June 2016 exam short form Qs

Question 1

Larch LLP (Larch) is a recently established firm of ICAEW Chartered Accountants specialising in
audit and assurance work. Larch has three partners and 20 staff.
Requirement
List the actions that Larch must take to comply with the Money Laundering Regulations.
(2 marks)

Answer 1

Actions to comply with the Money Laundering Regulations
* Appoint a Money Laundering Reporting Officer (MLRO) and a Money Laundering
Compliance Principal (MLCP)
– MLRO must be a senior member of the firm; MLCP must be on board of directors (or
equivalent)
– The roles of MLRO and MLCP may be performed by the same person
* Register with a supervisory body (eg, HMRC, ICAEW)
* Implement policies and procedures for:
– Client due diligence
– Record keeping of client identification
◦ For five years after relationship ends
◦ To cover identification of politically exposed persons
– Reporting Money Laundering
◦ Including no tipping off
* Introduce a staff training programme
* Monitor compliance with policies and procedures

Question 2

Your firm is the external auditor of Willow Aquatics Ltd (Willow) for the year ended 31 May
20X6. Willow is a retailer of a range of leisure boats. In recent years, Willow has sold an
average of 200 boats each month. Customers pay 40% of the selling price when the order is
placed and the balance on delivery of the boat. It is Willow’s policy to recognise revenue on
delivery of the boat to the customer.
Requirement
Describe the audit procedures that should be included in the audit plan, for the year ended 31
May 20X6, to address the risk of revenue misstatement.
(4 marks)

Answer 2

Audit procedures to address the risk of revenue misstatement
* Compare revenue with:
– expectation (eg, sale of 2,400 boats pa)
– prior year
* Discuss with management the reason for any changes in the number of boats sold and
corroborate explanations
* Evaluate and test system for recording deferred income
– Ensure 40% initial payment is accounted for as deferred revenue until delivered
* Match entries in the revenue account with invoices
* Match despatch records with invoices (cut off)
* Inspect post year-end credit notes which may relate to the year under review
* Inspect post year-end management accounts
– Low level of sales may indicate inflation of pre year-end revenue

Question 3

Fraudulent activities can be carried out through the use of journal entries.
Requirement
State the characteristics of journal entries that external auditors should select for testing to
identify fraudulent activities.
(3 marks)

Answer 3

Characteristics of journal entries that external auditors should select for testing to identify
fraudulent activities
Journals that:
* relate to unusual or seldom used accounts
* are processed by individuals who do not normally make journal entries
* are recorded after closure of the financial statements
* have no explanation or have a vague description
* are in round numbers
* are made outside office hours
* are made to suspense accounts
* involve contra entries
* involve directors or related parties
* lack commercial rationale
* involve accounts prone to misstatement or were misstated in the prior year

Question 4

Your firm is the external auditor of Chestnut Ltd (Chestnut), a manufacturer of vacuum cleaners, for the year ended 31 May 20X6. Historically, all vacuum cleaners were sold with a two-year warranty against defective materials and workmanship. In June 20X5, Chestnut increased the warranty period to five years to match the warranties offered by its competitors. Chestnut
includes a provision for such warranties in its financial statements. The provision is based on the finance director’s assessment of future claims.
You have been provided with the following relevant extracts from the financial statements:
20X6 20X5
(draft) (audited)
£’000 £’000
Revenue 28,990 25,260
Non-current provision for warranty claims 289 253
Current provision for warranty claims 319 316

Requirement
Explain the factors which could indicate that the provision for warranty claims may be materially misstated.
(4 marks)

Answer 4

Explain the factors which could indicate that the provision for warranty claims may be materially misstated
* Director’s assessment is subject to uncertainty
* Non-current provision represents 1% (20X6) and 1% (20X5) of revenue
* Current provision represents 1.1% (20X6) and 1.25% (20X5) of revenue
* Inconsistent with the increase in extended warranty period from two to five years
* Possible understatement
Alternative calculations
Marks were awarded where candidates presented the following alternative calculations:
* Increase in non-current provision of 14.2%
* Increase in current provision of 0.1%
* Total of current and non-current provision 2.1% (20X6) and 2.25% (20X5)
* Increase in warranty provision of 6.9%
* Increase in revenue of 14.8%

Question 5

Your firm has received notice from Ash plc (Ash), a listed company, that your firm will not be reappointed as external auditor when its term of office expires as the audit committee of Ash has
recommended the appointment of another firm.
Requirement
Set out the rights and responsibilities of your firm, including those under the Companies Act
2006, relating to the change in appointment.
(3 marks)

Answer 5

Rights and responsibilities, under the Companies Act 2006, relating to the change in
appointment of an external auditor
Rights
* Outgoing auditors may:
– make written representations
– circulate these to members
– attend and speak at the AGM
Responsibilities
* Prepare a statement of circumstances detailing the circumstances of resignation
– To be deposited at Ash’s registered office
– And a copy sent to the Registrar of Companies
* As Ash is a listed company, there is no option to state there are no circumstances
* Obtain permission from Ash to reply to a prospective auditor’s communication
* Return promptly all books and records of the company
* Maintain client confidentiality after ceasing to act
* Maintain client identification records
* Notify the audit authority of the change in appointment (eg, ICAEW/FRC)

Question 6

During the audit of Elm Ltd, a building contractor, you discovered that references were not
always obtained when new plumbers and electricians were employed.
Requirement
Outline the possible consequences of this internal control deficiency and provide
recommendations to remedy this deficiency.
(4 marks)

Answer 6

Possible consequences of this internal control deficiency and recommendations to remedy this deficiency.
Consequences
* Staff may not have appropriate skills, leading to:
– poor quality work
– costs to rectify
– adverse impact on reputation
* Staff may lack integrity, leading to:
– theft
* Staff may have falsified information about identity or qualifications, leading to:
claims and legal action
* Staff may be breaking the law
– Eg, right to work in UK, leading to:
◦ fines
* Adverse impact on cash flow/going concern risk
Recommendations
* Communicate policy to staff
* Obtain two references
* At least one reference from a former employer
* Inspect proof of qualifications
* All offers of employment made subject to satisfactory references
* Formal approval to appoint new employees
* Monitoring of procedures
* Disciplinary procedures for failing to comply with the policy