Required: (a) Explain the additional audit procedures you should take regarding the accidental underpayment of VAT. (b) Explain the additional audit procedures you should take regarding the possible under-provision of depreciation. (c) You have determined that the under-provision is material to the financial statements and therefore need to modify the audit report. The directors have informed you that they do not intend to take any action regarding the under-provision of depreciation. They also disagree with your action and have threatened to remove your company as the auditors of Highrise unless you agree not to modify your report. Explain the procedures that the directors must follow in order to remove your company as the auditors of Highrise.

THE END

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