Auditing and Assurance CPA revision questions and answers

This revision questions and answers can be used by students currently on the following Kasneb programmes:

Certified public accountants(CPA)

Revision questions paper 1

Auditing and assurance revision questions paper 1 part 1

What is an audit?

The explanatory foreword to the International Standards on Auditing (ISA) describes audit as the independent examination of and expression of an opinion on the financial statements of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation.

The objective of an audit is to enable auditors to express an opinion whether the financial status give a true and fair view and have been properly prepared in accordance with the relevant statutory requirements.

Explain the importance of audit to a limited liability company.

Importance of audit to a limited company

  • An audit protects the interests of the shareholders who are separated from the management of the company. This is especially
    the case for minority shareholders who have little say in the management of their company.
  • An audit being an independent examination of the financial statements gives credibility to the financial statements. The various
    users can therefore place reliance on them;
  • The audit ensures that the directors have fulfilled their statutory obligations and acts as a precaution against frauds on the part of employees.
  • The auditors experience will enable him to make recommendations on ways of improving the accounting, internal control system and in the standards of the company‟s reporting to its members.
  • An audit ensures that the financial statements are prepared in accordance with the generally accepted accounting standards. This improves the comparability of the financial statements.

In addition to shareholders, many different parties are interested in the  audited accounts of a company. Name FOUR such parties and state the significance of audited accounts to each one of them.

  • Tax authorities: Audited accounts give a true picture of the entity‟s profits and can be relied upon by tax authorities for the assessment of tax on the company.
  • Lenders:- audited accounts are credible and therefore can be  relied upon to assess the credit worthiness of the entity.
  • Employees – Are interested in whether the entity is a going  concern, which can be established from the audited accounts to
    ensure job security.
  • Employees – Are interested in whether the entity is a going  concern, which can be established from the audited accounts to
    ensure job security.
  • Customers – those who rely on entity‟s products are interested on  whether the entity will be producing in future (going concern) or whether they ought to look for alternative suppliers.
  • Potential/actual investors need to know whether investing in the  company is worthwhile i.e are they bound to benefit financially in terms of dividends and capital gains.

Describe the following types of Audits:
i. Statutory Audits;

Statutory audits  are carried out as per the requirements of the various statutes e.g. the Companies Act cap 486 requires that all public limited companies must have their financial statements subjected to an independent audit. The objectives of the audit are to express an opinion as to whether the balance sheet and the profit and loss account show a true and fair view. The rights and duties of the auditor are laid out in the Companies Act or the relevant statute. The powers of appointment of the auditor are
vested on the shareholders.

ii. Internal Audits;

Internal audits is an appraisal or monitoring activity established by management for the review of accounting and Internal Control System as a service to the entity. It examines, evaluates and reports to management on the adequacy and effectiveness of the systems. Other activities include: –
a) Examination and evaluation of financial and operating information.
b) Review of the economy, efficiency and effectiveness of operations  including non-financial controls
c) Review of compliance with external laws and regulations and  internal policies and procedures.
d) Carrying out special investigations including fraud investigations as  required by management.

NB:It is important to note that internal audit is a management function established to carry out a continuous appraisal on the internal controls system and report this to management.

iii. Private Audits;

Private audits  are audits that are not governed by the Companies Act or any other statute. These are performed by an independent auditor because the owners, members or other interested parties require them and not because the law requires them to be carried out. Private audits are carried out for organisations such as NGOs, partnerships, clubs and charities among others. The appointment of the auditor is usually carried out as a private contract between the auditor and the relevant stakeholder. The scope and objective of the work is determined by the agreed terms between the auditor and the client. The auditors‟ rights and duties are also laid out in the contract.

iv. Management Audits;

Management audits relate to the review and evaluation of the management structure within the organization and the performance of the management. It includes the appraisal of the environment for the exercise of management skills as well as the measurement of
external management performance against established criteria.

What are the similarities and differences between internal and  external audits?

Similarities between internal and external audits.

  • Both functions require the auditors to adhere to the international standards on auditing.
  • Both are carried out by competent auditors
  • Both are interested in evaluating and testing the effective operations of the internal control system
  • Both functions give recommendations to management on ways of improving the internal control system. The external auditor
    achieves this through the management letter, which is addressed to management.

Distinguish between internal audit and internal check.

Difference between internal audit and internal audit check.

Area of difference Internal Auditor External auditor
1. Scope Determined by management Determined by statute
2. Approach To ensure accounting
system is efficient and
providing management with
accurate information
To satisfy himself that the financial statements to be
presented to the shareholders portray a true and fair view
3. Responsibility Report to management Report to the shareholders of the company.

 

Give four examples of internal audit work that may e used by the external auditor.

Examples of internal audit work that can be used by the external auditor includes:

  • The physical verification of assets. The internal auditor could  undertake a physical verification of assets to confirm their existence; the results of such work could be relied upon by the external auditor.
  • To undertake on behalf of the external auditor to observe the stock take exercise, cash counts, and  attendance at wage payments.
  • Point out areas where there have been fundamental changes in  accounting, management and internal control system all of which could have an impact on the audit approach;
  • The internal auditor could also perform some substantive procedures on behalf of the external auditor such as evaluating the recoverability of debtors balances.

 

Explain why auditors carry out circularisation of debtors.

The most effective way of confirming debtor balances is by the auditor communicating directly with the customers of the client to
seek direct confirmation of the amounts outstanding.  Circularization satisfies the following objectives: –

  • Strong evidence whether debtors are overstated – Customers can usually be relied upon to complain if the balance they are supposed to owe is overstated (i.e. completeness and accuracy). However, it is a weaker source of evidence on whether debtors are understated – customers are less likely to complain if the balance is too small.
  • Evidence of the functioning of controls i.e. if the ICS over debtors is strong, there will be few discrepancies regarding what is stated by the debtors and what is stated in the clients records.
  • Evidence of the efficiency of cut-off procedures if carried out at year end.
  • Evidence regarding irregularities such as “teeming and lading” and window dressing.
  • Provides reliable evidence on existence of debtors.

Distinguish between „positive‟ and „negative‟ debtors circularisation  procedures.

In positive circularization the debtor is asked to confirm to the  auditor directly if he agrees or disagrees with the balance whereas in
negative circularization, the customer is only asked to respond if he disagrees with the balance stated in the request letter. Positive
circularisation is mainly used where the debtors‟ balances are material and the internal controls are not very reliable while negative
circularisation is mainly used where the debtors‟ balances are not very significant.

 

Describe in detail the work you would carry out in scrutinizing the replies to the debtors circularisation and in confirming whether the
debtors balances are collectable in the following situations:

i. where the debtor does not agree with the balance and states a difference.

The fact that the debtor has replied and stated a different balance confirms the existence of the debtor. However, the auditor will need
to carry out the following procedures to confirm completeness, accuracy and collectability of the debt:

  • Evaluate the causes of the difference between the balance in the client‟s ledger and the amount the debtor has confirmed. This could be as a result of either invoices or payments in transit.Invoices in transit refers to instances where the client has sent invoices for sales to the customer but these have not been recorded in the customer‟s books. Payments in transit refers to instances where the debtor has made some payments but these have not yet reached the client or maybe the client has received the payment but has not posted this in the ledger. Where payments has received the payment the client will need to post these in the ledger;
  • Other variances should be investigated and management should provide appropriate explanations. Where necessary adjustments should be made record any unrecorded transactions;
  • Check any payments received after year end as evidence of collectability of the debtors balance;
  • Analyse the account to confirm that the balance is within the credit terms and discuss with management the recoverability of
    the balance.

ii. where the debtor reports that he cannot confirm the balance.

  • The fact the debtor has replied confirms existence;
  • To confirm the completeness of the amount the auditor should analyse the debtors account to ensure that the balance is made of specific invoices supporting sales to the debtor;
  • The auditor should discuss with management the collectability of the balance.
    iii. where no reply is received from the debtor.

iii) Where no reply has been received

Where no reply has been received implies that the auditor has not been able to confirm the existence of the debtor. The auditor will
need to carry out alternative audit procedures, which include:

  • Inspecting correspondence between the client and the debtor. This will assist in confirming existence of the debtor;
  • Analyzing the debtor‟s account to verify that the balance is made up of specific invoices. The auditor can inspect a sample of these invoices;
  • Verifying if there are any payments that have been received after the year-end. This will confirm existence and collectability
    of the balance. Where the entire amount has been settled in one single payment this could also assist in confirming the
    completeness of the balance;
  • The auditor should discuss the account with management if there are any indications that the balance is doubtful.

Auditing and assurance revision questions paper 1 part 2

Explain why auditors seek letters of representation.

  • Auditors seek a letter of representation in order to obtain written audit evidence on matters that are material to the financial statements when other sufficient appropriate audit evidence cannot reasonably be expected to exist (ISA 580 ‘Management Representations’).
  • Representations may be the only evidence, which can reasonably be expected to be reasonably be expected to be available. Such matters may include management’s intention to hold an item for long-term appreciation.
  • The letter also ensures that directors acknowledge their collective responsibility for the presentation and approval of the financial statements. The letter is signed by those with knowledge of the matters concerned, on behalf of management.

 

List the matters commonly included in the letter of representation.

  • Confirmation of responsibility for, and approval of, the financial statements.
  • Confirmation that all of the accounting records, and all related documentation (such as minutes of management and shareholder meetings) have been made
    available, and that company transactions have been properly reflected therein.
  • Confirmation of the expected outcome of legal claims. Confirmation of company plans in relation to certain tax provisions.
  • Confirmation of the completeness of disclosure of related party transactions.  Confirmation that there have been no post-balance sheet events that require revisions to the financial statements.

Explain why it is important to discuss the content of the letter of representation at an early stage during the audit.

  • It is important to discuss the contents of the letter at an early stage because directors may disagree with what the auditors wish them to sign.
  • It is important in such cases for negotiations to take place and the letter to be redrafted until it is acceptable to both auditor and client.
  • The management representation letter is often regarded as a critical piece of audit evidence and if it is left to a late stage in the audit, when there is pressureon auditors and clients alike, negotiations may be difficult.

Explain why management is sometimes unwilling to sign a letter of representation and describe the actions an external auditor can take if management refuses to sign a letter of representation.

  • Management is sometimes unwilling to sign because they feel that auditors should be able to obtain independent evidence in relation to the relevant matters. Alternatively, they may feel that the auditors are trying to shift responsibility for the audit to them;
  • Sometimes, management is genuinely uncertain about whether it is sure of the matters included. However, there are occasions on which management is trying to ‘hide’ from the auditors the fact that the income recorded is incomplete, or the fact that there is an outstanding undisclosed legal claim against the company, for example;
  • Auditors should attempt to negotiate an agreement, as noted above. A formal letter may not be necessary, if management is able to provide some other written confirmation, such as a note of a meeting. Alternatively, a list of issues may be taken to the client to establish exactly which representations are causing the problem, and the letter redrafted;
  • If management still refuses to sign, and the auditor feels that the matter is critical to the financial statements, it may be necessary to qualify the audit report with an ‘except for’ (or even disclaimer of) opinion, on the basis of a limitation in the scope of the audit.

Auditing and assurance revision questions paper 1 part 3

Define the term “interim audit”?

Interim audit is an audit carried out within the financial year, normally after six to nine months after the start of the financial period. The auditor carries out some audit while leaving the bulk of the work to be audited in a final audit.

The results of audit tests carried out during the interim audit form part of final  audit, since they will be subjected to further tests at the final audit stage.

Identify any four circumstances under which an interim audit would be ideal.

Circumstances under which interim audit would be ideal.

i. Where the company is empowered by the Articles of Association to pay interim dividends, in which case the auditor will ascertain the company‟s interim performance for this purpose.
ii. Where it is a law requirement for a company to publish interim performance e.g. banks.
iii. Where an organization is operating in a volatile market and the owners wish to keep track of the interim performance.
iv. Where there is need to test the adequacy and compliance of the system of internal control.

List and briefly explain five disadvantages of an interim audit.

Disadvantages of interim audit.

i) Cost
The audit process is made expensive especially for small firms, hence it may only be suitable for large companies with many transactions.

ii) Disruption
Interim audit may disrupt client operations since the auditor has to be attended to by client staff for information.

iii) Alteration of entries
Client staff may alter already audited figures before the year end.

iv) Unanswered questions
Questions posed at the interim audit stage may remain unanswered and this may distort final opinion as answers obtained later may not be of substance.

v) Inadequate diligence
Due to the fact that final audit will be performed anyway, the interim audit may not be done with the seriousness it deserves.

vi) Note-taking

Interim audits entail a lot of note-taking e.g. of interim balance carried forwaror even budgeted performance figures to be used to facilitate final audit.

vii) Dependency Problem
Client staff may be dependent upon the interim auditing to solve their accounting problems which may compromise the objectivity of audit staff.

Briefly explain the following terms as used in auditing:
(i) Vouching audit (2 marks)

A voucher is a documentary evidence of a transaction as recorded in the books  of account e.g. receipt, invoice etc. Vouching is the process of examining a voucher with the view of proving whether it has been properly authorized, recorded and that the amount is reasonable. Vouching audit thus means the examination of vouchers with the view of proving the true and fair view of the client‟s financial position of the business as at the balance sheet date. It‟s applied when the auditor feels that the internal controls of the client is not promising.

(ii) Inherent risk. (2 marks)

This is part of the audit risk and is basically defined as the susceptibility of an account balance or class of transactions to misstatements that could be material, individually or when aggregated with misstatements in other balances
or classes, assuming that there were no related internal controls.

(iii) Control risk (2 marks)

Also part of audit risk and is defined as a risk that a misstatement that could occur in an account balance or class of transactions and that could be material individually or when aggregated with misstatements in other balances or classes, will not be prevented or detected and collected on a timely basis by the accounting and internal control systems.

(iv) In depth audit tests. (2 marks)

In depth Audit Tests These tests are aimed at justifying the figures in the books of account, and eventually, in the final accounts themselves. The tests are designed for 2 purposes:

1. Support the figures in the account and
2. Where errors exist, to assess their effect in monetary terms.

More related revision materials