Advanced Auditing-part 2

Advanced Auditing Time allowed-3hours Maximum marks-100 [N.B. – Questions must be answered in English. Figures in the margin indicate full marks. All workings are to be submitted. Examiner will take account of the quality of language and of the manner in which the answers are presented. Questions in each section as well as different parts, if any, of the same question must be answered in one place in order of sequence.] 1. (a)

Schedule C to the bye-law 134 of The Bangladesh Chartered Accountants Bye-laws 2004, provides that a chartered accountant in practice shall be guilty of professional misconduct if, among other things, he (I) accepts a position as auditor previously held by another Chartered Accountant without first communicating with him in writing; (II) accepts an appointment as auditor of a company without first ascertaining from it whether the requirements of section 211 of the Company Act, 1994 in respect of such appointment have been duly complied with; (III) accepts a position as auditor previously held by some other accountants in such conditions as to constitute under-cutting. Required (in the above sequence): (i)

explain the word ‘Communicating’ in the context of ICAB Council’s Statement of the explanation of the word ‘Communicating’ and state the procedures of communication issued by the Council in the form of directives. (ii) discuss the provisions of the Companies Act 1994 as to resolutions for appointing and removing auditors. (iii) explain the scope of this provision stating also the exceptions, if any.

(b) Ferdous Fashion Ltd. runs four private colleges in the Dhaka metropolitan area which provide education and training for the people in the fashion industry. Its two-year course includes training in design, textiles, manufacture and retail of fashion garments. You are conducting the interim audit for the year ended 30 June 2007. The property, plant and equipment of each college is recorded in an asset register which is maintained at each college location by each college manager. The system operates as described below: • • • • •

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In order to obtain new assets, a purchase requisition form is completed and approved by the manager at each college. The requisition is sent to head office, where the purchasing officer checks the requisition for approval and completes a purchase order for the new asset. Assets costing more than Tk. 5,000 are approved by the financial accountant. All assets over Tk 20,000 require board approval The purchase order is then sent to the supplier and a copy is sent to the central store at the head office location. The asset is received by the central store where the receiving clerk checks that all the asset details agree with those on the goods received note and the copy of the purchase order. The receiving clerk will then issue the asset with its computer generated sequential barcode number. This barcode is fixed to the asset and written on the goods received note and the supplier invoice. The relevant college manager inputs the new asset details into the asset register using a copy of the purchase order, the original requisition and the asset’s barcode. For disposal or write-off of an asset disposal write-off form is completed by the relevant college manager, signed and sent to head office. Disposals and write-offs are approved by the financial accountant. A copy of the form is filed at head office and the approved original returned to the college manager for action. The college manager will then update the fixed asset register for the subsequent disposal. The asset register is maintained on FAST, a tailored fixed assets computer system and reconciled to the general ledger by each college manager monthly. The FAST system calculates depreciation automatically each month using the rate input by the college manager at the time the asset was added to the register. [Please turn over]

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2 Required: (a) Identify five internal control strengths on which you would rely for your audit. (b) Design tests of control to evaluate the effectiveness of each of the controls identified. 2.

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Ahmed Kabir & Co. an audit firm, has seven partners. The firm has a number of audit clients in different industrial sectors, with a wide range of fee income. An audit partner of Ahmed Kabir & Co. has just delegated to you the planning work for the audit of Sruti Co. This company provides a range of mobile communication facilities and this will be the second year your firm has provided audit service. You have just met with the financial controller of Sruti prior to agreeing the engagement letter for this year. The controller has informed you that Sruti has continued to grow quickly, with financial accounting systems changing rapidly and appropriate control systems being difficult to maintain. Additional services in terms of review and implementation of control systems have been requested. An internal audit department has recently been established and the controller wants you to ensure that external audit work is limited by using this department. You have also learnt that Sruti is to market a new type of mobile telephone, which is able to intercept message from law enforcement agencies. The legal status of this telephone is unclear at present and development is not being publicised. The granting of the licence to market the mobile telephone is dependent on the financial stability of Sruti. The financial controller has indicated that Ahmed Kabir & Co. may be asked to provide a report to the mobile telephone licensing authority regarding Sruti’s cash flow forecast for the year ending December 2008 to support the license application. Required: (a) As part of your risk assessment procedures for the audit of Sruti Co. for the year ending 31 December 2007, identify and describe the issues to be considered when providing services to this client. 9 (b) When reporting on a cash flow forecast, explain the term ‘negative assurance’ and why this is used. 4

3. (a) On the audit of Meghna Gardens Ltd. the audit partner on the engagement set the preliminary level of audit materiality at Tk. 10,00,000. After the partner reviewed the audit senior’s assessment of inherent risk, he decided that the materiality level should be increased to Tk 15,00,000. Required: (i) What is the relationship between materiality and audit risk. 5 (ii) How will this new level of materiality affect the nature and extent of auditing procedures. 3 (b) You are the audit senior on Bangla Cola (BC) Ltd., a manufacturer of soft drinks. An extract from the draft financial report is set out below: Current assets Cash Receivables Inventory Non-current assets Property, plant and equipment Goodwill Total assets Current liabilities Creditors and borrowings Provisions Non-Current liabilities Creditors and borrowings Provisions

Tk 000 100 750 520 1520 200

Tk 000 1370 1720 3090

910 250

1160

700 310

1010 [Please turn over]

3 Total liabilities Net assets Profit before tax

2170 920 500

Other information: • •

The managers of the firm receive a bonus if profit for the final year exceeds Tk 400,000. The company has recently acquired a subsidiary, Orange Fresh Ltd. with whom it traded during the year. BC also borrowed some funds from Orange Fresh.

Required: (i) (ii)

Based on the quantitative information, calculate a preliminary estimate of materiality. Allocate your preliminary estimate of materiality to the individual account balances.

(iii) Discuss the effect the ‘other information’ would have on (i) and (ii).

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4. You are the chief internal auditor of Bay Ltd., which is a large manufacturing company listed on the Dhaka and Chittagong stock exchanges. At the last board meeting, one of the items discussed was the establishment of an audit committee. Some members of the board did not support the idea of having another committee, specially when they already have a well established internal audit department that has been in operation for the past three years. These particular Directors feel that there is too much being spent on the monitoring process, considering the resources already allocated to both the internal and external audit functions, and that this is eating up profits that could be redistributed to the shareholders in the form of higher dividends. They argue that investors place their money with them in the hope of high returns, not just to have it spent on checking and rechecking transactions. There have been no major problems uncovered by internal audit since its inception, and the external auditors have never qualified the audit report. Although you have read only a little about the functions of an audit committee, you feel uncomfortable with the directors dismissive attitude, and ask the Board to consider the matter further. As a result, you are asked to research the subject of audit committee further and report at the next board meeting whether Bay should establish an audit committee. Required: Prepare a report for the board, covering the following matters: (a) (b) (c) (d)

Outline the objectives of an audit committee. Recommend terms of reference for the committee. Identify who should constitute the committee. Discuss the interaction between the audit committee and both the internal and external audit functions.

5. The auditor’s report was drafted by Kamal, a staff accountant of Akbar & Akbar CAs at the completion of the audit of the financial statements of Ramna Publishing Co. Ltd. for the year ended December 31, 2007. The report was submitted to the engagement partner who reviewed the audit working papers and properly concluded that an unqualified opinion should be issued. In drafting the report, Kamal considered the following: *

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During the year 2007, Ramna changed its depreciation method. The engagement partner concurred with this change in accounting principle and its justification, and Kamal included an explanatory paragraph in the auditor’s report. The 2007 financial statements are affected by an uncertainty concerning a lawsuit, the outcome of which cannot presently be estimated. Kamal has included an explanatory paragraph in the auditor’s report. The financial statements for the year ended December 31, 2006 are to be presented for comparative purposes. Akbar & Akbar previously audited these statements and expressed an unqualified opinion.

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4 Auditor’s Report

To the Board of Directors of Ramna Publishing Co. Ltd. We have audited the accompanying balance sheet of Ramna Publishing Co. Ltd. as of December 31, 2007 and 2006, and the related statements of income and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. We conducted our audits in accordance with Bangladesh Standards on auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are fairly presented. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a basis for determining whether any material modifications should be made to the accompanying financial statements. As discussed in Note 3 to the financial statements, the company changed its method of computing depreciation in 2007. In our opinion, except for the accounting change, with which we concur, the financial statements referred to above present fairly, in all material respects, the financial position of Ramna Publishing Co. Ltd. as of December 31, 2007 and the results of its operations and its cash flows for the year ended in conformity with Bangladesh Accounting Standards. As discussed in Note 4 to the financial statements, the company is a defendant in a law suit alleging infringement of certain copyrights. The company has filed a counteraction, and preliminary hearings on both actions are in progress. Accordingly any provision for liability is subject to adjudication of this matter. Akbar & Akbar Chartered Accountants 05 March, 2008 Required Identify the deficiencies in the auditor’s report as drafted by Kamal. Group the deficiencies by paragraph and in the order in which the deficiencies appear. Do not redraft the report. 10 6. (a) How a ‘review engagement’ differs from an ‘audit engagement’? (b) The following report was drafted by a staff assistant at the completion of the review engagement of Brothers Ltd. for the year ended 30 June 2007.

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We have reviewed the balance sheet of Brothers Ltd. at 30 June 2007, and the related profit and loss account, statement of cash flows and accompanying notes for the year then ended in accordance with Auditing Standards. A review is limited to inquiries of company personnel and analytical review procedures applied to financial data and thus provides less assurance than an audit but more assurance than accounts prepared without audit. Based on our review, we are of the opinion that the financial report of Brothers Ltd. at 30 June 2007 is presented in accordance with accounting standards. ABC Auditors 02 August 2007 Required: Identify the deficiencies of the proposed report. (c) Explain the purpose of the three ‘Es’ in relation to a value for money audit.

The End

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