Planning and Risk Assessment Section B Rote

Question 1

Audit risk explanation for new client?

Answer 1

Increased detection risk as team not familar with policies, transactions and balances of the company

Question 2

Auditor’s response for new client?

Answer 2

Ensure they have a suitably experienced team. Adequate resources should be allocated to each team member to obtain understanding of company and ROMM

Question 3

Audit risk explanation for company considering stock exchange listing and CEO wants to report rising profit trend?

Answer 3

Possibility that directors try to maniplate FSs to achieve desired result, leading tor evenue overstatement

Question 4

Auditor’s response for company considering stock exchange listing and CEO wants to report rising profit trend?

Answer 4

An experienced audit team that maintains professional scepticism. Review of significant one-off journal entries should be performed

Question 5

Audit risk explanation for price of components steadily increasing when inventory is valued at cost?

Answer 5

NRV of value may have fallen below the cost incurred by company, resulting in inventory valuation being overstated

Question 6

Auditor’s response for price of components steadily increasing when inventory is valued at cost?

Answer 6

Also select a sample of inventory items and compare cost shown on PI with sales price charged at and after year end to confirm that NRV is above cost

Question 7

Audit risk explanation for revalaution of property from 3.4 to 8.4 based on a management revaluation

Answer 7

Revaluation may not have been carried out on an appropriate basis and designed to inflate asset values. Leading to overstatement in asset values

Question 8

Auditor’s response for revalaution of property from 3.4 to 8.4 based on a management revaluation (NCA)

Answer 8

Review methods used. Agree values on valuation records to NCA register and confirm the revaluation has been recorded correctly

Question 9

Audit risk explanation for period over which plant and equipment is depreciation has been extended from five to eight years?

Answer 9

Risk that the reduction has occurred to boost profits. Assets are overstated and depreciation expense understated

Question 10

Auditor’s response for period over which plant and equipment is depreciation has been extended from five to eight years? (useful life)

Answer 10

Compare eight-year useful life should be compared to how often these assets are replaced, as this provides evidence of useful life of assets

Question 11

Audit risk explanation for recognised receivable in respect of damages as lawyer advised action will likely be successful

Answer 11

If contingent assets recognised when they are not virtually certain. The receivables and profits will be overstated

Question 12

Auditor’s response for recognised receivable in respect of damages as lawyer advised action will likely be successful (written)

Answer 12

Audit team should obtain written confirmation from supplier’s lawyer has been settled

Question 13

Audit risk explanation for company’s credit controller absent for four months and receivables collection period increased from 45 to 75 days?

Answer 13

Increased risk that allowance will be required. Meaning receivables overstated and allowance understated

Question 14

Auditor’s response for company’s credit controller absent for four months and receivables collection period increased from 45 to 75 days? (allowance)

Answer 14

Need for allowance should be discussed with finance director and adequacy of any allowance for receivables assessed

Question 15

Audit risk explanation for a payroll clerk carried out fraudulent transactions at company and there is a concern additional frauds have taken place?

Answer 15

Increased control risk as extent of fraudulent transactions has not been determined. Any payments need to be written off so profit and payroll could be overstated

Question 16

Auditor’s response for a payroll clerk carried out fraudulent transactions at company and there is a concern additional frauds have taken place?

Answer 16

Audit team maintains professional scepticism and discuss with finance director what control have been put in place to prevent similar frauds

Question 17

Audit risk explanation for when a client wants the audit to be completed one month after year end?

Answer 17

Client staff are under pressure to complete financial information leading to errors. Thereby increasing detection risk that auditor will not gather sufficient evidence

Question 18

Auditor’s response for when a client wants the audit to be completed one month after year end?

Answer 18

Auditor should assign more staff to company, as more substantive testing required due to increased risk of error and detection risk

Question 19

Audit risk explanation purchases raw materials from overseas suppliers and has responsibility for goods at point of dispatch, with materials in transit for six weeks (goods in transit)

Answer 19

Risk cut-off is not accurate and inventory and payables are understated as company may not correctly recognise raw materials

Question 20

Auditor’s response for when purchases raw materials from overseas suppliers and has responsibility for goods at point of dispatch, with materials in transit for six weeks (goods in transit)

Answer 20

Audit team should undertake detailed cut-off testing of purchases of raw materials at year end

Question 21

Audit risk explanation for when company places reliance on controls testing work undertaken by IA department?

Answer 21

External audit team may form incorrect conclusion on strength of internal controls. Resulting in insufficeint levels of substantive testing, leading to increased detection risk

Question 22

Auditor’s response for when company places reliance on controls testing work undertaken by IA department?

Answer 22

Before using work of IA, audit team need to evaluate and perform audit procedures on the entirety of work which they plan to use to determine adequacy for purposes of the audit

Question 23

Auditor’s response for when finance director doesn’t believe an allowance for receivables is needed?

Answer 23

Test the controls surroinding way finance director identifies irrecoverable receivables and credit control processes to ensure they are operating effectively

Question 24

Audit risk explanation for when company changed one television speaker suppliers to a cheaper alternative, leading to an increase in warranty claims?

Answer 24

Warranty provision will be higher and if director expects provisions to be similar to prior years. Warranty and expenses could be understated

Question 25

Auditor’s response for when company changed one television speaker suppliers to a cheaper alternative, leading to an increase in warranty claims? (level claims post-year-end)

Answer 25

Review level of claims received during the year and post-year-end and compare this to provision made at year end to assess adequacy of the provision

Question 26

Audit risk explanation for when directors only disclosed the amount of renumeration payable to each director and doesn’t comply with local legislation

Answer 26

Director’s renumeration disclosure not complete and accurate if names and individual total payments are not disclosed. FSs are misstated as a result of non-compliance

Question 27

Auditor’s response for when directors only disclosed the amount of renumeration payable to each director and doesn’t comply with local legislation (amend if inadeuqate disclosure)

Answer 27

Discuss matter with management and review requirements of local legislation to determine if disclosure is included appropriately. If inadequate, amend directors’ renumeration disclosures

Question 28

Audit risk explanation for when company intends to capitalise all costs of an intangible asset

Answer 28

If research costs incorrectly classified as development expenditure, risk intangible assets are overstated and expenses are understated

Question 29

Auditor’s response for when explanation for when company intends to capitalise all costs of an intangible asset

Answer 29

Obtain a breakdown of expenditure capitalised and agree to supporting documentation as to whether costs relate to research or development stage

Question 30

Audit risk explanation for an interest bearing loan obtain and will be repaid in quarterly instalments over four years

Answer 30

If loan not allocated correctly between non-current and current liabilities, leads to classification error through misstatement

Question 31

Auditor’s response for an interest bearing loan obtain and will be repaid in quarterly instalments over four years (classification)

Answer 31

Review loan agreement to confirm details and reperform company’s calculation to confirm loan has been correctly split between non-current and current liabilities

Question 32

Audit risk explanation for directors are intending to propose a final dividend once financial statements are finalised?

Answer 32

A dividend is a non-adjsuting event and shouldn’t be recognised as a liability. If dividend recognised it will result in an overstatement of liabilities

Question 33

Auditor’s response for directors are intending to propose a final dividend once financial statements are finalised?

Answer 33

Discuss with management and confirm dividend not recognised within liabilities in the FSs

Question 34

Audit risk explanation for when company spent $1m on refurbhishing stores with this pexenditure is recognised as PPE in SFP

Answer 34

Risk some items of revenue expenditure have been capitalised. Which means PPE is overstated and expenses are understated

Question 35

Auditors respense for when company spent $1m on refurbhishing stores with this pexenditure is recognised as PPE in SFP (schedule)

Answer 35

Obtain schedule of costs which have been capitalised as part of refurbishment programme. Review documentation to ensure invoices are capital in nature

Question 36

Audit risk explanation for when daily cash tkaing reports sent to head show an increasing number of cash shortages when comparing contents of cash registers to reports?

Answer 36

Risk discrepancies are result of fraud and when these shortages are combined, could become material

Question 37

Auditor’s response for when daily cash taking reports sent to head show an increasing number of cash shortages when comparing contents of cash registers to reports? (directors)

Answer 37

Discuss with directors whether these cash shortages may be indicative of fraud

Question 38

Audit risk expalantion for there being an increase in corporate custoemr accounts but no increase for allowance made?

Answer 38

Risk of customers not paying. Result in receivables being overstated and allowance being understated

Question 39

Auditor’s response for there being an increase in corporate custoemr accounts but no increase for allowance made? (controller cash receipts)

Answer 39

Discuss with credit controller likelihood of recovering overdue balances and carry out extended post-year-end cash receipts testing to identify if overdue balances have been properly cleared after reporting date

Question 40

Audit risk expalantion for supplier statements indicating a higher balance is owing by company than is shown on list of individual supplier balances

Answer 40

Differences have been included as reconciling items on supplier statement reconciliations rather than being investigated

Question 41

Auditor’s response for supplier statements indicating a higher balance is owing by company than is shown on list of individual supplier balances

Answer 41

Review supplier statement reconciliations and discuss with payables ledger clerk why they have been included as reconciling items rather than investigated

Question 42

Audit risk explanation for inventory being noted as being damanged due to containing contaminated sole. And inventory holding period increased from 28 days to 54 days

Answer 42

If damaged inventory not written down to NRV, inventory is overstated and cost of sales understated

Question 43

Auditor’s response for inventory being noted as being damanged due to containing contaminated sole. And inventory holding period increased from 28 days to 54 days

Answer 43

Discuss with finance director whether damaged inventory is written down to its NRV and agree write down to final inventory valuation

Question 44

Audit risk explanation for last year’s management report higlighted a number of significant deficiencies in company’s payroll cycle? (misstatement)

Answer 44

If deficiencies not addressed, leads to increased ROMM. Wages and salaries expense may be misstated

Question 45

Auditor’s response explanation for last year’s management report higlighted a number of significant deficiencies in company’s payroll cycle? (substantive)

Answer 45

If recommendations haven’t been implemented, adopt a fully substantive approach to address completeness and accuracy of wages and salaries expense

Question 46

Audit risk explanation for company’s operating profit margin decreasing and gross profit margin increasing

Answer 46

Classification risk that costs have been omitted from cost or sales or included in operating costs incorrectly. Meaning cost of sales is understated and operating costs overstat ed

Question 47

Auditor’s response for company’s operating profit margin decreasing and gross profit margin increasing

Answer 47

Review nature of a sample of operating expenses during the year to identify if any direct costs have been incorrectly classified as overhead expenditure

Question 48

Audit risk explanation for a patent cost

Answer 48

Administrative expenses being capitalised when they shouldn’t be. Risk that intangible assets and profit for the year are both overstated

Question 49

Auditor’s response for a patent cost

Answer 49

Audit team should obtain a breakdown of total amount capitalised and review costs to ensure they’re allowable under IAS 38

Question 50

Audit risk explanation for a batch of invoices miscoded and not recorded as trade payables. The payables payment period has decreased from 64 days to 39 days

Answer 50

Risk there are other batches of miscoded invoices. If these are not identified, purchases and trade payables will be understated

Question 51

Auditor’s response for a batch of invoices miscoded and not recorded as trade payables. The payables payment period has decreased from 64 days to 39 days (testing balance, review)

Answer 51

Detailed testing of trade payables balance, including a review of supplier statement reconciliations, should be carried out to ensure liabilities are recorded

Question 52

Audit risk explanation for 1.1 inventory damaged as a result of figure and has not been replaced. Along with 1.9 inventory balance in year end and inventory holding period has increased?

Answer 52

Risk inventory has not been fully written off and there is other slow-moving inventory. Inventory may be overstated and cost of sales is undersated

Question 53

Auditor’s response for 1.1 inventory damaged as a result of figure and has not been replaced. Along with 1.9 inventory balance in year end and inventory holding period has increased? (discuss inventory items)

Answer 53

Audit team should discuss with management process for identifying damaged inventory items following the fire and review outcome to agree that items identified have been written off incorrectly

Question 54

Audit risk explanation for including a current asset of 1.1 in respect of an insurance claim relating to the fire and insurance company hasn’t responded to the claim?

Answer 54

Recognising the amount claimed overstates profit and other receivables

Question 55

Auditor’s response for including a current asset of 1.1 in respect of an insurance claim relating to the fire and insurance company hasn’t responded to the claim?

Answer 55

If receipt is not virtually certain, auditor should request management remove it from profit and receivables

Question 56

Audit risk explanation for an additional bonus is payable to sales staff which gives an incentive to achieve sales targets in that period

Answer 56

Increases incentive for staff to create ficticious sales or record sales for incorrect period to achieve additional bonus

Question 57

Auditor’s response for an additional bonus is payable to sales staff which gives an incentive to achieve sales targets in that period (cut-off_

Answer 57

Audit team should extent cut-off testing around year-end

Question 58

Audit risk explanation for trade discounts offered to regular customers been separately accounted for as an expense?

Answer 58

Trade discounts should be offset against revenue Risk that revenue and cost of sales are overstated

Question 59

Auditor’s response for trade discounts offered to regular customers been separately accounted for as an expense? (recalculate)

Answer 59

For sample of sales, recalculate discount and review a breakdown of revenue and cost of sales to agree that discounts have been accounted for correctly

Question 60

Audit risk explanation for being under tax investigation relating to sales tax and is likely that company will be required to pay a penalty of 0.6

Answer 60

Provision should be recognised as there is a probable outflow of resource as a result of past events. Provisions are understated and disclosures inadequate

Question 61

Auditor’s response for being under tax investigation relating to sales tax and is likely that company will be required to pay a penalty of 0.6 (letter)

Answer 61

The audit team should obtain a copy of letter from tax authorities and discuss matter with the directors

Question 62

Audit risk explanation for a new accounting system was introduced and post-impelementation testing has not been conducted?

Answer 62

Risk of opening balances being misstated and loss of ongoing data if it has not been transferred from the old system correctly

Question 63

Auditor’s response for a new accounting system was introduced and post-impelementation testing has not been conducted?

Answer 63

Audit team should undertake detailed testing to confirm that all balances have been completely and accurately transferred to the new accounting system

Question 64

Auditor’s response to the risk that amortisation has not been correctly calculated for the period resulting in misstated amortisation? (reperform)

Answer 64

Aksi reperform calculations to confirm the amounts are accurate

Question 65

Auditor’s response for significant staff costs involved in preparation of site for new machinery (breakdown)

Answer 65

Audit team should undertake a review of staff costs expensed and process for allocating staff costs to work undertaken to confirm the amounts that should be capitalised as part of cost of machinery

Question 66

Audit risk exaplanation for significant staff costs involved in preparation of site for new machinery

Answer 66

Costs directly attributable to bringing the asset to the condition necessary for its intended use are only capitalised

Question 67

Audit risk explanation for a a member of finance team fradulently purchased assets for personal use

Answer 67

Risk that non-current assets are overstated as reconciliation of physical assets to non-current asset register will be ongoing at year end

Question 68

Auditors response for a a member of finance team fradulently purchased assets for personal use (internal control)

Answer 68

Audit team should discuss fraud with management tto understand how fraud was detected and corrected. Along with understanding the internal controls

Question 69

Audit risk explanation for directors not accounted for any costs under new contract for bottles as no amnounts are due to be paid until after year end

Answer 69

Risk that costs incurred have not been recognised and therefore costs and liabilities are understated and profits overstated

Question 70

Auditors response for directors not accounted for any costs under new contract for bottles as no amnounts are due to be paid until after year end (terms of contract)

Answer 70

Audit team should review terms of contract to understand amounts payable and terms of payment

Question 71

Audit risk explanation for strict covenants in place regarding the loan?

Answer 71

Increased risk that existence of covenants gives an incentive to manipulate key balances by overstating revenue and profit to ensure convenants are made

Question 72

Auditors response for strict covenants in place regarding the loan? (calculate convenants)

Answer 72

Team should maintain professional scepticism and calculate covenants to understand whether any breaches have corred and discuss impact of breaches with management

Question 73

Audit risk explanation for company has a returns policy allowing a customer to return goods within 28 days of purchase if dissatisfied with the product

Answer 73

Company should recognise a refund liability for goods which are expected to be returned. If not correctly accounted for, revenue will be overstated and refund liability understated

Question 74

Auditor’s response for company has a returns policy allowing a customer to return goods within 28 days of purchase if dissatisfied with the product (compare)

Answer 74

Compare level of post-year-end returns to refund liability and discuss any significant differences with management

Question 75

Audit risk explanation for central warehouse and all 20 branches will be carrying out an inventory count at year-end date 31 August

Answer 75

As it is unlikely auditor will attend all sites. This increases detection risk

Question 76

Auditor’s response for central warehouse and all 20 branches will be carrying out an inventory count at year-end date 31 August

Answer 76

Audit team should assess inventory counts they will attend. This must contain count for central warehouse and branches which have most material balances of inventory

Question 77

Audit risk explanation for dismissal of payables supervisor, PIs have yet to be recorded in the individual supplier accounts

Answer 77

Risk purchases and trade payables at year-end have been understated if these invoices are not recorded before system is closed down for the year

Question 78

Auditor’s response for dismissal of payables supervisor, PIs have yet to be recorded in the individual supplier accounts (unprocessed)

Answer 78

Review the unprocessed invoices file at year-end to identify any invoices which relate to supply of pre-year-end goods and ensure properly accrued for year-end FSs and recognised as a liability

Question 79

Audit risk explanation for staff training costs being capitalised for purchasing a non-current asset?

Answer 79

Training costs should be charged to SPL. Therefore PPE and profits are overstated

Question 80

Auditor’s response for staff training costs being capitalised for purchasing a non-current asset?

Answer 80

Discuss accounting treatment with finance director and request training costs are written off to SPL to ensure treatment is in accordance with IAS 16. If adjusted, review journal entry for accuracy

Question 81

Audit risk explanation for company breaching terms of overdraft facility and company is dependent on this overdraft facility

Answer 81

If bank refuses to continue to support the company, there may be doubts as to the company’s ability to continue as a going concern

Question 82

Auditor’s response for company breaching terms of overdraft facility and company is dependent on this overdraft facility

Answer 82

Audit team should undertake detailed going concern testing, reviewing impact of a non-renewal of the overdraft facility

Question 83

Audit risk explanation for customers paying a 25% deposit on signing the contract to purchase the playgrounds

Answer 83

Deposit should not be recognised as revenue immediately and instead be recognised as deferred income within current liabilities. Risk revenue is overstated and current liabilities understated

Question 84

Auditor’s response for customers paying a 25% deposit on signing the contract to purchase the playgrounds (cut-off_

Answer 84

During final audit, audit team should undertake increased testing over cut-off of revenue and completeness of deferred income

Question 85

Audit risk explanation for audit team will only attend WIP counts at 5 of the 16 sites

Answer 85

As valuation of WIP is material and is a judgmental area. Detection risk is increased as team will be unable to directly obtain evidence relating to WIP since they can’t attend all sites

Question 86

Auditor’s response for audit team will only attend WIP counts at 5 of the 16 sites

Answer 86

Audit should assess which inventory counts team will attend, most likely to those with most material WIP balances or having the greatest ROMM

Question 87

Audit risk explanation for a rights issue in the year. There is a non-standard transaction and there is increased risk that issue has not been recorded correctly (FSs)

Answer 87

Risk split between share capital and share premium has not been accounted for correctly. As share capital and share premium is accounted for separately within equity

Question 88

Auditor’s response for a rights issue in the year. There is a non-standard transaction and there is increased risk that issue has not been recorded correctly (recalculate)

Answer 88

Recalculate the split of share capital and share premium and agree this to journal entry to record the rights issue

Question 89

Audit risk explanation for a payroll function is outsourced to an external service organisation

Answer 89

Detection risk arises as to whether appropriate evidence is available to confirm completeness and accuracy of controls over the payroil cycle

Question 90

Auditor’s response for a payroll function is outsourced to an external service organisation

Answer 90

Consideration should be given to contacting the auditor of service organsiation to confirm the level of controls in place

Question 91

Audit risk explanation for a temporary accountant being put in?

Answer 91

Increased risk of errors in FSs as temporary accountant may not be familar with company’s activities

Question 92

Auditor’s response for a temporary accountant being put in? (substantive)

Answer 92

Audit team should ensure increased substantive procedures are undertaken on material areas of FSs to reduce audit risk

Question 93

Audit risk explanation for FSs to be prepared in order to secure bank finance and management wish to report strong results

Answer 93

Increases risk that directors may manipulate FSs, overstating profits and understating liabilities

Question 94

Auditor’s response for FSs to be prepared in order to secure bank finance and management wish to report strong results

Answer 94

Audit engagement team should maintain professional scepticism. Detailed cut-off testing on areas such as revenue, inventory and paaybles should be performed to ensure cut-off correctly applied

Question 95

Audit risk explanation for a specialised machine was acquired and staff members had to be trained in machine’s use at a cost of 15 which has been capitalised as part of the cost of the machine

Answer 95

IAS 16 prohibits training costs being capitalised, so expenses are understated and PPE is overstated

Question 96

Auditor’s response for a specialised machine was acquired and staff members had to be trained in machine’s use at a cost of 15 which has been capitalised as part of the cost of the machine

Answer 96

Obtain breakdown of capitalised costs and agree to supporting documentation to ensure they meet recoginition criteria in IAS 16. Also discuss accounting treatment with directors

Question 97

Audit risk explanation for directors announed that a brand was being discontinued resulting in four members of staff being made redundant

Answer 97

A provision needs to be recognised in FSs as there is a present obligation for which costs can be reliably measured. If provision is not recognised, profits are overstated and liabilities and payables are understated

Question 98

Auditor’s response for directors announed that a brand was being discontinued resulting in four members of staff being made redundant

Answer 98

Obtain calculation of redundancy payments and agree that a provision has been included at a liabiltiy in year-end FSs

Question 99

Audit risk explanation for company’s suppliers have been paid on 1 June 20X5 and payment has been included as an unpresented item in year-end bank reconciliation

Answer 99

Possible evidence of window dressing which results in understated payables and bank balances

Question 100

Auditor’s response for company’s suppliers have been paid on 1 June 20X5 and payment has been included as an unpresented item in year-end bank reconciliation

Answer 100

Request that bank reconciliation is amended to remove supplier payments at year end as these should be accounted for in 31 May 20X6 FSs

Question 101

Audit risk explanation for finance director is planning on reducing estimated return rate for goods sold on a sale or return basis to wholesale customers from 10% to 5%

Answer 101

Goods which may be returned, company should recognised a refund liability if after 60 days goods are not returned. Liabiltiy should be reversed and revenue recognised. By reducing return return rate, risk revenue and cost of sales overstated and liabilities understated

Question 102

Auditor’s response for finance director is planning on reducing estimated return rate for goods sold on a sale or return basis to wholesale customers from 10% to 5%

Answer 102

Review a period of 50 days to quantify the levels of return in specified period and compare this to assumed rate of 5%

Question 103

Audit risk explanation for surplus plant and machinery was sold during the yer, resulting in a loss on disposal of 160

Answer 103

Significant profits or losses may indicate depreciation policy of plant and machinery may not be appropriate. Depreciation may be understated and profits are overstated

Question 104

Auditor’s response for surplus plant and machinery was sold during the yer, resulting in a loss on disposal of 160

Answer 104

Discuss depreciation policy for plant and machinery with finance director to assess its reasonableness

Question 105

Audit risk explanation for financial controller dismissed and threatening to sue company for unfair dismissal

Answer 105

if provision payable is probable make provision or if possible, make a disclosure. If company has not done this, risk over completeness of any provisions or contingent liabilities disclosures

Question 106

Auditor’s response for financial controller dismissed and threatening to sue company for unfair dismissal

Answer 106

Audit team should discuss with management and request confirmation from company’s lawyers of existence and likelihood of success of any claim from former financial controller

Question 107

Audit risk explanation for if production provblems affecting quality of a significant batch of tyres. Therefore inventory holding period has increased from 34 to 41 days

Answer 107

Inventory may be overvalued as NRV may be below its cost. If inventory can’t be fixed, may need to be written off completely. There is a risk of overstatement of inventory

Question 108

Auditor’s response for if production provblems affecting quality of a significant batch of tyres. Therefore inventory holding period has increased from 34 to 41 days (testing products)

Answer 108

Testing should be undertaken to confirm cost and NRV of affected products in inventory and all inventory on a line-by-line basis is valued correctly

Question 109

Audit risk explanation for a significant customer has been granted a six-month payment break and receivables collection period has increased from 38 to 51 days

Answer 109

A risk that receivables will be overvalued as some balances may not be recoverable and so will be overstated if adequate allowance has not been made

Question 110

Auditor’s response for a significant customer has been granted a six-month payment break and receivables collection period has increased from 38 to 51 days (test controls)

Answer 110

Review and test controls surronding how finance director identifies old or potentially irrecoverable receivables balances and credit control to ensure they are operating effectively

Question 111

Audit risk explanation for company wanting to restructure its debt finance. But interest cover decreased and gearing has increased

Answer 111

Worsening interest cover and gearing increases risk directors may manipulate FSs, by overstating profits and assets and understating liabilities

Question 112

Auditor’s response for company wanting to restructure its debt finance. But interest cover decreased and gearing has increased

Answer 112

Team should maintain professional scepticism and significant estimates and judgements should be carefully reviewed in light of misstatement risk

Question 113

Audit risk explanation for bonus issue and share capital should increase and a reserve should decrease accordingly

Answer 113

If company not accounted for bonus issue, risk could have been incorrectly treated with equity being under or overstated

Question 114

Auditor’s response for bonus issue and share capital should increase and a reserve should decrease accordingly

Answer 114

Review treatment of bonus issue and agree increase in shares to share register and share certificates, and agree corresponding reduction in reserves is correct

Question 115

Audit risk explanation for a customer has returned $120,000 of faulty goods to the company before the year end but a credit note is yet to be issued?

Answer 115

As this sale occurred before the year end, there is a risk that revenue and receivables are overstated if the credit note is not correctly recorded before the year end

Question 116

Auditor’s response for a customer has returned $120,000 of faulty goods to the company before the year end but a credit note is yet to be issued? (Inspect)

Answer 116

Inspect a copy of the credit note and confirm an adjustment to revenue and receivables has been recorded pre-year end

Question 117

Audit risk explanation for the company’s suppliers have been paid on 1 June 20X5 and the payment has been included as an unpresented item in the year-end bank reconciliation? (Window)

Answer 117

This is possible evidence of window dressing which results in understated payables and bank balances.

Question 118

Auditor’s response for the company’s suppliers have been paid on 1 June 20X5 and the payment has been included as an unpresented item in the year-end bank reconciliation? (Amended time)

Answer 118

Request that the bank reconciliation is amended to remove the supplier payments at the year end as these should be recognised in the 31 May 20X6 financial statements.