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External auditors: fraud and error in an audit of financial statements
External auditors are required by ISA 240 to consider the risks of material misstatements
in the financial statements due to fraud. Their audit procedures will then be based on a risk
assessment. Regardless of the risk assessment, auditors are required to be alert to the
possibility of fraud throughout the audit and maintain an attitude of professional skepticism,
notwithstanding the auditors’ past experience of the honesty and integrity of management
and those charged with governance. Members of the engagement team should discuss the
susceptibility of the entity’s financial statements to material misstatements due to fraud.
Auditors should make enquiries of management regarding management’s assessment of
fraud risk, its process for dealing with risk, and its communications with those charged with
governance and employees. They should enquire of those charged with governance about
the oversight process.
Auditors should also enquire of management and those charged with governance about any suspected or actual instance of fraud.
Auditors should consider fraud risk factors, unusual or unexpected relationships, and assess
the risk of misstatements due to fraud, identifying any significant risks. Auditors should
evaluate the design of relevant internal controls, and determine whether they have been
implemented.
Auditors should determine an overall response to the assessed risk of material misstatements
due to fraud and develop appropriate audit procedures, including testing certain journal
entries, reviewing estimates for bias, and obtaining an understanding of the business
rationale of significant transactions outside the normal course of business. Appropriate
management representations should be obtained.
Auditors are only concerned with risks that might cause material error in the financial
statements. External auditors might therefore pay less attention than internal auditors to
small frauds (and errors), although they must always consider whether evidence of single
instances of fraud (or error) are indicative of more systematic problems.
I t is accepted that because of the hidden nature of fraud, an audit properly conducted in
accordance with ISAs might not detect a material misstatement in the financial statements
arising from fraud. In practice, routine errors are much easier to detect than frauds
Where auditors encounter suspicions or actual instances of fraud (or error), they must
consider the effect on the financial statements, which will usually involve further investigations.
They should also consider the need to report to management and those charged with
governance.
Where serious frauds (or errors) are encountered, auditors need also to consider the effect
on the going concern status of the entity, and the possible need to report externally to third
parties, either in the public interest, for national security reasons, or for regulatory reasons.
Many entities in the financial services sector are subject to this type of regulatory reporting
and many countries have legislation relating to the reporting of money laundering activities,
for example.
Wilfykil answered the question on April 12, 2019 at 09:43
- Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission on holidays sold to customers through its chain of...(Solved)
Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission on holidays sold to customers through its chain of high street shops. Staff are partly paid on a commission basis. Well-established tour operators run the holidays that Stone Holidays sells. The networked reservations system through which holidays are booked and the computerised accounting system are both well-established systems used by many independent travel agencies. Payments by customers, including deposits, are accepted in cash and by debit and credit card. Stone Holidays is legally required to pay an amount of money (based on its total sales for the year) into a central fund maintained to compensate customers if the agency should cease operations.
Describe the nature of the risks to which Stone Holidays is subject arising from fraud and error.
Date posted: April 12, 2019. Answers (1)
- Fraud and error present risks to an entity. Both internal and external auditors are required to deal
with risks to the entity.(Solved)
Fraud and error present risks to an entity. Both internal and external auditors are required to deal
with risks to the entity.
Required:
Explain how the internal audit function helps an entity deal with the risk of fraud and error.
Date posted: April 12, 2019. Answers (1)
- You are the audit manager for Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions: mail order and on-line...(Solved)
You are the audit manager for Parker, a limited liability company which sells books, CDs, DVDs
and similar items via two divisions: mail order and on-line ordering on the Internet. Parker is a
new audit client. You are commencing the planning of the audit for the year-ended 31 May 2005.
An initial meeting with the directors has provided the information below.
The company’s turnover is in excess of Kshs85 million with net profits of Kshs4 million. All profits
are currently earned in the mail order division, although the Internet division is expected to return
a small net profit next year. Turnover is growing at the rate of 20% p.a. Net profit has remained
almost the same for the last four years. In the next year, the directors plan to expand the range of
goods sold through the Internet division to include toys, garden furniture and fashion clothes. The
directors believe that when one product has been sold on the Internet, then any other product
can be as well.
The accounting system to record sales by the mail order division is relatively old. It relies on
extensive manual input to transfer orders received in the post onto Parker’s computer systems.
Recently errors have been known to occur, in the input of orders, and in the invoicing of goods
following dispatch. The directors maintain that the accounting system produces materially
correct figures and they cannot waste time in identifying relatively minor errors. The company
accountant, who is not qualified and was appointed because he is a personal friend of the
directors, agrees with this view, The directors estimate that their expansion plans will require a
bank loan of approximately Kshs30 million, partly to finance the enhanced web site but also to
provide working capital to increase inventory levels. A meeting with the bank has been scheduled
for three months after the year end. The directors expect an unmodified auditor’s report to be
signed prior to this time.
Required:
Identify and describe the matters that give rise to audit risks associated with Parker .
Date posted: April 12, 2019. Answers (1)
- Ajio is a charity whose constitution requires that it raises funds for educational projects. These
projects seek to educate children and support teachers in certain countries(Solved)
Ajio is a charity whose constitution requires that it raises funds for educational projects. These
projects seek to educate children and support teachers in certain countries. Charities in the
country from which Ajio operates have recently become subject to new audit and accounting
regulations. Charity income consists of cash collections at fund raising events, telephone
appeals, and bequests (money left to the charity by deceased persons). The charity is small
and the trustees do not consider that the charity can afford to employ a qualified accountant.
The charity employs a part-time bookkeeper and relies on volunteers for fund raising. Your firm
has been appointed as accountants and auditors to this charity because of the new regulations.
Accounts have been prepared (but not audited) in the past by a volunteer who is a recently
retired Chartered Certified Accountant.
Required:
Describe the risks associated with the audit of Ajio under the headings inherent risk, control risk and detection risk and explain the implications of these risks for overall audit risk
Date posted: April 12, 2019. Answers (1)
- List and explain the audit tests to be performed on income and expenditure from fund raising events.(Solved)
List and explain the audit tests to be performed on income and expenditure from fund raising events.
Date posted: April 12, 2019. Answers (1)
- ISA 400 (Risk Assessments and Internal Control) deals with internal control objectives and
internal controls. ISA 500 (Audit Evidence) deals with audit objectives and audit procedures....(Solved)
ISA 400 (Risk Assessments and Internal Control) deals with internal control objectives and
internal controls. ISA 500 (Audit Evidence) deals with audit objectives and audit procedures. A
proper understanding of internal controls is essential to auditors in order that they understand the
business and are able to effectively plan and execute tests of controls and an appropriate level
of substantive procedures.
You are the auditor of a small manufacturing company, Dinko, that pays its staff in cash and by
bank transfer and maintains its payroll on a small stand-alone computer.
Required:
(a) For the payroll department at Dinko, describe the:
i. Internal control objectives that should be in place.
ii. Internal control environment and internal control procedures that should be in place to achieve the internal control objectives.
(b) For the payroll charges and payroll balances (including cash) in the financial statements of Dinko:
i. Describe the external auditor audit objectives.
ii. List the tests of control and substantive procedures that will be applied in order to achieve the audit objectives identified in (b) (i) above.
Date posted: April 12, 2019. Answers (1)
- Rhapsody Co supplies a wide range of garden and agricultural products to trade and domestic
customers. The company has 11 divisions, with each division specializing in...(Solved)
Rhapsody Co supplies a wide range of garden and agricultural products to trade and domestic
customers. The company has 11 divisions, with each division specializing in the sale of specific
products, for example, seeds, garden furniture, and agricultural fertilizers. The company has an
internal audit department which provides audit reports to the audit committee on each division
on a rotational basis.
Products in the seed division are offered for sale to domestic customers via an Internet site.
Customers review the product list on the Internet and place orders for packets of seeds using
specific product codes, along with their credit card details, onto Rhapsody Co’s secure server.
Order quantities are normally between one and three packets for each type of seed. Order details
are transferred manually onto the company’s internal inventory control and sales system, and
a two part packing list is printed in the seed warehouse. Each order and packing list is given a
random alphabetical code based on the name of the employee inputting the order, the date, and
the products being ordered.
In the seed warehouse, the packets of seeds for each order are taken from specific bins and
dispatched to the customer with one copy of the packing list. The second copy of the packing list
is sent to the accounts department where the inventory and sales computer is updated to show
that the order has been dispatched. The customer’s credit card is then charged by the inventory
control and sales computer. Bad debts in Rhapsody are currently 3% of total sales.
Finally, the computer system checks that for each charge made to a customer’s credit card
account, the order details are on file to prove that the charge was made correctly. The order file
is marked as completed confirming that the order has been dispatched and payment obtained.
Required:
a) In respect of sales in the seeds division of Rhapsody Co, prepare a report to be sent to the
audit committee of Rhapsody Co which:
i. Identifies and explains four weaknesses in that sales system.
ii. Explains the possible effect of each weakness.
iii. Provides a recommendation to alleviate each weakness.
Date posted: April 12, 2019. Answers (1)
- List down internal control procedures for raw material purchasing system of a large manufacturing firm(Solved)
List down internal control procedures for raw material purchasing system of a large manufacturing firm
Date posted: April 12, 2019. Answers (1)
- The time is now towards the end of the audit, and you are reviewing working papers produced by the audit team. An example of a...(Solved)
The time is now towards the end of the audit, and you are reviewing working papers produced by the audit team. An example of a working paper you have just reviewed is shown below.
Client Name Specs4You Co
Working paper Payables transaction testing
Year end 30 April 2007
Prepared by ……………………..
Reviewed by ……………………
Audit assertion: To make sure that the purchases day book is correct.
Method: Select a sample of 15 purchase orders recorded in the purchase order system. Trace
details to the goods received note (GRN), purchase invoice (PI) and the purchase day book
(PDB) ensuring that the quantities and prices recorded on the purchase order match those on
the GRN, PI and PDB.
Test details: In accordance with audit risk, a sample of purchase orders were selected from
a numerically sequenced purchase order system and details traced as stated in the method.
Details of items tested can be found on another working paper.
Results: Details of purchase orders were normally correctly recorded through the system. Five
purchase orders did not have any associated GRN, PI and were not recorded in the PDB.
Further investigation showed that these orders had been cancelled due to a change in spectacle
specification. However, this does not appear to be a system weakness as the internal controls do
not allow for changes in specification.
Conclusion: Purchase orders are completely recorded in the purchase day book.
Required:
Explain why the working paper shown above does not meet the standards normally expected of
a working paper.
Date posted: April 12, 2019. Answers (1)
- You are an audit senior responsible for understanding the entity and its environment and assessing
the risk of material misstatements for the audit of Rock for...(Solved)
You are an audit senior responsible for understanding the entity and its environment and assessing
the risk of material misstatements for the audit of Rock for the year ending 31 December 2004.
Rock is a company listed on a stock exchange. Rock is engaged in the wholesale import,
manufacture and distribution of basic cosmetics and toiletries for sale to a wide range of stores,
under a variety of different brand names. You have worked on the audit of this client for several
years as an audit junior.
Required:
Describe the information you will seek, and procedures you will perform in order to understand the entity and its environment and assess risk for the audit of Rock for the year ending 31 December 2004.
Date posted: April 12, 2019. Answers (1)
- Discuss on features of audit working papers(Solved)
Discuss on features of audit working papers
Date posted: April 12, 2019. Answers (1)
- Explain the following controlling procedures in a well planned audit:
• Direction and supervision of work
• Review and co-coordination of work
• Quality controls(Solved)
Explain the following controlling procedures in a well planned audit:
• Direction and supervision of work
• Review and co-coordination of work
• Quality controls
Date posted: April 12, 2019. Answers (1)
- You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants. You are preparing the engagement letter for the audit of...(Solved)
You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants. You are preparing the engagement letter for the audit of Ancients; a public limited liability company, for the year ending 30 June 2006.Ancients has grown rapidly over the past few years, and is now one of your firm’s most important clients. Ancients has been an audit client for eight years and McKay & Co has provided audit, taxation and management consultancy advice during this time. The client has been satisfied with the services provided, although the taxation fee for the period to 31 December 2005 remains unpaid. Audit personnel available for this year’s audit are most of the staff from last year, including Mr. Grace, an audit partner and Mr. Jones, an audit senior. Mr. Grace has been the audit partner since Ancients became an audit client. You are aware that Allyson Grace, the daughter of Mr. Grace, has recently been appointed the financial director at Ancients. To celebrate her new appointment, Allyson has suggested taking all of the audit staff out to an expensive restaurant prior to the start of the audit work for this year.
Required:
Identify and explain the risks to independence arising in carrying out your audit of Ancients for the
year ending 30 June 2006, and suggest ways of mitigating each of the risks you identify.
Date posted: April 12, 2019. Answers (1)
- Explain the situations where an auditor may disclose confidential information about a client.(Solved)
Explain the situations where an auditor may disclose confidential information about a client.
Date posted: April 12, 2019. Answers (1)
- You are a recently qualified Chartered Certified Accountant in charge of the internal audit
department of ZX, a rapidly expanding company.(Solved)
You are a recently qualified Chartered Certified Accountant in charge of the internal audit
department of ZX, a rapidly expanding company. Turnover has increased by about 20% p.a.
for the last five years, to the current level of Kshs50 million. Net profits are also high, with an
acceptable return being provided for the four shareholders. The internal audit department was
established last year to assist the board of directors in their control of the company and to
prepare for a possible listing on the stock exchange. The Managing Director is keen to follow
the principles of good corporate governance with respect to internal audit. However, he is also
aware that the other board members do not have complete knowledge of corporate governance
or detailed knowledge of International Auditing Standards.
Required:
Write a memo to the board of ZX that:
Explains how the internal audit department can assist the board of directors in fulfilling
their obligations under the principles of good corporate governance.
Date posted: April 12, 2019. Answers (1)
- a) Describe the matters to consider within your firm and the other procedures that must be
undertaken before accepting the appointment as auditor to a new...(Solved)
a) Describe the matters to consider within your firm and the other procedures that must be
undertaken before accepting the appointment as auditor to a new client.
b) Explain why it would be inappropriate to commence the audit before consideration of
the matters and the procedures referred to in (a) above have been completed.
Date posted: April 12, 2019. Answers (1)
- The objectivity of the external auditor may be threatened or appear to be threatened where:(Solved)
The objectivity of the external auditor may be threatened or appear to be threatened where:
i. There is undue dependence on any audit client or group of clients.
ii. The firm, its partners or staff have any financial interest in an audit client.
iii. There are family or other close personal or business relationships between the firm, its
partners or staff and the audit client.
iv. The firm provides other services to audit clients.
Required:
a) For each of the four examples given above, explain why the objectivity of the external
auditor may be threatened, or appear to be threatened, and why the threat is important.
b) Describe requirements that reduce the threats to auditor objectivity for each of the four examples given above.
Date posted: April 12, 2019. Answers (1)
- Your firm has been approached by the directors of UB Bank Ltd. a newly formed commercial bank
to undertake the audit for its first complete financial...(Solved)
Your firm has been approached by the directors of UB Bank Ltd. a newly formed commercial bank
to undertake the audit for its first complete financial year ended 31 December 1996. Your manager
has assigned you the responsibility for leading the team. You have had various discussions with
the directors about the timetable and the respective responsibilities of management and the
auditor. You have drafted a letter of engagement and have sent it to the managing director for
approval and acceptance but the management has not yet responded to your letter.
Required:
a) Explain why a letter of engagement is sent before any new audit appointment is accepted.
b) Set out the main contents of a letter of engagement.
c) Itemize the actions you would take in response to the non-reply by the management to your draft engagement letter.
d) State when it might be necessary to re-draft an engagement letter and have it reaffirmed by the client’s management.
Date posted: April 12, 2019. Answers (1)
- The purpose of an external audit and its role are not well understood. You have been asked to
write some material for inclusion in your firm’s...(Solved)
The purpose of an external audit and its role are not well understood. You have been asked to
write some material for inclusion in your firm’s training materials dealing with these issues in the
audit of large companies.
Draft explanation dealing with the purpose of an external audit and its role in the audit of large
companies, for inclusion in your firm’s training materials.
Date posted: April 12, 2019. Answers (1)
- List and describe SIX financial statement assertions, other than completeness, used by auditors
in the audit of financial statements.(Solved)
List and describe SIX financial statement assertions, other than completeness, used by auditors
in the audit of financial statements.
Date posted: April 12, 2019. Answers (1)