ACFI 301 Jan 2013 Questions (1).doc

PAPER CODE NO:ACFI 301EXAMINER: Phil Ormrod/Claire MallanaphyDEPARTMENT: ULMS TEL. NO: x53505/x52482JANUARY EXAMINATIONS 2013Auditing Theory and PracticeTIME ALLOWED:Three HoursINSTRUCTIONS TO CANDIDATESAnswer Question 1 in Section A and any TWO questions from Section B.Three questions in all.Page 1 of XXXXXContinuedSECTION AQuestion 1THIS QUESTION MUST BE ATTEMPTEDYour firm has recently been appointed as auditor of Prenton Ltd. The company owns a chain of 30 UK-based retail stores, selling luxury Italian ladies clothing and accessories. The company operates a central UK-based warehouse from which it supplies all 30 stores with inventory.The company purchases its inventory from a small number of major fashion wholesalers based in Italy. The majority of inventory items are the previous years designs, which the wholesalers supply to Prenton at discounted prices. Prenton places all its orders centrally three times a year, coinciding with the Spring, Summer, and Winter seasons. All transactions are conducted in euro and payment is due in full on arrival of the goods in the UK.Most of the Pentons sales are conducted by cash, cheque, or credit card. In order to remain competitive with other major high street retailers, the company offers a returns policy to its customers which allows goods to be returned to the store within a reasonable time of purchase, for any reason, with a full refund offered. Goods returned under this policy are then sold on in bulk through the trade, sometimes at less than their original cost to Prenton.Clothes are transferred between stores when there is a shortage of some items of clothing at one store and a surplus at another. Initial audit testing has discovered that there are poor accounting records for these transfers.Prentons managing director, aged 60, is also the companys main shareholder. He adopts a very hands-on approach to the business; he is involved in all major decisions and rarely delegates. He is known for his lavish lifestyle and in order to finance this he seeks each year to grow the business and improve upon the previous years profitability.The company has recently acquired new offices adjacent to its central warehouse. The purchase was financed by significant bank borrowings under fixed-term loans, which require annual capital repayments.Required(a) Describe and distinguish the different elements of audit risk (i.e. inherent risk, control risk and detection risk) according to ISA 315 and ISA 330. (10 marks)(b) Identify, from the circumstances outlined above, the factors which indicate high audit risk in respect of the audit of Prenton Ltd and, for each factor identified, explain why it contributes to high audit risk. (18 marks)(c) Explain, and critically appraise, the internal controls which Prenton Ltd should put in place to ensure the complete recording of sales and safe custody of cash. (12 marks)Total: 40 marksSECTION BQuestion 2(a)Explain the term professional scepticism in the context of an audit and provide examples of how this concept may be applied.(15 marks)(b) You are a senior on the audit of Lapdog Ltd for the year ended 31 December 2012. You are currently reviewing the payroll section of the working papers, which have been prepared by a junior member of the audit team. The audit junior has commented as follows:Several new employees have been added to the companys payroll during the year, with total payments of 125,000 being made to them. There does not appear to be any authorisation for these additions to the list of employees. When I questioned the payroll supervisor who made the amendments, she said that no authorisation was needed because the new employees are only working for the company on a temporary paid internship from university. However, when discussing staffing levels with management, it was stated that no new employees have been taken on this year. Other than the tests of controls, no other audit procedures have been performed.RequiredIn relation to the audit of Lapdog Ltd:(i)explain how professional scepticism may apply to the audit of payroll.(ii)recommend any further actions that should be taken by the audit team.(15 marks)Total: 30 marksQuestion 3“Common law in the UK and the Companies Act 2006 have made successful litigation against negligent auditors, by both shareholders and third parties, increasingly difficult. These changes have been both in terms of, who can successfully litigate against auditors, and of the conduct which would constitute negligent behaviour.” RequiredExamine the validity of this statement, clearly distinguishing contract law litigation from claims under the tort of negligence.Total: 30 marksQuestion 4 (a)“The postulates approach to auditing has failed to develop any coherent theory of auditing, or even any testable hypotheses about the nature and function of auditing in the modern business environment. In essence, the various attempts at developing a postulates approach have done little more than set out some basic, and self-evident, propositions about auditing.”RequiredAssess the validity of the above statement. Refer to attempts made in the literature to develop a postulates approach to auditing.(15 marks)(b)Critically appraise the extent to which agency theory can explain each of the following:(i)the willingness of companies to engage external auditors on a voluntary basis when there is no legal requirement to do so; (ii)the willingness of companies to engage quality-differentiated auditors when the cost of doing so is greater than other audit firms; andIn each case refer to relevant research, including empirical evidence.(15 marks)Total: 30 marksQuestion 5(a)Compare and contrast the nature and purposes of a statutory audit with an assurance assignment. You should consider both reasonable assurance and limited assurance assignments.(15 marks)(b)Examine the nature and usefulness of the concept of materiality according to ISA 320, Materiality.(15 marks)Total: 30 marksQuestion 6(a)The audit firm for which you work has been asked to provide the following additional services to existing audit clients: (1)Providing taxation services to the company and its directors.(2)Providing accountancy services, including preparing periodic management accounts and annual financial statements.(3)Providing management consultancy, including advice on new computer systems and systems of internal control.(4)Preparing confidential reports to the companys bank and other lenders on the financial position of the client. The