ICAEW A&A - ORCHID ME - Qs
ICAEW A&A - ORCHID ME - Qs
ICAEW A&A - ORCHID ME - Qs
2021
ORCHID
(2.5 hours)
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1.1 As part of your analytical procedures on the financial statements of Kraken Ltd
(Kraken), a retailer, you note an improvement in the current ratio. The financial
controller explains that this is due to the factors listed below:
(a) A restructuring of Kraken's finances with short-term borrowings consolidated
into a 10-year loan with annual repayments.
(b) The sale of one of Kraken's freehold stores to a developer for cash.
For each of the above factors, briefly explain whether it is a plausible explanation
for the improvement in the current ratio. (2 marks)
1.2 Your firm is the external auditor of Nessie Ltd (Nessie). Nessie and Klingon Ltd
(Klingon) are competitors engaged in the manufacture of mobile phones. On
1 December 2021, Nessie received notification of legal proceedings against it by
Klingon for an alleged infringement by Nessie of a number of patents granted to
Klingon.
Explain why your firm should consider this matter during the audit of the financial
statements of Nessie for the year ended 31 October 2021. (4 marks)
1.3 Outline the differences between the conclusion expressed following an
engagement to examine prospective financial information and the opinion
expressed in an external auditor's report on financial statements. Give reasons for
these differences. (4 marks)
1.4 Your firm is the external auditor of Hydra Ltd (Hydra) for the year ended
31 October 2021. Trade receivables at 31 October 2021 included £750,000 due
from Orc plc (Orc). The chief executive of Hydra refused to provide any
information about the contract with Orc and refused permission for your firm to
contact Orc to confirm the outstanding balance. The chief executive claimed that
the contract involved the military and that Hydra had signed a confidentiality
agreement with Orc. No alternative audit procedures are available to establish the
existence of the debt. Hydra's total assets at 31 October 2021 were £29.0 million
and profit before tax for the year then ended was £5.0 million.
Explain the implications for the auditor's report on Hydra's financial statements for
the year ended 31 October 2021. (4 marks)
1.5 Describe the responsibilities of the ethics partner within an external audit firm.
(3 marks)
1.6 You are an audit senior on the external audit of Vampire Ltd (Vampire) for the year
ended 31 October 2021. Whilst planning the external audit you read the following
comment on the 'points forward for next year' working paper included in last year's
audit file:
'During the course of our audit we discovered that Vampire had underpaid payroll
taxes of £25,755. We notified Vampire in writing, of the need to pay this amount as
soon as possible. The statement of financial position has been adjusted to include
this sum within current liabilities as 'Amounts payable – unpaid taxes'.
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Included in the company's unaudited financial statements for the year ended
31 October 2021 is a credit entry of £25,755 in the statement of profit or loss
described as ''payroll difference''. Revenue and profit before tax for the year ended
31 October 2021 are £27 million and £2.2 million respectively.
State, with reasons, the actions that you and your firm should take in respect of
this matter. (3 marks)
Total: 20 marks
QUESTION 1.6 COMPLETES THE SHORT FORM QUESTIONS
LONG FORM QUESTIONS (2–4) FOLLOW
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2 Assume it is 21 February 2019.
Your firm has recently been appointed as the external auditor of Elephant
Company (Elephant), following the resignation of the previous auditor. Your firm is
auditor to a number of digital marketing firms, including one of Elephant's main
competitors.
Elephant is in the process of applying for a long-term bank loan to finance an
international expansion in order to be able to target larger European projects. The
bank has requested the audited financial statements by 31 March 2019 to support
the loan application.
You are assigned as audit senior to the audit of Elephant for the year ended
31 December 2018. Audit materiality for the financial statements of Elephant has
been assessed at £30,000.
Elephant is a digital marketing company operating from three locations in different
regions of the UK. Elephant agrees fixed price contracts with its customers for the
delivery of integrated traditional media and digital marketing services related to
specific marketing projects. The contract specifies deliverables such as website
design and development, together with creation of website content, social media
content and visual assets.
Each contract Elephant undertakes is typically between two and four months.
Contracts are only invoiced once complete and the customer has signed off to
confirm that the agreed deliverables were achieved. Where Elephant has been
unable to achieve all contract deliverables a discount is applied to the contract
price on invoicing. At the year end, accrued revenue related to incomplete and
uninvoiced contracts was posted to account 54800 Other Income.
Each contract is assigned to one of Elephant's ten project managers. As well as
achieving contract delivery, the project manager is responsible for controlling and
recording the cost of sales related to each project. Project managers are assessed
and awarded an annual bonus based on the profitability of the projects that they
control.
Project managers record direct costs incurred on separate 'job card' spreadsheets
for each contract. Significant direct costs relate to photography, artwork, printing,
marketing mock-ups and other consultancy. Purchase invoices are approved for
payment by project managers and then passed to accounts for payment.
The audit manager has identified the following as key areas of audit risk:
Revenue cut-off
Cost of sales
You have identified that all photographic services used by Elephant in the year
were exclusively purchased from Fox Ltd (Fox). You have also identified that Fox
is owned by the wife of one of Elephant's executive directors. Elephant's finance
director has informed you that these transactions were all at market rates and that
there is no intention to include any specific disclosure in relation to the matter in
Elephant's financial statements for the year ended 31 December 2018.
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You have identified the following relevant accounts from Elephant's accounting
system.
Account name Account code
Domestic Sales 51010
Overseas Sales 51020
Other Income 54800
Accruals Control A/C 34030
Photography 61060
Requirements
2.1 Identify and explain the matters that your firm should have considered before
accepting appointment as external auditor of Elephant. (7 marks)
2.2 Justify why revenue cut-off and cost of sales have been identified as key areas
of audit risk and describe the procedures for each that should be included in
the audit plan to address those risks. The Explore module of the audit software
should be used to support your answer. (17 marks)
2.3 Identify and explain the probable impact of Elephant's use of Fox on the
content of the auditor's report for the financial statements of Elephant for the
year ended 31 December 2018. The Explore module of the audit software
should be used to support your answer. (6 marks)
Total: 30 marks
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3 Your firm is the external auditor of Gremlins plc (Gremlins), a listed company.
Gremlins is a building contractor with operations throughout Europe. The
engagement partner signed an unmodified audit report on 31 August 2021 in
respect of the financial statements of Gremlins for the year ended 30 June 2021.
On 30 September 2021, a liquidator was appointed at Gremlins following breaches
in loan covenants and the bank's refusal to renew the overdraft facility.
The senior partner of your firm is considering whether to notify the firm's
professional indemnity insurers as he believes that an inappropriate audit opinion
may have been issued. He has instructed an independent partner to undertake a
cold review of the audit files, prior to making that decision.
The independent partner's review identified the following four issues:
Issue 1
There was no evidence that a briefing meeting involving members of the audit
team took place before or during the audit fieldwork.
Issue 2
An extract from the working paper summarising the audit work in respect of the
direct confirmation of the trade receivables balances is shown below:
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Issue 3
An engagement quality control reviewer had not been appointed.
Issue 4
Planned audit work in respect of the going concern status was not completed.
Requirements
3.1 Explain why issue (1) above was identified by the independent partner and
outline the matters that should have been discussed with the audit team at a
briefing meeting. (5 marks)
Note. You should assume that the current date is 13 December 2021.
3.2 Explain why issues (2) and (3) above were identified by the independent
partner and for each item, list the additional procedures that should have been
undertaken by your firm. (7 marks)
3.3 In respect of issue (4), describe the audit procedures that should have been
undertaken to address the going concern risk. (6 marks)
3.4 Assuming that your firm should have concluded that Gremlins was not a going
concern, state whether you would have modified the audit opinion if the
financial statements of Gremlins for the year ended 30 June 2021 were
prepared:
(a) on a break-up basis with adequate disclosure included in the notes to the
financial statements; or
(b) on a going concern basis.
Give reasons for each conclusion and describe the modifications, if any, to the
auditor's report. (6 marks)
3.5 List the possible consequences for your firm if an inappropriate auditor's report
had been issued. (4 marks)
Total: 28 marks
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4 Your firm Griffin LLP (Griffin), an ICAEW firm of chartered accountants, is the
external auditor of Yeti plc (Yeti), a listed company. Yeti employs 2,500
consultants and provides management consultancy services to clients throughout
the world. All consultancy services are provided under fixed-price contracts.
You are the audit manager responsible for the audit of Yeti. You will be attending
Yeti's forthcoming audit committee meeting with Nicola Canvey, the audit
engagement partner. Nicola has provided you with a copy of the audit committee's
agenda and has requested that you research each agenda item so that you are in
a position to answer any questions. An extract from the agenda is given below.
Extract from the audit committee's agenda
(1) External auditor's report to those charged with governance following the
audit for the year ended 31 October 2021.
Griffin will present to the audit committee, a report to those charged with
governance which highlighted the following internal control deficiencies:
(a) The company's policy requires that each month, contract managers
compare the costs incurred to date and the expected costs to complete
each contract with the total budgeted costs. This comparison was not
made in 50% of the contracts examined by the auditors.
(b) Yeti has signed a contract with Zombie Ltd (Zombie) to manage all of the
consultants' transport arrangements. The contract requires that all airfares
and hotels must be booked through the website recently developed by
Zombie for this purpose.
However, some consultants claim that the website is often unreliable and
is not user friendly. Consequently, consultants frequently book airline
tickets and hotel rooms directly with the airline and hotel. They
subsequently reclaim the cost from Yeti by submitting their receipts along
with manual expense claim forms.
(2) Rotation of the audit engagement partner
A letter has been received from Griffin advising that Nicola Canvey is due to
be rotated off the audit team as she has been the audit engagement partner
for five years. The audit committee will discuss the chief executive's proposal
that Nicola continues in her role to help future audits run smoothly. Yeti's
current chief executive has recently announced his retirement.
(3) Griffin's response to the invitation to provide non-audit services
Griffin has stated that there is capacity to undertake non-audit services for Yeti
and will present to the audit committee, their response to the following
invitations:
Invitation (a)
To assist with, and take responsibility for, the recruitment of a new chief
executive.
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Invitation (b)
To provide payroll services for Yeti, on an outsourced basis, as the audit
committee is unhappy with the performance of the company currently
providing these services.
(4) Potential conflict of interest
Griffin has advised that they have been approached by Gorgon Ltd (Gorgon)
to act as external auditor. Gorgon is one of Yeti's major competitors. Griffin
has indicated that they will only accept appointment at Gorgon if they have
Yeti's informed consent to act. Griffin has stated that they will implement a
number of procedures to address any conflict of interest.
Requirements
4.1 For each internal control deficiency listed as (a) and (b) in agenda item (1),
outline what should have been included in the report to those charged with
governance regarding the possible consequence(s) of the deficiency and the
recommendations to address the deficiency. (8 marks)
4.2 In respect of agenda item (2), identify and explain the threats to Griffin's
objectivity and state, with reasons, how Griffin should respond to the proposal
that Nicola Canvey continues as audit engagement partner. (4 marks)
4.3 For each invitation to provide non-audit services listed as (a) and (b) in agenda
item (3), draft notes that identify and explain the threats to Griffin's objectivity.
State, with reasons, how Griffin should address those threats. (7 marks)
4.4 In respect of agenda item (4), outline the procedures that Griffin should
implement to address the potential conflict of interest. (3 marks)
Total: 22 marks
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