common mistakes Flashcards
The directors’ report contains a statement without amplification that ‘the company’s trading for the period resulted in a 10% increase in profit compared to the previous period.’ However, the statement of profit or loss shows that the company’s profit for the period includes a profit of £35,000 which did not arise from trading but from the disposal of non-current assets of a discontinued operation. Without this profit on the disposal of non-current assets, the company would have reported a profit for the year of £75,000 representing a reduction in profit of 25% compared to the previous period on a like-for-like basis. The directors are unwilling to change the wording of the directors’ report.
Should you modify the audit opinion? Explain the steps the auditor should take
- Check if misstated in FS or DR
- If the misstatement is indeed in the directors’ report, then the opinion on the financial statements will not be modified, on the grounds that the director’s report does not form part of the financial statements.
- Auditor should first request the directors to amend the misstatement in the director’s report. If they do not amend, then a modified report is required.
- The UK Companies Act requires a specific statement on whether the information given in the directors’ report is consistent with the financial statements. The auditor’s report should be modified to include a statement that the information in the directors’ report is inconsistent with the financial statements. This should be headed ‘Opinions on other matters prescribed by the Companies Act 2006’. The auditor’s report should also include a section which describes the misstatement in the directors’ report and is headed ‘Matters on which we are required to report by exception’.
85.6 On 18 August 20X0, your firm was appointed as the external auditor of Lapine Ltd (Lapine) for the year ended 30 June 20X0. Consequently, it did not attend the year-end inventory count. No other procedures could be performed during the audit to obtain sufficient evidence in respect of the existence of inventory at 30 June 20X0.
Requirement
The directors of Lapine have included closing inventory of £1.9 million in the financial statements at 30 June 20X0. Lapine’s profit before tax for the period is £14.8 million. State, with reasons, the implications for the auditor’s opinion on the financial statements for the year ended 30 June 20X0.
(2 marks)
- Implications for auditor’s opinion
- Modified opinion
- Unable to obtain sufficient appropriate evidence
- 12.8% of profit
- Material
- Not pervasive
- Isolated to one area/inventory
- Qualified opinion/’Except for’
You are the audit manager responsible for the audit of Fiver Ltd for the year ending 31 October 20X0.
Requirements
Outline the actions you would take in relation to junior members of the audit team, before and during the audit fieldwork, to ensure the quality of their work will be of a high standard.
(3 marks)
Actions in relation to junior members of the audit team to ensure the quality of their work is of a high standard
- Select a team with appropriate competence
- Assign work to team members according to experience
- Inform team of the need to:
- comply with ethical standards
- exercise professional scepticism
- Brief the audit team on:
- industry/entity/risks/fraud
- audit approach
- Ensure they understand instructions
- Supervise by:
- regular communication/provide feedback
- track progress of work
- review work completed
Hutch is negotiating the acquisition of Lendris, an interior design company. Hutch’s board of directors would your firm to accept an engagment to advise Hutch on an appropriate valuation of Lendris.
Discuss whether it would be appropriate for your firm to accept the engagement to advise Hutch’s board on the valuation of Lendris. (4 marks)
There may be threats to independence and objectivity, such as:
Self-review
- the valuation will be included in the financial statements and be subject to audit
- the audit team may be too trusting/insufficiently sceptical of the valuation work and reluctant to highlight any errors.
Management
- the firm’s views may become too closely aligned with management
- the valuation is subjective and requires judgment
- the auditor should not make management decisions.
The level of engagement risk may be high. If Lendris does not perform as expected, the firm may be liable to Hutch.
If the valuation is material to the financial statements, the firm must decline the engagement.
If the valuation is not material to the financial statements, then the firm may be able to accept the engagement with appropriate safeguards.
How to calculate trade receivable and trade payables days for the audit procedures questions where there may be a risk
TP Days = TP / Purchases * 365
TR Days = TR / Revenue * 365
Compare to the credit terms mentioned in the question for easy marks
Always use these mechanisms to determine if there has been any over or understatement of trade receivables or trade payable balances
You are responsible for planning the external audit of Downe and you are considering the audit procedures relevant to the audit of inventory. Downe
does not keep continuous inventory records. It performs a year-end inventory count at each shop.
For each type of audit procedure listed below, describe two procedures relevant to the audit of Downe’s inventory:
- Tests of controls
- Tests of details
- Analytical procedures
(6 marks)
Tests of controls
- Attend inventory count/observe controls at inventory count.
- Observe physical security procedures regarding storage.
- Review adequacy of inventory count instructions/observe compliance with instructions.
- Evaluate management’s procedures over the identification and write off of obsolete inventory.
Tests of details
- Perform test counts (sheet to floor/floor to sheet).
- Inspect inventory for damaged/obsolete items.
- Inspect use by/best before dates.
- Obtain confirmations of inventory from shops not attended/returns from shops not visited
- Agree the cost of inventory to supplier invoices.
- Agree quantities of items on the inventory listing to the inventory count records.
- For a sample of inventory items, recalculate price x quantity.
- Investigate journal entries impacting the inventory account.
- Ascertain the basis of inventory provision/recalculate the inventory provision
Analytical procedures
- Compare the current year’s inventory balance/inventory days with the previous year’s.
- Compare inventory days/inventory turnover by shop.
- Compare gross margin for each shop/with the prior year.
- Identify shops holding higher than average value/amounts of inventory items.
Your firm is the external auditor of Hampshire. Hampshire was listed on the London Stock Exchange in June 20X0 and has a year end of 30 September. In recent years, your firm has earned the following fees from Hampshire. These are expected to remain at the same level for the year ending 30 September 20X0.
External audit - £m25
Annual taxation services £m - 20
Your firm’s total annual fee income is, and is expected to remain at, f580 million.
Requirement
Identify and explain any legal, professional and ethical issues arising for your firm. State any actions that should be taken by your firm or its employees.
There are a number of threats to the firm’s independence and objectivity:
Self-interest
- recurring fee income is 7.8% of annual fee income
- this is above the 5% threshold but below the 10% relevant to listed entities
- the firm may be overly reliant on the fees earned from Hampshire and may be reluctant to modify its opinion or challenge Hampshire’s management.
Self-review
- The output of the tax services may be reflected in Hampshire’s financial statements
- The audit team may place too much reliance on the tax work and be reluctant to criticise it or point out errors.
Management threat
- There is a risk of making management decisions as part of the tax engagement.
Threat to professional competence
- The firm may not have the relevant experience/resources to audit a PIE/listed entity
There is an increased reputational risk to the firm when auditing a PIE/listed entity.
Many tax services to PIEs/listed entities are prohibited by the Ethical Standard.
Actions
The firm needs to implement safeguards in respect of the self-interest threat:
- the % fee income should be disclosed to those charged with governance
- an independent quality control review is required
- there should be a regular review of the fee income to ensure the 10% threshold is not breached
The firm should reconsider whether the tax services are now prohibited by the Ethical Standard. The firm should use separate personnel for any permitted tax services and document informed management. The firm should assess its experience/resources in the audit of PIE/listed entities.
What is the difference between the following ethical principles:
- Professional behaviour
- Professional competence and due care
Professional behaviour - to comply with the relevant laws and regulations and avoid any behaviour that the professional accountant knows, or should know, might discredit the profession
Professional competence and due care, to:
- Attain and maintain a level of professional knowledge and care at the level required so that the client or the employing organisation receives competent professional services, based on current technical and professional standards and relevant legislation; and
- act diligently and in accordance with technical and professional standards.
What are the additional reporting requirements for listed entities?
- A paragraph related to the key audit matters of the entity (KAM) (e.g. Going concern)
- The audit report should includes sections about how it addressed such KAM’s
When would you include the following paragraphs in your modified audit report:
- Emphasis of matter paragraph
- Other matter paragraph
Emphasis of matter paragraph:
Where the auditor considers it necessary to draw the user’s attention to a specific matter or matters presented or disclosed in the financial statements that are of such importance that they are fundamental to the user’s understanding of the financial statements.
Other matter paragraphs:
Where the auditor considers it necessary to draw users attention to any matters or matters other than those disclosed in the financial statements that are relevant to the users’ understanding of the audit, the audtiors responsibility, or the auditors report
Both dont result in a modified opinion and a paragraph related to these must be included in a paragraph following the basis of opinion paragraph.
In what circumstances would the following auditor’s opinion be issued:
- Qualified (Except for)
- Adverse opinion
What is the wording included in such opinions
Need to consider if the misstatement is pervasive. If Pervasive, adverse opinion is given.
Pervasive - A misstatement is “pervasive” if not confined to a single element of the FS, or, if it is confined, represents a substantial portion of the FS
Qualified opinion - i.e. FS and assertions give a true and fair view except for…
Adverse opinion - FS and its assertions do not give a true and fair view
When should you issue a disclaimer of opinion?
How should this be reported
Disclaimer of opinion - The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
You need to lack audit evidence and it needs to be pervasive for it to be a disclaimer of opinion. Otherwise if not pervasive its an qualified opinion (except for).
State the disclaimer of opinion in the auditor opinion section. Include a paragraph called “basis for disclaimer of opinion”
Three types of audit opinion that may be issued in a modified audit opinion?
- Unqualified opinion (except for)
- Adverse opinion
- Disclaimer of opinion
GDPR requirements and what actions can be taken if there is a breach?
- anyone processing data must ensure it is protected
- Individuals have right to access the data held against them and how it is being processed
- Can only hold data if its for a lawful reason and the person has opted in to it.
If breach:
- Notifty the Information commisioners office (ICO)
- Notify the client / impacted person
- Resolve the breach
- Subject to fines as a result of breach
What are the thresholds for revenue earned from an audit client and when would it start to be a risk?
Why is it a risk and what are the safeguards against such risks?
What are the steps to be taken regarding contingent fees?
- Fees amount to 10% for listed clients (if >5% then need to monitor)
- Fees amount to 15% for non-listed clients (if >10% then need to monitor)
Self-interest threat as the firm may be over-reliant on the engagement, and unlikely to modify its opinion or challenge management. Safeguards:
- Disclose % fee income to those charged with governance
- independent quality control reviewer to review work undertaken
- regular review of fee income to ensure it doesnt exceed threshold (if within 5%)
Contingent fees are banned, both for audit work and non-audit work
