The question paper begins on page 3.
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Section A – BOTH questions are compulsory and MUST be attempted1You are an audit manager in Montreal & Co, a firm of Chartered Certified Accountants, and you are responsible forthe audit of the Vancouver Group (the Group). The Group operates in the supply chain management sector, offeringdistribution, warehousing and container handling services. Its operations are wholly in the UK. The Group comprisesa parent company, Vancouver Ltd, and two subsidiaries, Toronto Ltd and Calgary Ltd. Both of the subsidiaries wereacquired as wholly owned subsidiaries many years ago. Montreal & Co audits all of the individual company financialstatements as well as the Group consolidated financial statements.You are beginning to plan the Group audit for the financial year ending 31 July 2016, and the audit engagementpartner has sent you the following email:To: Audit managerFrom: Albert Franks, audit engagement partnerSubject: The Vancouver Group –audit planningHelloI held a meeting yesterday with Hannah Peters, the Group finance director. A representative of the Group auditcommittee was also at the meeting to discuss two issues raised for our attention by the committee. Hannah gaveme some projected financial information for the Group’s forthcoming year end, along with comparatives andexplanatory notes, and we discussed some matters relevant to the Group this year. I am preparing for the audit teambriefing next week at which there will be a number of recent recruits into the audit department whose firstassignment will be the Vancouver Group.I have attached some notes from my meeting as well as the financial information provided by Hannah. Using theinformation provided you are required to prepare briefing notes for use in the audit team briefing in which youidentify and explain the audit risks which should be considered in planning the Group audit. In order to provide training for the recent recruits who are included in the audit team, you should also explain whyanalytical procedures are performed as a fundamental part of risk assessment at the planning stage of the audit.Finally, please discuss the ethical issues relevant to Montreal & Co, and recommend any actions which should betaken by our firm.Thank you.Notes from meeting with the Group finance director and audit committee representativeThe Group has not changed its operations significantly this year. However, it has completed a modernisationprogramme of its warehousing facilities at a cost of £25 million. The programme was financed with cash raised fromtwo sources: £5 million was raised from a debenture issue, and £20 million from the sale of 5% of the share capitalof Calgary Ltd, with the shares being purchased by an institutional investor.An investigation by HMRC into the Group’s tax affairs started in January 2016, focusing on the possibleunderpayment of corporation taxes by each of the companies in the Group. The Group’s tax planning was performedby another firm of accountants, Victoria & Co, but the Group’s audit committee has asked if our firm will support theGroup by looking into its tax position and liaising with HMRC in respect of the tax investigation on its behalf. Victoria& Co has resigned from their engagement to provide tax advice to the Group. The matter is to be resolved by a tribunalwhich is scheduled to take place in September 2016.The Group is not listed, but aims to apply the provisions ofthe UK Corporate Governance Codeas best practice. TheGroup audit committee has asked whether one of Montreal & Co’s audit partners can be appointed as a non-executivedirector and serve on the audit committee. The audit committee lacks a financial reporting expert, and theappointment of an audit partner would bring much needed knowledge and experience.3[P.T.O.
Financial information provided by the Group finance directorConsolidated statement of financial position
Note
ProjectedActualAssets
Non-current assets
Property, plant and equipmentIntangible assets – goodwillDeferred tax assetTotal non-current assetsCurrent assetsInventories
Trade and other receivablesCash and cash equivalentsTotal current assetsTotal assets
Equity and liabilitiesEquity
Equity share capitalRetained earnings
Non-controlling interestTotal equity
Non-current liabilitiesDebentureProvisions
Total non-current liabilitiesCurrent liabilities
Trade and other payablesOverdraft
Total current liabilitiesTotal liabilities
Total equity and liabilities
31 July 2016
£m
1230302
––––10––––2703562–––––––––97––––367––––
50
1263
––––5––––181604
––––6––––66105––––15––––120––––186––––367––––
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31 July 2015
£m
187
30––––15––––2322845––––10––––83––––315––––
50
103–––––––––15355––––12––––6795–––––––––95––––162––––315––––
Consolidated statement of profit or loss for the year to 31 July
Projected2016£m375(348)––––2710(4)––––33(10)––––23––––––––
Actual
2015£m315(277)––––38–(3)––––35(15)––––20––––––––
Revenue
Operating expenses
Operating profit
Profit on disposal of shares in Calgary LtdFinance costsProfit before taxTax expenseProfit for the yearNotes:1.2.3.
Several old warehouses were modernised during the year. The modernisation involved the redesign of the layoutof each warehouse, the installation of new computer systems, and the replacement of electrical systems.The deferred tax asset is in respect of unused tax losses (tax credits) which accumulated when Toronto Ltd wasloss making for a period of three years from 2009 to 2012.
The non-controlling interest has arisen on the disposal of shares in Calgary Ltd. On 1 January 2016, a 5% equityshareholding in Calgary Ltd was sold, raising cash of £20 million. The profit made on the disposal is separatelyrecognised in the Group statement of profit or loss.
The provisions relate to onerous leases in respect of vacant properties which are surplus to the Group’srequirements.
4.
Required:
Respond to the instructions in the partner’s email.
(31 marks)
Professional marks will be awarded for presentation, logical flow, and clarity of explanations provided.(4 marks)
(35 marks)
5[P.T.O.
2
You are a senior manager in Macau & Co, a firm of Chartered Certified Accountants. In your capacity as engagementquality control reviewer, you have been asked to review the audit files of Stanley Ltd and Kowloon Ltd, both of whichhave a financial year ended 31 December 2015, and the audits of both companies are nearing completion.(a)Stanley Ltd is a frozen food processor, selling its products to wholesalers and supermarkets. From your review of
the audit working papers, you have noted that the level of materiality was determined to be £1·5 million at theplanning stage, and this materiality threshold has been used throughout the audit. There is no evidence on theaudit file that this threshold has been reviewed during the course of the audit.
From your review of the audit planning, you know that a new packing machine with a cost of £1·6 million wasacquired by Stanley Ltd in March 2015, and is recognised in the draft statement of financial position at a carryingamount of £1·4 million at 31 December 2015. The packing machine is located at the premises of Aberdeen Ltd,a distribution company which is used to pack and distribute a significant proportion of Stanley Ltd’s products.The machine has not been physically verified by a member of the audit team. The audit working papers concludethat ‘we have obtained the purchase invoice and order in relation to the machine, and therefore can concludethat the asset is appropriately valued and that it exists. In addition, the managing director of Aberdeen Ltd hasconfirmed in writing that the machine is located at their premises and is in working order. No further work isneeded in respect of this item.’
Inventory is recognised at £2 million in the draft statement of financial position. You have reviewed the resultsof audit procedures performed at the inventory count, where the test counts performed by the audit teamindicated that the count of some items performed by the company’s staff was not correct. The working papersstate that ‘the inventory count was not well organised’ and conclude that ‘however, the discrepancies wereimmaterial, so no further action is considered necessary’.
The audit senior spoke to you yesterday, voicing some concerns about the performance of the audit. A summaryof his comments is shown below:
‘The audit manager and audit engagement partner came to review the audit working papers on the same daytowards the completion of the audit fieldwork. The audit partner asked me if there had been any issues on thesections of the audit which I had worked on, and when I said there had been no problems, he signed off theworking papers after a quick look through them.
When reading the company’s board minutes, I found several references to the audit engagement partner, Joe Lantau. It appears that Joe recommended that the company use the services of his brother, Mick Lantau, foradvice on business development, as Mick is a management consultant. Based on that recommendation, Mickhas provided a consultancy service to Stanley Ltd since September 2015. I mentioned this to Joe, and he toldme not to record it in the audit working papers or to discuss it with anyone.’Required:
Comment on the quality of the audit performed discussing the quality control, ethical and other professionalissues raised.(13 marks)(b)Kowloon Ltd works on contracts to design and manufacture large items of medical equipment such asradiotherapy and X-ray machines. The company specialises in the design, production and installation of bespokemachines under contract with individual customers, which are usually private medical companies. The draftfinancial statements recognise profit before tax of £950,000 and total assets of £7·5 million.
The audit senior has left the following note for your attention:
‘One of Kowloon Ltd’s major customers is the Bay Medical Centre (BMC), a private hospital. In June 2015 acontract was entered into, under the terms of which Kowloon Ltd would design a new radiotherapy machine forBMC. The machine is based on a new innovation, and is being developed for the specific requirements of BMC.It was estimated that the design and production of the machine would take 18 months with estimated installationin December 2016. As at 31 December 2015, Kowloon Ltd had invested heavily in the contract, and designcosts totalling £350,000 have been recognised as work in progress in the draft statement of financial position.Deferred income of £200,000 is also recognised as a current liability, representing a payment made by BMC tofinance part of the design costs. No other accounting entries have been made in respect of the contract withBMC.
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As part of our subsequent events review, inspection of correspondence between Kowloon Ltd and BMC indicatesthat the contract has been cancelled by BMC as it is unable to pay for its completion. It appears that BMC losta significant amount of funding towards the end of 2015, impacting significantly on the financial position of thecompany. The manager responsible for the BMC contract confirms that BMC contacted him about the company’sfinancial difficulties in December 2015.
The matter has been discussed with Kowloon Ltd’s finance director, who has stated that he is satisfied with thecurrent accounting treatment and is not proposing to make any adjustments in light of the cancellation of thecontract by BMC. The finance director also advised that the loss of BMC as a customer will not be mentioned inthe company’s integrated report, as the finance director does not consider it significant enough to warrantdiscussion.
Kowloon Ltd is currently working on six contracts for customers other than BMC. Our audit evidence concludesthat Kowloon Ltd does not face a threat to its going concern status.’
Your review of the audit work performed on going concern supports this conclusion.Required:(i)
Comment on the matters to be considered, and recommend the actions to be taken by the auditor; and
(7 marks)
(ii)Explain the audit evidence you would expect to find in your review of the audit working papers.
(5 marks)
(25 marks)
7[P.T.O.
Section B – TWO questions ONLY to be attempted3
(a)According to ISA 240 (UK and Ireland) The auditor’s responsibilities relating to fraud in an audit of financial
statements:
‘When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on apresumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenuetransactions or assertions give rise to such risks.’ Required:
Discuss why the auditor should presume that there are risks of fraud in revenue recognition and why ISA 240 requires specific auditor responses in relation to the risks identified.(7 marks)(b)You are the manager responsible for the audit of York Ltd, a chain of health and leisure clubs owned andmanaged by entrepreneur Phil Smith. The audit for the year ended 30 November 2015 is nearing completionand the draft financial statements recognise total assets of £27 million and profit before tax of £2·2 million. Theaudit senior has left the following file notes for your consideration during your review of the audit working papers:
Cash transfers
During a review of the cash book, a receipt of £350,000 was identified which was accompanied by thedescription ‘BD’. Bank statements showed that the following day a nearly identical amount was transferred intoa bank account held in a foreign country. When I asked the financial controller about this, she requested that Ispeak to Mr Smith, as he has sole responsibility for cash management. According to Mr Smith, an old friend ofhis, Brian Davies, has loaned the money to the company to fund further expansion and the money has beeninvested until it is needed. Documentary evidence concerning the transaction has been requested from MrSmithbut has not yet been received.Legal dispute
At the year end York Ltd reversed a provision relating to an ongoing legal dispute with an ex-employee who wasclaiming £150,000 for unfair dismissal. This amount was provided in full in the financial statements for the yearended 30 November 2014 but has now been reversed because Mr Smith believes it is now likely that York Ltdwill successfully defend the legal case. Mr Smith has not been available to discuss this matter and no additionaldocumentary evidence has been made available since the end of the previous year’s audit. The audit report wasunmodified in the previous year.Required:
Evaluate the implications for the completion of the audit, recommending any further actions which shouldbe taken by your audit firm. (13 marks)
(20 marks)
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You are a manager at Chennai & Co, a firm of Chartered Certified Accountants. One of the partners has asked you toinvestigate and respond to a number of issues which have arisen with two different companies.
(a)Delhi Ltd is a potential new client. It is a privately owned and rapidly expanding company. The company’s
management is currently considering having either a full audit or a limited assurance review of the financialstatements. The audit partner would like you to write a response to Delhi Ltd’s management in which you explainthe difference between an audit of historical financial statements and a limited assurance review. You should alsodiscuss the relative advantages and disadvantages to Delhi Ltd of having an audit of their historical financialstatements as opposed to a limited assurance review.
The financial statements for the year ended 31 March 2016 recognise revenue of £5·4 million (2015 –£4·3 million) and total assets of £2·7 million (2015 –£2·1 million).
Delhi Ltd was incorporated in 2005, with founder and chief executive Mr Nimesh Dattani as the sole shareholder.After a period of rapid growth, Delhi Ltd took out a ten-year bank loan facility in June 2007 to finance Mr Dattani’s ambitious expansion plans. This was supported by a further injection of financial capital in 2014through a new issue of shares in the company. The shares were sold to Mr Robert Hyland, an ex-business partnerof Mr Dattani. The sale gave Mr Hyland a 40% shareholding in Delhi Ltd. He has no involvement in themanagement of the company.
Until recently Delhi Ltd operated with a small accounting department, comprising one full-time member of staffand one part-time employee. Due to the expansion of the company and Mr Dattani’s plans to expand thecustomer base outside the UK, it has been necessary to increase the size of the accounting function to includetwo new full-time members of staff. Both of the new recruits are part-qualified accountants and Mr Dattani hascommitted to sponsoring them through their remaining training and ACCA examinations.Required:
Prepare the response to the management of Delhi Ltd as requested by the partner.
(12 marks)
(b)The audit committee of another client, Mumbai plc, has contacted you to ask whether Chennai & Co can perform
a review of the company’s internal control system. A number of recent incidents have raised concerns amongstthe management team that controls have deteriorated and that this has increased the risk of fraud, as well asinefficient commercial practices. The audit report for the audit of the financial statements of Mumbai plc for theyear ended 31 March 2016 was signed a few weeks ago.
Required:
In respect of the request for Chennai & Co to review Mumbai plc’s internal control systems:
Identify and discuss the relevant ethical and professional issues raised, and recommend any actionsnecessary.(8 marks)
(20 marks)
9[P.T.O.
5
You are the manager responsible for the audit of Boston Ltd, a producer of chocolate and confectionery. The audit ofthe financial statements for the year ended 31 December 2015 is nearly complete and you are reviewing the auditworking papers. The financial statements recognise revenue of £76 million, profit before tax for the year of £6·4 million and total assets of £104 million.
The summary of uncorrected misstatements included in Boston Ltd’s audit working papers, including notes, is shownbelow. The audit engagement partner is holding a meeting with the management team of Boston Ltd next week, atwhich the uncorrected misstatements will be discussed. Summary of uncorrectedmisstatements:(i)Impairment(ii)Borrowing costs(iii)Irrecoverable debt(iv)InvestmentTotals(i)
Statement of profit or lossDebitCredit££400,000
75,000
65,000
43,500
––––––––––––––––465,000118,500––––––––––––––––
Statement of financial position
DebitCredit££
400,000
75,000
65,000
43,500––––––––––––––––118,500465,000––––––––––––––––
During the year Boston Ltd impaired one of its factories. The carrying value of the assets attributable to the factory
as a single, cash-generating unit totalled £3·6 million at the year end. The fair value less costs of disposal andthe value in use were estimated to be £3 million and £3·5 million respectively and accordingly the asset waswritten down by £100,000 to reflect the impairment. Audit procedures revealed that management used growthrates attributable to the company as a whole to estimate value in use. Using growth rates attributable to thefactory specifically, the audit team calculated the value in use to be £3·1 million.
(ii)Interest charges of £75,000 relating to a loan taken out during the year to finance the construction of a new
manufacturing plant were included in finance charges recognised in profit for the year. The manufacturing plantis due for completion in November 2016.(iii)One of Boston Ltd’s largest customers, Cleveland Ltd, is experiencing financial difficulties. At the year end
Cleveland Ltd owed Boston Ltd £100,000, against which Boston Ltd made a 5% specific allowance. Shortlyafter the year end Cleveland Ltd paid £30,000 of the outstanding amount due but has since experienced furtherproblems, leading to their primary lender presenting a formal request that Cleveland Ltd be liquidated. Ifsuccessful, only secured creditors are likely to receive any reimbursement.(iv)During the year Boston Ltd purchased 150,000 shares in Nebraska plc for £4·00 per share. Boston Ltd classified
the investment as a financial asset held at fair value through profit or loss. On 31 December 2015, the sharesof Nebraska plc were trading for £4·29. At the year end the carrying value of the investment in Boston Ltd’sfinancial statements was £600,000.Required:
Explain the matters which should be discussed with management in relation to each of the uncorrectedmisstatements, including an assessment of their individual impact on the financial statements; and assuming thatmanagement does not adjust any of the misstatements, discuss the effect on the audit opinion and auditor’sreport.
(20 marks)
End of Question Paper
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