Examiners’ commentaries 2023 (October)

Examiners’ commentaries 2023 (October)

Important note

This commentary reflects the examination and assessment arrangements for this course in the
academic year 2022–23. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).

Information about the subject guide and the Essential reading

Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2022).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refer to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.

General remarks

Learning outcomes

At the end of the course, and having completed the Essential reading and activities, candidates
should be able to:

explain why external audits and other types of assurance services are conducted
discuss the duties of auditors and other assurance providers and how these have changed
over time
explain the meaning of concepts that are fundamental to auditing and assurance services,
such a ‘independence’, ‘evidence’, ‘risk’, ‘materiality’
describe, in general terms, the processes involved in auditing and other assurance services
distinguish between compliance and substantive testing and describe various audit tests
discuss the form, content and importance of the reports provided at the end of the audit or
assurance service
discuss the issue of legal liability arising from audits and other assurance services
discuss current developments in auditing and assurance services.

General comments

It is very difficult to produce a general picture of the examination performance given that the cohort
sitting the October paper was so small. However, we attempt below to bring out the main aspects
that may be of some future benefit to those who have yet to sit a paper for this course.

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AC3093 Auditing and assurance

What the examiners are looking for

Candidates should be able to demonstrate a sound knowledge of auditing principles and practices.

They should be able to apply their knowledge to simple case scenarios to show that they understand
the nature of basic risks and appropriate audit responses to those risks.

Candidates should show that they appreciate the ethical and professional concerns that impact on
the conduct of auditing or other assurance services.

Candidates need also to be able to consider theoretical aspects of the auditing profession and to be
able to discuss possible solutions to the tensions and conflicts which could occur in an assurance
engagement.

Finally, candidates should be able to present their work in a professional manner showing the ability
to structure their thoughts in a logical way and to organise their words into coherent sentences and
paragraphs.

Examination revision strategy

Many candidates are disappointed to find that their examination performance is poorer than they
expected. This may be due to a number of reasons, but one particular failing is ‘question
spotting’, that is, confining your examination preparation to a few questions and/or topics which
have come up in past papers for the course. This can have serious consequences.

We recognise that candidates might not cover all topics in the syllabus in the same depth, but you
need to be aware that examiners are free to set questions on any aspect of the syllabus. This
means that you need to study enough of the syllabus to enable you to answer the required number of
examination questions.

The syllabus can be found in the Course information sheet available on the VLE. You should read
the syllabus carefully and ensure that you cover sufficient material in preparation for the
examination. Examiners will vary the topics and questions from year to year and may well set
questions that have not appeared in past papers. Examination papers may legitimately include
questions on any topic in the syllabus. So, although past papers can be helpful during your revision,
you cannot assume that topics or specific questions that have come up in past examinations will
occur again.

If you rely on a question-spotting strategy, it is likely you will find yourself in difficulties
when you sit the examination. We strongly advise you not to adopt this strategy.

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 Examiners’ commentaries 2023 (October)

Examiners’ commentaries 2023 (October)

Important note

This commentary reflects the examination and assessment arrangements for this course in the
academic year 2022–23. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).

Information about the subject guide and the Essential reading

Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2022).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refer to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.

Comments on specific questions

Candidates should answer FOUR of the following EIGHT questions: TWO from Section A, ONE
from Section B and ONE further question from either section. All questions carry equal marks.

Section A

Answer AT LEAST TWO but NO MORE THAN THREE questions from this section.

Question 1

You are the audit manager of Bumper plc, a large manufacturing company with a
number of production sites in the UK. As part of the planning process you have
identified the following areas as having a high inherent risk:

Inventory
Payroll
Cash and Bank
Investments in other quoted companies.

Required:

(a) Explain the inherent risk typically encountered in the above areas and suggest
three controls which you would expect to find in order to reduce the risk in
each area.
(15 marks)

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AC3093 Auditing and assurance

(b) Write a memo to explain to new trainee auditors in your firm what is meant by
the following terms:
• Materiality
• Sampling
• Detection risk
• Reasonable assurance.
(10 marks)

Reading for this question

For (a):

Porter et al., Chapters 8 and 10.

Gray et al., Chapters 6 and 8.

Subject guide, Chapter 7.

For (b):

Porter et al., Chapter 9.

Gray et al., Chapter 12.

Subject guide, Chapter 7.

Approaching the question

(a) Good candidates were able to articulate their concerns about the inherent risks in each of
these areas – for example, the risk of misappropriation in each case, the risk of inaccurate
judgements when valuing inventories and the risk of penalties imposed by tax authorities if
there are errors in the payroll calculations. Having correctly identified the risks, the
solutions in the form of controls which need to be put in place suggest themselves fairly
easily. For example, conducting regular independent inventory checks, an appropriate level
of segregation of duties in the payroll department, and strict controls on the access to ready
cash and back accounts. If there were weaknesses in the answers, it tended to be around the
investments in quoted companies. Some candidates seemed not to appreciate that access to
share certificates both physical and virtual, needs to be as tightly controlled as the access to
cash and bank.

(b) Well-prepared candidates had learned from previous commentaries that when a memo or a
report is called for, a small number of marks can be obtained merely from adopting the right
presentation. The majority of the marks, however, were attributed to the substance of the
issues and good candidates demonstrated that they well understood the meaning of the
terms. The real skill here was to bee able to explain in words that would be something to
new trainees – not experienced accountants – the nature of these ideas.

Question 2

You are the audit partner in charge of the following five audits

Client Able has a substantial amount of motor vehicles included in its non-current
assets. Audit tests on the life of the vehicle fleet indicate that none of the vehicles
disposed of during the year had been fully written off suggesting that the
depreciation policy is inaccurate. Management refuses to change the depreciation
policy.

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 Examiners’ commentaries 2023 (October)

Client Baker has a number of large offices. One of these suffered a catastrophic
systems failure just before the year-end which resulted in the loss of all of its sales
data. It will take several months to reconstruct the missing data. To avoid delaying
publication of the financial statements, the directors have included an estimate of
the missing sales figure based on the prior year’s figure of 25% of the company’s
total sales.

Client Charlie appointed your firm during the year. The previous year’s audit had
been carried out by another audit firm.

Client Doubtful has suffered a serious decline in cash flow since the end of the last
financial year-end. Sales have slumped and expenses have escalated. The bank
overdraft limit has been exceeded. The bank has indicated that it will not extend
further finance to Doubtful. No other lenders have been found and major
shareholders have said that they will not provide additional capital. Senior
management nevertheless insist that the going concern basis is appropriate for the
financial statements and refuse to make any disclosures about the state of the
company’s finances.

Client Excellent has a very tightly controlled accounting system. However, one item
in the auditors’ sample of 50 employees’ expense claims could not be found. The
audit team tested another 50 expense claims and all items were found to be
satisfactory.

Required:

(a) State, with reasons, which category of audit opinion is most appropriate for
each of the above clients.
(15 marks)
(b) In addition to the audit opinion on the financial statements, what other
information is given in the typical auditors’ report?
(10 marks)

Reading for this question

Porter et al., Chapter 14.

Gray et al., Chapter 18.

Subject guide, Chapter 5.

Approaching the question

(a) Most candidates were able to identify the majority of the issues and to categorise the audit
opinion correctly. However, for candidates who seemed to be not so sure, as in previous
years, there was a tendency to opt for the emphasis of matter style of report. As has been
pointed out before, the emphasis of matter is only applicable in a narrow range of situations:
there has to be a material uncertainty which is appropriately disclosed. Failure to obtain
sufficient evidence and cases of disagreement with the management’s accounting treatment
cannot be dealt with through using an emphasis of matter paragraph.

(b) There are several additional matters on which auditors must report. Good candidates know
that they would be expected to do more than just produce a list of memorised points. Good
answers gave a brief description of each item. For example, the respective responsibilities of
auditors and management should be explained in the report or a direction given to the
reader as to where they can find such an explanation. This extra element in the report is
designed to try to reduce the expectations gap and to educate the average reader.

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AC3093 Auditing and assurance

Question 3

KPY LLP is a medium sized audit firm with offices in three UK cities. It provides
specialises in audit and professional services to local businesses in the finance
industry. Its annual fee income is £10 million. It now faces the following new
engagement opportunities.

i. Credit plc is a large national insurance broker and has invited KPY LLP to
tender for the annual audit, with an annual audit fee in the region of £1 million.
ii. An audit client of KPY LLP, PZ plc, has asked KPY LLP to promote the new
share issue of PZ plc.
iii. KPY LLP has been invited to tender for the audit of Solar plc, a leading
manufacturer of solar panels and electric batteries.
iv. Mills Ltd is a small insurance broker not currently audited by KPY LLP. Mills
Ltd is owned by two people who each own 50% of the business and both are
directors of Mills Ltd. Fleet plc, a large national insurance broker, has offered
to buy Mills Ltd and the directors of Mills Ltd are very keen to sell their
shares. However, the sale is conditional on a clean interim audit report. The
directors of Mills Ltd have asked KPY LLP to prepare and audit the interim
financial statements.
v. Friends Ltd is a fast growing mortgage broker not currently audited by KPY
LLP. As part of a financing package its bank requires forecast financial
statements covering the coming twelve months. Friends Ltd has asked KPY
LLP if they would prepare and audit the forecasts. The directors of Friends Ltd
have indicated that if the forecast statements satisfy the bank, KPY LLP will
be invited to tender for the audit and other professional services of Friends Ltd.
vi. KPY LLP currently audits Brokers Ltd and has been asked to prepare its
monthly and annual financial statements.
vii. As a result of ongoing bad debt issues, Advance Ltd is suffering severe cashflow
problems and is in breach of bank loan covenants. The bank has asked for a set
of audited interim accounts by the end of the month. The directors of Advance
Ltd have invited KPY LLP to do the interim audit provided that it can be
completed in time.
viii. HKZ International plc is a global shipping insurance broker. HKZ plc has
headquarters in London, but the vast majority of HKZ plc’s business,
operations and administration takes place in the South East Asia and China.
The director’s of HKZ plc have invited KPY LLP to tender for the group audit
of HKZ International plc.

Required:

(a) For each of the above scenarios, explain the risk and state, with reasons,
whether KPY LLP should accept or decline the engagement.
(15 marks)
(b) Explain why proper ethical conduct is important for auditors.
(10 marks)

Reading for this question

Porter et al., Chapter 5.

Gray et al., Chapter 3.

Subject guide, Chapter 4.

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 Examiners’ commentaries 2023 (October)

Approaching the question

(a) Candidates generally were quite good at identifying the ethical or practical problems in each
of the scenarios. Less sure candidates often side-stepped the main issue as to whether or not
the client should be accepted or declined. This was disappointing to see since it meant that
candidates lacked confidence in their own judgements even when they had correctly
identified the issues. The ‘take-away’ from this is that candidates must understand that
marks will not be deducted if their answer is wrong so there is nothing to be lost in being
brave and decisive.

(b) This was an open question which invited the thoughtful candidate to explain why good
conduct is essential to a profession whose existence is meaningless if the public cannot trust
its practitioners. Well prepared candidates not only identified the characteristics of good
ethical conduct, they also were able to articulate why each characteristic added to the
credibility of the profession.

Question 4

Williams Ltd is a high street bicycle retailer based in the UK selling high-end,
handmade, bespoke bicycles which are imported directly from a prestigious Italian
manufacturer. Orders are only placed with the manufacturer upon receipt of a
customer deposit of 20% of the sales value. Once the deposit is received, a purchase
order (PO) is raised on the accounting system by the sales manager, who signs the
PO off and passes it to the finance manager who checks the details, the value of the
sale and receipt of the deposit. The finance manager then passes the PO to the
managing director for final approval before the order is placed with the
manufacturer. The PO is then passed to the accounts department and the system is
updated. When the bicycle is received from the manufacturer, it is checked for
quality, and the goods received note (GRN) is signed off by the stock manager. The
bicycle is then logged into the inventory system. The GRN is passed to the accounts
department, checked and attached to the PO. When the purchase invoice is received
from the manufacturer, it is checked by the accounts clerk and attached to the PO
and GRN and the purchase ledger is updated. At the end of each month all invoices
due for payment are passed to the finance manager for final checking and payment is
then approved by both the finance manager and the managing director. Paid
invoices are passed back to the accounts clerk for the purchase ledger to be updated
and invoices filed.

The raising of the PO generates a sales order (SO) which updates the sales ledger.
A copy of the SO is passed to the accounts department where values are checked.
Once the bicycle has been received from the manufacturer the customer is notified
and a sales invoice is raised, requiring the agreed outstanding balance to be paid
prior to the customer collecting the bicycle. The accounts department checks
payment of the invoice and upon confirmation of full payment, a goods delivered
note (GDN) is raised and attached to the invoice. The GDN and invoice are passed
to the finance manager for final checking. Upon approval, the invoice and GDN are
sent to the sales manager who arranges collection of the bicycle by the customer.
The customer visits the local store to take delivery of the bicycle, signing the GDN
to indicate satisfaction of the bicycle’s quality and condition. The GDN and invoice
are passed back to the accounts department where the sales ledger and inventory
are updated and invoices filed.

All checks are evidenced by the individual’s title and signature.

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AC3093 Auditing and assurance

Required:

(a) You are a member of the audit team currently auditing Williams Ltd. Explain
the risk associated with purchases and sales and design the steps that would be
followed to complete a walk through test (test of understanding of controls) for
both purchases and sales.
(15 marks)

(b) Explain the term ‘audit risk’ and identify four significant risks that contribute
to audit risk.
(10 marks)

Reading for this question

For (a):

Porter et al., Chapters 8 and 10.

Gray et al., Chapter 10.

Subject guide, Chapter 7.

For (b):

Porter et al., Chapter 9.

Gray et al., Chapter 6.

Subject guide, Chapter 7.

Approaching the question

(a) Candidates needed to have a sound knowledge of the concept of risk and control. The better
candidates addressed the issues in the context of both purchases and sales.
A walk-through test is a way that the auditors confirm that they have a good understanding
of the control system by ‘walking’ a single transaction ‘through’ the purchases or sales cycle.
They note whether the particular check of control is applied at each stage. For example, is
they have been told that each purchase order has to be approved by a senior manager, they
will trace the item selected to that point in the process in order to see the approval being
granted for the individual purchase order.

(b) As usual, whenever the term ‘audit risk’ is mentioned, a small number of candidates feel
honour-bound to trot out the formula AR = IR × CR × DR. This a fairly meaningless
notation without some accompanying explanation. Better candidates avoided the formula
and instead concentrated on explaining the components. Audit risk is basically the risk that
the wrong type of audit report is appended to the financial statements. The error of
judgement could have arisen because of ignorance of or the overlooking of the natural risks
which are inherent in a financial figure – for example, the degree of judgement involved.
Control risk is the chance that the client’s internal processes did not adequately address the
inherent risks and detection risk is that the auditors’ own tests do not pick up on the
misstatement. Again, candidates who were prepared to stray from conventional wording and
who dared to put the thoughts in their own words would have been rewarded.

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 Examiners’ commentaries 2023 (October)

Section B

Answer AT LEAST ONE but NO MORE THAN TWO questions from this section.

Question 5

Explain the auditor’s responsibilities regarding the going concern assumption in an

Reading for this question

Porter et al., Chapter 13.

Gray et al., Chapter 19.

Subject guide, Chapter 8.

Approaching the question

A fairly straightforward question asking candidates to talk about the difficulties of auditors
‘predicting the future’. Of course, the future is uncertain and things can happen unexpectedly.
Good candidates were keen to point out that auditors should not be held liable for failing to
anticipate problems with a client’s ability to survive but they might be expected to quiz
management on potential future problems with cashflow, the state of the order book, and the
extent to which the bank is prepared to advance finance.

Question 6

Discuss the factors that courts take into account when deciding whether or not to
order an auditor to pay damages for negligence in the conduct of an audit.

Reading for this question

Porter et al., Chapter 15.

Gray et al., Chapter 21.

Subject guide, Chapter 8.

Approaching the question

A reasonable knowledge of professional negligence cases would have been very valuable and a few
candidates appeared to have that knowledge. The Caparo case laid out the basic tests – there
must be a duty of care, the professional’s conduct must have fallen below that reasonably to be
expected of a professional, the carelessness caused the loss, the loss can be quantified and it is
fair and reasonable for a court to impose liability on the professional.

Question 7

It is often said that the investing public expect too much of auditors of financial
statements. To what extent do you believe that auditors could do more to match
public expectations?

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AC3093 Auditing and assurance

Reading for this question

Porter et al., Chapter 18.

Gray et al., Chapter 20.

Subject guide, Chapter 2.

Approaching the question

Candidates who had rehearsed the various argument around the ‘expectations gap’ scored well.
A good knowledge of the recognised aspects of the gap was essential as was an understanding of
the defences with which the auditing profession has justifiably countered the ‘public’s’ claims.
For example, untutored members of the public may associate the auditor with fraud detection
but auditors cannot be expected to detect or prevent fraud since they are not all-seeing,
all-knowing. A basic grasp of auditing would show that auditors do not and cannot test every
transaction. Improving auditor performance by increasing the stringency of professional
standards and by education those who rely on audit reports are two ways of trying to bring
expectations and practice into line.

Question 8

In addition to audits of financial statements, accounting firms also offer other

Reading for this question

Porter et al., Chapter 17.

Gray et al., Chapter 17.

Subject guide, Chapter 9.

Approaching the question

Candidates should have been able to talk about – at the very least – negative assurance
engagements, agreed-upon procedures and compilation. In addition there is a wide range of other
services which provide assurance but not on financial statements and students who could expand
upon services such as environmental audits, tax compliance audits and due diligence activities
prior to a take-over would have been given credit.

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