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This paper is not to be removed from the Examination Hall
UNIVERSITY OF LONDON AC3093 ZA
BSc degrees and Diplomas for Graduates in Economics, Management, Finance
and the Social Sciences, the Diplomas in Economics and Social Sciences
Auditing and Assurance
Wednesday, 09 May 2018: 14:30 to 17:30
Candidates should answer FOUR of the following EIGHT questions: TWO from Section
A, ONE from Section B and ONE further question from either section. All questions
carry equal marks.
PLEASE TURN OVER
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SECTION A
Answer AT LEAST TWO questions, and NO MORE THAN THREE questions from this section.
1. Edgy & Co. are an established firm of accountants based in a rural area. They have two
main types of client. One type is the local businesses mainly farmers, farm suppliers,
retailers and estate agents. The second type is the wealthy individuals who have retired and
who need help with their tax returns and investment advice. The clients are all small or
medium-sized.
You have just been made a partner of Edgy & Co. bringing the number of partners to six. As
the youngest partner, it was thought that you would be most aware of the latest rules and
regulations. You have been instructed to review the state of the firm’s technical and ethical
values and its compliance with professional regulations. You note the following:
• Thaws, a client which sells tractors and other equipment, has recently been taken over
by a larger, national concern, Mega plc. You discover that your senior partner has been
approached to quote for the audit of Mega plc. He is keen to make a pitch at a low initial
fee since he thinks that this will bring in some big fees for other services in the longer
term.
• By chance, you discover that another of your partners, Bill Oddly, works in his spare
time for an audit client, Lovely Lands, a real estate agency. You are relieved to find that
Oddly has never been the audit partner on the audit of Lovely Lands.
• In conversation with one of the tax managers, you learn that a tax client has good
connections in the City of London and has offered to give some lucrative share tips
based on information that has not yet been released to the public. If these tips proved
successful, the client would expect a reduced tax bill and a lower fee.
• Edgy & Co has just gained a new audit client, a country estate which rents holiday
cottages. One of your partners has made a business loan to help the estate to develop.
• At a partners’ meeting recently, the decision was made that Edgy & Co. should become
more commercial and go after more clients by means of a local advertising campaign.
The majority of the partners liked the slogan ‘For the best advice, get Edgy’.
Required:
a) Identify in each of the above situations, the technical or ethical concerns you might have.
(15 marks)
b) What are the key elements of good professional ethics and why is it important for the
accounting profession to have high ethical values?
(10 marks)
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2. Jean Chamois comes to you as a potential audit client and explains the nature of his
business.
Jean owns Rub-a-Dub, a car wash business operated from three disused petrol stations.
Cars are washed by hand not by machine. Customers like the low prices, £10 for a wash,
wax and polish, compared to the nearest machine-wash which charges £15. But the
numbers of cars washed every day can fluctuate significantly and unpredictably.
Jean employs immigrant labourers because they are prepared to work hard at a tedious job
for wages which the local people refuse to accept. Jean ‘employs’ these workers on a casual
basis instructing them that as they are effectively self-employed, it is their duty to declare
their income to the tax authorities. However, he cannot be certain that all of his operatives
are legally allowed to work since he has never asked to see the identification documents or
other evidence of their right to work in the country.
Each site is manned by a team of four workers who are overseen by a foreman. The
foremen are expected to supervise the servicing of the cars, to step in to cover when one of
the operatives needs a break and to hire and fire operatives. The foremen are responsible
for the safe-keeping of the equipment and stores, such as the jet washes, buckets and
brushes, supplies of detergent and polish. They also buy replacement supplies and
equipment when these are needed, using the cash they have collected that day. They do not
always remember to obtain a receipt for these purchases. The foremen take payments from
customers and record each sale on a scrap of paper. No receipts or invoices are given to
customers. At the end of every day, Jean calls in to each site to collect the cash and to
check that it agrees with the foremen’s records of sales.
The foremen record the number of hours each worker has worked each day. Every Friday
afternoon, Jean visits each site and reviews the record of hours worked. He then calculates
the amount each worker is to be paid. The workers are paid in cash from the amounts which
Jean has accumulated through the week. Generally the workers seem happy, although
recently a dismissed worker deliberately damaged a customer’s car. Jean had to pay for the
repair to the customer’s car out of his own money because he has no insurance to cover
such damage.
Jean relies on his daily contact with each site and his knowledge of the business as a control
over the accuracy of the recorded sales. His view is that if he is being defrauded, it is not by
very much. His bigger concerns are the effect of the UK leaving the European Union, which
may affect the supply of workers, and the introduction of similar car washes by reputable
local supermarkets.
Required:
a) Identify potential weaknesses in the handling of cash and suggest practical controls which
might prevent a misstatement of income and/or expenses.
(15 marks)
b) Apart from issues concerning internal control over the handling of cash, what other
concerns do you have about this client?
(10 marks)
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3. Teds Ltd is a private limited company that manufactures cuddly teddy bears. The company
was established in 1985 and was until recently owned and managed by the Rufus family. In
2016 the Rufus family sold 60% of their shareholding to an outside investor; Mark and Janet
Rufus remain 40% shareholders and continue to manage the company. As a condition of the
sale the company must now be subject to an annual external audit.
Since 2010 the company has been outsourcing its manufacturing to China in order to cut
costs and ensure its products remain competitively priced on the global stage. The product
range has expanded since the decision to outsource and the company has successfully
launched its products in the US and in China. The decision to outsource the manufacturing
was difficult for the Rufus family who had prided themselves on being British manufacturers
but it was encouraged by their bank manager and other advisers owing to the considerable
cost savings to be made. Mark and Janet Rufus visited China in 2010 in order to inspect the
two companies involved in their manufacturing, but have not visited since. They
communicate quarterly with the companies and are reassured by their reputation and the fact
they have had few issues in terms of customer complaints over product quality. Sales to UK
retailers are distributed from the UK warehouse but sales to the US and China are distributed
direct from China.
Product sales are primarily to large retail stores and sales executives are required to build
close relationships with the stores in order to ensure continued business. All executives are
authorised to offer large discounts to secure sales although these should be on the condition
of payment in advance of distribution. The sales team is based primarily in the UK, although
there are and two employees in the US and one located in China. Teds Ltd offers members
of the sales team competitive terms with large bonuses based on sales figures offered each
year.
The sale of 60% of the company’s shares in 2016 was in order to bring in much needed
funds. The Rufus family had been relying on bank loans and a generous overdraft facility
prior to this. However, the bank had begun to restrict and tighten their borrowing terms and
so were no longer prepared to offer long term finance to Teds Ltd. As at 31st December 2017
the company has an outstanding bank loan of £500,000 and a £300,000 bank overdraft
facility with an interest rate of 14% per annum. The outside investor who purchased the
shares is not taking any part in the management of the company but has insisted on an
annual external audit.
Required:
a) Identify potential audit risks associated with the audit of Teds Ltd and detail the additional
information you would require as auditors in order to assess these risks.
(15 marks)
b) Explain the importance of risk assessment during the audit planning stage and how auditors
assess risk.
(10 marks)
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4. Run for Life Ltd operates a chain of stores selling athletic equipment across the South West
of England. The company is wholly owned by the managing director Chris Cadence who
opened his first store in 2000. Since then the business has expanded to its current level of
ten stores employing 75 people and with an annual turnover of £5 million. Chris Cadence has
requested an audit following the discovery in 2016 of an employee fraud involving purchasing
and inventory which is thought to have cost the company up to £100,000.
You are an audit manager at TDL Chartered Accountants and have been assigned to
manage the audit of Run for Life Ltd in respect of the year ended 31st December 2017. In
carrying out your review you discover that the ten stores are all managed separately and
treated as separate units for reporting purposes. Chris likes to reward his staff in accordance
with their store’s performance and enjoys offering regular incentives to store managers
through bonus schemes and competitions. The stores all have separate purchasing and
inventory systems and if customers require goods that are out of stock in one store they are
not permitted to call another store to locate the stock, instead they must place an order for
the stock themselves or ask the customer to try one of their other stores. The company does
not have an internet presence and so on-line ordering by customers is not possible.
The stock purchasing system for each store is the same. The store managers are
responsible for ordering stock and it is at their discretion to determine when and how much to
order. Anybody at the store can raise a purchase requisition, from any supplier, but it must be
authorised by the store manager before being processed. When the goods are delivered,
they are received by whoever is available in store and the Goods Received Note (GRN) is
sent to accounts at the company’s head office to be matched to the purchase invoice. If there
are any queries then the accounts assistant will contact the relevant store manager for
clarification. However, there is no further authorisation required before payment of the
invoice by the accounts staff. Chris Cadence reviews cash flow and individual store stock
reports on a monthly basis but relies largely on the experience of his store managers and his
accounts staff. There is no finance director but an accounts manager who has worked with
Chris since he started the business, Chris relies on his accountants to prepare quarterly
management accounts and inform him of any concerns.
The employee fraud is thought to have gone on for about two years. It involved an assistant
manager who was amending purchase requisitions after they have been authorised by the
store manager. When the additional goods were delivered the fraudster ensured that she
received the goods and then sent the GRN to head office. She was able to take the
additional stock items and sell them on social media sites for personal gain. The store
manager alerted Chris to concerns over the assistant manager following her suspicious
behaviour.
Required:
a) Identify the weaknesses in the company’s purchases and stock control systems and explain
how these would have assisted the assistant manager with his fraud.
(15 marks)
b) Detail the audit testing you will need to carry out in order to ensure the weaknesses you
have identified are not causing material misstatement in the financial statements.
(10 marks)
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SECTION B
Answer AT LEAST ONE question, and NO MORE THAN TWO questions from this section.
5. In what ways can auditors limit their liability to clients?
6. What are the difficulties for auditors in applying the concept of materiality and to what
extent are these addressed by ISA320?
7. The modern auditors’ report is much longer now than it was twenty or thirty years ago.
What extra information is now revealed in auditors’ reports and to what extent do you
think that this extra information informs the investing public?
8. The audit risk model has underpinned the conventional approach to the audit of
financial statements and other engagements. Describe what you understand by the
audit risk model, explain how it assists auditors in planning their audits and identify any
limitations to its effectiveness.
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