Chapter# 01 (Concept and need for assurance)

ISA 200 and Basics of Auditing

1. Briefly explain any four elements of an assurance engagement. (04)

A: An assurance engagement performed by a practitioner consist of the following elements:

(i) Three party relationships: An assurance engagement is a three party relationship consist of practitioner, responsible party and intended users.

(ii) Subject matter: This is the data such as the financial statements that have been prepared by the responsible party for the practitioner to
evaluate.

(iii) Evidence: Information used by the practitioner in arriving at the conclusion on which their opinion is based. This must be sufficient and
appropriate.

(iv) Assurance Report: The report containing the practitioner's opinion. This is issued to the intended user(s) following the collection of evidence.

2. You are the audit manager responsible for the audit of Beachwood Textile Limited (BTL). At the planning stage, your audit team has assessed
that there is no significant risk of material misstatement due to fraud and management override of controls. The audit team's assessment is
based on the fact that BTL has been an audit client of the firm for the last 10 years and no material misstatement had been reported in the
previous years.

Required: Guide your audit team with regard to their assessment of risk. (08)

A: When planning and performing an audit, we should adopt an attitude of professional skepticism. We should have an attitude that includes a
questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.

We should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding our past experience of the honesty and
integrity of the entity's management and those charged with governance.

Although the level of risk of management override of controls will vary from entity to entity, the risk is nevertheless present in all entities. Due to
the unpredictable way in which such override could occurs, it is a risk of material misstatement due to fraud and thus a significant risk Irrespective
of our assessment of the risks of management override of controls, we shall design and perform the audit procedures for management override of
controls.

Assessing the risk of fraud as non-significant is also not correct based on the presumption that BTL has been the firm's client for the last 10 years
and no material misstatement had been reported in the previous years. The audit team should identify and assess the risk of material
misstatement due to fraud at the financial statement level and at the assertion level. Furthermore, the audit team shall consider that there is a risk
of fraud in revenue recognition which may result in a material misstatement unless justifiably rebutted.

3. Amjad is the chief executive and major shareholder of a newly incorporated private limited company. He has offered your firm to be the first
external auditor of the company. During a meeting, he was of the viewpoint that statutory audit exists because it has been legally mandated
and it does not add value to business. However, he believes that audit helps in finding all major frauds within the company.

Required: Discuss how you will respond to the viewpoints of Amjad regarding the audit of financial statements. (07)

A: Our response to the viewpoints of Amjad would be as follows:

(i) It is not correct that the statutory audit does not add value to business. In fact:

• it increases the credibility of the financial statements. This is important to potential lenders, who may insist on the company having an audit as
a pre-condition for lending money.

• it confirms to management that they have performed their statutory duties correctly.

• it provides assurance to management that they have complied with nonstatutory requirements.

• it helps on establishing accountability of the management, especially when the business owners (shareholders) have hired others to manage
their business, as is typically in modern corporations.

• the need for assurance also arises because there is a complexity of transactions, information and processing systems which renders difficult in
determining the proper presentation without a review by an independent expert.

• it provides feedback on effectiveness of internal controls. Where internal controls are weak or inadequate, the auditor will give
recommendations for improvement. This will assist management in improving the internal controls and reducing the risk(s).

(ii) The objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness of the view presented by the financial
statements. Its objective is not primarily the prevention or detection of all or major fraud. In fact, it is primarily the responsibility of

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management to establish systems and controls to prevent or detect fraud. Further, the auditor is concerned with fraud that might impact
the financial statements and is therefore concerned with the risk of material fraud.

4. Aslam is a junior member of your audit team. During an informal discussion with your team members, Aslam has inquired you about the
reasons of emphasizing on professional skepticism when honesty and integrity of the management is not questionable based on prior
experience. Briefly respond to the inquiry of Aslam. (03)

A: The past experience regarding honesty and integrity of the entity's management and those charged with governance is critical for the auditor.
However, a belief that management and those charged with governance are honest and have integrity, does not relieve the auditor of the need to
maintain professional skepticism. In fact, maintaining of professional scepticism throughout the audit helps the auditor to reduce the risks related
to:

• overlooking unusual circumstances.

• over generalizing when drawing conclusions from audit observations.

• using inappropriate assumptions in determining the nature, timing and extent of the audit procedures and evaluating the results thereof.

• critical assessment of audit evidence.

• identification of material misstatement.

4. A friend of yours has invested in the shares of Ascender Limited. On receiving the company's annual report, he made the following comments:

"The auditor has expressed an unqualified opinion. Since the auditor must have arrived at his opinion after testing majority of the transactions,
therefore the financial statements are correct in all respects. Since no control deficiencies and fraudulent conduct had been reported by the
auditor, I can safely invest further amount of money in the company because there is no risk that I will lose my money due to fraudulent conduct
of management or misrepresentations in the financial statements."

Required:

Write a letter to your friend to remove his misconceptions related to the audit of financial statements including brief explanation of your point of
view. (08)

A: To: ABC

Dated: 4 September 2018

Subject: Explanation Of Misstatement Related To Audit

I received your comments on the audit report of Ascender Limited and want to clarify that:

The auditor, because of inherent limitation of audit, cannot reduce audit risk to zero. Therefore, auditor provides a reasonable assurance but not
absolute assurance that financial statements are free from material misstatement.

In order to provide reasonable assurance, auditor plans and performs audit procedures based on the concept of materiality and assessment of audit
risk. Auditor does not aim to examine all or the majority of transactions. Based on professional judgment about the effectiveness of the selection,
auditor applies audit procedures using 100% selection, specific selection or audit sampling. Thus, selective examination of specific items does not
provide audit evidence about the whole population and conclusion drawn from a sample may be different if the entire population were subject to
the same procedure.

The management is responsible for the internal controls for the preparation of financial statements and auditor is responsible to obtain
understanding of the same in order to design audit procedures. Auditor is not required to express opinion on effectiveness of internal controls.

Furthermore, the auditor is responsible to provide reasonable assurance not the absolute assurance that financial statements as a whole are free
from material misstatement, whether caused by fraud or error. As stated above, the principle of materiality will also be applied here in case of
misstatement due to fraud.

The objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness of the view presented by the financial
statements. Its objective is not the prevention or detection of fraud.

Moreover, there is a possibility that despite all due care, the auditor is unable to detect a fraud especially those involving management override of
controls.

I hope above explanations would enhance your understanding regarding auditor's roles and responsibilities in the audit of financial statements.

Yours faithfully,

XYZ

6. In response to an audit engagement letter sent to Roof Limited (RL), Mr. Aziz Aslam, the new chief executive of RL has requested your firm to
provide absolute assurance in the audit report.

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Required:

Draft an appropriate reply mentioning any four reasons why the above request cannot be complied with. (05)

A: To CEO, APL.

An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the auditor's ability to detect material
misstatements. These limitations arise because of the following:

(i) The use of testing/sampling techniques;

(ii) The limitations that exist in any accounting and internal controls system (for example, the possibility of collusion);

(iii) The fact that most audit evidence is persuasive rather than conclusive; and

(iii) The work undertaken by the auditor to form an opinion is permeated by judgment.

Further, other limitations may affect the persuasiveness of evidence available to draw conclusions on particular financial statement assertions (for
example, transactions between related parties).

7. Discuss the concepts of stewardship and accountability in the context of a limited company and fair presentation (true and fair view) in
relation to the financial statements.

A: Stewardship:

The directors have a stewardship role. They look after the assets of the company and manage them on behalf of the shareholders.

Accountability:

As agent of the shareholders, the board of directors is accountable to the shareholders. The directors show their accountability to the shareholders
by preparing annual F /S and presenting them to the shareholders for discussion and approval.

Fair presentation (True and fair view):

Although the phrase 'true and fair view' has no legal definition, the term 'true' implies free from error, and 'fair' implies that there is no undue bias
in the F /S or the way in which they have been presented. In preparing the F /S, a large amount of judgement is exercised by the directors. Similarly,
judgement is exercised by the auditor in reaching his opinion. The phrases 'true and fair view' and 'present fairly' indicate that a judgement is being
given that the F /S can be relied upon and have been properly prepared in accordance with an appropriate FRF.

8. In relation to the audit report on financial statements and the contents thereof ( under revised/new ISAs), discuss the appropriateness or
otherwise of the following statements:

(b) Reasonable assurance is a high level of assurance and is a guarantee that if audit is conducted in accordance with ISAs, it will always detect
a material misstatement whenever it exists. (03)

(c) The auditor obtains an understanding of controls relevant to the audit in order to design audit procedures that are appropriate in the
circumstances and also for the purpose of expressing an opinion on the effectiveness of the entity's internal control.(03)

A: (b) The statement is appropriate to the extent that reasonable assurance is a high level of assurance. However, second statement is not
appropriate as reasonable assurance is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement,
due to inherent limitations of audit.

(c) The statement is appropriate to the extent that auditor has to obtain an understanding of internal control relevant to the audit in order to
design audit procedures that are appropriate in the circumstances. However, the second statement is not appropriate because the auditor is not
required to express an opinion on the effectiveness of internal controls in conjunction with the audit of the F /S.

9. Briefly explain with examples, the different levels of assurance that can be provided to an assurance client. (03)

A: Reasonable Assurance:

A high (but not absolute) level of assurance provided by the practitioner's conclusion expressed in a positive form. The reasonable assurance is
usually expressed in case of statutory audits.

Limited Assurance:

A moderate level ofassurance provided by the practitioner's conclusion expressed in a negative form. The negative form of assurance is usually
expressed in case of review engagements.

10. Briefly describe the meaning of professional judgment and explain its importance in the context of an audit (04)

A: Professional Judgment:

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It means making informed decisions by a professional accountant about the courses of actions that are appropriate in the circumstances during an
audit engagement, in the context of auditing, accounting and ethical standards and by applying the relevant training, knowledge and experience.

Why Professional Judgment is necessary;

Professional judgment is essential to the proper conduct of an audit. This is because interpretation of relevant ethical requirements and the ISAs and
the informed decisions required throughout the audit cannot be made without the application of relevant knowledge and experience to the facts
and circumstances.

Professional judgment is necessary in particular when taking decisions about:

• Materiality and audit risk

• The nature, timing and extent of audit procedures used to meet the requirements of the ISAs and gather audit evidence.

• Evaluating whether sufficient appropriate audit evidence has been obtained to achieve the objectives of the auditor.

• The evaluation of management's judgments in applying the entity's AFRF and accounting policies.

• The drawing of conclusions based on the audit evidence obtained, for example, assessing the reasonableness of the estimates made by the
management in preparing the F /S.

11. List three reasons why audit evidence is considered to be persuasive rather than conclusive. (03)

A: Audit evidence is persuasive rather than conclusive because of the following reasons:

(i) The auditor gathers evidence on a test basis (the sample may or may not be representative).

(ii) People make mistakes (both client and auditor).

(iii) Documents could be forged (increasingly easy with digital technology)

(iv) The client's personnel may not always tell the truth.

12. Briefly highlight the management's responsibilities relating to the financial statements? (07)

A: a) The management's responsibilities in relation to the F /S include the following:

• The overall responsibility for the preparation and presentation of the F /S.

• Identifying the FRF to be used in the preparation and presentation of the F /S.

• Designing, implementing and maintaining internal controls relevant to the preparation and presentation of F /S that are free from material
misstatement whether due to fraud or error.

• Selecting and applying appropriate accounting policies.

• Making accounting estimates that are reasonable in the circumstances.

Companies Act 2017

1. Haris & Company, Chartered Accountants was appointed as the auditor of Cactus (Private) Limited (CPL) for the year ending 31
December 2021. Haris, the only audit partner of Haris & Company, passed away on 5 September 2021. No other auditor has yet
been appointed by CPL.

Required:

State the requirements of the Companies Act, 2017 for the appointment of auditor in the above situation. (03)

A: Death of Mr. Haris has caused casual vacancy in the office of auditor. The board shall fill this vacancy in the office of auditor within
30 days. If the board fails to fill up the casual vacancy within 30 days, the commission may of its own motion or on as application
made to it by the company or any of its member direct to make good the default within the specified time. In case company fails to
report compliance within the specified period the commission shall appoint auditors. Any auditor appointed to fill the vacancy shall
hold the office until the conclusion of the next annual general meeting.

2. Salman is the shareholder of Polkadot Limited (PL) and wants to appoint auditor other than the existing auditor as proposed by
the board.

Required:

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In the light of the Companies Act, 2017 briefly explain the process that Salman should follow in the above situation. Also discuss
the requirements that PL should follow. (05)

A: Salman should follow the following process if he alone or together with other willing shareholders, holds 10% shareholdings in PL:

• The shareholder(s) should first obtain the consent of the proposed auditor.

• A notice should be given to PL in this regard not less than seven days before the date of the annual general meeting.

PL shall forthwith send a copy of notice received from shareholder(s) to the retiring auditor and shall also post it on its website.

Since an auditor, other than the retiring auditor is proposed to be appointed, PL shall ensure that:

• the retiring auditor is given an opportunity to make a representation in writing to PL at least two days before the date of general
meeting.

• representation received from the retiring auditor is read out at the meeting before taking up the agenda for appointment of the
auditor.

3.In the light of Companies Act 2017, describe the requirements for cost audit and person authorized to conduct it. (04)

A: • Where any company is required under the Act to include in its books of accounts the particulars of cost accounts.

• The Commission may direct that an audit of cost accounts of the company should be conducted in the order subject to
recommendation of the regulatory authority supervising the business of relevant sector.

• The audit of cost accounts will be conducted by Chartered Accountant or Cost and Management Accountant and will have same
powers, duties and liabilities as an auditor of the company.

4. Wealthy Bank Limited (WBL) is considering to appoint external auditor for the year ending June 2020. WBL has shortlisted the
following three audit firms for appointment as external auditor and has presented certain matters relating to each of them for
your consideration:

Rao Arif & Company, Chartered Accountants

The firm has recently admitted a new partner who worked as CFO till June 2017, of Noor Engineering Limited, a subsidiary ofWBL.

Hatim Tughiaq &Company, Chartered Accountants

One of the partners in the firm has obtained a loan from WBL of Rs. 5 million. The firm has informed that the partner would not
be able to repay the loan till 2021.

Rashid Kareem & Company, Chartered Accountants

Rashid, one of the partners in the firm, has several commercial properties in Lahore. He has rented out five properties to WBL for
its branch operations.

Required: In the light of the Companies Act, 2017 discuss whether any of the above firms can be appointed as external auditor
ofWBL. (06)

A: Rao Arif & Co.

Under the provision of Companies Act, 2017, a person who is, or at any time during the preceding three years was a director, other
officer or employee of the company is not eligible for appointment as auditor. Furthermore, a person will not be qualified for
appointment as auditor of a company if he is disqualified for appointment as auditor of any other company which is that company's
subsidiary or holding company. Therefore, being the former CFO of WBL's subsidiary will make Rao Arif & Co. ineligible for
appointment as external auditor.

Hatim Tughlaq & Co.

Under the provision of Companies Act, 2017, a person who is indebted to the company other than in the ordinary course of business
of such entities cannot be appointed as the auditor. Since it is in the ordinary course of WBL to grant loan therefore HatimTughlaq &
Co. can be appointed as external auditor WBL.

Rashid Kareem & Co.

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A person or a firm who, whether directly or indirectly, cannot be appointed as auditor if it has business relationship with the
company other than in the ordinary course of business of such entities. If properties are rented out in the ordinary course of
business than Rashid Kareem & Co. can be appointed as the external auditor of WBL.

5. (a) Under the Companies Act, 2017, state the procedure to be followed if the board of directors decides to recommend the
reappointment of existing auditor for the next year. (02)

(b) The board of directors of Alpha Limited intends to re-appoint the existing auditor for the next year. However, Javed, a
shareholder of the company, wants to appoint a different auditor.

Required:

Briefly explain the procedure that Javed should follow. Also state the responsibilities of the board in this regard.(6)

A: (a) Following procedures shall be followed for appointment of the existing auditor for the next year:

• The board shall first obtain the consent of the proposed auditor.

• A notice shall be given to the members with the notice of general meeting.

• On the appointment of the auditor the board shall ensure that, within fourteen days from the date of appointment of the
auditor, an intimation is sent to the registrar thereof, together with the consent in writing of the appointed auditor

(b) Procedure for shareholder(s):

Javed should follow the following process if he alone or together with other willing shareholders, holds 10% shareholdings in Alpha
Limited:

• The shareholder(s) should first obtain the consent of the proposed auditor.

• A notice should be given to the company in this regard, not less than seven days before the date of the annual general meeting.

Responsibilities of the board:

The company shall forthwith send a copy of notice received from Javed to the retiring auditor and shall also post it on the company's
website.

Since an auditor, other than the retiring auditor is proposed to be appointed, the board shall ensure that:

• The retiring auditor is given an opportunity to make a representation in writing to the company at least two days before the
date of general meeting.

• Representation received from the retiring auditor is read out at the meeting before taking up the agenda for appointment of the
auditor.

6. Under the Companies Act, 2017 identify the situations in which the Commission may appoint a person to fill the vacancy of an
auditor. (03)

A: The Commission may appoint a person to fill the vacancy in the cases if:

• The company fails to appoint the first auditors within a period of 90 days of the date of incorporation of the company;

• The company fails to appoint the auditors at an annual general meeting;

• The company fails to appoint an auditor to fill up a casual vacancy within thirty days after the occurrence of the vacancy;

• The appointed auditors are unwilling to act as auditors of the company.

7. On 5 March 2018, HSB & Company, Chartered Accountants (HSB) has been offered appointment as external auditor of Tahir
Limited (TL) for the year ending 31 December 2018. TL is the subsidiary of Crypto Bank Limited (CBL), which is audited by another
firm of chartered accountants.

Hatim, a partner of HSB is using credit card of CBL and the balance outstanding against it on 28 February 2018 was Rs. 1.1 million.
Hatim plans to clear the dues by 30 July 2018, which is well before the commencement of audit. It is expected that the audit
planning activities will commence from 1 November 2018.

Required:

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Comment on the above situation in the light of Companies Act, 2017.

A: A person shall not be qualified for appointment as auditor if he/she is indebted to the company or any of its holding or subsidiary
company other than in the ordinary course of business of such entities. Further, a person who owes a sum of money not exceeding
one million rupees to a credit card issuer shall not be deemed to be indebted to the company.

Hatim's plan that he would pay off all his dues before the commencement of audit is not valid, as the auditor appointed in the
general meeting holds the office from the conclusion of that meeting until the conclusion of the next annual general meeting. If the
firm intends to be appointed as the auditor of TL, Hatim would have to reduce the amount due on his credit card to less than Rs. 1
million prior to the firm's appointment as the auditor of TL.

8. Comment on each of the following situations with reference to the appointment of external auditors in accordance with the
requirement of the Companies Act, 2017.

(a) Bilal and Company, Chartered Accountants has received an offer for appointment as auditor of Dawood Limited (DL). Ghalib,
a partner in Bilal and Company holds 100,000 Term Finance Certificates of DL. (03)

(b) Zain and Company, a firm of Chartered Accountants, has received an offer for appointment as auditor of Haris Limited (HL).
Imran, a partner in Zain and Company is also a partner in Pure Investment Associates, a partnership firm, which owns 100,000
shares in HL. (03)

A: (a) According to Companies Act 2017, there is no bar on Bilal and Company to be appointed as the auditor of DL as holding of
TFC's in the audit client is not prohibited under the provisions of the Companies Act, 2017.

(b) Zain and Company is ineligible for appointment as the auditor of HL as Imran is a partner in Pure Investment Associates, which
holds share in HL which is prohibited under the Companies Act, 2017. In order to be eligible for appointment, the fact of holding of
shares is required to be disclosed at the time of appointment.

Further, the shares are to be disposed-off within 90 days of such appointment.

9. Daud and Company, Chartered Accountants (DC), has received an offer for appointment as auditor of Jamal Limited (JL). Wife
of Daud is a Shareholder and Director in Royal Limited (RL).

Required: In accordance with the requirements of the Companies Act, 2017, state whether and under what circumstances DC
could accept the audit, under each of the following situations:

(a) JL holds 51 % shareholding in RL. (03)

(b) JL is an associated company of RL. (05)

( c) One of the directors in JL also holds 10% shareholding in RL. (02)

A: (a) JL holds 51 % shareholding in RL:

As Daud & Co. (DC) is not qualified for appointment as the auditor of RL due to directorship and shareholding of partner's wife in RL,
DC cannot be appointed as the auditor of any of its holding company i.e. JL.

(b) JL is an associated company of RL:

DL is ineligible to act as the auditor of JL, as the spouse of the partner holds shares in the associated company. However, since
Daud's wife holds shares prior to the appointment,

DC can be appointed as auditor of JL subject to comply with the following requirements:

• Disclose this fact to JL at the time of appointment as auditor.

• Divest her investment in RL within 90 days of appointment.

The directorship of Daud's wife in RL is not relevant for the appointment of DC as the auditor ofJL.

c) One of the directors in JL also holds 10% shareholding in RL:

Daud and Company can be appointed as the auditor of JL as there is no disqualification with respect to common shareholding in
another company, which is neither a subsidiary nor an associated company of the prospective audit client.

10. Justify giving reasons whether the appointment of auditors in the following cases is in compliance with the requirements of
Companies Act, 2017.

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a) Kashif and Company, Chartered Accountants (KC) has received an offer for appointment as the auditor of National Electricity
Limited (NEL). On the request of one of the partners of KC, NEL has allowed him to pay his last month's electricity bill amounting
to Rs. 150,000 in monthly installments of Rs. 15,000 each. (03)

b) Zubair and Company, Chartered Accountants (ZC) has received an offer for appointment as auditor of Haroon Limited (HL).
Saima, who is the wife of a partner of ZC, is the chief executive of Jameel Limited (JL). JL is an associated company of HL. Saima
also holds 100,000 shares in JL. (03)

A: (a) The appointment of KCC is valid, as 90 days have not lapsed in case of outstanding bill. However, the concerned partner should
be requested to settle the amount of bill before the expiry of 90 days as it will result in disqualification of KCC as auditors of NEL.

(b) • Appointment of Zubair and Company is valid.

• Under the Companies Act, 2017, there is no restriction on the appointment of spouse of chief executive of an associated
company as the auditor.

• The holding of 100,000 shares by Saima is required to be disclosed at the time of appointment. Further, these shares should be
disposed off within 90 days of the appointment.

11. Comment on each of the following situations with reference to the appointment of external auditors in accordance with the
requirements of the Companies Act, 2017.

a) ABC Limited and DEF Limited are associated companies on account of common directorship. Salman and Company, Chartered
Accountants (SCC) have received an offer for appointment as the auditor in ABC. Salman, a partner in SCC is the spouse of
Naveen, who is an employee in DEF. (02)

b) All the partners of Kashif Associates are Cost and Management Accountants. The firm has received an offer for appointment
as the auditor of Nihal (Private) Limited (NPL). NPL has a paid-up capital of Rs. 500,000 and 30% of its shares are held by Siyal
Limited which is a public company. (03)

A: (a) Salman and Company is eligible to be appointed as the auditor of ABC Limited because, Naveen is in the employment of DEF
which is an associated company and such employment has not relevance in the context of appointment of an auditor.

(b) Kashif Associates can be appointed as the auditor of NPL as qualification criteria mentioned for private companies having paid
up capital of less than Rs. 3 million under Companies Act 2017 is either a CA or CMA having certificate of practice from respective
institute or Firm of CAs/CMAs having such criteria as may be prescribed.

Holding of 30% shares of NPL by a public company is of no relevance.

12. The external auditors are normally appointed by the shareholders at the annual general meeting (AGM) of the company. State
the exceptions to this rule. (03)

A: Exceptions:

The Directors are allowed to:

• appoint the first auditors of a newly formed company within 90 days of incorporation.

• fill a casual vacancy; for example where the current auditors is no longer able to act

The Commission may appoint a person as an auditor to fill the casual vacancy, if neither the shareholders nor the directors have
appointed the auditors.

13, Your firm is the auditor of ABD Limited (ABDL). After the acquisition of majority shareholding in HG Motors (Private) Limited
(HGM), ABDL has decided to replace the existing auditors of HGM in the next annual general meeting and has approached you for
appointment as HGM's auditors for the next year.

Required:

In the light of the Companies Act, 2017 explain the procedures to be followed and formalities to be complied with for
appointment of your firm as the auditor of HGM. Also explain the rights of the existing auditors in this situation. (08)

A: Retirement of existing and Appointment of new auditor in an AGM

• Member(s) having at least 10% shareholding shall also be entitled to propose any auditor whose consent has been obtained.

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• A notice shall be given to company at least 7 days before the date of the AGM ..

• On receipt of such notice, company shall:

- Sent a copy of notice to the retiring auditor, forthwith.

- Post it on its website.

• Retiring auditor can make representation to company at least 2 days before AGM. It shall be read in AGM and it shall be
mandatory for auditor /representative to attend the meeting.

• Company shall intimate the registrar within 14 days of appointment/ removal/ casual vacancy together with the consent of
appointed auditor.

14. Comment on the following independent situations, with reference to the requirements of the Companies Act, 2017.

a) Mateen has recently joined Humayun and Company (HC), a firm of Chartered Accountants, as a Director with a commitment
of being promoted as a partner in due course. HC is the auditor of Strawberry Limited (SL). Mateen was previously associated
with SL as a Director. He left that job in 2011 but still holds 1,000,000 shares in SL. (03)

b) Khawar is a partner in Ghalib and Company, Chartered Accountants. He writes occasionally as a Free Lancer for 'Investment
Times', a leading Financial Magazine. Ghalib and Company are the auditors of Financial Press Limited, publisher of Investment
Times. Khawar has received a remuneration of Rs. 20,000 for his articles published in the magazine. (02)

c) Hamid is a partner in a Chartered Accountant firm and holds 100,000 Term Finance Certificates in Sona Fertilizers Limited
(SFL). Hamid's firm is considering to accept the audit of SFL. (02)

A: a) Since Mateen presently is not a partner in the firm, his firm can be the auditor of the company.

However, the firm at the time of admitting him as a partner, would need to ensure that:

the period of three years has lapsed from the date when Mateen resigned from the directorship of SL.

The shareholding of Mateen in SL is disposed off.

(b) Appointment of Kha war's firm is valid because he is not an employee of Financial Press Limited, and writes as a free lancer in
the newspaper published by the company.

(c) There is no restriction in the Companies Act, 2017 on holding the Term Finance Certificates issued by the audit client. Therefore,
the appointment of Hamid's firm as an auditor of SFL is valid.

15. Comment on each of the following independent situations in the light of the requirements of the Companies Act, 2017:

a) Khan and Company, Chartered Accountants has received an offer for appointment as auditors of Good Bank Limited (GBL).
Shahid is a partner in Khan and Company. He has obtained a personal finance of Rs. 450,000 from GBL and also holds GBL's credit
card. The outstanding balance on his credit card is Rs. 100,000. (03)

b) Abid is a partner in AFL & Company, Chartered Accountants. AFL has accepted an offer for appointment as auditors of Saima
Limited (SL). Saima, the wife of Abid, owned 11 % shares in SL. She also works as SL's General Manager Marketing. Saima
disposed of the shares held by her to Ab id's father, within 30 days of the appointment of AFL but continues to remain employed
in SL. (03)

A: (a) The credit card balance of Rs. 100,000 is within the limit allowed by the Companies Act, 2017 i.e. Rs. 1,000,000 outstanding
towards a credit card issuer. Moreover obtaining personal finance from GBL is in the context of being indebted, but due to the loan
being obtained from a bank having ordinary course of business, therefore Khan and Company is eligible to be appointed as auditors
of GBL.

(b) • Saima has rightfully disposed off the shares held by her on appointment of Abid's firm as auditors of SL.

• Holding of shares by Father of Abid and association of Saima as General Manager Marketing in SL is not in contravention of any
of the requirements of the Companies Act, 2017 and hence appointment of Abid's firm as an auditor is valid.

16. Comment on each of the following independent situations with reference to the applicable requirements of the Companies
Act, 2017.

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a) Jahangir (Private) Limited (JPL) has a paid-up capital ofRs. 2.5 million. Till recently, it was a wholly owned subsidiary of Malik
Limited (ML). Recently ML has disposed of 60% of its holding in JPL to Zubair Enterprises (ZE), a partnership firm. All the partners
in ZE are on the Board of Directors of ML. JPL intends to appoint Mr. Ahsan as its auditor. Mr. Ahsan is an MBA and his brother is
also a partner in ZE. (03)

b) A notice for appointment of Kashif and Company, Chartered Accountants (KCC) was received by Khanewal Limited (KL),
fourteen days before the AGM. The notice was served by Mr. Iqbal, who is a holder of 500,000 non-voting preference shares. (02)

c) Mr. Khan is a partner in a firm of Chartered Accountants. He also holds 70% shares in Khan Limited, (KL). Construction Bank
Limited (CBL) has granted a loan of Rs. 10 million to KL. Mr. Khan's firm has received an offer for appointment as auditor of CBL.
(02)

A: (a) • Holding of interest by brother of Mr. Ahsan or his brother being a director of ML, does not make Mr. Ahsan ineligible for
becoming the auditor of JPL

• However as per the Companies Act 2017, the auditor of a private company where paid up capital is less than Rs. 3 million
(provided it is not a subsidiary of a public company) shall be a CA or CMA having certificate of practice from respective institute or
Firm of CAs/CMAs having such criteria as may be prescribed

• Therefore appointment of Mr Ahsan is invalid as per the Companies Act 2017.

(b)

• A notice for appointment of auditor is required to be served by a member of the company having at least 10% shareholding, but
Mr. Iqbal is not a member of the company as he only holds non-voting shares.

• Hence, the notice served by him is not in order.

c) Appointment of Mr. Khan's firm is in order as Mr. Khan and KL are separate persons and indebtedness of KL cannot be termed as
indebtedness of Mr. Khan.

17. Comment on each of the following independent situations with reference to the applicable rules and regulations.

a) Zaman is a partner in a firm of Chartered Accountants and holds 5,000 shares in Mardan Limited (ML). His firm has received
an offer for appointment as auditors of Khanewal Limited (KL). ML and KL are subsidiaries ofDera Khan Limited (DKL). (03)

b) Bilal and Company has received an offer for appointment as auditors of IJK Limited. The total paid up capital of the company
is Rs. 990 million whereas its ordinary share capital is Rs. 130 million. Faryal, the wife of a partner in Bilal and Company, is a
director in LMN Limited which holds 50 million non-voting preference shares and 2 million ordinary shares in IJK Limited. Faryal
also holds 10,000 shares in LMN Limited. The par value of both types of shares is Rs. 10 each. (04)

A: (a) As per the Companies Act, 2017 a person shall not be appointed as auditor of a company, if he is disqualified for appointment
of any other company, which is that company's subsidiary or a holding company or a subsidiary of that holding company.

• Therefore, the firm cannot be appointed as an auditor of of KL as Mr. Zaman holds 5,000 shares in ML which together with KL is
a subsidiary of DKL.

• For appointment as the auditor of the company, Mr .Zaman is required to dispose off the shares in ML.

(b) • Bilal and Company, Chartered Accountants are eligible to act as the auditor of IJK Limited.

• IJK Limited is not an associated company of LMN Limited as LMN Limited holds 15.4% shares of IJK Limited. Therefore the wife
of the partner is not required to dispose of the shares in LMN Limited.

• Holding of non-voting shares is not relevant in determining the status of the company.

18. Comment on each of the following independent situations with reference to the applicable rules and regulations.

a) Waqar is a partner in Sohail and Company, Chartered Accountants, who are the auditors of Wasim Limited for the year 2011.
Aqib who was a partner of Waqar in 2008 in his food business, has recently been appointed as a Director of Wasim Limited. (02)

b) Aleem, Asif and Company (AAC), Chartered Accountants, has accepted an offer for appointment as auditors of Gui Limited
(GL). Kamal who is a partner in AAC, held 5000 shares in GL. Within thirty days of acceptance, he gifted the shares to his son
Kamran, who is a manager in AAC. (06 marks )

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c) Sajid, Hameed and Company (SHC), Chartered Accountants, are the auditors of Mir Hasan Limited (MHL). Kashif is a senior
manager in SHC and is being promoted as a partner. He teaches auditing in a college. The college is owned by a trust whose
trustees include two directors of MHL. (02 marks )

d) Saleem is a partner in Orange and Company, Chartered Accountants. He also practices as a sole proprietor and has received
an offer for appointment as auditor of ABC Financial Services Limited which is a subsidiary of DEF Bank Limited. The balance
outstanding against the credit card issued by DEF Bank Limited to a partner of Orange and Company is Rs. 1,110,500. (02 marks )

A: (a) Sohail and Company can continue to be the auditor of WasimLimited.Waqar was a partner of Aqib, two years back, whereas
the Companies Act, 2017 restricts only a present partner or the director of a company, from becoming the auditor of that company.

(b) According to the Companies Act, 2017, Kamal should disclose the fact that he holds shares in GL at the time of appointment. His
decision to disinvest shares of GL within thirty days is in accordance with the requirements of the Companies Act, 2017.

Disposal of shares to his son who is the manager in AAC, does not attract any contravention of the Companies Act, 2017 because
there is a bar on the holding of shares by the auditor, his spouse and minor children, however there is no bar on holding of shares by
his son Kamran who has attained the age of majority. Moreover, the Companies Act, 2017 and the Code ofEthics does not restrict
the Manager of the Audit firm from holding shares in the Company. Hence the appointment of AAC as an auditor of GL is in order.

(c) The appointment of Sajid, Hameed and Company (SHC), Chartered Accountants is in order as Kashif is not the employee of any
director of the company. He is employed by the trust in which the directors are the trustees.

(d) Orange and Company is not qualified for appointment as the auditor of ABC Financial Services as the credit card balance of a
partner exceeds the threshold limit of Rs. 1,000,000, set by the Companies Act, 2017. However, there is no restriction on the
appointment of Saleem, in his sole capacity, as an auditor of ABC Financial Services Limited as Orange and Company and his Sole
Proprietorship firm are separate entities.

19. Comment on each of the following independent situations in respect of appointment of auditors, with reference to the
applicable rules and regulations:

a) Guava and Company, Chartered Accountants, have received a request for appointment as auditor of Orange Bank Limited
(OBL). Most of the partners of Guava and Company maintain their accounts with OBL and are enjoying credit card facilities from
them. The maximum outstanding balance on the credit card facility, due from any partner is Rs. 399,000.

b) Apricot and Company, Chartered Accountants, have received an offer for appointment as auditor of Banana Limited. Mr.
Pumpkin who is a nominee director of the Government on the Board of Directors of Banana Limited holds 25% shares in Water
Melon Limited. The spouse of a partner also holds shares in Water Melon Limited.

c) Mr. Zaheer, a legal practitioner, has received an offer for appointment as external auditor of Lychee (Private) Limited (LPL).
The paid up capital of LPL is Rs. 1,500,000 of which 40% is owned by Blue Black Limited, a listed company.

d) Walnut and Company, Chartered Accountants, have received an offer for appointment as external auditors of Wasim
(Private) Limited (WPL), in place of the previous auditors, who were removed before the completion of their term. You may
assume that WPL has completed all the legal formalities before removing the previous auditors.

e) Mr. Sadiq has recently joined your firm as a partner. He has served on the Board of Directors of Strawberry Limited (SL) until
30 June 2009, as a Government nominee. In the Annual General Meeting of SL held on 31 August 2011, a shareholder has
proposed the name of your firm for appointment as the external auditors for the year ending 30 June 2012. (11 marks)

A: (a) (i) The appointment of Guava and Company, Chartered Accountants, will be in order.

(ii) The firm would not be deemed indebted to the company as the amount of debt is not exceeding Rs. 1,000,000.

(b) (i) The Appointment of Apricot and Company, Chartered Accountants will be in order.

(ii) Banana Limited and Water Melon Limited are not associated companies as the common director is a Government nominee.

(c) (i) Mr. Zaheer cannot be appointed as the Auditor of Lychee (Private) Limited

(ii) There specific qualification requirement for auditors of companies having paid-up capital of less than Rs. 3 million; The auditor
shall be a CA or CMA having certificate of practice from respective institute or Firm of CAs/CMAs having such criteria as may be
prescribed

(iii) The fact that 40% of the shareholding is owned by Blue Black Limited does not disqualify Mr. Zaheer as the auditor of LPL but
the fact that he is not a CA or a CMA disqualifies him.

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(d) Before accepting the offer Wallnut and Company, Chartered Accountants, apart from obtaining professional clearance from the
existing auditor is also required to inform the ICAP (Institute) and obtain prior clearance from the Institute.

( e) (i) Since the three year period has not been lapsed,

(ii) Our firm cannot be appointed as the auditor of Strawberry Limited,

iii) The fact that Mr. Sadiq was serving on the board as a Government nominee does not make any difference, in this case.

20. Comment on each of the following situations with reference to the appointment of external auditors in accordance with the
requirements of the Companies Act, 2017

a) Farrukh& Co., Chartered Accountants, has received an offer to be appointed as the external auditor of Ebrahim Gas
Company. The firm is indebted to the company as it has not paid the last two months' bills amounting to Rs. 4,860.

b) After hundred days of incorporation, the directors of Rahman Limited (RL) decided to appoint Mr. Shahid as the company's
statutory auditor. Mr. Shahid was employed by RL before he started his own practice.

c) The directors of Fazal Limited (FL) have decided to appoint Syed & Company, Chartered Accountants, as external auditor of
the company. One of the partner's spouse holds 1,000 shares in the subsidiary of FL.

d) The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million have appointed Mr. Dawood to act as the
external auditor of the company. Mr. Dawood has been awarded a diploma in International Financial Reporting Standards by the
Institute of Chartered Accountants of Pakistan and has completed the mandatory period of training from a leading firm of
chartered accountants.

e) All directors of Hussain Associates (Pvt.) Limited are chartered accountants. The company has recently received an offer for
appointment as the external auditor of Masood (Pvt.) Limited which has a paid-up share capital of Rs. 1,000,000. (10)

A: (a) The appointment of Farrukh& Co. will be in order because the firm would not be considered indebted to the company as
the period for which the utility dues are unpaid does not exceed 90 days.

(b) Mr. Shahid cannot be appointed as statutory auditor of Rehman Limited because of the following:

(i) Mr. Shahid is not eligible for appointment as statutory auditor since only 100 days have passed since the company's
incorporation and therefore obviously less than three years have elapsed since he left the employment of the company.

(ii) Directors have lost their authority to appoint external auditors after the expiry of 90 days from date of incorporation.

(c) Syed & Co. shall not be appointed as auditor of the company because his spouse holds shares in its associated company.
However, the firm can be appointed as auditor of Fazal Limited if the spouse of the partner disinvests the shares within 90 days of
appointment.

(d) Mr. Dawood's appointment shall be void because only a chartered accountant can be appointed as auditor of a private limited
company having share capital of Rs. 3 million or more ..

( e) Hussain Associates (Pvt.) Ltd. being a body corporate cannot be appointed as external auditor of any company.

12
Chapter#02 (Obtaining an engagement)
1. Discuss the auditor's course of action when a client requests to change the existing terms of the audit engagement.

A: The auditor should consider the justification for the request and whether it is "reasonable". If the auditor considers that it is a
reasonable request and the terms of engagement are changed, the auditor and management shall agree on and record the new
terms of engagement in an engagement letter.

If the auditor is unable to agree to a change of terms he should withdraw from the engagement and consider whether there is any
obligation to report the circumstances to those charged with governance, owners or regulators.

2. (a) You are the audit manager in a firm of chartered accountants. Your firm has been appointed as the auditor of a listed
company, Rustam Raees Limited (RRL) for the year ending 31 December 2019. RRL has been publishing their annual financial
statements within one month of the year end and have set strict deadlines for the completion of audit. Further, this year, RRL has
changed its accounting policy relating to property, plant and equipment, from historical cost to revaluation model.

Required:

List the matters (related to the given scenario only) which you would like to include in the engagement letter, along with their
justification. (04)

A: (a) Matters to be included in engagement letter

• Being the first year of audit for our firm, arrangements concerning the involvement of predecessor auditor would be necessary.

• Use of auditor's expert may be required as RRL has changed its accounting policy from historical cost convention to revaluation
model.

• Due to strict deadlines:

It should be included in the engagement letter that management would make available the draft financial statements along with all
relevant information in time to allow for the completion of audit in accordance with the proposed time table.

We need to communicate the planning and performance of the audit, including the composition of the audit team.

We may also consider using RRL's internal audit department and this fact may have to be communicated through the engagement
letter.

3. State the matters which an auditor should consider to establish whether the pre-conditions for an audit are present. (05)

A: To establish if the preconditions for an audit are present, the auditor shall:

• establish if the financial reporting framework to be used in the preparation of the financial statements is acceptable; and

• obtain the agreement of management that it acknowledges and understands its responsibility (the 'premise'):

- for the preparation of the financial statements in accordance with the applicable financial reporting framework, including
where relevant their fair presentation;

- for internal controls to ensure that the financial statements are not materially misstated; and

- to provide the auditor with all relevant and requested information and unrestricted access to all personnel.

4. List any four situations that may require revision in the terms of audit engagement letter. ( 4)

A: Situations that may require revision in the terms of engagement letter are as follows:

• Any indication that the entity misunderstands the objectives and scope of the audit;

• Any revised or special terms of the audit;

• A recent change in the senior management/ ownership;

• A significant change in nature or size of the entity's business;

5. Discuss the course of action which may be adopted by the auditor if pre-conditions of audit are not present. ( 4)

A: Pre-conditions of an audit are not present:

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If the pre-conditions of audit are not present, the auditor shall:

discuss the matter with the management and explain to them what the preconditions are and why they are required.

unless required by law or regulation, the auditor shall not accept the proposed audit engagement. If the management is unable to
address the auditor's concern.

6. In relation to the audit report on financial statements and the contents thereof ( under revised/new ISAs), discuss the
appropriateness or otherwise of the following statements: The management is only responsible for preparation of financial
statements in accordance with the financial reporting framework and for such internal controls as management determines are
necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or
error. (03)

A: The statement is not appropriate, as management is also responsible for assessing the entity's ability to continue as a going
concern and whether the use of the going concern basis of accounting is appropriate as well as disclosing, if applicable, matters
relating to going concern.

7. Your firm has been re-appointed as the auditor of Elegant Limited (EL) for the year ended 30 June 2015. The firm has been the
auditor of EL for the last five years.

Required:

(a) How would you assess whether it is necessary to send an audit engagement letter to EL for the year ended 30 June 2015? ( 5
marks)

(b) State how would you proceed If EL requests your firm to change certain terms of engagement. (4 marks)

A: (a) In determining the need to send an engagement letter, the firm should assess whether:

• circumstances require a revision in the terms of engagement.

• management need to be reminded of the existing terms of the engagement.

The following factors may indicate that the above is appropriate:

• Any indication that the entity misunderstands the objective and scope of the audit.

• Any revised or special terms of the audit engagement.

• A recent change of senior management.

• A significant change in ownership.

• A significant change in nature or size of the entity's business.

• A change in legal or regulatory requirements.

• A change in other reporting requirements.

(b) We would consider whether the request is "reasonable".

• If the request is reasonable then revised terms should be agreed and recorded in engagement letter.

• If the request is unreasonable, we should discuss the matter with the management and if the management agrees with our view
point, then there is no need for amendment in the existing terms of engagement.

• If we are unable to agree to the changes and management also do not agree with our viewpoint then we would consider
withdrawing from the engagement and consider whether there is any obligation to report the circumstances to TCWG, owners or
regulators.

8. The audit engagement letter specifies objective and scope of audit, responsibilities of auditor and management, applicable
financial reporting framework and form and contents of audit report. State any four additional matters that may be included in
the engagement letter. (04)

A: Additional matters that can be included in the engagement letter:

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• Additional details on the scope of the audit, such as reference to applicable legislation, regulations, ISAs, and ethical
pronouncements.

• The fact that because of the inherent limitations of an audit, and the inherent limitations of the internal control, there is an
unavoidable risk that some material misstatements may not be detected even though the audit was properly planned and
performed in accordance with ISAs.

• Arrangements regarding planning & performance of audit including composition of audit team

• The expectation that management will provide written representations.

9. Khanewal Limited (KL) has requested your firm to submit engagement letter for KL's statutory audit. The engagement partner
has asked you to establish whether preconditions for the audit of KL are present.

Required:

What matters would you consider in order to ensure that preconditions for the audit exist? (05)

A: In order to establish whether the preconditions for an audit are present, I will:

(i) determine whether the FRF to be applied in the preparation of F /S is acceptable;

(ii). obtain the agreement of management that it acknowledges and understands its responsibility:

• for the preparation of the F /S in accordance with the AFRF.

• for such internal control as management determines is necessary to enable preparation of F /S that are free from material
misstatement, whether due to fraud or error.

• to provide us with all relevant and requested information and unrestricted access to all personnel.

10. Briefly describe the steps that an auditor should take in order to establish whether preconditions of an audit are present. (06)

A: In order to establish whether the preconditions for an audit are present, the auditor shall:

• Determine whether the FRF to be applied in the preparation of the F /S is acceptable; and

• Obtain the agreement of management that it acknowledges and understands its responsibility: For the preparation of the F /S in
accordance with the AFRF, including where relevant their fair presentation;

For such internal controls as management and, where appropriate, TCWG determine is necessary to enable the preparation of F /S
that are free from material misstatement, whether due to fraud or error; and

To provide the auditor with:

o Access to all information of which management is aware that is relevant to the preparation of the F /S such as records,
documentation and other matters;

o Additional information that auditor may request from management for the purpose of the audit; and

o Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

11. List the important matters that are required to be included in an audit engagement letter.

A: Key Components of Audit engagement letter:

• The objective and scope of the audit of F /S;

• The responsibilities of the auditor;

• The responsibilities of management;

• Identification of the AFRF for the preparation of the F /S;

• Reference to the expected form and content of any reports to be issued by the auditor and;

• A statement that there may be circumstances in which a report may differ from its expected form and content.

12. An auditor may agree to a change in the terms of engagement provided there is a reasonable justification for doing so.

15
Required:

a) List the circumstances in which the management may request the auditor to change the terms of an audit engagement.

b) What factors should be considered by the auditor before accepting a change in the terms of the engagement?

c) List the steps that the auditor should consider, if he is unable to agree to a change in the terms of engagement. (09 marks)

A: (a) Circumstances in which the management can request the auditor to change the terms of audit engagement:

(i) Change in circumstances affecting the need for the service.

(ii) A misunderstanding as to the nature of an audit as originally requested.

(iii) A restriction on the scope of an audit engagement, whether caused by management or caused by other circumstances

(b) Factors that are to be considered by auditor before accepting the change in terms of engagement:

(i) Justification provided for changing the terms of engagement.

(ii) The information in respect of which the change is requested by the management.

(iii) Legal or contractual implications of the change.

(c) Steps that the auditor can take, if he is unable to agree to a change in terms of engagement:

If the auditor is unable to agree to a change in the terms of the audit engagement and is not permitted by management to continue
the original engagement, the auditor shall:

(i) Withdraw from the audit engagement where possible under applicable law or regulation; and

(ii) Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to other parties, such
as TCWG, owners or regulators.

13. List the circumstances in which it may become necessary to revise the terms of audit engagement for a recurring audit. (07
marks)

A: The following factors may make it appropriate to revise the terms of the audit engagement or to remind the entity of existing
terms:

(a) Any indication that the entity misunderstands the objective and scope of the audit.
(b) Any revised or special terms of the audit engagement.
( c) A significant change in the ownership.
(d) A significant change in nature and size of the entity's business.
( e) A change in legal or regulatory requirements.
(f) A change in the FRF adopted in the preparation of the F/S.
(g) A change in other reporting requirements.

14. Strawberry Pakistan Limited (SPL) was incorporated on March 1, 2011. The directors of SPL are in the process of appointing
the first statutory auditor of the company. They have requested your firm to submit a proposal for the statutory audit
assignment. A partner of your firm has asked you to draft the proposal after assessing whether the preconditions for the audit
exist.

Required:

Briefly discuss the term 'preconditions for an audit'.

a) What are the steps that you would perform in order to ensure that preconditions for the audit exist?

b) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the audit is not present. (10
marks )

A: (a) Preconditions for an audit are as follows:

(i) An acceptable FRF has been used by the management in the preparation of the F /S; and

(ii) the management and, where appropriate, TCWG agreed on the premise on which the audit is to be conducted.

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(b) In order to establish whether the preconditions for an audit are present, we will:

(i) determine whether the FRF to be applied in the preparation of F /S is acceptable;

(ii) obtain the agreement of management that it acknowledges and understands its responsibility:

• for the preparation of the F /S in accordance with the AFRF.

• for such internal control as management determines is necessary to enable the preparation of F /S that are free from material
misstatement, whether due to fraud or error.

• to provide us with:

access to all information of which management is aware, that may be relevant to the preparation of the F /S;

additional information that the auditor may request from management for the purpose of the audit; and

unrestricted access to persons within the entity from whom the auditor determine it necessary to obtain audit evidence.

( c) If a precondition for an audit is not present, the matter would be discussed with the management. Unless required by law or
regulation to do so, we will not accept the proposed audit engagement, if the pre-conditions are not met.

15. (a) A prestigious company has approached your firm to accept appointment as its external auditor. State the matters that
your firm should consider before accepting the engagement. (04)

C) Your firm has been the auditor of Mujahid Limited (ML) for many years. Before the commencement of the current year's audit
ML has requested that some changes be made in the terms of engagement.

Required:

(i) What are the circumstances which may lead to changes in terms of engagement? (03)

(ii) Discuss the important points which should be considered before accepting the changes in the terms of engagement. (05)

A: (a) Before accepting the audit, our firm should consider the following:

(i) Whether the firm is technically competent to act as auditors?

(ii) Does it possess the resources necessary to carry out the engagement?

(iii) Could there be any self interest threat involved?

(iv) Are there any professional reasons for not accepting the engagement?

(c) (i) The change in the terms of engagement may result from:

I. change in circumstances affecting the need for the service.

II. misunderstanding as to the nature of the audit or of the related service originally requested.

III. restriction on the scope of the engagement, whether imposed by management or caused by circumstances.

(ii) In response to the request for change in the terms of the engagement the firm should consider the following:

• Appropriateness of such a request for change by considering carefully the reason given by Mujahid Limited.

• in case the change results in restriction on the scope of the engagement, the firm should assess whether or not it would be able
to able to meet its statutory responsibility after the impositions of such restriction.

• A change in circumstances or a misunderstanding concerning the nature of service originally requested would ordinarily be
considered a reasonable basis for requesting a change. A change would not be considered reasonable if it appears that change
relates to information that is incorrect, incomplete or unsatisfactory.

• Before agreeing to change the terms of engagement the auditor should consider any legal or contractual implications of change
to assess whether it would still be possible to carry out the audit in accordance with ISAs.

ISA-220

17
1.State any five matters that need to be considered by engagement quality control partner while performing objective evaluation
of audit of a listed company. (05)

A: The objective evaluation shall involve the following matters:

• Discussion of significant matters with the engagement partner;

• Review of the financial statements and the proposed auditor's report;

• Review of selected audit documentation relating to the significant judgments the engagement tea1

• Evaluation of the conclusions reached in formulating the auditor's report and consideration of wl:

• Evaluation of the Firm's independence in relation to the audit engagement;

Code of Ethics

1. Your firm is the auditor of ABD Limited (ABDL). After the acquisition of majority shareholding in HG Motors (Private) Limited
(HGM), ABDL has decided to replace the existing auditors of HGM in the next annual general meeting and has approached you for
appointment as HGM's auditors for the next year.

Required:

Explain the responsibilities of your firm and the existing auditors in the above situation under the Code of Ethics for Chartered
Accountants. (05)

A: Responsibilities of our firm and of the existing auditors:

Our firm will communicate with the existing auditors to establish if there are any matters that it should be aware of when deciding
whether or not to accept the appointment The following points should be noted in connection such communication:

• HGM permission is required for any such communication. If HGM refuses to give its permission, the appointment as auditor
should not be accepted.

• If HGM does not give the existing auditor the permission to reply to any relevant questions of our firm, the appointment as
auditor should not be accepted.

• If existing auditor provides the required information, our firm should assess all the available information and take a decision
about whether or not to accept the audit engagement.

• If the existing auditor does not provide any information relevant to the appointment, we may accept or reject the engagement
based on other available knowledge.

• Even if the existing auditor provides professional reasons to suggest that we should not accept the audit, the final decision in
this regard shall be based on our professional judgment.

18
Chapter#03 (Planning and risk assessment)
ISA 300
1. Afaq & Co has been appointed as the auditor of Ethereum Limited (EL) in place of retiring auditor in the AGM.

Required:

List the additional matters that you should consider in the first year of EL's audit (04)

A: Planning activities to be performed by Afaq & Co.

• Arrangements to be made with the predecessor auditor, for example, to review the predecessor auditor's working papers.

• Any major issues (including the application of accounting principles or of auditing and reporting standards) discussed with management in
connection with the initial selection as auditor, the communication of these matters to those charged with governance and how these matters
affect the overall audit strategy and audit plan.

• Audit procedures to be performed to obtain sufficient appropriate audit evidence regarding opening balances.

• Other procedures required by the firm's system of quality control for initial audit engagement.

2. Briefly discuss the key benefits which may arise due to splitting of work between interim and final audit. (02)

A: Key benefits that may arise from splitting the work between interim and final audit are as follows:

• More flexible resource planning within the firm (the timing of interim audit is typically more flexible than the timing of final audit. This helps to
reduce demand for audit staff during 'busy season')

• Earlier identification of significant matters

• Shareholders and other users receive audited accounts earlier/Earlier completion of the audit

• Increased audit efficiency

3. Your firm has recently been appointed as the external auditor of Door Limited. The engagement partner has planned a meeting with the audit
team to discuss the overall audit strategy and finalize the audit plan.

Required:

List the planning activities which you would need to discuss with the engagement partner regarding the issues related to first year of audit
engagement. (04)

A: Since it will be the first time we will be auditing Door Limited, I will have to discuss the following additional matters with the engagement
partner:

• Arrangements to be made with the predecessor auditor, for example, to review the predecessor auditor's working papers;

• Any major issues (including the application of accounting principles or of auditing and reporting standards) discussed with management in
connection with the initial selection as auditor, the communication of these matters to those charged with governance and how these matters
affect the overall audit strategy and audit plan;

• The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances; and

• Other procedures required by the firm's system of quality control for initial audit engagements.

4. Briefly discuss the concept of 'Professional skepticism'. (03)

A: Professional Skepticism:

It refers to an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud,
and a critical assessment of audit evidence. However, it does not mean that the auditors should disbelieve everything they are told, but they should
view what they are told with a skeptical attitude, and consider whether it appears reasonable and whether it conflicts with any other evidence.

5. (a) Briefly describe 'Preliminary Engagement Activities' and 'Planning Activities'. (05)

(b) You are the partner of Alamgir and Company, Chartered Accountants and have received an offer for appointment as auditor of Guava
Limited (GL). The previous year's audit was carried out by Babur and Company, Chartered Accountants.

Required:

State the matters that you would consider:

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(i) while deciding about the acceptance of audit of GL. (03)

(ii) in establishing the overall audit strategy, including matters which are to be considered, being the initial audit engagement. (08)

A: (a) Preliminary Engagement Activities:

These are the activities undertaken by the auditor at the beginning of audit engagement, and include:

Performing procedures regarding continuance of the client relationship and the specific audit engagement;

Evaluating compliance with the relevant ethical requirements, including independence; and Establishing an understanding of the terms of the
engagement.

Planning Activities:

Planning activities includes establishing an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the
development of the audit plan.

(b)

(i) Information that Alamgir & Co. Chartered Accountants needs to obtain in deciding whether or not to accept the audit of GL:

Following matters may be considered in deciding about the acceptance of audit:

• The integrity of the principal owners, key management and TCWG of the entity;

• Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and
resources;

• Whether the firm and the engagement team can comply with relevant ethical requirements;

ii) Matters that may be considered in establishing the overall audit strategy:

In establishing the overall audit strategy, the auditor shall:

• Identify the characteristics of the engagement that define its scope;

• Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications required;

• Consider factors that, in auditor's professional judgment, are significant in directing engagement team's efforts;

• Consider the results of the preliminary engagement activities and, where applicable, whether knowledge gained on other engagement
performed by the engagement partner for the entity is relevant; and

• Ascertain the nature, timing and extent of resources necessary to perform the engagement.

Being initial audit engagement following matters should also be considered in establishing overall audit strategy:

• Arrangements to be made with the predecessor auditor.

• Communicate major issues identified during discussion with the management, to TCWG and consider that how these matters will affect the
overall audit strategy and audit plan.

• The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances.

• Other procedures required by the firm's system of quality control for initial audit engagements (for example, the firm's system of quality
control may require the involvement of another partner or senior individual to review the overall audit strategy prior to commencing significant
audit procedures or to review reports prior to their issuance).

6. a) What is the difference between audit strategy and audit plan? (04marks)

b) You have been appointed as the auditor of a company which was previously audited by another auditor. Being a new client, what
additional considerations would you take into account while performing the preliminary engagement activities prior to commencement of the
audit? (05 marks)

A: (a) The audit strategy sets the scope, timing and direction of the audit. It also provides guidance for the development of audit plan.

The audit plan is more detailed than the audit strategy and it includes the nature, timing and extent of audit procedures to be performed by the
engagement team members. The planning for these audit procedures takes place over the course of audit as the audit plan for the engagement
develops.

(b) The auditor should perform the following activities prior to starting an initial audit engagement:

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(i) Performing procedures regarding the acceptance of the client relationship and the specific audit engagement.

(ii) Unless prohibited by law, arrangements to be made with the predecessor auditor, for example, to review the predecessor auditor's working
papers.

(iii) Any major issues discussed with management in connection with the initial selection as auditor, the communication of these matters to
TCWG, and how these matters affect the audit strategy and audit plan.

(iv) The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances.

(v) Other procedures required by the firm's system of quality control for initial audit engagements.

7. During the audit team planning meeting, a member of the audit team passed a comment that based on past experience with the client, he
was confident that the management of the client was honest and there was no issue as regards management integrity or risk of fraud in the
Company. The audit manager responded that the auditor should always maintain an attitude of professional skepticism throughout the audit.
Required: Briefly describe 'Audit Skepticism' and elaborate on the response of the audit manager. (08)

A: Audit Skepticism

Audit skepticism is an attitude of professional skepticism which means that the auditor should recognize the fact that circumstances may exist that
may cause the F JS to be materially misstated. Consequently, he should make a critical assessment with a questioning mind of the validity of audit
evidence obtained. He should remain alert to audit evidence that contradicts or brings into question the reliability of documents and responses to
inquiries and the reliability of other information obtained from management and TCWG.

Elaboration on the response of the audit manager that auditor should always maintain an attitude of professional skepticism throughout the audit:

Although the auditor cannot be expected to disregard past experience of the honesty and integrity of the entity's management and TCWG, the
auditor's attitude of professional skepticism is particularly important in considering the risks of material misstatement on account of changes in
circumstances.

ISA 320
1. Comment on the validity of each of the following statements:

(i) Inherent risk can be lowered by a strong control environment and oversight by the entity.

(ii) The audit risk is derived from errors arising out of inherent risk which are not prevented/detected by entity's internal controls.

(iii) Detection risk can be lowered by carrying out more substantive tests in the audit.

(iv) Higher inherent risk leads to higher detection risk. Consequently, it increases overall audit risk.

(v) At an audit client, inherent risk has been assessed at 50% and control risk at 80%. To achieve an overall level of acceptable audit risk of
10%, the detection risk would be 25%. (06)

A: (i)This statement is not correct. Inherent risk operates independently of controls. It cannot be controlled. The auditor must accept that the risk
exists and will not 'go away'.

(ii) This statement is not complete as the audit risk is derived from errors arising out of inherent risk which are not prevented/detected by entity's
internal controls and are not detected by further audit procedures.

(iii) This statement is correct. Detection risk can be managed by the auditor in order to control the overall audit risk, by increasing substantive
procedures, therefore reducing detection risk.

(iv) This statement is not correct. It is not necessary that if the inherent risk is high then the detection risk will also be high because a strong
control environment may reduce the risk. However, the detection risk is adjusted in order to achieve the overall required level of risk in the audit.

(v) This statement is correct because of the following: AR= IR x CR x DR

Then DR= AR / (IR x CR) DR= 0.10 / (0.5 x 0.80)

And therefore, DR=25%

2. Your firm is the statutory auditor of Teak Pakistan Limited (TPL) for the year ended 30 June 2020.

During the final review of audit work, your audit team informed you that TPL uses a third party software for its payroll. While checking the tax
calculation, they identified an error in the calculation of monthly tax deduction from salary. The audit junior who performed the test,
extrapolated the error over the entire population. This resulted in an overall short deduction of Rs. 920,985. She concluded that the error was
not material because this amount was less than the audit materiality set at the financial statement level i.e. Rs. 1,000,000.

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Further, she discussed this matter with the TPL's management who has agreed to deduct the differential amount from the salary of the next
month and will deposit it into government exchequer. Therefore, she concluded that no accounting adjustment is required for the year ended
30 June 2020.

Required:

(i) Briefly discuss the conclusion made by audit junior regarding materiality of the transaction and recording of the error.

(ii) State additional steps that you would suggest to your audit team. (Implications on audit report are not required) (07)

A: Discussion on conclusion: Since the auditor has extrapolated the error over the entire population, he should obtain sufficient evidence that the
misstatement or deviation also affects the rest of the population.

Steps to be performed:

• Investigate the nature and cause of the error i.e. whether the errors identified are an indication of system errors.

• Investigate whether the problem lies within one transaction only, or it affected multiple transactions or affected any specified period.

Discussion on conclusion:

The conclusion drawn by the audit junior is not correct, as there may be other errors which when aggregated, may result in a material
misstatement.

It may also be an indication of similar errors in the accounting software.

The accounting treatment suggested by the management is also not correct, because payable to FBR and receivable from employees have been
understated at year-end.

Steps to be performed:

• Involve the IT specialist for obtaining assurance on the proper functioning of the accounting software.

• Consider whether there is any fines or penalties which need to be accounted for in the financial statements.

• Discuss with the management to record the short deduction as receivable from employees and payable to FBR.

3.You are the manager responsible for the audit of a newly incorporated company, Trojan Limited (TL). Following are the extracts from the first
draft financial statements of TL for the year ended 31 December 2019:

Rs. In “m”

Revenue 2.000

Profit before tax 72

Total assets 13,000

Total liabilities 7,000

Since this is the first year of operation, the profit before tax was quite low. However, as per the management's projection, the profit before tax
would grow exponentially over the next three years.

Your audit team has determined the materiality on the basis of profit before tax for the year ended 31 December 2019. In view of the audit
team profit before tax is the main performance indicator for TL's board of directors.

Required: Discuss the appropriateness of the benchmark used by your team in determining the materiality and suggest the alternative(s)
available to your team. (06)

A: Information is considered material if its omission could influence the economic decision of the users taken on the basis of the financial
statements. Only considering the board of director as the only users of financial statements for determining materiality is not correct.

Furthermore, since TL is a newly established entity, use of 'profit before tax' will not be a good benchmark as current year profit is low because of
first year of operation. Further, considering a benchmark on the basis of future profitability is also not correct.

If materiality is still to be determined based on 'profit before tax', it will result in a low materiality level, which will require performing detailed
testing. By setting a lower materiality the audit team would also increase their sensitivity to a potential misstatement.

Alternatively assets or revenue may be considered to be an appropriate benchmark, in the determination of materiality. The audit team however,
based on their audit strategy and approach, may consider other appropriate benchmarks (e.g. total expenses, net assets etc.).

4.(a) Discuss the term 'performance materiality' and the purpose for which it is used. (03)

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A: Performance materiality means the amount or amounts set by the auditor at less than materiality for the financial statements as a whole or at
less than the materiality level for particular classes of transactions, account balance or disclosures.

Performance materiality is set to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected
misstatements in the financial statements or in classes of transactions, account balance or disclosures exceeds the materiality as a whole.

5. Apart from profit before tax, list any four benchmarks which can be used to determine the materiality at the financial statement level. (02)

A: The following can be the benchmark for determining materiality:

• Gross profit

• Total expenses/ Total Revenue

• Total equity

• Total assets / Total Liabilities

6. Determination of materiality level requires professional judgment on the part of the auditor.

(a) Briefly describe the importance of materiality in the following stages of audit:

(i) Planning stage (01)

(ii) Reporting stage (02)

(b) What aspects of materiality should be documented by an auditor in the working papers? (04)

A: (i) Planning stage - The concept of materiality is used in determining the nature, timing and extent of further audit procedures;

(ii) Reporting stage - The materiality concept is used in evaluating the effect of uncorrected misstatements, if any, on the F JS and in forming the
opinion in the auditor's report.

(b) The auditor shall document the following aspects of materiality:

(i) Materiality for the F JS as a whole;

(ii) Performance materiality;

(iii) Basis of computing materiality; and

(iv) Any revision of (i) to (ii) as the audit progresses

7. You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly inducted trainees, on the following:

Materiality and Performance Materiality. (05)

A: Materiality:

Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of F /S. The auditor
keeping in view the concept of materiality gives his opinion i.e. whether the F JS present fairly in all material respects the financial position and
performance of the entity.

Performance Materiality:

Performance materiality means the amount or amounts set by the auditor at less than materiality for the F JS as a whole to reduce to an
appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the F JS as a
whole. If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for
particular classes of transactions, account balances or disclosures. Performance materiality recognizes the fact that errors/omissions detected in a
particular area may not breach the overall materiality level but when all the errors/omissions in all the areas is combined or added together, the
overall materiality could be breached.

8. a) Sajjad is the audit senior on the audit of Hameed Limited (HL). Upon his manager's instruction Sajjad had determined the acceptable
materiality level to be Rs. 10 million at the initial planning stage. However, at the time of evaluating the results of audit procedures carried out
at the interim stage, he has reduced the materiality level to Rs. 7.5 million.

Required:

(i) Identify the possible causes which motivated Sajjad to reduce the materiality level. (02 )

(ii) Discuss the impact of reduction in the materiality level on audit risk and the audit procedures to be performed. (05 )

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(b)During the course of an audit, both quantitative as well as qualitative misstatements need to be considered. Give four examples of
qualitative misstatements. (04)

A: (a) (i) Sajjad may have decided to change the level of materiality because of any of following causes:

• a change in circumstances; or

• a change in the auditor's knowledge as a result of performing audit procedures.

(ii) There is an inverse relationship between materiality and the level of audit risk. This relationship is considered by an auditor in determining the
nature, timing and extent of audit procedures.

Mr. Sajjad reduced the materiality level which resulted in increase in audit risk. Therefore, in order to compensate

the effect of increased audit risk, he should either:

• reduce the assessed risk of material misstatement, where this is possible by carrying out extended or additional tests of control; or

• reduce the detection risk by modifying the nature, timing and extent of planned substantive procedures.

(b) Examples of qualitative misstatements would include the following:

(i) Inadequate or improper description of an accounting policy when it is likely that a user of the F JS would be misled by the description.

(ii) Failure to disclose the breach of regulatory requirements when it is likely that the consequent imposition of regulatory restrictions will
significantly impair operating capability

(iii) Non disclosure of directors personal expenses, charged to company even if they are insignificant.

(iv) Non disclosure of failure to meet debt covenant requirements.

(vi) Illegal payments which may not be material but if revealed may have severe repercussions.

ISA 315
1. Your firm is the auditor of Adventure Travel (Private) Limited (APL) which offers a wide range of adventure sports services such as paragliding,
parasailing and scuba diving. APL follows high safety standards to avoid any unfortunate events.

However, during the year, one of its paragliding trips was affected due to bad weather which caused severe injuries to its clients. Immediately
after this unfortunate incident, APL has invested heavily in further upgrading its equipment to prevent happening of such incident in future. The
entire investment has been financed through a bank loan.

You have been informed that due to overwhelming response towards adventure trips, number of tour operators have launched the same services
at significantly low prices as compared to APL; however, all these new tour operators are not following as high safety standards as are being
followed by APL.

Considering the increased competition, APL has recently widened its scope of business and introduced:

• booking of air tickets and hotel rooms on behalf its clients at a discounted rate. APL is entitled to a commission, if bookings are made
through APL. The commission on booking is recorded when the payment has been received.

• "Book now and Pay later" instalment scheme for all of its services.

Required:

(a) Identify the matters that you will consider while obtaining an understanding of APL and its environment. (05)

(b) Identify and discuss the business risks and the related audit risks from the above scenario. (09)

A: (a) The auditor should consider the following matters while obtaining understanding of APL and its environment This will involve following
factors:

• Obtaining the understanding of the tourism industry in which APL operate.

• Inquire specific laws and regulation applicable on tourism industry.

• Understand APL's operations, the range of services it offers and its dynamics.

• Obtain the ownership structure, management structures and types of current and planned investments.

• Assess APL's selection and application of accounting policies, including whether they are appropriate for its business and consistent with the
industry and the applicable financial reporting framework.

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• Obtain understanding of APL's strategies of managing the tough competition and assess the business risk which may result in risks of material
misstatement.

• Review the APLs financial performance.

S# Business Risk Audit Risk

(i) Breach of the safety standards may result in litigation against Liabilities of APL might be understated as a result of non-
APL. Due to the increasing competition, any such incident will recognition of the provision in respect of the litigation.
also affect APL' s reputation. The disclosure regarding contingencies may not adequately
disclose the effects of the pending litigation.
(ii) Frequent upgradation of equipment is required to prevent The frequent upgradation of equipment might decrease the useful
accidents. life of the equipment or might need to be charged off instead of
capitalizing them.
(iii) APL's competitor has introduced similar products at a low price If the revenues keep on decreasing, APL's equipment may need to
which has affected APL's revenue. be tested for impairment.
(iv) Due to bank loan, APL will now have to manage its debt load and In order to meet bank's covenants, APL may overstate its revenue
all the terms and conditions of that loan. or understate its expenses to depict a better picture to its lenders
(v) There is a risk that a client may cancel its booking. Dealing with fhere is a risk that APL may recognize commission as revenue even
cancellation will also effect revenue flow of APL when the criteria for recording of commission is not me
(vi) recording of commission is not me pay its debt on time, whereas There is a risk that receivable from customers is overstated and a
it would be receiving money from its customers provision for doubtful customers has not been recorded.
later on.
There is also a risk that APL may offer
credit to those customers who are not
financially viable and would not be able
to pai on time.
2. You are the audit senior responsible for the audit of Dragon Pakistan Limited (DPL), a listed company. DPL operates in the pharmaceutical
industry which is highly regulated by the government and heavy fines are placed on any non-compliance of the regulations. The main product of
DPL is Drug A.

The raw material for the production of Drug A is imported from Switzerland. Drug A has been underperforming for a number of years and is
currently sold at low margins. Last year, a competitor introduced a much-improved version of Drug A.

Considering the tough competition, all the companies in the pharmaceutical industry including DPL have to continuously carry out research
activities for development of new drugs and improvement of the existing drugs.

Required:

(a) Outline the business risks that exist in DPL. (02)

(b) Identify and briefly discuss the financial statement line items that could be misstated as a result of the business risks outlined in (a) above.
(06)

A:

(a) Business (b) Financial statement asseration

DPL has to comply with very strict regulations and any non-compliance Liabilities may be understated relating to undisclosed penalties. A
would result in heavy fines. contingent liability may not be disclosed in the financial relating to anv
legal action taken bv reguulator against DPL.
DPL's competitor has introduced a new product which has caused DPL Since DPL is selling Drug-A at lower margin, its inventory might need
to reduce it selling price. to be recorded at lower of cost or net realizable value.
Since DPL is a listed entity and the revenues are decreasing, DPL may
overstate its revenue or understate its expenses.
If the revenues keep on decreasing DPL's property, plant and
equipment may need to be tested for impairment
DPL has to continuously carry on research projects. If the criteria for development cost (or intangible asset) has not been
met research cost might be in-appropriately recorded as development
cost
Due to significant imports of raw material DPL is exposed to foreign There is a risk that trade payables may not be translated using the
currency risk because of the fluctuation in exchange rates. correct exchange rate.
Exchange gains and losses may not be calculated correctly.
3. You are the audit manager of the Educational University (EU) for the year ended 31 December 2015. EU has a student base of 2,500 students.
It follows a policy of receiving 50% of the fees at the start of the semester and 50% in the middle of the semester. However, 10% discount is
allowed to those students who pay the entire amount in advance. The cost of course material is included in the fees. The semester starts in
December and June each year. You have noticed that 30% of the students who were registered in December 2015 had not claimed the course
material till 31 December 2015.

25
Required:

Discuss the audit risks in the above scenario and how you would deal with them. (07)

A: Audit risk

There is a risk that revenue from fees income and sale of goods is misstated due to following reasons:

• Fees income may be recognized immediately on receipt of fees rather than recognized on monthly basis as the services are rendered.

• Discounts given to students may not be accounted for properly, resulting in overstatement of revenue.

• There is a risk that revenue related to sale of course material is in appropriately classified as part of the university fees, as a result of which it
may have been recognized proportionately on the basis of time (services provided).

• Entire revenue from sale of course material may not be recognized

4. You are the Audit Manager on the audit of Durable Cement Limited (DCL). The information contained in the planning document includes the
following:

(i) DCL is presently operating in poor general economic conditions and is also faced with tough competition, due to the availability of low
priced imported cement.

(ii) In addition to the wholesalers, DCL supplies cement directly to various government departments and real estate developers. The sale is
authorized by the credit control department; however, payments from government departments are often delayed.

(iii) During the year, DCL has made investment in securities of unlisted public companies.

(iv) A long-term loan was obtained in 2007 to finance the existing plant. The amount is repayable in 10 annual installments.

(v) DCL operates a non-funded gratuity scheme for its employees.

Required:

Assess the inherent risks (high, low or moderate) along with appropriate justification, related to the following assertions: (9)

- Valuation of factory plant - Valuation of trade receivables

- Valuation of unlisted securities

- Valuation of provision for gratuity

- Ownership right of finished goods inventory

- Accuracy oflong-term finance

A:

Sr. Assertion Assessment of inherent risk Justification

No
A Valuation of factory plant High • Due to poor economic conditions, there is a risk that the
value of plant may be impaired.
• Inherent risk is also high due to the complexity and
subjectivity involved in calculation of impairment loss.
B Valuation of trade receivables Low /Moderate The valuation assertion for trade receivable and allowance for
doubtful debts is affected by judgments. However as the debts
from Government departments are usually secured, the
chances of bad debts are low.
C Rights to ownership of finished Low /Moderate Cement bags are usually kept in company's' premises
goods Inventory (Godowns) and in the absence of any other information the
ownership of inventory can be verified.
D Value of unlisted securities High Determination of fair value is complex, and involves
subjectivity and judgment in the absence of anv market
Quotations.
E Accuracy of long term finance Low Third party confirmation i.e., bank confirmation is available
therefore inherent risk is low.
F Valuation of provision for High Due to complexity and subjectivity involved in the calculation
1?ratuitv of provision for J:!fatuitv.

26
5. The auditor is required to identify and assess the risk of material misstatement at both the financial statement and assertion levels. State
what is meant by risk at financial statement level and assertion level. Give one example of risk at each level. (03)

A: Financial Statement Level: Risks at financial statement level are those which are pervasive to the F JS as a whole and which potentially affect
many assertions.

Example: If management has a tendency to override internal controls it would affect all areas of the accounting system.

Assertion Level: Risk at assertion level are those which relate to specific objectives of the F /S. Example: All liabilities have not been recorded and all
recorded assets exist.

6. An auditor is required to identify and assess the risks of material misstatements to provide a basis for designing and performing further audit
procedures.

Required:

(a) State factors which an auditor should consider while evaluating significance of audit risks. (06)

(b) State the matters which you would include while documenting the risk identification and risk assessment procedures. (06)

A: (a) Factors to be considered by auditor in exercising judgment relating to the significance of audit risks:

In exercising judgment as to which risks are significant risks, the auditor shall consider at least the following:

• Whether the risk is a risk of fraud;

• Whether the risk is related to recent significant economic, accounting or other developments and, therefore, requires specific attention;

• The complexity of transactions;

• Whether the risk involves significant transactions with related parties;

• The degree of subjectivity in the measurement of financial information related to the risk; and

• Whether the risk involves significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be
unusual.

(b) Documentation Required for Risk Identification and Risk Assessment procedures: The auditor shall include in the audit documentation:

• The discussion among the engagement team about the susceptibility of the entity's F /S to material misstatement and decisions reached.

• Key elements of the understanding obtained regarding each aspect of the entity and its environment and each internal control component;
the sources of information from which the understanding was obtained; and the risk assessment procedures performed;

• The identified and assessed risks of material misstatement; and

• The risks identified, and related controls about which the auditor has obtained an understanding.

ISA 240
1. State the auditor's responsibility for identifying, detecting and responding to fraudulent activities. (04)

A: Responsibilities of auditors for fraud in an audit of financial statements:

The auditor is concerned with fraud only to the extent that it might impact on the view shown by the financial statements. He will therefore be
concerned with the risk of material fraud. This is to identify and assess the risks of material misstatement and to obtain sufficient appropriate
evidence about those risks through appropriate audit procedures. He must also respond appropriately to fraud or suspected fraud identified during
the audit. It is particularly important in relation to fraud that the auditor maintains an attitude of professional skepticism.

Auditor should communicate to those charged with governance concerning the detection or possibility of fraud.

2. (a) You are the audit senior on the audit of Nano Footwear Limited (NFL) for the year ending 31 March 2021. NFL is in the business of making
a wide variety of footwear products. Your review of the last year working papers and initial meeting with the NFL management have revealed
the following:

(i) Due to a high influx of low priced Chinese products in the local market, NFL has been experiencing a decline in customers' demand and high
degree of competition. The sales managers have been given aggressive sales targets during the year which are their key performance indicators
and are considered in their annual appraisals.

(ii) All the management and policy decisions such as human resources, accounting estimates and procurement are taken by the CEO himself.

Required:

27
Briefly discuss the possible 'fraud risk factors' from the above scenario. (06)

b) Discuss what actions that an auditor should take on identification of the fraud risk factors. (05)

A: (a) (i) Pressure on the sales managers to meet sales target:

Since the performance of the sales manager is measured in terms of sales, they would have an incentive to fraudulently record the fake sales at
year end to meet their targets in order to obtain bonuses or increments.

(ii) Aggressive sales targets:

Sales managers are given aggressive sales target, which might not be attainable. Therefore, sales managers would be under pressure to achieve
those targets by recording fake sales at year end to meet their targets.

(iii) Decline in customers' demand:

Decrease in customers' demand due to cheap alternatives, the management would have under pressure to overstate the revenue or book fictitious
revenue transactions.

(iv) Domination of the management by a single person:

All the management decisions including those related to HR and accounting estimate are dominated by the CEO. Due to his dominant position,
there is an opportunity for the CEO to override control and involve in any fraudulent activity.

(v) Excessive involvement of CEO in application of accounting estimates:

The authority of adoption of accounting estimates should be with the CFO and not with the CEO. CEO's excessive involvement in the adoption of
accounting estimates indicates his attitude which may lead to fraudulent financial reporting.

(b) In response to assessed risk of material misstatement due to fraud, the auditor shall:

• emphasize to the audit team the need to maintain an attitude of professional skepticism.

• assign more experienced staff or increased supervision of staff.

• obtain to the extent not already done, an understanding of the entity's related controls, relevant to such risks.

• evaluate whether the selection and application of accounting policies by the entity, particularly those related to subjective measurements and
complex transactions, may be indicative of fraudulent financial reporting resulting from management's effort to manage earnings.

• incorporate an element of unpredictability in determining the nature, timing and extent of audit procedures.

• design and perform further audit procedures whose nature, timing and extent are responsive to the assessed risk of material misstatements.

• consider revising the materiality level.

3. Your firm is the auditor of Manero Limited (ML).

ML's financial statements were issued on 28 February 2021. However, after receiving a High Court judgement on 2 March 2021, ML's
management assesses its impact and has decided to revise its financial statements.

Required:

Discuss the documentation that is necessary to be included in the audit working file regarding the above matter. (03)

Note: Audit procedures are not required.

A: If, the auditor performs new or additional audit procedures or draws new conclusions after the date of the auditor's report, the auditor shall
document:

• the circumstances encountered;

• the new or additional audit procedures performed, audit evidence obtained, and conclusions reached, and their effect on the auditor's report;
and

• when and by whom the resulting changes to audit documentation were made and reviewed.

4. State any four actions that an auditor should take on identification of a fraud risk factor. (04)

A: In response to assessed risk of material misstatement due to fraud, the auditor shall:

• emphasize to the audit team the need to maintain an attitude of professional skepticism.

• assign more experienced staff or increased supervision of staff.

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• to the extent not already done, the auditor shall obtain an understanding of the entity's related controls, relevant to such risks.

• evaluate whether the selection and application of accounting policies by the entity, particularly those related to subjective

• measurements and complex transactions, may be indicative of fraudulent financial reporting resulting from management's effort to manage
earnings.

5. Your firm is the external auditor of Avian Limited (AL), a listed company, for the year ending 31 March 2020. AL is engaged in the business of
construction and selling of construction material.

During the planning stage, the audit team has noted the following points for your consideration:

(i) AL's CEO aggressively follows up with the departmental heads for meeting the financial targets established by the directors. Performance of
senior management at AL is measured in terms of year-on-year profit growth. There is an internal audit division of AL and it reports directly to
the CEO.

Required: Briefly discuss the possible 'fraud risk factors' from the above scenario. (09)

A: Aggressive targets for departmental heads

CEO aggressively follows up with the departmental heads for achieving the targets set by those charged with governance. It seems that there is an
excessive pressure on management to meet financial targets established by the directors therefore they may be under undue pressure to misstate
the financial statements.

Performance measurement of senior management

Since the performance of the senior management is measured in terms of year-on-year profit growth they would have an incentive to fraudulently
misstate the financial statements to obtain bonuses or increments.

Internal audit department reports to CEO

Reporting of internal audit department to the CEO will impair their independence. Therefore this deficiency in internal control structure would give
an opportunity for fraudulent financial reporting. Significant subjective judgements Determination of the provision required for onerous contract
may require significant subjective judgements on part of the management. There is an opportunity for the management to misstate the recognition
of expenses and liabilities.

Furthermore, since the performance is measured in terms of year-on-year profit growth, management would have an opportunity to achieve those
targets by not recording the required provision.

Not recording provision

Justification of the CFO does not seem correct as information regarding rise in the cost of raw material can easily be obtained from the market. The
fraud risk factor further increases with the fact that the audit team also suspects that the provision has not been recorded to maintain the
profitability.

Maintaining the profitability

Excessive interest by management in maintaining the profitability and earning trend represents the management's attitude which would increase
the fraud risk.

6. Briefly describe any five inquiries that the auditor may make for identifying the risk of material misstatement due to fraud. (05)

A: The auditor may make the following inquiries to identify the risk of material misstatement due to fraud:

• Management's assessment of the risk that the financial statements may be materially misstated due to fraud, including the nature, extent and
frequency of such assessments.

• Management's process for identifying and responding to the risks of fraud in the entity, including any specific risks of fraud that management
has identified or that have been brought to its attention, or classes of transactions, account balances, or disclosures for which a risk of fraud is likely
to exist;

• Management's communication, if any, to those charged with governance regarding its processes for identifying and responding to the risks of
fraud in the entity; and

• Management's communication, if any, to employees regarding its views on business practices and ethical behavior.

• Enquire whether they have knowledge of any actual, suspected or alleged fraud affecting the entity.

7. The auditor should be cognisant of the fact that fraudulent financial reporting often involves management override of controls. State any four
techniques which the management may use for fraudulent financial reporting. (04)

A: (a) Fraud can be committed by management overriding controls using techniques such as the following:

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• Recording fictitious journal entries.

• Inappropriately adjusting / changing assumptions and judgments used previously to estimate account balances.

• Omitting, advancing or delaying recognition in the financial statements of events and transactions that have occurred during the reporting
period.

• Concealing or not disclosing facts that could affect the amounts recorded in the financial statements.

• Engaging in complex transactions / unusual transactions to misrepresent the financial position or financial performance of the entity.

• Altering records and terms related to significant and unusual transactions.

8. Following matters arose during the performance of test of details on sales:

(i) Three invoices of superstores could not be found in the record room. The staff explained that it would require a lot of time to find them
and requested your team to select some other invoices. Scrutiny of the ledger revealed that total amount of these missing invoices was Rs. 6
million.

(ii) Five of the invoices issued to distributors were booked at the rate of Rs. 1,725 per carton instead of Rs. 1,275 per carton. The quantity
involved was 3500 cartons.

Required:

Explain how you would resolve the above issues. (Impact on the audit report is not required) (5)

A; • The audit team should not accept other invoices as a sample in replacement of the three misplaced invoices. It should try to perform alternate
audit procedures to verify those sales. If that is not possible, the team should request the management to find those invoices. Otherwise it should
be considered as a misstatement.

• The audit team should investigate whether the missing invoices represent a control weakness or indicative of fraud and evaluate its impact on
the overall audit accordingly.

• As for the sale recorded with incorrect rates, the management should be asked to reduce the sales by Rs. 1,575,000.

• The audit team should also investigate whether the invoices recorded at incorrect rate represent control weakness, due to which the
management was unable to detect the error in the invoices previously.

• The audit team must obtain a high degree of certainty that such misstatement is not representative of the population for which it may need to
perform additional audit procedures.

• If it is established that the misstatement is representative of the population, the audit team should project the misstatements found in the
sample to the entire population of the stratum and consider increase in the extent of substantive testing and the nature of testing.

9. Green Limited (GL) is a listed company engaged in the manufacturing of garments and apparels. During the audit planning meeting for the
year ending 31 March 2018, the Chief Financial Officer of GL has provided the following information:

a) GL was previously exporting all its production under the brand name of 'Wearables'. However, it has been facing the issue of decline in
export orders and therefore has decided to start focusing on the local market. Accordingly, it has made an agreement with BL, according to
which GL's products would be sold to BL who would market them through BL's retail outlets spread throughout Pakistan. A director of GL holds
major shareholding in BL.

b) Two of the directors of GL holding 16% and 13% shares in GL have informed the Board that they intend to sell their entire shareholding in
GL in order to concentrate on some of their other businesses.

c) While discussing some of the internal control deficiencies in the payroll processing department, which were raised in the previous year's
management letter, the CFO has informed that the matter has been referred to the internal audit department but is pending because of the
illness of the Chief Internal Auditor.

Required:

(a) Identify fraud risk factors in the above scenario.(4)

(b) Describe what actions an auditor should take on identifying a fraud risk factor. (05)

A: (a) Fraud risk factors:

Significant decline in customer demand:

Due to significant decline in demand of foreign customers, the management may be inclined to show improved results by manipulating the
accounting records.

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Significant related party transactions:

Significant related party transactions between GL and BL would provide an opportunity for engaging in fraudulent financial reporting.

Sale of shares by director:

The directors' intention to sell their shareholding in GL provides them an incentive to manipulate the annual profits so that they can achieve the
maximum possible gain from the sale of shares.

Non-implementation of last year's external auditor's recommendations:

Management failure to place controls against weaknesses identified by the external auditor on timely basis shows the management's attitude
towards the improvement of internal controls and consequently it increases the risk of fraud.

{b) Course of action:

In response to assessed risk of material misstatement due to fraud, the auditor shall:

• emphasize to the Audit team the need to maintain an attitude of professional skepticism.

• assign more experienced staff or increased supervision of staff.

• to the extent not already done, the auditor shall obtain an understanding of the entity's related controls, relevant to such risks.

• evaluate whether the selection and application of accounting policies by the entity, particularly those related to subjective measurements and
complex transactions, may be indicative of fraudulent financial reporting resulting from management's effort to manage earnings.

• incorporate an element of unpredictability in determining the nature, timing and extent of audit procedures.

• design and perform further audit procedures whose nature, timing and extent are responsive to the assessed risk of material misstatements.

10. You are the audit manager responsible for the audit of Clocks (Private) Limited (CPL). While reviewing the draft planning document prepared
by the audit senior, you observed that he has assessed risk of material misstatement due to fraud and risk of management override of control as
low due to the fact that CPL has been an audit client of the firm for the last 10 years and no material misstatement had been reported in the
previous years.

Required:

(a) Draft an email to be sent to the audit senior to guide him with regard to the above matter. (06)

(b) Suggest appropriate procedures with regard to risk of material misstatement due to fraud. (07)

A: (a) Email to job-in-charge

To: Audit Senior

Date: 07 September 2017

Subject: Risk of material misstatement due to fraud and management override of control

I have reviewed the draft planning document prepared by you and I want to bring your attention to the risk of material misstatement due to fraud
and management override of control.

When planning and performing an audit, we should adopt an attitude of professional skepticism. We should have an attitude that includes a
questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence. We should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding our past experience of the
honesty and integrity of the entity's management and those charged with governance.

Although the level of risk of management override of controls will vary from entity to entity, the risk is nevertheless present in all entities. Due to
the unpredictable way in which such override could occur, it is a risk of material misstatement due to fraud and thus a significant risk. Irrespective
of our assessment of the risks of management override of controls, we shall design and perform the audit procedures for management over ride of
controls.

If you require any further information on the above, please do not hesitate to contact me

Yours faithfully,

XYZ

(b) Following are the procedures for risk of material misstatement due to fraud:

(i) Make enquiries of management in respect of:

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• their assessment of the risk of material fraud;

• processes in place for identifying and responding to the risks of fraud;

and

• any specific risks of fraud identified or likely to exist.

(ii) Make inquiries of management and others within the entity as to whether they have any knowledge of any actual, suspected or alleged frauds
and to obtain views about the risks of fraud.

(iii) Make inquires of internal audit.

jv) Evaluate any unusual or unexpected relationships identified while performing analytical

procedures which might indicate a risk of material fraud.

(v) Evaluate information obtained from other risk assessment procedures to see if any fraud risk factors are present.

11.You have been assigned the audit of Sukkur Limited (SL), a listed company, for the year ended 31 December 2016. The company engaged in
the business of manufacturing security equipment for the local market. During the planning phase, while reviewing the previous year's audit
file, you have noted that in 2015, due to introduction of many new equipment in the market and changes in technology, SL faced stiff
competition and its market share reduced from 45% to 35%. However, the management has now informed you that SL has made significant
investment in technology which has helped the company to increase the market share to 38% in 2016.

The following information has been extracted from the draft financial statements:

Extracts from the statement of comprehensive)ncome

2016 2015 2014

(draft) (audited) (audited)
Rs. in million
Revenue 10742 9703 9650
Cost of sales 8050 7177 6740
Finance Charges 750 600 350
Profit before tax 1550 1601 2260
Extracts from the statement of cash flows

2016 2015 2014

(draft) (audited) (audited)
Rs. in million
Cash flow from operations (3,361) (1,948) (585)
Cash flow from financing activities 4,000 3,500 1,500
Required:

(a) Identify any four fraud risk factors in the above scenario. (04)

(b) Identify four audit risks which the auditor should consider while planning the audit. (06)

A: (a) Fraud risk factors in the scenario are:

• high degree of competition or market saturation, accompanied by declining margins and profitability.

• High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates.

• Excessive pressure exists for management to meet the requirements or expectations of third parties due to the need to obtain additional debt
financing to stay competitive.

• Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting profitable operation.

(b) Audit risks

(i) Risk of fraudulent financial reporting by Management override of controls:

In view of the declining earnings trend and declining margin and increase in financing the management may be inclined to fraudulent financial
reporting by overstating the revenues or understating the expenses.

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(ii) Risk of impairment in value of property, plant and equipment:

Due to introduction of new technology there is a possibility that value of existing plant and machinery is impaired.

(iii) Risk of overstatement of existing inventory:

Due to change in technology, the demand for SL's products has been affected and there is a possibility that net realizable value of inventory may
have declined and a provision for obsolescence may be required.

(iv) Risk of overstatement in value of debtors:

In view of the negative operating cash flows, it seems that SL has not been able to generate operating cash flows despite increase in sale, which
might indicate that debtors are either doubtful or not recoverable.

12. (a) Discuss the external auditor's responsibility relating to fraud in an audit of financial statements. (04)

(b) Sometime the management's attitude towards the audit/auditors is indicative of the possibility of material misstatement in the financial
statements due to fraud. Give four examples of such attitude/circumstances. (04)

(c) You are the auditor of Information Limited (IL), which is engaged in the development of customized software. During the last three years IL
has become the leading software developer in the industry due to completion of large number of projects. During the initial meeting the client
has informed that:

• IL has achieved a growth of 60% as compared to the growth target of 30% set for the financial year ended 30 June 2016 and the board of
directors are considering to distribute 25% of the profit to the management staff as performance bonus.

• one of the competitors has shown its willingness to acquire IL.

Required: Identify the fraud risk factors in the above situations. (03)

A: (a) The objective of a statutory audit (an external audit) is to express an opinion on the truth and fairness of the views presented by the F /S. The
auditor is not primarily responsible for the prevention or detection of fraud.

The auditor will be concerned with fraud only to the extent that it might impact on the view shown by the F /S. He will therefore be concerned with
the risk of material fraud.

The auditor should maintain an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due
to error or fraud, and a critical assessment of audit vidence.

Further, he must respond appropriately to fraud or suspected fraud identified during the audit

(b) Management's attitude towards the auditor which may indicate the possibility of a material misstatement includes:

• Denial of access to records, facilities, certain employees, customers, vendors, or others from whom audit evidence might be sought

• Undue time pressures imposed by management to resolve complex or contentious issues.

• Unusual delays by the entity in providing requested information.

• An unwillingness to add or revise disclosures in the F /S to make them more complete and understandable.

(c) ffl Rapid growth or unusual profitability:

• Significant portions of key management personnel's compensation i.e. bonus being contingent upon achieving aggressive targets for operating
results.

• Pressure on management to show good profitability considering the proposed acquisition.

13. Because of its ability to exert influence, management is in a position to perpetrate fraud and prepare fraudulent financial statements.

( a) Identify six different ways in which fraud may be committed by management through overriding of controls. (06)

(b) Briefly state the audit procedures which may be performed to identify the risks of material misstatement due to fraud. (O5)

A: (a) (i) Forging or altering accounting records or supporting documentation which form the basis of the F/S.

(ii) Misrepresenting or intentionally omitting events or transactions from the F /S.

(iii) Intentionally misapplying accounting principles.

(iv) Concealing or not disclosing, facts that could affect the amounts recorded in the F /S.

(v) Engaging in the complex transactions that are structured to misrepresent the financial position or financial performance of the entity.

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(vi) Embezzling receipts (for example, diverting them to personal bank accounts)

(b) The auditor is required to perform the following procedures to identify the risks of material misstatement due to fraud:

• Make inquiries of management in respect of:

their assessment of the risk of material fraud;

their process in place for identifying and responding to the risks of fraud;

any specific risks of fraud identified or likely to exist;

any communications within the entity in respect of fraud (including to employees regarding management's -views on business practices and ethical
behavior).

• Make inquiries of management and others within the entity as to whether they have any knowledge of any actual, suspected or alleged frauds
and to obtain views about the risks of fraud.

• Evaluate any unusual or unexpected relationships identified in performing analytical procedures which might indicate a risk of material fraud.

• Evaluate information obtained from other risk assessment procedures to see if any fraud risk factors exist.

14. While reviewing the audit files of four different clients you confronted the following situations:

.ifr Due to tough competition in the market, the company has been unable to increase the prices of its products since last 5 years.

(ii) Addition to intangible assets, amounting to Rs. 500 million include research cost of Rs. 10 million which is duly supported by invoices from
suppliers.

(iii) During the last three years, the Chief Executive and higher management has been earning handsome bonuses, based on the profitability of
the company.

(iv) Physical stock take on 31 December 2014 included goods sold but not dispatched amounting to Rs. 52 million. The delivering of goods was
stopped on the request of a distributor. Upto 20 January 2015, the distributor has taken delivery of goods amounting to Rs. 2 million.

Required:

(a) In each of the above situations, identify with justification whether it represents a risk of fraud. (06)

(b) Describe what actions are to be taken by an auditor on identifying a fraud risk factor.(04)

A: (a) (i) Inability to increase the prices of its products since last 5 years

The Company's profitability is under threat due to increased competition therefore the management may be inclined to manipulate the accounting
records.

(ii) Research costs wrongly capitalized

It is an error and is not indicative of fraud, as research costs is only 2% of the total amount capitalized and the underlying records were duly
supported by invoices from the suppliers.

(iii) Bonuses linked with profitability

It is a fraud risk factor as it is evident that management is receiving profit related bonuses, therefore the management may be inclined to
manipulate the accounting records.

(iv) Goods sold but not dispatched

It is a fraud risk factor as it seems that management has tried to inflate the sales in order to deceive financial statement users, an apparent
intention behind this action can be to overstate the profits of the company.

(b) Course of action:

In response to assessed risk of material misstatement due to fraud, the auditor shall:

• Emphasize to the Audit team the need to maintain an attitude of professional skepticism.

• Assign more experienced staff or increased supervisor of staff.

• To the extent not already done, the auditor shall obtain an understanding of the entity's related controls, relevant to such risks.

• evaluate whether the selection and application of accounting policies by the entity, particularly those related to subjective measurements and
complex transactions, may be indicative of fraudulent financial reporting resulting from management's effort to manage earnings; and

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• Incorporate an element of unpredictability in the selection of the nature, timing and extent of audit procedures.

• Design and perform further audit procedures whose nature, timing and extent of audit procedures are responsive to the assessed risk of
material misstatements.

15. Your firm is the auditor of Cell Phones (Private) Limited (CPPL), which operates a chain of mobile phone retail outlets. About 25% of
shareholding in CPPL is owned by Anwar and his wife. Anwar is the Chief Executive of CPPL and also looks after the finance and operations of
the company. There are five other directors and each of them holds 15% shares in CPPL.

The Internal Audit Function comprises of three senior officers who are graduates. Their duties include checking of accounting records, physical
stock taking, preparation of bank reconciliations, reviewing payments and verification of fixed and current assets.

During the planning phase, Anwar stressed the need for early completion of audit, in order to be able to submit the audited financial statements
for seeking a long term finance. He was of the view that internal internal audit working papers would be of enormous help in performing and
early completion of the audit

Required:

Identify and briefly describe the fraud risk factors in the above scenario. (06)

A: (a) Fraud Risk Factors:

Rapid Changes in Technology:

Products like mobile phones are likely to become obsolete very quickly, as more advanced products come on to the market The company faces a
threat due to rapid changes in technology; therefore the management may be inclined to manipulate the accounting records.

Lack of Segregation of Duties/ Dominance of management by a single person:

As Anwar is the Chief Executive and is also responsible for finance and operations of the company, this gives him a personal motivation to misstate
figures to show improved performance.

Long Term Loan:

As the company has applied for long term loan, it may be inclined to manipulate the figure to show better financial position to the bank.

Demand for early completion of audit:

The demand by Anwar for early completion of audit creates undue susp1c10n because such pressures are sometime applied to distract the auditor
from his responsibilities.

16. Management is in a unique position to perpetrate fraud because of its ability to manipulate accounting records and prepare fraudulent
financial statements by overriding controls that otherwise appears to be operating effectively.

Required:

Determine the audit procedures that may be performed by the auditor to address the risks related to override of controls. (08)

A: Course of action:

Irrespective of the auditor's assessment of the risks of management override of controls, the auditor shall design and perform audit procedures to:

• Make inquiries of individuals in the accounts department about inappropriate or unusual activity they have noticed during processing of
journal entries and other adjustments;

• Select journal entries and other adjustments made near the yearend; and

• Consider the need to test journal entries and other adjustments throughout the period.

(ii) Review accounting estimates for biases and evaluate whether the circumstances producing the bias, if any, represent a risk of material
misstatement due to fraud. In performing this review, the auditor shall:

• Evaluate whether the judgments and decisions made by management in making the accounting estimates, even if they are individually
reasonable, indicate a possible bias on the part of the management that may represent a risk of material misstatement due to fraud. If so, the
auditor shall reevaluate the accounting estimates taken as a whole; and

• Evaluate the results of the accounting estimates and judgments made in the prior years.

(iii) For significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be unusual, the auditor
shall evaluate whether the business rationale ( or the lack thereof) of the transactions suggests that they may have been entered into to engage in
fraudulent financial reporting or to conceal misappropriation of assets.

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17. You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the year ended June 30, 2010. ASPL is engaged in the
manufacture of a wide range of plastic products. While reviewing the initial work performed by the audit team, the following matters have
come to your notice:

(i) The quantity of material scrapped during the year is materially different from the quantity of scrap sold. The company's records show nil
balance both at the beginning and at the close of the year. No reconciliation for the difference has been provided by the company.

(ii) Sales for the year have increased by 7% over the previous year. However, it has been noted that sales in the last two weeks of June 2010
have been exceptionally high and represent 15% of the annual sales. The audit working papers carry the following observations in respect of the
above:

• 70% of the sales in the last two weeks of June were made to two new customers whose credit assessment has not been formally
documented;

• a significant portion of the goods sold to the above referred customers were returned in the first week of July 2010; and

• management bonuses are linked to the operating performance of the company.

(iii) During the year, ASPL purchased a machine for Rs. 25 million. The payment voucher is duly supported by the invoice from the supplier.
However, the fixed assets schedule provided by the client shows the amount capitalized as Rs. 2.5 million. Depreciation has been charged on
this amount The difference of Rs. 22.5 million is appearing in the Bank Reconciliation Statement.

Required:

(a) Analyze each of the above situations and assess whether it represents a fraud or an error. (06)

(b) What action would you take to deal with the above matters? (09)

A: (a)ln the absence of any valid explanations from the management, it would be considered as misappropriation of assets i.e. fraud as it seems to
involve the theft of an entity's assets.

(i) It is a case of fraudulent financial reporting as it seems that management has tried to inflate the sales in order to deceive financial statement
users. An apparent intention behind this action is the management bonuses which are linked to the operating performance of the company.

(ii) It is an error on the part of accountant. The underlying records such as the invoice etc have not been altered and even the voucher has been
prepared with the correct amount which shows that it is an unintentional misstatement.

(b) (i) & (ii) If we have identified a fraud or has obtained information that indicate that a fraud may exist, we should communicate these matters on
a timely basis to the appropriate level of management. This is so even if the matter might be considered immaterial. We should consider whether
there are matters related to fraud to be discussed with TCWG of the entity.

Matters may include:

• Concerns about the nature, extent and frequency of management's assessments of the controls in place to prevent and detect fraud and of
the risk that the F /S may be misstated.

• A failure by management to appropriately address identified significant deficiencies in internal control, or to appropriately respond to an
identified fraud.

• Our evaluation of ASPL's control environment, including questions regarding the competence and integrity of management.

• Actions by management that may be indicative of fraudulent financial reporting, such as management's effort to manage earnings in order to
deceive financial statement users by influencing their perceptions as to the entity's performance and profitability.

• Concerns about the adequacy and completeness of the authorization of transactions that appear to be outside the normal course of business.

Based on the discussion and our overall understanding of the matter, we should:

• ask the management to reverse the sales made;

• revise its risk assessment of the entity's control environment and modify the further planned audit procedures accordingly.

• Consider the impact on audit report.

(iii) Since this seems to be an error, the appropriate level of management should be informed about it and the relevant adjustments in fixed assets
and depreciation account should be made.

18. During the course of audit an auditor is expected to be vigilant enough to develop understanding about the propriety of important
transactions and to determine whether or not such transactions have appropriate business rationale. Required: Briefly describe the situations in
which a transaction is indicative of fraud or an attempt to conceal fraud or fraudulent reporting. (07)

A: Some of the situations which are indicative of fraud or an attempt to conceal fraud or fraudulent financial reporting are as follows:

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• Significant transaction, that are outside the normal course of business or that otherwise appear to be unusual.

• Where a transaction appears overly complex.

• Management has not discussed the nature of and accounting for such transactions with TCWG of the entity and there is inadequate
documentation.

• Management is placing more emphasis on the need for a particular accounting treatment than on the underlying economics of the
transaction.

• Transactions that involve non-consolidated related parties, including special purpose entities and have not been properly reviewed or
approved by TCWG of the entity.

• The transactions involve previously unidentified related parties or parties that do not have the substance or the financial strength to support
the transaction without assistance from the entity under audit.

Not for Profit Organization

1. Khyber Foundation (KF) is a non-profit organization engaged in providing medicines and medical equipment free of cost or at substantially
discounted rates to the underprivileged people of the society. KF has obtained the approval from the relevant regulatory authorities to operate
as a non-profit organization. Therefore, KF is entitled to tax exemption subject to conditions that administrative expenses do not exceed 15% of
total donations and all withholding taxes are duly deposited with the taxation authorities.

During the financial year 2020-21, KF has received cash donations from the following three sources:

• Corporate entities through banking channel;

• Donation boxes placed in various retail shops; and

• Collection kiosks placed in the major shopping malls as part of donation campaign in Ramadan.

KF has also received medical equipment from donors which are recorded at fair value.

Medicines and medical equipment are given only on a valid doctor's prescription. This facility is also available to KF's employees.

KF has employed two accountants who are pursuing their bachelor's degree. Both of them are responsible for recording receipts, making
payments, managing inventory and reporting to the trustees.

Required:

Identify the risks which KF's auditor would need to consider.(7)

A: (i) There is a risk of embezzlement of cash collected from donation boxes as no receipt is generated for cash collected in donation box.
(ii) Cash collected at kiosks may be embezzled by personnel collection cash donations; therefore, cash is highly susceptible to theft.

(iii) There is an inherent risk that the donation income may be overstated by overvaluing the donation in kind.

(iv) There is a risk that the management may miss-classify administration spending by classifying items of expense incorrectly.

(v) Since there is no qualified accountant, there is a risk that:

• proper withholding of taxes may not be done leading to ineligibility of tax credit.

• transactions are not recorded on a timely basis.

• withholding taxes are not timely deposited with the taxation authorities.

(vi) Since only two employees are responsible for recording all transactions including inventory management, there is a lack of segregation of
duties and hence risk of:

• fraud and error may arise.

• theft of medicines may arise;

(vii) The medicines may be issued to the employees or other beneficiary without fulfilling the requirements.

2.Ameer Welfare Trust (A WT) is engaged in providing education and three daily meals to the underprivileged citizens of the society. Donation
collection kiosks have been established at various public spots which collect donations predominantly in cash.

The constitution of A WT states that administration costs should not exceed 10% of its income. Due to this restriction, A WT has employed only
one accountant who works on part time basis

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The constitution further requires AWT to maintain separate bank accounts for donations collected for education and meals. Donors are
requested to mention the purpose of donation. Donation received for a specific purpose cannot be spent for any other purpose.

Required:

Identify the risks which A WT's auditor would need to consider. (05)

A: • There is a risk of embezzlement in cash collection and inventory.

• Donation for food are recorded in donation for education account and vice versa.

• Contributions are spent on other than intended purpose.

• There is a risk that the money spent on administration is not recorded as administration cost and is misclassified.

• Since only one person is responsible for managing the accounts, there is a lack of segregation of duties and hence risk of fraud and error may
arise.

• Since there is no full time person to look after the accounts, there is a risk that transactions are not recorded on a timely basis.

3. AI-Madad Foundation (AMF) is a charitable organization. It receives donations which are utilized to help the destitute persons in accordance
with the rules and regulations prescribed by the AMF's Trust Deed. The donations are received from the following sources:

(i) Cash collected from the general public through charity boxes placed at key points in hospitals, airports, superstores etc.,

(ii) cash and cheques received from individuals and institutions at AMF's office; and

(iii) cash from generous individuals who prefer to remain anonymous.

Donations received in case of (ii) and (iii) above, often contain specific instructions for utilisation of the donated amount for specific purposes
e.g. for education of orphan children.

Required:

( a) Identify the inherent risks in the operations of AMF. (03 marks )

(b) Briefly discuss the effect of each of these risks on the audit of AMF. (03 marks )

A: ( a) Areas of Inherent Risk

(i) Donations

• Donations may fall, especially where donors' own income is limited or declining, or there is a change in the circumstances.

• No control over the completeness of donations (especially over the cash donations).

(ii) Expenses

• Donations are spent outside the aims and objectives of AMF.

• Donations are not spent in accordance with donors' instructions.

(b) Effect on the audit approach

(i) It is difficult to estimate that income in the future will be sufficient to meet the expenditure of the AMF. Audit of the going concern concept (
as in ensuring that the AMF can still operate) will therefore be quite difficult.

(ii) Audit tests are unlikely to be effective to meet the assertion of completeness. The audit report may need to be modified and qualified to
explain the lack of evidence stating that completeness of income cannot be confirmed.

(iii) Careful review of expenditure will be necessary to ensure that expenditure is not 'ultra vires' the objectives of the AMF. The auditor will need
to review the trust deed and other documents of the AMF carefully in this respect.

(iv) The use of donations received for specific purposes would have to be checked to ensure that instruction of donors has been followed.

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Chapter#04 (Evidence and Sampling)

ISA 500
1. State the factors which may assist the auditor in assessing the reliability of audit evidence. (05)

A: Reliability of audit evidence is dependent on the following factors:

• Audit evidence is more reliable when it is obtained from independent sources outside the entity under audit.

• Internally generated audit evidence is more reliable when the related controls are effective.

• Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference.

• Audit evidence is more reliable when it exists in documentary form.

• Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies.

2. Briefly describe how an auditor evaluates the sufficiency of audit evidence (04)

A: Factors to be considered by auditor in deciding sufficiency of audit evidence:

The decision relating to sufficiency of audit evidence depends upon the judgment of the auditor. Apart from professional judgment, following
factors are also relevant in determining the sufficiency of audit evidence.

(i) the seriousness of the risk that the F /S might not give a true and fair view; when this risk is high, more audit evidence will be required

(ii) the materiality of the item

(iii) the strength of the internal controls in the client's accounting systems.

3. State any two factors which the auditor should consider to ensure reliability of audit evidence. (02)

A: Auditor should consider source of audit evidence, effectiveness of related controls, form of audit evidence etc.

4.Narrate the circumstances under which the auditor would resort to the following techniques while selecting items for tests of details and
controls:

Selecting all items of a population. (03)

A: (a) (i) Selecting all items

Selecting all items of a population for examination may be appropriate in the following situations:

The population constitutes a small number of large value items;

There is a significant risk and other means do not provide sufficient appropriate audit evidence; or

The repetitive nature of a calculation or other process performed automatically by an information system makes a 100% examination cost
effective.

5. Briefly explain any six methods for collecting audit evidence. (12)

A: (b) Methods of Collecting Audit Evidence:

• Physical Examination:

Physical examination means physical verification of an asset, such as stocks, investment certificates and fixed assets, as an evidence of its existence
and its condition.

• Third party confirmation:

Confirmation of an amount or other information shown in the client's records by an independent third party provides a reliable evidence of the
existence of the amount and correctness of the information, as the case may be. For example, receivables, payables, contingent liabilities, stock
with third parties etc.

• Examination of original records:

Original records like ownership documents, bills, notices etc. provide a reliable and conclusive evidence of the legal claims, transactions, balances
etc.

• Recomputation:

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Recomputation technique is applied to prove arithmetical accuracy of a transaction and to verify that the computation is in accordance with the
rules, procedures and acceptable practices. The areas where recomputation techniques are generally applied include depreciation computations,
bonus calculations, provisions etc.

• Enquiry:

Enquiry consists of seeking information from knowledgeable persons, both financial and non-financial, within the entity or outside the entity. The
enquiry may not provide conclusive audit evidence but it may give some form of clue which may lead to further verification.

• Analytical Procedures

Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among financial as well as non-
financial data. Analytical procedures also encompass investigation of identified fluctuations or relationships that are inconsistent with other
relevant information or that differ from expected values by a significant amount.

6. Explain the term "Sufficient and Appropriate Audit Evidence". (04)

A: (i)The sufficiency and appropriateness of audit evidence are interrelated.

(ii) Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is affected by the auditor's assessment of
the risks of misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also by the quality of such audit
evidence (the higher the quality, the less may be required).

(iii) Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for the conclusions
on which the auditor's opinion is based.

ISA 530
1. State two advantages and two disadvantages of statistical sampling. (04)

A: Advantages of statistical sampling:

• Statistical sampling provides an objective, mathematically precise basis for the sampling process.

• The required sample size can be calculated precisely ( using statistical probability techniques).

Dis-advantages of statistical sampling:

• A degree of training and technical expertise is required if auditors are to use statistical sampling techniques effectively.

• This requires an investment in the necessary training for audit staff.

2. You are the audit senior at FSY Limited (FSY) for the year ended 30 June 2018. FSY manufactures and supplies toys to wholesalers, super
stores and distributors. Different prices are charged from each customer depending upon their credit rating and amount of purchases.

Your team has made a plan for test of details for verification of sales. The sampling of invoices would be made as per the following plan:

(i) Sales reported in the financial statements is Rs. 800 million net of sales returns. This would be used for determining the sample size.

(ii) 50% of the net sales represents sales to distributors, 40% to super stores and 10%to wholesalers.

(iii) FSY sells its toys to 10 super stores only, who are invoiced on a monthly basis. The audit team would test all the invoices of June and
December because invoices prepared close to period end are more prone to overstatement. In addition, 2 invoices would be checked for each of
the other 10 months.

(iv) 100 sales invoices to distributors and wholesalers would be selected haphazardly from invoice files. The number of invoices to be checked
has been determined considering that expected rate of deviation is low. The expectation regarding rate of deviation is based on the fact that
overall audit risk has been assessed as low.

Required:

Identify the weakness in the sampling approach planned by the audit team and suggest appropriate changes. (10)

A:

S. Weakness in sampling approach Recommendation

No.
(i) The audit team had used net sales for Sample should be representative of the population, which in this case is 'sales'.
calculating the sample size. Therefore, sampling should be based on gross sales.
(ii) Testing all the invoices of June and Total super stores invoices issued in a year are 120 and the sales of superstores
December, being specific selection, will not constitute 40% of the total sales, therefore, the audit team may consider testing all the
invoices of the super stores.

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enable the auditor to project the results to Audit team could use statistical sampling so that results can be projected to entire
entire population. population.
Furthermore, the risk of overstatement of sales near the year-end may be catered
through other tests such as cut off test of sales.
(iii) Haphazard selection of 100 invoices is a non- In view of low risk, it appears that the team considers random sampling appropriate
statistical selection and risk of auditor under the given circumstances, but in order to make the process efficient opted for
biasness is very high. It will not enable the haphazard selection. The sales to distributors and wholesalers is around 60%.
auditor to project the results to entire Therefore, use of statistical sampling would be more appropriate so that results could
population. be projected to entire population.
(iv) Selection of invoice from the files instead of There is a risk that those transactions would not be identified for which files are not
selecting from the sales ledger. made. Hence, the selection should be made from the ledger for occurrence and
accuracy and from delivery record for completeness and cutoff.
(v) Distributors and wholesalers have been If sales to distributors and wholesalers have different characteristics, then they should
clubbed together for determining the be considered separately as two strata for calculating the sampling size and selecting
sample size. They are likely to have different the sample.
characteristics.
(vi) In performing test of details on sales, The inherent risk for sales is generally considered to be high, therefore setting the
expected misstatement is based on expected misstatement should not be set as low without considering the inherent risk.
expected deviation rate. In case of sales
The following will be considered while setting expected misstatement:
expected misstatement cannot be based onSubjectivity involved
overall risk assessment. • Results of risk assessment and test of controls
• Results of audit procedures applied in prior
• period warrants such a use; or
• Results of other substantive procedures
3. a) List any four ways in which the debtor balances may be stratified. (02)

(b) You are the audit incharge on the audit of Opportunity Limited (OL). OL deals in fast moving consumer goods. For sending of confirmations,
an audit team member has stratified the debtors as follows:

Category A Balances exceeding Rs. 50 million 12 customers

Category B Balances below Rs. 50 million 100 customers
Category C Balances below Rs. 10 million 280 customers
Category D Balances below Rs. 1 million 600 customers
During a meeting some of the team members have expressed divergent views, as follows:

(i) Verification of balances of category A and B will provide sufficient coverage and evidence; therefore there is no need to cover other
categories.

(ii) Selection should be done on haphazard basis, as under this method all items of population have equal chance of selection.

(iii) Selection of sample should be done systematically, whereby items constituting 10%of the amounts in each category should be selected in
descending order.

Required:

Discuss the appropriateness of options discussed in the meeting and give your suggestion in this regard. (05)

A: (a) Ways in which debtors population may be stratified are as under:

• By product

• By customers or category of customers

• Geographically

• Terms of sales such as credit terms/ Aging

• By values

(b) Views expressed by the team member:

(i) The view that if verification of balances of category A and Bis carried out than there is no need to perform further procedures is not correct as
the results of audit procedures applied to items in category A and B will only provide evidence about the items that make up that category
(stratum).

(ii) The auditor should obtain sufficient appropriate audit evidence regarding items in categories C & D as these can also be material.

(iii) The view that sampling should be carried out on haphazard basis to ensure equal chance of selection is not correct as such assurance is only
ensured by using random sampling,

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i. e. use of random numbers to select items.

(iv) The view related to systematic sampling is not correct, as selection of 10% items is not systematic sampling. Systematic sampling involves,
selection of first item on random basis and then items are selected with a standard gap between them (for example, every 10th item).

Suggestion:

Both haphazard and systematic sampling may be used in the normal manner, either with or without stratification. However, these methods cannot
be used in the manner as suggested by the team members because it may result in extensive testing on immaterial items, thereby increasing the
cost which may not be efficient. It may also be appropriate to use random sampling to ensure all items in a population have an equal chance of
selection.

4. What are the matters which the auditor should consider while designing an audit sample, determining its size and selecting the sampling
units? (03)

A: • When designing an audit sample, the auditor shall consider the purpose of the audit procedure and the characteristics of the population from
which the sample will be drawn.

• The sample size should be sufficient to reduce sampling risk to an acceptably low level.

• The auditor shall select items for the sample in such a way that each sampling unit in the population has an equal chance of selection.

5. Briefly Describe the term 'systematic sampling'. (01)

A: Systematic sampling:

It is a method of sampling whereby a random starting point is chosen from the population and then items are selected with a standard gap
between them (for example, every 10th item).

6. Differentiate between the following:

(ii) Tolerable mis-statement and performance materiality (O5)

A: A Tolerable misstatement is a monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of
assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population.

Performance materiality means the amount or amounts set by the auditor at less than materiality for the F JS as a whole to reduce to an
appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the F JS as a
whole. Performance materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for particular
classes of transactions, account balances or disclosures.

7. ( a) Differentiate between the following:

(i) Statistical and non-statistical sampling

(ii) Sampling and non-sampling risk (05)

(b) You are the audit manager on Apple Distribution Limited (ADL). While reviewing the audit planning documentation, you found that the
audit team has selected 100 out of a total of 2,550 debtors for balance confirmation. The details are as follows:

• 50 largest debtors constitute approximately 40% of total debtors. Out of these, 10 have been selected.

• 90 other debtors were selected through haphazard sampling.

• All debtors below Rs. 5,000 were ignored as immaterial.

• Balances due from government and some of the related parties were ignored as prior years working papers showed that they never
responded to requests for confirmation.

Required:

(i) Comment on the sampling approach adopted by the audit team.

(ii) Suggest alternative means of selecting the sample in which the material balances have a greater probability of selection. (04)

A: (a)

(i) Statistical and non-statistical sampling

An approach to sampling that has the following characteristics is called statistical sampling:

• Random selection of the sample items; and

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• Use of probability theory to evaluate sample results, including measurement of sampling risk. A sampling approach that does not have above
characteristics is considered non-statistical sampling.

(ii) Sampling and non-sampling risk

Sampling risk is the risk that the auditor's conclusion based on a sample may be different from the conclusion if the entire population were
subjected to the same audit procedure.

Non sampling risk is the risk that the auditor may reach an erroneous conclusion for any reason not related to sampling risk.

(b) (i) The following shortcomings have been observed in the approach adopted by the Audit Team: 1) By ignoring less than Rs. 5,000 debtors, the
government debtors and some of the related parties, for the purpose of sampling, the following important principles have not been complied with.

• That the auditor should consider the risk of material misstatement on the entire population.

• That the auditor should attempt to ensure that all items in the population have a chance of selection

2) In stratification, the audit efforts are directed towards larger value items. However, the audit planning documentation should explain why the
only 10 debtors out of 50 largest debtors were selected.

(ii) Alternative means of sampling material balances are as follows:

Stratification

This would involve dividing the sample into discrete sub-populations (stratum) which have an identifying characteristic. In our case, the population
may be stratified by monetary value.

For example, following strata may be created:

• Above Rs. 1,000,000

• Between Rs. 500,000 and Rs. 1,000,000

• Below Rs. 500,000

The sample may be made from each strata allowing effort to be directed to the larger value items.

8. Describe the circumstances in which an auditor may decide to examine entire population of items that make up an account balance. (03)

A: The auditor may decide to examine the entire population in the following circumstances:

• when the population constitutes a small number oflarge value items.

• when there is a significant risk and other means do not provide sufficient appropriate audit evidence; or

• when the repetitive nature of a calculation or other process performed automatically by an information system makes a 100% examination
cost effective.

9. You are the audit manager on a client where an annual sale is Rs. 640 million. During the course of annual audit the following table was
developed by an audit team member, to categorize the annual sales:

Category A 50 sales transactions to different customers 300 million

Category B 100 transactions to different customers 200 million
Category C 500 transactions to different customers 140 million
Total 640 million
So hail, a team member, is of the view that if verification of all the transactions in category A is carried out, there is no need to perform further
procedures. However, other team members do not agree and consider that proper sampling should be carried out from the total population and
categorization should be ignored.

Required: As an audit manager of the job, you are required to:

(i) Explain how audit efficiency could be improved by using the above table.

(ii) List other ways in which the sales population may be categorized and what precaution should be taken while carrying out such
categorization.

(iii) Give your opinion on the views expressed by Sohail & Other audit team members. (11)

A:(a) (i) Audit efficiency may be improved as the auditor has stratified a population by dividing it into discrete sub-populations which have an
identifying characteristic. The stratification reduces the variability of items within each stratum and therefore allow sample size to be reduced
without a proportional increase in sampling risk .

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(ii) Other ways by which sales population may be stratified are as under:

• By product

• By customers or category of customers

• Geographically

• Terms of sales such as credit, cash, advance etc.

Precaution: sub-categorization/sub-populations need to be carefully defined such that any sampling unit can only belong to one stratum.

(iii) Views expressed by Sohail

His view that if verification of total transaction of category A is carried out than there is no need to perform further procedures is not correct due to
the following reasons:

• The results of audit procedures applied to all the items within category A can only provide evidence about the items that make up that
category(stratum).

• The auditor should obtain sufficient appropriate audit evidence regarding items in Categories B & C as these are also material.

Views expressed by other audit team member

Their view that proper sampling should be carried out from the total population of 640 million and categorization should be ignored altogether is
not correct because stratification helps in improving the efficiency of the audit.

ISA 230
1. (a)State the auditor's responsibility in respect of'Assembly offinal audit file'. (03)

(b) The audit report of Salim Limited was signed on 30 April 2016. After issuance of the audit report, the auditor was informed that a major
debtor has become bankrupt.

Required: Specify the matters that the auditor would be required to document in the above situation. (03)

A: (a) The auditor is required to assemble the final audit file(s) on a timely basis after the date of the auditor's report. This usually excludes
drafts of working papers or F /S, or notes that reflect incomplete or preliminary thinking. After the assembly of the final audit file has been
completed, the auditor must not delete or discard audit documentation before the end of its retention period.

(b) In such case the auditor is required to document:

• the circumstances;

• the new or additional procedures performed, audit evidence obtained, conclusions reached and their effect on the auditor's report; and

• when and by whom resulting changes to audit documentation were made and who reviewed them.

2. While reviewing the final audit file of XYZ Limited for the year ended 30 June 2014, you have identified that certain amendments were made
in the final audit file after the date of the auditor's report.

Required:

Comment on the above situation in the light of International Standards on Auditing. (07)

A: (i) After the assembly of the final audit file has been completed, the auditor must not delete or discard audit documentation before the end of its
retention period.

(ii) However the changes to document can be made if:

• the changes are deemed necessary.

• there are exceptional circumstances in which the auditor has to perform new or additional procedures or reaches new conclusions.

(iii) If it appears that it was necessary to modify existing or add new documentation after this stage, the auditor is required to document:

• when and by whom the modifications were made.

• the reasons for making them.

(iv) If exceptional circumstances arise after date of audit report; auditor is required to document:

• the circumstances

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• the new or additional procedures performed, audit evidence obtained, conclusions reached and their effect on the auditor's report, and

• when and by whom the resulting changes to audit documentation were made and who reviewed them.

3. You are the training manager at Guava & Co., Chartered Accountants. Some trainees in the firm have requested you to clarify the following
issues:

a) Can the auditor discard any audit document, forming part of his opinion, after the issuance of the auditor's report?

b) The changes that can be incorporated during the final file assembly process citing three such examples.

C) The circumstances under which it becomes necessary to modify the existing audit documents or add new audit documents after the issuance
of the auditor's report and the matters that should be documented in such a situation.

Required:

Offer appropriate explanations for each of the above issues. (11 marks )

A: (a)After the assembly of the final audit file has been completed, the auditor shall not delete or discard audit documentation ofany nature before
the end of the retention period.

The firm should establish its own policies and procedures for the retention of engagement documentation. The retention period for audit
engagement ordinarily is no shorter than five years from the date ofauditor's report.

(b) Changes in the audit documentation during the final file assembly process may only be made if they are administrative in nature. Examples of
such changes include:

(i) Deleting or discarding superseded documentation;

(ii) Sorting, collating and cross referencing working papers;

(iii) Signing off on completion checklist relating to file assembly process;

(iv) Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant members of the engagement team before
the date of the auditor's report.

(c) Under exceptional circumstances, the auditor performs new or additional procedures or draws new conclusions after the date of the Auditor's
report. In this relation the auditor should document:

(i) The circumstances encountered.

(ii) The new or additional audit procedures performed, audit evidence obtained, and conclusion reached, and their effect on the auditor's report.

(iii) When and by whom the resulting changes to audit documentation were made and reviewed.

4. The preparation of working papers is an integral part of the auditor's responsibilities. Identify the factors that the auditor should consider
while determining the form, content and extent of audit working papers. (07)

A: Audit documentation may be recorded on paper, or on electronic or other media.

The precise contents of the audit file varies, depending on the nature and size of the client and the complexity of the audit processes required to
reach a conclusion but will include:

• audit programs

• analyses

• summaries of significant matters

• letters of confirmation and representation

• checklists, and

• correspondence.

All audit working papers should clearly show the following (where relevant):

• The name of the client

• The accounting date

• A file reference

• The name of the person preparing the working paper

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• The date the paper was prepared

• The name of any person reviewing the work and the extent of such review

• The date of the review

• A key to 'audit ticks' or other symbols used in the papers

• A listing of any errors or omissions identified

• A conclusion on the area.

5. You work as assistant manager in one of the leading firm of chartered accountants. Your partner has asked you to prepare a presentation for
some of the newly recruited staff. As part of this presentation, you are required to explain the nature and objectives of maintaining 'Audit
Documentation.' (10 )

A: Audit documentation should provide:

(i) Evidence of auditor's basis for a conclusion about the achievement of the overall objective of the auditor; and

(ii) Evidence that audit was planned and performed in accordance with ISAs and applicable legal and regulatory requirements.

Audit documentation serves a number of additional purposes, which include:

• Assisting the engagement team to plan and perform the audit.

• Assisting members of the engagement team responsible for supervision, to direct and supervise the audit work and to discharge their review
responsibilities.

• Enabling the engagement team to be accountable for its work

• Retaining a record of matters of continuing significance to future audits.

• Enabling the conduct of quality control reviews and inspections.

• Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements.

46
Chapter# 05 (Internal Control)
1. Discuss any five IT General Controls relating to program change management. (05)

A: (i) Tests are carried out on program changes before they are introduced.

(ii) All new versions of programs must be authorised at an appropriate level of management.

(iii) All changes to the existing program should be formally approved by the system 'user'.

(iv) There should be a segregation of duties between the designers and testers of systems.

(v) There should be full documentation of all program changes.

2. List any six examples of system logs. (03)

A: Examples of system logs include:

(i) Which user logged-in, when and where from

(ii) Failed log-in attempts

(iii) Who accessed and amended data in a file

(iv) Changes made to a program - what, when and by whom

(v) When employees entered and left the building

(vi) Black box flight recorders

3. The management of Rose (Private) Limited (RPL) seeks your guidance for the following matters:

(a) RPL is developing a sales invoicing system both for its cash and credit customers. The system would record customer's name, email address,
cell number, NTN number etc. at the time of sale.

Required:

Briefly discuss any four application controls, with the help of examples, which should be incorporated in the system to ensure completeness and
accuracy of data. (06)

(b) RPL's office has recently been damaged by fire causing a system downtime for five days.

Required:

Advise any three general controls to RL which may ensure continuity of its operations in future. (03)

A: (a) (i) Data input should be kept at minimum. For example, data of repeat customer should be auto retrieved on entering their phone number.

(ii) Data should not exceed a predetermined amount For example, if the sale amount exceeds the allowed credit limit the data would be rejected
for further verification.

(iii) A field should always contain data and not zeros or blanks. For example, the record should not be saved unless data is entered in all the fields
like phone number, email address etc.

(iv) Programmed checking of the data validity in accordance with predetermined criteria/format. For example, the system will not process record
if non- numeric character is entered in amount field or the system will pop up an alert if less than 13 numbers are entered in the CNIC field, etc.

(b) (i) There should be measures for the protection of equipment against fire, power failure and other hazards.

(ii) There should be controls over maintaining secure second copies of all programs and data files ('back-up copies'). The back-up copies can be
used if the original copies are damaged or corrupted.

(iii) The company should have disaster recovery plans, such as an agreement with another entity to make use of its computer centre in the event
of a disaster such as a fire or flood.

4. (a) Describe any four limitations of flow chart as a tool of system documentation. (04)

(b) Companies having large in-house developed software, have a risk that new programs might be introduced without proper authorisation.
Briefly discuss any four general IT controls to mitigate this risk. (04)

(c) Discuss effects on application controls where general IT controls are ineffective. (02)

A: (a) Limitations offlow chart:

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• These are only suitable for describing standard systems rather than recording systems with numerous unusual transactions.

• Flowcharts are also not appropriate for recording systems with further classifications of subsystems or subroutines.

• Constructing a flow chart is a time consuming process because an auditor must learn about the operating personnel involved in the system
and gather samples of relevant documents. Thus involves a lot of effort and observation.

• There is a possibility of recording and checking areas that are of no audit significance.

(b) • There should be a segregation between the tasks of programmers (who write new programs) and computer operators (who use the
programs).

• There should be full documentation of all program changes.

• There should be restricted access to programs (program files), and only authorised programmers should have access to them.

• Program logs should be maintained, to record which programs and which versions are used.

(c) Since the General IT controls provides assurance regarding the effectiveness of the overall control objectives, therefore in case, IT General
controls are not effective, there may be a risk that misstatements occur and go undetected in the application system or the application controls
becoming ineffective. However, it is possible that manual procedures exercised by users may provide effective controls at the application level.
Consequently, the auditor may consider extensive testing of application control to obtain reliance on their operating effectiveness.

5. (a)Differentiate between general IT controls and application controls. (04)

(b) The internal auditor of Cyprus (Private) Limited has identified some discrepancies in the sales revenue. After investigation, it was identified
that some unknown changes were made to the master price-list which resulted in such discrepancies.

Required:

Suggest any three general IT controls and three application controls to prevent occurrence of such error. (06)

A: (a)

General IT Controls Application Controls

General IT controls aim to establish a framework of overall control Application controls are the specific controls over the relevant
over the computer information system's activities to provide a applications maintained by the computer. The purpose of application
reasonable level of assurance that the overall objectives of internal controls is to establish specific control procedures over a particular
controls are achieved. application to provide reasonable assurance that all transactions are
authorized and are processed completely, accurately on a timely basis.
(b) Examples of general IT controls:

• Physical access to computer terminals may be restricted to authorized employees.

• Access to programs and data files may be restricted using passwords. There should be rigorous checks by management to ensure that a
password system is being used effectively by employees (so that passwords are not easy to 'guess')

• Firewalls (software and hardware) can be used to prevent unauthorized external access via the internet.

Examples ofapplication cotrols:

• Management review of master files and standing data

• Regular updates of master files

• Review log files for changes made in master files

6.(b)What do you understand by logical access controls? Briefly describe any four logical access controls. (06)

(c) riefly discuss the key characteristics of small sized organizations with respect to internal controls and risks which the auditor may face in such
audits. (06)

A: (b) Logical access controls are tools and protocols used for identification, authentication, authorization and accountability in computer
information systems. It enables the organization to identify users, restrict access to specific resources and produce audit trail of systems and user
activity.

• The login account must uniquely identify the person, but it must be part of a standard similar to all other logins.

• The password has to be sophisticated and must be of a certain prescribed length.

• The access to the system must be limited in accordance with roles and responsibilities of the users.

• User must be logged out after a certain period of in-activity.

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(c) Many of the control activities that are typically found in a large company such as segregation of duties, internal audit etc. may be
inappropriate for a small entity because they are too costly or impractical for such smaller organizations. Often, control systems in small entities
are based on a high level of involvement by the directors or owners.

Following audit risks may arise when control systems rely excessively on the involvement of senior management:

• There may be a lack of evidence as to how systems are operating.

• There may be lack of evidence of controls.

• Management may override controls that are in place.

• Management may lack the expertise necessary to control the entity effectively.

7. Sawari Limited (SL) is engaged in the business of assembling motorcycles. Following IT related matters are under consideration of the
management:

(i) SL uses Inventory Management System (IMS) which is connected with the systems of all its suppliers. IMS generates and sends purchase
orders to the suppliers automatically when the inventory reaches the reorder level. SL has recently been receiving the complaints of short
deliveries. On further inquiry it was revealed that the supplier received different quantity orders than those actually generated by IMS. Initial
investigation revealed that data was changed during transmission to the suppliers.

(ii) SL's IT data room maintained at its head office caught fire. All data including last month backup kept within the premises was lost and
critical hardware was also slightly damaged due to this incident. Consequently, SL's IT operations suffered a downtime of ten days.

Required: Suggest any three mitigating controls against each of the above matters. (06)

A: (i) • Firewalls to prevent intrusion into the programs that send and receive data.

• Restricting access to source data that is transmitted.

• Using check sums and check digits to ensure that data received is intact

(ii)

• SL should also store its backup data at some other location.

• SL should develop disaster recovery plans, such as an agreement with another entity to make use of its computer center in the event of a
disaster such as a fire or flood.

• The company should make suitable maintenance and service agreements with software companies, to provide 'technical support' in the event
of operating difficulties with the system.

8. Plover Limited has recently developed an integrated system for maintaining its financial records. During testing, following input and
processing errors were identified in the system:

Input errors

(i) A non-existent product number was mentioned on the online order form.

(ii) Inward movement of inventory was recorded in some other inventory account.

Processing errors

(i) Salaries of few employees were processed twice.

Required: Identify and briefly describe one application control in respect of each of the above type of errors that would have been effective in
either preventing or detecting the error. (08)

A: Input Errors

(i) Existence check:

Existence check can be written into a computer program to test the validity of input data. The program looks at the value for a particular item of
data in the input transaction, and if it is invalid, it produces an error report and will not process the transaction. A program check can be carried out
on the product code for all order forms, and if the code is not within the defined list, an error report will be produced.

(ii) Check digit:

PL can use check digits with the inventory codes to prevent the posting of in-ward movement in in-correct inventory account. Check digits are
controls within a computer program on the validity of key numerical codes, such as customer codes, supplier codes and employee identification
numbers. When check digits are used, every code is given an extra digit, the check digit This is a unique digit obtained from the other digits in the
code.

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Processing Errors

(i) Control total:

PL may use control total, batch total or hash total to prevent duplicate processing of salary. Control totals may be used when several transactions
are input for processing at the same time. Control total means the total value for all the transactions input. This total is given by the computer prior
to processing. The total given by the computer is checked with the total taken manually.

9. Mention any four general controls over development of new computer information systems and applications. (04)

A: Following general control may be considered while developing a new computer systems or applications:

• Appropriate IT Standards should be used when designing, developing, programming and documenting a new computer system.

• There should be controls to ensure that tests are carried out on new systems before they are introduced.

• A new computer system design should be formally approved by the system 'user'.

• There should be a segregation of duties between the designers and testers of systems.

10. (a) Chand Travels (CT) is a tour operator, which provides airline ticket bookings, hotels reservations and customized tour packages. CT has
recently implemented a software for maintaining its financial records.

Required:

What do you understand by logical access controls? Briefly describe four logical access controls that CT should employ. (07)

(b) Describe four controls which CT may employ to reduce the possibility of disruption of operations.(4)

A: Logical access controls are tools and protocols used for identification, authentication, authorization and accountability in computer information
systems. It enables the organization to identify users, restrict access to specific resources and produce audit trail of systems and user activity.

• The login account must uniquely identify the person, but it must be part of a standard similar to all other logins.

• The password has to be sophisticated and must be of a certain prescribed length.

• The access to the system must be limited in accordance with roles and responsibilities of the users.

• User must be logged out after a certain period of in-activity.

(b) • Maintaining secure second copies of all programs and data files ('back-up copies').

• Take measures for the protection of equipment against fire, power failure and other hazards.

• Make disaster recovery plans, such as an agreement with another entity to make use of its computer center in the event of a disaster.

• Suitable maintenance and service agreements with software companies to provide 'technical support' in the event of operating difficulties
with the system.

11. (a) Briefly describe what is a system log file and give any four types of information that may be generated by a system log. (03)

(b) Differentiate between General IT controls and Application controls. (04)

(c) Advanced Limited (AL) uses an in-house developed integrated system for all its accounting and operational needs. AL has been facing
following issues in transaction processing:

(i) While processing a batch of 50 purchase invoices, it was noticed that 3 invoices of suppliers were posted twice in the accounts.

(ii) Some instances have been identified in which AL's accountant had posted the amount received from the customers in some other
customer's account due to a typing error of the customer code.

(iii) While processing the payments, the accountant often fails to mention the cheque number, due to which it takes a lot of time to trace the
payment in bank statement.

(iv) While recording inventory movement, the accountant had used incorrect inventory codes. Since those codes did not exist, the system
posted the transaction in suspense account.

Required:

Identify and briefly describe one specific application control in respect of each of the above type of errors, to reduce the risk of such errors. (08)

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A: (a) Logical access controls are tools and protocols used for identification, authentication, authorization and accountability in computer
information systems. It enables the organization to identify users, restrict access to specific resources and produce audit trail of systems and user
activity.

• The login account must uniquely identify the person, but it must be part of a standard similar to all other logins.

• The password has to be sophisticated and must be of a certain prescribed length.

• The access to the system must be limited in accordance with roles and responsibilities of the users.

• User must be logged out after a certain period of in-activity.

(b) • Maintaining secure second copies of all programs and data files ('back-up copies').

• Take measures for the protection of equipment against fire, power failure and other hazards.

• Make disaster recovery plans, such as an agreement with another entity to make use of its computer center in the event of a disaster.

• Suitable maintenance and service agreements with software companies to provide 'technical support' in the event of operating difficulties
with the system.

3. State any four controls that an auditor expects over data transmission. (3)

A: (a) A system log is a file that records events taking place in the execution of a system. This generates an audit trail that can be used to
understand the sequence of activities of the system and to diagnose problems.

• Types of information that may be generated by a system log are:

• Which user logged-in, when and where from

• Failed log-in attempts

• Who accessed and amended data in a file

• Changes made to a program - what, when and by whom

• When employees entered and left the building

• Black box flight recorders

• CPU speed

• Broadband speed

• Which web pages a user accessed

• Attempted cyber intrusions

(b)

General IT Controls Application Controls

General IT controls aim to establish policies and procedures for overall Application controls are the specific controls over the relevant
control over the computer formation system's activities such as applications maintained by the computer. The purpose of application
development, changes in program and data files. It provides a controls is to establish specific control procedures over a particular
reasonable level of assurance that the overall objectives of internal application. In order to provide reasonable assurance that all
controls are achieved. transactions are authorized and are processed completely, accurately
and on a timely basis.
(c) (i) Control Totals

Control total means the total value for all the transactions input. This total is given by the computer prior to processing. The total given by the
computer is checked with the total taken manually.

(ii) Check Digits

AL can use check digits with the customer code to prevent the posting of amounts in in-correct customer account. Check digits forms part of the
account code which allows the computer program to check the validity of the code.

(iii) On-Screen Prompts

On-screen prompts are displayed on the computer screen when a compulsory field in the data entry form is not filled.

(iv) Existence Check

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Existence check could be written into the system to ensure that the program will look at the value for a particular item of data in the input
transaction, and if it is invalid, it will produce an error report and will not process the transaction.

12. State any four controls that an auditor expects over data transmission.(3)

A: • Data encryption during data transmission

• Availability of firewalls to prevent intrusion into the programs that send and receive data

• Program controls that ensure data is transmitted in the correct format

• Restricting access to source data that is transmitted

• Only using secured Wi-Fi with password protection

• Using check sums and check digits to ensure that data received is intact.

13. You have been assigned the audit of Pacific Shipping Limited (PSL) for the year ended 31 December 2017. During the audit, you have noted
that the invoicing system was not operational for four days in January 2017. Upon inquiry, you were informed that some changes were made by
one of the three programmers working in the IT department, merely on the request of a sales officer.

The change caused the whole invoicing system to malfunction and it had to be closed down. During these four days, all invoices were generated
manually.

Required:

Identify any three control weaknesses in the above situation and suggest any two mitigating controls against each weakness. (09)

A:

Control Weakness Suggested Control

It appears that changes are made in the system without proper - All changes must be authorized at an appropriate level.
authorization. Change requisition, assessment and approval should be properly
documented.
Log of changes in program must be maintained and reviewed at an
appropriate level periodically to ensure that no unauthorized
changes in the programs are made.
• There should be restricted access to program files and only
authorised programmers should have access to them.
It appears that there was lack of testing in the offline environment • No change shall be made in live environment. All changes made
prior to the implementation, which resulted in the malfunction of in the program should first be tested in offline environment.
the system. • Impact of change on existing functioning must be assessed
before implementing the change.
It appears that due to unavailability of last updated backups or • Backup policy as per needs of the PSL must be in place.
improper backup policy, the invoicing system was not operational for • Recorded backups must be restored periodically to assess their
four davs. effectiveness.

14. TS Limited is a small software house. Due to the nature of the business no significant human resources are required except the programmers
and system analysts. The Managing Director (MD) oversees all the operations. Besides the programmers and system analysts there is only one
manager, who reports to the MD.

Required:

Describe the key characteristics of such organizations with respect to internal controls and the risk which the auditor may face in such audits.
(06)

A: Many of the control activities that are typically found in a large company such as segregation of duties, internal audit etc. may be inappropriate
for a small entity because they are too costly or impractical for such smaller organizations. Often, control systems in small entities are based on a
high level of involvement by the directors or owners.

Following audit risks may arise when control systems rely excessively on the involvement of senior management:

(i) There may be a lack of evidence as to how systems are operating.

(ii) There may be lack of evidence of controls.

(iii) Management may override controls that are in place.

(iv) Management may lack the expertise necessary to control the entity effectively.

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15. Your firm is the auditor of Bell Limited (BL) which is engaged in manufacturing and assembling of vehicles. BL has been encountering
frequent stock-outs. To address this issue, it has developed an Inventory Management System (IMS) and connected it with the systems of all the
suppliers. IMS generates and sends purchase orders to the suppliers automatically when the inventory reaches the reorder threshold.

Required:

a) Discuss the risks to be considered due to the introduction of the above mentioned solution. (4)

b) What controls would you expect in IMS to mitigate the above risks? (5)

A: (a) The introduction of IMS may create the following risks:

• There is an increased level of dependency on the computer system of the organisation and also of the supplier. Any computer failure may
therefore have an increased impact on the organisation.

• There is an increased risk of possible loss or corruption of data due to the process of transmission.

• There are also security risks in the transmission of data and unauthorised individuals may be able to gain access to the data.

(b) Controls that could mitigate the above risks are as follows:

• Controls over transmission of data (encryption, acknowledgement systems, authentication codes, etc.);

• Monitoring and checking of output;

• Virus protection systems; and

• Contingency plans and back up arrangements.

16, Differentiate between General IT controls and Application controls. Also give two examples of each type of control.

A:

General IT Controls Application Controls

General IT controls aim to establish a framework of overall control Application controls arc the specific controls over the relevant
over the computer information system's activities to provide a applications maintained by the computer. The purpose of application
reasonable level of assurance that the overall objectives of internal controls is to establish specific control procedures over a particular
controls are achieved. application. In order to provide reasonable assurance that all
transactions are authorized and recorded, and arc processed
completely, accurately and on a timely basis.
Examples of General IT controls:

• Segregation of duties

• Password protection

• Virus checks

• Backup copies

Examples of Application controls:

• Authorisation controls e.g. data is input only by authorized personnel

• Control totals

• Batch controls

• Authorisation controls e.g restriction on printing of document.

17. Discuss the effects on Application controls where General IT controls are ineffective.

A: Weaknesses in general IT controls may result in IT application controls becoming ineffective. However it is possible that manual procedures
exercised by users may provide effective controls at the application level.

18. (a) You are working in IT department of a firm of Chartered Accountants. The partners are concerned about the confidentiality of client data
which is electronically transmitted by firm's staff from the clients' offices.

Required: Suggest controls over data transmission to ensure confidentiality of data. (03)

(c) In the context of control activities explain what is included in 'Performance reviews (3)

( e) Specify any four main categories of general controls that an auditor would expect to find in a computer based information system. (04)

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A: (a) Controls over data transmission may include the following:

• Firewalls to prevent intrusion into the programs that send and receive data

• Only using secured Wi-Fi with password protection

• Data encryption

( c) Performance reviews - In the context of control activities, performance review includes:

• analyses of actual performance against budget and forecasts;

• analyses of actual performance against prior period performance

• control reporting and variance analysis

(e) The main categories of general controls that an auditor would expect to find in a computer based information system are:

(i) controls over the development of new computer information systems and applications

(ii) controls over the documentation and testing of changes to programs

(iii) the prevention or detection of unauthorised changes to programs (for example, by an employee committing fraud or by a 'hacker' accessing
the system)

(iv) controls to prevent the use of incorrect data files or programs

19. Briefly describe the following concepts:

Audit trail in a computerized environment (03)

A: Audit Trail in a computerized environment

An audit trail refers to the ability of the auditor to trace a transaction through all its processing stages. An audit trail can be provided by a record
(1og') of how the computer has processed any transaction.

An audit trail may not exist in 'paper form' in an online system, but the computer program should be written so as to generate the audit trail on
request for any transaction.

20. List six physical access controls over an IT system. (3 marks)

A: Physical access controls over an IT System might include:

(i) Doors and door-locks

(ii) Alarms

(iii) Surveillance camera or video

(iv) Cables that allow a user to lock a laptop to a desk

(v) Fingerprints readers to log-in to a system

(vi) Lockable briefcase

21. a) Differentiate between Symmetric key ciphers and Asymmetric key ciphers in relation to data encryption techniques. (02)

b) Identify any four types of information that can be extracted from system logs. (02)

A: (a) Symmetric key ciphers:

These use related ( often identical) keys to both encrypt and decrypt information. This is sometimes called 'shared secret' between two or more
parties.

Asymmetric key ciphers:

These use different keys to encrypt and decrypt information (one to lock, the other to unlock). This is sometimes called 'public/private' key.

(b) Information that can be extracted from system logs include:

(i) Which user logged-in, when and where from

(ii) Failed log-in attempts

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(iii) Who accessed and amended data in a file

(iv) Changes made to a program - what, when and by whom.

22. Following IT related controls are being employed at Vision Limited:

(i) The general ledger system is automatically updated with sub-ledger transactions ( e.g. Accounts Receivable) every night through batch
processing.

(ii) The system automatically maintains second copies of all programs and data files.

(iii) Access to programs and data files is restricted using passwords.

(iv) Invoices that are entered into the system are physically counted.

(v) Firewalls (software and hardware) are installed to restrict unauthorized access.

(vi) Screen warnings are displayed as regards incomplete processing.

(vii) Vision Limited has service level agreements with reliable software companies, for technical support.

(viii) Review of output against expected values.

Required:

c) In respect of each control, determine whether it is a preventive, detective or corrective control. (04)

d) Also classify each of the above between general IT controls and application controls. (04)

A:

S. No Controls Ans 5-a (Type of Ans 5-b

Controls) (General/Application)
(i) The general ledger system is automatically updated with sub-ledger transactions (e.g. Preventive Application controls
Accounts Receivable l everv night through Batch orocessing.
(ii) The system automatically maintains second copies of all programs and data files. Corrective Application Controls
(iii) Access to programs and data files is restricted using passwords. Preventive General IT Controls
(iv) Invoices are physically counted that are entered into the system. Detective Application Controls
(v) Firewalls ( software and hardware are installed to restrict unauthorized access). Preventive General IT Controls
(vi) Screen warnings about incomplete processing. Detective Application Controls
(vii) Service level agreements. Corrective General IT Controls
(viii) Review of output against expected values. Detective Application Controls
23. International Standards on Auditing require an auditor to evaluate the control environment and assess its effectiveness. State the factors
that the auditor should consider in evaluating the control environment. ( 04)

A; In evaluating the control environment, the auditor should consider such factors as • management participation in the control process,
including participation by the board of directors

• management's commitment to a control culture

• the existence of an appropriate organization structure with clear divisions of authority and responsibility;

• an organization culture that expects ethically-acceptable behavior from its managers and employees; and

• appropriate human resources policies, covering recruitment, training, development and motivation, which reflect a commitment to quality
and competence in the organization.

24. Controls over data transmission help to ensure that transmitted data is complete, secure and unaltered.

Required:

State any five controls over data transmission which help to ensure that the data is secure and unaltered. (04)

A: Controls over data transmission include:

• firewalls to prevent intrusion into the programs that send and receive data.

• restricting access to source data that is transmitted.

• only using secured Wi-Fi with password protection.

• using check sums and check digits to ensure that data received is intact.

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• data encryption.

25. Deehan Super Stores has launched a sales promotion scheme. Accordingly, the customers who purchase a loyalty card gain reward points on
every purchase. The points may be redeemed by adjusting the value of the available points in any subsequent purchase.

Required:

Draw a flow chart showing the payment process including point accumulation and point redemption. (09)

A: Print the page and Past it

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26. Classify the following controls as preventive, detective, or corrective controls. Give brief reasons to justify your answers.

(i) Training on applicable policies, department policy/ procedures

(ii) Batch totals

(iii) Segregation of duties

(iv) Contingency planning

(v) System logs

(vi) System backup (06)

A: (i) Training on applicable policies, department policy/ procedures:

It is a preventive controls, as the individuals are trained to perform their duties as per the applicable policies and procedures that are in place.

(ii) Batch totals:

It is a detective control as program will report any discrepancy between the manually counted batch total and its own batch total, as an error
report.

(iii) Segregation of duties:

It is a preventive control as it involves assigning different people the responsibilities of authorizing and recording transactions and maintaining the
custody of assets. This reduces the likelihood of an employee being able to both carry out and conceal errors or fraud.

(iv) Contingency planning:

It is a corrective control as it involves the corrective measures to be adopted in case of any mishap.

(v) System logs:

It is a detective control as this generates an audit trail that can be used to understand the activity of the system and to diagnose problems.

(vi) System backup:

It is a corrective control as it will involve any retrieval measures in case of any damage to the original data.

27. You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly inducted trainees, on the following:

a) Control Environment and its elements (04)

b) Walk through tests and why these are performed (03)

A: (a) Control Environment and its elements

The 'control environment' is often referred to as the general 'attitude' to internal control of management and employees in the organization.

The elements of control environment includes the following:

• Communication and enforcement of integrity and ethical values

• Commitment to competence

• Participation ofTCWG.

• Management's philosophy and operating style

• Organizational structure

• Assignment of authority and responsibility

• Human resource policies and practices

(b) Walk through tests:

Auditor is required to gain an understanding of the various elements of the internal control system operating within an entity.

Once this understanding has been gained, the auditor should confirm that his understanding is correct by performing 'walk-through' tests on each
major transaction type (for example, revenue, purchases and payroll). Walk-through testing involves the auditor selecting a small sample of
transactions and following them through the various stages in their processing in order to establish whether his understanding of the process is
correct.

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The components of internal controls are as follows:

(i) Control environment:

The control environment includes the attitudes, awareness and actions of management and TCWG concerning the entity's internal control and
their importance in the entity

(ii) Entity's risk assessment process:

It is the entity's process for identifying business risks relevant to financial reporting objectives and deciding about actions to address those risks,
and the results thereof.

(iii) Information system, including related business processes, relevant to financial reporting, and communication.

(iv) Control activities:

These are the policies and procedures that help ensure that management's directives are carried out

(v) Monitoring of controls:

It is a process of assessing the design and operation of controls on a timely basis and taking necessary corrective actions on account of change in
conditions.

28. Briefly explain the components of internal control as referred to in the International Standards on Auditing. (09 )

A: Read the answer from the book because the answer is not in the book.

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Chapter# 06 (Test of controls)
1. State any three controls which would ensure that wages and salaries are not paid to the ghost (fake) employees. (03)

A: • There should be a segregation of duties: the individual responsible for preparing wages and salaries should not be the person who
actually pays them.

• The gross pay for each individual employee should be authorised by an appropriate person.

• There should be formal authorisation of new employees.

2. Cardano Limited (CL) is engaged in the business of assembling motor bikes. CL has a fully integrated Computerised Accounting System (CAS).
You have been given responsibility for reviewing the internal controls relating to procurement. In this respect, you have gathered the following
information:

Ordering of inventory:

• Approved supplier's list is maintained in CAS. The list was last reviewed for changes two years ago. However, during the intervening
period, any supplier whose performance is not satisfactory is timely removed from the list. As a control measure, the list is accessible and
editable only by the employees of Procurement Department (PD).

• The Inventory Control Department (!CD) of CL generates a numerically sequenced Purchase Requisition (PR), when the quantity of a
particular inventory item reaches re-order level. PR is electronically forwarded within the CAS to the PD.

• For all regular and routine orders, PD reviews the PR and selects a supplier from the approved supplier's list. A Purchase Order (PO)
having a unique sequential order number is then generated for the selected supplier.

• For large or out of the ordinary purchases, a tendering process is carried out by the PD. Procurement Manager invites tenders through
an advertisement in newspaper and the supplier offering the lowest price is selected by the Procurement Manager in consultation with Head of
Procurement.

Receiving of inventory:

When inventory items are received, the officer in ICD confirms that the inventory agrees to the PO. The CAS is then updated to confirm receipt
of inventory and an electronic numerically sequenced Good Received Note (GRN) is generated. The physical inventory items are then
transferred to store.

Required:

Identify any six weaknesses in the internal control system of CL and their possible effects. Also give your recommendations to overcome these
weakness to CL. (12)

A:

S No. Control weakness Possible effect Recommendation

(i) The list has not been reviewed since CL may miss out some more The suppliers list should be regularly updated in
the last two years. competent supplier(s) then the which new supplier(s) should be added.
existing one.
(ii) Suppliers' list is editable by all the Any changes made to the suppliers list Supplier list should only be editable by the person
employees in PD. may go unnoticed. who is authorized to make changes.
The change log should be reviewed on a regular
basis for changes.
All the changes made in supplier list must be
approved the appropriate authority.
(iii) Supplier selected without asking for CL may be paying higher prices to the Quotations from at least three suppliers should be
quotation. suppliers. There is a risk that CL may invited.
fail to claim discounts from supplier( s A member of the purchasing staff must be
). responsible for checking discounts allowed by
suppliers.
(iv) There is no segregation of duties in This could lead to inappropriate All routine purchase requisition should be approved
the ordering process. purchases, i.e. in terms of type of by the store manager. There should be a purchase
goods or heir quantity. committee and all large purchases should first go
through the purchase committee.
All orders exceeding a certain amount should
require an approval from finance department

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(v) Suppliers are selected merely on the Goods may be ordered which may not Suppliers should also be screened for the quality of
basis of prices offered fulfill the technical requirements. the goods being offered. Such as obtaining quality
The supplier may not have the certifications from the supplier.
capacity to fulfill the orders. Volume requirements should also be considered
when selecting a supplier as well as their financial
stability ( credit reference checks).
(vi) There is no system of quality Sub-standard goods may be received. Proper inspection should be carried out before
inspection accepting the goods.
3. You are the job-in-charge on the audit of Sambar (Private) Limited (SPL), engaged in production and marketing of textile products.

Your team has performed a walkthrough of the sales and receivable process which is summarized as follows:

(i) SPL has employed a Sales Representative (SR), who is responsible for finding new customers and taking orders from all customers.

(ii) Orders are recorded on a pre-numbered order form duly signed by the customers. After taking the customer order, SR mentions the
maximum credit limit and credit time after verbally confirming them with the Director Operations, on the order form. SR then forwards one
copy of the order form to the warehouse and another copy to the Factory Accountant (FA).

(iii) Warehouse supervisor dispatches the completed order from the warehouse, accompanied by a manually prepared pre-numbered delivery
note. He keeps a copy of delivery note and sends another to FA.

(iv) FA manually prepares a pre-numbered invoice using the details mentioned on the order form. FA also ensures that the customer should not
exceed the maximum credit limit after the new order. FA normally sends one copy of invoice to the customer along with the delivery note and
keeps the second copy along with the order form in the record of accounts department. However, due to delay in receiving the order
information, invoice is sometime sent after the delivery.

(v) Each Friday, FA inputs the week's invoices into the computerized accounting software. At each month end, FA prepares age analysis and
follows-up with customers who have not paid within their credit time.

Required:

Identify the control weaknesses in sales and receivable process of SPL along with their possible effects and give your recommendations to SPL.
(15)

A;

S No. Control weakness Possible effect Recommendation

(i) No formally approved credit list exits Goods may be supplied to customers All new customers should undergo a credit
with a poor credit rating. This may reference check before being accepted as new
increase the risk of bad debts and customers.
financial losses. Credit limits should be set for all customers and it
should be reviewed on a periodic basis every month
to avoid selling goods on credit to risky customers.
(ii) Credit limit is confirmed verbally. SR may mention the limit which was Communication regarding the confirmation of
not mentioned by Director Operations credit limit should be appropriately documented.
as no documentary evidence exist.
(iii) Credit limit is not checked with New production order may be issued SR should ask the credit balance of the customer
accounts department before for goods which are not required to be from FA prior to forwarding it to the warehouse.
forwarding the customer order to produced. Goods may be dispatched
warehouse for processing. to customers who have already
availed their credit limit.
(iv) There seems to be no process to Incorrect quantity of goods may be Before orders are dispatched, the warehouse
match the GDN to the original order dispatched which may affect goodwill supervisor should also compare the quantity and
prior to dispatch. as well as revenue. quality of goods with the original order.
(v) There seems to be no procedures to The company could suffer financial All GDNs should be matched to the invoice and filed
ensure the completeness and accuracy loss if invoices are not raised or are together. On a periodic basis FA should perform a
of invoices. not timely not raised or are prepared review ofun-invoiced GDNs to ensure all dispatches
inaccurately. have been invoiced.
The customer order file should be reviewed
periodically in order to confirm that the order, GDN
and invoice details are matched with each other.
(vi) No acknowledgment from customer is Customer may falsely claim that The person responsible for delivery should obtain
obtained after the delivery of the delivery has not been made. customer acknowledgment on delivery order.
order.
(vii) Invoices are not prepared on the basis There is mismatch in the quality of Invoice should be prepared after checking the
of GDN. goods delivered and invoiced. quantity from the GDN and price from the customer
order.

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(viii) Ledgers are not updated on a timely Due to this delay there is a possibility All the invoices and receipts should be recorded
basis. that some of the invoices or receipts when they are prepared and deposited/ received.
may go un-recorded.
Ledgers would not reflect
updated balances, due to
which sales may be made to
customers who have fully
utilized their credit limits or
vice versa.
(ix) Updated age analysis may not be Sales may be made to those Director Operation should also review the age
available when the Director customers who are already overdue analysis as he is the one who is setting the credit
Operations decides on the credit limit for a long time limits.
to be given to the customer.
(x) Debtors are only followed up on Delayed follow up of overdue Debtors should be followed up whenever their
periodic basis. accounts may lead to bad debts. invoices are becoming due or they are close to the
expiry of their credit limits.
4. Mention any six tests of controls which an auditor may perform in respect of dispatch of goods and invoicing in an organisation where all
related documents are prepared manually. (06)

A: • Check whether appropriate segregation of duties exist

• Check whether all invoices and GDNs are pre-numbered.

• Check that invoices show a customer order number and a dispatch note number.

• Check the signature of customers on delivery notes to confirm the acceptance of the customers.

• Check that credit notes are cross-referred to a sales invoice number.

• Observe the dispatch process in operation.

• Obtain documentary evidence that a member of the accounts staff has carried out arithmetical checks on the accuracy of invoices.

• Check the credit notes to ensure that they contain the authorization signature of the appropriate manager.

5. You are audit senior at Advanced Limited (AL) which is engaged in the business of assembling and marketing of consumer electronics. The
process followed by AL for procurement is as follows:

a) Store Department generates a numerically sequenced purchase requisition (PR), when the quantity falls below re-order level. PR shows the
name of goods and quantity required and is signed by the store officer. The approved PR is forwarded to the Purchase Department for
procurement.

b) Purchase Department has a list of suppliers which was prepared in 2015 by including all the suppliers who had supplied goods to AL during
the previous five years. Later, some suppliers were added to the list on the recommendation of the store manager.

c) When a PR is received, the five most experienced suppliers are contacted and purchase order (PO) is issued to the most experienced
supplier provided he agrees to supply the goods on the same price which was paid by AL on the latest purchase. The PO is issued in the form of
an email by the purchase manager. A copy of the email is also sent to the store manager and the finance manager. In case of large or unusual
purchases, PR and PO are also authorised by the store manager prior to sending the email.

d) On receiving the goods, the store officer agrees the goods dispatch note (GDN) of the supplier with the PO to ensure that description of
goods is the same as were ordered by AL. An acknowledged copy of GDN is given to the supplier and another copy is sent to the accounts
department.

e) Store Department prepares sequentially numbered Goods Received Note (GRN), which is signed by the store officer after counting the
goods received. Entry in the stores ledger is made on the basis of GRN.

f) On receiving the invoice, purchase is recorded by the accounts department after comparing the quantity received as per the GDN with PO
and the invoice.

Required:

Identify the weaknesses in the internal control system of AL and their possible effects and give your recommendations to AL. (15)

A:

S No. Control weakness Possible effect Recommendation

(i) The list prepared by the purchase There might be suppliers on the list There should be a formal process of approving the
department has not been approved by who are not competent enough to list and also for placing the suppliers on the
make the supply. approved list.

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anyone other than the purchase
department
(ii) List has not been updated since 2015 The list of the suppliers should be updated on a
ree:ular basis.
(iii) Lack of proper criteria for selecting Purchases may be made from The criteria for addition of new suppler should be
suppliers as presently suppliers are unreliable suppliers. comprehensive which should cover both financial
added to the list without considering and technical capabilities of the suppliers.
their financial soundness, experience,
etc.
(iV) Purchase requisitions are processed This could lead to inappropriate All purchase requisitions should be authorized by
merely on the initials of the stores purchases, ie. In terms of type of the store manager as well as the user department.
officer. /There is no formal process of goods or their quantity.
reviewing the purchase requisition
received from store department.
(v) Purchase orders are not pre- Liabilities for goods received may not PO should be pre-numbered or be issued in
numbered as they are issued in the be recorded or may be recorded more sequential order controlled by a computer system.
form of email. than once if there is no sequential
numbering.
(VI) Quotations are not obtained from the Purchases may be made at a higher Prior to ordering of goods the shortlisted suppliers
supplier before placing the orders. price be availed. should be asked to submit the quotations, which
should be reviewed by the purchase committee.
(vii) High value or other than routine This lead to lack of segregation of A purchase committee comprising of senior officials
purchases are only authorized by the duties which may result in should be formed to oversee purchases above a
purchase manager and store manager. inefficiencies. certain amount.
(viii) There is no system of quality Sub-standard goods may be received. Proper inspection should be carried out before
inspection. accepting the goods.
(ix) Although GRN has been prepared by There is a possibility of incorrect Before payment, supplier’s invoice should be
the store department, payment has payment to the supplier. reconciled with GRN and PO.
been made on the basis of GDN
instead of GRN.
(x) Inventory and payable are recorded
Cut off errors may arise i.e. where Inventory /payables should be recorded on the
upon receipt of invoice only. goods are received but invoice is basis of GRN.
received after year end.
6. You are the CFO of a newly incorporated company which has recently established five

super markets in the city. One of your responsibilities is to implement internal controls.

List six key controls:

(a) over cash sales and cash handling; (06)

(b) to reduce possibility of misappropriation of inventory. (06)

A; a) Key controls on cash sales and cash handling:

(i) Responsibility to receive cash should be clearly identified.

(ii) Proper locks should be provided to each person responsible for handling cash.

(iii) Cash should be kept in a locked and secure area until it is deposited.

(iv) Cash registers and credit card machines should be balanced at least once a day.

(v) Proper policies should be made to deal with cash shortages/excesses.

(vi) Timely deposit of cash should be ensured.

(vii) Cash register should be used to record cash sales.

(viii) Transfers of cash from one person to another should be kept at a minimum.

(b) (i) Adequate segregation of duties or independent checks.

(ii) Adequate system of authorization and approval of transactions (for example, in purchasing, movement between locations etc.)

(iii) Use of door locks and surveillance cameras.

(iv) Surprise physical count and timely reconciliation of inventory items.

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(v) Mandatory vacations for employees performing key control functions.

(vi) Periodic rotation of employees.

(vii) Restricted storage area.

(viii) Different entry and exit doors.

(ix) Access controls over automated records, including controls over and review of computer systems event logs.

(x) Job applicant screening of employees with access to assets.

7. You have been assigned to plan the test of controls in respect of salaries and wages. In this regard you are required to identify the following:

a) Possible control weaknesses in overtime payments (03)

b) Principal controls over payment of overtime (04)

A: (a) Following are the possible weaknesses that may exist in overtime payments:

• There may be weaknesses in the system for recording time spent at work. When employees are paid on the basis of time, there will be a
system of'time-in' and 'timeout', typically using employee identity cards and a time recording device. The risk is that employees will 'clock on' on
behalf of a colleague, using the identity card that the colleague has given him.

• Overtime payments may not be properly authorized which includes situation where a person works overtime without proper authorization.

• Incorrect rates of overtime may be used.

(b) Principal controls over payment of overtime:

• List of overtime payment (time or the amount) should be signed by person duly authorized in this regard by the organization.

• A overtime rates should be checked by a person authorized in this regard by the organization.

• The process of recording time should be monitored either by an authorized supervisor or by the use ofbio-metric machine.

• It should be ensured that the amount of overtime is correctly incorporated in the salary sheets and deductions therefore if any have been
appropriately made.

8. You have been assigned to plan the test of controls in respect of receiving of goods and invoices from suppliers of Bhurban Limited. In this
regard, you are required to identify the following:

a) The related risks (03)

b) Controls that you expect to see to address the above risks (04)

c) Audit procedures that you need to perform to test the controls (03)

A: (a) Risks:

Risks related to receiving of goods and invoice from suppliers are as follows

• Goods may be accepted from a supplier without having been ordered.

• The company may fail to claim discounts from suppliers despite being due.

• Supplier may raise invoices for goods that have not actually been received/purchased.

• Goods received from suppliers are of inferior quality.

(b) Related controls

Suitable controls may be as follows:

• A copy of all delivery notes should be retained, with a signature of the member of staff who took receipt and checked the goods.

• Goods received notes should be produced for each delivery, from the delivery note or after a physical count of the items received.

• A member of the accounts staff or purchasing staff must be responsible for checking discounts allowed by suppliers.

• There should be a segregation of duties between the individuals who take delivery of goods, those who place the orders and those who record
the purchase invoices in the accounting system.

• All purchase invoices should be checked against a purchase order and a goods received note.

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( c) Tests of control

• Ensure that goods received notes, purchase orders and purchase invoices are matched with each other.

• Confirm from documentary evidence that discounts are claimed from suppliers when available.

• Check that the segregation of duties does exist.

9. You are audit incharge at Quick Enterprises Limited (QEL), a distributor of fast moving consumer goods. QEL supplies goods to retailers all
over the country. The purchase procedure of the company includes the following:

(i) Minimum stock levels are fixed on the basis of the changing demand for different brands which is monitored by the marketing department.

(ii) At the minimum stock level, requisitions for stock purchases are generated by the marketing department and signed by the Marketing
Manager.

(iii) Pre-numbered purchase orders are generated in triplicate.

(iv) Purchase Manager signs the purchase order after matching these with the requisitions signed by the Marketing Manager.

(v) Purchase orders are faxed to the suppliers and copies thereof are forwarded to the stores and finance departments.

(vi) On receipt of goods, pre-numbered Goods Receiving Notes (GRNs) are prepared and signed by the Store Incharge. Each GRN is compared
with the relevant purchase order by the Store Incharge.

(vii) GRN is forwarded to the finance department for recording in the stores ledger.

Required:

Identify the key internal controls that appear to be in place in the above system and test of controls required to evaluate each control. (08)

A:

S No. Internal Controls Test of Controls

(i) (i) Segregation of duties • Ensure that the person carrying out the
There is a proper segregation of duties in respect of following functions: procedures does not have incompatible
- Authorization of purchase requisitions functions.
- Initiation of purchase • Enquire about what happens when any of
- Stock keeping the persons carrying out a particular function
- Stock recording is on leave.
(ii) Authorization Select suitable number of documents using
Stock purchase requisitions, purchase orders and GRN's are duly authorized. appropriate sampling techniques and check
whether each document is duly authorized as
mentioned in the purchase procedures.
(iii) Completeness Check files of copies of purchase orders and
Purchase orders and Goods Receiving Notes are pre-numbered. GRN's and unused purchase orders/ GRNs to
ensure that they pre-numbered and are
arranged in serial.
(iv) Accuracy -Investigate a sample of goods-received notes
The quality and condition of stock received are investigated on receipt thereof. and substantiate that the quantity and
condition of stock are noted thereon
-Observe the storekeeper performing these
duties.
(v) Documentation Select suitable number of documents using
Matching of purchase orders with purchase requisitions. appropriate sampling techniques and check
Comparison of GRN with Purchase orders. whether each document is duly matched/
compared as mentioned in the purchase
procedures.

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Chapter# 07 (Introduction to substantive procedures)
1. Briefly describe the following concepts:

Embedded audit facilities and its significance (04)

A: Embedded Audit Facilities:

It is an audit software that is built into the client's IT system, either temporarily or permanently. The purpose of embedded audit facilities is to
allow the audit to carry out tests at the time the particular transactions are being processed, in 'real time'.

This can be very useful for the audit of online systems where:

• data is continually processed and master files are being continually updated, and/or

• it is difficult, if not impossible, for the system to provide a satisfactory audit trail for the transactions, through the system.

• an embedded audit facility may also print details of the transactions it has monitored, or copy them to a computer file, so that the auditor can
study the transactions

ISA-520
1. You are the audit manager in a firm of chartered accountants. Your audit client Dairy (Private) Q.7 Limited (DPL) has emailed you its draft
financial statements for the year ended 30 June 2021 (A-21) along with related notes. The information provided by DPL is summarized below:

Draft statement of financial position as at 30 June 2021 2021 2020

Equity and reserves 35,922 26,000

Long-term loan 6,000 12,000
Trade and other payables 7,800 6,500
Equity and Liabilities 49,722 44,500

Property, plant and equipment 22,630 26,818

Prepayments 1,500
Trade debtors 12,000 8,000
Inventory 13,000 7,000
Cash and bank balances 592 2,682
Assets 49,722 44,500
Draft income statement for the year ended 30 June 2021

Sales 110,000 73,000

Cost of sales (83,050) (54,750)
Gross profit 26,950 18,250
dmin and marketing expenses (12,100) (10,950)
Finance cost (675) (1,530)
Net profit before taxation 14,175 5,770
Taxation @ 30% (4,253) (1,731)
Net profit 9,922 4,039
Notes:

(i) During the year, sales price of DPL products were increased by 20%, to offset the corresponding increase in cost of production.

(ii) On 30 June 2019, DPL had obtained a loan of Rs. 20 million, which is payable in 10 equal quarterly instalments at the end of every quarter.
The loan carries fixed mark-up rate of 9%.

(iii) Decrease in property, plant and equipment represents disposals made during the year, net of depreciation.

(iv) Prepayment represents advance rental payment of warehouse, obtained for 6 months on 16 June 2021 at a monthly rent of Rs. 250,000.

Required:

Using analytical procedures, identify any four unexplained fluctuations and inconsistencies in the above situation. State the key audit
procedures which you would perform to address the issues identified by you. (10)

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A: Long-term loan

It seems that DPL has failed to make the quarterly installment of its long-term loan or has made delayed payment This may represent default on
part of DPL. Furthermore, no accrual of finance cost for the last quarter has been made.

Audit procedures

• Obtain the loan agreement and look for any penal provision.

• Obtain correspondence with the bank to assess the possibility of any penalty or action taken against DD.

• Critically analyze the confirmation received from the bank.

• Ask the management to record any penalty amount or loan re-classification.

Trade payables

Creditor days have decreased from 43 days to 34 days. This may represent that creditor balances might be understated. Consequently, the
following procedures may be performed:

Audit procedures

• Circulate balance confirmation requests to trade creditors.

• Compare the current list of trade payables with prior year's working papers to identify any omissions.

• Ensure that all regular suppliers are included in the list of trade creditors.

• Scrutinize subsequent payments and ensure that appropriate accruals were made against those payments.

Prepayments

Since the warehouse was obtained on 16-June-21, an expense amounting to Rs. 125,000 should be transferred to profit and loss and prepayment
should be reduced to Rs. 1,375,000 in the statement of financial position.

Audit procedures

• Obtain the rent agreement of the warehouse to verify the monthly rent.

• Verify and trace the payment made for the rent.

• Ask the management to record the expense amounting to Rs. 125,000.

Inventory

The inventory turnover days have increased from 4 7 to 5 7 days. Due to this increase there might be some obsolete inventory which requires
provisioning.

Audit procedures

• Verify from the stock count sheet whether any obsolete or old inventory was identified

• Obtain the inventory aging analysis.

• Obtain the management working of net realizable value and assess its accuracy.

2. You are manager responsible for the audit of Pine Limited (PL) for the year ended 31 August 2020. PL has large contracts with many
government entities. During the year, the government has significantly reduced its spending which has also affected its contract volumes with
PL. Devaluation of the local currency has also resulted in increased costs of the materials purchased from overseas suppliers.

During the planning work review, your team has provided you the following ratios:

2020 2019
Gross Profit Margin 32 Percent 28 Percent
Accounts payable to cost of sales ratio 0.2 Percent 0.28 Percent
Trade days receivable 90 days 75 days
Required:

(i) Explain the fluctuations and inconsistencies in the given ratios.

(ii) State any four key audit procedures which you would perform to address each issue identified in (i) above. (09)

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A: The increase in the gross profit margin is inconsistent with the increase in the cost of materials due to devaluation of local currency and
decrease in volume of sales with the government. Considering this inconsistency, following steps may be performed:

• Review the explanations obtained by the audit team for the increase in the gross profit margin even after decrease in government contracts
and increase in import prices.

• Perform cut-off test for purchases and sales.

• Check that the costing of material, labour and overheads have been correctly applied.

• Perform analytical calculations over the cost of inventory consumed and other major costs.

The accounts payable to cost of sales ratio has decreased significantly (29%), despite weakening of the local currency. Consequently, the following
procedures may be performed:

• Ensure that foreign trade payables are translated at the closing foreign currency exchange rates.

• Circulate balance confirmation requests to trade creditors.

• Compare the current list of trade payables with prior year's working papers to identify any omissions.

• Ensure that all regular suppliers are included in the list of trade creditors.

Trade day receivable has increased significantly (20%), which indicates that PL is facing problems in collecting trade debts. There is a possibility that
provision for doubtful debt may not be correctly recorded. Considering this, following procedures may be performed:

• Obtain aging of the receivable balances.

• Obtain confirmation from major customers.

• Review the subsequent collection of trade receivables.

• Assess the adequacy of provision against overdue balances.

3. You are the audit manager in a firm of chartered accountants. Your audit client Zakir Textile Mills Limited (ZTML) has emailed you its draft
financial statements for the year ended 31 December 2018 along with certain explanations. The information provided by ZTML is summarized
below: (i) 2018 2017

Equity and Liabilities ------Rs. in ‘000------

Equity and reserves 29,287 22,000
Long-term loan 8,000 12,000
provision against litigation 1,100 1,000
Trade and other payables 6,400 6,500
44,787 41,500
Assets
Property, plant and equipment 25,100 22,818
Loans to employees 1,000 800
Trade debtors 8,500 8,000
Inventory 7,600 f,000
Cash and bank balances 2,587 2,882
44,787 41,500
(ii) Extracts from statement of profit or loss 2018 2017

Sales 84,000 73,000

1 Briefly describe the following concepts: 60,400 54,750
Embedded audit facilities and its
significance (04)
ISA — 520
Gross profit 23,600 18,250
Expenses 12,850 10,950
Net profit before taxation 10,750 7,300
Taxation 3,463 2,555
Net profit 7,287 4,745
(iii) At the start of the year, ZTML had increased the sale price of its products by 13%.

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(iv) The entire long term loan was obtained in 2017. The principal is payable in three annual instalments along with the amount of interest.

(v) Increase in property, plant and equipment represents additions made during the year, net of depreciation. There were no disposals during
the year.

(vi) ZTML has a policy of giving interest free loan to its employees. The loan entitlement was reduced during the year from 8 times the gross
salary to 5 times of gross salary.

Required:

Using analytical procedures, identify unexplained fluctuations and inconsistencies in the above scenario. State the key audit procedures which
you would perform to address the issues identified by you. (Maximum of three key audit procedures are required for each issue) (11)

A: (i) Provision against litigation

Even though the change in provision against litigation is not significant but due to the high inherent risk, further steps needs to be taken as follows:

• Circulate confirmation to legal advisors of the company.

• Scrutinize payments of legal expenses to ensure that all legal cases have been identified by the client.

• Review the minutes of the board meetings.

• Obtain expert advice, if considered necessary.

• Verify the basis for recording of provision.

(ii) Trade payables

Despite the increase in cost of sales, trade payables have decreased. Consequently the following procedures may be performed:

• Circulate balance confirmation requests to trade creditors.

• Compare the current list of trade payables with prior year's working papers to identify any omissions.

• Ensure that all regular suppliers are included in the list of trade creditors.

• Scrutinize subsequent payments and ensure that appropriate accruals were made against those payments.

(iii) Loans to employees

Despite the reduction of entitlement of loan, it has increased from previous year. Considering this inconsistency, following procedures may be
performed:

• Discuss the increase in loan amount with management.

• Check payment of amount of loan given to employees during the year with payment voucher having acknowledgment of employees.

• Obtain confirmation ofloan balances from employees.

• Verify approval of new loan given to employees.

• Ensure that recoveries are being made as per policy and are recorded.

(iv) Trade debtors

Sales has increased by 15% but debtors have only increased by 6%. Considering this inconsistency following procedures may be performed:

• Discuss the reason for change with the management.

• Circulate confirmation requests to debtors.

• Trace a sample of shipping documents to sales invoice and into the sales and receivable ledgers.

(v) Cost of sales

Despite 15% increase in sales, cost of sales has increased by only 10%. Considering this fluctuation, following steps may be performed:

• Perform cut-off test for purchases.

• Check that the correct quantity of material, labour and overheads has been used.

• Perform analytical calculations over the cost of inventory consumed and other major costs.

• Verify the major costs with bills, invoices and other related documents.

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(vi) Expenses

Even though the finance cost would also have reduced due to reduction in loan, expenses have increased by 17%. Considering this fluctuation,
following steps may be performed:

• Ask the client for the detailed breakup of the expenses

• Enquire from management for any inconsistencies in the break-up of expenses obtained.

(vii) Taxation

Tax rate was exactly 35% of the profit before taxation in last year which have reduced to 32%. Considering this fluctuation, following steps may be
performed.

• Obtain and review the tax working prepared by the management

• Check the enacted tax rates.

4. State the factors which determine the extent to which an auditor may use Analytical procedures as a form of substantive audit evidence.

A: The factors which determine the extent to which analytical procedures may be used as a form of substantive procedures are as follows:

• suitability of particular substantive analytical procedures for given assertions;

• reliability of data from which the auditor's expectation of recorded amounts or ratios is developed;

• whether the expectation as regards the recorded amounts is sufficiently precise to identify a misstatement that, individually or when
aggregated with other misstatements, may cause the F /S to be materially misstated.

5, Identify the matters that need to be considered by the auditor at the time of designing and performing substantive analytical procedures. (04)

A: When designing and performing substantive analytical procedures the auditor should:

• determine the suitability of particular substantive analytical procedures for given assertions -

i. e. how effective they will be in detecting a particular type of material misstatement.

• develop an expectation of recorded amounts or ratios and evaluate whether that expectation is sufficiently precise to identify a misstatement.

• evaluate the reliability of the data from which the expectation has been developed.

• determine what level of difference from expected amounts is acceptable without further investigation.

6. In the planning phase of the audit of Dynamic Limited for the year ending 30 June 2012, you have calculated the following ratios from the
management accounts of the company for the eight mont h sen d e d 29 F e b ruary 2012 :

Eight months
Year ended Year ended 30
period ended 29
30 June 2011 June 2010
February 2012

Debtors turnover days 35% 40% 40%

Inventory turnover days 120 105 78
Current ratio 1.5 2.3 2.6
Quick ratio 0.78 1.6 1.7
Times interest earned 0.91 1.67 2.1
Debtors turnover days 132 86 68
Identify the prospective audit risks which the auditor should consider while planning the audit. (09 marks)

A: The prospective audit risks are as follows:

Overstatement of Debtors:

Average period for outstanding debtors has reached to four months which is indicative of a risk of inadequate provision against doubtful debts.

Overstatement/ Understatement of Inventories:

The inventories turnover rate has decreased to 3 times per year from 5 times in 2010. It is indicative of the following types of risks:

(a) Obsolescence of inventories.

(b) Improper valuation of inventories.

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Overstating of income as well as understating of expenses:

The income position has weakened and the company has suffered losses as the interest coverage has moved below 1.0. In such a situation there is
a risk that the management may like to overstate its revenue, and understate its expenses.

Liquidity Problems:

The company is experiencing liquidity problems as are evidenced from the decline in current ratio and quick asset ratio.

Decline in Gross Profit %:

The decline in GP % needs to be justified. The absence of an appropriate explanation may be indicative of:

(a) Improper pricing and discounting policies

(b) Improper purchasing policies

(c) Other irregularities like unauthorized spending, intentional manipulation of profitability etc.

Going Concern:

Losses/significant decline in profitability and fast deteriorating liquidity position are financial indicators of going concern issues, which should not
be overlooked.

7. The analytical procedures which are carried out near the end of the audit usually assist the auditor in forming an overall conclusion on the
financial statements.

Required:

a) State the objectives which an auditor expects to achieve while applying analytical procedures at the end of an audit. (04 marks)

b) Discuss the course of action an auditor should adopt when results of analytical procedures identify inconsistent relationships or differ from
expected values by significant amounts. (04 marks)

A; (a) The auditor should apply analytical procedures at or near the end of the audit in order to

(i) Form an overall conclusion as to whether the F /S as a whole are consistent with the auditor's understanding of the entity.

(ii) Corroborate the conclusions formed through other procedures performed during the audit of individual components or elements of the F /S.

(iii) Identify previously unrecognized risk of material misstatement. In such circumstances, the auditor may:

• revise the auditor's assessment of the risk of material misstatement;

• modify the further planned audit procedures accordingly. and

(b) When analytical procedures identify significant fluctuations or relationships, the auditor shall investigate such differences. Fluctuations can be
investigated in the following manner:

(i) Inquiring of management and obtaining appropriate audit evidence relevant to management responses. These audit evidence may be
obtained by taking into account:

• the auditor's understanding of the entity and its environment; and

• with other audit evidence obtained during the course of the audit

(ii) Performing other audit procedures when:

• management is unable to provide an explanation, or

• the explanation together with the audit evidence obtained is not considered adequate.

Chapter# 08 (Substantive procedures: non-current assets)

70
1.You are the audit manager in a firm of chartered accountants. While reviewing the audit working papers of a client you came across the
following audit program on property, plant and equipment:

A:

S. No. Audit Procedures Related Assertion

(i) Verify reconciliation of ledger balances with the fixed asset register. Completeness
(ii) Obtain schedule of fixed assets showing opening balances, additions, disposals, depreciation and closing Accuracy
balances.
(iii) Verify the cost of additions to fixed assets and capital work in progress with the related invoices. Accuracy
(iv) Physically inspect the additions made during the year. Existence &
Ownership
(v) On sample basis select assets and check the depreciation calculation. Accuracy
Required:

Critically review the audit program and suggest changes or additional audit procedures as may be necessary. Assume that the assets are carried
at cost, no disposal was made during the year and no impairment testing is required. (11)

A: (i) No comments.

(ii) Obtaining the asset schedule showing opening balances, addition, disposal, depreciation and closing balance addresses the assertion of
completeness only but not accuracy.

(iii) Apart from verifying the cost of the asset through purchase invoices, the following steps would also be required:

• Verify the date from which asset was available for use from purchase invoices or the completion certificate of capital work in progress, to
ensure that depreciation is recorded from the correct date.

• Check the allocation of total expenditure between capital and revenue expenditure in case of additions.

• Check that purchases are duly authorised.

(iv) Physical inspection of assets may not address the assertion of ownership.

Additional procedures

• For addressing the assertion of ownership, check the title documents of the assets especially the assets purchased on sample basis.

• Check bank confirmation for any charge on assets, if any.

• Check register of charges maintained by the client, if any.

• Physically verify the existing assets from register to floor and vice versa.

(v) This step would not be enough. Following procedures would also be required.

• Perform analytical procedures on the overall depreciation.

• Review the depreciation rates for reasonableness in the light of the nature of assets, its estimated useful life and residual value.

• Ensure that consistent depreciation methods are in use.

• Ensure that fully depreciated assets are not subject to depreciation.

• Obtain approval for additions made during the year.

The audit program has no procedure related to presentation assertion. Auditor should review the disclosure in the financial statements and ensure
that they are correct and clear.

Ensure that non-current assets have been classified in appropriate account.

2. You are the audit senior on the audit of Ormara (Pvt.) Limited (OPL). During the planning phase of the audit, you have identified that OPL has
adopted the revaluation model for buildings for the first time. The valuation was carried out by an independent well established external
valuer.

Required:

Identify and assess the risks of material misstatement at assertion level and briefly state the key audit procedures to mitigate these risks. (05)

{Procedures for assessing the competence and objectivity of the expert are not required)

A: Adoption of revaluation model for building indicates the risk of in-correct valuation and presentation of buildings and surplus on revaluation.

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Audit procedures to mitigate the above risk are as follows:

• Verify amounts in the financial statements with the valuer's report.

• Consider the reasonableness of the valuation and the assumptions used for valuation.

• Check that the rise in value on revaluation have been appropriately recorded in the financial statements and depreciation has been calculated
on the revalued amount(s).

• Consider involving auditor's own expert.

• Check that revaluation have been appropriately disclosed in the financial statements.

• Ensure that all class of building has been revalued.

3. Briefly state test of details for verifying the valuation assertion of tangible non current assets where the company follows revaluation policy
for valuation of such assets. (08)

A: Test of details for verification of valuation assertion of tangible non-current assets:

• Check the cost in the F /S against the purchase invoices/contracts for the assets.

• Check that the purchase expenditure is analysed reasonably between land, buildings and equipment.

• Review the allocation of total expenditure on non-current assets between capital and revenue amounts.

• Verify amounts in the F /S with the valuer's report.

• Obtain an understanding of the work of the expert through considering the reasonableness of valuations/assumptions used in valuations.

• Evaluating the competence, capabilities and objectivity of the expert.

• Check that valuations are regularly updated.

• Check that all the assets of the similar class are revalued.

Chapter# 09 (Substantive procedures: current assets)

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ISA-501 & Inventory
1. Your firm is the auditor of Shahzad Limited (SL), a wholesaler of consumable products, for the year ended 30 June 2021. SL maintains up to
date computerized inventory records. The following matters have been observed during the inventory count:

(i) The inventory count took place on 1 July 2021 under the supervision of the warehouse manager and his staff, who are responsible for
maintaining the inventory. No movement of inventory took place on that day.

(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was allocated by the teams among themselves.

(iii) Each team was instructed by the warehouse manager to remember which inventory had been counted.

(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. To facilitate inventory count, inventory belonging
to third parties and the inventory ledger balances were mentioned on the pre-numbered count sheets.

(v) All the cut-off documents were provided to the audit team on the very next day after the inventory count.

Required:

Identify any four weaknesses in the inventory count procedures and state their implications on the physical count. (06)

A:

Weakness Implication
The warehouse manager is supervising the inventory count procedure. Since there is a lack of segregation of duties, the Warehouse Manager
may influence the inventory count process.
No system of marking on counted items. This may lead to double counting or omission completely and
possibility that some items may not be counted at all.
Perpetual inventory records and third party inventory records are The person responsible for counting may try to match the numbers
available on count sheets. provided instead of carrying out an independent count.
The third party inventory may be made part of the inventory. Confirm
that inventory belonging to third parties, but on the client's premises
at the date of the count, is not included in the inventory.
Cut-off documents not obtained during the inventory count. There is a possibility of recording back dated entries, therefore the
cut-off documents should have been obtained on the date of the
inventory count date.
2. During the audit of Shahbaz Chemicals Limited (SCL) for the year ended 31 December 2016, the audit team had noticed that sales of SCL has
declined due to various reasons and SCL is facing difficulties in selling the existing stock of inventory at current price levels.

Required:

Explain the steps which the auditor should perform to ensure that carrying value of inventories is based on lower of cost and net realisable
value. (04)

A; Shahbaz Chemicals Limited

The following steps shall be performed by the audit team:

• Review and test the procedures in place for comparing NRV with cost for each item of inventory.

• Review the information gathered during the physical inventory count ( e.g. deterioration of inventory) which may suggest that NRV may be
lower than cost

• Review the records relating to goods returned by customers or allowances granted to customers.

• Review inventory records and order books for evidence of slow-moving items and compare their expected NRV with cost.

• Select major items of inventory from the list of stock and compare NRV with cost.

• Review prices at which goods have been sold after the reporting period, for evidence that NRV is higher than cost.

3. You are the audit senior on the audit engagement of Farhan Foods Limited and assigned to attend the inventory count.

Required:

(a) State what matters you would consider while observing the inventory count. (05)

(b) State the procedures to be performed during the final audit in relation to the cut-off assertions for sales and purchases.(03)

A: (a) During the count, the auditor should consider:

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• whether or not the count is being conducted in accordance with the written instructions of the client's management

• the condition of the inventory, in order to identify items where NRV might be below cost (and in particular, inventory that seems to have
deteriorated in condition)

• whether or not inventory not owned by the client entity is properly identified and labelled (for example, inventory owned by customers but
held on the entity's premises)

• whether or not, during the count, production of new inventory and the movement of inventory are controlled and properly documented, in
accordance with management's instructions for the count

• At the end of the count, whether or not all inventory items have been counted and tagged accordingly.

(b) Cut-off at final audit:

The audit team should take last few receiving and delivering notes on either side of the year-end and trace these to invoices and ledgers and
inventory record to ensure that sales and purchases have been included in the correct periods and related receivables and payables are booked
accordingly.

Weakness Implications
The warehouse in charge is supervising the inventory count The warehouse in charge is himself responsible for the inventory,
procedure. therefore he lacks independence
Temporary staff involved in the physical inventory count. Temporary staff may not be aware of the nature of inventory, and
may not have any interest in detecting or reporting discrepancies.
Lack of precise instructions to the counting team. The staff has been instructed to remain in constant contact with each
other to avoid double counting. This depicts lack of precise
instructions and it increases the risks of mistakes in counting like
missing out items or double counting.
Inventory is not tagged when it is counted This gives ride to a risk that items of inventory will be counted twice,
and possibility that some items may not be counted at all.
Count sheets not signed by staff carrying out the count. In this case, it becomes difficult to identify the staff who has carried
out the count, therefore any discrepancy found cannot be investigated
properly.
Count sheets stated the quantity of items expected to be found in Count teams will focus on finding the number of items mentioned on
warehouse. the count sheets. This could more likely result in undercounting
inventory.
4. Your audit team members have attended the physical inventory count of Sutlaj Limited. Their observations are as follows:

(i) Stock count was supervised by the warehouse incharge who reports to the production manager.

(ii) In view of the various ongoing projects, temporary staff had to be hired to conduct the stock count.

A: (a) Physical verification:

(i) Evaluate the client's physical inventory taking instructions and procedures to their staff.

(ii) Attend physical inventory count to observe the inventory count procedures.

(iii) Ascertain whether the staff members are carrying out the physical inventory count as per approved instructions issued to them.

(iv) Perform test counts to ensure the efficiency and effectiveness of the physical count procedures.

(v) Observe the physical inventory count and identify the matters for appropriate follow-up during the audit. These matters may include the
following:

• Excess/ Shortages found in test count performed by the auditors.

• Items of inventory identified as obsolete, slow moving, damaged or defective.

• Details of instances where the approved inventory count procedures are not followed by the staff members of the client.

• Instances where the stock records (bin cards, stock and stores ledger etc) do not contain adequate details relating to balance of inventory in
hand, minimum level, maximum level, ordering level, specification of inventory and location of inventory etc.

• Cut-off procedures and adherence thereto.

( vi) Check that adjustments arising out of the physical count have been made in stock count sheets.

(vii) Check final stock sheets for quantity, pricing, extensions, casting, summarization, and signatures of the stock taking staff.

(b) Finished Goods:

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(i) Obtain a list of items (schedule) shown as finished goods, with full particulars, quantity and value

(ii) Compare the list with physical count sheet balances and with stock ledger balances

(iii) On test basis check the items and quantities in the stock ledger with the bin card.

(iv) With regard to cut-off procedures performed during the attendance at the physical inventory count, check the 'goods outward book' or
'delivery challans' book for the last few days of the year, and early few days of the succeeding financial year.

(v) If goods are sold on consignment, check the closing stock with the consignment account

(c) Work in Process:

(i) Obtain a list of items shown as work in progress, with full particulars, quantity and value.

(ii) Compare the list with physical count sheet balances and with stock ledger balances

(iii) Check the quantity and items included in the list with the production reports and job cards etc.

(iv) Check records showing the work in progress opening balances, raw material and other material issued and labour and overheads charged to
production and closing balance of work in process.

(v) Where it is not possible to quantify or value the work in process for technical reasons, the auditor should consider to use an expert

( d) Raw material:

(i) Obtain a list of items shown as Raw material, with full particulars, quantity and value.

(ii) Compare the list with physical count sheet balances and with stock ledger balances.

(iii) Verify cost of raw material appearing in F /S by matching with them with purchase invoices etc.

(e) Valuation oflnventories:

(i) Ensure that stock has been valued in accordance with the valuation policy.

(ii) Ensure that inventories have been valued at the lower of cost and net realizable value.

(iii) Ensure that the cost of inventories comprise of purchase price, cost of conversion and other costs incurred in bringing the inventories to their
present location and condition.

(iv) Check that the following costs have not been included in the cost of inventories:

• Abnormal wastes in labour, material or other production overheads.

• Storage costs unless considered necessary for the production process/ inventory.

• Administrative overheads

• Selling and distribution costs

• Financial charges

(v) Examine and perform test checks to verify the proper allocation of overheads is in accordance with the requirements of IAS 2.

(vi) Where the inventories are valued at net realizable value, check that valuation is correct and is based on the most reliable evidence.

(vii) Check that the cost of obsolete and damaged items is properly written down.

(viii) Test arithmetical accuracy of the calculation of the stock sheets.

(t) Disclosure:

Ensure that inventories have been disclosed in accordance with the requirements of International Financial Reporting Standards and the
Companies Act, 2017.

(g) General:

(i) Trace opening balance from last year's working papers.

(ii) Agree closing balance appearing in the F /S with books of accounts.

(iii) Ensure that inventories have been appropriately classified.

(iv) Obtain direct confirmation for stocks held by third parties.

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(v) Check reconciliations of opening and closing balances with production/ sale records, wherever possible.

5. List the substantive procedures that may be performed by the auditor to verify the amount of inventories as appearing in the financial
statements of a manufacturing concern. (15 marks)

A: Read the above substantive procedures.

6. Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a wholesaler of consumable products. SL records its sale on
delivery of goods and maintains up to date computerised inventory records. A full inventory count was conducted at the year end.

The senior who attended the physical stocktaking at the central warehouse has observed the following matters:

(i) The inventory count took place on January 1, 2010 under the supervision of the Inventory Controller. No movement of inventory took place
on that day.

(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was allocated by the teams among themselves.

(iii) Each team was instructed by the Inventory Controller to remember which inventory had been counted.

(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. The count sheets showed the inventory ledger
balances, to facilitate reconciliation.

(v) Old, slow-moving or already sold inventories were highlighted on the count sheets at the time of counting.

(vi) Items not located on the pre-numbered inventory sheets were recorded on separate sheets which were numbered by the staff.

(vii) At the end of the count, all inventories against which advances from customers had been received were removed from the physical
inventory on the instruction of the Inventory Controller

Required:

Identify the weaknesses in the system of inventory count. Give appropriate explanations to support your point of view. (09 )

A: Following weaknesses in inventory count are identified from audit senior's observations:

(i) Lack of segregation of duties

Inventory Controller is responsible for physical control of the inventory and is also supervising the stock count.

(ii) Non availability of detailed plan

Allocation of counting area by the teams themselves indicates non availability of detailed plan which may lead to certain inventory items being
counted more than once while some items may not be counted at all.

(iii) No system of marking on counted items

This again may lead to double counting or omission completely.

(iv) Perpetual inventory records available on count sheets

The person responsible for counting may try to match the numbers provided instead of carrying out an independent count.

(v) Additional count sheets are not pre-numbered

If the separate sheets are numbered as they are used, there is no means of identifying that all sheets issued have been returned and the last count
sheet( s) may go unnoticed.

7. You are the senior member of the audit engagement team, auditing the financial statements of a manufacturing company, Hard Stone
Limited. List down the primary substantive procedures, which you would carry out in the verification of:

stores and spares. (06)

A; Substantive procedures for verification of stores and spares

(i) Obtain the listing of stores and spare balances at period-end and investigate large or unusual quantities or amounts.

fi... Review large or unusual entries in the ledger account.

(iii) Review period end reconciliation of subsidiary and general ledger and investigate large and unusual items.

(iv) Attend inventory counts at period end and ensure that physical differences are appropriately recorded and resolved and damaged items if any
are identified.

(v) Check valuation of selected items using one or more of the recommended sampling techniques.

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(vi) Identify slow moving items and discuss/determine the impact thereof.

ISA 505 & Debtors

1, Tetra Milk Limited

Customer's name and address: DB Limited, 46-Safoora Palace, Mall Road, Quetta. Date: 7 September 2021

Dear Mr. Salman Shahid

In accordance with the request of our auditor, Abid Ali & Co, Chartered Accountants, we ask that you kindly confirm your indebtedness to us
which, according to our records, amounted to Rs. 45.6 million as shown by the enclosed statement.

If the above amount is in agreement with your records, please sign in the space provided below.

If the amount is not in agreement with your records, please notify us of the amount shown by your records.

Yours faithfully,

-Signature-

Tetra Milk Limited

Confirmation No. A-172

The amount shown above is/is not in agreement with our records.

Account No .......................................................................................................... ..

Signature ......................................................................................................................................

Date .......................................................................................................................... .

Title or position .................................................................................................. .

Required:

Identify the shortcomings in the above draft of balance confirmation request and suggest the necessary changes. (06)

A;

Short comings Required Changes

(i) The client has been asked to confirm the balance and notify any Instead of using the word 'us' we should use 'our auditors directly'.
difference to the audit client's management. It should be specifically mentioned somewhere in the confirmation
that it needs to be mailed directly to the auditor.
ii) The year-end date at which the balance need to be confirmed is not The year-end date needs to be inserted just before or after the places
mentioned. where the account balance has been mentioned and the place where
client confirms his balance.
(iii) An addressed and stamped envelope is always attached with the This also needs to be mentioned in the balance confirmation request
confirmation request
(iv)Balance reconciliation in case of difference has not been asked. The debtor should be asked that in case he does not agree with the
mentioned balance, he should provide the detail and full particulars of
the difference.
2. You are the audit manager responsible for the audit of NKL Limited for the year ended 28 February 2021. The audit team has prepared the
following summary of debtors' balances for your review:

Summary of debtors' balances and their confirmed amounts as at 31 January 2021

Assertions verified: Com leteness, Cut-off and Ri ts and Obligations

Balances (Rs.)
confirmed
S. No. Debtor(s) as per Comments
by
book
debotr(s)
(i) Alpha 800,000 800,000

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Confirmation was returned by the courier on the grounds of
invalid address. Confirmation was resent by the client
through its rider. The reply was received directly by the
(ii) Beta 900,000 900,000 auditor.
No reply
(iii) Gama 700,000 received Gamma has gone into liquidation.

These represent various small distributors whose balances

Small Not were below Rs. 30,000. Due to immaterial balances, they
(iv) distributors applicable weren't selected for sending confirmation.
Required:

Assess the appropriateness of the work performed by the audit team. Also suggest the additional procedures (if any) which the audit team may
perform. (10)

A: Interim balances:

Since the interim balances were used for sending confirmation, the auditor will need to check the

changes in the receivable balances between the confirmation date and the end of reporting

period. This check will consist mainly of checking entries in the receivable control account with the transactions entered in the book of prime entry
during the same period.

Assertions addressed:

Cut-off, rights and obligation assertion has been correctly identified the audit team.

However, the receivable balances are generally tested for overstatement, the completeness assertion is therefore less relevant. Assertion related
to existence is more relevant as this exercise

confirms that the receivables do in fact exist, and there is no overstatement of receivables in the financial statements. Accuracy and valuation
assertion is also verified during the confirmation

exercise which has not been addressed by the audit team.

Debtors' wise assessment of work:

(i) Alpha:

No further procedure required.

(ii) Beta:

The auditor should maintain control over the external confirmation requests, including the process of sending the requests himself. The
confirmation being sent directly was returned by the courier on the grounds of invalid address and that resending by the client may indicate doubts
on the reliability of the response. The auditor should also consider performing alternate audit procedures to verify the receivable balance such as
subsequent clearance, review the supporting documentation such as signed PO, delivery documentation and sales invoice.

(iii) Gamma:

From the winding up event it appears that the amount receivable is irrecoverable. Therefore, the auditor needs to ensure that the amount of
irrecoverable receivables is written off or is duly provided for.

• Review any correspondence with the liquidator/debtor, relating to recovery of the amount due.

• Review the calculation of amount of provision/write off and basis thereof.

(v) Small Distributors:

Audit team's decision to ignore small balance is not correct The team may consider sending negative balance confirmation. If the team ensure that
there is low risk of material misstatement, low exception rate is expected and there is no reason to disregard the confirmation request

3. You are the audit manager in a firm of chartered accountants. During the audit of a client for the year ended 31 December 2019, the audit
team has prepared the following schedule to summarize th e responses from three debtors:

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Balance
Balance
confirmed
Debtor(s) at year Comments
by the
end
debtor

A 500,000 500,000 Confirmation was received through client.

Confirmation was received after many follow-ups with the
client. However, the audit team have come to know that
the confirming party had not received the confirmation
B 800,000 800,000 request.
Consignment of Rs. 500,000 was shipped on 27 December
2019 but goods of Rs. 350,000 were returned subsequent
C 500,000 150,000 to year-end.
Evaluate the evidence obtained and describe the steps (if any) which the audit team may perform in respect of the above debtors. (10)

A; Debtor A

Evaluation

Even though the balance confirmed is the same, it raises doubt for the reliability of the response because the confirmation was not received
directly from the confirming party.

Steps to perform

• Auditor should modify or add procedures to resolve doubts over the reliability of information to be used as audit evidence.

• Auditor should contact the confirming party and request them to respond directly to the auditor.

Debtor B

Evaluation

It appears that the confirmation did not come from the originally intended confirming party. It carries risk of interception, alteration or fraud.

Steps to perform

• Auditor should resend the confirmation again to the debtor.

• Auditor should revise the risk of material misstatement at the assertion level and modify planned audit procedures accordingly.

• If it is ascertained that fraud exist, it is important that the matter is brought to the appropriate level of management and those charged with
governance.

• If the auditor has doubts about the integrity of the management or those charged with governance, than the auditor should consider to obtain
legal advice for appropriate course of action.

DebtorC

Evaluation

Sales return subsequent to the year-end can be an adjusting event which needs to be adjusted in the financial statements.

Steps to perform

• Check the return of goods with the relevant goods receipt document

• Inquire from the management the reasons for the return of good and assess whether it is an adjusting event

• If it is established that it is an adjusting event than ask the client to reduce the sales and receivables and incorporate corresponding effects in
cost of sales and inventory.

• Consider the fraud risk that whether the sales were made for overstating the sales for the year end.

Additional steps ( overall)

Since there are doubts over the reliability of the confirmation response, the auditor should also perform the following alternate audit procedures
to gather audit evidence:

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• Subsequent receipt of the amount should be checked.

• If no payment has been received, the outstanding sales invoices should be checked with purchase order issued by the customer and delivery
note duly acknowledged by the customer.

4. You are the job-in-charge on the audit of Ostrich Limited (OL), a food processing company, for the year ended 30 June 2019. For sending
debtor balance confirmations, OL has provided you the following scheduIe for the year ended 30 June 2019

Balance as at 30 June
Debtor(s) No. of cutomers
2019 (Rs. '000)

Chain Stores
Store-A 1 5150
Store-B 1 3390
Store-C 1 4236
Supermarkets 30 7104
Restaurants 500 6364
Credit balance 3 -1000
Total 25,252
There are no overdue and nil balances as on 30 June 2019. The risk of material misstatement has been assessed as low and controls have been
tested.

Required: Discuss the audit strategy that you would follow for selecting the debtors for balance confirmation. (07)

A; We will have to check the completeness and accuracy of the list prepared by the client.

Stratified sampling could be used for selecting customer balances for circularizing the confirmation.

If the chain stores are selected, 51 % ( or 49% in absolute terms) of the population can be covered without excessive time and cost being involved.
Therefore, all the three chain stores could be selected for confirmation.

Debtors from superstores and restaurants should be chosen on the basis of any appropriate sample selection method adopted by the team.

Since balances of chain stores and super stores consist of large balances, positive confirmation should be circulated.

Since the population of restaurant comprises of large number of small account balances, the risk of material misstatement has been assessed as
low and control have been tested, negative confirmation can be used if the following two conditions are also met:

• A very low exception rate is expected; and

• The auditor is not aware of circumstances which would cause the respondent to ignore the request for confirmation.

• Credit account balances should also be separately selected for circulating the confirmation.

5. (a) You are the audit manager in a firm of chartered accountants. During the audit of a client for the year ended 31 December 2018, the audit
team has prepared the following schedule to summarize the responses from the debtors:

Balance
Debtor
confirmed
S. No. Debtor(s) account Management Explanation
by the
balance
debtor

(i) AB 500,000 500,000 No explanation.

Consignment of Rs. 100,000 was shipped on 31 December
(ii) CD 800,000 700,000 2018 and received by customer on 01 January 2019.
Consignment of Rs. 600,000 was shipped on 27 December
2018 but goods amounting to Rs. 350,000 were returned
(iii) KL 600,000 250,000 due to quality issues, subsequent to year end.
No reply
(iv) YZ 400,000 received No explanation.

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Required:

Describe the steps (if any) which the audit team may perform in respect of each of the above debtors. (05)

A: (a) (i) No further audit work is required.

(ii) This is a timing difference. We need to obtain goods delivery note and customer acknowledgement to ascertain the date of delivery and
date of acceptance of goods.

(iii) This is an adjusting event. We should perform the following steps:

• Check the return of goods with the relevant goods receipt document.

• Ask the client to reduce the sales and receivables and incorporate corresponding effects in cost of sales and inventory.

(iv) Follow-up procedures should be initiated. For example, second request and third request letters could be sent, or the client could be asked
to contact the customer for a reply. Subsequent receipt of the amount should be checked.

If no payment (or only part-payment) has been received, the outstanding sales invoices should be checked with:

• Purchase order issued by the customer.

• Delivery note duly acknowledged by the customer.

6. Briefly discuss the steps an auditor would need to take if management refuses to allow him to send confirmation request to a debtor. (05)

A: If management refuse to allow the auditor to send a confirmation request the auditor should:

• inquire about the reasons for refusal and seek audit evidence as to the validity and reasonableness;

• evaluate the implications of management's refusal on the auditor's assessment of the relevant risks of material misstatement, including the
risk of fraud, and on the nature, timing and extent of other audit procedures; and

• perform alternative audit procedures such as, subsequent receipts and inspection of documents, designed to obtain relevant and reliable
audit evidence.

If the auditor concludes that management's refusal to allow the auditor to send a confirmation request is unreasonable, or the auditor is unable to
obtain relevant and reliable audit evidence from alternative audit procedures, the auditor shall communicate with those charged with governance

Failure to obtain sufficient appropriate audit evidence indicates scope limitation and the auditor shall assess the implications of such limitation on
the auditor's opinion.

7. You are the audit manager in a firm of chartered accountants. Following is the extract of the email received from the job-in-charge
responsible for the audit of your client Concordia Limited (CL) for the year ending 31 March 2018:

"I am considering to circulate negative confirmations on 1 April 2018 for debtor balances outstanding as on 31 March 2018 as firstly, the
reporting deadlines at CL are very stringent, secondly, the population comprises of a large number of small balances and thirdly, risk of material
misstatement has been assessed as low.

I have also been offered by Cl's CFO that one of their staff would get all the confirmations signed from the debtors and deliver them to our
firm's office. This could help us in meeting the reporting deadline."

Required:

Comment on the suggestions of the job-in-charge. Assuming that the suggestion by job in charge is not considered appropriate, suggest an
alternative approach keeping in view the time limitations. (06)

A: We cannot choose to circulate negative confirmation merely on the fact that risk of material misstatement has been assessed as low and
majority of the balances comprise of large number of small balances. Before using the negative confirmation as the substantive procedures, we
also need to ascertain that:

• exception rate is expected to be low; and

• there is no apparent reason to suspect that the customers would disregard the confirmation request.

Furthermore, we cannot consider the offer of CFO because we should maintain control over external confirmation requests which include sending
the requests ourselves with an instruction for responses to be sent directly to us.

Ideally, confirmation of balances should take place after the reporting period, and should be based on customers' account balances as at the
reporting period. However, to reduce the time pressure at the final audit stage, the confirmation process can also be based on balances at an
interim date before the end of the financial year (normally no more than three months before the end of the reporting period). However, while

81
doing so, we should consider the fact that we will need to check the changes in the debtor balances between the confirmation date and the end of
the reporting period.

8. You are currently in the planning phase of the audit of Fresh Dairies Limited (FDL) for the year ended 31 December 2016. The information
available to you in respect of the company's debtors includes the following:

Percentage of customers
Balance outstanding
Customer Category No. of Customers who confirmed the balance
(Rs. In '000)
last year

Distributors 1 10,500 90%

Wholesalers 1 12,750 70%
Restaurants 1 20,400 83%
Individual Customers 30 9800 20%
73,450
FDL is a low risk client and therefore you are assessing whether to send negative confirmation requests.

Required:

In respect of each of the above categories of customers, discuss the appropriateness of sending negative confirmation requests. (09)

A; For sending negative confirmation, all of the following conditions are required to be met:

(i) The risk of material misstatement has been assessed as low and controls have been tested.

(ii) The population is comprised of large number of small account balances or transaction.

(iii) A very low exception rate is expected.

(iv) The auditor is not aware of circumstances which would cause the respondent to ignore his request for confirmation.

Based on the above, my comment on appropriateness of sending confirmation requests for each category of customers are as follows:

Customer category Comments

Distributors The condition of large number of small account balances is missing, therefore positive confirmation will be
sent.
Wholesalers All the conditions of sending negative confirmation exists, therefore ne􀀑ative confirmation can be used.
The condition of large number of small account balances is missing, therefore positive confirmation will be
Restaurants sent.
It is evident from past experience that confirmation request is usually ilinored, therefore positive
Individual Customers confirmation will be used.
9. Discuss the auditor's course of action if management refuses to allow auditor to send confirmation request (Impact on audit report is not
required) (05)

A; If management refuse to allow the auditor to send a confirmation request the auditor should:

• inquire as to management's reasons for the refusal, and seek audit evidence as to the validity and reasonableness of those reasons;

• evaluate the implications of management's refusal on the auditor's assessment of the relevant risks of material misstatement, including the
risk of fraud, and on the nature, timing and extent of other audit procedures; and

• perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

The auditor shall communicate with TCWG if:

• the auditor concludes that management's refusal to allow the auditor to send a confirmation request is unreasonable; or

• the auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures,

10. You are the Audit lncharge of Rehan Limited for the year ended 31 December 2015. While reviewing the working papers and discussion with
audit team, you have noted the following:

(i) The audit team did not send balance confirmation requests for amounts below Rs. 100,000 because according to the client, lots of efforts
were required to follow up the customers and the balances were also not material.

(ii) One of the conclusions drawn as per the working papers is "there are no unrecorded liabilities, as confirmations have been received from
all selected parties and no differences were noted. Hence, no further test is required."

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Required:

a) Discuss with reasons whether you agree with approach adopted/conclusion drawn by audit team. (03)

b) Provide brief guidance to the audit team in respect of each of the above situations. (05)

A; (a) (i) The approach of not sending confirmation requests to balances below Rs. 100,000 is not correct unless the total of such balances is clearly
immaterial.

(ii) The conclusion documented by the team is not correct as the confirmation received from creditors only confirms the recorded amount and is
not relevant for the purpose of testing of unrecorded liabilities.

(b) (i) The audit team is required to discuss the matter with client's management and ask them to send confirmation as per the normal sampling
procedure of the audit firm.

In case the management does not agree, the audit team should evaluate the implications of management's refusal on the auditor's assessment of
the relevant risks of material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit procedures;

(ii) Following information should be tested by the audit team to draw conclusion related to unrecorded liabilities:

• subsequent disbursements

• unmatched receiving reports (Inventory Cutoff)

11. State the conditions under which an auditor may send negative confirmations ( 4 marks)

A: A negative confirmation can be used, where any of the following condition is met:

• The risk of material misstatement has been assessed as low and controls have been tested.

• The population is comprised of large number of small account balances.

• A very low exception rate is expected.

• The auditor is not aware of the circumstances which would cause the respondent to ignore the request for confirmation.

12.The audit of Sehat Pharmaceuticals Limited (SPL) is in progress. Based on the previous experience with the client and the initial tests of
control, the auditor has assessed a low risk of material misstatement in the area of debtors.

Balance
Customer No. of amount Confirmation
outstanding Confirmations Nature
segment cutomers recovered Received
(Rs. In '000)

Distributors 12 75,200 8 70,500 Positive 7

Wholesalers 105 52,500 30 12,500 Positive 28
Hospitals &
Clinics 250 31,200 75 20,300 Negative 4
Retailers 130 12,500 50 7,000 1,784 12
Analysis of confirmations received is as follows:

• 3 out of 7 confirmations received from distributors did not agree with the amount outstanding in SPL's ledger.

• One of the distributors, Saleem Distributors (Private) Limited (SDPL) has gone into winding up. The balance receivable from SDPL is
outstanding since last one year.

• Replies received from the hospitals did not agree with the balance outstanding in SPL's records. However, the differences were reconciled
by the audit staff.

• All the 12 confirmations received from the retailers showed disagreement with the records of SPL. However, only 2 could be reconciled.

Required:

a) Evaluate the decision regarding sending of negative confirmations. (04)

b) Determine the course of action the auditor should consider in case of balances agreed, balances not agreed and replies not received. (05)

c) State the procedures that need to be performed in case of amount due from SDPL. (03)

A: (a)(i) Hospitals and clinics:

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The decision to send negative confirmation was appropriate as all the conditions for sending negative confirmation i.e. Large number of small
account balances, low risk of material misstatement, low exception rate as only four customers have disagreed with the balances due and that
have been also reconciled and there was no knowledge of circumstances that would cause recipient to disregard the confirmation request.

Results of confirmations depict high risk of material misstatement and high exception rate. However, since the decision to send negative
confirmation was taken on the basis of initial assessment, the decision under the circumstances seems correct.

(b)Balance agreed:

No further audit work is required.

Balance not agreed:

• The client should be asked to review the replies and reconcile the balances in its records with the balances confirmed by the customer.

• The reconciliation prepared by the client should be checked.

The reconciling items depicting errors in the client's records should be investigated and corrected.

The client should be asked to resolve the difference in case the reconciling items depicting errors on part of the customers.

No reply received:

In these cases, alternative procedures should be performed (e.g. subsequent payments and checking of invoices/ dispatch notes in order to obtain
evidence to confirm the customer's balances.

(c) From the winding up event it appears that the amount receivable from SDPL is irrecoverable. Therefore, the auditor needs to ensure that the
amount of irrecoverable receivables are written off or is duly provided for.

The following substantive procedures should also be performed:

• Review any correspondence of the SPL with the liquidator/management of SDPL (if any), relating to recovery of the amount due.

• Review the calculation of amount of provision/write off and basis thereof.

13. State the conditions under which it may be appropriate to send negative confirmations. (02)

A: Conditions required to be met for sending external confirmations:

It may be appropriate to send negative confirmation request if all of the following conditions are met:

• The risk of material misstatement is low and controls have been tested.

• The population comprises of large number of small account balances or transactions.

• A very low exception rate is expected.

• There is no specific reason which would cause the respondent to ignore the confirmation request.

14. You are currently in the planning phase of the audit of Mineral Water Limited (MWL) for the year ended 30 June 2012. The following
information is available to you:

Customer No. of Balance outstanding 10-20 21-30 31-90

10 days >90 days
segment cutomers (Rs. In '000) days days days

Super markets 12 20,014 8,125 5,053 6,396 311 129

Wholesalers 65 14,910 5078 6,019 3,150 454 209
Retailers 553 4,743 4743 1,798 724 278 187
Five Star
Hotels 7 7,694 2805 2,793 1,784 201 111
47,361 17764 15,663 12,054 1,244 636
50% provision for doubtful debts has been made by MWL against balances outstanding for more than 30 days whereas the balances outstanding
for more than 90 days have been fully provided.

A; (a) Selection of Accounts Receivable for circulation at year-end

(i) The debtors listing will be stratified in accordance with the different market segments (Super markets, whole sellers, retailers and five star
hotels)

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(ii) For positive circulation the selection may be as follows:

• All twelve super markets, as well as the seven five star hotels will be purposely selected (56% of the total debtors balance will be covered in
this manner).

• Whole sellers and retailers will be stratified further according to value and days outstanding. A sample will be made from the above-
mentioned sub-populations, with greater focus on the high value and long-outstanding populations.

• Debtors with nil and credit balances, as well as overdue debtors should also be selected.

(iii) A negative circulation of non-selected debtors may be considered on sample basis.

(b) Situation where a debtor confirms a balance which is different from the amount appearing in the confirmation request:

A response that indicates a difference between information requested to be confirmed and information provided by the confirming party is termed
as exception. The exception may be on account of:

(i) Timing difference

(ii) Misstatement

• In case of timing differences, the auditor will need to reconcile the amount confirmed by the confirming party and the amount sent for
confirmation.

• If the amount cannot be reconciled, the auditor is required to evaluate whether it is indicative of a fraud or deficiency or deficiencies in the
entity's internal control over financial reporting.

• In either case, the auditor will consider whether he needs to revise his risk assessment and audit procedures.

15. You are the Manager on the audit of Ghazi Power Limited (GPL), a gas transmission and distribution company, for the year ending 31
October 2011. On the company's request, your firm has agreed to complete the audit by 20 November 2011.

In order to meet the audit deadline, you are considering various measures which include sending requests for negative confirmations related to
balances due on 31 August 2011. On 31 August 2011, total debtors aggregated Rs. 45 Million. 50% of the amount is due from 15 major debtors,
whereas the total number of debtors is 2,450. Moreover, GPL's management is not allowing you to send a request for confirmation of balance
to SSO Ltd, which is among one of the 15 major debtors, because of certain ongoing legal disputes. Your previous experience with the client and
the results of initial risk assessment procedures suggest that the risk of material misstatement is low.

Required:

a) Discuss whether it would be appropriate to use the negative confirmations procedure in the above situation. (06)

b) What audit procedures should be performed at the year end, if requests for confirmation of balances are sent on 31 August 2011? (07)

c) List the procedures that should be adopted due to management's refusal to send a request for confirmation of balance to SSO Ltd. (06)

A: (a) Certain conditions are required to be met before an auditor can decide to use negative confirmation as a sole substantive procedure, these
conditions include:

(i) Auditor has assessed risk of material misstatement as low and has obtained sufficient appropriate audit evidence regarding operating
effectiveness of controls relevant to assertions;

(ii) The population of items subject to negative confirmation procedure comprises a large number of small, homogeneous account balances,
transactions or conditions;

(iii) A very low exception rate is expected; and

(iv) The auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such
requests.

In the given situation, condition # (i) and (ii), are met; the fact that risk of material misstatement is low suggests that condition # (iii) is also being
met Therefore it would be appropriate to use negative confirmation provided that the fourth condition is met

For 15 major debtors, it would be appropriate to use positive confirmation as their population consists of small number of large balances.

(b) Audit Procedures:

(i) Prepare or obtain a client roll forward schedule from 31 August 2011, to 31 October 2011.

(ii) Agree Individual entries for 31 October 2011, with the sales ledger and debtors control accounts.

(iii) Note and obtain explanation for any unusual journal adjustments.

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(iv) Vouch material sales or receipts with supporting documents.

(v) Select a sample of receipts and sales and perform tests of controls to ensure that system of internal controls continued to operate effectively.

( vi) Re-perform cutoff test at year end.

(vii) Perform analytical procedures by comparing the balances of debtors on 31 August 2011, to Debtors on 31 October 2011, and ascertain
reasons for major variances, if any.

(viii) Check subsequent recovery of year end balances.

( c) If Management refuses to allow the auditor to send a confirmation request, the auditor shall:

(i) Inquire as to management's reason for the refusal, and seek audit evidence as to their validity and reasonableness;

(ii) Evaluate the implications of management's refusal on the auditor's assessment of the relevant risks of material misstatement, including the
risk of fraud

(iii) , and on the nature, timing and extent of other audit procedures; and

(iv) Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

(v) If the auditor concludes that

• Management's refusal to allow the auditor to send a confirmation request is unreasonable; or

• the auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures the auditor shall communicate with
TCWG and auditor shall also determine implications of results of procedures carried out above on the audit and the auditor's opinion.

16.Direct confirmations of balances due from customers are obtained to satisfy the objective of ensuring that the customer exists and owes the
specified amount to the company at a certain date.

Required:

a) State the circumstances in which an auditor may decide not to circulate the requests for direct confirmation. (05 )

b) What are the factors that an auditor considers while designing the requests for direct confirmation? (05 )

c) Describe the alternative audit procedures which may be conducted if the customer does not reply to a request for confirmation. (06 )

A: (a) The auditor may consider not to circulate the direct confirmation to the customers where:

(i) accounts receivables are immaterial to the F /S; or

(ii) the response rate is not expected to be adequate; or

(iii) the responses are not expected to be reliable; or

(iv) inherent and control risk in aggregate are assessed at low level.

(v) audit evidence expected to be gathered through other substantive procedures (e.g. analytical procedures) is sufficient to reduce the audit risk
to an acceptable level.

(vi) management requests not to send the confirmation and auditor after satisfying himself from the reason and explanation given by the
management

(b) While designing the confirmation request, the auditor considers the following factors:

(i) Assertions being addressed through the direct confirmation.

(ii) Form of the external confirmation requests (i.e. positive or negative or combination of both)

(iii) Prior experience on the audit of similar engagements.

(iv) The nature of the information being confirmed.

(v) The intended respondent.

(vi) Type of information respondents will be able to confirm readily.

( c) The auditor may perform one or more of the following steps:

(i) Check receipt from customers after balance sheet date.

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(ii) When there is no receipt from customers after balance sheet date, the auditor should consider the following audit procedures:

• Verify validity of purchase orders, if any.

• Verify goods dispatched note other documents duly acknowledged by the customers.

(iii) Obtain explanations for invoices remaining unpaid, if any, after subsequent one have been paid

(iv) Examine sales near the period end to provide audit evidence about cutoff assertion.

17. You are the senior member of the audit engagement team, auditing the financial statements of a manufacturing company, Hard Stone
Limited. List down the primary substantive procedures, which you would carry out in the verification of:

(a) trade debts (excluding receipts from customers). (06)

A: a) Substantive procedures for verification of trade debts ( excluding receipt from customers)

• Investigate any unexpected or unusual movement/differences between current and prior period as regards the amounts of trade debts,
debtor's turnover, ageing of receivable and ratio of debtors to credit sale etc.

• Review of period end reconciliation of subsidiary and general ledger and investigate large and unusual items.

• Reviewing the period-end bank reconciliation statements with specific reference to the list of cheques deposited but not credited in the bank.

Review the following:

Large or unusual postings in the general ledger.

Large or unusual balances in subsidiary records including, credit balances, past due balances and balances exceeding credit limits etc.

• Circularization of confirmations and performance of appropriate follow-up of selected customer balances at period end and obtaining and
testing reconciliation of balances confirmed with book balance.

• Review the ageing schedule and ensure reasonableness of provision based on:

Discussion with the credit manager. Examination of the subsequent collections made. Past practice and consistency.

Cash & Bank

1. You are a part of the team on the audit of Fresh Meat (Private) Limited which sells fresh meat products through 25 retail outlets. Each outlet
holds cash at the year end. Sales are made on cash as well as against credit cards. All the accounting records are maintained at the outlets and
balances with the Head Office are reconciled on a monthly basis. Required: List the audit assertions relevant to the audit of cash in hand and
state how you would obtain audit evidence to support those assertions. (06 marks )

A; (a) Audit Assertions

The key audit objectives in the audit of cash are to verify the assertions of:

(i) Existence

(ii) Completeness

(iii) Rights and obligations

(iv) Presentation and disclosure

(b) Audit Procedures

(i) Existence

• Carry out cash count and reconcile it with the accounting records.

• Any unusual items such as IOU should be investigated thoroughly.

(ii) Completeness

• Perform cutoff procedures to ensure that there is no unrecorded cash or cash in transit is not missed.

• Check the reconciliation between Cash as per Head Office records with the Cash at the outlets.

(iii) Rights and obligations

• Ensuring that Company owns the cash in hand and none of the cash is held on behalf of any third party.

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(iv) Presentation and Disclosure

Ensure that cash and balances have been disclosed, classified and described in accordance with AFRF

2. You are the Audit Senior on the audit of Al-Haq Limited. The company is a trading concern and 70% of its business relates to imported goods.
The chief accountant has provided you the bank reconciliation statements of all the bank accounts along with the bank statements.

Required:

(i) State the substantive procedures that you would carry out for the verification of bank balances. (06 marks)

(ii) Identify any eight types of information which you would verify from the confirmations received directly from the bank. (08 marks)

A: (i) Substantive procedures for bank balance verification

(Following procedures apply individually to all bank accounts)

• Obtain bank confirmation from the company's bank and agree the balances per the bank confirmation to the company's bank reconciliations.

• Check arithmetic accuracy of bank reconciliation.

• Perform cut-off procedures.

• Agree the balance per the bank books to the bank reconciliation and to the F /S and the ledger.

• Trace outstanding cheques per the bank reconciliation to the cash book and to after-date bank statements.

• Agree any un-cleared banking have been paid in prior to the year-end date by examination of paying-in slips.

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Chapter# 10 (Substantive procedures – Others Areas)
1.You have received a copy of the year-end bank reconciliation statement, from your audit client Harison Limited (HL). Details of which are
reproduced below:

Rupees
Balance as per bank statement as at 31 December 2021 10,500,000
Add:
(i] Incorrect interest charged by the bank (Note-I) 240,000
(ii) Charges reversed by bank on 10 January 2022 (Note-Il) 100,000
Less:
(iii) Cash directly deposited in bank by the customer to avail 5% discount (220,000)
Jiv) Cheques issued to customers not yet presented (800,000)
y) Chegues signed but not yet handed over to suppliers (250,000)
Balance as per ledger 9,570,000
Notes to bank reconciliation statement:

(I) Interest on bank overdraft amounting to Rs. 750,000 was recorded in the bank statement. However, review of the Accounts Officer
indicated an error and HL recorded the correct amount of Rs. 510,000 in the bank ledger.

(II) This represents Letter of Credit charges which were charged twice by the bank for import of raw material in December 2021.

Required:

(a) State the audit procedures that should be performed on the above bank reconciliation statement. (06)

(b) Briefly discuss whether the client's year-end bank reconciliation provides evidence about receipts and payments cut-off. (02)

A: (a) • Verify the balance from bank statement/confirmation letter.

• Trace the ledger balance to the trial balance.

• Obtain and verify the interest working prepared by the management.

• Check whether the amount was also subsequently adjusted by the bank.

• Check from the bank statement that the excess charges have been reversed.

• Cash directly deposited in the bank is not a reconciling item. Ask the client to record cash receipt in cash book.

• Ask the client to adjust the receivable balances and also record discount expense.

• Verify subsequent clearance of these cheques.

• Ask the client to reverse the payment relating to suppliers.

(b) Yes, we can check to see when money was received and paid around the year end and compare it to when the receipts and payments
occurred.

2. While reviewing the list of 'trade and other payables' at BAC Limited, you have noticed that one of the trade creditors is not in the list. State
any two audit procedures to be performed in relation to the completeness assertions for trade payables. (02)

A; • Review the list to identify major suppliers i.e. regular suppliers of frequently purchased items who are not in the listing of trade payables.

• Compare the list of trade payables with the listing of the previous year's audit. Look for explanations as to why any major supplier is not
appearing on the current year's listing.

• Apply other analytical procedures and obtain explanations for any significant differences identified while carrying out the above tests.

3. State five key substantive audit procedures for verification of Provisions (5 marks)

A: Key substantive procedures for verification of provisions include the following:

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(i) Ensure that all provisions have been recognized in accordance with the IAS 37.

(ii) Review the measurement of the closing balance for each provision and discuss these with management if appropriate. Consider whether it
might be appropriate to take expert advice on the existence or measurement of a provision.

(iii) Review the board approval related to provisions booked in the F /S.

(iv) Review the list of provisions for possible omissions, based on the auditor's knowledge of the business and the industry in which it operates.

(v) Relate the testing of provisions to other areas of the audit work, such as correspondence with lawyers/minutes of Board of director's meeting
(which might reveal more information about matters to which the provisions relate).

(vi) Compare provisions for the current financial year with provisions in previous years, and investigate any major differences or omissions.

( vii) Review the subsequent events to ensure completeness of provisions

4. State four substantive procedures for verification of share premium account appearing in the statement of financial position ( 2 marks)

A; Audit procedures for verification of share premium account:

• Obtain an analysis of movements in share premium account during the period.

• Check the accuracy of these movements by checking supporting documentation.

• Ensure that any specific legal requirements relating to share premium have been complied with. (For example, check that the entity has not
breached legal restrictions on use of the share premium account.)

• Check authorization in respect of all movements during the year.

5. List any five substantive procedures for the verification of each of the following:

(i) Accrued expenses

(ii) Contingencies (10)

A: The audit approach to gathering evidence on contingencies and commitments is as follows:

Accrued expenses:

• Obtain or prepare a listing of accrued expenses as at the end of the reporting period. Check the calculations and additions for arithmetical
accuracy.

• Check the amounts in the listing against the balances in the relevant main ledger expense accounts and ensure that the amounts are the
same.

• Verify the invoices received or payments made after the year end and ensure that the amount accrued appears reasonable in relation to this
evidence.

• Compare the list of accrued expenses with the list that was prepared at the same date in the previous financial year, and enquire about items
not listed in the current year that were in the list in the previous year.

• Review the list of accruals for completeness, based on the auditor's knowledge of the business.

• Relate items on the list of accruals to other audit areas, such as the bank confirmation letter ( which might provide details ofunpaid/accrued
bank charges).

• Perform analytical procedures on accrued expenses. For example, the auditor might measure the ratio of accrued payroll expenses to total
payroll costs for the year, and compare this with the similar ratio in previous years. Significant differences should be investigated.

Contingencies:

• Ascertain the approach taken by the client's management for identifying contingencies.

• Review the minutes of board meetings (where such matters are likely to be discussed).

• Review relevant material related to the industry as a whole such as F /S of major companies in the industry to identify possible industrywide
contingencies.

• Review the client's correspondence with lawyers.

• Review the invoices for legal services to identify undisclosed contingencies and additional information about contingencies

• Consider direct confirmation from the company's lawyers and legal advisors.

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• Consider whether expert advice may be required from outside sources other than lawyers.

• Ensure that provisions has been made in case relevant condition as specified in IFRS are met.

6. List the substantive procedures which may be performed by the auditor to verify the Long Term Bank Loan. (07)

A: Substantive Procedures for verification of Long Term Bank Loan:

• Check approval of board of directors.

• Study loan agreement and make relevant extracts.

• Check calculation of interest paid/ accrued.

• Obtain bank confirmation and confirm the particulars of security deposited with the bank as security for the loans or charge created on an
asset or assets of the client.

• Ensure that the particulars mentioned in the bank confirmation are same as mentioned in the loan agreement

• If the loan is secured against mortgage or charge, check the mortgage deed or any other related document.

• If there is any default in the payment of installments, check the related implications of the default and ensure they are properly reflected in
the F /S.

• Prepare a movement schedule during the year and match the opening and closing balances, and also confirm that loan balance is
appropriately reduced by the amount paid during the year.

• Ensure proper disclosure is made in the F /S.

7. List the substantive procedures that may be performed by an auditor to verify the following:

a) Bank reconciliation statements (06 marks)

b) Payroll (08 marks)

c) Raw material purchases (06 marks)

A: ( a) Substantive Procedures for verification of Bank reconciliation statements:

• Trace and agree balances per books of accounts (ledger or bank book) as appearing in the bank reconciliation statement with the general
ledger/ bank book.

• Trace and agree balances per bank statement as appearing in the bank reconciliation statement with the bank statements

• Trace reconciling items appearing in the previous months bank reconciliation into current month's ledger/ bank statement/ bank
reconciliation statement

• Check subsequent clearance of current months reconciling items.

• Review and discuss long outstanding items appearing in the bank reconciliation statement.

• Ensure that all outstanding items requiring adjustments are properly accounted for in the books of accounts.

• Check arithmetical accuracy of reconciliation statements.

(b) Substantive Procedures for Payroll:

From the payroll record:

Select a sample of newly appointed staff and check their salaries with the appointment letter.

Select a sample of other staff (appointed in previous years) and check their salaries with the increment letter.

In both the above cases check that allowances and deductions are in accordance with the company's policies or the relevant legal requirements.

Select a sample of payroll summaries and:

Check that payroll summary has been approved by an appropriate authority. Trace totals of payroll summaries to appropriate general ledger
accounts. Check allocation of payroll to cost of sales and operating expenses. Compare net payroll after deductions with transfer letter issued to
the bank.

o Carryout analytical review by comparing the monthly and annual payroll and inquire reasons for significant fluctuations.

o Ensure that payroll costs have been properly disclosed in the F /S.

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(c) Substantive Procedures for Raw material purchases:

Select a sample of transactions and carryout the following tests.

Check weather appropriate measures have been taken as per the company's policy to ensure that purchases are made from most competitive
sources.

Check the relevant invoices.

Match invoices with goods receiving notes to ensure that goods have been received for all billings made by supplier.

Match supplier's invoices with purchase orders to ensure that:

Purchases were duly authorized.

Rates and quantities mentioned on the invoice are same as those mentioned on the purchase order.

• Check posting of supplier's invoices to creditor's accounts/ general ledger.

• Perform cut-off procedures on purchases.

• Perform analytical procedures on purchases made during the year by comparing current year purchases with the last year and investigate
significant differences, if any.

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Chapter# 11 (Related party transactions)
1. During the audit of Tether Limited (TL), the audit senior noticed that in one of the floors of the office building, a business other than that of TL
was being run. On inquiry with TL’s management, it was identified that the floor was given to the daughter of a director for six months for
running her online business. No rent is being charged as it has been a vacant floor and carries no marginal cost to TL.

Required:

Evaluate the above arrangement and discuss the procedures which should be performed by the audit senior. (09)

A: Evaluation:

Transaction with the daughter transaction not conducted at arm’s length. Even though the any amount from the daughter of the Director, being a
related party needs to be disclosed in the financial statements. Not disclosing the related party transaction would be a non-compliance of IAS-24
and the Fourth Schedule of Companies Act 2017 and will be a material misstatement. Furthermore, it was a transaction which was not disclosed to
the audit team.

Procedures to be performed by the audit senior:

(i) Communicate the relevant information to the audit team.

(ii) Discuss with management the terms of the arrangement, and whether is there any contract or agreement in place.

(iii) Request management to identify all transaction related to the new arrangement.

(iv) Request management to identify the fair value of the new arrangement.

(v) Reconsider the risk of other unidentified or undisclosed related parties or related party transactions.

(vi) Inquire from the management that whether this arrangement has been authorized.

(vii) Inquire as to why the client’s system failed to identify or disclose this related party relationship and transaction.

(viii) If the management does not disclose the arrangement in the financial statements, then discuss the non-disclosure with those charged with
governance.

(ix) Consider the risk of fraud and management integrity if the non-disclosure appears intentional and evaluate the implications for the audit.

(x) Obtain management representation that all related parties and the transactions with them have been disclosed to the audit team.

2. During the audit of Cedar Limited (CL), your audit team observed that CL has sold one of its freehold lands to Maple (Private) Limited (MPL) at
a loss of Rs. 10 million. Your team’s further investigation of the matter and reading of the minutes of the board of directors’ meeting revealed
that:

(i) a director of CL holds 20% shareholdings in MPL which makes this entity as CL’s related party; and

(ii) MPL would pay 30% of the consideration in cash and the remaining amount over a period of five years.

Required: Evaluate the above related party transaction and suggest any eight key audit procedures that your team should perform in this
respect. (10)

A: Since the related party transaction was not disclosed to the audit team by the client, it creates a risk of not disclosing all related party(ies) and
related party transaction(s). Further, the way the transaction is structured (i.e. sold on loss and 70% payment over a period of five years), it seems
that it is not in the ordinary course of business.

Key audit procedures to be performed:

(i) Inquire with management the reasons for disposal of freehold land.

(ii) Promptly communicate the relevant information of the related party transaction to other members of the audit team.

(iii) Request management to identify all transactions with MPL for further evaluation.

(iv) Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified
or disclosed to the auditor, and perform additional audit procedures.

(v) Inquire as to why the CL’s system failed to identify or disclose this related party relationship and transaction.

(vi) Obtain representation from the management that all related parties have been identified and disclosed to the auditor.

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(vii) Inquire about the influence of director with respect to the said transactions.

(viii) If the non-disclosure by management appears intentional (and therefore indicative of risk of material misstatement due to fraud), evaluate the
implications for the audit.

3. You are the manager responsible for the audit of Zebra Limited (ZL). ZL normally has significant sale and purchase transactions with its related
parties.

Guide your audit team regarding the audit procedures and related activities that should be performed for obtaining information relevant to
identifying the risks of material misstatements associated with related party relationships and transactions. (08)

A: I would suggest the following activities/procedures to my team, in respect of identification of risks of material misstatement related parties:

• The audit team’s discussion on risk shall include specific consideration of susceptibility of financial statements to material misstatement due to
fraud or error through related parties and their transactions.

• The audit team should inquire of management regarding:

- the identity of related parties including changes from prior period;

- the nature of the relationships between the entity and its related parties; and

- whether any transactions occurred between these related parties during the period and, if so, the type and purpose of the transactions.

- what controls the entity has to identify, account for and disclose relating to related party relationships and transactions.

• The audit team should obtain an understanding of the controls, if any, that management has established to:

identify, account for, and disclose related party relationships and transactions; authorize and approve significant transactions and arrangements
with related parties;

authorize and approve significant transactions and arrangements outside the normal course of business.

The audit team should maintain alertness for evidence of related party information when obtaining other audit evidence, in particular, when
scrutinizing bank and legal confirmations and minutes of meetings.

• If significant transactions outside the normal course of business are discovered, the audit team should inquire management the nature of the
transactions and whether related parties could be involved.

• The audit team should share relevant information obtained about the entity’s related parties with other members of the engagement team.

4. Imran is the audit senior responsible for the audit of Pasni Garments Limited (PGL). During the audit he noticed that PGL made significant
transactions with related parties.

Required:

(a) State the audit procedures which should be performed to check whether all related parties have been disclosed. (05)

(b) What steps should Imran perform if he identifies any related party transactions which were not identified and disclosed by the
management?

(Impact on the audit report is not required) (06)

A: (a) Imran should perform the following audit procedures to ensure the completeness of identification of related parties.

• Review working papers for previous years, to look for names of known related parties.

• Assess the adequacy of the company’s procedures for identifying related parties.

• Review minutes of shareholder meetings and board of directors meeting.

• Review shareholder records for the names of major shareholders.

• Review the regulatory returns and the information supplied by the entity to the regulatory authorities.

• Inspect non-routine and unusual transactions.

• Inspect significant contracts and agreements not in the ordinary course of business.

• Review significant contracts renegotiated by the entity during the period.

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• Identify all employee benefit plans and the names of officers and trustees.

• Review internal audit reports.

(b) If he discovers previously unidentified or undisclosed related parties or (significant) related party transactions he must:

(i) promptly communicate the relevant information of the related party transaction to other members of the audit team.

(ii) perform appropriate substantive procedures on the newly identified related parties or significant related party transactions.

(iii) request management to identify all transactions with the newly identified related parties.

(iv) inquire as to why the entity’s internal control system failed to identify or disclose these related party relationships or transactions.

(v) Reassess the risk of there being unidentified or undisclosed related parties or (significant) related party transactions and respond to the
reassessed risk.

(vi) If the non-disclosure by management appears intentional (and therefore indicative of risk of material misstatement due to fraud), evaluate the
implications for the audit.

5. Briefly describe any three risks of material misstatement in case of significant related party transactions. (03)

A: • Accounting systems may not be effective at identifying and summarizing related party transactions and balances.

• Related party transactions may not be conducted on normal market terms.

• Related parties may operate through complex structures and therefore may be used to commit fraud.

6. On the audit of Babar Limited (BL) you have noted a transaction whereby a loan payable to the holding company which was overdue for six
months was settled by transfer of securities owned by BL.

Required:

Evaluate the above scenario and specify the audit procedures which need to be performed. (06)

A: Repayment of loan to the holding company in the form of transfer of securities indicates a significant and unusual related party transaction,
which is outside the entity’s normal course of business. In this regard following audit procedures may be performed:

• Inspect the underlying contracts or agreements to evaluate whether:

- the terms of the contracts etc. are consistent with management’s explanations. the transactions have been properly accounted for and disclosed.

- the contracts and agreements were entered to engage in fraudulent financial reporting or to hide the misappropriation of assets (a lack of
business rationale might indicate this).

• Obtain evidence that the transactions were properly authorised.

• If management has made a statement in the notes to the financial statements that a related party transaction was made on the same terms as an
arm’s length transaction, the auditor must obtain evidence to support this statement.

7. (a) Specify the procedures that an auditor should perform to ensure completeness of the list of related parties provided by the directors. (06)

(b) As part of audit procedure you have requested the management of Energy Limited to provide specific representation relating to
completeness of related parties and related party transactions.

The management is of the view that since the auditor has carried out a detailed review in which no undisclosed transactions were identified, a
written representation is not necessary.

Required: Evaluate the above situation, comment on the management’s stance and suggest the appropriate course of action available to the
auditor. (06)

A: (a) In order to ensure the completeness of list of related parties provided by the client, your audit procedures could include the following:

• Review working papers for previous years, to look for names of known related parties.

• Review the company’s procedures for identifying related parties.

• Inquire about the relationships between directors and other entities i.e. whether any director is a director, CEO, major shareholder etc. in
another company.

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• Review shareholder records for the names of major shareholders.

• Review minutes of BOD meetings and general meetings of the company.

• Get confirmation from any other audit firms involved in the audit about related parties. (e.g. in case of audit of a group of companies, more than
one firm of auditors are involved)

(b) According to the International Standard on Auditing (ISAs) the auditor is required to obtain written representations from management and,
where appropriate, TCWG that:

• they have disclosed to the auditor the identity of the entity's related parties and all the related party relationships and transactions of which they
are aware; and

• they have appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements of the framework.

In view of the above, the auditor should not accept the argument given by the management. If management does not provide one or more of
requested written representations, the auditor shall:

• discuss the matter with management/ TCWG;

• re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of representations (oral or written) and
audit evidence in general; and

• take appropriate actions, including determining the possible effect on the opinion in the auditor's report.

8. A schedule of related party transactions provided by the client includes two significant transactions which are outside the normal course of
business. State the substantive procedures that an auditor should undertake, in respect of these transactions. (4 marks)

A: If the auditor discovers significant related party transactions outside the entity's normal course of business he must:

• Inspect the underlying contracts or agreements to evaluate whether:

the contracts etc. were entered into in order to engage in fraudulent financial reporting or to hide the misappropriation of assets (a lack of business
rationale might indicate this) the terms of the contracts etc. are consistent with management’s explanations, and

the transactions have been properly accounted for and disclosed.

9. You are the audit manager on the audit of a listed company, Kamil Limited (KL). Prior to completion of audit, you came across a prospectus
issued by Neelum Limited (NL) according to which a director of KL is the chief executive of NL. However, the name of NL was not included in the
list of related parties provided by KL. On being confronted the management has advised that the name was omitted advertently as the
appointment took place just two months prior to the year end.

Required:

Discuss your course of action in the above situation. (07)

A: In the scenario, a previously undisclosed related party has been identified. I shall:

• communicate the relevant information to the audit team.

• assess as to why the entity’s system failed to identify or disclose the related party relationship.

• request management to identify all transactions with NL and disclose them accordingly.

• perform appropriate substantive procedures on the newly identified related parties or significant related party transactions.

• assess the reasonableness of the management’s explanation and;

• evaluate the implications on the audit, if the non-disclosure appears intentional.

10 Give any three audit procedures to ensure completeness of list of related parties provided by the management. (02)

A: Audit procedures to ensure completeness of related parties

The procedures to ensure completeness of related parties will generally include:

• review of prior year working papers

• review of company’s procedures for identification of related parties

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• review shareholder’s records

11 While reviewing the audit working papers of Apple Limited (AL), the following matters have come to your attention:

(i) The audit team was able to ascertain that AL has entered into a number of transactions near the year-end with a new distributor Fruits
Limited (FL), which is a related party. On being confronted, the management has informed that since there were no transactions with FL in the
past, its inclusion in the schedule of related party transactions was inadvertently omitted. (05)

(ii) The details of related party transactions provided by the management includes a payment of Rs. 300 million to Mango Limited. The job
incharge is of the view that this transaction is not in normal course of business of the company. (04)

Required:

Analyse each of the above situations and briefly describe your course of action.

A: (i) Since related party relationship/ transactions have been identified which were not previously identified or disclosed to the auditor, the
auditor shall:

• Promptly communicate the relevant information to the other members of the engagement team;

• Where the AFRF establishes related party requirements:

Request management to identify all transactions with FL for the auditor’s further evaluation; and

Perform appropriate substantive audit procedures relating to significant related party transactions with FL;

Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified or
disclosed to the auditor, and perform additional audit procedures as necessary; and

If the non-disclosure by management appears intentional (and therefore indicative of a risk of material misstatement due to fraud), evaluate the
implications for the audit.

(ii) For identified significant related party transactions outside the entity’s normal course of business, the auditor shall:

• Inspect the underlying contracts or agreements, if any, and evaluate whether:

The business rationale (or lack thereof) of the transactions suggests that they may have been entered into to engage in fraudulent financial
reporting or to conceal misappropriation of assets;

The terms of the transactions are consistent with management’s explanations; and

The transactions have been appropriately accounted for and disclosed in accordance with the AFRF; and

• Obtain audit evidence that the transactions have been appropriately authorized and approved.

12. Strong Vehicles Limited (SVL) manufactures heavy vehicles. As the job incharge on SVL’s audit , you have come across the following
situations:

The management had provided you with a representation that they had disclosed all the related party transactions and relationships of which
they were aware. However, before finalization of the audit, you found that subsequent to the year-end, a payment of Rs. 100 million has been
made to Strong Engines Plc (SEP), a company incorporated in a foreign country. On your query, the management has advised you that SEP is a
foreign subsidiary of SVL and its name was not disclosed inadvertently because it had been non- operational for the last many years. (05)

A: • Non disclosure of the name of a subsidiary raises concerns relating to competence, integrity, ethics and diligence of management..

• We shall determine the possible effects of such concerns on the reliability ofother representations provided to us and audit evidence in general.

We shall perform the following procedures:

1. Promptly communicate the other members of the engagement team that Strong Engine Plc of Strong Vehicles Ltd., which was not identified by
the management.

2. As IFRS requires certain disclosures and treatment of related party and transactions, we would:

(i) Request management to identify all transactions with the SEP for our further evaluation; and

(ii) Inquire as to why the entity’s controls over related party relationships and transactions failed to enable the identification or disclosure of SEP
and transactions;

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3. Perform appropriate substantive audit procedures relating to SEP and significant related party transactions;

4. Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified or
disclosed to the auditor, and perform additional audit procedures as necessary; and

5. If the non-disclosure by management appears intentional (and therefore indicative of a risk of material misstatement due to fraud), evaluate the
implications for the audit.

13. As the auditor of a listed company with a number of related parties, what steps would you consider as part of your audit planning to ensure
that all related party relationships and transactions are identified and disclosed in the financial statements. (13 marks)

A: The steps that I as an auditor would consider as part of the audit planning to ensure that all related party relationships and transactions are
identified and disclosed in the F/S are as follows:

(a) Obtaining an understanding of the controls, if any, that management has established to identify, account for, and disclose related party
relationships and transactions in accordance with the AFRF.

(b) Inquiring of the management regarding:

(i) The identity of the entity’s related parties, including changes from the prior period;

(ii) The nature of relationships between the entity and these related parties; and

(iii) Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the
transactions.

(c) Inspecting the following documents for indications of the existence of related party relationships or transactions that management has not
previously identified or disclosed:

(d) Reviewing the extent and nature of business transacted with major customers, suppliers, borrowers and lenders for indications of previously
undisclosed relationships.

(e) Reviewing the significant transactions outside the normal course of business, paying particular attention to the transaction recognized at or
near end of the reporting period and inquire of management:

• The nature of these transactions

• Whether related parties are involved in these transactions

(f) Once related parties have been identified, the client should provide the details of transactions with such parties. I as auditor would ensure that
these transactions are disclosed appropriately in the F/S as per AFRF.

14. Al-Shams Limited is an unquoted public company. A large part of its business is carried out with persons / organisations who are related to
the management or the shareholders.

Required:

a) State any eight procedures which an auditor may perform for determining the existence of related parties or related party transactions. (08
marks)

A: (a)

(i) Evaluate the company’s procedures for identifying and for properly accounting for related- party transactions.

(ii) Inquire of management regarding:

• the identity of the entity’s related parties, including changes from prior period;

• the nature of relationship between the entity and these related parties; and

• whether entity entered into any transaction with these related parties during the period and, if so, the type and purpose of the transactions.

(iii) Inspect information supplied by the entity to regulatory authorities (e.g. SECP, FBR, SBP, etc.)

(iv) Identify all employee benefit plans and the names of the officers and trustees thereof.

(v) Review shareholder registers to identity the entity’s principal shareholders.

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(vi) Review material investment transactions during the audit period to determine whether the nature and extent of investments during the period
create related parties.

(vii) Review contracts and agreements with key management or TCWG.

(viii) Review significant contracts re-negotiated by the entity during the period.

(ix) Review significant contracts and agreements not in the entity’s ordinary course of business.

(x) Review of internal auditor’s report

(xi) Review of third party confirmations obtained by the auditor

(xii) Minutes of meetings of shareholders and of TCWG.

15. Describe the procedures that the auditor may perform, in order to ensure the completeness of the information provided by the
management, about related parties. (06)

A(i) Review prior year working papers for names of known related parties;

(ii)Review the entity’s procedures for identification of related parties;

(iii) Inquire as to the affiliation of TCWG and officers with other entities;

(iv) Review shareholder records to determine the names of principal shareholders or, if appropriate, obtain a listing of principal share-holders from
the share register;

(v) Review minutes of the meetings of shareholders and TCWG and other relevant statutory records such as the register of directors’ interests;

(vi) Inquire of other auditors currently involved in the audit, or predecessor auditors, as to their knowledge of additional related parties; and

(vii) Review the entity’s income tax returns and other information supplied to regulatory agencies.

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Chapter #12 (Reliance on others)
1. How would an auditor assess the competency and capabilities of an auditor’s expert? (03)

A: We will assess the competence, of the expert in one or more of the following ways:

(i) Personal experience with previous work of that expert.

(ii) Discussions with that expert.

(iii) Discussions with other auditors or others who are familiar with that expert's work.

(iv) Knowledge of that expert’s qualifications, membership of a professional body or industry association, license to practice, or other forms of
external recognition.

(v) Published papers or books written by that expert.

2. Malta Limited (ML) has been facing problems in running an effective internal audit department. The directors of ML has shared with you a
brief structure, functioning, roles and responsibilities of the current internal audit department, which are as follows:

The internal audit department is headed by Hina Akram, a Chartered Accountant. She works in close coordination with CFO and CEO. She
prepares audit plan for each quarter by herself. All the internal audit findings are first discussed at length with both the CFO and the CEO and
are then presented to the audit committee.

Hina’s internal audit team comprises of three members, Usman, Kashif and Amna. Usman is responsible for the audit of treasury and payments,
Kashif is responsible for the audit of procurement, payables and production and Annua is responsible for the audit of revenues, receivables and
assets, for the last three years. Hina believes that the continued involvement of her team in the same areas has helped them to develop
expertise in their assigned areas. This also helps her and her team to design internal controls for the above-mentioned areas in an effective
manner.

Required: Identify the deficiencies relating to independence of internal audit department and recommend measures which should be taken to
protect the independence. (07)

A: Reporting lines: Hina works in close coordination with CFO and CEO and also discusses all of the findings with them. Therefore it seems that the
internal audit department is also reporting to CFO and CEO which would impair its independence. Hina should be directly reporting to the audit
committee rather than going through CEO and CFO.

Deciding the scope of internal audit work: The scope of work carried out by the internal auditors is solely decided by Hina without the consultation
of the audit committee. The scope of internal audit work should be decided by the audit committee or the chief internal auditor herself with the
approval of the audit committee.

Rotation of internal audit staff: Internal auditor staff has been auditing the same processes for the last three years. They would have become too
familiar with the operations that they audit or the management responsible for them. To reduce the familiarity threat, internal auditors should be
rotated regularly.

Designing internal controls: The internal audit department is also involved in designing the internal controls. However, they should not be
responsible for the design of internal controls within the entity. If they did, they would be required to audit their own work, which creates self-
review threat. Senior management in accounting and finance or line management should have responsibility for the design and implementation of
internal controls, taking advice where appropriate from the external auditors when control weaknesses are identified during the external audit.

3. State the matters to be documented by the external auditor if he uses the internal auditor for providing direct assistance on the audit. (04)

A: (b) If the external auditor uses internal auditors to provide direct assistance on the audit, the external auditor shall include the following in the
audit documentation:

• The evaluation of the existence and significance of threats to the objectivity of the internal auditors, and the level of competence of the internal
auditors used to provide direct assistance;

• The basis for the decision regarding the nature and extent of the work performed by the internal auditors;

• Who reviewed the work performed and the date and extent of that review in accordance with ISA 230;

• The written agreements obtained from an authorized representative of the entity and the internal auditors; and

• The working papers prepared by the internal auditors who provided direct assistance on the audit engagement.

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4. Faheem is the audit manager on audit of Blue Bell Limited (BBL) for the year ending 31 March 2018, which is in the planning stage. BBL has a
well-established internal audit function which reports directly to the audit committee. The staff of the internal audit department have adequate
level of competence and are members of professional accounting bodies.

Considering the above, Faheem intends to engage internal auditors to perform audit procedures for certain audit areas.

Required:

On behalf of the engagement partner, provide appropriate guidance to Faheem to assist him in selecting the areas where direct assistance of
internal auditors can be utilized. (06)

A: Before selecting the areas where direct assistance of internal auditors can be used. Faheem should consider the following matters:

• The internal auditor should not be involved in making significant amount of judgement in: planning and performing audit procedures; and

evaluating the audit evidence gathered.

• The audit areas assigned to internal auditors should not relate to areas where risk of material misstatement is assessed as high.

• Evaluate the existence of threats to objectivity and level of competence of the internal audit staff who will be providing direct assistance

• The areas assigned should not relate to work in which the internal auditors have been involved and which has already been, or will be, reported
to management or those charged with the governance by internal audit function.

• The areas assigned should not relate to the decisions you make in accordance with ISA regarding the internal audit function and the use of its
work or direct assistance.

• It should be ensured that despite using internal auditors to provide direct assistance to the extent planned, together with the planned use of the
work of the internal audit function, the external auditor would still be sufficiently involved in the audit, given the external auditor’s sole
responsibility for the audit opinion expressed.

5. Briefly explain how an external auditor would evaluate the adequacy of the work performed by the internal audit function. (04)

A: In order to evaluate the adequacy of internal audit function, the external auditor should assess whether:

(i) The work was properly planned, performed, supervised, reviewed and documented;

(ii) Sufficient, appropriate evidence was obtained to enable internal auditors to draw reasonable conclusions;

(iii) Appropriate conclusions were reached, consistent with any reports prepared;

(iv) Any exceptions or unusual matters were properly resolved.

6. Identify the factors that are considered in determining the independence of internal auditors. (2)

A: Following factors are considered in determining the independence of internal auditors:

• To whom does the internal auditor reports to.

• Who decides the scope of internal audit work.

• Frequency of rotation of internal audit staff.

• Appointing authority of chief internal auditor.

• Conflict of interest i.e. they should not be responsible for designing internal controls.

7. Your firm is the auditor of Cell Phones (Private) Limited (CPPL), which operates a chain of mobile phone retail outlets. About 25% of
shareholding in CPPL is owned by Anwar and his wife. Anwar is the Chief Executive of CPPL and also looks after the finance and operations of
the company. There are five other directors and each of them holds 15% shares in CPPL.

The Internal Audit Function comprises of three senior officers who are graduates. Their duties include checking of accounting records, physical
stock taking, preparation of bank reconciliations, reviewing payments and verification of fixed and current assets.

During the planning phase, Anwar stressed the need for early completion of audit, in order to be able to submit the audited financial statements
for seeking a long term finance. He was of the view that internal audit working papers would be of enormous help in performing and early
completion of the audit.

Required:

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State whether it would be advisable to use the internal audit working papers in the above situation and give three distinct reasons to support
your decision. (06)

A: (b) It is not advisable to use the work of internal audit for external audit purposes due to following reasons:

• Status of the internal audit function within the entity

Administratively all the internal audit staff are under the influence of Anwar and hence their independence is impaired.

• Conflicting responsibilities:

The internal audit staffis responsibilities for preparing bank reconciliation statement is in conflict with its responsibility as a member of the internal
audit function

• Qualifications of internal audit staff:

All the internal audit personnel are graduates and do not have required competence about various aspects of the internal audit function.

8. During the audit of PQR Limited you have been assigned the task of evaluating the work performed by the internal audit department of the
company on certain specific areas.

Required:

a. Describe how would you evaluate the work performed, in order to determine the extent of reliance that may be placed thereon. (06 )

b. List the important differences between internal and external audit with respect to the following:

• Independence

• Objectives

• Reporting (08)

A: (a) For the purpose of determining the extent of reliance that may be placed on the work of internal auditor in specified areas, it may be
evaluated by:

(i) Inspecting the adequacy of the scope of the work and related programs.

(ii) Determining by means of inspection whether the preliminary assessment of Internal audit function remains appropriate.

(iii) Obtain evidence that:

• The work is performed by staff having adequate technical training and proficiency as internal auditors and the work of assistants are properly
supervised, reviewed and documented.

Sufficient appropriate audit evidence was obtained to serve as a reasonable basis for conclusions reached.

Conclusions reached are appropriate in the circumstances and any reports prepared are consistent with the results of work performed.

Any exceptions/unusual matters disclosed by internal audit are properly resolved.

(b) Important differences between Internal Audit and the External Audit

Independence

Since internal audit is a part of the entity, no matter how autonomous and objective it is., it cannot reach the level of independence enjoyed by the
external auditors.

Objectives

The objectives of internal audit function vary according to management’s requirements. Whereas, the primary objective of external auditor is to
ascertain whether or not the F/S are free of material misstatements.

Reporting

• Report of external auditor is addressed to the members (shareholders) / owners / those charged with the governance of the entity.

Internal audit reports are addressed to the management and those charged with the governance.

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• The reporting requirement of the external auditor is determined by the framework under which the audit is being carried out and by applicable
legal and regulatory requirements.

Reporting requirement of internal audit is based on the objectives/scope of work determined by the management and TCWG

ISA – 620

1. State any four factors which the external auditor may need to consider while assessing the competence of the internal audit function. (04)

A: (i) Are the internal auditors members of relevant professional bodies?

(ii) Do they have adequate technical training and proficiency?

(iii) Are there established policies for hiring and training internal auditors?

(iv) Do the internal auditors possess the required knowledge of financial reporting?

2. You are manager responsible for the audit of Bamboo Limited. Your team has asked for your guidance whether to involve an auditor’s expert
for:

(i) valuation of provision for doubtful debts. The provision has significantly reduced by Rs. 100 million as compared to previous year.

(ii) fixed asset revaluation. The management has recently revalued its fixed assets. The revaluation surplus has increased by Rs. 80 million.

The draft financial statements show a profit before tax of Rs. 500 million.

Required: Guide your audit team about involvement of an auditor’s expert. (06)

A: (i) Valuation of provision for doubtful debts

The auditor may use the work of an expert to provide knowledge relevant to the audit, which the audit firm does not possess. Provision of doubtful
debt is an area of accounting and auditing for which an auditor is expected to have expertise and can be verified by various evidences available,
such as aging, subsequent receipts, etc. Therefore, the audit team does not require an expert for valuation of provision for doubtful debts.

(ii) Fixed asset revaluation

The balance of fixed asset revaluation is material to the financial statements. Furthermore, due to complexity involved it has an inherent risk of
material misstatement. Since the only source of evidence available is valuation report, the auditor should involve an expert due to lack of expertise
and availability of audit evidence for verification of revaluation surplus.

3. An audit junior of your firm has inquired about the following matters relating to an audit:

(i) Is there any need to evaluate the adequacy of expert’s work, if the procedures related to competency and independence of the auditor’s
expert have been performed?

(ii) Can an audit firm include a reference to the expert’s work in the audit report so that the audit firm’s responsibility may be reduced in the
areas in which the audit firm does not have expertise?

Required: Comment on the above queries raised by audit junior in the light of International Standards on Auditing. (06)

A: Auditor remains fully responsible for the report produced, even if evidence on which it is based was produced by others. The auditor has sole
responsibility for the audit opinion issued and this is not reduced in any way by his use of an expert.

Therefore, he should not refer in his report to the use of an expert, unless that is required by law or regulation. Even then, or if the auditor refers to
the expert’s work in his report because it is relevant to an understanding of a modified opinion, then he must make it clear that such a reference
does not reduce his responsibility for that opinion in any way.

The auditor therefore cannot simply accept work performed by experts. That work must be evaluated in the same way as any other audit evidence
is evaluated.

• reasonableness of the expert’s conclusions.

• consistency of those conclusions with other audit evidence.

• reasonableness of significant assumptions and methods used.

• relevance, completeness and accuracy of source data.

4. Identify four examples of situations which may require the engagement of an auditor’s expert. (02)

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A: Following are the situations which may require the engagement of an auditor’s expert:

• legal opinions

• specialist valuation areas, such as property or pension liabilities

• analysis of complex or unusual taxation issues

• specialized inventory counts

5. You are the audit manager in a firm of Chartered Accountants. Your firm is often required to engage an auditor’s expert for reporting on
matters relating to the audits.

(a) List four key terms of engagement which should be agreed with the expert. (02)

(b) Specify the factors which should be considered in evaluating the adequacy of the work performed by the expert. (04)

A: a)

(i) the nature, scope and objectives of the expert’s work

(ii)the respective responsibilities of the expert and the auditor

(iii) the form of the expert’s report

(iv) confidentiality requirements

(b) The factors that should be considered in evaluating the adequacy of the experts work, include:

• reasonableness of the expert's conclusions

• consistency of those conclusions with other audit evidence

• reasonableness of significant assumptions and methods used

• Relevance, completeness and accuracy of source data.

6. Mineral Limited (ML) has incorporated a liability for gratuity payable to its employees on the basis of actuarial valuation carried out by
Professionals Limited (PL). As the audit partner of ML you are not satisfied with the valuation report prepared by PL, and have decided to
appoint Experts Limited (EL) to carry out the valuation exercise again.

Required:

(a) State the matters that you would consider regarding:

(i) The competence, capabilities and objectivity of EL. (03)

(ii) Evaluation of the adequacy of EL’s work. (03)

(b) Briefly discuss the course of action in case you are not satisfied with the work performed by EL. (03)

A: (a)

(i) Matters that should be considered by the auditor in determining the competence, capabilities and objectivity of EL

The competence, capabilities and objectivity of an expert may be assessed in one or more of the following ways:

• Personal experience with previous work of that expert.

• Discussions with that expert.

• Discussions with other auditors or others who are familiar with that expert’s work.

• Knowledge of that expert’s qualifications, membership of a professional body or industry association, license to practice, or other forms of
external recognition.

• Published papers or books written by that expert.

(ii) While evaluating the adequacy of the EL’s work, the following would be considered:

• Reasonableness of the EL’s conclusions.

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• Consistency of such conclusions with other audit evidence.

• Reasonableness of significant assumptions and methods used.

• Relevance, completeness and accuracy of source data.

(b) If the auditor decides that the work of the expert is not adequate he is required to:

• agree additional work with the expert, or

• perform other appropriate additional audit procedures.

• hire another expert.

7. You are the manager responsible for the audit of Park Hotels Limited (PHL), which operates three hotels in Pakistan. PHL has adopted the
revaluation model for the valuation of buildings. In the current year, revaluation has been carried out by a new firm, Farhan Associates (FA). PHL
has incorporated the effects of revaluation in the financial statements accordingly.

Required:

a) Briefly describe the matters that you would consider before using the report prepared by FA. (04)

b) Identify and explain the principal audit procedures to be performed on the valuation of the hotel’s buildings. (06)

A: (a) When planning to use the report of FA (the valuer) the auditor should:
• Evaluate the competence, capabilities and objectivity of FA.

• Obtain an understanding of the work carried out by FA; and

• Evaluate the appropriateness of FA’s work as audit evidence for the relevant assertion.

(b)

• Inspect written instructions given to FA by PHL, which should include the objectives and scope of the work, the intended use of the work to be
performed by FA and the extent of the valuer’s access to records and files.

• Consider the assumptions and methods used by the valuer to ensure they are reasonable based on other audit evidence and the auditor’s
previous knowledge of PHL.

• Evaluate the method used to measure fair value to ensure consistency.

• Examine the valuation report to ensure each property has been valued consistently and that the date of valuation is reasonably close to year-end.

• Inspect the buildings physically to ensure their condition is the same as described in valuation report.

• Obtain written representations from management regarding reasonableness of any assumptions used in determining the fair value.

8. When expertise in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence, the auditor has to
determine whether to use the work of an auditor’s expert.

Required:

List down the sources from where the auditor may get the information regarding the expert’s competence, capabilities and objectivity. (06
marks )

A: Information regarding the competence, capabilities and objectivity of an auditor’s expert may come from a variety of sources, such as:

a) Personal experience with previous work of that expert.

b) Discussions with that expert.

c) Discussions with other auditors or others who are familiar with that expert’s work.

d) Knowledge of the expert’s qualifications, membership of a professional body or industry association, license to practice or other forms of
external recognition.

e) Published papers or books written by that expert.

f) The auditor’s firm’s quality control policies and procedures.

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Chapter# 13 (Professional ethics and codes of conduct)
1. Your firm has been approached by a recently formed IT Company, Data Technology Limited (DTL), for appointment as its statutory auditors.
DTL is mainly owned by three foreign companies who are all registered abroad in tax heaven countries. Your firm does not have any experience
of auditing an IT company.

Required:

In the light of the Code of Ethics for Chartered Accountants, identify the threats to the fundamental principles and discuss how your firm would
evaluate these threats in the context of accepting the client and engagement. Also briefly discuss the safeguards available to your firm to
address the threats. (13)

A: Self-interest threat to compliance with the principles of integrity or professional behavior might be created. As there may be questionable issues
associated with the client owners because of their registration abroad in tax heaven countries, it might create threat(s) of client’s involvement in
illegal activities, dishonesty, questionable financial reporting practices or other unethical behavior.

To further evaluate this threat, we will have to obtain:

• knowledge and understanding of:

• the client;

• who are the eventual owners, management and those charged with governance; and

• business activities.

• the client’s commitment to address the questionable issues raised by the firm.

A self-interest threat to compliance with the principle of professional competence and due care is created if the engagement team does not
possess, or cannot acquire the competencies to perform the professional services.

Factors that are relevant in evaluating the level of such a threat include the following:

• Understanding of the nature of the DTL’s business; what type of IT services does it provide.

• The complexity of DTL’s operations.

• The requirements of the engagement.

• The purpose, nature and scope of the work to be performed.

• Knowledge of relevant industries or subject matter.

• Experience with relevant regulatory or reporting requirements.

• The existence of quality control policies and procedures designed to provide reasonable assurance that engagements are accepted only when
they can be performed competently.

The threats to professional competence and due care can be reduced by the following safeguards:

• Assigning sufficient engagement personnel with the necessary competencies.

• Agreeing on a realistic time frame for the performance of the engagement.

• Using experts where necessary.

2. (b) Khursheed Jamal is a Chartered Accountant and has recently established his audit firm in the name of Khursheed & Company, Chartered
Accountants. He is trying to expand his clientele and in this process his friend, who is his audit client and the owner of an advertising agency, has
offered to provide significant discount for publicity of his new firm.

Required:

In the light of Code of Ethics for Chartered Accountants, discuss whether Khursheed should accept the offer of his friend. (07)

(c) Hussain Tarar is the audit partner responsible for the audit of Petra Travels (Private) Limited (PTL). The chief executive officer (CEO) of the
company has informed Hussain that due to liquidity issues amid COVID-19, several employees including some staff members of finance
department left the company. CEO has therefore requested Hussain to provide two staff of the audit firm for some time to run the finance
department.

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Required:

In the light of Code of Ethics for Chartered Accountants, discuss the threats in the above scenario and suggest appropriate safeguards. (07)

A: (b) As per the “Code of Ethics” for Chartered Accountants, the practicing chartered accountants are not allowed to publicize their services in a
manner done by other normal businesses.

However, appropriate newspapers or magazines may be used to inform the public of the establishment of a new practice, of changes in the
composition of a partnership, or of any alteration in the address and telephone number of a practice. The following should be considered before
placing the announcement:

• Such announcements should be limited to a bare statement of facts in an objective manner.

• Consideration should be given to the appropriateness of the area of distribution of the newspaper or magazine and number of insertions.

• The basic principles of legality, decency, clarity, honesty and truthfulness should be followed; and

• Do not project an image, which is inconsistent with that of a professional person bound to high ethical and technical standards.

The purchase of services from an audit client by a firm does not usually create a threat to independence if the transaction is in the normal course of
business and at arm’s length. However, the magnitude of the transaction needs to be evaluated to substantiate that whether a self- interest threat
may be created. The firm should evaluate that the whether the amount of discount is material to the firm and would it impair the audit team’s
objectivity. It also needs to be evaluated that whether such discounts are also offered to other clients.

The firm may accept the discounted offer only if other clients are also given similar sort of offers and the advertisement is in the compliance with
the above mentioned principles.

(c) A self-review threat may be created as the firm would be auditing the same financial information which the team had worked on.

An advocacy threat would also be created as the firm’s employees might promote the in-correct position adopted by them to the point that their
objectivity is impaired.

A familiarity threat would also be created as the seconded employees will become too familiar with the management of the audit client.

The following safeguards may be adopted to address the above threats:

• Conducting an additional review of the work performed by the loaned personnel.

• Not including the loaned personnel as an audit team member.

• Not giving the loaned personnel audit responsibility for any function or activity that the personnel had performed.

• Providing such assistance only for a short period of time.

• Not assuming management responsibilities and the audit client is responsible for directing and supervising the activities of the personnel.

3. You are the Ethics and Quality Control Manager in an audit firm namely HMB Chartered Accountants. The audit manager responsible for the
audit of Fantom Limited (FL), has started the audit planning for FL and come across the following matters for which he needs your guidance:

(i) Fizza was planned to be the engagement supervisor for the audit of FL. She has received an employment offer from FL. However, she is
considering not to accept FL’s employment offer.

(ii) FL is the main sponsor of the ongoing cricketing event. Being the main sponsor, FL has received some entry passes of VIP enclosure of the
final match. It has offered three such passes to the audit team members.

(iii) Your firm is under renovation process and about to procure two central air conditioning systems through tendering process. Your firm has
received quotations from various vendors including FL. The total expenditures for purchase and installation of two central air conditioning units
are expected to be Rs. 50 million.

(iv) FL has offered your firm that the fee for taxation services of this year may be based on a percentage of tax saved.

Required:

Identify the threat(s) which may arise and evaluate their significance. Also recommend the course of action or the mitigating actions which may
be taken by your firm. (12)

A: (i) A self-interest threat will be created when a member of the audit team may join the audit-client in near future, as her decision making and
objectivity may be impaired due to the potential employment with the client. It needs to be ensured that refusal have been formally

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communicated to the audit manager before planning her in the audit team. When it has been assured that she won’t be accepting the offer then
no threat would be created and she could be made part of the audit team.

If it can’t be ensured that Fizza will not accept the employment offer, then she should not be made part of the audit team.

(ii) Accepting gifts or hospitality from an audit client may create self-interest, and familiarity threats. The audit team’s objectivity may be
compromised and they would be too accepting the audit clients work if they are treated with gifts of considerable value. Intimidation threat would
also arise as the client may threaten the firm of making such offers public.

Even though the tickets would not have any direct cost to the audit client but they are still of significant value to the audit team. Therefore, the
audit team should not accept the tickets for the VIP enclosure of the final match.

(iii) The purchase of goods and services from an audit client by the firm does not generally create a threat to independence if the transaction is in
the normal course of business and at arm’s length. Since the expected transaction is of significant value, a self-interest threat may be created.

Firm should ensure that no undue favors are accepted and that contract is awarded after a proper tendering process.

(iv) Agreeing to accept taxation work on the percentage of the tax saved is essentially accepting a contingent fee. This would create a self-interest
threatas there will be pressure to gain the highest tax savings for the client and this could tempt the audit firm to suggest inappropriate tax advice.

The threat created would be so significant that no safeguard could reduce the threat to an acceptable level, therefore the fee must be based on
time and experience for the job, not the contingent fee.

A self-review might also be created and therefore the firm should have separate teams for the taxation service and the audit services.

4. In the light of ICAP’s Code of Ethics, state the circumstances where a Chartered Accountant is required to disclose confidential information.
(03)

A: • Disclosure is permitted by law and is authorized by the client or the employer

• Disclosure is required by law

• There is a professional duty or right to disclose

5. Haris Awan has recently been appointed as a partner in HBC Chartered Accountants. Haris has been assigned the audit of Hemlock Limited
(HL). HL has been the firm’s client for the past 15 years. Haris has asked Babar Raza, manager responsible for the audit of HL for the last seven
years, to assist him in the planning phase. Babar has informed him that:

(i) attitude of HL’s Chief Financial Officer (CFO) has been very aggressive towards audit team members, particularly at times when questioned on
any of his judgements in relation to accounting matters.

(ii) CFO normally gives us a short deadline for completion of the audit.

(iii) one of the previous audit team members has recently joined HL as Manager Finance and has ensured us his full cooperation towards the
timely completion of the audit.

Required: Discuss the possible threat(s) which may arise in the above situation, their significance and the safeguards required to mitigate those
threats. (12)

A: Familiarity and self-interest threat may arise because of using Baber on the audit of HL over a long period of time.

The threat is significant but it also needs to be further evaluated by considering whether HL’s management team has changed or whether the
nature or complexity of HL’s accounting and reporting issues has changed. Furthermore, due to the long association of Babar with HL, he may be
too sympathetic to their interest or too accepting of their work.

Following safeguards may be applied:

Replace Baber with any other manager having appropriate experience.

• Ask a professional accountant who is not a member of the audit team, to review the work.

• Regular independent internal or external quality reviews of the engagement.

CFO aggressive attitude towards the audit team and setting short deadlines for completion of audit indicates presence of intimidation threat.

The threat is significant as audit firm may be pressurized into accepting CFO’s judgements even when these may not be appropriate and due to
very strict deadlines firm may not be able to obtain sufficient appropriate audit evidence. This may result in the issuance of an inappropriate audit
opinion.

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Following safeguards may be applied:

• Independent review of areas requiring judgements.

• Assign highly skilled and competent audit team members.

• Discussing with those charged with governance the attitude of CFO towards the audit team.

Familiarity or intimidation threats are created as the manager finance has been a member of the previous audit team.

Being in the position of manager finance, the individual is responsible for the preparation of financial statements and will be in continuous
communication with the audit team. Due to these factors the threat seems significant.

Following safeguards may be applied:

• Assign individuals to the audit team who have sufficient experience in relation to the individual who has joined the client; or

• Have a professional accountant review the work of the former member of the audit team.

• Modify the audit plan.

6. (a) You are a partner in a firm of chartered accountants. You have received a letter from a special investigation committee formed by the
government to investigate the affairs of Naqshbandi Limited (NL).

Your client Rahim Limited (RL) is the subsidiary of NL. The investigation committee requires you to submit the details of all the transactions
carried out by RL with NL and its related parties. The committee also requires your firm to report the transaction value and the arm’s length
value of all the transactions.

Required: In the light of Code of Ethics for Chartered Accountants, discuss any three factors that your firm should consider while disclosing client
information to the investigation committee. (03)

(b) Your firm has just been appointed as the auditor of Get Fit Gym Limited (GFG) which operates a chain of high end gyms and fitness centers
across the country. The managing director of GFG is a close friend of the audit manager and the audit was awarded to your firm through this
connection.

In a recent meeting, the managing director of GFG has offered to grant membership to all the staff members of your firm at 50% discount.

Required: Evaluate the threat(s) which may arise in the above situation. Also discuss the safeguards required to mitigate such threat(s). (08)

A: (a)

• Whether the interests of all parties, including third/related parties whose interests may be affected, could be harmed if the client consents to the
disclosure of information.

• Whether all the relevant information related to the related parties is known and substantiated, to the extent it is practicable.

• Since the requirement of the committee involves reporting on the arm’s length price of the transaction which generally involves unsubstantiated
facts or unsubstantiated conclusions,

professional judgment shall be used in determining the type of disclosure to be made, if any.

(b)

Threat

Close friendship of the audit manager with the managing director would cause a familiarity threat, because the audit manager would be biased
towards the managing director and would sympathetic to his interest or too accepting of his work.

Safeguard

• Structure the audit manager’s responsibilities to reduce any potential influence over the assurance engagement; or

• Review the assurance work from a chartered accountant; or

• Remove the audit manager from the engagement.

Threat s

• Offering of membership at reduced rate could cause a self-interest threat to the audit, because the recipients may not want to lose their benefit,
and therefore be biased in their audit work or not seek adjustments where there are material issues in the financial statements.

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• An intimidation threat may also arise because the audit client may threaten to make such offers public to degrade the firm’s reputation.

Safeguards

Auditors are not allowed to accept such benefits unless their value is trivial and inconsequential. In this case, the value of a reduced membership of
a high end gym is unlikely to be trivial and inconsequential to audit staff members and therefore the firm should reject this discounted offer of MD.

7. (a) Shayan has recently been hired as the audit manager in a firm of chartered accountants which is the auditor of Python Limited (PL).
Shayan previously served as manager finance in PL for three years.

The firm is considering to depute Shayan as the engagement manager for the audit of PL for the year ended 31 August 2019.

Required: Identify the possible threats which may arise and discuss their significance. Also, discuss the safeguards required to mitigate the
threats under each of the following assumptions:

(i) Shayan resigned from PL with effect from 30 June 2019

(ii) Shayan resigned from PL with effect from 30 June 2018 (07)

(c) You are the manager on the audit of Dolphin (Private) Limited for the year ending 31 December 2019. The client has requested you to send
an audit trainee on secondment for October and November 2019 to assist the chief financial officer, as one of the key staff members of the
accounting team has resigned.

Required: Identify the threat(s) in the above scenario and suggest appropriate safeguards. (04)

A: (a) Self-interest threat, self—review threat or familiarity threat may be created. Shayan previously being the manager finance was in a position
to exert significant influence over the preparation of the PL’s accounting records which would now be subject to his own review in the capacity of
audit manager. Furthermore, since Shayan has worked for three years in PL, he may be influenced by his ex-subordinates. Considering these facts,
the threat appears to be significant.

If Shayan had previously worked in PL until 30 June 2019

Since he resigned during the period covering by the audit, the threat created would be so significant that no safeguard could reduce the threat to
an acceptable level. Consequently, Shayan shall not be part of the audit team.

If Shayan had previously worked in PL until 30 June 2018

• Threats would only be created for decisions made or work performed by Shayan in the prior period, while employed at PL and should be
evaluated in the current period as part of the current audit engagement.

• If Shayan is appointed as the engagement manager then the work performed by him as a member of the audit team should be independently
reviewed.

(c) The lending of staff by a firm to an audit client will create a self-review threat, However, the threat may be reduced to an acceptable level if:

• they are not involved in exercising discretionary authority; or

• they do not assume management responsibilities and the audit client should acknowledge its responsibility for directing and supervising the
activities of assigned personnel.

• an additional review of the work performed by the seconded staff may be carried out.

• they are not given audit responsibility in future for any function or activity that they performed or supervised.

• are not included in the audit team.

8. You are the audit manager at a client Exim (Private) Limited (EPL). During the finalisation meeting with the client, the CFO of EPL admired the
performance of the audit team. He informed that a junior member of the audit team gave valuable suggestions regarding a trading business
which EPL is considering to launch in the near future, as he had worked as an intern in a large business house involved in similar business. The
CFO also informed that the audit junior has offered to arrange a warehouse on reasonable rent as he works part time in his brother’s estate
agency.

Required:

Identify the threats in the above scenario and suggest appropriate safeguards. (05)

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A: (a) Offering business advice to the audit client in such an informal manner is a breach of professional behavior by the audit junior. He also
appears to be in breach of the fundamental principal of professional competence and due care, unless he has the required competency to offer
such an advice.

Moreover, business relationship between the member of the audit team and the audit client will create self-interest threat and intimidation threat.

Due to above, the following safeguards may be implemented:

• Any work performed by the audit junior to date should be critically reviewed.

• We need to take steps to ensure that the client does not act on any advice that the junior provided.

• We should also assess any gaps in our internal training process; the junior should have received training prior to his audit assignments so that he
understood his role as an auditor.

9. (a) You have recently been promoted as a partner in the assurance department of a firm of chartered accountants. Your portfolio of clients
includes Shah Motors (Pvt.) Limited (SML), a leading car dealer. Qaiser, a senior manager assurance in your firm, has been auditing SML for the
past 7 years. While updating you about SML, Qaiser informed about the following:

(i) On the request of an audit team member, CFO of SML has helped the team member’s brother in securing early delivery of a vehicle ordered
by him on preferential basis.

(ii) SML has hired a new Head of Marketing. His son Amjad is expected to be included as a junior team member in SML’s audit team.

Required:

Discuss the possible threats which may arise, their significance and the safeguards required to mitigate those threats. (10)

(b) State the circumstances where a chartered accountant may be required to disclose the information obtained during the audit. (03)

A: (a)(i) Familiarity and self-interest threat may arise because of long association of Qaiser on the audit of SML.

The threat is significant but it also needs to be further evaluated by considering whether SML’s management team has changed or whether the
nature or complexity of SML’s accounting and reporting issues has changed.

Following safeguards may be applied:

• Replace Qaiser with any other senior manager having appropriate experience.

• Asking a professional accountant who was not a member of the audit team to review the work.

• Regular independent internal or external quality reviews of the engagement.

(ii) Requesting CFO for expediting the delivery may create self-interest, familiarity, intimidation threat to the independence of the audit team
member.

The threats seem to be significant because the preferential treatment was not in the normal course of the business.

The audit team member who has obtained preferential treatment should not be made part of the audit team and in case he is made part of the
team, his work should be reviewed by an independent chartered accountant.

It should also be ensured that no such breach of ethics occurs in future and the firm should communicate and strictly implement its policies in this
regard. Firm may also consider taking disciplinary action against the individual who had obtained the preferential treatment from SML.

(iii) Family and personal relationship between a member of the audit team and the Head of Marketing of SML may create self-interest, familiarity
and / or intimidation threats.

The threat would be significant because of the close relationship. The significance would also depend on Amjad’s responsibilities on the audit team.

Following safeguards may be applied:

• Removing Amjad from the audit team

• Structuring the responsibilities of the audit team so that Amjad does not deal with matters that are within the responsibility of his father.

• Review of work carried out by Amjad

(b) A chartered accountant should refrain from disclosing confidential information acquired as a result of professional and business relationships.
However, under the following circumstances, a chartered accountant may be required to disclose confidential information:

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• Disclosure is required by law.

• There is a professional duty or right to disclose, when not prohibited by law.

• Disclosure is permitted by law and is authorized by the client.

10. (a) Discuss the threats and the related safeguards in each of the following situations:

(i) Saleem is the audit senior at Mango Industries Limited (MIL). MIL’s finance manager has requested him to provide the residential addresses
of the engagement manager and the engagement partner. The finance manager wants to send them one of MIL’s latest product. (03)

(ii) Akram is the audit senior engaged on the audit of Dragon Limited (DL). He has informed the audit manager that he has been offered a job by
DL and that he would be joining DL from 1 April 2018. The audit is expected to be completed on 15 March 2018.(03)

(b) Amjad is the audit senior at Orange Limited (OL), a software house. OL has adopted IFRS 15 ’Revenue from Contracts with Customers’ for
preparation of its financial statements for the year ending 31 March 2018. However, the manager finance of OL is indecisive as regards revenue
recognition on certain contracts.

He has asked Amjad to suggest accounting treatment of such contracts in accordance with IFRS 15. Amjad does not have in-depth knowledge of
this IFRS and therefore, he has consulted his friend who has recently attended a workshop on IFRS 15.

Required:

(i) Discuss the threats in the above situation. (03)

(ii) What actions the firm should take to ensure that such situation is avoided in future? (03)

A: (a) (i) Accepting of gift may create self-interest and familiarity threats.

If the value of the gift is not clearly insignificant, the threat to independence cannot be reduced to an acceptable level by the application of any
safeguard.

Consequentially in such situation, the members of the audit team should be instructed not to accept the gift.

(ii) A self-interest threat is created when a member of the audit team participates in the audit engagement while knowing that he / she may join
the client sometime in the future.

On receiving such notification, the significance of threat shall be evaluated and following safeguards could be applied:

• Removing the individual from the audit team; or

• A review of any significant judgments made by that individual while on the team. (b)

(i) Following are the threats in the mentioned situation:

• Suggesting the client about accounting treatment would create a selfreview threat, because that accounting treatment will also be the subject
matter of the assurance engagement.

• Even though Amjad’s friend has attended the workshop on IFRS-15, it does not necessarily mean that he is competent enough to advise the client
regarding the accounting treatment under IFRS- 15, as it could involve significant judgment. It would create a threat to professional competence
and due care.

Sharing of information with his friend may create threat to confidentiality.

(ii) Following actions could be taken by the firm to avoid such a situation in future:

• Regularly conduct professional development of its staff for any recent changes or updates in professional pronouncement.

• Circulate documented internal policies and procedures requiring compliance with the fundamental principles.

• Implement an effective disciplinary mechanism to promote compliance with policies and procedure.

11. Discuss the threat(s) that may be involved and the related safeguards in each of the following situations:

a) Anwar, an ex-trainee has recently rejoined your firm. He is interested in acting as the engagement manager on Curtains Limited, where he
had been employed during the past two years. (04)

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b) House Limited (HL) owns the building in which the Karachi office of your firm is located. HL owns multiple projects across the city and
provides its premises to various concerns on rental basis. HL has requested your firm to become its auditor for the year ending 30 June 2018.
(05)

c) Window Limited (WL), an audit client of your firm has approached the taxation department of your firm to review the income tax return to be
filed by WL. (03)

A: (a) The association of Anwar with Curtains Limited will create self-review and familiarity threat. If the threats are significant, Anwar should not
be part of the assurance engagement team.

In case Anwar is included in the Audit engagement the related safeguards may include:

• Involving an additional chartered accountant to review the work done by Anwar or otherwise advise as necessary.

• Independent internal quality reviews.

(b) In the given situation, the acceptance of audit engagement will result in a business relationship with an audit client which may pose a familiarity
threat to objectivity.

However, the significance of the threat in such situation depends upon the following:

• Whether it is in the ordinary course of business;

• Whether the tenancy agreement is on an arm’s length basis; and

• The materiality of the contract for either of the party.

From the situation given, it can be determined that this business relationship is in the ordinary course of business on an arm’s length basis and not
material to either of the parties, hence, the engagement can be accepted.

(c) Income tax return contains information which is directly related to a significant figure in the financial statements. Therefore, the acceptance of
review of income tax return would create a self review threat.

In case the engagement is accepted the related safeguards may include the following:

• The review may be performed by professionals who are not members of the audit team;

• If the service is performed by a member of the audit team, a partner or senior staff member with appropriate expertise and is not a member of
the audit team, review the tax calculations; or

• The firm does not get involved in management decision making and clarifies this fact in the communication with the client.

12. Discuss the categories of threats and related safeguards in each of the following situations:

(a) An unlisted audit client which has recently been incorporated has requested your

firm to assist the finance department in the preparation of financial statements. (03)

(b) Saleem has recently been promoted as a partner and the audit of TTL has been assigned to him. TTL owns and operates a chain of
restaurants. The following matters are under his consideration:

(i) Asif has been involved in the audit of TTL as audit senior for the last three years. He has recently qualified as chartered accountant and
Saleem wants to appoint him as audit manager.

(ii) TTL’s management has requested Saleem to include Rashid, a semi-senior, in the audit team. Rashid is the son of TTL’s Marketing Director.

(iii) The firm has long cordial relationship with the management of TTL. Saleem has noticed that the firm often uses the restaurants run by TTL
for conducting its internal functions. (07)

A: Assisting financial statement audit client in matters such as preparing accounting records or F/S may create a self-review threat when the F/S are
subsequently audited by the firm. The related safeguards are as follows:

• Arrange for such services to be performed by an individual who is not a member of audit team.

• If such services are performed by a member of the audit team, use a partner or senior staff member with appropriate expertise who is not a
member of the audit team, to review the work performed by such person, during the audit.

(i) As Asif is associated with the client since last three years it will create a familiarity threat, an appropriate safeguard would be to exclude Asif
from the engagement team.

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(ii) Independence of Rashid can be threatened as Rashid is a close family member of marketing director. Although marketing director is not directly
related to the preparation of F/S, however, he could be tempted by management for not identifying errors due to influence of his father. In order
to provide safeguard against the threat the firm should not include Rashid in the audit team.

(iii) Independence of audit firm can be compromised if extra ordinary benefits is obtained for conducting internal functions at restaurants of TTL. As
a precaution, the firm should avoid using the restaurants of TTL.

13. Identify the threats which may be involved and suggest appropriate safeguards, if any, in each of the following scenarios:

(a) The planning phase of the annual audit of ABC (Private) Limited for the year ended 30 June 2016 is in progress. The engagement partner
intends to include Kamran as a member of audit team who joined the firm last month. Before joining the firm Kamran was employed in the
finance department of ABC. (05)

(b) Nasir is the audit manager on the audit of Diamond Limited (DL) for the year ended 30 June 2016. Nasir has informed that his father owns
10,000 shares in DL. (04)

A: (a) Self-interest, self-review and familiarity threats will be created, as Kamran has served as an employee in ABC.

Safeguards:

• Conducting a review of the work performed by Kamran as a member of the audit team,

• Not including the member in the audit team.

(b) As the father of Nasir is a close family member, having a direct financial interest in DL, a self- interest threat is created.

Safeguards:

• Disposing as soon as practicable, of all the shares by Nasir’s father (a close family member)

• Having a professional accountant review the work of Nasir;

• Replacement of Nasir from the Audit team.

14. Identify the threats that may be involved and applicable safeguards, if any, in each of the following scenarios:

a. Your firm is the auditor of Delicious Biscuits Limited (DBL) for the past three years. On previous year’s audit, Affan was the audit manager. He
has recently joined DBL as GM finance. (05)

b. ABC leasing company has a lease portfolio of Rs. 500 million. Atif, the Audit Manager on ABC, has obtained a lease finance amounting to Rs.
800,000 from ABC. (05)

A; a) Familiarity or intimidation threats may be created if a member of audit team joins the audit client. Following are the safeguards:

(i) Modifying the audit plan;

(ii) Assigning individuals to the audit team who have sufficient experience as compared to the individual who has joined the client;

(b) A loan from an audit client to an audit team member will not create a threat to independence, if the loan is made under normal lending
procedures, terms and conditions.

If the loan is not made under normal lending procedures, terms and conditions, a self- interest threat would be created that would be so significant
that no safeguard could reduce the threat to an acceptable level. However, as the loan has already been disbursed, the only safeguard available is
to remove the manager from the audit team or ask him to settle the lease obligation.

15. Discuss the categories of threats and related safeguards in each of the following situations:

a) Your firm is the auditor of Prime Super Markets Limited, a chain of super markets. During a promotional campaign, the management has
distributed discount vouchers which have also been given to the audit team members. (04)

b) You are manager on audit of Abid Textile Mills Limited. Client has requested you to send two staff members on secondment for three months
to assist chief financial officer as its two senior accounting team members have resigned recently. (05)

c) Fine Petroleum Limited (FPL) is the audit client of your firm for five years. During the year, the engagement partner has been changed due to
mandatory rotation as per Code of Corporate Governance. However, the firm has decided to retain Atif, the audit manager, who has been
involved in the audit of FPL for past five years. (04)

A: (a) Accepting of discount vouchers may create self interest and intimidation threats.

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However, if the value of discount vouchers is not clearly insignificant, the threat to independence cannot be reduced to an acceptable level by the
application of any safeguard.

If the value is other than clearly insignificant, the members of the audit team should be instructed not to accept the discount vouchers.

(b) The lending of staff by a firm to an audit client will create a self-review threat. However, the threat may be reduced to an acceptable level if the
firm's personnel:

• are not involved in exercising discretionary authority; or

• do not assume management responsibilities.

• are not given audit responsibility for any function or activity that they performed or supervised. The audit client should acknowledge its
responsibility for directing and supervising the activities of assigned personnel.

(c) Familiarity and self-interest threats are created by using the same senior personnel on an audit engagement over a long period of time. This
applies to the audit manager also.

The significance of the threats shall be evaluated and following safeguards should be applied if necessary to eliminate the threats or reduce them
to an acceptable level:

• Rotating the audit manager as well;

• Having a professional accountant who was not a member of the audit team review the work of the audit manager;

• Regular independent internal or external quality reviews of the engagement.

16. Discuss the categories of threats that may be involved in each of the following independent situations and advise the partners of the
concerned firm with regard to the possible course of action that may be followed in each situation:

a) Ahmed has recently joined a firm of Chartered Accountants. The firm intends to depute him on the audit of Masoom (Private) Limited (MPL).
Prior to joining the firm, Ahmed had been providing accounting and taxation services to MPL for many

years, in the capacity of a consultant. (04)

b) It has been discovered that father of one of the trainees posted on the audit of Chalak Limited (CL), has a financial interest in CL. (04)

c) Hoshiyar Limited (HL), an audit client of your firm has recently advertised certain vacancies in its accounts department. The said positions
have been applied for by

number of individuals including two staff members who are posted on the audit of HL. (04)

A: (a) The previous provision of accounting and taxation services to MPL and long association of Ahmed with MPL will create self-review and
familiarity threat.

Significance of threats needs to be evaluated and if threats are other then clearly insignificant, safeguards need to be applied to reduce the threats
to an acceptable level.

In case Ahmed is included in the Audit engagement the related safeguards may include:

• involving an additional chartered accountant to review the work done by Ahmed or otherwise advise as necessary.

• independent internal quality reviews.

If the threats are significant, Ahmed should not be part of the assurance engagement team.

(b) In the given situation involvement of such trainees in the audit of CL may result in a self-interest threat.

The materiality and significance of the financial interest, needs to be evaluated. If the financial interest is immaterial then the audit trainee may be
allowed to work on that client, otherwise only safeguard available is to withdraw the trainee from this assignment.

(c) A self interest threat is created when a member of the assurance team participates in the assurance engagement while knowing, or having
reason to believe, that he may join the assurance client in future.

The threat created can be reduced to an acceptable level by the application of the following safeguards:

• Ask the individual to notify the firm when entering serious employment negotiations with the assurance client;

• Remove of the individual from the assurance engagement;

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• Perform an independent review of any significant judgments made by that individual while on engagement.

17. a) Briefly describe the term ’Integrity’ in accordance with the Code of Ethics for Chartered Accountants. (02)

b) Briefly describe ’advocacy threat’ and give an example thereof. (02)

c) Briefly state the difference between ’actual independence’ and ’perceived independence’. (03)

d) The principle of confidentiality imposes an obligation on chartered accountants to refrain from disclosing confidential information. State
three key exceptions to the above rule. (02)

A; (a) Integrity:

Members should be straightforward and honest in all professional and business relationships. Integrity implies not just honesty but also fair dealing
and truthfulness.

A chartered accountant should not be associated with reports, returns, communications or other information which according to him is materially
false or misleading.

(b) Advocacy threat:

Advocacy threat occur when members promote a position or opinion on behalf of a client to the point that subsequent objectivity may be
compromised.

Example: Acting as an advocate for an assurance client in litigation or dispute with third parties.

(c) Actual Independence:

Actual independence means that the auditor should not be influenced by anything which results in compromising his professional judgement while
expressing an opinion.

Perceived independence: The auditor must be seen to be independent, i.e. the auditor should avoid facts and circumstances due to which a third
party may conclude that his integrity, objectivity or professional skepticism had been compromised.

(d) The following are circumstances where chartered accountants are or may be required to disclose confidential information:

• Disclosure is permitted by law and is authorized by the client.

• Disclosure is required by law.

• There is a professional duty or right to disclose, when not prohibited by law:

18. Discuss the categories of threats that may be involved in each of the following mutually exclusive situations and advise the partner of the
concerned firms with regard to the possible course of action which may be adopted in each case:

a) The audit of JJ Limited (JJL) is at its completion stage. The meetings of the audit committee and the board of directors are scheduled to be
held within a week, to consider and approve the annual financial statements. JJL is facing financial difficulties and has not paid the audit fee of
the previous year. The CFO of JJL has committed to pay the previous as well as current year’s audit fee, after signing the audit report. (04)

b) During the course of audit of HP Limited (HPL), the engagement partner has informed the firm that his brother has acquired 200,000 shares in
HPL. (05)

A: (a) Threats:

Self interest threat is created as the auditor would like to recover the previous year’s audit fee.

Safeguards:

Generally the payment of previous year audit fees should be received before the report is issued. However, if the fee is not paid additional
safeguards may be applied, which may include:

• Discussing the outstanding fees with the audit committee and TCWG.

• Involving an additional chartered accountant who did not take part in the assurance engagement, to provide advice or review the work
performed.

(b) Threats:

Self interest threat is created as the shares are held by a close relative of the engagement partner.

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As the engagement partner has promptly notified the firm about the interest of his brother, hence it is likely that it would not impair the
independence of the engagement partner.

Safeguards:

Significance of threat should be evaluated and if the threat is other than clearly insignificant, safeguards should be considered and applied as
necessary to reduce the threat to an acceptable level.

Such safeguards might include:

• If possible the engagement partner may convince his brother to dispose of the shares;

• If disposal does not occur at the earliest practical date, the engagement partner may be changed.

• An additional chartered accountant who did not take part in the assurance engagement may review the work done or otherwise advise as
necessary.

19. Discuss the categories of threats that may be involved in each of the following independent situations and advise the concerned
engagement partners with regard to the possible course of action that may be adopted in each case.

a) Awesome Hotels Limited (AHL) is a listed company and is audited by Mansoor andCompany, Chartered Accountants. The partners of Mansoor
and Company stay in the hotels managed by AHL while they are travelling. (05)

b) An audit team member on Hunza Limited (HL) has inherited 100,000 shares in HL after the death of his father. (05)

A: (a) The purchase of goods and services from an assurance client by the firm would not generally create a threat to independence unless the
transaction is not in the normal course of business and not on an arm’s length basis.

The creation of self interest threat or otherwise shall depend upon the nature of the transaction and its magnitude.

If the threat created is other than clearly insignificant, safeguards should be considered and applied as necessary to reduce the threat to an
acceptable level.

Such safeguards might include:

• Discontinue the practice of staying in hotels managed by AHL or reducing its frequency so as to reduce the magnitude of the billing.

• ensure that the charge out rates are in accordance with those applicable to normal customers.

• Ensure that the dealing is at arm’s length and no undue advantage is secured by the firm.

• Discussing (informing) the issue with TCWG. (b)

• As a result of inheritance of shares, a self-interest threat has been created. The following safeguards should be applied to eliminate the threat or
reduce it to an acceptance level:

The financial interest may be disposed of at the earliest practical date; or The concerned staff may be removed from the assurance engagement.

• During the period prior to disposal of the financial interest or the removal of the individual from the assurance team, consideration should be
given to whether additional safeguards are necessary to reduce the threat to an acceptable level. Such safeguards might include:

Discussing the matter with TCWG, such as the audit committee; or

Involving an additional chartered accountant to review the work done, or otherwise advise as necessary.

20. Discuss the categories of threats that may be involved in each of the following independent situations and advise the partners of the
concerned firm with regard to the possible course of action that may be followed, in each case.

a) Burewala Bank Limited (BBL) is a listed audit client of Umer and Company, Chartered Accountants (UCC). BBL has granted a house loan of Rs.
5 million to a partner in UCC. (04 marks)

b) Kamal was the audit manager during the last year’s annual audit of Faisalabad Textile Mills Limited (FTML). He has joined FTML as their
Manager Finance, prior to the commencement of the current year’s audit. (08 marks)

A: (a) Burewala Bank Limited:

Threats

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(i) A threat to independence may be created if the loan is made under abnormal lending procedures, terms and requirements and the loan is
material to both the firm and the BBL.

(ii) A self interest threat may be created if the loan amount is material to the firm/ partner.

Safeguards:

As the Companies Act, 2017, restricts a person who is indebted to the company from being auditor of the said company, therefore the course of
action available to the partners of UCC is to withdraw from the engagement or repayment of the loan by the partner concerned.

(b) Faisalabad Textile Mills Limited:

Threats:

It has created self interest, familiarity and intimidation threats.

The assurance team’s independence is threatened, on account of the fact that Kamal is in a position to exert direct and significant influence over
the assurance engagement as Kamal was a member of the assurance team during the previous year audit.

Safeguards:

The safeguards might include:

(i) Consider the appropriateness or necessity of modifying the assurance plan for the assurance engagement;

(ii) Assigning an assurance team that is of sufficient experience in relation to the individual who has joined the assurance client;

(iii) Involve an additional chartered accountant who was not a member of the assurance team to review the work or advise as necessary; or

(iv) Quality control review of the assurance engagement.

(v) Ensuring that the individual concerned is not entitled to any benefits or payments from the firm unless these are made in accordance with fixed
pre-determined arrangements. In addition, any amount owed to the individual should not be of such significance to threaten the firm’s
independence.

(vi) Ensuring that the individual does not continue to participate or appear to participate in the firm’s business or professional activities.

(i) Self-interest threats - This may occur as a result of the financial or other interests of a chartered accountant or of an immediate or close family
member.

• A financial interest in a client or jointly holding a financial interest with a client.

• Undue dependence on total fees from a client.

• Having a close business relationship with a client.

• Concern about the possibility of losing a client.

• Potential employment with a client.

• Contingent fees relating to an assurance engagement.

• A loan to or from an assurance client or any of its directors or officers.

(ii) Self-review threat - This may occur when a previous judgment needs to be re-evaluated by the chartered accountant responsible for that
judgment.

• The discovery of a significant error during a re-evaluation of the work of the chartered accountant in practice.

• Reporting on the operation of financial systems after being involved in their design or implementation.

• Having prepared the original data used to generate records that are the subject matter of the engagement.

• A member of the assurance team being, or having recently been, a director or officer of that client.

• A member of the assurance team being, or having recently been, employed by the client in a position to exert direct and significant influence over
the subject matter of the engagement

• Performing a service for a client that directly affects the subject matter of the assurance engagement.

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(iii) Advocacy threats - This may occur when a chartered accountant promotes a position or opinion to the point that subsequent objectivity may be
compromised.

• Promoting shares in a listed entity when that entity is a financial statement audit client.

• Acting as an advocate on behalf of an assurance client in litigation or disputes with third parties.

(iv) Familiarity threats - This may occur when, because of a close relationship, a chartered accountant becomes too sympathetic to the interests of
others.

• A member of the engagement team having a close or immediate family relationship with a director or officer of the client

• A member of the engagement team having a close or immediate family relationship with an employee of the client who is in a position to exert
direct and significant influence over the subject matter of the engagement.

• A former partner of the firm being a director or officer of the client or an employee in a position to exert direct and significant influence over the
subject matter of the engagement.

• Accepting gifts or preferential treatment from a client, unless the value is clearly insignificant.

• Long association of senior personnel with the assurance client.

(v) Intimidation threats - This may occur when a chartered accountant may be deterred from action objectively by threats, actual or perceived.

• Being threatened with dismissal or replacement in relation to a client engagement.

• Being threatened with litigation.

• Being pressured to reduce inappropriately the extent of work performed in order to reduce fees.

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Chapter# 13 (Audit finalization and reporting)

ISA - 560
1. You are the audit manager in a firm of chartered accountants. Following independent situations are under your consideration:

(i) Mega Motors Limited (MML) offers 3-year warranty for its products. MML assessed its warranty obligation to be Rs. 20 million for the year
ended 30 June 2021. The board of directors has approved the financial statements on 6 September 2021. Just before signing the audit report,
your audit team came to know about a latent defect in MML’s products. This defect was neither earlier discovered nor known to MML.

(ii) Dawn Hotel Limited was severely damaged by flash flood on 31 August 2021. Initial assessment of the incident shows that significant repairs
are required and the hotel would not be operational for at least a month. Audit report for the year ended 30 June 2021 has not yet been issued.

Required:

For each of the above situations, evaluate the need for amendment in the financial statements and suggest the auditor’s course of action. (10)

A: Evaluation:

Even though MML came to know about the defect after the year end, the existence of defect in MML products provide evidence of conditions that
already existed at the end of the reporting period. Therefore, it is as an adjusting event. The warranty provision should be reassessed on the basis
of the identified defect and the financial statements should be adjusted accordingly.

Course of action:

(i) Inquire with the management about the quantity of effected products which have been sold until the year end.

(ii) Inquire from the management whether they have assessed the revised warranty provision on the basis of this new information.

(iii) Consider involving auditor’s expert to re-assess the warranty provision.

(iv) Evaluate the management assumptions for the revised warranty provision.

(v) Assess whether there is any material effect to the warranty provision because of the identified defect.

(vi) Ask the management to revise the financial statements and get it approved by the board of directors.

(vii) Obtain management representation that the warranty provision reflects the management best estimate.

(viii) Ask the management to prepare a working for the net realizable value of the inventory and assess its adequacy.

Evaluation:

The incident occurred after the year-end for which no condition existed before the year- end. Therefore, it is a non-adjusting event for which the
financial statements do not need amendment. The incident has a significant impact and it seems material for the users of the financial statements.
Therefore, DHL shall disclose nature of the event and an estimate of its financial effect.

Course of action:

(i) Inquire from the management about the time it would take to repair the hotel and make it operational.

(ii) Inquire from the management to assess the amount of revenue lost due to non- functionality of hotel.

(iii) Inquire from the management about the estimated cost of repair.

(iv) Inquire from the management about any amount to be received from the insurance company.

(v) Ask the management to disclose the matter in accordance with the requirements of IFRSs.

2. Consider each of the following independent situations:

(i) Spruce Limited issued its financial statements on 15 September 2020 for the year ended 30 June 2020. On 22 September 2020, your audit
team came to know that a major debtor has filed bankruptcy due to destruction of its production facility in a terrorist attack on 20 August 2020.

(ii) During the audit of Larch Limited (LL) for the year ended 30 June 2020, the audit team noticed that the management of LL had worked out
the net realizable value (NRV) on the basis of the sales price at year-end. Since NRV was greater than cost, LL recorded the inventory in the draft
financial statements at cost. However, after reporting period, LL is facing difficulties in selling the inventory at current price level and therefore
considering to revise its prices.

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Required:

In each of the above situations, evaluate the need for amendment in the financial statements and suggest the audit procedures, if any, which
the auditor would need to perform. (09)

A: (i) Evaluation: The incident occurred after the year-end for which no condition existed before the year-end. Therefore, it is a non-adjusting event
for which the financial statements does not need an amendment.

Furthermore, after the financial statements have been issued, the auditor has no obligation to perform any audit procedures regarding such
financial statements.

Therefore, no action from the auditor with regards to financial statements for the year ended 30 June 2020 is required. However, auditor shall
inquire how the management intends to address the matter in the financial statements. If the management amends the financial statements to
disclose the non-adjusting event then the auditor shall extend the audit procedures to the date of new audit report.

(ii) Evaluation: The difficulty in selling the inventory after the year-end at current prices and consideration of revising the price give the evidence
about their net realizable value (NRV) at the year-end, which is an adjusting event. Therefore, NRV of the inventory should be calculated on the
basis of revised selling price after the yearend and the financial statements should be adjusted accordingly.

Suggested audit procedure:

• Review prices at which goods have been sold after the reporting period, for evidence that NRV is higher than cost.

• Review and test the procedures in place for comparing NRV with cost for each item of inventory.

• Select major items of inventory from the list of stock and compare NRV with cost.

• Review inventory records and order books to identify of slow-moving items and compare their expected NRV with cost.

• Review the information gathered during the physical inventory count (e.g. deterioration of inventory) which may suggest that NRV may be lower
than cost.

• Review the records related.

3. Expert Limited (EL) is an unlisted public company engaged in production of various products. In January 2018, an equipment malfunctioned
which caused severe injuries to some of the workers. EL had paid compensation to the workers but a case for violation of safety regulations had
also been filed by the regulator. On the basis of legal advice, EL had recorded a provision of Rs. 5 million in its financial statements for the year
ended 31 December 2018. The board of directors approved the financial statements on 01 March 2019 and on the same date your firm
expressed an unmodified opinion. EL plans to issue the financial statements on 5 March 2019. On 3 March 2019 the court imposed a penalty of
Rs. 15 million on EL. Management of EL informed the auditor accordingly.

Required:

Evaluate the need for amendment in financial statements and state the procedures which the auditor would need to perform in the above
situation. (09)

A; Evaluation of the situation:

The auditor has no obligation to perform any audit procedures regarding the financial statements after the date of the auditor’s report. However,
the matter has come to the knowledge of the auditor before publication of financial statements and imposition of penalty is indicative of condition
that existed at balance-sheet date.

Course of action:

Had the actual amount of penalty imposed by the court been known to the auditor at the date of the auditor's report, it may have caused the
auditor to ask the management for adjustment in the financial statements. Therefore, the auditor need to perform the following procedures:

• Discuss the matter with management and, where appropriate those charged with governance

• Inquire how management intend to address the matter in the financial statements.

• Instruct management not to issue the financial statements before the necessary amendments have been made

• If the financial statements are amended, the auditor is required to:

— Carry out the necessary audit procedures on the amendment.

— Extend his review of subsequent events up to the date of the new audit report.

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• If the financial statements are not amended, the auditor is required to

— Take appropriate action to prevent reliance on the audit report, after taking legal advice.

— In the longer term, the auditor should also consider resigning from the audit, but this would not be appropriate as an immediate response to the
problem.

4. Auditor should actively look for subsequent events up to the date of auditor’s report. State the procedures which an auditor should perform
specifically for identification of subsequent events. (04)

A: • Obtain an understanding of management’s procedures for identifying subsequent events.

• Inquire of management as to whether any subsequent events have occurred which might affect the financial statements.

• Read the entity’s latest subsequent financial statements.

• Read minutes of shareholders’ meetings, meeting of the board of directors held after the date of the financial statements and inquire about
matters discussed at any such meetings where minutes are not available.

• Obtain written representations in respect of subsequent events.

5. Express Limited is a medium size entity engaged in trading of electronic appliances. After the issuance of financial statements and audit
report for the year ended 30 June 2016, a major debtor was declared bankrupt by the Court. No recovery has been made from the debtor after
year-end.

Required:

Evaluate the above situation and state the procedures which auditor would need to perform. (08)

A; Express Limited

The auditor has no obligation to perform any audit procedures regarding the F/S after the date of the auditor’s report. However, the matter has
come to the knowledge of the auditor and bankruptcy of customer is indicative of condition that existed at balance sheet date as no recovery has
been made from the debtor after the balance sheet date. Had the bankruptcy been known to the auditor at the date of the auditor’s report, it may
have caused the auditor to amend the audit report, therefore, he shall:

• discuss the matter with management and, where appropriate, those charged with governance.

• determine whether the F/S need amendment and, if so inquire how management intends to address the matter in the financial statements.

• carry out the necessary audit procedures on the amendment.

• review the steps taken by management to inform about the situation to anyone who received the original F/S and audit report.

• extend the review of subsequent events up to the date of the new audit report

• if management does not agree to change the F/S, the auditor should consider the available alternative to him.

6. Your firm is the auditor of Customized Machinery Limited (CML), a listed company, for the year ended 30 June 2015. CML has an asset base of
Rs. 3.5 billion and profit before tax of Rs. 350 million. On 10 August 2015, after the issuance of audit report but prior to the issuance of financial
statements, you have been informed as under:

(i) CML had been awarded a contract of Rs. 500 million in April 2015 for supply of specialized machinery parts in August 2015 to a foreign
customer. CML was expecting a profit of 20% on the contract. However, the government of the foreign country has placed certain restrictions on
import because of which the customer has cancelled the purchase order under force majeure clause.

(ii) The inventory against the above order is lying in the warehouse and requires an expense of Rs. 105 million in order to become usable for
other customers.

(iii) According to the management, the cancellation of this order will not affect the operations of the company in any significant manner.

Required:

Discuss how you would deal with the above situation. (7 marks)

A: The imposition of restriction by foreign country is an adjusting event as the inventory prepared for the order can not be supplied to any other
customer, without considerable expense of Rs. 105 million. The revised net realizable value of the inventory would therefore be approximately Rs.
395 million (500-105), as against the cost of Rs. 416.67 million (500+1.2), resulting in an adjustment of Rs. 21.67 million which is approximately
6.19% of the profit before tax.

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As an auditor we have no obligation to perform any audit procedures after the date of the audit report. However, in view of the fact that the above
situation has come to our knowledge, we are required to discuss the matter with management and inquire how it intends to address the matter in
the F/S.

If the F/S are amended, the auditor is required to:

• carry out the necessary audit procedures on the amendment.

• extend his review of subsequent events up to the date of the new audit report.

If management do not amend the F/S for the event identified, then the auditor should take appropriate action to prevent reliance on the audit
report after taking legal advice.

7. State the auditor’s responsibility with respect to events between the end of the reporting period and the date of the auditor’s report. (02)

A; Auditor’s responsibility with respect to events between end of reporting period and date of the auditor’s report:

The auditor is required to obtain sufficient appropriate evidence that all subsequent events that require adjustment or disclosure in the F/S:

• have been identified, and

- are suitably reported in the F/S.

8. a. Briefly describe the extent of auditor’s responsibility relating to subsequent eventsoccurring between the date of the financial statements
and the auditor’s report. (03)

b. Identify any five procedures that the auditor may undertake to fulfill the responsibilityas discussed in (a) above. (05)

A: (a) The auditor shall perform the audit procedures designed to obtain sufficient appropriate audit evidence that all events occurring between
the date of the F/S and the date of the auditor’s report that require adjustment or disclosure in the F/S have been identified.

However, the auditor is not expected to perform additional audit procedures on matters to which previously applied audit procedures have
provided satisfactory conclusions.

(b) The following procedures will help the auditor in identifying ‘subsequent events’ that require either adjustment or disclosure in the F/S:

(i) Review existing procedures (if any) laid down by the management to identify these events.

(ii) Study minutes of the meetings of Members, Board of the directors and other important executive committees (if any) held after the balance
sheet date and enquire about the matters which may be relevant in this regard.

(iii) Discuss with key officials on matters such as company’s policy on marketing of new products, price structure, major sales orders booked or
cancellation of sales orders and loss of major customers, if any, new borrowings, capital commitments, fresh guarantees, outcome of pending law
suits and any change in accounting policies etc.

(iv) Ascertain the status of litigations, claims etc. against the company from its legal advisors.

(v) Read the entity’s latest available budgets, cash flow forecasts and other related management reports for periods after the date of the F/S.

9. You were the engagement partner on the audit of Bhurban Limited (BL) for the year ended 30 September 2012. A few days after the issuance
of the audited financial statements, the job senior informed you that a long outstanding suit for recovery of Rs. 140 million has been decided in
favour of BL and the amount has been recovered. The profit before taxation, as reported in the financial statements for the year ended 30
September 2012 was Rs. 178 million and the above debt had been fully provided for in those financial statements.

Required:

Describe what actions you would need to take in this regard. (12)

A; Decision given by court confirms the existence of debtor which is material, therefore audit report issued on the basis of provision against debtor
does not hold good and therefore auditor needs to amend the report.

In view of the above, the auditor needs to take the following steps:

• Discuss the matter with management and, where appropriate, TCWG.

• Inquire how management intends to address the matter in the F/S.

• If management amends the F/S, the auditor shall:

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Carryout audit procedures (as may be necessary under circumstances) on the amendment. Review the steps taken by management to ensure that
anyone in receipt of the previously issued F/S together with the auditor’s report thereon is informed of the situation.

Extend the audit procedures on subsequent events to the date of the newauditor’s report and date the new auditor’s report no earlier than the
date of approval of the amended F/S; and .

Provide a new auditor’s report on the amended F/S.

• Provide a new or amended auditor’s report that includes a statement in an emphasis of matter paragraph or other matter paragraph that
conveys that the auditor’s procedures on subsequent events are restricted solely to the amendment of the F/S as described in the relevant note to
the F/S; and

The emphasis of matter paragraph or other matter paragraph included in new or amended auditor’s report shall refer to a note to the F/S that
more extensively discusses the reason for the amendment of the previously issued F/S and to the earlier report provided.

• If the management does not take the necessary steps to ensure that anyone in receipt of the previously issued F/S is informed of the situation,
the auditor shall notify management and where appropriate, TCWG, that the auditor will seek to prevent reliance on the auditor’s report

. If despite such notification, management or TCWG do not take necessary steps, the auditor shall take appropriate action to seek to prevent
reliance on the auditor’s report.

10. List the audit procedures that may be performed by the auditor in order to ensure that all events occurring between the date of the financial
statements and the date of the auditor’s report that require adjustment of, or disclosure in, the financial statements are identified and
appropriately reflected in the financial statements. (10 marks)

A: The following procedures will help the auditor in identifying ‘subsequent events’ that require either adjustment or disclosure in the F/S:

(i) Review existing procedures (if any) laid down by the management to identify these events.

(ii) Study minutes of the meetings of the Members, Board of directors and other important executive committees (if any) held after the balance
sheet date and enquire about the matters which may be relevant in this regard.

(iii) Discuss with key officials on matters such as company’s policy on marketing of new products, price structure, major sales order booked or
cancellation of sales orders and loss of major customers, if any, new borrowings, capital commitments, fresh guarantees, outcome of pending law
suits and any change in accounting policies etc.

(iv) Ascertain the status of litigations, claims etc. against the company from its legal advisors.

(v) Inquire, or extend previous oral or written inquiries, of entity’s legal counsel concerning litigation and claims

(vi) Read the entity’s latest available budgets, cash flow forecasts and other related management reports for periods after the date of the F/S.

(vii) Obtain written representation from the management that all relevant events have been appropriately accounted for/dealt with.

(viii) Obtain an assurance from management about the :

• Current status of items that were accounted for on basis of estimates or inconclusive data.

• Any events occurred or likely to occur which will require change in the existing accounting policies.

• Any events which may cast doubts about the validity of entities 'going concern’ assumption. For this purpose, the auditor should remain alert for
the circumstances which may cast significant doubt on the company’s ability to continue as a going concern.

11. Fieldwork for the annual audit of Peach Textile Mills Limited (PTML) has been completed and the financial statements and the audit report
are due to be signed next week. During the concluding meeting with the client, the auditor was informed that a fire has destroyed all the raw
cloth placed in the warehouse at the mill. About 60% of the destroyed cloth was purchased after the reporting date. However, due to certain
defect in the insurance policy, the insurance company settled the claim by paying 80% of the amount of loss. Required: Explain the auditor’s
responsibility and the audit procedures and actions that should be carried out by the auditor in the above situation. (05)

A: The auditor is responsible to consider the impact on the F/S, of all events that take place before the signing of the audit report.

The loss due to fire is a non-adjusting event as it is indicative of conditions that arose after the reporting period. Therefore in the above situation
auditor will need to carry out following procedures:

a) Assess the financial impact of the damage as may have been determined by the management by reviewing the accounting documents, board
minutes, surveyor’s report etc.

b) If the event needs to be disclosed in the F/S, because of its materiality, advise the management to make appropriate disclosure.

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c) If appropriate disclosure is not made or disclosure is inappropriate, consider modification of the audit report.

12. The management of Zafar Textile Limited (ZTL) has become aware of an error in its audited financial statements after its issuance to the
shareholders. ZTL intends to rectify the error and have approached the auditor for issuance of a new audit report on the revised financial
statements.

Required: Describe the procedures which the auditor should adopt in the above circumstances. (08 )

A: When management revises the F/S, the auditor should undertake the following audit procedures.

a) Carry out the audit procedures necessary in the circumstances

b) Audit procedures should be designed to obtain sufficient appropriate audit evidence that all events up to date of auditor’s report that may
require adjustment of, or disclosure in, F/S have been identified.

c) Review the steps taken by management to ensure that anyone in receipt of the previously issued F/S together with the auditors’ report thereon
is informed of the situation

d) Issue a new report on the revised F/S. The new auditors’ report should include an emphasis of a matter paragraph referring to a note to the F/S
that more extensively discusses the reason for the revision of the previously issued F/S and to the earlier report issued by the auditor.

e) The new audit report should be dated not earlier than the date of approval of the revised F/S.

f) If the auditor is unable to obtain sufficient, appropriate audit evidence or if he is not satisfied with the steps taken by the management, he shall
seek a legal opinion.

ISA – 580

1. Your audit client has provided you a draft representation letter. The extract from the representation letter is as follows:

No management employee is involved in any fraudulent activity.

All the related party transactions and the identities of those related parties have been disclosed to you. These have also been appropriately
accounted for and disclosed in accordance with the requirements of International Financial Reporting Standards.

All the uncorrected misstatements identified are immaterial individually and

therefore do not need any adjustments.

Required:

Critically analyze the above representations given by the audit client. (08)

A: Representation from management regarding any knowledge of fraud, which has occurred is required. However, only obtaining the
representation regarding management employees narrows the representation. The representation should also include management and other
employees. Furthermore, the wording is more directed towards an absolute assurance that no fraud has occurred. Preferably the representation
should state that “no frauds...had come to the attention of management” rather than “no frauds...have occurred”.

The auditor is required to obtain a representation from the management regarding the related party relationship and transactions. However, in the
above statement, management has only given the representation of those related parties with which transactions have been made. In fact,
representation should to be obtained for all the related party relationships, irrespective of the fact that whether transaction has been made or not.
Similarly, disclosures are also required for all related party relationships.

Materiality of uncorrected misstatement should be evaluated on aggregate basis instead of individually. If aggregate uncorrected adjustments are
immaterial, representation letter may include the effect of any uncorrected immaterial misstatements.

2. Your firm is the auditor of Iota Limited (IL) and audit report is expected to be signed on 10 March 2021.

IL’s management has just informed you that due to certain personal reasons, CEO will not be available from 5 March 2021 to 15 March 2021.
They have provided you with the following alternate options:

(i) CEO will sign all the representations either on 4 March 2021 or 16 March 2021.

(ii) CEO will call on 10 March 2021 to the engagement partner and will verbally confirm all the representations required by the auditor.

Required:

Comment on the acceptability of each option with reason(s) and suggest the best course of action for obtaining the representations in the
above scenario. (06)

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A: Representation letter dated 05 March 2021:

Offer of CEO cannot be accepted as the letter of representation is to be dated as near as practicable to the date of audit report because further
matters might also arise during the intervening period for which the auditor may require management representation.

Representation letter dated 16 March 2021:

The audit report should not be signed unless the written representation has been received as it supports other audit evidence obtained during the
course of audit. If management does not provide the written representation, it will result in limitation of scope, which would impact the audit
opinion.

Verbal Representation:

Verbal evidence is not strong audit evidence. Therefore, in order to improve the quality of this evidence, the auditor will need to ask for any
significant discussions to be confirmed in writing.

Suggestion:

If it is practicable to do so sign the audit report on 16 March 2021 or management representation may be obtained from the Chief Financial Officer
or those charged with governance on the date of signing.

3. You are the manager of Saba and Company, Chartered Accountants, responsible for the audit of Tiger Limited (TL). While reviewing the draft
financial statements and the working paper file, following matters have come to your attention:

(i) No subsequent events were identified.

(ii) During the stock count, certain items were physically present but were not appearing in stock sheets provided by TL. The management
informed you that these items were sold but were not dispatched upon customer request.

(iii) TL has a policy for making full provision against receivables when they become overdue for 360 days or more. However, three customers
were not fully provided for in accordance with the TL’s policy. The management contented that they are rigorously following up with these
parties and are confident to recover the outstanding balances very soon.

(iv) There was only one litigation pending against the company which has appropriately been disclosed in the financial statements.

Required: Discuss whether it would be necessary to obtain management representation in respect of above matters.

A: (i) The must be included in the representation letter. The written representation must cover that there were no events subsequent to the date
of the financial statements and for which IFRSs require adjustment or disclosure.

(ii) This may not be included in the representation letter. The auditor should obtain sufficient appropriate evidence on this matter such as checking
the customer correspondence or directly confirming from the customer. However, after obtaining sufficient appropriate audit evidence, the auditor
may still ask for management representation that the stock has been held on the instruction of the customer.

(iii) This should not be included in the representation letter. This is a matter of incorrect application of accounting policy, which the auditor should
discuss and resolve with the management.

(iv) The auditor must include this matter in the representation letter. The representation would cover that all known actual or possible litigation
and claims, whose effects should be considered when preparing the financial statements, have been disclosed to the auditor and accounted for and
disclosed in the financial statements.

4. Tariq Limited (TL) is in dispute with one of its suppliers Hamid (Private) Limited (HPL) over a claim of Rs. 10 million; due to quality issues with
the product. The management has informed you that negotiations with HPL have concluded and HPL has agreed to pay Rs. 7 million whereas
the rest of the amount would be written off. TL’s management has provided a written representation to the auditor with respect to the said
receivable. However, they want to preclude the auditor from sending a confirmation to HPL.

Required:

Evaluate the appropriateness of written representation as audit evidence and determine the course of action available to the auditor in the
above situation. (07)

A; Written representations are necessary information that the auditor requires in connection with the entity's financial statements. Although
written representations provide audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters
with which they deal.

The fact that the management has provided reliable written representations do not affect the nature or extent of other audit evidence that the
auditor should obtain. Hence, considering the scenario, the auditor should take the following steps to obtain the required evidence:

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• Inquire management about reasons for refusal to send confirmation.

• Seek audit evidence as to their validity and reasonableness.

• In case a valid reason is not provided by the management, evaluate the implications of management’s refusal on the auditor’s assessment of the
relevant risks of material misstatement, including the risk of fraud and on the nature, timing and extent of other audit procedures;

Perform alternative audit procedures to obtain relevant and reliable audit evidence, such as:

— Obtain the correspondence with the supplier.

— Check subsequent receipt from the supplier.

• Communicate with those charged with governance, if:

— The auditor concludes that management’s refusal to allow the auditor to send a confirmation request is unreasonable.

— The auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures.

• The auditor shall determine the implications for the audit and the auditor’s opinion in accordance with ISA 705 given such a limitation on scope.

5. You are the audit manager responsible for the audit of Hub Mills Limited (HML). At the planning stage, materiality level was determined at
Rs. 8 million.

Audit team has completed the audit field work for the year ended 30 June 2018 and has presented the following issues identified during the
audit for your review:

(i) Goods worth Rs. 3 million were returned by a customer on 5 July 2018 due to poor quality. Since the goods were returned subsequent to year
end, no adjustment has been recorded by the management.

(ii) HML is facing liquidity issues which has resulted in adverse key financial ratios. To address the issue, HML has sold one of its offices to a
company managed by a director of HML. The office was sold for Rs. 40 million. Since the management had correctly recorded the disposal, no
specific disclosures related to this sale have been made in the financial statements. Directors are confident that these sale proceeds would solve
the cash flow problems of HML.

(iii) A customer who owed Rs. 11 million at year-end, was declared bankrupt on 15 August 2018. The management had already provided 50% of
the balance in the financial statements.

Revenue for the current year is Rs. 800 million (2017: Rs. 950 million) and loss before tax is Rs. 22 million (2017: Rs. 7.6 million).

Required:

(b) What matters would you want to include in the management representation letter, with regard to the above issues. (05)

A: If he discovers previously unidentified or undisclosed related parties or (significant) related party transactions he must:

(i) promptly communicate the relevant information of the related party transaction to other members of the audit team.

(ii) perform appropriate substantive procedures on the newly identified related parties or significant related party transactions.

(iii) request management to identify all transactions with the newly identified related parties.

(iv) inquire as to why the entity's internal control system failed to identify or disclose these related party relationships or transactions.

(v) Reassess the risk of there being unidentified or undisclosed related parties or (significant) related party transactions and respond to the
reassessed risk.

(vi) If the non-disclosure by management appears intentional (and therefore indicative of risk of material misstatement due to fraud), evaluate the
implications for the audit.

6. What course of action should the auditor take, if he doubts the reliability of the management representation due to its inconsistency with
other audit evidence? (04)

A: • Perform other audit procedures to attempt to resolve the matter or finalize your view point.

• Consider the effect of the above on reliability of other representations and the audit evidence.

• Consider whether the risk assessment remains appropriate and if not, revise the risk assessment and determine the nature, timing and extent of
further audit procedure. The auditor may also reconsider assessment of the competence, integrity, ethical values or diligence of the management.

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• If the auditor has concerns about the integrity of management, he should document those concerns and consider withdrawing from the audit and
the impact on the report.

7. You are the audit partner of GMP & Company, Chartered Accountants. The following matters are under your consideration:

(a) The CEO of a client is travelling out of the country on 20 September 2017 and would not be available on the date of signing of report which is
29 September 2017. However, he has offered to sign all the representations before leaving. (04)

(b) A client has modified the representation letter with regard to the responsibility of management to provide the auditor with all information
relevant for the purpose of audit. It has been stated, that “except for the information destroyed in fire, we have provided all the necessary
information for the purpose of audit”. (03)

(c) The managing director of a client which is a family owned business has sent the following email to the audit manager:

“I believe the financial statements we have provided to you are final. Although adjustments are required to correct some of the balances, but
being immaterial, they would not affect the decision making of the owner. We therefore believe that the audit report may now be signed and
the required corrections may be included in the representation letter”. (04)

Required:

Discuss how you would deal with the above situations.

A: (a) Offer of CEO cannot be accepted as the letter of representation is to be dated as near as practicable (but not after) the date of audit report,
because:

• written representation is also obtained in respect of subsequent events

• further matters might also arise during the course of audit for which we may require management representation.

However, the written representations are requested from those responsible for the preparation of financial statements. Therefore, in the absence
of the Chief Executive Officer, management representation may be obtained from the Chief Financial Officer and those charged with governance.

(b) If the management modifies our requested wording, we may still be able to conclude that it is a reliable representation.

However, before arriving at any conclusion, we must consider the effects of the information destroyed in the fire on the financial statements and
on our ability to obtain the necessary audit evidence and the possible impact on our audit report.

(c) If adjustments are immaterial, representation letter may include the effect of any uncorrected immaterial misstatements. However, the decision
regarding materiality of the uncorrected misstatements is to be made by the auditor and not by the client.

Further, materiality depends on the fact that omission or misstatement would influence the economic decision of the user, and the financial
statements are relevant not only for the owners but also for other users which may include bankers, government institutions, etc., therefore, the
comment of the managing director regarding the effect on decision making is not correct.

If financial statements remain uncorrected and the required correction is material also, its impact on audit report would need to be assessed.

8. Briefly state the course of action which should be adopted by a firm if the requested written representations are not provided by the
client.(02)

A: • Discuss the matter with the management.

• Re-evaluate the integrity of the management.

• Take appropriate action including determining the possible effects on the auditor’s report.

9. You are the audit manager at Afzal Textile Mills Limited (ATML). While reviewing the draft financial statements and the working paper file,
the following matters have come to your attention:

(i) There is a significant decline in the number of related parties and related party transactions.

(ii) During the year, ATML has acquired 15% shareholding in Bashir Textiles Limited, a listed company.

(iii) ATML owns six buildings out of which four have been revalued during the current year while the remaining buildings would be revalued next
year.

Required:

Discuss whether it would be necessary to obtain management representation in respect of the above matters.(6)

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A: (i) This must be included in a representation letter. The written representation must cover the completeness of the information that has been
provided about the related parties and related party transactions.

(ii) This may not be included in a representation letter. The auditor should obtain sufficient appropriate audit evidence on this matter such as
checking the shareholding in the share register, etc.

(iii) This should not be included in a representation letter. This is a matter of incorrect accounting treatment which the auditor should discuss and
resolve with the management.

10. You are the audit partner of XYZ & Company, Chartered Accountants. The following matters are under your consideration:

a) Asif Limited has made certain investments and has classified them as long term investments. The management has also provided written
representation in this regard. However, before the finalization of financial statements the company disposed of some of the said investments.
(04)

b) Mansoor Limited has entered into significant related party transactions during the year which are approved by the Board of Directors and
appropriately disclosed. The management has also agreed to provide a written representation but you have not received it yet. (03)

Required:

Analyse the above situations and explain how you would proceed in the above matters.

A: (a) In this case, the representation provided by the management contradicts with the audit evidence obtained later and therefore we should:

• consider whether his risk assessment of that area is still appropriate

• consider whether additional audit procedures are needed

• assess the impact on auditors assessment of management’s integrity, document those concerns and consider withdrawing from the audit.

(b)The written representation from the management must cover:

• the completeness of the information that has been provided about the identity of related parties and related party relationships and
transactions, and

• the adequacy of accounting for and disclosure of such related party relationships and transactions in the F/S.

The audit report should not be signed unless the written representation has been received.

If management does not provide the written representation, it will result in limitation of scope and we would take appropriate actions, including
determining the possible effect on the opinion in the auditor’s report.

11. State the matters that auditor needs to consider where the written representation provided by the management is inconsistent with other
audit evidence. (03)

A: If a representation by management is contradicted by other audit evidence, the auditor should:

• consider whether his risk assessment of that area is still appropriate.

• consider whether additional audit procedures are needed.

If the auditor has concerns about the integrity of management, document those concerns and consider withdrawing from the audit.

12. The management of Pioneer Textile Limited (PTL) has provided you with management representation that they have disclosed to you all
known instances of non-compliances with laws and regulations that are relevant to the preparation of the financial statements.

However, during the field work your team identified a payment of penalty of Rs. 2 million to an environmental agency. PTL’s management
claims that the disclosure of the related non-compliance was inadvertently omitted.

Required:

Discuss the appropriateness of management representation and how would you deal with the above situation. (05)

A: The management representation regarding disclosure of non-compliance with law does not remain appropriate, as it contradicts with the audit
evidence obtained.

To address the contradiction, we should:

• consider whether his risk assessment of that area is still appropriate.

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• consider whether additional audit procedures are needed.

• consider the integrity of management, document those concerns and consider the possible course of action.

13. Hashim Industries Limited (HIL) is a manufacturer of household appliances. Its products are popular in the market mainly because the
company provides are placement warranty for three years. HIL’s auditor has verified that the basis of arriving at the warranty provision is same
as in the previous year. However, the auditor has requested a written representation from the management that there is no significant change
in circumstances necessitating a change in the basis of arriving at the amount of warranty provision. The management has yet to confirm
acceptance of this representation.

Required:

Discuss the importance of written representation in the above situation and list the steps that the auditor should take and the possible impact
on the audit report, if the management is not willing to provide the required written representation.(11)

A: (a) The Auditor is generally not in a position to obtain evidence from an external source in relation to warranty provisions. Hence the written
representation, whilst being an entity generated source of evidence, would still be useful as there are few other alternatives.

Steps to take if written representation on warranty provision is not provided

• If management does not provide the requested written representation on the warranty provision the auditor should discuss the matter with
management to understand why they are refusing.

• In addition, the auditor should re-evaluate the integrity of management and consider the effect that this may have on the reliability of other
representations (oral or written) and audit evidence in general.

• Auditor should then take appropriate actions, including determining the possible effect on the audit opinion.

Impact on audit report

Unless auditor is able to obtain sufficient appropriate evidence* to conclude that warranty provision is free from material misstatement, a
modified audit opinion will be required, as discussed below:

• If the warranty provision is material but not pervasive then a qualified opinion would be appropriate, a disclaimer of opinion would be
appropriate if the effect of misstatement is both material and pervasive.

14. Strong Vehicles Limited (SVL) manufactures heavy vehicles. As the job incharge on SVL’s audit , you have come across the following
situations:

The management has provided you with written representation that lives of fixed assets are realistically estimated. Similar representation was
also provided in the prior years. However, SVL has incurred losses on disposal of fixed assets during the year, because of which you are now of
the view that the useful lives of fixed assets were not realistically estimated. (04)

A: • Representation provided by management that useful lives of fixed assets are realistically estimated seems inconsistent with audit evidence
related to the losses on disposal of fixed assets.

• However, since the matter pertains to future estimates, the error does not seem to render other management representations unreliable.

• The auditor shall discuss the matter with the management to attempt to resolve the matter.

• If after discussion with the management, the matter remains unresolved, the auditor may:

• Consider whether the risk assessment remains appropriate and, if not, revise the risk assessment and determine the nature, timing and extent of
further audit procedures.

• Ask the management to reassess the estimated useful lives of fixed assets.

15. Briefly discuss how the auditor would deal with a situation where he is in doubt regarding the reliability of the written representations
provided by the management of the company. (05 mark)

A: How the auditor would deal with a situation where he is in doubt as regards the reliability of the written representation provided by the
management of the company:

The doubt as regards management’s representation can be on account of several different reasons. Auditor’s response in each situation is
described below:

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• If there is inconsistency between one or more written representations and audit evidence is obtained from another source, the auditor may
consider whether the risk assessment remains appropriate and, if not, revise the risk assessment and the nature, timing and extent of further audit
procedures to respond to the assessed risk.

• If the matters relates to the competence, integrity, ethical values, diligence and commitment of management, the auditor may conclude that the
audit cannot be conducted. In such a situation,

the auditor may consider withdrawing from the engagement and if withdrawal is not possible, he may disclaim an opinion.

16. As part of the audit process, the management provides written representations to confirm certain matters in connection with the audit.

Required:

a) State the matters that you will consider as an auditor while assessing the reliability of representations made by the management. (05 marks)

b) Describe the course of action available to an auditor if the management refuses to provide representation on a particular issue. (05 marks)

A: (a) Matters that will be considered as an Auditor while assessing the reliability of representation made by the management:

When the representations relate to matters material to the F/S:

(i) Whether the representations appear reasonable and consistent with other audit evidence obtained.

(ii) Whether the individuals making them can be expected to be well informed on such matters.

(iii) Integrity of those making the representations.

(iv) Accuracy of representations made in the past.

(v) Corroborate audit evidence from sources inside or outside the entity.

(b) Auditor’s course of action if management refuse to provide a management representation on a particular issue:

If management does not provide one or more of the requested written representations, the auditor shall:

(i) Evaluate whether sufficient, appropriate audit evidence can be obtained from other sources;

(ii) If sufficient appropriate audit evidence cannot be obtained from other sources than this will constitute a scope limitation and the auditor should
express a qualified opinion or disclaimer of opinion.

(iii) Re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of representations (oral or written) and
audit evidence in general; and

(iv) Consider possible implications that the refusal may have on the auditor’s report.

(v) Re-assess the continuation of engagement with the audit client

17. One of the objectives of obtaining a written representation from management is to ensure that the management knows and acknowledges
its responsibility for the preparation of the financial statements and for the completeness of the information provided to the auditor.

Required:

Specify the situations which may create doubts as to the reliability of written representations. What course of action would the auditor take in
such a situation? (07)

A: Under the following situations, the auditor would have doubt as to the reliability of written representation:

(a) When the auditor has concerns about the competence, integrity, ethical values or diligence of management, or about its commitment to or
enforcement of these.

(b) When written representations are inconsistent with other audit evidence obtained.

Course of action in situation (a)

(i) The auditor shall determine the effect that such concerns may have on the reliability of representations and audit evidence in general.

(ii) If the auditor concludes that the risks related to management representations on the F/S is such that an audit cannot be conducted, the auditor
may consider withdrawing from the engagement

Course of action in situation (b)

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(i) The auditor may consider whether the risk assessment remains appropriate and, if not, revise the risk assessment and determine the nature,
timing and extent of further audit procedures to respond to the assessed risks.

(ii) If the matter remains unresolved, the auditor shall reconsider the assessment of the competence, integrity, ethical values or diligence of
management, or of its commitment to or enforcement of these, and shall determine the effect that this may have on the reliability of other
representations and audit evidence in general.

(iii) If the auditor concludes that the written representations are not reliable, the auditor shall take appropriate actions, including determining the
possible effect on the opinion in the auditor’s report.

ISA —700& Form 35A

1. In relation to the audit report on financial statements and the contents thereof (under revised/new ISAs), discuss the appropriateness or
otherwise of the following statements:

(d) The description of the auditor’s responsibilities for the audit of the financial statements should be included within the body of the auditor’s
report. (03)

(e) The audit report can only be signed in the personal name of the auditor. (02)

A: (d) The statement is not appropriate the responsibilities in addition to the main body of the audit report can be included;

• Within an appendix to the auditor’s report, in which case the auditor’s report shall include a reference to the location of the appendix; or

• By a specific reference within the auditor’s report to the location of such description on a website of an appropriate authority.

(e) The statement is not appropriate as the audit report can either be signed in the name of the audit firm or the personal name of the auditor or
both.

2. Explain the term ‘expectation gap’ in the context of an audit and give three examples of expectation gap. ( 4 marks)

A: The term 'expectation gap’ refers to the fact that the public perception of the role and responsibilities of the external auditor is different from
his statutory role and responsibilities. The expectations of the public are often set at a level higher than that at which the external auditor actually
operates.

Some examples of the misunderstandings inherent in the public’s expectations are as follows:

• The public believes that the audit opinion in the audit report amounts to a ‘certificate’ that the F/S are correct and can be relied upon for all
decision-making purposes.

• The public also believes that the auditor has a duty to prevent and detect fraud and that this is one reason for an audit.

• The public assumes that, in carrying out his audit work, the auditor tests 100% of the transactions undertaken during the accounting period.

3. Differentiate between the following:

(i) Fair presentation framework and compliance framework (04 marks )

A: The term fair presentation framework is used to refer to a FRF that requires compliance with the requirements of the framework and:

• Acknowledges explicitly or implicitly that, to achieve fair presentation of the F/S, it may be necessary for management to provide disclosures
beyond those specifically required by the framework; or

• Acknowledges explicitly that it may be necessary for management to depart from a requirement of the framework to achieve fair presentation of
the F/S. Such departures are expected to be necessary only in rare circumstances.

Term ‘compliance framework’ is used to refer to a FRF that requires compliance with the requirements, but does not contain acknowledgements of
fair presentation framework

4. The auditor is required to issue an audit report at the end of the audit, which sets out his opinion on the financial statements. An important
element of the audit report is the statement of auditor’s responsibility. Required: Narrate the matters that should be contained in the
statement of auditor’s responsibility as included in an audit report issued under ISA-700 ‘The Independent Auditor’s Report on a Complete Set
of General Purpose Financial Statements’. (08)

A: • The statement of responsibility should state the following:

• It is the responsibility of the auditor to express an opinion on the F/S.

• The audit was conducted in accordance with International Standards on Auditing.

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• Those standards require that :

the auditor complies with ethical requirements.

the auditor plans and performs the audit to obtain reasonable assurancewhether the F/S are free from material misstatement.

• That an audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the F/S.

• As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit.

• That while selecting the procedures to be performed the auditor exercises judgment, including the assessment of risks of material misstatements
and whether due to fraud or error.

• In making the risk assessment the auditor considers internal controls relevant to fair presentation of F/S in order to design audit procedures that
are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.

• That an audit includes evaluation of the appropriateness of the accounting policies used, the reasonableness of estimatesand the overall
presentation of information in the F/S.

• That auditor has concluded on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit
evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability
to continue as a going concern.

• That an audit involves evaluating the overall presentation, structure and content of the F/S, including the disclosures

• That auditor communicate with TCWG regarding, among other matters, the planned scope and timing of the audit and significant audit findings,
including any significant deficiencies in internal control that auditor identify during the audit.

• That auditor also provide TCWG with a statement that auditor have complied with relevant ethical requirements regarding independence, and to
communicate with them all relationships and other matters that may reasonably be thought to bear on auditor’s independence, and where
applicable, related safeguards.

5. The auditor’s report as specified in form 35A in the Companies (General Provisions and Forms) Rules, 1985 includes the auditor’s opinion on
certain matters which have not been specified in the format of auditor’s report given in the International Standards on Auditing. Required: List
the additional reporting responsibilities of the auditor, as discussed in the preceding paragraph. (08)

A: The report specified in form 35A in the in the Companies (General Provisions and Forms) Rules, 1985 covers the following additional reporting
responsibilities.

(i) that proper books of accounts are being maintained by the company as required by the Companies Ordinance, 1984.

(ii) that the balance sheet and the profit and loss account together with notes thereonare in conformity with the Companies Ordinance, 1984 and
in agreement with the books of accounts and are further in accordance with the accounting policies consistently applied.

(iii) Opinion as regards the following:

• whether expenditure incurred during the year was for the purposes of the company’s business and

• whether the business conducted, investments made and expenditure incurred during the year were in accordance with the objects of the
company.

(iv) Opinion as regards the following:

• whether Zakat deductible at source under the Zakat and Usher Ordinance, 1980; was deducted and

whether the zakat deducted (if any) was deposited in the Central Zakat Fund.

ISA – 701

1. Respond to the following independent situations in the light of International Standards on Auditing:

(a) Risk of overstatement in revenue was considered as significant risk and was also communicated to those charged with governance. Discuss
whether it should be included in the key audit matters section. (04)

(b) No such matter arose during the audit which needs to be reported as key audit matter.

Discuss whether the auditor still needs to include key audit matters section in audit report. (02)

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(c) A qualified opinion has been expressed. The details of the qualification are also mentioned in the key audit matters section. Is it appropriate
to do so? (03)

A: (a) The audit report should include only those matters in the KAM section which required significant auditor attention.

Areas which require significant auditor attention are those which:

• Involve significant audit risks

• Significant judgement on the part of management / auditor.

• Significant transactions and events affecting the audit.

Even though KAMs are extracted from the matters communicated with those charged with governance, however, not all significant risks or matters
communicated to those charged with governance are considered as KAMs. The auditor needs to determine whether the risk of overstatement of
revenue fulfills the above mentioned criteria and is of most significance to the current year audit, only then it can be included as a key audit matter.

(b) Even if the auditor determines, depending on the facts and circumstances of the entity and the audit, that there are no key audit matters to
communicate, the audit report shall include the key audit matter section.

The fact that there are no key audit matters to communicate in the report, should be mentioned under the heading Key Audit Matters.

(c) A matter giving rise to a qualification by their nature is a key audit matter. However, these matters shall not be described in the Key Audit
Matters section of the audit report, rather the matter is to be reported in accordance with the requirements of related ISA. However, reference to
the basis for qualified opinion is to be included in the Key Audit Matter section.

2. You are the audit partner in a firm of chartered accountants. Some of the audits are in the finalization stage and presently the following
matters are under your consideration:

(a) The management of Sohni Limited has changed its revenue recognition policy. As the audit engagement partner you are satisfied with the
accounting and disclosures related to change in accounting policy. Further, the impact of the change is significant.

Required:

Discuss the possible impact on the audit report and specify the procedures (if any) which you would undertake in the above situations

A: Change in accounting policy has to be reported as a key audit matter. For this purpose it is necessary that it should be discussed with TCWG. In
the key audit matter section, the auditor shall:

• include a reference to the related disclosure(s), if any, in the F/S

• state why the matter was considered to be one of most significance in the audit;

• specify how the matter was addressed in the audit.

3. In relation to the audit report on financial statements and the contents thereof (under revised/new ISAs), discuss the appropriateness or
otherwise of the following statements:

(f) Key audit matters are determined from the matters communicated with the management of the entity that required significant auditor’s
attention in performing the audit. In making that determination, the auditor shall take into account the effects on the audit of significant events
or transactions that occurred during the current

year and prior period presented. (03)

A: The statement is not appropriate as the Key Audit Matters are selected from the matters communicated with TCWG and in making those
assessments matters pertaining current period only are considered as opposed to matters pertaining to prior period.

ISA 705 & ISA 706

1. You are the audit partner in a firm of Chartered Accountants. Following independent matters for the year ended 31 December 2021 are
presently under your consideration:

(a) Pioneer Electronics Limited (PEL) had implemented a new accounting software in 2021. Due to high pressure from top management, the
implementation of the new accounting software was hurried, which has resulted in numerous errors in the inventory, payable and receivable
module of the software. PEL’s staff is still in the process of identifying and rectifying the software deficiencies. The audit team has been unable
to verify these balances through alternate means. Inventory, payable and receivable are appearing as Rs. 200 million, Rs. 150 million and Rs. 100
million respectively in the financial statements.

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Profit before tax is Rs. 500 million, whereas the net assets are Rs. 1,850 million. (07)

(b) Your firm has been appointed as auditor in place of retiring auditor for Smart Footwear Limited (SFL), a listed company. SFL owns number of
retail outlets across Pakistan and many of them were acquired on rental basis. During the year, SFL has adopted IFRS 16 ‘Leases’. The audit team
has made significant efforts to review the adjusting entries made in the financial statements to reconcile the change in accounting policy of
operating leases. The matter was discussed in detail in the audit committee meeting.

Your team has included the details about adjustments and impact on financial statements in the board letter. (07)

Required:

In each of the above independent situations, discuss the reporting implication(s) including the changes that needs to be made in the audit
report as illustrated in ISA-700.

A: (a) Reporting implication:

Multiple accounts balances of the financial statements are affected for which the auditor has not been able to obtain sufficient appropriate audit
evidence, which is a scope limitation imposed by the circumstances. Since the undetected misstatements are not confined to single specific
element of the financial statements and these also represent a substantial portion of the financial statements, it will have a pervasive effect on the
financial statements.

Auditor shall disclaim an opinion as they are unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor
concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.

Changes in the standard audit report:

When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor shall state in the opinion
paragraph that:

• the auditor does not express an opinion on the financial statements.

• because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, the auditor has not been able to obtain
sufficient appropriate audit evidence to provide a basis for an audit opinion;

• the auditor shall amend the opinion section of the auditor’s report to state that the auditor was engaged to audit the financial statements.

• the auditor shall also amend the description of the auditor’s responsibility and the description of the scope of the audit accordingly.

• unless required by law or regulation, when the auditor disclaims an opinion on the financial statements, the auditor’s report shall not include a
Key Audit Matters section in accordance with ISA 701.

(b) Reporting implication:

The matter of application of IFRS 16 is significant as Smart Footwear operates through number of rentals outlets. Furthermore, the change in
accounting policy and related adjustments have taken considerable time of audit team to verify. The matter was also discussed and brought to the
knowledge of those charged with governance in the meeting of the audit committee and through board letter. Considering all these factors, the
auditor will add the matter of application of IFRS 16 as key audit matter in the audit report.

Changes in the standard audit report:

Since the financial statements of previous year were audited by another auditor, the other matter paragraph will be added in the report which will
mention that the financial statements were audited by another auditor, the type of opinion expressed and the date of that auditor’s report.

2. You are the audit manager in a firm of chartered accountants. Following independent matters are under your consideration:

(i) In the draft financial statements of Elrond (Private) Limited (EPL) for the year ended 30 June 2021, capital work in progress of Rs. 100 million
related to construction of a new production facility is included in property, plant and equipment. Your team has observed that the last cost
incurred on the said facility was on 30 April 2021. However, it was put to use from 1 August 2021 and therefore no depreciation has been
charged at the year-end.

The useful life of the said facility is assessed to be 10 years. The draft financial statements show that EPL’s profit before tax is Rs. 150 million.

(ii) Cafe Elixiar (Private) Limited (CEL) operates a chain of cafes in Pakistan. Before the year-end, a large number of customers complained about
food poisoning, possibly as a result of eating at the cafe. Some of the customers have taken legal action against CEL. An out of court settlement
with these customers is under process. No information has been provided in this regard in the draft financial statements.

Required:

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For each of the above independent matters:

(a) state the audit procedures which may be performed by your audit team. (10)

(b) discuss the implication(s) on the audit report. (08)

A: EPL-Audit Procedures:

(i) Inquire from management when the asset was available for use.

(ii) Obtain the engineer’s certificate / documentation to assess when the asset was completely built.

(iii) Read the management meeting minutes to find out whether any discussion has been made related to the project completion.

(iv) Obtain management representation regarding when the asset was available for use.

(v) Inspect the purchase invoice of the additions made to this CWIP.

(vi) Review that only capital expenditure has been capitalized and revenue expenses has been recorded in profit and loss.

(vii) Review the useful life for reasonableness by comparing it with other similar assets.

EPL-Reporting Implications:

EPL should start depreciating the asset when it is available for use and not when it is put to use. If it is established that the asset has been
completed before year end, the management of EPL should be asked to record depreciation. However, the maximum possible adjustment i.e. Rs.
1.67 million is below the materiality level i.e. Rs. 7.5 million. Therefore there would not be any impact on the audit report and we will express an
unqualified opinion. The potential adjustment amount would need to be added to the list of uncorrected misstatements and assess that whether
they are material in aggregate. We will also obtain a written representation in this regard that the effects of uncorrected misstatements are
immaterial, both individually and in the aggregate, to the financial statements as a whole.

(v) Inspect the purchase invoice of the additions made to this CWIP.

(vi) Review that only capital expenditure has been capitalized and revenue expenses has been recorded in profit and loss.

(vii) Review the useful life for reasonableness by comparing it with other similar assets.

EPL-Reporting Implications:

EPL should start depreciating the asset when it is available for use and not when it is put to use. If it is established that the asset has been
completed before year end, the management of EPL should be asked to record depreciation. However, the maximum possible adjustment i.e. Rs.
1.67 million is below the materiality level i.e. Rs. 7.5 million. Therefore there would not be any impact on the audit report and we will express an
unqualified opinion. The potential adjustment amount would need to be added to the list of uncorrected misstatements and assess that whether
they are material in aggregate. We will also obtain a written representation in this regard that the effects of uncorrected misstatements are
immaterial, both individually and in the aggregate, to the financial statements as a whole.

CEL-Reporting Implications:

Not giving disclosure of the event is qualitatively material to the financial statements. The financial statements should include the disclosure
required by the applicable financial reporting framework. If CEL does not disclose this matter, it would be considered as a material misstatement
that relates to the non-disclosure of information required to be disclosed. The auditor shall:

• discuss the non-disclosure with those charged with governance;

• Express a qualified opinion

• describe in the basis for opinion section the nature of the omitted information; and

• unless prohibited by law or regulation, include the omitted disclosures, provided it is practicable to do so and the auditor has obtained sufficient
appropriate audit evidence about the omitted information.

For the customers with whom out of court settlement has been agreed a provision needs to be recorded. If the management does not record the
provision and if it is material, then the auditor shall express a qualified opinion. The auditor needs to include a basis for qualified opinion,
explaining the reasons for qualifying the opinion.

3. You are a partner in a firm of chartered accountants. Following independent matters are under your consideration:

(i) The draft financial statements of Elrond Pakistan Limited (EPL) for the year ended 31 January 2021 include inventory of Rs. 26 million that
was purchased on 1 January 2021 for fulfilling a large specialized order of a foreign customer. Due to sudden imposition of import restriction in

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the foreign country, the customer cancelled the order on 28 January 2021. The draft financial statements show that EPL’s profit before tax is Rs.
130 million.

(ii) During the audit of Stellar Limited (SL), the management informed the audit team that its largest customer, Ether Limited (EL) has recently
notified that it will not renew its contract with SL, which is due to expire on 30 June 2021. Sales from EL constitutes 70% of the total revenue.
The management has further informed that they are in negotiation with EL and are hopeful to retain the customer.

Required:

For each of the above independent matters:

(a) state the audit procedures which may be performed by your audit team. (08)

(b) discuss with reasons, the implication(s) on the audit report. (IO)

A: (i) (a) Audit procedures:

• Inquire from the management that whether any contract was made with the foreign customer.

• Review the contract to identify as to whether any recovery can be made from the customer for exiting/breaching the contract.

• Inquire from the management that since the inventory was for specific use, could it be put to some other use.

• Inquire from the management that whether they have carried out any exercise to determine the NRV of this inventory.

• Assess the managements working of NRV for accuracy.

(b) Reporting implication:

The value of the inventory recorded by management is 20% of profit before tax and therefore material but not pervasive as its effect restricted to
one account head of the financial statements.

If the management records the NRV adjustment then a clean opinion would be issued. However, the auditor may consider including it as a key
audit matter.

If the auditor considers that no major adjustment is required in the inventory value and the management has not recorded that adjustment, then
the auditor will combine it with other misstatements to assess whether the combined effect is material.

If the auditor considers that major adjustment is required in the inventory value and the management has not recorded that adjustment, then the
auditor expressed a qualified opinion. The auditor needs to include a basis for qualified opinion, explaining the reasons for qualifying the opinion.

(ii) (a) Audit procedures:

• Discuss with the management that whether they have carried out a going concern assessment.

• Discuss with management that whether there are any contingency plan(s) in place for the loss of this contract.

• Review the negotiations with EL regarding the contract renewal being carried out.

• Inquire the management that whether any new customer has been identified subsequently.

• Review the minutes of board of directors meeting to identify the course of action to be adopted by the management.

• Review the projected cash flow and profit and loss forecast prepared by the management in light of this event.

• Review subsequent financial statements of EL to obtain evidence regarding the going concern assumption.

• Obtain management representation regarding the fact that EL have sufficient resources/support from sponsors to continue as a going concern.

(b) Reporting implication:

If there is uncertainty about the going concern status of the company and management is willing to fully disclose the circumstances, a paragraph
headed Material Uncertainty Related to Going Concern should be included, highlighting the issue and drawing users’ attention to the note in the
financial statements. There should be a specific statement that the opinion is not modified.

If management refuses to disclose the uncertainty, the opinion should be modified due to misstatement/disagreement. The modification should be
a qualified opinion if the issue is considered material but not pervasive or an adverse opinion if considered material and pervasive.

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If the entity's going concern is not valid and the financial statements are prepared on an inappropriate basis and consequently many items in the
financial statements will be materially misstated. This would be pervasive requiring an adverse opinion stating that the financial statements do not
give true and fair view.

If the management is unwilling to make or extend its assessment a disclaimer of opinion would be given.

4. You are manager responsible for the audit of Oak (Private) Limited (OPL) for the year ending 30 September 2020. The following issues have
been brought to your notice by your audit team:

(i) During planning the year-end inventory count, audit team decided to visit third party premises for inventory valued at Rs. 10 million. Third
party has informed that because of restrictions imposed by the government in the wake of COVID-19, it has limited number of staff and
consequently may not allow the audit team to visit its premises for inventory count at year-end. However, the audit team may visit its premises
on or after 31 October 2020 for inventory count.

(ii) A competitor has alleged that OPL has infringed its patent rights and has taken legal action for damages of Rs. 500 million. OPL’s
independent legal advisor is of the view that no estimate can be made about the outcome of the case at this point of time. No provision has
been made for the possible loss, however OPL intends to fully disclose it in the notes to the financial statements.

The projected profit before tax is Rs. 75 million.

Required:

For each of the above issues:

(a) state the audit procedures which may be performed by your audit team. (10)

(b) discuss with reasons, the implication(s) on the audit report. (08)

A: (a) Inventory count:

Audit team should consider whether the physical count can be conducted on 31 October 2020. If the inventory count can be carried out, then the
following procedures should be performed:

■ Conduct physical inventory count after the date of the financial statements.

■ Check whether the changes in inventory between the count date and the date of the financial statements are properly recorded.

■ Investigate the reason for significant differences identified during the physical count and the inventory records.

• Assess the reliability of inventory records.

Audit team should also consider and discuss with the management and the third party that whether the physical count can be conducted through
video link.

If it is impracticable to conduct an inventory count at a later date, then the following procedures should be performed:

■ Inquire from the management whether third party will carry out any inventory count on 30 September 2020, and if yes, obtain the inventory
count sheets.

• Inquire from the management whether third party regularly provides the inventory levels held at their warehouse, and whether any
discrepancies has previously been identified.

• Obtain details of the inventory transferred to the third party warehouse and inspect documents of subsequent sale/transfer out to ascertain the
condition and existence of the inventory.

■ Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity.

Litigation:

• Discuss with the OPL's legal advisor(s) in respect of the outcome of the case.

■ Obtain the minutes of meeting with regards to discussion on this litigation.

■ Review the subsequent correspondence with the competitor, if any.

■ Involve auditor's legal expert to assess the outcome of the case.

■ Evaluate the adequacy of the disclosure in the financial statements, in particular the disclosure of the uncertainty in estimation and its
quantification.

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■ Obtain written representation from the management regarding the fact that no estimate can be made about the outcome of the case.

(b) Inventory count

■ If the auditor is able to attend the inventory count or obtains sufficient appropriate audit evidence without attending the inventory count, an
unmodified opinion will be expressed.

■ If the auditor is not able to attend the inventory count at the third party warehouse and also could not obtain sufficient appropriate audit
evidence through alternate audit procedures, it will be a limitation of scope.

If the auditor attends the inventory count on 31 October 2020 but still could not obtain sufficient appropriate evidence, it will also be a limitation of
scope.

The value of the inventory recorded by management is 13.3% of profit before tax and therefore material but not pervasive as it is isolated to one
account head of the financial statements.

Therefore, the audit opinion should be modified with a qualified opinion. The auditor needs to include a basis for qualified opinion, explaining the
reasons for inability to obtain sufficient appropriate audit evidence.

Litigation

■ If the auditor agree with management's treatment, an unmodified opinion should be issued.

■ The claim is 667% of profit before tax and represents a significant uncertainty which would turn

OPL's profit into a loss. Therefore, the audit report should be modified using an Emphasis of Matter paragraph and a brief description should draw
the users' attention to the relevant disclosure note.

• If the auditor does not agree with management's treatment based on the opinion of the auditors expert, auditor should modify his opinion
accordingly.

5. You are the manager responsible for the audit of Crown Limited (CL) for the year ended 31 December 2019. Your audit team has informed you
that CL is developing a new product ’Solar giant’ which would have three times more power generation capacity than the

regular solar panels available in the market.

CL had capitalised development costs of Rs. 40 million in 2018 and Rs. 38 million in 2019. Based on technical feasibility carried out by the
production department, testing of solar giant is in the right direction and the product would be launched as per plan in June 2020. However,
review of board minutes revealed that CL is facing technical problems that may delay the launch of solar giant till March 2021. The minutes
further revealed that CL may require to incur further Rs. 50 million for the development of this project. This would result in increase in selling
price that was originally envisaged by CL.

CL’s management is of the view that they would overcome these technical problems without incurring any additional cost and would launch the
solar giant as per original plan, in June 2020.

The draft financial statements show a profit before tax of Rs. 150 million.

Required:

State the audit procedures which may be performed in respect of above audit issue. Also discuss the implication of this issue, if any, on the audit
report. (08)

A: The total development cost incurred to date is Rs. 78 million which is 52% of profit before tax and is therefore material.

Your team should first discuss with the management and those charged with governance to evaluate the contradicting views obtained from the
board minutes and the management's explanation.

If the view of the board of directors is valid then perform the following audit procedures:

• Consider whether CL would be able to arrange the additional funding requirements for completion of the project.

■ Ask management to provide the revised marketing plans to assess that whether a market at such an increased price actually exists.

• Review revised projections, feasibility and forecasts for using resources and generating future economic benefits.

• Obtain written representation from management as to their commitment to complete the project.

■ Assess whether CL would be able to produce the solar roof at an increased cost.

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If the view of the board of directors is not valid then perform the following audit procedures:

■ Obtain and read the documentation of research team's notes and conclusions related to completion of the project and the funding requirements.

Reporting implications:

If the matter is resolved the auditor may consider including it in the key audit matter section of the audit report. However, if it is established that
conditions required for recognition of development cost are not met then auditor should request the management and those charge with
governance to expense out the development cost. If they disagree, as the matter is not pervasive as it only affects specific items in the financial
statements and therefore a qualified opinion should be issued. The audit report should include an explanation of the issue in the basis for qualified
opinion paragraph.

6. You are the audit manager on Beluga Limited (BL) for the year ended 31 August 2019. The following issues have been brought to your notice
by your audit team:

(i) BL has pending tax litigation in which tax department has raised demand of Rs. 75 million. The matter has been challenged by BL and the
decision in this respect is currently pending with the Appellate Tribunal. BL’s tax advisor is confident of positive outcome of this litigation. No
provision has been made in this regard; however, it has been disclosed as a contingency in the financial statements.

(ii) On 20 September 2019 one of the warehouses of BL caught fire destroying entire inventory, furniture, fixtures and equipment. The book
values of the destroyed assets at the time of fire were Rs. 100 million. BL has lodged a claim with the insurance company.

The draft financial statements for the year ended 31 August 2019 show a profit before taxation of Rs. 500 million and net assets of Rs. 1,400
million.

Required:

(a) State the audit procedures which may be performed in respect of each of the above audit issues identified by your team. Also briefly discuss
the implications of these issues on the audit report. (10)

(b) Draft an opinion paragraph to be included in the audit report of BL in accordance with the requirement of International Standards on
Auditing, assuming that the matter in

(i) above is not dealt with in accordance with the requirements of IFRS. (Basis of opinion paragraph is not required) (05)

A: (a) (i)

■ Review minutes of the board meeting in which such matter were discussed.

■ Review the client's correspondence with the tax advisers and invoices for tax services.

■ Obtain direct confirmation from tax adviser.

■ Obtain and review the correspondence with the tax authorities.

■ Consider whether expert advice may be required from outside sources other than tax advisor.

■ Consider any legal precedent or case law by assessing relevant historical and recent judgments passed by the courts and other authorities in
similar situation.

■ Obtain written representation from the management.

■ Evaluate the adequacy of the disclosure in the financial statement.

From the information provided it seem to indicate that the accounting treatment adopted is in line with IAS 37 which requires a contingent liability
to be disclosed. Therefore there would be no impact on the audit report of BL.

We may have to include an emphasis of matter paragraph in the audit report highlighting the matter with a reference to the note to the financial
statements.

(ii) Since the event occurred after the date of financial statements and the amount of loss is material, the auditor should obtain evidence that
whether the incident has been appropriately disclosed in the financial statements as a non-adjusting event.

We will need to verify the financial impact to be disclosed in the financial statements by verifying the write down of stocks, loss of property and
equipment, etc.

We will also need to assess the adequacy of the insurance claim and whether it covers all the losses by reviewing the insurance policy and the
correspondence with the insurers.

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We will have to include an emphasis of matter paragraph in the audit report highlighting the matter with a reference to the note to the financial
statements.

In case the management disagrees to disclose the incident then we may consider expressing a qualified opinion.

(b) Qualified Opinion We have audited the financial statements ofBeluga Limited (the Company), which comprise the statement of financial
position as at 31 August 2019, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the
year then ended, and notes to the financial statements, including a summary of significant accounting policies.

In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the accompanying financial
statements present fairly, in all material respects, (or give a true and fair view of) the financial position of the Company as at 31 August 2019, and
(of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs).

7. You are the audit manager responsible for the audit of Hub Mills Limited (HML). At the planning stage, materiality level was determined at
Rs. 8 million.

Audit team has completed the audit field work for the year ended 30 June 2018 and has presented the following issues identified during the
audit for your review:

(i) Goods worth Rs. 3 million were returned by a customer on 5 July 2018 due to poor quality. Since the goods were returned subsequent to year
end, no adjustment has been recorded by the management.

(ii) HML is facing liquidity issues which has resulted in adverse key financial ratios. To address the issue, HML has sold one of its offices to a
company managed by a director of HML. The office was sold for Rs. 40 million. Since the management had correctly recorded the disposal, no
specific disclosures related to this sale have been made in the financial statements. Directors are confident that these sale proceeds would solve
the cash flow problems of HML.

(iii) A customer who owed Rs. 11 million at year-end, was declared bankrupt on 15 August 2018. The management had already provided 50% of
the balance in the financial statements.

Revenue for the current year is Rs. 800 million (2017: Rs. 950 million) and loss before tax is Rs. 22 million (2017: Rs. 7.6 million).

Required:

(a) In respect of each of the audit issues identified by your team, mention the impact (if any) which these might have on the audit report along
with proper justification. (10)

A: (a)

(i) The return of goods due to quality issues is an adjusting event for which condition existed at the year end. Revenue reported in the financial
statements should be reduced by Rs. 3,000,000 by recording sales return. The cost of sales should also be reduced accordingly.

The auditor should also consider that there may be quality issues with other inventory items as well requiring them to be written down to NRV.

In term of the impact on the audit report, the level of misstatement is not material as the materiality has been set at Rs. 8 million, consequently
this issue will have no impact on the audit report; unless there are other misstatements and the aggregate of such misstatements is material to the
financial statements.

(ii)

■ HML's liquidity issues, adverse key financial ratios and recurring net loss cast a doubt on HML's ability to continue as a going concern.

We need to satisfy that there is no doubt over the going concern assumption.

If the going concern basis is appropriate but a material uncertainty exists, which is adequately disclosed in the financial statements, then a
paragraph related to material uncertainty would have to be included in the audit report. In case adequate disclosures are not given, audit report
may express qualified or an adverse opinion.

If the going concern basis is not appropriate an adverse opinion would be given, unless HML agrees to present the financial statements on other
than going concern basis.

■ Sale of office to a company managed by the director of HML is a related party transaction and needs to be disclosed specifically as a related party
transaction.

The disclosure and the magnitude of transaction are both material to the financial statements. If it is not disclosed in the financial statements
appropriately, it will be considered as a misstatement on account of application of accounting policy. The opinion will be modified accordingly.

(iii) Declaration of a customer as bankrupt is an adjusting subsequent event and the remaining 50% of the balance also needs to be written off.

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The above issue individually is not material to the financial statement, therefore has no impact on audit report. However, if this misstatement is
not corrected and aggregate of all uncorrected misstatements is material to the financial statements, the report will be modified accordingly.

8. You are the audit partner at BLC & Company, Chartered Accountants. The following matters are under your consideration:

(i) Artificial Technologies Limited (ATL) has recognised an intangible asset of Rs. 100 million in respect of development costs relating to a
software which ATL expects to market in future.

The market research conducted by ATL indicates a promising demand for such software. However, the expected cost required to complete the
software has increased significantly and ATL requires further Rs. 50 million to complete the project. Since ATL has already utilised its existing
credit limit on other projects, it is facing difficulties in raising financing for the above software.

ATL’s draft financial statements show profit before tax of Rs. 270 million. (05)

(ii) RL is involved in the manufacturing and supply of beverages throughout Pakistan, through its plant situated in Lahore. During the year, a fire
occurred at RL’s plant due to which a significant portion of the plant has been destroyed. The management has written off the plant and
recorded an insurance claim amounting to Rs. 400 million. The written down value of the plant at the time of fire was Rs. 390 million.

RL is negotiating the purchase of another plant and order is expected to be placed soon after receiving the insurance claim.

RL’s draft financial statements show profit before tax of Rs. 300 million. (07)

Required:

Discuss how you would deal with each of the above situations and the possible implications of the above on the audit report. (Drafting of audit
opinion is not required)

A: (i)

■ The intangible asset measured at Rs. 100 million is material as it represents 37% of profit before tax.

■ !AS 38 requires that the entity should be able to demonstrate the availability of adequate technical, financial and other resources to complete
the development and to use or sell the intangible asset. As ATL appears to be short of finance, it is questionable whether sufficient funds would be
available to complete the development work and take the product to market. Therefore, it appears that the criteria for capitalization of
development costs contained in IAS

38 Intangible Assets is not met.

■ Discuss this matter with the management and those charged with governance to assess their plans for arranging the necessary finance. In case
the auditor believes that there is a doubt as regards the company's ability to complete the development work, the intangible asset should be
derecognized and the auditor should request the management to amend the financial statements.

■ If the management fails to resolve the issue appropriately, the auditor may have to qualify the report as the misstatement is material, but not
pervasive.

(ii)

■ Since the fire has destroyed a significant portion of RL's plant, the auditor should consider RL's ability to continue as a going concern.

■ Evaluate financial condition of RL as the cost of new plant is expected to be much higher and insurance claim of Rs. 400 million may not be
sufficient to purchase a new plant.

■ Discuss with the management and those charged with governance that how they intend to

finance the new plant and the operational expenses during the closure of the plant.

■ Inspect the insurance policy and the correspondence with insurance company for the verification of the insurance claim.

■ Read the minutes of those charged with governance for further details.

■ Analyze the latest available interim financial statements, to assess the impact of the accident on RL's financial performance.

■ In case the going concern basis is inappropriate but the financial statements have not been adjusted accordingly we will express an adverse
opinion.

■ In case going concern basis is appropriate but material uncertainty exists and the management has not made appropriate disclosures, we will
express a qualified or adverse opinion depending upon the materiality and pervasiveness of the situation.

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■ If the management has made appropriate disclosures in the financial statements regarding material uncertainty, we will express an unmodified
opinion and will draw attention to the disclosure through a separate section under the heading material uncertainty related to going concern.

9. You are audit partner of the firm and your manager has highlighted the following matters: The profit before tax of Tariq Limited (TL) for the
year ended 30 June 2017 is Rs. 790 million. TL provides three year warranty to its customers and has made provision of Rs. 80 million in this
regard. The management carries out the computation internally. The process is complex and based on various assumptions. Therefore, your
firm has appointed an expert after following all the necessary procedures for assessing the competence, capability and objectivity of the expert.
(08)

Your firm has been appointed as the auditor of Yaqoob Limited for the audit of the year ended 30 June 2017. The audit team was not able to
perform the inventory count at year end because the appointment was made on 15 July 2017. (07)

Required:

Describe the steps that will be performed in each of the above situation and discuss the possible implications of the above on the audit report.
(Drafting of opinion not required)

A: (a) Provision of warranty is 10% of the PBT and therefore it is material to the financial statements Since the expert has been appointed and
matters related to his appointment have already been considered, we may need to perform the following procedures:

■ Evaluate the reasonableness of significant assumptions and methods used

■ Evaluate the relevance, completeness and accuracy of source data

■ Evaluate the reasonableness of the expert's conclusions

■ Carry out analytical procedures to assess the reasonableness of the provision as compared to other relevant items

■ Confirm that the accounting provisions of !AS 37 have been complied with, in making the provision

■ In case there is a difference between the valuation of the auditor's expert and the valuation of

the management, discuss the difference with the management.

Reporting implication

In case the difference between the valuation of the auditor's expert and the valuation of the management is material and cannot be resolved, we
will have to give a qualified opinion.

However, if we have obtained sufficient appropriate evidence regarding the valuation and presentation of the warranty provision, then we will
have to include relevant details under the heading of key audit matters in our audit report, because it is an area of higher assessed risk of material
misstatement due to involvement of high degree of uncertainty and significant auditor

judgment.

(b) Our firm was not appointed as auditors of the YL until 30 June 2017 and thus did not observe the counting of physical inventories as the end of
year 30 June 2017. In this situation, we may perform the following procedures:

• Conduct physical inventory count after the date of the financial statements.

• Check whether the changes in inventory between the count date and the date of the financial statements are properly recorded.

• Investigate the reason for significant differences between the information obtained during the physical count and the inventory records.

• Assess the reliability of inventory records.

Reporting implication

If the auditor concludes that it would be impracticable or not possible to work back the inventory then this would be a scope limitation and
depending upon the material and pervasiveness of the amount of inventory, the auditor should qualify or disclaim his opinion.

Furthermore, the auditor should include other matter paragraph and mention that the prior period financial statements were audited by another
auditor.

10. You are the audit partner in a firm of chartered accountants. Some of the audits are in the finalization stage and presently the following
matters are under your consideration:

(b) There is a legal dispute between Marvi Limited and one of its customers. In this regard, the legal advisor has confirmed the stance of the
management in a meeting with you. However, he has refused to provide a written confirmation thereon. (02)

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(c) The management of Laila Limited is not willing to make certain disclosures. The management is of the view that these disclosures will not
add any value to the financial statements. Further, the information required to make these disclosures cannot be compiled before the deadline
for completion of the audit. (04)

Required:

Discuss the possible impact on the audit report and specify the procedures (if any) which you would undertake in the above situations.

A: (b) The verbal confirmation from the legal advisor cannot be taken as sufficient appropriate audit evidence and on account of inability to obtain
sufficient appropriate audit evidence. The auditor may consider to qualify or disclaim an opinion on the F/S

(c) Ifin the opinion of the auditor the non-disclosure of information results in material misstatement in the F/S, he shall:

• discuss the non-disclosure with TCWG;

• describe in the 'Basis for opinion section' the nature of the omitted information; and

• issue a qualified opinion on the basis of inability to obtain sufficient appropriate audit evidence.

11. As the engagement partner, you have reviewed the working papers of Nadeem Limited (NL) in which the audit team has highlighted the
following matters:

a) NL provides six months warranty to its customers and has hired an expert to compute the warranty provision. The management is not willing
to provide written representation for the warranty provision because the provision is in accordance with the expert’s advice. (04)

b) Certain contingent assets have been disclosed in the draft financial statements in which inflow of economic benefits is possible but not
probable. The management is of the view that International Financial Reporting Standards does not prohibit making additional disclosures
which enhance the users understanding of the financial statements. (03)

c) According to the accounting policy for revenue recognition, revenue from sale of goods is recognized on dispatch of goods to customers.
However, during the year, NL has entered into various agreements in which the goods are required to be delivered at the premises of the
customers. (03)

Required:

Discuss the possible impact on the audit report

A: (a) The argument that the written representation is not necessary because the provision is incorporated on the basis of expert's advice is not
correct.

The recognition of provision on basis of expert's advice will not preclude management from assuming responsibility for the warranty provision.

If the management do not provide the written representation, the auditor will require to reevaluate the effect which may have on reliability of
representations and audit evidence in general.

The auditor may qualify or disclaim the opinion on the F/S depending on the materiality and pervasiveness of the matter.

(b) The argument of management relating to additional disclosures is not valid, as this disclosure will make F/S misleading, as IAS allows disclosure
of only those contingent assets which are probable.

If the amount is material and the management refuses to remove the disclosures from the F/S, then the auditor may qualify the audit report.

(c) It is not a change in Accounting policy. However, if the revenue for the customers to whom the goods are to be delivered to their premises, is
material to the F/S, auditor will ask the management to revise the accounting policy for revenue recognition to cover all types of sales contracts.

If the management refuses to revise the policy accordingly and record the sales based on such policy then the audit report will be qualified.

12.You are the audit manager in a firm of chartered accountants and are currently faced with the following situations at two different clients.

(i) A bank confirmation has not been received despite extensive follow up by the client. As the deadline is close, the client has provided you the
original bank statement of 31 December 2013 duly stamped and signed by the Bank Manager. Consequently, the client is of the opinion that
confirmation is no more necessary. (06)

(ii) At the planning stage of audit of Orange Limited, the management has refused to send confirmations to three major debtors who constitute
45% of the total debtors. On inquiry, you have been informed that these debtors are partnership concerns and take lot of time in replying to
confirmation requests. However, as an alternative the management has offered to send negative confirmation requests. (07)

Required:

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Discuss how you would deal with the above situations. Also state the possible implications on the audit report.

A: (i)

■ Bank confirmation contains details such as facilities, securities, additional banking relationships, trade finance, derivative and commodity trading
and custodian arrangements. These information are not available in bank statement. Moreover, the bank confirmation is supposed to be received
directly from the bank whereas the bank statement has been received through the client.

• We need to determine whether a response to a positive confirmation is necessary to obtain sufficient appropriate audit evidence related to bank
balance as at December 31, 2013.

■ If it is concluded that the response to bank confirmation is not necessary then we would perform alternate audit procedures to obtain sufficient
appropriate audit evidence relating to details not provided by the bank.

■ If we are unable to obtain sufficient appropriate audit evidence from alternative audit procedures or if we conclude that the response to the
bank confirmation is necessary and we are unable to obtain bank confirmation , then it will constitute a scope limitation. Accordingly,

we would qualify the audit report or issue a disclaimer of opinion depending on the materiality and pervasiveness of the matter.

(ii)

■ The request by management for sending negative confirmation requests is not appropriate as these are usually sent when population comprises
of large number of small account balances.

■ The reason provided by the management for not sending confirmation request to three debtors is not appropriate.

■ In view of the above, we would ask the client to send positive confirmation request.

■ If the client refuses to send positive confirmation, we would evaluate the implications of the refusal on the risk of material misstatement,
including the risk of fraud and on the nature timing and extent of other audit procedures.

• Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

• If we are unable to obtain sufficient appropriate audit evidence form alternative audit procedures or if we conclude that the confirmation is
necessary and we are unable to obtain confirmation from the debtors, then it will constitute scope limitation. Based on materiality and
pervasiveness of the matter, we would issue a qualified or disclaimer of opinion as appropriate.

13. The following situations have arisen on different clients being audited by your firm. The year-end in each instance is 31 December 2013.

(i) During the year Iron Limited has changed its policy for valuation of intangible assets from Cost Model to Revaluation Model. (03)

(ii) Due to fire in the record room of Titanium Limited, all the records and backup related to the fixed assets, trade debtors and stocks were
destroyed and you are unable to perform audit procedures for verification of the balances. (03)

(iii) During the planning stage of Coal Limited it was noted that the system of internal controls of the company is weak. This aspect was taken
into consideration in determining the nature, timing and extent of the audit procedures. (02)

(iv) One of the plants of Uranium Limited was destroyed subsequent to year-end. Appropriate disclosure thereof has been made in the financial
statements. (02)

Required:

Discuss the impact of each of the above matters on the audit report.

A: (i) Exception to the consistent application of accounting policies will be mentioned in the audit report along with the note reference where
disclosure is made about change in accounting policy and statement whether the auditor concurs with it or not.

■ The auditor will issue a disclaimer of opinion on account of limitation of scope and as the matter is material and pervasive in nature.

■ It is also to be mentioned that proper books of accounts as required by the Companies Act, 2017 have not been kept by the company.

(ii) The responsibility of management regarding establishing and maintenance of system of internal controls is mentioned in the Audit Report,
however, no opinion is required regarding operating effectiveness of internal controls. There would be no impact on audit report.

(iii) If in the auditor judgement, the matter of destruction of plant is fundamental to users understanding of the financial statement then an
emphasis of matter paragraph is required to be given in the audit report referring to a note in the F/S where the relevant disclosure is made in the
financial statement.

14. The following situations have arisen on different clients of your firm. The year end in each instance is 31 December 2012.

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a. In November 2012, Wazir Limited (WL) entered into a five year contract with Safeer Limited (SL), for supply of specific parts. The supply was
to commence on 1 April 2013. In December 2012 WL purchased plant and machinery specifically for the contract with SL at a price of Rs. 150
million with useful life of five years. However, in January 2013 SL incurred heavy losses in a natural disaster and went into liquidation.

During 2012 sale to SL amounted to Rs. 5 million and the amount receivable from SL at the year end was Rs. 450,000. For the year ended 31
December 2012, WL had earned profit before taxation of Rs. l25million. The turnover for the year was Rs. 900 million and the net assets as of
that date were Rs. 1.2 billion. (07)

b. As the auditor of Mianwali Tracking Company Limited (MTCL), you have noticed that proper cash book has not been maintained by the
company due to shortage of staff. However, MTCL has provided you with summaries showing party-wise receipts and payments and you have
been able to trace them to company’s bank statements. (05)

c. During the year, Jhelum Limited (JL) paid 10% dividend to the shareholders. On account of an error, Zakat could not be deducted from some of
the shareholders. The

amount involved was Rs. 22,000 which was deposited by JL in the Central Zakat Fund and charged as other expenses. (03)

Required: Discuss the impact of each of the above matters on your audit report.

A: (a) The liquidation of SL is a non adjusting event. However, the amount due from SL is only 0.36% of profit before tax and is not material to the
F/S therefore the disclosure relating to uncollectability of amount due from SL is not required. The cost of plant is 120% of the profit before
taxation and 12.5% of the net assets of the company and it is material to the F/S.

Since plant was purchased exclusively for the production of items to be supplied to SL, an impairment review under IAS 36 must be carried out. If
material impairment is eminent then a disclosure would be required as it is a non adjusting event. In case of non disclosure, a qualified opinion
would be given as the matter is material to the F/S.

(b) Under the requirements of the Companies Act, 2017 every company is required to keep a record of sums of money received and expended by
the company and the matters in respect of which the receipts and expenditure takes place. By tracing the receipts and payments mentioned in the
party wise summaries with the bank statement, the matter in respect of which these receipts and payment took place cannot be verified. Unless
the information relating to the matters in respect of which receipt and expenditure takes place is available elsewhere, the audit opinion regarding
proper books of accounts as required under the Companies Act 2017 shall be qualified .

(c) It will be mentioned in the auditor's report that "In our opinion, Zakat of Rs. 22,000 was deductible at source under the Zakat and Ushr
Ordinance, 1980, but was not deducted by the Company. However, an equivalent amount was deposited by the Company in the Central Zakat Fund
and is included in other expenses".

15. Sher Khan Limited (SKL) had announced a major restructuring in the year 2011 and a provision of Rs. 120 million was made against the cost
of restructuring and redundancies. During 2012 all known claims and liabilities relating to the restructuring were settled for Rs. 90 million.
However, as a matter of prudence, the company has not written back the excess amount of provision in view of a suit filed by certain staff
members against termination of their employment.

SKL’s legal counsel is of the view that the possibility of an adverse decision against the company in this matter is remote. The audit senior does
not agree with the management’s contention and has drafted the following modification in the audit report:

“An amount of Rs. 30 million has been provided in respect of the expected amount which the company may be required to pay to the
employees whose employment was terminated during the year. The management is of the view that in case the company is required to pay the
amount to those employees, the said provision would be utilized. In our opinion, the company’s decision to make the above provision is not in
accordance with International Accounting Standards.

Had the liabilities been recognized correctly the profit for the year would have increased by Rs. 30 million. Because of the effects of the matters
discussed above, the financial statements do not give a true and fair view of the financial position of the company as at 30 September 2012.”

Profit before taxation and net assets of SKL are Rs. 145 million and Rs. 350 million respectively.

Required: Comment on the decision of the audit senior and identify the shortcomings, if any, in the modification drafted by him. (08)

A: The 2012 statement of financial position shows provisions of Rs. 30 million. Since all known liabilities and claims have been settled, and
according to the legal advisor as well as the company's management, the chances of payment are remote, hence inclusion of a provision for
liabilities is inappropriate.

Materiality

The amount of Rs. 30 million is material, as it is 8.57% of net assets and 20.69 % of profit before taxation. However, the auditor's report for 2012
gives an adverse opinion which is inappropriate because the impact of the misstatement is material but not pervasive. Hence, a qualified opinion
would be appropriate.

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Short Comings in Modification paragraphs

The paragraph does not mention the note reference, where the details relating to the Provision can be found in the F/S.

There is no need to mention the management's point of view in the report. Managements view point should be disclosed in the relevant notes to
the F/S.

---, The draft audit opinion is not in accordance with the form recommended by ISA, as the basis of modification paragraph has been merged with
the opinion paragraph. The two paragraphs should be separated and contain appropriate headings also. Moreover, the phrase "In our opinion"
should be used at the beginning of the opinion paragraph and a qualified opinion should be given as has been discussed above.

16. As the engagement partner, you have reviewed the audit working papers of Samarkand Limited (SL). The audit team has highlighted the
following matters in the working papers.

a) Twenty percent of the company’s recorded turnover (revenue) comprises of cash sales. Proper records of cash sales have not been
maintained. Consequently, the audit team was unable to design audit procedures to verify the cash sales.

b) During the current year, the company changed the method of charging depreciation on its fixed assets from the straight line to the
diminishing balance method. However, all the required disclosures have been included in the notes to the financial statements.

c) The previous year’s financial statements were audited by another firm of chartered accountants which has issued an un-modified opinion on
those financial statements.

Required: Discuss the impact of each of the above matters on your audit report. (10)

A: (a)

■ The audit report will be modified on ground of limitation of scope.

■ Either a qualified or disclaimer of opinion will be given depending upon the materiality and pervasiveness of the matter.

• We may have to mention that "proper books of accounts as required by the Companies Act 2017 have not been kept by the Company".

(b) There will be no impact on the audit report as the change of depreciation method is a change in accounting estimate.

(c) The auditor will include an other matter paragraph in the auditor's report, referring to the fact that the F/S of Samarkand Limited for the
Previous year, were audited by another auditor, who expressed an un-modified opinion on those F/S.

17. Platinum Limited (PL) is a key supplier of raw materials to Zinc Limited (ZL). PL has filed a suit against ZL for breach of terms of an
agreement. The amount claimed by PL is Rs. 10 million. ZL has disclosed it as a contingent liability in the draft financial statements for the year
ended 31 December 2011. However, ZL is striving for an out of court settlement and recent correspondence indicates that PL is likely to agree
and settle the dispute for 50% of the amount claimed by them. Required: Describe the audit procedures that ZL’s auditor should perform in the
above situation. Also discuss the impact, if any, of the above procedures on the audit report. (07 marks)

A: The following audit procedures should be applied to assess whether an adjustment is required:

(i) Obtain direct confirmation from the company's lawyers seeking their opinion as to whether the settlement is probable and whether Rs. 5 million
is the likely amount.

(ii) Review the correspondence with PL to confirm that the amount they are willing to accept is in fact Rs. 5 million.

(iii) Discuss with management as to whether they intend to accept PL's offer and obtain a written representation.

If on the basis of the above procedures the auditor concludes that a settlement at 50% of the amount claimed is likely, he shall ask the
management to make a provision.

In case the management refuses to provide for the amount then a qualified opinion may be given, if the amount of Rs. 5 million is considered
material.

18. The following situations have arisen on different clients being audited by your firm.

(b) Malakand Industries Limited (MIL) is engaged in the supply of customised machinery to textile manufacturers. On 18 February 2012 one of
its customers, who owed Rs.

9.6 million, went into voluntary liquidation. In addition to the above amount, a job was in progress on behalf of that customer and on which MIL
had already spent Rs.

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13.9 million. The directors have refused to make a provision against the debt on the grounds that the liquidator was appointed after the balance
sheet date. They have also refused to make any provision in respect of the work in process as they are planning to sell the machinery being
manufactured to another customer for Rs. 15.7 million. The profit after tax of MIL is Rs. 85 million. The materiality level is 10% of profit after
tax. (05 marks )

(c) Swat Limited has invested Rs. 150 million in a business which is not mentioned in the object clause of its Memorandum of Association.
However, the object clause was amended a week before the signing of the audit report. (03 marks )

Required: In the light of the relevant requirements, discuss how should the auditor deal with the above situations and describe the impact
thereof on the audit report.

A: (b) (i) The amount of Rs. 9.6 million which is due from MIL is material to the F/S.

(ii) With respect to job in progress, if the auditor can satisfy himself that management would be able to recover the cost of work in process from
another customer, he may conclude that a provision is not required in this respect.

(iii) In making the above decision the auditor should also consider the expenses that are required to be incurred on the job, subsequent to year
end.

(iv) The auditor should ask the management to provide for the loss of Rs. 9.6 million or any part thereof depending upon the estimated amount of
default, plus any further provision that may be necessary in respect of the work in process. In case of management's refusal, the auditor shall
qualify his report.

(c) The auditor shall qualify the audit report by mentioning that investment of Rs. 150 million was not in accordance with the objects of the
company with a clarification that the object clause was amended a week before the issuance of audit report, to include the said objective.

19. You are the audit manager of MM Electronics (Private) Limited. The company markets its products through retail outlets in nine major cities.
The draft financial statements for the year ended 30 June 2011 show a profit after tax of Rs. 20 million and net assets of Rs. 150 million. The
audit team has noted the following matters for your consideration:

a) During the year the company has changed its policy of valuation of property, plant and equipment from historical cost to revalued amount.
For this purpose, the services of Professional Valuers (Private) Limited were hired. They have issued valuation reports of three outlets indicating
a revaluation surplus of Rs. 10 million, which has been recognised in the financial statements. The management has informed you that the
valuation reports of the remaining properties are expected to be issued in December 2011.

b) The company was sued for breach of contract by a customer claiming damages of Rs. 10 million. The legal advisor has confirmed the
management’s assertion that no liability existed at the balance sheet date. However, while reviewing the customers’ files, you found an email
from the Manager (Legal Department) addressed to the Chief Executive in which he has opined that the company will have to pay atleast 50% of
the damages claimed.

c) With effect from 01 July 2010, the company has introduced a policy of providing one year warranty on its television sets. No warranty is
provided on the other products. Sales of television sets aggregated Rs. 20 million, whereas the total sales for the year amounted to Rs. 80
million. The company has a customer support department which provides after sales services on all products. For defects not covered under the
warranty, the company bills the customers at 25% above cost. The management has included a note in the draft financial statements stating
that no provision has been made in respect of the warranty, as the amount cannot be measured reliably.

d) The directors have decided not to disclose earnings per share as the same had reduced significantly on account of issuance of 100% bonus
shares. The disclosure was however made in all previous financial statements.

Required: Express your views on each of the above situations and discuss the impact thereof on the audit report. (14 marks)

A: (a) Revaluation of Properties:

(i) In accordance with !AS 16, Property, Plant and Equipment, if a policy of revaluation is to be applied, it should be applied to all the non current
assets in a particular class of assets.

(ii) Since compliance with (i) above is not possible, the auditor should advise the client to not to change the accounting policy and state the values
of the property at cost.

(iii) In case of disagreement the auditor may consider issuing a qualified report

(b) Suit for damages:

The reliability of audit evidence provided by the legal advisor is high because it has been obtained from an independent source outside the entity.
As management is also of the view that no liability exists at the balance sheet date, therefore in the presence of legal advisor's confirmation a
conclusion should not be drawn on the basis of manager's legal email.

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(i) However, since there is inconsistency in audit evidence obtained and the auditor is unaware of the context in which the manager (legal) sent the
email, he shall investigate the reasons thereof and may need modification or addition to the audit procedures.

(ii) The auditor should analyze the situation, in the light of !AS 37, Provisions, Contingent Liabilities and Contingent Assets, and assess whether a
disclosure of the event as a contingent liability is required or not.

(iii) If disclosure of contingent liability is required, and the client disagrees the audit report may be qualified.

(c) Warranty Provision:

(i) Management's claim that amount cannot be measured reliably is not correct because they were charging customers at 25% above cost prior to
July 01, 2010 i.e. when there was no warranty on the sale of television sets and hence they must be in a position to make a reliable estimate based
on their past experience and records available with them.

(ii) If a provision is not made for the warranty then if the amount of provision is material to the F/S then the audit report should be qualified

(d) Non Disclosure of Earnings per share in the F/S:

International Accounting Standards 33, Earnings per share does not apply to non listed entities; therefore there is no requirement of disclosing
earnings per share in the F/S.

20. a) Briefly explain the term 'pervasive effects on the financial statements’. (04 marks )

b) As the engagement partner, you have reviewed the audit working papers of Apricot Engineering Limited (AEL). The audit team has
highlighted the following matters in the working papers.

(i) The company has issued a bank guarantee to one of its related parties after the balance sheet date. No disclosure in this regard has been
made in the draft financial statements.

(ii) AEL has paid a dividend after many years. Zakat has been appropriately deducted and deposited in the Central Zakat Fund.

(iii) Subsequent to the year end, a major debtor has declared bankruptcy. The company expects to recover only 20% of the outstanding amount.
The management has refused to make a provision but is ready to disclose the fact by way of a note.

(iv) With effect from January 1, 2010, AEL has:

• Changed the method of charging depreciation on its fixed assets from the 'straight line’ to the ‘diminishing balance’; and

• revised its estimate of useful lives of vehicles from 6 years to 4 years.

Required: Discuss impact of each of the above matters on your audit report. (10 marks)

A: (a) Pervasive is a term used to describe the effects of misstatement on the F/S or the possible effects thereon if any misstatement remains
undetected due to the auditor's inability to obtain sufficient appropriate audit evidence. Pervasive effects on the F/S are those that, in the auditor's
judgments:

i. are not confined to specific elements, account or items of the F/S,

ii. if so confined, represent or could represent a substantial proportion of the F/S or

iii. in relation to disclosures, are fundamental to user's understanding of the F/S

(b)

(i) Issuance of bank guarantee after the year end does not require any adjustment or disclosure. Therefore, there will be no effect on the audit
report on this issue.

(ii) The audit report shall state that "Zakat deductible at source under the Zakat &Ushr Ordinance, 1980, was deducted and deposited in the Central
Zakat Fund established under section 7 of that Ordinance".

(iii) The auditor should consider the materiality of the amount. If the amount is material, the auditor should express a qualified or adverse opinion.

(iv) • The audit report shall mention the exception to the consistent application of accounting policies and whether the auditor concurs with it or
not.

• The F/S shall be adjusted accordingly and the effect of change in estimate shall be disclosed in the notes to the F/S unless the differences are
material and auditor has reasons to differ with the reviewed estimate. There would be no impact on the audit report on this issue.

ISA – 706

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1. Discuss the circumstances in which an auditor may include other matter paragraph in the audit report. (04)

A: Following are circumstances in which an auditor may include other matter paragraph in audit report:

• Relevant to Users' Understanding of the Audit: In the rare circumstance where the auditor is unable to withdraw from an engagement, the
auditor may consider it necessary to include an Other Matter paragraph in the auditor's report to explain why it is not possible for the auditor to
withdraw from the engagement.

■ Relevant to Users' Understanding of the Auditor's Responsibilities or the Auditor's Report: Law, regulation or generally accepted practice in a
jurisdiction may require or permit the auditor to elaborate on matters that provide further explanation of the auditor's responsibilities in the audit
of the financial statements or of the auditor's report thereon.

■ Reporting on more than one set of financial statements: An entity may prepare set of financial statements in accordance with more than one
framework and engage the auditor to report on both sets of financial statements. If both the frameworks are acceptable, the auditor may include
an Other Matter paragraph in the auditor's report

■ Restriction on distribution or use of the auditor's report: When the financial statements are prepared for a specific purpose, the auditor may
consider it necessary to include an Other Matter paragraph, stating that the auditor's report is intended solely for the intended users, and should
not be distributed to or used by other parties.

2. Differentiate between the following:

(i) An ‘emphasis of matter’ paragraph and an ‘other matter’ paragraph. (04 marks)

A: Emphasis of matter paragraph is a paragraph that is included in the auditor's report that refers to a matter appropriately presented or disclosed
in the F/S that, in the auditor's judgment, is of such importance that it is fundamental to users' understanding of the F/S.

Other Matter paragraph is a paragraph that is included in the auditor's report that refers to a matter other than those presented or disclosed in the
F/S that, in the auditor's judgment, is relevant to the users' understanding of the audit, the auditor's responsibilities or the auditor's report.

3. Give three examples each of circumstances which may necessitate the inclusion of the following in the auditor’s report:

(i) An ’emphasis of matter’ paragraph; and

(ii) an ’other matter’ paragraph. (06 marks)

A: (i) Examples of circumstances which necessitate the inclusion of emphasis of matter paragraph:

■ Early application (where permitted) of a new accounting standard (for example, a new International Financial Reporting Standard) that has a
pervasive effect on the F/Sin advance of its effective date.

■ A major catastrophe that has had, or continues to have, a significant effect on the entity's financial position.

■ The existence of material uncertainty relating to the event or condition that may cast significant

doubt on the entity's ability to continue as a going concern but has been appropriately disclosed.

(ii) Examples of circumstances which necessitate the inclusion of Other matter paragraph:

■ Any matter which in the auditor's opinion is relevant to user's understanding of the Audit

■ Any matter which in the auditor's opinion is relevant to User's Understanding of the Auditor's responsibilities or the Auditor's Report

■ When the auditor is required to report on more than one set of F/S.

■ When there is restriction on distribution or use of the auditor's report.

ISA – 570

1. You are the audit manager in a firm of Chartered Accountants. Following independent matters for the year ended 31 December 2021 are
presently under your consideration:

(a) Quality Foods Limited has been facing liquidity issues and is heavily reliant on a bank overdraft, which was due for renewal on 15 February
2022. Management has informed you that negotiations with the bank are underway and it is expected that bank overdraft limit will be renewed
in next few days. (07)

(b) During the year, Delta Limited (DL) has recognised an intangible asset of Rs. 55 million in respect of development costs of a software which
DL expects to market in future. The market research conducted by DL indicated a promising demand for such software.

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In November 2021, one of DL’s competitors successfully launched a similar software with the help of high foreign investment. It has helped
them to capture a large market share in a short span of time.

DL’s draft financial statements show profit before tax of Rs. 250 million. (08)

Required:

For each of the above independent situations:

discuss, from an audit perspective, the impact on the financial statements. state the audit procedures which may be performed by the audit
team.

(Reporting implications are not required}

A: (a) Financial Statement Impact:

The delay in the renewal and lack of agreement of the overdraft facility raises material uncertainties over going concern. It needs to be determined
that in case the facility is not renewed, then would QFL would still be able to continue as a going concern. In case there is only a material
uncertainty then these should be adequately disclosed in the financial statements to ensure that the users understand the details of the
uncertainties. Ifit is concluded that QFL is not a going concern then it's financial statements should be prepared as not a going concern.

Audit procedures:

(i) Review the correspondence of the bank with QFL's management.

(ii) Review the board of director meeting minutes to assess the stage and likely outcome of the with the bank.

(iii) Discuss with the management the status of negotiation with the bank.

(iv) Review the disclosures made by the management regarding the material uncertainty/ or the preparation of financial statement as not a going
concern basis.

(v) Obtain the management's assessment of QFL ability to operate as a going concern.

(vi) Evaluate the reasonableness of the assumptions taken by the QFL's management.

(b) Financial Statement Impact:

!AS 38 requires that the entity should be able to demonstrate the ability to sell the intangible asset and generate future economic benefit. As BL's
competitor has successfully launched its product and has captured majority of the market share, it appears that the criteria for capitalization of
development costs contained in !AS 38 Intangible Assets might not be met. Therefore, BL might have to either derecognize the asset or consider
booking an impairment loss.

Audit procedures:

(i) Test a sample of development costs for appropriate capitalisation.

(ii) Discuss the development project with management, to assess the feasibility of the project and product.

(iii) Review revised projections and forecasts for using resources and generating future economic benefits.

(iv) Assess marketing plans and whether a market still actually exists.

(v) Whether the entity will actually be able to use or sell the asset.

(vi) Discuss management's intention to complete the asset and either use or sell it.

(vii) Inspect development contracts and records supporting and safeguarding patents.

2. State any five audit procedures that could be performed to obtain sufficient appropriate audit evidence for determining whether or not a
material uncertainty exists when events

are identified that may cast doubt on the entity’s ability to continue as a going concern. (05)

A: (i) Analyzing and discussing the cash flow, profit and other relevant forecasts with the management.

(ii) Analyzing and discussing latest available interim financial statements.

(iii) Reading the terms and loan agreements.

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(iv) Confirming existence, terms and adequacy of the borrowing facilities.

(v) Reading minutes of meetings of shareholders, those charged with governance and relevant committees for reference to financing difficulties.

Chapter# 15 (International standards on review engagements)

1. Differentiate between review engagement of financial statements and the annual audit. (04)

A:

Review Engagement Annual Audit

The procedures performed are substantially less than those The procedures performed in an audit includes test of controls,
performed in an audit and are mostly limited to analytical procedures substantive procedures, analytical procedures and inquiries.
and inquiries.
A review does not provide a high level of assurance and in some cases An audit is designed to provide a high level of assurance to the users
do not provide any assurance. of the financial statements.
2. State any eight key procedures which are performed during a review engagement of historical financial statements. (08)

A: Procedures for the review of historical F/S will usually include the following:

• Obtain an understanding of the entity’s business and the industry in which it operates. o Make inquiries into:

o the entity’s accounting policies, practices and procedures, including the preparation of F/S

o material assertions in the F/S that are subject to the review

o decisions taken at board meetings and other meetings of the entity that may affect the F/S

o the completeness of the accounting records that were used to prepare the F/S.

• Applying analytical procedures designed to identify unusual relationships between items in the F/S, and individual items that appear unusual.
Analytical procedures would include:

o comparing the F/S under review with F/S for prior periods

o comparing the F/S with the anticipated results and financial position of the entity

o a study of the relationships between elements in the F/S that should be expected to conform to a predictable pattern (based on the entity’s past
experience or normal ratios/relationships for the industry as a whole).

• Other procedures that will usually be carried out in a review of F/S include:

o discussions with the company’s auditors (if the audit firm is not the firm of accountants that is performing the review engagement)

o obtaining representations from management

o considering the appropriateness of the accounting policies employed by the entity

o making inquiries into subsequent events (after the date of the statement of financial position)

o making a review of the statements as a whole.

3. State the key features of review engagement which distinguish it from a statutory audit and identify two types of review engagements. ( 3
marks)

A: The key features of review engagement that distinguish it from statutory audit are as follows:

• Review engagement requires less evidence than an audit

• Opinion in the review engagement is expressed in negative terms Two types of review engagements:

• Attestation engagement

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• Direct reporting engagement

4. State any three procedures which are generally adopted by the auditor to obtain evidence in review engagement. (02)

A: Procedures of review engagement:

The procedures for the review of F/S will usually include:

• Inquiry

• analytical procedures

• Agree and reconcile Interim Financial Information with the accounting records.

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