Answers - ACCA Global

1 AnswersFundamentals Level Skills Module, Paper F8 Audit and Assurance March/June 2017 Sample AnswersSection B16 (a)Audit risk and the components of audit riskAudit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materiallymisstated. Audit risk is a function of two main components, being the risk of material misstatement and detection risk. Riskof material misstatement is made up of a further two components, inherent risk and control risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatementwhich could be material, either individually or when aggregated with other misstatements, before consideration of any risk is the risk that a misstatement which could occur in an assertion about a class of transaction, account balanceor disclosure and which could be material, either individually or when aggregated with other misstatements, will not beprevented, or detected and corrected.

2 On a timely basis by the entity s internal risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will notdetect a misstatement which exists and which could be material, either individually or when aggregated with othermisstatements. Detection risk is affected by sampling and non-sampling risk. (b)Audit risks and auditor s responses7 Audit riskAuditor s responseHurling Co upgraded their website during the year at a costof $1 1m. The costs incurred should be correctly allocatedbetween revenue and capital the website has been upgraded, there is a possibility thatthe new processes and systems may not record data reliablyand accurately.

3 This may lead to a risk over completenessand accuracy of data in the underlying accounting a breakdown of the costs and agree to invoices toassess the nature of the expenditure and if capital, agree toinclusion within the asset register or agree to the statementof profit or audit team should document the revised system andundertake tests over the completeness and accuracy of datarecorded from the website to the accounting Co has entered into a transaction to purchase a newwarehouse for $3 2m and it is anticipated that the legalprocess will be completed by the year end. Only assets which physically exist at the year end should beincluded in property, plant and equipment.

4 If the transactionhas not been completed by the year end, there is a risk thatassets are overstated if the company incorrectly includes thewarehouse at the year end. Discuss with management as to whether the warehousepurchase was completed by the year end. If so, inspect legaldocuments of ownership, such as title deeds ensuring theseare dated prior to 1 April 20X7 and are in the finance has been obtained in the year, as thecompany has issued $5m of irredeemable preference finance needs to be accounted for correctly, withadequate disclosure made. As the preference shares areirredeemable, they should be classified as equity rather thannon-current liabilities.

5 Failing to correctly classify the sharescould result in understated equity and overstated share issue documentation to confirm that thepreference shares are irredeemable. Confirm that they havebeen correctly classified as equity within the accountingrecords and that total financing proceeds of $5m addition, the disclosures for this share issue should bereviewed in detail to ensure compliance with relevantaccounting finance director has extended the useful lives of fixturesand fittings from three to four years, resulting in thedepreciation charge reducing. Under IAS 16 Property, Plantand Equipment, useful lives are to be reviewed annually, andif asset lives have genuinely increased, then this change , there is a risk that this reduction has occurred inorder to boost profits.

6 If this is the case, then fixtures andfittings are overvalued and profit with the directors the rationale for any extensions ofasset lives and reduction of depreciation rates. Also, the four-year life should be compared to how often these assetsare replaced, to assess the useful life of customer of Hurling Co has been encountering difficultiespaying their outstanding balance of $1 2m and Hurling Cohas agreed to a revised credit the customer is experiencing difficulties, there is anincreased risk that the receivable is not recoverable andhence is the revised credit terms and identify if any after datecash receipts for this customer have been with the finance director whether he intends to makean allowance for this receivable.

7 If not, review whether anyexisting allowance for uncollectable accounts is sufficient tocover the amount of this riskAuditor s responseA sales-related bonus scheme has been introduced in theyear for sales staff, with a significant number of newcustomer accounts on favourable credit terms being openedpre year end. This has resulted in a 5% increase in revenue. Sales staff seeking to maximise their current year bonus mayresult in new accounts being opened from poor credit risksleading to irrecoverable receivables. In addition, there is arisk of sales cut-off errors as new customers could placeorders within the two-month introductory period andsubsequently return these goods post year end.

8 Increased sales cut-off testing will be performed along with areview of any post year-end returns as they may indicate cut-off errors. In addition, increased after date cash receiptstesting to be undertaken for new customer Co has halted further sales of its new product Lugeand a product recall has been initiated for any goods sold inthe last four there are issues with the quality of the Luge product,inventory may be overvalued as its NRV may be below , products of Luge sold within the last fourmonths are being recalled, this will result in Hurling Copaying customer refunds. The sale will need to be removed;a refund liability should be recognised along with thereinstatement of inventory, although the NRV of thisinventory could be of a minimal value.

9 Failing to account forthis correctly could result in overstated revenue andunderstated liabilities and inventory. Discuss with the finance director whether any write downswill be made to this product, and what, if any, modificationsmay be required with regards the should be undertaken to confirm cost and NRV of theLuge products in inventory and that on a line-by-line basisthe goods are valued the list of sales made of product Luge prior to therecall, agree that the sale has been removed from revenueand the inventory included. If the refund has not been paidpre year end, agree it is included within current liabilities. Petanque Co, a customer of Hurling Co, has announced thatthey intend to commence legal action for a loss of informationand profits as a result of the Luge product sold to it is probable that the company will make payment to thecustomer, a legal provision is required.

10 If the payment ispossible rather than probable, a contingent liability disclosurewould be necessary. If Hurling Co has not done this, there isa risk over the completeness of any provisions or thenecessary disclosure of contingent & Co should write to the company s lawyers toenquire of the existence and likelihood of success of anyclaim from Petanque Co. The results of this should be usedto assess the level of provision or disclosure included in thefinancial finance director has requested that the audit completesone week earlier than normal as he wishes to report resultsearlier. A reduction in the audit timetable will increasedetection risk and place additional pressure on the team inobtaining sufficient and appropriate addition, the finance team of Hurling Co will have lesstime to prepare the financial information leading to anincreased risk of errors arising in the financial timetable should be confirmed with the finance it is to be reduced, then consideration should be given toperforming an interim audit in late March or early April.