June 2017 exam short form Qs

Question 1

You are the audit senior on the external audit of Chance Ltd (Chance), a UK construction
company. During a review of Chance’s bank statements, you identified a large monthly receipt
from an overseas company. The amount of the receipt is the same every month. You have also
identified an identical monthly payment to another overseas company. No entries have been
made in Chance’s accounting records for any of these receipts and payments. Chance has not
previously traded with any overseas company.
Requirement
State, with reasons, the actions that you and your firm should take in respect of this matter.
(3 marks)

Answer 1

Actions
* Report to the money laundering officer within the firm (MLRO)
* MLRO to report to the National Crime Agency (NCA)
* Avoid tipping off the client
* Consider impact on financial statements
* Consider management’s integrity
Reasons
* Suspicion of money laundering
* Transactions not consistent with trading history
* Not recorded in accounting records
* Activity may represent the proceeds of crime
* Criminal offence if auditor does not report
* Tipping off may prejudice legal proceedings.

Question 2

The testing of journal entries is one of the procedures used by external auditors to respond to
the risk of fraud at audited entities.
Requirement
List the characteristics of journal entries that external auditors should select for testing to
identify any fraudulent activities.
(3 marks)

Answer 2

Journals that:
* relate to unusual or seldom used accounts
* are processed by individuals who do not normally make journal entries
* are recorded at the end of the period
* have no explanation or have a vague description
* are in round numbers
* are made outside of office hours
* are made to suspense accounts
* involve contra entries
* involve directors or related parties
* lack commercial rationale
* involve accounts prone to misstatement.

Question 3

Circus Ltd (Circus) has outsourced its payroll function to Payco Ltd (Payco). Each month, Circus
provides Payco with the hours worked by each employee. Payco calculates monthly payroll
information by reference to employees’ details held as standing data on Payco’s IT system.
Based on the information provided by Payco, Circus pays wages directly into its employees’
bank accounts and pays payroll taxes to the authorities. Payco is responsible for the online
filing of the monthly returns required by the tax authorities.
Requirement
Identify the business risks to which Circus is exposed by outsourcing its payroll function to
Payco and state the implications for the financial statements.
(4 marks)

Answer 3

Business risks
* Loss of data/breaches of data protection legislation
* Incorrect calculation of wages/taxes
* Loss of employee goodwill
* Reputational damage
* Late/incorrect submissions to the tax authorities
* Fines
* Increased costs
* Negative cash flow
Implications for financial statements
* Misstatement of wages/payroll taxes
* Unrecorded liabilities
* Undisclosed contingent liabilities.

Question 4

Audit committees are responsible for monitoring the quality of the work of an internal audit
function within an audited entity. One of the ways this can be achieved is by the use of agreed
performance indicators.
Requirement
List three performance indicators which could be used by audit committees to monitor the
quality of an internal audit function.
(3 marks)

Answer 4

Performance indicators:
* Actual time compared to budget
* Actual work completed compared to planned work
* Number of reports produced within target dates
* Number of recommendations accepted
* Savings identified
* Feedback from users
* Results of third party reviews
* Number of staff in post against planned requirement/staff turnover rates
* Number of qualified staff.

Question 5

A firm sets its senior employees targets for generating non-audit fees from its external audit
clients. One of the criteria for paying annual bonuses to senior employees is achieving these
targets.
Requirement
Identify and explain the threat to the objectivity of senior employees arising from this
arrangement. State, with reasons, whether the arrangement is appropriate.
(3 marks)

Answer 5

Threat to objectivity
* Self-interest threat
Explanation
* Senior employees may promote services not required by the client/exaggerate the benefits
of non-audit services
* Audit quality may suffer/lack of scepticism.
Is arrangement appropriate?
* Not appropriate
* For each audited entity, ES 4.36 states that the audit firm shall establish a policy to ensure
that:
– objectives of the members of the team do not include selling non-audit services
– criteria for evaluating performance or promotion of the members of the audit team do
not include success in selling non-audit services
– no specific element of remuneration of the members of the audit team is based on
success in selling non-audit services.

Question 6

Kent LLP (Kent) is an international external audit firm. Kent is considering transferring some
external audit work relating to UK audited entities to an overseas office.
Requirement
State how Kent could manage audit quality if work is transferred to an overseas office.
(4 marks)

Answer 6

How Kent could effectively manage audit quality overseas:
* No work to be transferred that involves judgements/only work of mechanical nature
* Recruitment of appropriately qualified/experienced overseas staff
* Training of overseas staff/staff exchange with UK office
* Direction/supervision of overseas staff
* Review of work by overseas/UK office
* Ensure instructions sent to overseas office followed
* Ethical and independence declarations in place