ACCA paper f8 auditiing and assurance F8AA(Int)Mock1 as j08

No completeness or accuracy checks are made when the order data is transferred from the orders file to the legacy system.. A despatch note is produced and the customer’s credit card char

Fundamentals Skills Module - Mock 1

Audit and Assurance

(International)

F8AA-MK1-X08-A

Answers & Marking Scheme

INTERNATIONAL

1 TOPNOTCH4U

(a) Sales system report

(1 mark for each weakness, effect and recommendation total of 3 marks per matter The solution provides a guideline of the detail expected If less, only award a maximum of ½ mark per element.)

Weakness Potential effect of weakness Recommendation

The detail of the orders placed by customers

through the website is taken directly from the

web page to the orders file rather than being

verified through the product file first

It is possible that data on the webpage may be altered In particular the sales price may be lowered by an experienced hacker and this price will then be used as the basis of charging the customer, resulting in lost income

The web program should be amended so that when the customer accepts the shopping basket order, key data will be transferred from the product data base to the order file This will ensure that the sales price is the real price and not the price as manipulated by the customer

Despatch notes are not pre-numbered and only

the customer’s copy is authorised by the

despatch manager

This effectively prevents completeness and

authorisation checks to be made to ensure all

orders despatched are valid, accounted for and

entered correctly into the system

The despatch note used by the despatch manager may be lost and the goods not sent

With the second copy of the note being sent to the accounts department, it is possible that a customer will be charged for goods not received

Additionally, if the second copy sent to the accounts department is lost, then goods may

be sent to customers but no charge made

Despatch notes should be pre-numbered by the system

As goods are despatched, the second copy should be authorised by the despatch manager

as “goods sent”

A completeness check can then be carried out

by the accounts department as well as a check that each note is authorised

No completeness or accuracy checks are made

when the order data is transferred from the

orders file to the legacy system Errors made

when transferring the data may not therefore

be identified

In copying the converted data via the Zip drive there is a possibility that some data may corrupt The sales report used to update the inventory records may therefore be inaccurate

Batch total controls should be used to check for the completeness and validity of the data transferred between the two systems

In addition, the original sales order data should

be backed up (before conversion) and archived

at the end of each day This will provide the ability to restore any data that becomes

Weakness Potential effect of weakness Recommendation

The inventory programme is manually updated

from the product sales report There is a risk

that the data will not be accurately entered

The inventory records may not accurately reflect the physical inventory held due to inaccurate sales reports and/or inaccurate data entry from the reports

Incorrect inventory records may result in orders not being placed to replace low levels

of inventory

Data entered into the inventory system should

be validated to ensure its completeness and validity

A perpetual inventory counting approach should be introduced to ensure that the inventory records accurately reflect the level

of inventories held

The customer’s credit card is charged after

despatch of goods to the customer, meaning

that goods are already sent to the customer

before payment is authorised

The company will not be paid for goods despatched where the credit company rejects the payment request, thus incurring a bad debt

The customer’s credit card authorisation should be obtained before the toys are despatched Ideally this should be done directly after the customer submits their shopping basket and confirmed to the customer

There is no check to verify the inventory level

at the point of customer order nor any formal

system to inform customers of a delay in

shipping their order

It is possible that a customer may be charged for their toys, when no toys have been sent/received as the second copy of the despatch note may still be sent to the accounts department

Customer goodwill will also be lost if the delivery of toys is delayed

The product database should incorporate an inventory program that informs the customer

of the current inventory status (eg In stock, Out of stock, delivery will be made within one week, Only 2 items in stock) and allows the customer to accept, change their order or cancel

The system will require updating to keep track

of ‘out of stock’ orders

The system does not produce a separate sales

invoice for despatch to the customer A

despatch note is produced and the customer’s

credit card charged, but no VAT invoice is

produced and sent to the customer

Under most jurisdictions, it is essential that a VAT audit trail is maintained to clearly identify the VAT payable to the authorities

In addition, customers will require an input VAT invoice for their own VAT process

The current system is likely to raise negative comments on a VAT inspection

The system should be updated to provide a VAT audit trail and a VAT invoice sent to customers

The invoice could be sent by e-mail to customers on confirmation of order despatch

or as a hard copy with the order

Weakness Potential effect of weakness Recommendation

Inventory is only counted once a year, at the

end of the financial period No regular

reconciliation takes place between items

purchased, sold and in inventory It is possible

that items may be dispatched without being

recorded or stolen

Toys that are despatched in excess of the orders or are directly stolen are considered to

be an understatement of sales, a direct impact

on the financial statements and profit

A perpetual inventory counting approach should be introduced to ensure that the inventory records accurately reflect the level

of inventories held Any discrepancies should

be thoroughly reviewed and explained Regular reconciliations of items purchased, sold and held in inventory should take place

(b) Internet sales system

(1 mark for each relevant and FULL point made If no explanation is given for the test, only award

½ mark Note that the requirement only refers to recording in the sales module of the legacy system – no marks should be awarded for tests relating to the use of day books, financial statements etc )

̈ In order to establish that the toys despatched are those ordered by the customer, it

will be necessary to test that the data initially entered through the website is correctly captured by the system

An order should therefore be placed by the auditor using the website and then checked to the orders file agreeing the completeness and accuracy of the data

In obtaining their initial understanding of the control design and implementation, the auditors will have already established the functionality of the website and the transfer of data to the orders file

̈ Access the order file and select a sample of orders Agree the unit prices to an

authorised price list/file Check the additions of the order and VAT calculations

̈ Trace each order through to the sales module within the legacy system, agreeing all

details to ensure completeness and accuracy of the data transfer Agree that the correct accounts have been updated, ie sales, receivables and VAT

̈ Agree the order detail to the despatch note filed in the accounts department This

will provide evidence of goods having been despatched and that the despatch notes were accurately printed by the system

̈ From the sales module, trace the order details through to a daily product sales

report., ensuring that the date of the report is the day after the order was placed This tests the completeness, accuracy and validity of the sales report

̈ From the daily sales report, agree that the inventory records have been updated for

the order placed Completeness and accuracy of updating inventory records for despatch of private customer orders

̈ Agree that the order entry in the sales module of the legacy system has been flagged

to show goods despatched and credit card authorisation obtained

̈ Agree to a credit card statement that the payment (less any agreed charges) has been

received Trace the total of the credit card statement through to the cash book and bank statement

Use of CAATS

Whilst not specifically mentioned, award appropriate marks where answers refer to the use of CAATs, eg:

̈ Extract complete data files from the orders file and the sales files of the legacy

system Compare both sets of data using a CAAT to ensure completeness and accuracy of data transfer from the order system to the legacy system

̈ Applying the same procedure, compare the inventory data from the orders file with

the data extracted from the inventory files to ensure complete and accurate update

of the inventory system for internet sales

̈ For each month, using the data from the sales module of the legacy system, compute

the total sales value and reconcile to the credit card companies monthly statement to test for completeness of credit card authorisation

(c) Commercial customers receivables (1 mark for each FULL and valid point ½ mark only

if lack of explanation /depth Max of 8 marks

NOTE 1: As there are only ten commercial balances, procedures should reflect this If

answers are clearly wrote learnt without consideration of the scenario, eg select sample from balances, award no marks

NOTE 2: As the customers are overseas, award no marks for any comments made on

sending second letters etc There will be insufficient time to do so and the student’s answer will be wrote learnt without application to the scenario Only award marks if within the specific context of the circularisation being done at the year end to allow time for second letters to be sent

NOTE 3: Some students may take the view that as there are only ten commercial

customers, an alternative approach to circularisation should be taken

An acceptable procedure would be to apply alternative procedures to all balances, eg establish existence, makeup of balance, after date cash received PROVIDED a strong systems approach (manual or CAATs) had been applied and made clear in the answer

NOTE: Award no marks for any suggestion of using CAATs to select balances etc As

there are only ten balances, this would clearly be inappropriate CAATs would be appropriate to establish closing balances from initiating records which could then be tested for after date cash )

̈ Consider the timing of the circularisation re reporting deadlines and the audit

timing As overseas, a longer period of time will be needed to receive replies The circularisation may therefore need to be carried out at or before the year end

̈ Obtain a list of the commercial customer receivables from the client Check the

addition of the list and that the total receivables agrees to the general ledger Check the extraction of the list from the sales ledger to ensure completeness and accuracy

of the extraction

̈ Review the list for credit balances Where the total of credit balances are material,

add back to the receivables balance and to the payables balance to ensure the balances show a true and fair view Establish the reasons why there are material credit balances or a significant number and consider impact on audit approach (eg may increase audit risk)

̈ As there are only ten commercial customers, include all within the circularisation,

unless clearly immaterial Agree with client that all will be circularised If client requests any not to be circularised, establish reason as to why (and is reasonable) and include balance for other procedures

̈ Prepare positive , closed circularisation letters (ie those stating the balance due and

requiring a reply regardless of agreement or disagreement) on TopNotch4U’s letterhead and signed by the company

̈ The letters should be posted independent of the client (to ensure the client is not

able to suppress or directly reply to any ) with the return from customers to be made directly to the auditors to reduce any risk of the client being able to interfere with the letters or replies

̈ Replies will either agree balances or disagree balances Where disagreement, the

amount disagreed must be analysed and audited Disagreement will usually be based on cash and/or goods in transit

̈ Where cash in transit, agree subsequent receipt of cash to cash book and through to

the bank statement Where goods in transit, agree to sales invoice, goods despatch note and entry in inventory records to ensure correct cut-off

̈ Where no replies, apply alternative procedures, eg establish existence of customer

(website, contracts, correspondence); make up of balance (invoices, despatch notes, inventory entries); after date payment received (cash book, bank statement)

(d) Cut-off (1 mark for each valid point Max of 3 marks If no example given max of 2

marks)

̈ Cut off is a financial statement assertion that basically means that a transaction that

occurred in one period is recorded within that period A cut-off test gathers substantive evidence that transactions are recorded in the period to which they relate

̈ A cut off test, depending on its direction, provides evidence as to two types of

misstatement, namely:

̌ a misstatement relating to completeness, where an economic event that

occurs in the financial period being audited (i.e up to and including the cut-off date) is recorded in the related account balance in the subsequent

accounting period (1 mark)

̌ a misstatement relating to validity, where an economic event that occurs

in the period following the period being audited (i.e after the cut-off date)

is recorded in the related account balance in the period being audited (1

mark)

̈ Auditors perform cut-off tests for all major classes of transactions, either at the end

of the financial period or, where substantive evidence is gathered prior to the year end, at an earlier cut-off date

̈ A basic example would be sales and receivables Despatches made before the year

end should be recorded as sales and receivables before the year end and excluded from inventory before the year end Despatches made after the year end should be evidenced as invoiced after the year end and recorded as sales/receivables after the year end

2 ISAs

(a) Threats to the Fundamental Principles (½ mark identifying plus ½ mark explaining, to

include at least two examples, otherwise only ½ mark Max of 5 marks)

̈ Self-interest – may occur as a result of the financial or other interests of members

(including immediate or close family of the member) eg, loans or guarantees, close personal or business relationships, financial interest in a client, gifts and hospitality

̈ Self-review – may arise when a previous judgment needs to be re-evaluated by

individuals responsible for that judgment Examples include:

̌ providing a service to a client that will then be subject to review as part of

the assurance engagement;

̌ reporting on the operation of systems after being involved in their design

or implementation;

̌ the discovery of a significant error during a re-evaluation of the work

being undertaken by the member

̈ Advocacy – occurs when members promote a position or opinion to the point that

subsequent objectivity may be compromised, eg

̌ commenting publicly on future events in particular circumstances, having

made assertions without detailing the assumptions;

̌ where information is incomplete or advocating an argument which is

unlawful;

̌ promoting shares in a listed audit client or a client seeking to list;

̌ acting as an advocate on behalf of an assurance client in litigation or

disputes with third parties

̈ Familiarity – can arise where members, because of a close relationship, become too

sympathetic to the interests of others There is a significant risk that professional scepticism will not be applied Examples include:

̌ a member in a position to influence business decisions, financial (or

non-financial) reporting (e.g the audit report) having an immediate or close family who is in a position to benefit from that influence (e.g a director or shareholder);

̌ over-familiarity with the management of the organisation such that

professional judgement could be compromised;

̌ long association with business contacts influencing business decisions;

̌ acceptance of gifts or preferential treatment, unless the value is clearly

insignificant

̈ Intimidation – will occur where members may be deterred from acting objectively

by threats, actual or perceived, direct or indirect Examples of circumstances that may create intimidation threats include:

̌ threat of dismissal or replacement of the member;

̌ a dominant personality attempting to influence the decision-making

process;

̌ being threatened with litigation;

̌ coming under pressure to reduce necessary work to ensure a reduction in

fees

(b) Controls (½ mark each point, max of 1 mark each element, 5 marks in total)

̈ The control environment - sets the tone of an organization, influencing the control

consciousness of its management and employees It is the foundation for effective internal control, providing discipline and structure

Strongly relates to how management (and governance) has created a culture of honesty and ethical behaviour, supported by appropriate controls to prevent and detect fraud and error

̈ Risk assessment procedures – how the entity’s management identify business risks

relevant to the financial reporting objectives and how they decide to address those risks and review the results of doing so

Risks relevant to financial reporting include external and internal events and circumstances that may occur and adversely affect an entity’s ability to initiate, record, process, and report financial data

̈ Information system – consists of the physical and hardware (if IT based)

infrastructure, software (if IT based), people, procedures and data

It includes the accounting system and consists of the procedures and records established to initiate, record, process, report and maintain accountability which must also be able to deal with errors and incorrect processing

̈ Control activities – the policies and procedures that help ensure that management

directives are carried out, e.g that actions are taken to address risks that threaten the achievement of the entity’s objectives

They have various objectives and are applied at various organisational and functional levels Examples include authorisation, performance reviews, information processing, physical controls and segregation of duties

̈ Monitoring controls – the process to assess the effectiveness of internal control

performance over time It involves assessing the design and operation of controls on

a timely basis and taking necessary corrective actions for changes in conditions Without monitoring control systems and receiving feedback on the performance of those controls, the entity’s management will have no idea if a control, whilst still operating, is actually effective Ongoing monitoring activities are often built into the normal recurring activities of an entity and include regular management and supervisory activities

3 ISA REGULATORY FRAMEWORK

(a) Financial statement risks (1 mark per valid point Max of 12 marks)

Client business

̈ Okalas operates in the high-tech field of military tank engine production Inventory

obsolescence through technological change is a high risk area Values may be overstated

̈ Turnover consists of a small number of very high value contracts (eg currently

tendering for $200m NATO contract) Such “economic dependence” may lead to going concern problems should one (or more) of the contracts fail

̈ Considerable expenditure is made in R & D, to develop up-to-date engines to

maintain the company’s market position Such expenditure classified as development may not be recoverable, thus there is a risk of impairment and overstatement of the balance

̈ The client faces the risk of high expenditure and investment in technical

development when: (2 points necessary to gain 1 mark)

̌ fierce domestic and overseas competition may force unprofitable

tendering (going concern risk);

̌ failure to deliver engines to the terms of contracts could lead to significant

penalties (understatement of provision for penalties);

̌ the majority of sales are overseas (NATO, Middle-East, Australasia)

subjecting the company to:

– foreign currency exposure;

– potential bad debt problems (understatement of allowance); – political volatility (going concern considerations);

Products

̈ Thunderflash – Very recently developed with high development costs, this the

subject of the NATO tender (1 mark each point, max of 2 marks)

̌ Overall reliability is unclear until the engine has been in operation for a

longer period There may be future developments or warranty expenses to

be incurred (potential understatement of provision)

̌ Development costs may be fairly amortised under IAS 38 Intangible

Assets if it is:

– likely to make future profits;

– commercially and technically viable

Otherwise, the capitalisation of such costs will be overstated