ACCA Strategic

Professional

Advanced Audit and

Assurance (AAA)
(International)

Mock Exam 2
ACCA Specimen Exam

Questions

Time allowed 13 hours 15 minutes

ALL THREE questions are compulsory and MUST be attempted

DO NOT OPEN THIS EXAM UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS

@ BPP
LEARNING 605
MEDIA
606 Advanced Audit and Assurance - International (AAA - IND
@ BPP
LEARNING
MEDIA
ALL THREE questions are compulsory and MUST be
attempted
Question 1
It is 1 July 20X5. You are a manager in the audit department of Pegasus G Co, a firm of Chartered
Certified Accountonts. You are assigned to the audit of the Crux Group (the Group), which has a
financial year ending 30 September 20X5, and is a listed entity.
Pegasus S Co was appointed auditor to the Group in January 20X5.

The Group operates in the travel industry, offering a selection of worldwide itineraries and has a
fleet of 20 cruise ships. The Group operates three brands which provide different types of cruise
experience.

The following exhibits, available on the left-hand side of the screen, provide information relevant
to the question:

Partner's email - an email which you hove received from Norma Star, the Group audit
engagement partner.

2 Background information - information and matters relevant to audit planning.

3 Selected financial information - extracts from the Group management accounts.

4 Audit team meeting notes - extracts from meeting notes taken at a recent audit team
meeting.

This information should be used to answer the question requirement within your choses response
option(s).
Exhibit 1:

To: Audit manager

From: Norma Star, Audit engagement partner
Subject: Audit planning for the Crux Group
Date: 1 July 20X5

Hello

I hove provided you with some information which you should use to help you with planning the
audit of our new client, the Crux Group (the Group), for the financial year ending 30 September
20X5. Based on the analysis I have done on this industry, it is appropriate for overall materiality
to be based on the profitability of the Group as this is a key focus for investors and providers of
finance.

I require you to prepare briefing notes for my own use, in which you:

(a) Using the information in all exhibits, evaluate and prioritise the significant audit risks to be
considered in planning the Group audit.

Note. You are NOT required to consider audit risks relating to foreign exchange
transactions and balances as this will be planned separately. (25 marks)
(b) Design the principal audit procedures to be performed on the segmental information
relating to the Group's revenue. (5 marks)
Using the information in Exhibit 4:
(c) fvaluatc the matters to be considered in deciding whether Pegasus 8 Co should accept the
engagement to provide advice on the Group's social and environmental information.
(10 marks)
Thank you

@ BPP LEARNING Mock exam 2: Questions 607

MEDIA
Exhibit 2:
Group operations
The Group operates cruises under three brands which offer passengers o variety of cruise
itineraries with o wide choice of destinations. Cruises typically lost for two weeks, though some
lost for up to six weeks.

The brands ore internally generated and therefore ore not recognised as intangible assets within
the Group financial statements.

Information about the three brands operated by the Group is as follows:

Sunseeker Cruises - Cruises which visit beach destinations in the Caribbean, Europe and North
America.

Explorer Cruises - Cruises which focus on visiting cities and landmarks around the world.
Pioneer Cruises - Cruises which take in areas of natural beauty including the Antarctic and
Alaska.

Business developments in the 1:1eor

Sunseeker Cruises
In this financial year, the Group will spend $75 million on upgrading and maintenance of the
Sunseeker Cruise ships. These luxury ships hove to adhere to a very high standard, so the Group
regularly incurs high expenditure on their maintenance. As well as refurbishment, several ships
hove been enhanced by the installation of new entertainment facilities including cinemas and
gyms. Equipment in the gyms will need to be replaced on overage every three years.

Explorer Cruises
The Explorer Cruise ships, while still luxurious, are the oldest ships in the fleet, and the Group is
gradually replacing these with new ships. During this financial year, two new ships with a total
cost of $1 10million will come into use. The ships took three years to build, and were constructed
by Vela Shipbuilders Co, a company which is not owned by the Group. However, the chairman of
the Group, Mox Draco, is also the chairman of Velo Shipbuilders Co, and his son is the company's
chief executive officer. The purchase of the ships was financed through a $110million loon with a
fixed interest rate of 6% per annum. A further three ships ore currently under construction by Vela
Shipbuilders Co. The Group hos taken out a loan of $180million with a 6·5% fixed interest rate to
finance this capital expenditure.

Pioneer Cruises
These cruises are for more adventurous travellers and are growing in popularity. In order to visit
certain destinations on these specialist cruises, the Group has to acquire operating licences from
the local governments. The cost of licence acquisition is capitalised as an intangible asset.

Exhibit 3:
Crux Group - Extracts from the Group management accounts
Projected to Actual to
30September 20X5 30September 20X4
Note $million $million
Group revenue 1 7 64 670

Operating profit 145 101

Profit before tax 81 65

Total assets 1,800 1,780

Included in total assets:

Intangible assets - operating licences 2 56 57
Property, plant and equipment 3 1,520 1,510

608 Advanced Audit and Assurance - International (AAA - IND

@ BPP
LEARNING
MEDIA
Notes
Revenue includes passenger ticket sales, which accounts for approximately 85% of
revenue. When customers book a cruise they are required to pay a refundable 20%
deposit, which is initially recognised as deferred revenue. The balance of 80% is paid at
least six weeks before the cruise commences and at that point it is also recognised as a
deferred revenue. The full amount of the ticket price is transferred to revenue when the 'i
cruise starts irrespective of the duration of the cruise.

The remaining 15% of revenue is derived from on-board sales of food, drinks, entertainment
and other items to passengers. Management monitor this revenue stream closely as it
achieves a high gross profit margin, and staff are encouraged to maximise these sales to
customers.

Revenue is presented on a segmental basis in the notes to the financial statements, with
segments based on the three brands of the Group:

Projected to Actual to
Revenue per operating segment 30 September 20X5 30 September 20X't
$million $million
Sunseeker Cruises 320 288
Explorer Cruises 180 190
Pioneer Cruises 264 192
Total 761t 670
2 Operating licences are required for the Pioneer Cruise ships to visit certain destinations.
Licences are amortised over the specific period to which each licence relates.

3 Property, plant and equipment is comprised as follows:

Projected to Actual to
Property, plant and equipment 30 September 20X5 30 September 20X't
$million $million
Ships in use 2,041 2,010
Ships under construction 83 62
Other property, plant and equipment 180 173
2,301t 2,21t5
Accumulated depreciation (784) (735)
Carrying amount 1,520 1,510

Exhibit It:
A meeting took place yesterday in which the audit engagement partner discussed several issues:
Recent development affecting Pioneer Cruises
Last week, the governments of several countries which form a major part of the Pioneer Cruise
itineraries withdrew their operating licences with immediate effect. The governments have stated
that this is likely to be a temporary measure being put in place to limit the number of tourists
visiting areas of natural beauty, but they will not confirm when the Group can resume operations
in these countries.
Cyber-security attack
Last month, the Group suffered a cyber-security attack in which the personal information of
1,400 customers, including their credit card details, were stolen. According to a representative of
the Group audit committee, the Group's internal audit team had not properly assessed the risks
relating to cyber-security, which is a requirement of recently introduced data protection
legislation in the jurisdiction in which the Group operates. The issue which led to the cyber­
security attack has now been resolved.

@ BPPLEARNING Mock exam 2: Questions 609

MEDIA
Social and environmental information
The Group audit committee has enquired whether Pegasus & Co can provide an additional
service, to advise management on how to measure certain social and environmental information
which is to be published on the Group's website and is required by new regulations in the industry
and is required to be submitted to regulatory authorities. The social and environmental
information relates to matters such as water efficiency, energy consumption, charitable
donations and initiatives which support diversity in the workplace. In recognition that this work is
quite urgent, as the deadline for submission to the regulatory authorities falls within the next
month, the Group audit committee has stated it is willing to pay an 'enhanced fee' for this
service.
Required
Respond to the instructions in the email from the audit engagement partner.
Note. The split of the mark allocation is shown in Exhibit 1 - Partner's email. (1+0 marks)
Professional marks will be awarded for the demonstration of skill in communication, analysis and
evaluation, professional scepticism and judgement and commercial acumen in your answer.
(10 marks)
(Total= 50 marks)

610 Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
Question 2
It is 1 July 20X5. You are an audit manager in Welford & Co, a firm of Chartered Certified
Accountants. Your role includes performing post-issuance audit quality reviews, and you have
been asked to review the audit work performed on Rivers Co for the financial year ended
31 January 20X5.
'i
The following exhibits, available on the left-hand side of the screen, provide information relevant
to the question:
Team and fees - information regarding the audit team composition, the time spent on the
audit and fees charged to the client.
2 Going concern - details some matters you have identified during your review of the going
concern section of the audit file.
This information should be used to answer the question requirement within the response option
provided.

Exhibit 1
Rivers Co is a listed company operating in the construction industry. The company complies with
corporate governance regulations and has an audit committee. Rivers Co has been an audit
client of Welford & Co for eight years, and Bob Newbold has been the audit engagement partner
during this time.
Rivers Co's auditor's report was signed by Bob Newbold and issued last week. The report
contained an unmodified opinion.
Welford & Co requires its staff to record each hour they spend working on each client in the firm's
time management system. From reviewing the time records relating to the audit of Rivers Co, you
are aware that Bob and the other audit team members recorded the following amount of time on
the audit:
Bob Newbold - audit engagement partner 2 hours
Pat Conley - senior audit manager 6 hours
Anesa Kineton - audit manager 35 hours
Six audit assistants 130 hours
Total time spent on audit 173 hours

It is apparent from your review that almost all of the detailed review of the audit working papers
was completed by Anesa Kineton, who has evidenced her review by stating 'final review' on each
page of the audit file. She has recently been promoted to audit manager.
You are also aware that Bob Newbold booked a total of 40 hours to Rivers Co in respect of
non-audit work performed. The only information you can find in the documentation is that the
non-audit work related to a 'special investigation', and that Bob confirms that it does not create a
threat to auditor objectivity.
The total fee charged for the audit was $250,000 and the fee for the 'special investigation' was
$890,000.

Exhibit 2
From reviewing the audit working popers, you are aware that going concern was identified as a
significant audit risk at the planning stage of the audit due to low profit margins or losses being
made on many of the company's construction contracts and increasing economic uncertainty.
The company typically has 20 contracts ongoing at any time.
Most of the audit work on going concern was performed by Mary Loxley, an audit assistant who
has just taken her last professional exam and is not yet qualified. The majority of the audit work
performed on going concern focused on a review of five major contracts to determine their
profitability. The management of Rivers Co identified the major contracts for review and provided
Mary with forecasts indicating that the contracts would all make a small profit. Mary confirmed

@ BPP
LEARNING Mock exam 2: Questions 611
MEDIA
that the assumptions used in the forecasts agreed to assumptions used in previous years. Mory
also used the firm's data analytics tool to confirm the mathematical accuracy of the forecasts
and that the assumptions set out by management hod been appropriately reflected in the
forecasts. Following this work, Mory concluded that the contracts which she hod reviewed
support the going concern status of the company.
Hoving reviewed these major contracts, Mory completed the conclusion on going concern, stating
that there is no significant uncertainty over going concern.
Mory commented that due to the effectiveness of the data analytics tool, she only hod to record
eight hours in relation to the work she hod performed on going concern.
Required
Evaluate the quality of the planning and performance of the audit of Rivers Co, discussing the
quality management, ethical and other professional issues raised and recommending appropriate
actions to be token.
(20 marks)
Professional marks will be awarded for the demonstration of skill in analysis and evaluation,
professional scepticism and judgement and commercial acumen in your answer. (5 marks)
(Total = 25 marks)

612 Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
Question 3
It is 1 July 20X5. You are the manager responsible for the audit of Myron Co. a listed company
and you are in the process of completing the audit of the financial statements for the year ended
31 March 20X5. The auditor's report is due to be signed in the next few weeks. The company's
principal operating activity is the publication of trade and scientific journals.
The draft financial statements recognise revenue of $108 million (20X4: $102 million), profit before
tax of $9.3 million (20X4: $8.2 million) and total assets of $150 million (20X4: $149 million).
Materiality has been set at $0.5 million.
The following exhibits, available on the left-hand side of the screen, provide information relevant
to the question:

Completion matters - details regarding an issue you have discovered during your review of
the audit working papers.

2 Chairman's statement - management has provided you with an extract from the
chairman's statement which they intend to publish in the annual report.

This information should be used to answer the question requirements within the response option
provided.

Exhibit 1
You are in the process of reviewing the audit working papers and have identified the following
potential issue:

Sole of division
Myron Co is at the advanced stage of negotiations to sell its scientific publishing division to a
competitor. This division contributed revenue of $13 million and profit before tax of $1·4 million
during the year to 31 Morch 20X5. The draft sole agreement which is due to be finalised by
1 August 20X5 shows on agreed sole price ofter costs of disposal of $42 million. The division is o
separate cash generating unit of Myron Co. None of the assets of the division ore held under a
revaluation policy and depreciation is charged on o straight-line basis over the determined useful
life of the assets.
The finance director of Myron Co hos not mode any disclosures with respect to the upcoming sale
in the financial statements for the year ended 31 March 20X5 as he considers it to be part of next
year's accounting transactions. However, the division has been written down from its current
carrying amount of $45 million to its estimated value in use of $41 million in the financial
statements for the year ended 31 March 20X5.

Exhibit 2
As part of your review of Myron Co, you have also been presented with an extract from the draft
Chairman's statement which will be published in the annual report alongside the financial
statements for the year.

Extract from Chairman's statement

The company's results for the year are extremely positive. Our year on year revenue growth is
5·9% and our profit growth is even stronger at 13·4%. All our revenue streams hove performed
well, especially the scientific publishing division, and we ore looking forward to exciting and
sustained growth levels again next year. As you can see from our auditor's report, the auditors
agree that our results ore strong and o sound basis for toking the company to on even greater
place next year.

We have also made significant progress with our social and environmental aims of reducing our
carbon footprint and encouraging re-use and recycling across our divisions. We are proud to
announce that we hove now moved all our printed products to recycled paper.

@ BPP
LEARNING Mock exam 2: Questions 613
MEDIA
To help with your review of the information, you also hove the following analysis of the results for
the year.
Year ended 31 Morch 20X5 Year ended 31 Morch 20X4
Other Scientific Total Other Scientific Total
divisions publishing divisions publishing
division division
$million $million $million $million $million $million
Revenue 95 13 108 93 9 102
Profit before tax 7.9 1.4 9.3 7.5 0.7 8.2
A file note from the audit supervisor states that at least three of the publications Myron Co sells
ore not prepared on recycled paper.
Required
(a) Using the information contained in Exhibit 1:
(i) Comment on the completion matters to be considered in relation to the issue
described and recommend the further actions necessary before the auditor's report
con be signed; and
(ii) Evaluate the implications for the auditor's report if no adjustments ore mode to the
financial statements. (10 marks)
( b) Using the information contained in Exhibit 2:
(i) Described the auditor's responsibilities in relation to the other information presented
with audited financial statements and evaluate the matters arising from the extract
from the chairman's statement; and
(5 marks)
(ii) Assuming no changes ore mode to the chairman's statement, evaluate the
implications for the completion of the audit and the auditor's report.
(5 marks)
Professional marks will be awarded for the demonstration of skill in analysis and evaluation, and
professional scepticism and judgement in your answer. (5 marks)
(Total• 25 marks)

611+ Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
Answers

.
. . . .
. .
. . •
• . • •

.
• • •
. . . . . •
. . . . .
. . •
• • • • •
• • . • •
. . . .
. . . . . .
616 Advanced Audit and Assurance - International (AAA - INT)
@ BPP
LEARNING
MEDIA
A plan of attack
If this hod been the real Advanced Audit and Assurance exam and you hod been told to turn over
and begin, what would hove been going through your mind?
An important thing to soy (while there is still time) is that it is vital to hove a good breadth of
knowledge of the syllabus because the question requirements for each question will relate to
different areas of the AAA syllabus. However, don't panic. Below we provide guidance on how to
approach the exam.

Approaching the answer

It is vital that you attempt all the questions in the exam to increase your chances of passing. The
best way to do this is to make sure you stick to the time allocation for each question - both in
total and for each of the question ports. The worst thing you con do is run over time in one
question and then find that you don't hove enough time for the remaining questions, leading you
to miss out on some of the easier marks in those questions.
Section A consists of one long case-study style question set at the planning stage of the audit.
This may contain detailed information such as extracts from financial statements and audit
working papers. A range of requirements will be set for this question, but will only cover areas
from syllabus areas A to D inclusive.
Question 1 is for 50 marks, all set at the planning stage in the context of a single scenario, here
dealing with the audit of o group. As it is a very long question, it is important that you breok it
down into its component ports as this will make it easier to manage - and enable you to allocate
your time to each of them.
Section B contains two more compulsory questions, and may be set on any area of the AAA
syllabus.
Question 2, for 25 marks, featured a review of a completed audit and touched on many different
aspects of the management of the audit process (quality management, ethics and other
professional issues).
Question 3 offers 25 marks set in the completion phase, covering matters around the auditor's
report and other information.

Forget about it!

And don't worry if you found the exom difficult. More than likely other candidates will too. If this
were the real thing you would need to forget the exam the minute you left the exam hall and think
about the next one. Or, if it is the lost one, celebrate!

@ BPP
LEARNING Mock exam 2: Answers 617
MEDIA
Question 1

Workbook references. Chapters 6, 7, 9 and 15.

Top tips. Your general approach should be to read the requirement carefully, and then to work
through the question noting down issues (audit risks) as they occur to you.

Part (a) asked for audit risks, as was expected. It is important that you heed the warning not to
consider risks from forex transactions as there will be no marks available here for these. The key
ta scoring well here is to make sure that your answer is the right length - enough to pass this
question part, but without writing so much that you go over your time allocation. You should look
to develop each point you make thoroughly, trying to connect together points where this is
possible.

Part (b) was on procedures on segmental information. This is not an area that is tested often, so
its inclusion here should serve as a warning against revising only those topics that you think are
more examinable.

Part (c) related to the acceptance of a non-audit engagement. You may have found this to be
particularly challenging; if this was the case then the key would be to focus on trying to pass this
part of the question. You only need to score five marks here to do this.

Eas1,1 marks. The presentation marks here are valuable, and are well worth the time it takes to
get them.

H@ii+iii:M:+-11...______________________________
Marks
(a) Audit risk evaluation
Up to 3 marks for each audit risk (unless indicated otherwise).
Marks may be awarded for other, relevant audit risks not
included in the marking guide.
In addition, ½ mark for relevant trends or calculations which
form part of the evaluation of audit risk (max 3 marks).
Appropriate materiality calculations and justified materiality
level should be awarded to a maximum of 2 marks.
• New audit client (2 marks)
• Revenue recognition
• Upgrade and maintenance costs
• Component depreciation
• Cyber-security breach (control risk, corporate
governance weakness, data corruption, financial
statement implications - max 5 marks)
• Related party transaction disclosure
• Operating licences
• Borrowing costs
• Revenue and profit trends
• On-board sales
Maximum 25

618 Advanced Audit and Assurance - International (AAA - INT)

@ BPP LEARNING
MEDIA
 Marks
(b) Audit procedures on segmental reporting
Up to 1 mark for each relevant audit procedure. Examples are
provided below, and marks will be awarded for other relevant
points.
• Review the financial reports sent to the highest level of
monogemcnt to confirm the bo5i5 of 5cgmcntol
information which is reported internally
• Review the Group's organisational structure to confirm
identify of the chief operating decision maker
• Discuss with management the means by which segmental
information is reviewed by the chief operating decision
maker
• Review board minutes to see that segmental information is
subject to regular review
• Discuss with management whether the on-board sales
should be reported separately
• Obtain a breakdown of the revenue to confirm that
revenue has been appropriately allocated between the
reportable segments
• Perform analytical procedures to determine trends for
each segment and discuss unusual patterns with
management
• Recalculate the revenue totals from the breakdown
provided to confirm that they are reportable segments
Maximum 5
(c) Additional service to provide advice on social and
environmental Information
Up to 1 mark for each relevant answer point explained:
• Assuming management responsibility identified and fully
explained
• Assuming management responsibility is prohibited
• Self-review threat identified and fully explained
• Self-review threat increased if the social/environmental
information included in annual report
• Self-interest threat identified and fully explained
• Pressure to perform work quickly
• Appropriate safeguards recommended (1 mark each to
max3 marks)
• Group audit committee to approve non-audit work
• It may be prohibited in the jurisdiction of the Group
• Scope of the work, and specific requirements from the
regulators
• Level of assurance which may be required and who is
going to provide this
• Skill and competence to perform work
Maximum 10

@ BPP LEARNING Mock exam 2: Answers 619

MEDIA
 Marks
Professional marks
Communication
• Briefing notes format ond structure - use of headings/sub­
headings ond on introduction
• Style, language and clarity - appropriate layout and tone of
briefing notes, presentation of materiality and relevant
calculations, appropriate use of the CBE tools, easy to follow
and understand
• Effectiveness and clarity of communication - answer is relevant
and tailored to the scenario
• Adherence to the specific requests mode by the audit
engagement partner
Analysis and evaluation
• Appropriate use of the information to determine suitable
calculations
• Appropriate use of the information to support discussions and
draw appropriate conclusions
• Assimilation of all relevant information to ensure that the risk
evoluotion performed considers the impact of contradictory or
unusual movements
• Effective prioritisation of the results of the risk evaluation to
demonstrate the likelihood and magnitude of risks and to
facilitate the allocation of appropriate responses
• Balanced discussion of the information to objectively make a
recommendation or decision
Professional scepticism and judgement
• Effective challenge of information supplied, and techniques
carried out to support key facts and/or decisions
• Determination and justification of a suitable materiality level,
appropriately and consistently applied
• Appropriate application of professional judgement to draw
conclusions and make informed decisions about the courses of
action which ore appropriate in the context of the audit
engagement
Commercial acumen
• Audit procedures ore practical and plausible in the context of
the Crux Group.
• Use of effective examples and/or calculations from the scenario
to illustrate points or recommendations.
• Recognition of the appropriate commercial considerations of the
audit firm
Maximum 10
Total 50

620 Advanced Audit and Assurance - International (AAA - IND

@ BPP
LEARNING
MEDIA
Briefing Notes
To: Audit engagement partner
From: Audit manager
Subject: Crux Group - Audit Planning
Introduction
These briefing notes are prepared to assist with planning the audit of the Crux Group (the Group)
for the financial year ending 30 September 20X5. The notes contain an evaluation of the audit
risks which should be considered in planning the Group audit, which has been structured to
prioritise the risks in terms of the likelihood and magnitude of misstatement in relation to each
risk. The notes also recommend the audit procedures to be performed on the Group's segmental
disclosure of revenue. Finally, there is a discussion of the matters to be considered by Pegasus &
Co in relation to a proposed additional engagement to advise management on the Group's social
and environmental information.

(a) Evaluation of audit risk

Materiality
For the purposes of these briefing notes the following overall materiality level will be used to
assess the significance of identified risks and as requested this has been based on the
profitability of the Group.
Benchmarks
Using profit before tax or operating profit as a suggested benchmark, see spreadsheet for
detailed calculations, results in a suggested range of $4.05 million to $14.5 million.
These benchmarks are only a starting point for determining materiality and professional
judgement will need to be applied in determining a final level to be used during the course
of the audit. As this is a new client and therefore an initial audit engagement, due to the
increased detection risk, materiality should be set at the lower level of the range at $4
million.

New audit client

The Group is a new client, our firm having been appointed six months ago. This gives rise to
detection risk, as our firm does not have experience with the client, making it more difficult
for us to detect material misstatements. However, this risk can be mitigated through
rigorous audit planning, including obtaining a thorough understanding of the business of
the Group.
In addition, there is a risk that opening balances and comparative information may not be
correct. As the prior year figures were not audited by Pegasus & Co, if any misstatements
existed in relation to the opening balances this would have a significant impact on our
ability to gather sufficient and appropriate evidence over closing balances. As such we
should plan to audit the opening balances carefully, in accordance with ISA 510 Initial Audit
Engagements - Opening Balances, to ensure that opening balances and comparative
information are both free from material misstatement.
Revenue recognition
An audit risk arises in relation to the timing of revenue recognition. Given the requirement
of ISA 240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial
Statements, that when assessing audit risks the auditor shall presume there are risks of
fraud in relation to revenue recognition this could be a significant area of concern. It is
appropriate that customer deposits are recognised as deferred revenue when they are
received. This is in line with IFRS® 15 Revenue from Contracts with Customers which
requires that revenue is recognised when a performance obligation is satisfied, and
therefore any amounts paid to the Group by customers before a cruise begins are not
revenue and should be deferred. However, the policy of recognising all of the revenue from
a ticket sale when the cruise starts may not be in line with the principles of IFRS 15 because
the Group is performing its obligations over time, which may be as long as a six-week
period for some cruises. This is a problem of cut-off, meaning that recognition of all
revenue at the start of a cruise could result in overstated revenue and understated
liabilities.

@ BPP LEARNING Mock exam 2: Answers 621

MEDIA
 Upgrade and maintenance costs
The Group incurs high costs in relation to upgrade and maintenance of its fleet of ships.
For the Sunseeker ships, $75 million is being spent this year. Based on initial materiality
calculations, this amount is material to the financial statements and represents 92.6% of
profit before tax and is therefore extremely significant. There is on audit risk that costs ore
not appropriately distinguished between capitol expenditure and operating expenditure.
Upgrade costs, including costs relating to new facilities such as gyms, should be
capitalised, but maintenance costs should be expensed. There is a risk that assets ore
overstated, and expenses understated, if operating expenses hove been inappropriately
capitalised. A further risk relates to depreciation expenses, which will be overstated if
capitol expenditure is overstated.

Component depreciation
IAS® 16 Property, Plant and Equipment requires that each part of an item of property,
plant, and equipment (PPE) with a cost which is significant in relation to the total cost of
the item must be depreciated separately. There is a risk that ships in use are not broken
down into component parts for the purpose of determining the individual cost, useful life,
and residual value of each part. For example, if significant, the gym equipment should be
depreciated over three years and therefore requires separate consideration from other
assets such as ship exterior, engine, etc. There is on audit risk that depreciation is not
correctly determined on this component basis, meaning that the assets and their
associated depreciation expense could be over or understated in value. This risk is also
heightened due to the unusual movement in relation to the accumulated depreciation
figure, which has only increased by $49 million in the year. Information is not given on the
Group's depreciation policy, however compared to the total cost of PPE at the financial
year end of $2,304 million, this equates to only 2.1%, which appears quite low, suggesting
understatement.

Cyber-security attack
The recent cyber-security attack could highlight that internal controls ore deficient within
the Group. Even though this particular problem has now been rectified, if the Group
internal audit team hod not properly identified or responded to these cyber-security risks,
there could be other areas, including controls over financial reporting, which are deficient,
leading to control risk. The situation could also indicate wider weaknesses in the Group's
corporate governance arrangements, for example, if the audit committee is not
appropriately discharging its responsibilities with regards to internal audit.

Tutorial note. Based on best practice the audit committee should review and approve the
annual internal audit plan and monitor and review the effectiveness of internal audit work.
The audit committee should ensure that the internal audit plan is aligned to the key risks of
the business. Credit will be awarded for discussion of these issues in the context of the
cyber-security attack.

In addition, the cyber-security attack could have resulted in corrupted data or loss of data
relating to the sales system, if the customer details were integrated with the accounting
system. There is an audit risk that reported revenue figures ore inaccurate, incomplete, or
invalid. Though the issue could be confined to the sales system, it is possible that other
figures could also be affected.
Finally, the cyber-security incident is likely to result in some fines or penalties being levied
against the Group as it seems the risk was not properly dealt with, leaving customer
information vulnerable to attack. It may be necessary for the Group to recognise a
provision or disclose a contingent liability depending on the likelihood of a cash payment
being made, and the materiality of any such payment, in accordance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets. The related audit risk is
understated liabilities and understated expenses or incomplete disclosures if any necessary
liability is not recognised or disclosure not made in the notes to the financial statements.

622 Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
 Related party transaction
It appears that Vela Shipbuilders Co, which is building new Explorer Cruise ships for the
Group, is a related party of the Group. This is because Max Draco is the chairman of both
the Group and Vela Shipbuilders Co. According to IAS 24 Related Party Disclosures, a
related party relationship exists where a person has control or joint control, significant
influence, or is a member of the key management personnel of two reporting entities. The
fact that Max Draco's son is the chief executive officer of Vela Shipbuilders Co also
indicates a related party relationship between the Group and the company.
IAS 24 requires that where there have been transactions between related parties, there
should be disclosure of the nature of the related party relationship as well as information
about the transactions and outstanding balances necessary for an understanding of the
potential effect of the relationship on the financial statements. There is an audit risk that
the necessary disclosures regarding the Group's purchases of ships from Vela Shipbuilders
Co are not made in the Group financial statements.
The related party transactions are material by their nature, but they are also likely to be
material by monetary value. The information provided does not specify how much has
been paid in cash from the Group to Vela Shipbuilders Co during the year, but the amount
could be significant given that the Group has presumably paid any final instalments on the
ships which have come into use during the year, as well as initial instalments on the new
ships starting construction this year.

Operating licences
The Group's operating licences of $56 million are material to the financial statements. It is
appropriate that the licences are recognised as intangible assets and that they are
amortised according to their specific useful life. However, an audit risk arises due to the
possible impairment of some or all of these licences, which arises from the governments
having withdrawn the licenses in some countries where the Group operates their Pioneer
cruises. While the licence withdrawal is apparently temporary in nature, the withdrawal is
an indicator of impairment and it is possible that the operating licences are worth nothing,
so should be written off in full. Management should conduct an impairment review in
accordance with IAS 36 Impairment of Assets to determine the recoverable amount of the
licences and if this is less than the carrying amount, recognise an impairment loss
accordingly. If this does not take place, the intangible assets are likely to be overstated,
and profit overstated.

Tutorial note. Credit will also be awarded for discussion regarding de-recognition of the
operating licences as well as their reduction in value, and for considering whether the
Pioneer Cruise ships also need to be reviewed for impairment.

Borrowing costs
The ships being constructed fall under the definition of a qualifying asset under IAS 23
Borrowing Costs, which defines a qualifying asset as an asset that takes a substantial
period of time to get ready for its intended use or sale. This includes property, plant, and
equipment during the relevant construction period, which for the ships is three years. IAS
23 requires that borrowing costs which are directly attributable to the acquisition,
construction or production of a qualifying asset should be capitalised. The audit risk is that
interest costs have not been appropriately capitalised and instead have been treated as
finance costs, which would understate assets and understate profit for the year.
The amounts involved appear to be material. The information does not state precisely when
the loans were taken out and when construction of the ships commenced or when they
come into use by the Group on completion, so it is not possible to determine exactly when
capitalisation of finance costs should commence and cease. However, looking at the loan
of $180 million taken out for the ships currently under construction, the interest for the year
would be $11.7 million, which is a material amount.

Revenue and profit trends

Overall Group revenue is projected ta increase by 14% in the year. The segmental
information shows that this overall increase is comprised of different movements across the

@ BPP
LEARNING Mock exam 2: Answers 623
MEDIA
 three brands (see spreadsheet for detailed calculations) and there are some potential risks
associated with these movements.
The different trends for each segment could be explained by business reasons, however there
is a potential risk that revenue has been misclassified between the segments, eg revenue from
Explorer Cruises could be understated while revenue from Pioneer Cruises is overstated.
In particular, the projected revenue for Pioneer Cruises could be impacted by the recent
withdrawal of operating licenses which affects the operation of these cruise itineraries.
Management may not have factored this into their projections, and there is a risk that this
segment's revenue is overstated.
Operating profit is projected to increase by 43.6% in the year, and profit before tax is
projected to increase by 24.6% in the year. While the increased margins could be due to
economies of scale, the increase in profit appears out of line with the increase in revenue
and could indicate that expenses are understated or misclassified.
On-board sales
On-board sales of food, drink, and entertainment account for approximately 15% of
revenue. There is a risk that this is a reportable operating segment, but the projected
operating segment information does not disclose this revenue separately. According to IFRS
8 Operating Segments, an operating segment is a component of an entity which engages
in business activities from which it may earn revenues and incur expenses, whose operating
results are reviewed regularly by the entity's chief operating decision maker and for which
discrete financial information is available which seems to be the case in this instance.
A reportable segment exists where the segment's revenue is 10% or more of the combined
revenue of all operating segments. There is a risk of incomplete disclosure of revenue by
reportable segments if on-board sales meet the definition of on operating segment and it is
not disclosed in the notes to the financial statements as such.
(b) Principal audit procedures to be performed on the segmental information
• Review the financial reports sent to the highest level of management to confirm the
basis of segmental information which is reported internally and confirm that this
basis is used in the notes to the published financial statements.
• Review the Group's organisational structure to confirm the identity of the chief
operating decision maker.
• Discuss with management the means by which segmental information is reviewed by
the chief operating decision maker eg through monthly financial reports and
discussion at board meetings.
• Review board minutes to confirm that the segments as disclosed ore used as the
basis for monitoring financial performance.
• Discuss with management whether the on-board sales should be reported separately
given that it appears to constitute a reportable segment contributing more than 10%
of total Group sales and is actively monitored.
• Obtain a breakdown of the revenue, eg by cruise line or individual ship, to confirm
that revenue hos been appropriately allocated between the reportable segments.
• Perform analytical procedures to determine trends for each segment and discuss
unusual patterns with management.
• Recalculate the revenue totals from the breakdown provided to confirm that they ore
reportable segments, ie that they each contribute more than 10% of revenue.
(c) Additional service to advise management on measurement of social and
environmental information
The Group's request for Pegasus & Co to advise management on its social and
environmental reporting creates on ethical threat to objectivity. Providing additional, non­
audit services to on audit client con create several threats to the objectivity and
independence of the auditor.

621t Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
 The IESBA International Code of Ethics for Professional Accountants (the Code) does not
specifically discuss this type of additional engagement, so the audit firm should apply the
general framework to consider whether it is appropriate to provide the service. This means
that the firm should evaluate the significance of the threats to independence and consider
whether safeguards con reduce the threats to on acceptable level.
Perhaps the most significant ethical issue, is that providing advice to management, which
would involve determining how social and environmental information is measured and
published could be perceived as taking on management responsibilities, which is prohibited
by the Code. To avoid taking on management responsibilities, the audit firm must be
satisfied that client management makes all judgements and decisions that ore the proper
responsibility of management. Measures to achieve this could include:
• Ensuring that a member of the Group's management with appropriate skill,
knowledge and experience is designated to be responsible for the client's decisions
and to oversee the service,
• Management oversees the work performed and evaluates the results, and
• Management accepts responsibility for any actions arising as a result of the service
provided.
A self-review threat could also arise if Pegasus & Co provides the service to the Group.
Some of the social and environmental information could be related to transactions or
balances within the financial statements which will be subject to audit, for example the
value of charitable donations. The self-review threat means that less scrutiny may be used
in performing procedures due to over-reliance on work previously performed by the audit
firm. This potentially impacts on the level of professional scepticism applied during the
audit and the quality of work carried out.
There could be a further self-review threat depending on whether the social and
environmental information will form part of the Group's annual report. If this is the case,
the audit team is required by ISA 720 The Auditor's Responsibilities Relating to Other
Information, to read the other information included in the annual report and to consider
whether there is a material inconsistency between the other information and the financial
statements and to also consider whether there is a material inconsistency between the
other information and the auditor's knowledge obtained in the audit. This requirement
creates a self-review threat if members of the audit team have been involved with the
additional service to provide advice on measurement of the social and environmental
information.
A self-interest threat can also be created by the provision of non-audit services where the
fee is significant enough to create actual or perceived economic dependence on the audit
client. The Group is willing to poy on 'enhanced fee' for this service due to its urgent
nature, and while this does not necessarily create fee-dependency there could be a
perception that the audit firm has secured a lucrative fee income in addition to the income
from providing the audit.
The Group needs the work to be carried out to a tight deadline, which could impact on the
scope and extent of the procedures which the firm can carry out, also impacting on the
quality of work and the risk of the engagement. This pressure to perform work quickly
within the next month could be viewed as intimidation by the client.
All of these threats are heightened by the fact that the Group is a listed entity, therefore a
public interest entity in the terminology of the Code.
Other safeguards could possibly be used to reduce the threats identified to an acceptable
level. These may include having a team separate from the audit team, including a separate
partner, perform the work on the social and environmental information; and conducting a
review of both the audit and additional service by the engagement quality reviewer.
The audit firm should discuss the request with the Group audit committee, who ultimately
will need to approve that the firm can perform the service. The corporate governance code
under which the Group operates may restrict or prohibit the provision of non-audit services
by the audit firm in the case of listed entities, so the audit committee should consider if any
such restrictions exist.

@ BPP
LEARNING Mock exam 2: Answers 625
MEDIA
 Discussions should olso be held regarding the new regulatory requirements. The audit firm
should be clear on the reliance which will be placed on the report by the regulatory
authorities and matters such as whether on assurance report is required, and if so, who will
be performing this work. In addition, there may be specific requirements which impact on
the scope of the work, for example whether any specific KPls ore required to be published.
Finally, even if the ethical issues con be overcome, the firm should consider whether it hos
the skills and competencies to provide the advice to management. This con be quite
specialised work and it is not necessarily the case that the firm will hove staff with the
appropriate skills available to carry out the work, especially if the work is to be carried out
to a tight deadline.
In conclusion in terms of providing advice to management on social and environmental
information, this will be difficult to do without breaching ethical principles and should be
further discussed with the Group audit committee.
Conclusion
These briefing notes highlight a number of significant audit risks, including those relating to
property, plant and equipment, revenue recognition and disclosure requirements. A
number of audit procedures hove been recommended in relation to the audit of segmental
information provided in relation to revenue. As mentioned, the provision of the additional
service should be further discussed with the Group audit committee.

626 Advanced Audit and Assurance - International (AAA - INl)

@ BPPLEARNING
MEDIA
Question 2

Workbook references. Chapters 2, 4, and 5.

Top tips. Question two of this exam was divided into two mini scenarios, one covering a
completed audit and the other an audit yet to take place.
The question required you essentially to criticise the conduct of the completed audit. There were
20 marks available here, so your answer to this part would hove needed to be substantial. This
makes it important to set everything out as clearly as you possibly can, so that the marker can
follow everything and award you as many marks as possible!
It was important here not to overlook the requirement to recommend appropriate actions to be
taken. The audit is now complete, so these actions cannot be just the actions that should have
been taken at the time, but rather what the auditor will need to do now that everything has
already happened.
Eas11 marks. There were some clear difficulties with the audit that should have given rise to some
easy points for you to make.

H®ii+IH:%:i-■______________________________
Marks
Rivers Co
Generally, up to 1 mark for each well explained point:
• Long association of audit partner breaches the IESBA Code 7-
yeor maximum period allowed
• Self-interest threat identified and explained
• Familiarity threat identified and explained
• Recommend replace Bob with a new audit partner as soon as
possible
• Firm's monitoring of the length of time partners act for clients
seems deficient
• Audit partner should have spent more time on the audit and in
particular on the final review
• The total amount of time spent on the audit appears low for the
audit of a listed company - implications for audit quality
• Inappropriate delegation of tasks, the junior audit manager
locks experience
• There may not be sufficient, appropriate evidence to support the
audit opinion
• Welford & Co may have provided a prohibited non-audit service
to Rivers Co, a listed company
• The size of fee for the non-audit service creates a self-interest
threat
• Bob's involvement with the non-audit service creates familiarity
threats to audit objectivity
• Lack of documentation could indicate that no work has been
performed - possibly a bribe from the client
• Welford & Co to review policies, procedures and documentation
on engagement acceptance
• Apparent lock of Engagement Quality Review being carried out
before the audit opinion was issued.

@ BPP
LEARNING Mock exam 2: Answers 627
MEDIA
 Marks
• Inappropriate delegation of work on going concern to an
inexperienced audit assistant
• Sample of contracts reviewed is too small - insufficient evidence
obtained
• Management selection of contracts is likely to be subject to bias
- the auditor should select which contracts should be reviewed
• Over-reliance on and misunderstanding of use of data analytics
tools
• Insufficient work on going concern - assumptions should be
challenged not agreed to prior year
• Data analytics could have been used to carry out specific going
concern testing such as sensitivity analysis
• Lack of time spent on going concern testing due to over-reliance
on data analytics
• Additional training required
• Client audit committee - should have identified the ethical and
audit quality issues
• Overall conclusion relating to the quality of the engagement
Maximum 20
Professional marks
Analysis and evaluation
• Appropriate assessment of the ethical and professional issues
raised, using examples where relevant to support overall
comments
• Effective appraisal of the information to make suitable
recommendations for appropriate courses of action
Professional scepticism and judgement
• Effective challenge and critical assessment of the evidence
supplied with appropriate conclusions
• Demonstration of the ability to probe into the reasons for quality
issues including the identification of missing information or
additional information which would be required
• Appropriate application of professional judgement to draw
conclusions and make informed comments regarding the quality
of the work carried out.
Commercial acumen
• Inclusion of appropriate recommendations regarding the
additional quality management procedures required by the firm
Marks
• Appropriate recognition of the wider implications on the
engagement, the audit firm and the company.
Maximum 5
Total 50

628 Advanced Audit and Assurance - International (AAA - INT)

@ BPP
LEARNING
MEDIA
Rivers Co
A review of the information relating to the audit of Rivers Co indicates many problems with how
the audit has been planned and performed which imply that the audit has not been conducted in
accordance with ISA 220 Quality Management for an Audit of Financial Statements, ISQM 1
Quality Management for Firms that Perform Audits or Reviews of Financial Statements, or other
Assurance or Related Services Engagements, and the IESBA International Code of Ethics for
Professional Accountants (the Code).
Audit partner rotation
Bob Newbold has been acting as audit engagement partner for eight years. As Rivers Co is a
listed company this goes against the requirements of the Code which requires that an individual
shall not act as the engagement partner for more than seven years. The problem is that long
association of the engagement partner with the client leads to a self-interest threat to auditor
objectivity, whereby the audit firm's judgement is affected by concern over losing the long­
standing client. There may also be a familiarity threat due to close relationships between the
audit engagement partner and management of Rivers Co, meaning that the partner ceases to
exercise sufficient professional scepticism, impacting on audit quality. This is especially the case
given that Bob Newbold is performing additional non-audit services for the client, which will be
discussed further below. Bob Newbold should be replaced as soon as possible by another audit
engagement partner.
The fact that Bob has been allowed to continue as audit partner for longer than the period
allowed by the Code indicates that Welford & Co does not have appropriate policies and
procedures designed to provide it with reasonable assurance that the firm and its personnel
comply with relevant ethical requirements, as required by ISQM 1. The firm should review whether
its monitoring of the length of time that audit engagement partners act for clients is operating
effectively and make any necessary improvements to internal controls to ensure compliance with
ISQM 1.

Tutorial note. The Code does allow a key audit partner to serve an additional year in situations
where continuity is especially important to audit quality, as long as the threat to independence
can be eliminated or reduced to an acceptable level. Credit will be awarded for appropriate
discussion on this issue.

Supervision and review

Bob Newbold has booked only two hours for audit work performed on Rivers Co. This is not
sufficient time for the audit partner to perform their duties adequately. The audit partner is
required to take overall responsibility for the supervision and performance of the audit. He should
have spent an appropriate amount of time performing a review of the audit working papers in
order to be satisfied that sufficient appropriate audit evidence had been obtained; this is a
requirement of ISA 220. Instead it appears that most of the final review was performed by a newly
promoted audit manager who would not have the necessary experience to perform this review. It
is possible that there is insufficient evidence to support the audit opinion which has been issued,
or that inappropriate evidence has been obtained.
There is also a related issue regarding the delegation of work. Possibly some of the detailed
review of the working papers could have been delegated to someone other than the audit partner,
in which case the senior audit manager Pat Conley would be the appropriate person to perform
this work. However, Pat only recorded six hours of work on the audit. Thus, confirming that too
much of the review has been delegated to the junior audit manager, especially given that going
concern was identified as a significant audit risk, meaning that the partner has even more reason
for involvement in the final review of audit work.
There is also an issue around the overall amount of time which has been recorded for the audit
work performed on this client. A total of 173 hours does not seem sufficient for the audit of a listed
company, suggesting that audit quality could have been impacted by inadequate time spent in
planning and performing the audit work.

@ BPP
LEARNING Mock exam 2: Answers 629
MEDIA
Special investigation
Bob Newbold's focus appears to have been on the special investigation performed for Rivers Co,
to which he booked 40 hours of time.
There is insufficient documentation as to the nature of this non-audit work, and it could relate to
the provision of a non-audit service which is not allowed for a public interest entity. Rivers Co is a
listed company, and the Code prohibits the audit firm from providing certain non-audit services,
for example certain internal audit services, valuation services and tax services. The lock of
documentation means that Welford & Co could hove provided a prohibited service and therefore
be in breach of the Code.
The feet that $890,000 was charged for this special investigation indicates that it was a
substantial engagement and just the matter of inadequate documentation is a cause for concern.
There is also a possibility that in actual fact no work has been performed, and the firm has
accepted this money from the client but provided no service. This would be a very serious issue,
could be perceived as a bribe, and it should be investigated with urgency.
However there are also possible threats to auditor objectivity including a self-interest threat due
to the monetary value of the service provided meaning that Bob Newbold's attention seems to
hove been focused on the special investigation rather than the audit, leading to the problems of
inappropriate delegation of this work as discussed above. His additional involvement with Rivers
Co by providing this work compounds the familiarity threat also discussed previously. Depending
on the nature of the work performed for the client there may also be other threats to objectivity
including self-review and advocacy.
A self-interest threat is created as the value of the services provided is substantial compared to
the audit fee. The fact the non-audit fees are so high would create a proportionately bigger
intimidation threat because they would form a larger part of the firm's income and the audit firm
may not be objective for fear of losing the client.
Welford & Co should ensure that its policies and documentation on engagement acceptance,
especially in relation to additional services for existing audit clients, are reviewed and made more
robust if necessary.
Engagement Quallty Review
As this is a listed audit client, an Engagement Quality Review should have been performed. It is
not clear whether this took place or not, but no time hos been recorded for this review. If a pre­
issuance review was carried out, then it should have picked up these problems prior to the audit
opinion being issued.
Audit of going concern
The audit work on going concern has been inappropriately delegated to an audit assistant who
would not have the necessary skill or experience. This is especially concerning given that going
concern was identified as a significant audit risk, and that the work involves using judgement to
evaluate information relating to contract performance. The work should have been performed by
a more senior member of the teem, probably one of the audit managers, who is more able to
exercise professional scepticism and to challenge management where necessary on the
assumptions underpinning the forecasts. Mary certainly should not have documented the
conclusion on going concern, the conclusion should be reached by a more experienced auditor
having reviewed all of the evidence obtained.
It is concerning that the audit work appears to have been based on a review of contracts which
were selected by management. First, only five contracts were reviewed but the company is
typically working on 20 contracts at one time. So, it is likely that the coverage of the audit work
was insufficient, and more contracts should hove been subject to review. Given the risk attached
to going concern perhaps all of the contracts currently being carried out should have been
reviewed, or the sample selected based on the auditor's evaluation of the risk associated with
each contract and their materiality.

630 Advanced Audit and Assurance - International (AAA - INl)

@ BPPLEARNING
MEDIA
Second, management may hove selected the better performing contracts for Mory to review. This
would create a false impression of the performance of the company as a whole, leading to on
inappropriate conclusion on going concern being reached. Mory, or one of the more senior
members of the audit team, should hove challenged management on the selection of these
contracts.
Finally, the work performed by Mory on this small selection of contracts appears insufficient and
inappropriate. The audit assistant also oppeors to hove placed too much reliance on the firm's
data analytics tool and demonstrates a lock of understanding of how the data analytics tools
should be used to obtain audit evidence. By simply using the data analytics tool to agree the
mathematical accuracy of the forecasts and the assumptions, insufficient testing hos been
carried out in relation to these key documents. Assumptions should not just be agreed as
consistent with the previous year, especially in a situation of increasing economic uncertainty as
applies in this case. Assumptions should be challenged, and other work performed as required by
ISA 570 Going Concern. The data analytics tool could hove been used more appropriately, eg to
perform sensitivity analysis which would hove allowed for identification of areas of concern or
requiring further investigation.
The lock of further audit procedures means that the audit evidence is not likely to be sufficiently
robust in this significant area. This is further demonstrated by the fact that Mory only spent eight
hours on this critical area of the audit work and hos commented that this was due to the evidence
generated by the data analytics tool. This again demonstrates the over-reliance placed on this
tool, raising a concern that staff require further training in the use of and interpretation of
evidence generated in this way.
Audit Committee
It is concerning that the audit committee of Rivers Co does not appear to hove raised concerns
about the issues discussed, especially the provision of the non-audit service and the length of
time which Bob Newbold hos served as audit engagement partner. One of the roles of the audit
committee is to oversee ethical issues relating to the external auditor and to be involved with the
engagement of external providers. Welford & Co should ensure that these matters ore discussed
with the audit committee so that further ethical issues do not arise in the future.
Conclusion
From the discussion above it con be seen that there are many problems with the audit of Rivers
Co. Bob Newbold appears to hove ignored his responsibilities as audit engagement partner, and
the audit firm needs to discuss this with him, consider further training or possibly toking
disciplinary action against him. Welford & Co need to implement procedures to ensure all work is
carried out at the appropriate level of personnel with the appropriate experience and that
training is given to staff to ensure they understand the client does not pick or specify the audit
work to be carried out in any area, it is to be selected by the audit team in accordance with the
audit firms methodology and sampling tools. Training may also need to be provided in the
appropriate use of audit data analytics tools as a basis for obtaining audit evidence.

@ BPP
LEARNING Mock exam 2: Answers 631
MEDIA
Question 3

Workbook reference. Chapters 8, 10 and 11.

Top tips. This question covered two separate issues related to a single audit client.
Port (a) may have appeared intimidating but if you had found a way to keep your cool then there
were marks on offer. You needed to calculate materiality for each issue, taking core to choose the
most appropriate benchmark and to conclude on whether the issue is material. Then you should
work through the accounting treatments given, and recommend the actions that should be token.
It is key not to overlook the auditor's report implications, as the marks available for correctly
stating these were among the easiest on the exam.
Port (b) covered other information, and featured a relatively large number of marks for simple
knowledge (in (i)). This should have been a strong part of the exam for you, but notice its
positioning at the very end of the paper; time management is a key professional skill, so you need
to make use of this if you ore going to get these (relatively) easy marks.

Easy marks. Port (a) contained easy marks for correctly calculating (and evaluating) materiality
where this was possible.

H@ii+!B:H:+-11�------------------------------
Marks
(a) Matters, further actions and auditor's report implications
Up to 1 mark for each point unless otherwise stated
Matters
• Assessment of finance director's approach
• Assessment of materiality
• Disclosure rules re held for sale/discontinued operations
• Application to the scenario to conclude asset is held for
sole (HFS)
• Material misstatement of classification and disclosure
• Accounting rule on valuation of held for sole assets
• Rule that depreciation should cease when asset meets
criteria of HFS
• Application to the scenario to derive correct value
• Materiality of the error in valuation
Further actions
• Request adjustment from management to recognise the
discontinued operation and to separately disclose the
assets held for sole
• Request management to amend the carrying amount of
the assets to the recoverable amount of $42 million
• If management refuse escalate to Those Charged with
Governance (TCWG)
• If still refuse obtain written representation confirming
intent to proceed

632 Advanced Audit and Assurance - International (AAA - INT)

@ BPP LEARNING
MEDIA
 Marks
Auditor's report Implications
• Qualified on basis of material misstatement
• Justification of whether pervasive and possible adverse
impact due to lock of significant disclosures
• Basis of opinion paragraph position and content
Maximum 10
(b) (i) Auditor's responsibilities In relation to other Information
presented with the financial statements
Assessment of ISA requirements including:
• Auditor must read other information for
inconsistency with financial statements or
understanding of the business
• Consider the source of the inconsistency
(i) A material misstatement of the other
information exists;
(ii) A material misstatement of the financial
statements exists; or
(iii) The auditor's understanding of the entity and
its environment needs to be updated.
• Auditor does not give opinion on the other
information
Matters arising from Chairman's statement
• Growth discussion ignores discontinued operation
• Calculations to support the ongoing growth
• Statement obscures actual growth hence
misleading/material misstatement in other
information
• Inappropriate reference to the content of the
auditor's report
• Misstatement of fact regarding recycled paper
usage
• Judgement as to whether it is material
misstatement of other information
Maximum 5
(ii) Implications for the completion of the audit
• Seek further information to confirm understanding
• Request management to correct
• Escalate to TCWG
• Impact on assessment of management integrity
and written representations
• Notify TCWG effect on auditor's report
• Consider resigning

@ BPP LEARNING Mock exam 2: Answers 633

MEDIA
 Marks
Implications for the auditor's report arising from the
draft Chairman's statement
• Addressed in other information paragraph to draw
attention to issue covering
Statement other information not audited
Responsibilities of auditor regarding other
information
Description of uncorrected misstatements
• Auditors opinion is not modified.
Maximum 5
Professional marks
Analysis and evaluation
• Appropriate use of the information to support discussion, draw
appropriate conclusions and design appropriate responses
• Identification of omissions from the analysis or further analysis
which could be carried out
• Balanced assessment of the information to determine the
appropriate audit opinion in the circumstances
Professional scepticism and judgement
• Effective challenge of information, evidence and assumptions
supplied and, techniques carried out to support key facts and/or
decisions
• Appropriate application of professional judgement to draw
conclusions and make informed decisions about the actions
which are appropriate in the context and stage of the
engagement.
Maximum 5
Total 25

(a) Matters, further actions and auditor's report Implications

Matters
The company is at an advanced stage of negotiations with a competitor to sell its scientific
publishing division. Currently the finance director has not included any reference to the
sale in the financial statements for the year ended 31 March 20X5 and there is no
appropriate justification for this. The finance director's assessment that the sale only
affects next year's financial statements is incorrect.
Materiality
The revenue of the scientific publishing division of $13 million and the profit of the division of
$1.Lt million are both material. The assets of the division are also significant, as they
represent 27.3% of the company's total assets, based on their value in use which is
recoqnised in the financial statements.

631+ Advanced Audit and Assurance - International (AAA - INl)

@ BPP LEARNING
MEDIA
 Discontinued operation end classification of assets held for sole
IFRS® 5 Non-Current Assets Held for Sale and Discontinued Operations defines a
discontinued operation as a component of an entity which either has been disposed of or is
classified as held for sale, and:
• represents either a separate major line of business or a geographical area of
operations;
• is part of a single co-ordinated plan to dispose of a separate major line of business
or geographical area of operation.

IFRS 5 requires specific disclosures in relation to assets held for sole and discontinued
operations, including that the assets are recognised as current assets and the results of the
discontinued operation are presented separately in the statement of profit or loss and the
statement of cash flows.
According to IFRS 5, a disposal group of assets should be classified as held for sale where
management plans to sell the assets, and the sale is highly probable. Conditions which
indicate that a sale is highly probable are:
• management is committed to a plan to sell
• the asset is available for immediate sole
• an active programme to locate a buyer is initiated
• the sale is highly probable, within 12 months of classification as held for sale (subject
to limited exceptions)
• the asset is being actively marketed for sale at a sales price reasonable in relation to
its fair value
• actions required to complete the plan indicate that it is unlikely that plan will be
significantly changed or withdrawn.

In respect of the scientific publishing division, management has decided to sell the division
and a buyer has been found. The advanced stage of negotiations would suggest the sale
is highly probable.
As a result, important disclosures are currently missing from the financial statements which
could mislead users with respect to the future revenue, profits, assets and cash flows of the
company. Failing to provide information about the sale of the division could be seen as a
significant omission from the financial statements, especially given the materiality of the
assets of the division to the company's assets as a whole.
There is therefore a material misstatement as the scientific publishing division hos not been
classified as held for sale and its profit presented as a discontinued operation and the
necessary disclosures hove not been made in the financial statements.

Held for sole - valuation

IFRS 5 provides further guidance regarding the valuation of the assets held for sale. Prior to
classification as held for sale, the dispcsal group should be reviewed for impairment in
accordance with IAS® 36 Impairment of Assets. This impairment review would require the
asset to be held at the lower of carrying amount and recoverable amount where the
recoverable amount is the higher of value in use or fair value less costs of disposal.
In this case the recoverable amount would be $42 million representing the fair value less
costs of disposal. Management has valued the disposal group based on its value in use at
$41 million which means that assets and profit are currently understated by $1 million. This
represents 10.7% of profit before tax and is material to the profit for the year.
After classification as held for sale, non-current assets or disposal groups are measured at
the lower of carrying amount and fair value less costs which would continue to be $42
million. Depreciation ceases to be charged when an asset is classified as held for sale.

@ BPP
LEARNING Mock exam 2: Answers 635
MEDIA
 Further actions
• The auditor should request that management adjusts the financial statements to
recognise the discontinued operation and to separately disclose the assets held for
sole in accordance with IFRS 5.
• In addition, the client should be requested to amend the carrying amount of the
assets to the recoverable amount of $42 million in line with IFRS 5 requirements.
• If management refuses to adjust the financial statements, the auditor should
communicate the misstatements to those charged with governance. They should
repeat the request and inform them of the modifications which would be mode to the
auditor's report if the adjustments ore not mode.
• If management still refuses to amend the financial statements, the auditor should
request a written representation from management confirming their intent to
proceed without amending the financial statements and that they ore aware of the
potential repercussions.

Auditor's report implications

If the adjustments ore not mode, then there is a material misstatement in the financial
statements. The matter hos resulted in on understatement of assets and profits by $1
million which in isolation is unlikely to be pervasive as limited components of the financial
statements ore affected. This would result in a qualified audit opinion in which the auditor's
report would state that 'except for' the material misstatement in relation to the valuation of
the assets held for sole the financial statements ore fairly stated.
However, there ore also several important disclosures omitted which would be required for
users to understand both the current financial position of the company and its ability to
generate future revenue and profits. As such, it would be a matter of judgement as to
whether the lock of disclosures in conjunction with the material misstatement mentioned
above hove a pervasive impact on the financial statements. Depending on the auditor's
judgement on this issue, this may give rise to on adverse opinion if the auditor considered
the impact of these issues to result in the financial statements being wholly misleading.
Depending on the opinion provided, a basis for qualified or adverse opinion paragraph
would be added underneath the opinion paragraph to describe and quantify the effects of
the misstatements.

(b) (i) Auditor's responslblllty for other Information presented with the financial
statements
ISA 720 The Auditor's Responsibilities Relating to Other Information requires the
auditor to read other information, defined as financial or non-financial information
(other than financial statements and the auditor's report thereon), included in on
entity's annual report.

The purpose of reading the other information is to consider whether there is a

material inconsistency between the other information and the financial statements
or between the other information and the auditor's knowledge obtained during the
course of the audit. If the auditor identifies that a material inconsistency appears to
exist, or becomes aware that the other information appears to be materially
misstated, the auditor should discuss the matter with management and, if
necessary, perform other procedures to conclude whether:

(i) A material misstatement of the other information exists;

(ii) A material misstatement of the financial statements exists; or

(iii) The auditor's understanding of the entity and its environment needs to be
updated.

The auditor does not audit the other information and does not express on opinion
covering the other information.

636 Advanced Audit and Assurance - International (AAA - INT)

@ BPPLEARNING
MEDIA
 Matters identified from the chairman's statement
In this case, the chairman's statement refers to strong growth in the year, in
particular the scientific publishing division and suggests that the growth will
continue. In the current year, the scientific publishing division represented 12% of
revenue and 15% of profit before tax and is a material component of the company.
As the scientific publishing division will be disposed of early in the next financial
period, it will not continue to form port of the basis for revenue or growth, and the
chairman's statement could be considered misleading. Further, because of the
disposal, on a like for like basis it is more likely that the financial statements for the
year ended 31 Morch 20X6 will include a reduction in revenue rather than growth.
In addition, the remainder of the business has experienced a lower level of growth in
revenue and profits in the period than the scientific publishing division. Revenue
growth of continuing business is 2% compared to 44% in the scientific publishing
division. Profit growth of the ongoing business is 5% compared to 100% for the
scientific publishing division.
ISA 720 states that a misstatement of the other information exists when the other
information is incorrectly stated or otherwise misleading, including because it omits
or obscures information necessary for a proper understanding of a matter disclosed
in the other information. In the case of the chairman's statement regarding growth
of the company, it could be argued that the way the information is presented
obscures the understanding of the growth and profitability of the ongoing business.
As mentioned above, this would be considered very misleading.
The chairman hos also mode an inappropriate reference to the view of the auditor,
implying that the auditor's report validates this assertion. The statement also
appears to inappropriately pre-empt that the auditor's report will provide on
unmodified opinion which based on the assessment above may not be the case given
the material misstatement and lock of disclosures. This is inappropriate and all
reference to the auditor's report should be removed.
In addition, there is also on issue arising with respect to the use of recycled paper.
The chairman's statement in this case is inconsistent with the knowledge obtained
during the audit. Whether the auditor considers this to be material would be a matter
of judgement, depending on how many publications there ore in total and the
proportion using non-recycled paper and whether the issue may be material by
nature rather than by size. This could be the case if it is perceived that there is a
deliberate misrepresentation of facts which may be misleading to the users of the
financial statements.
(ii) Implications for completion of the audit
The auditor should discuss with management and the chairman the information in
the statement which appears to inaccurate or inconsistent. In particular, this should
focus on a discussion of the misleading growth analysis given that the scientific
publishing division will not be contributing to company performance once it is sold.
In the case of the incorrect disclosure relating to the use of recycled paper, the
auditor should seek further information to support the file note regarding
publications not using recycled paper. The names of those publications should be
obtained, and a discussion held with the production manager to confirm the
auditor's understanding.
Following these investigations and discussions, the auditor should then request that
ony information which is inaccurate, inappropriate, or inconsistent is removed or
amended in the chairman's report.
If management refuse to make the changes then the auditor's request should be
escalated to those charged with governance. The auditor should also consider the
effect of this situation on their assessment of management integrity and whether it
effects the reliance which can be placed on written representations from

@ BPP
LEARNING Mock exam 2: Answers 637
MEDIA
 management. If the issue remains unresolved then the auditor should take
appropriate action, including:
• Considering the implications for the auditor's report and communicating with
those charged with governance about how the auditor plans to address the
issues in the auditor's report; or
• Withdrawing from the engagement, where withdrawal is possible under
applicable low or regulation.
Implications for the auditor's report
If the other information remains uncorrected the auditor would use the Other
Information section of the auditor's report to draw the users' attention to the
misstatements in the chairman's statement. This paragraph would include:
• A statement that management is responsible for the other information;
• A statement that the auditor's opinion does not cover the other information
and, accordingly, that the auditor does not express (or will not express) an
audit opinion or any form of assurance conclusion thereon;
• A description of the auditor's responsibilities relating to reading, considering
and reporting on other information as required by this ISA; and
• A statement that describes the uncorrected material misstatement of the other
information.
• As the inconsistency is in the chairman's statement rather than the audited
financial statement the audit opinion is not modified as a result.

638 Advanced Audit and Assurance - International (AAA - INT)

@ BPP LEARNING
MEDIA