2.

(a) ISA 500 expects the auditor to obtain audit evidence from an appropriate mix of
tests of control systems and substantive tests of transactions and balances. It requires
the auditor to obtain sufficient and appropriate audit evidence in order to draw
reasonable conclusion on which to base the audit opinion.

ISA 500 identifies eight types of procedures that the auditor can adopt to obtain audit
evidence; inspection of records or documents, inspection of tangible assets,
observation, enquiry, confirmation, recalculation, reperformance and analytical
procedures.

‘Sufficient appropriate’ audit evidence requires that while the nature of an item is
under scrutiny (class of transaction, account balance, disclosure) and the assertion
being tested affects the type of procedure performed, these issues do no necessarily
affect considerations of how much evidence to gather.

This is driven by 3 factors:

• The risk assessment (of material misstatement)

• The quality of the evidence available
• The purpose of the procedure

There needs to be sufficient evidence to support the auditor’s conclusion. Whether

the auditor has enough is a matter of professional judgement. However when
determining whether they have enough evidence on file the auditor must consider:

• The risk of material misstatement

• The results of control tests
• The size of the population being tested
• The size of the sample selected to test
• The quality of the evidence obtained

Appropriateness of the evidence can be broken down into reliability and relevance.
Auditors should always attempt to obtain evidence from the most trustworthy and
dependable source available, this ensures the evidence is more reliable. To be
relevant the evidence has to address the objective/purpose of a procedure and the
assertion being considered.

Auditors are only requires to perform procedures to give reasonable assurance that the
financial statements are free from material misstatement; they can never give absolute
assurance.

(b) Auditors Responsibilities

The auditor is responsible for obtaining reasonable assurance that the financial
statements, taken as a whole, are free from material misstatement, whether caused by
fraud or error, therefore the auditor has some responsibility for considering the risk of
material misstatement due to fraud.
Auditors must maintain an attitude of professional scepticism, meaning that the
auditor must recognise the possibility that a material misstatement due to fraud could
occur.
The audit engagement team should obtain information for use in identifying the risk
of fraud when performing risk assessment procedures. IAS 315 states that identifying
and assessing the risks of material misstatement through understanding the entity and
its environment goes further than general concept and requires that engagement teams
discuss the susceptibility of their clients to fraud.

Auditors must identify, through enquiry, how management assesses and responds to
the risk of fraud. They must also enquire of management, internal auditors and those
charged with governance if they are aware of any actual or suspected fraudulent
activity.

Directors Responsibilities
The directors have a primary responsibility for the prevention and detection of fraud,
by implementing an effective system of internal control they should reduce the
possibility of undetected fraud occurring to a minimum.

The directors should be aware of the potential for fraud and this should feature as an
element of their risk assessment and corporate governance procedures.
 5. (a) Auditors have two fundamental duties; to form an opinion on whether the
financial statement give a true and fair view and are prepared in accordance with
applicable reporting framework, and issue an audit report.
In addition to this national law may impose duties upon the auditor. UK auditors are
required to incorporate the following implicit matters into their consideration of the audit
opinion;

• Proper returns received from branches not visited by the auditor.

• The company’s financial statements agree with the underlying accounting records.
The trial balances and all receipts and invoices should agree with the financial
statement.
• Proper accounting records have been kept. Invoices, receipts, purchase orders
should all be kept on record and easily viewable for the auditor..
• All necessary information and explanations have been obtained.
• Information issued with the financial statements is consistent with the financial
statements.
• Other information required by law, if not included in the financial statements, is
included in the auditors report. Information about directors pay and benefits must
be included.

(b) In most cases it is the directors that negotiate an audit contract with the auditors. This
may cause problems. Audit firms on occasions quote low prices to directors to ensure
repeat business, or to get new clients. By doing so the firm may not be able to perform
the audit fully as they do not have enough income to pay for a thorough investigation.
Cutting corners could mean the audit team would be reporting without all the
evidence required which will affect the quality of the report. This would bring into
question their independence. It is common for the audit firm of a company to provide
extra services as well as performing the audit.

Having this additional working relationship with the client would result in
questions being asked of the independence of the audit firm. If non-audit fees are
substantial in retaliation to audit fees suspicions will arise that auditing standards may
be compromised. The firm would no longer be unbiased, as it would want the
company to perform well so it can continue to earn the addition fee for their
consultancy. This would mean the audit firm would be dependent on the directors and
they would no longer be working with independence.

(c) Legal rights of an auditor of a limited company

During the audit/continued appointment;

• Access to the company’s books and record
• To receive information and explanations necessary for the audit
• To receive notice of and attend any general meeting of members of the
company
• To be heard at such meetings on matters of concern to the auditor.
 On Resignation;
• To request n Extraordinary General meeting (EGM) of the company to explain
the circumstances of the resignation.
• To require the company to circulate the notice of circumstances relating to the
resignation
(d) Directors do not have the authority to remove auditors. Arrangements for removing
the auditor have to be made in such a way that:

• The auditor has sufficiently secure tenure of office, to maintain independence

of management.
• Incumbent auditors can be removed if there are doubts about their continuing
abilities to carry out their duties effectively.
Auditors may also resign if they have differences with management, but to prevent the
circumstances of the resignation being hidden from the company’s members, the
auditors have to submit a statement of the circumstances surrounding their
resignation.

(e) Before accepting the appointment as auditor to Lopit, the following issues will need to
be addressed;

Risk Analysis
• Obtain references to check on management integrity.
• Check on past performance of business.
• Check internal controls.
• Unusual transactions.

Ethical Issues
• If changing auditor, need to ask permission to get in contact with existing
auditor and then wait for clearance. If no response consider the new
appointment carefully.

Legal Issues
• The directors of Lopit seem very casual, they are willing to indemnify against
any legal action as a consequence of taking the position, not professional.
• They state that the board remains the right to dismiss at anytime without
reason. The directors cannot dismiss an auditor, only the shareholders can.
The auditor has to have a secure tenure of office, to maintain independence of
management.
3. (a)
(i) Audit Risk – the risk of that the auditor expresses an inappropriate audit
opinion. i.e. that they give an unmodified audit opinion when the financial
statements contain a material misstatement.

Audit Risk

Inherent Risk*Control Risk*Detection Risk

(ii) Inherent Risk – This is the susceptibility of a class of transaction, account

balance or disclosure to a misstatement that could be material, either
individually or in aggregate, before consideration of related controls, this is
the risk that a misstatement occurs on the first place.
(iii) Control Risk – Control risk is that a misstatement will not be prevented, or
detected and corrected on a timely basis by the entity’s internal controls.
This is either due to the internal control system being insufficient in the
circumstances of the business or because the controls have not been applied
effectively during the period.
(iv) Detection Risk – This id the risk that the procedures performed by the
auditor to reduce audit risk to an acceptable level will not detect potentially
material misstatements, either individually or in aggregate.
(b)

Identified Risk Audit Risk

Bonus Scheme
Falling Profit figures
Customers repackaging perfumes under If customers brands incur any bad press it
their own brand name
Client is based in multiple locations
Finance director only working part time The finance director of the company is
Managers and Directors may put controls
in place to speed up the manufacturing to
exceed the production level in order to
gain the bonus. This will create poor
quality products, drop in sales, bonus will
still be paid out
can be carried onto Collins Cosmetics,
therefore affecting goodwill and sales
figures.
Stock held at other locations may be
omitted from year end stock, controls
may be less effective
only working part time whilst the
company is aiming to make a profit and
gain a listing on the stock exchange,
auditors will not be able to communicate
with finance director in regards to
controls and financial statements of the
company due being away.
 Promotion of incompetent Sales Director

(c) If the auditor concludes there is a high inherent risk in the audit engagement, there
are risks resulting from conditions, events, circumstances, actions or inactions that
could adversely affect an entity’s ability to achieve its business objectives and
goals. Ultimately these business risks can lead to complications and deficiencies in
the accounting process, which can lead to fraud, error or omission.
1 (a)
(i)
Deficiencies in the Sales and Receivables System; invoicing incorrectly,
despatch notes not retained, input of week’s invoices into the computerised
computer ledger, computer system for receivables ledger not used, orders
recorded on 2 part order form.

(ii)
Invoicing incorrectly – The invoice is sent to the customer after the completed order
has been despatched from the warehouse, the customer may not pay for the product,
that would result in unpaid goods. Voyager should credit check their customers and
release goods after the invoice has been paid.

Despatch notes not retained – despatch notes are not retained because the filing
system is limited, no record of the despatched product is kept. If a customer does
not receive the product Voyager has no way of identifying if the product was
despatched or not, therefore they would have to send out another product. This can
be overcome if Voyager scans the despatch notes onto their system as they have no
filing space.

Input of week’s invoices into the computerised revenue ledger – Mr- Jones inputs
all the invoices into computerised ledger, the deficiency here is that Mr. Jones could
make a mistake and miss something out, this would mean missing income. Voyager
can overcome by having a second employee to check all the figures for all the
invoices inputted into the system.

Computer system for receivables ledger not used – Currently receivables are
inputted manually, there is a chance of error, Mr. Jones could make a mistake and
miss something off. Voyager can overcome this by implementing the computer
system as this way they have records on computer, and it would be less time
consuming.

Orders recorded on 2 part order form – The orders are currently taken on a 2 part
form by the sales representative, if the 2 part form is lost that will mean the sale is
lost. Voyager could create a control where once the sale is made the sales
executive calls it through to the accounts department and it is recorded on the
computer. Or order forms with 3 copies so the customer can have one as well. The
order forms should have unique numbers on the according date to make them easily
traceable.

(b)
(i)
Deficiencies in the purchases and wages control system; 25% of expense claims not
supported by receipt, send cheques to suppliers 60 days or older, Supplier
statements not retained, amending payables master file with details of new supplier.
 (ii)
25% of expense claims not supported by receipt –Voyager are paying out for 25% of
employee expenses which might not have been for business use. Voyager can over
come this by making it a rule whereas expenses cannot be claimed unless a receipt is
shown; they could also introduce corporate cards where all expenses are put on the
card.

Send cheques to suppliers 60 days or older – Currently Mrs.Singh sends the cheques
to all suppliers that are older than 60 days, this is a deficiency as the amount the
cheques are going out for could be wrong. Mrs.Singh should wait for the invoices,
check it against the supplier details for payables and then send the cheque off.

Supplier statements are not retained – this is a deficiency because there is a chance the
new supplier statement could come in and put the reconciliation off balance, then
there would be no previous supplier statements to refer to. To overcome this Voyager
could implement a system where all supplier statements are either filed away or
scanned onto the computer.

Amending payables master file with details of new supplier – this is a deficiency as
the new suppliers are on the payables master file due to the verbal authority of the
executive director, they may not have been approved by the policy the Voyager use to
select their suppliers. The deficiency here is that because a printout of the
amendments is not recorded it will not be known which suppliers made are on the list
due the executive directors authority.
4 (a)
The management threat assumes that independence and objectivity will be impaired if
the auditor acts in a management role on behalf of the client.
As the auditor had decided to join Mart, there are a few issues here. Firstly Mart is
growing steadily and is in the acquisition process of companies in the same industry
sector, there is a chance once the auditor joins the board of directors of Mart, he/she
could disclose vital information regarding the financial position of Mart’s
competitors.

The auditor should follow the fundamental principles;

Objectivity – members should not allow bias, conflicts of interests or undue influence
of others to override professional or business judgements.

Professional behaviour – Members should comply with relevant laws and regulations
and should avoid any action that discredits the profession.

Professional competence and due care – Members have a continuing duty to maintain
professional knowledge and skill at a level required to ensure that a client or employer
receives competent professional service based on current developments in practice,
legislation and techniques.

Integrity – Members should be straightforward and honest in all professional and

business relationships.

Confidentiality – Members should respect the confidentiality of information acquired

as a result of professional and business relationships and should not disclose and such
information to third parties without proper and specific authority or unless there is a
legal or professional right or duty to disclose. Confidential information acquired as a
result of professional and business relationships should not be used for the personal
advantage of members or third parties.

To mitigate any threats to objectivity which may arise, the audit firm first has to
identify the threats, then evaluate the risk, evaluate whether the safeguards are in
place, and then take necessary corrective action.