CL 1 Advanced Audit

PRACTICE & REVISION KIT
CA SRI LANKA CURRICULUM 2020
CL1 ‒ Advanced Audit and

Assurance
First edition 2020
ISBN 9781 5097 3164 0
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2020
ii
Contents
Page
Question Index iv
Introduction vii
How to use this Practice & Revision Kit viii
Exam techniques x
Action verbs checklist xii
Questions 3
Answers 83
Mock exam 203
iii
Contents
Question index
Time Page
Marks
Title allocated
allocated Question Answer
(Minutes)
Section 1: Objective Test Questions
1 – 25 Short Form Questions 50 45 3 83
26 – 30 Vimukthi Ltd. 10 18 11 86
31 – 35 Ratwatte Ltd. 10 18 13 87
36 – 40 Bridgford 10 18 16 89
41 – 45 South 10 18 19 91
46 – 50 Madugalle Ltd. 10 18 22 92
51 – 55 Weerawansa 10 18 25 94
56 – 60 Gemunu & Silva 10 18 28 95
Section 2: Constructed Response Questions
A. Governance internal control frameworks
1 Jafna Flowers 10 18 31 98
2 Lily Window Glass Plc 10 18 31 99
3 SouthLea Plc 10 18 33 102
4 Matalas Ltd. 10 18 34 103
B. Audit Planning Risk Assessment
5 Favorita Plc 10 18 35 105
6 Paranthan Ltd. 10 18 35 106
7 Zak Ltd. 10 18 36 108
8 Sleeptight Ltd. 10 18 37 109
9 Ja-Ela Ltd. 10 18 38 110
10 Matale Products 10 18 39 112
11 Regulation 10 18
iv
AAA Advanced Audit and Assurance
Time Page
Marks
Title allocated
(Minutes)
C. Gathering Audit Evidence
12 Buttala (Pvt) Ltd 10 18 40 114
13 Uva Toys (Pvt) Ltd 10 18 41 115
14 Badulla Ltd. 10 18 41 116
15 Rocks Forever 10 18 42 117
16 Panadura Ltd 10 18 42 119
17 Jaffna Oil Plc 10 18 43 120
18 Mankulam Cakes (Pvt) Ltd 10 18 43 121
D. Auditing in a digital environment
19 E-Spark Ltd 10 18 46 125
E. Evaluating evidence and Audit Reporting
20 Moratuwa National Bakeries 10 18 47 127
21 Mendes and Vimukithi 10 18 47 128
22 Daisy & Fuchsia 10 18 48 129
23 Builders Merchants Plc 10 18 49 130
24 Hood Enterprises (Pvt) Ltd 10 18 50 132
25 Glitch Ltd 10 18 132
F. Assurance and Related Services
26 Batulo Ltd 10 18 51 134
27 Verity 10 18 52 136
G. Audit Quality and Ethics
28 Maho (Pvt) Ltd 10 18 54 139
29 Independence 10 18 55 141
30 De Abrew Plc 10 18 55 143
31 Devapriya & Co 10 18 56 144
32 Dharsha and Saram 10 18 57 145
33 Estarellas Plc 10 18 57 146
v
Question Index
Time Page
Marks
Title allocated
(Minutes)
Section 2: Long Form Questions
1 Puttalam (Pvt) Ltd 20 36 59 148
2 Mannar (Pvt) Ltd 20 36 60 150
3 Pear Plc 20 36 62 154
4 Tempest (Pvt) Ltd 20 36 63 159
5 Ajantha Plc 20 36 64 162
6 Glo-warm 20 36 66 166
7 Shantha Holidays 20 36 67 169
8 Minty Cola Plc 20 36 67 172
9 Vakarai (Pvt) Ltd 20 36 68 175
10 Fonseca Distributors (Pvt) 20 36 70 179
Ltd
11 Kelanyia Joinery (Pvt) Ltd 20 36 72 183
12 Turbo Plc 20 36 73 185
13 Ratnapura Manufacturing 20 36 75 189
(Pvt) Ltd
14 Snu 20 36 76 192
15 Homes'r'Us 20 36 78 194
16 Chandan 20 36 79 197
17 Axis 20 36
18 Columbo 20 36
19 Beech 20 36
20 Gills Group 20 36
21 Dragon Group 20 36
22 Faster Jets 20 36
23 Lychee 20 36
24 Willow 20 36
25 Lapwing 20 36
26 Baltimore 20 36
vi
Time Page
Marks
Title allocated
(Minutes)
27 Banana 20 36 79 197
28 Retriever 20 36
29 Megabon 20 36
vii
Question Index
Introduction
Welcome to this first edition Practice & Revision Kit for the Institute of Chartered
Accountants of Sri Lanka professional examinations for curriculum 2020.
One of the key criteria for achieving exam success is question practice. There is
generally a direct correlation between candidates who revise all topics and practise
exam questions and those who are successful in their real exams. This Practice &
Revision Kit gives you ample opportunity for such practice in the run up to your
exams.
The Practice & Revision Kit is structured to follow the modules of the Study Text, and
comprises banks of non-complex mini scenario and functional scenario questions as
appropriate. Suggested solutions to all questions are supplied.
We welcome your feedback. If you have any comments about this Practice &
Revision Kit, or would like to suggest areas for improvement, please email
[email protected].
Good luck in your exams!
BPP LEARNING MEDIA
viii
How to use this Practice & Revision Kit
This Practice & Revision Kit comprises banks of practice questions, mostly in the style
that you will encounter in your exam. It is the ideal tool to use during the revision
phase of your studies.
Questions in your exam may test any part of the syllabus so you must revise the
whole syllabus. Selective revision will limit the number of questions you can answer
and hence reduce your chances of passing. It is better to go into the exam knowing a
reasonable amount about most of the syllabus rather than concentrating on a few
topics to the exclusion of the rest. You should at all costs avoid falling into the trap of
question spotting, that is trying to predict what are likely to be popular areas for
questions, and restricting your revision and question practice to those.
Practising as many exam-style questions as possible will be the key to passing this
exam. You must do exam-style questions under timed conditions and ensure you
write full answers to the discussion parts as well as doing the calculations.
Planning your revision
When you begin your course you should make a plan of how you will manage your
studies, taking into account the volume of work that you need to do and your other
commitments, both work and domestic.
In this time, you should go through your notes to ensure that you are happy with all
areas of the syllabus and practise as many questions as you can. You can do this in
different ways, for example:
· Revise the subject matter a module at a time and then attempt the questions
relating to that module; or
· Revise all the modules and then build an exam out of the questions in this
Practice & Revision Kit.
Using the practice questions
The best approach is to select a question and then allocate to it the appropriate time,
based on the real exam. All the questions in this Practice & Revision Kit have mark
allocations, so you can calculate the amount of time that you should spend on the
question.
Using the suggested solutions
Avoid looking at the answer until you have finished a question. It can be very
tempting to do so, but unless you give the question a proper attempt under exam
conditions you will not know how you would have coped with it in the real exam
scenario.
ix
How to use this Practice & Revision Kit
When you do look at the answer, compare it with your own and give some thought to
why your answer was different, if it was.
If you did not reach the correct answer make sure that you work through the
explanation or workings provided, to see where you went wrong. If you think that
you do not understand the principle involved, go back to your own notes or your
study materials and work through and revise the point again, to ensure that you will
understand it if it occurs in the exam.
Our suggested solutions are comprehensive, but in some discursive questions it may
be that you have made points that are not included in the suggested solution that are
equally valid. In the real exams you should be given credit for such points.
x
Exam techniques
Using the right techniques in the real exam can make all the difference between
success and failure.
Here are a few pointers:
1. During the 20-minute reading time at the start, read through the questions and
decide in what order you are going to attempt the exam. You have to write
your answers in the order set out in the question and answer booklet, but you
can attempt the questions in any order that you like.
Some candidates like to attempt the easiest questions first, on the basis that will
enable them to gain the easiest available marks quickly, and build up their
confidence.
If you select a question on a topic area about which you feel confident, and do
that first, you will build up your confidence right at the start, which will help to
calm you if you are nervous and set the tone for the rest of the exam. You should
decide what approach is best for you.
2. Having established the order that you are going to do the exam, allocate the
time available to the questions and work out at what time you will need to
stop working on one question and move on to the next. When you reach the end
of the allocated time for the question that you are working on, STOP. It is much
easier to gain the straightforward marks for the next question than to spend a
long time working on the previous question in the hope of gaining one or two
final marks.
3. Read the question. Read it carefully once, and then read it again to ensure that
you have picked everything up. Make sure that you understand what the
question wants you to do, rather than what you might like the question to be
asking you.
4. Answer all parts of the question. Even if you cannot do all of the calculation
elements, you will still be able to gain marks in the discussion parts.
5. Don't worry if you think that you have made a mistake in a computational part
of a question. You will not earn the mark for that particular part, but you will
still be able to gain credit for correct application in the later parts of the
question, even if you are using the wrong figure.
6. When starting to read a question, especially a long case study, read the
requirement first. You will then find yourself considering the requirement as
you read the data in the scenario, helping you to focus on exactly what you have
to do.
Exam techniques xi
7. Plan your answer before you start to write your response, especially for longer
case studies. This will help you to focus on the requirements of the question and
to avoid irrelevance.
8. Try to make sure that your answer relates to the specifics of the question
itself. If you are asked to consider the impact of the scenario on someone named
in the question, make sure that you do that, so your answer is as relevant as
possible.
9. If you finish the exam with time to spare, use the rest of the time to review your
answers and to make sure that you answered every requirement of every
question.
xii
Action verbs checklist
Knowledge Process Verb List Verb Definitions
Tier - 1 Remember Define Describe exactly the nature, scope or meaning

Recall important
information Draw Produce (a picture or diagram)
Identify Recognise, establish or select after consideration
List Write the connected items one below

the other
Relate To establish logical or causal connections
State Express something definitely or clearly
Tier - 2 Calculate/Compute Make a mathematical computation

Comprehension
Explain important Discuss Examine in detail by argument showing
information different aspects, for the purpose of arriving at a
conclusion
Explain Make a clear description in detail
revealing relevant facts
Interpret Present in understandable terms or to translate
Recognise To show validity or otherwise, using knowledge

or contextual experience
Record Enter relevant entries in detail
Summarise Give a brief statement of the main points

(in facts or figures)
Classify Allocate into categories

Describe Communicate the key features
Provide Give illustrations to support or illuminate

a point or assertion
Tier - 3 Application Apply Put to practical use

Use knowledge in a
Assess Determine the value, nature, ability
setting other than the or quality
one in which it was
learned/solve close- Demonstrate Prove, especially with examples
ended problems
Graph Represent by means of a graph
Prepare Make ready for a particular purpose
Prioritise Arrange or do in order of importance
Reconcile Make consistent with another

Solve To find a solution through calculations and/
or explanations
Action verb checklist xiii

Conduct Organize and carry out a task

Communicate Transmit thoughts or knowledge
Display Make evident or noticeable
Perform Do or execute, usually in the sense of

a complex procedure
Reconcile Make or prove consistent or compatible

or show differences
Set Fix or establish
Select Choose from a range of options

or possibilities
Support Assist to make decisions by providing
appropriate information about
respective concepts
Use Apply in a practical way
Undertake Commit to do or perform
Tier - 4 Analysis Analyse Examine in detail in order to determine
the solution or outcome
Draw relations among
Compare Examine for the purpose of
ideas and to compare
discovering similarities
and
Contrast Examine in order to show
contrast/solve open- unlikeness or differences
ended problems
Construct Build or make a diagram, model
or formula
Differentiate Constitute a difference that

distinguishes something
Outline Make a summary of significant features
Write Provide word descriptions to express an opinion

or idea
Tier - 5 Evaluate Advise Offer suggestions about the best course of
Formation of action in a manner suited to the recipient
judgments and Convince To persuade others to believe something
decisions about the using evidence and/or argument
value of methods, ideas, Criticise Form and express a judgment
people or products
Comment Provide written remarks expressing an opinion
in both positive and negative perspectives
Evaluate To determine the significance by careful appraisal
Conclude Form a judgment about, or determine or resolve

the outcome of, an issue through a process
involving reasoning
Determine Ascertain or conclude after analysis and
consideration; judge
xiv
Justify Give valid reasons or evidence for
Review Study critically with a view

to correction or improvement
Recommend A suggestion or proposal as to the
best course of action
Resolve Settle or find a solution to a
problem or contentious matter
Validate Check or prove the accuracy
Tier - 6 Synthesis Compile Produce by assembling information

Solve unfamiliar problems by collected from various sources
combining different aspects Design Devise the form or structure according to
to form a unique or novel a plan
solution Develop To disclose, discover, perfect or unfold a
plan or idea
Propose To form or declare a plan or intention

for consideration or adoption
Anticipate Foresee, or experience or realise

beforehand
Draft Write original material for the scrutiny

of others
Formulate Devise and put into words
Plan Devise the plan for an assurance

engagement
Report Give the formal final conclusion for an

assurance engagement
Submit Send a completed document to a

particular party
Suggest Put forward an idea or give reasons
Synthesize Make or propose a new concepts or ideas

by combining existing knowledge in
different aspects
xv
Action verb checklist
xvi
Learning outcomes
CA Sri Lanka's Learning outcomes for the module are set out on the following pages. Section A Questions 1 – 60 cover all sections of the syllabus. Section B 10
marks questions and Section C 20 mark questions are referenced to syllabus learning outcomes in the following table. Note. longer questions can cover
multiple learning objective, so the main ones are referenced below and questions may cover additional learning outcomes.
A. Governance Internal Control Frameworks
(Syllabus Weighting: 10%)
Knowledge Learning Outcome Specific Knowledge Section B Section C
Component Questions Questions
1.1 Corporate 1.1.1 Discuss the need for an audit of financial statements Ability to connect stewardship, 8
governance using agency theory. accountability and agency
and audit conflict with a need to conduct
an independent audit
1.2 Internal 1.2.1 Evaluate components of an integrated internal COSO-2014 Internal controls five 1,2,3,14
control control system. components and 17 principles
framework
1.2.2 Analyse design, implementation and operating SLAuS 315 1,2,3,4
effectiveness of identified controls.
1.2.3 Outline deficiencies in control activities to be SLAuS 265
communicated to those charged with governance.
1.3 IT risk and 1.3.1 Demonstrate the importance of IT general controls IT general controls and 2,3
controls and application controls in an audit of financial application controls
statements.
xvii
B. Audit Planning and Risk Assessment
2.1 Terms of 2.1.1 Explain precondition required to perform an audit of SLAuS 210 31
engagement financial statements.
2.2 Overall audit 2.2.1 Demonstrate the importance of overall audit strategy Including non-complex group and 9 14,18,19,20,21
strategy as part of audit planning. SME audit scenarios covering the
2.3 Risk of 2.3.1 Assess risk of material misstatements including risk requirements of SLAuS 300, 315, 5,6,7,8,9,10 14,18,19,20,21
material of frauds to be focused during the audit using risk 240 and 600
misstatement assessment procedures.
2.4 Materiality 2.4.1 Apply the concept of materiality in planning and 5,6,10 14,18,19,20,21
performing the audit.
2.5 Responding to 2.5.1 Outline suitable overall response and further audit Including non-complex group and 6,8 17,18,29,20
risk of material procedures for identified risk at financial statement SME audit scenarios covering the
misstatements level and assertion level. requirements of SLAuS 330
xviii
B. Audit Planning and Risk Assessment
2.6 Complex issues 2.6.1 Apply risk assessment procedures to identify risks Requirements of SLAuS 540, 550 5,9,11,17,29,20
relating to related party transactions, going concern and 570 in relation to risk ,22
and accounting estimates including fair value and assessment
measurement.
2.7 Using the work 2.7.1 Demonstrate the use of experts (both management Requirements under SLAuS 610, 15 19,22
of others and auditors experts), internal auditors and service SLAuS 620 & SLAuS 402
organisation auditors in an audit of financial
statements.
2.8 Laws and 2.8.1 Explain auditors requirements consider compliance Understanding the legal and 11,28
regulations with laws and regulations during an audit of financial regulatory framework,
statement. procedures when
non-compliance is identified or
suspected and reporting of
identified or suspected non-
compliance
xix
3.1 Test of details 3.1.1 Outline audit procedures to address assertion level This should cover audit evidence 12,13,14,15,17 3,4,8,9,10,11,
risk for non-complex key account balances and over key account balances and 13,21
classes of transactions. classes of transactions
3.1.2 Apply specific considerations in obtaining sufficient SLAuS 501 14
appropriate audit evidence with respect to inventory,
litigation and claims involving the entity, and
segment information.
3.2 External 3.2.1 Apply procedures to design and perform external SLAuS 505 14 12
confirmation confirmation to obtain relevant and reliable audit
evidence.
3.3 Opening 3.3.1 Discuss the requirements to be considered by an SLAuS 510 and 710 10,22
balances and auditor in an initial engagement and in relation to
corresponding corresponding figures.
figures
3.4 Selecting items 3.4.1 Apply different methods of selecting items for audit SLAuS 530 12 28
for testing and testing including audit sampling.
the use of audit
sampling
3.5 Analytical 3.5.1 Apply analytical procedures as substantive Recognise the importance of 17 1,2,11
procedures procedures and in the overall review of financial analytical software which has the
statements. ability to analyse 100% data to
identify outliers
3.6 Complex 3.6.1 Design audit procedures to address complex items SLAuS 540, 550, 570 18 9,11
account including accounting estimates, fair valuation, related
balances party transactions and going concern.
3.7 Subsequent 3.7.1 Outline procedures required to deal with events SLAuS 560 9,11,19
events occurring between the date of the financial
statements and the date of the auditor's report and
xx
facts that become known to the auditor after the date
of the auditor's report.
D. Auditing in a Digital Environment

4.1 Digital 4.1.1 Recognise trends in a digital business environments Artificial intelligence (AI), robotic 19 29
business including Artificial Intelligence (AI), Robotic Process process automation (RPA),
environment Automation (RPA), Block chain, digital currencies and blockchain, digital currencies
their impacts on internal controls and audit.
4.1.2 Recognise the use of big data and analytics as Big data and analytics 19 29
business intelligence tools and potential risk
associated with big data.
4.2 Audit 4.2.1 Demonstrates the use of cloud based audit working Audit automation 19
automation papers, audit automation tools and their limitations.
4.3 Data analytics 4.3.1 Discuss the use of data analytics software including Data analytics 12,16
CAATs in planning and gathering audit evidence.
4.4 Cyber security 4.4.1 Outline controls required to mitigate cyber security Cyber security risk 29
risk.
xxi
E. Evaluating Audit Evidence and Audit Reporting
5.1 Audit report 5.1.1 Evaluate the effects of material misstatements on SLAuS 450 20,21 15,24
audit the audit opinion.
5.1.2 Evaluate the effect of misstatements in opening SLAuS 510 and SLAuS 710 23,25 22
balances and corresponding figures on current year
audit opinion.
5.2 Key audit 5.2.1 Explain matters to be communicated with those SLAUS 250 11,25 24, 27
matters charged with governance.
5.2.2 Apply Key Audit Matters (KAM) for a given scenario. SLAuS 701 25
5.3 Modified audit 5.3.1 Apply modified audit opinions and going concern Reporting considerations relating 21,22,24,25 9, 15,23,24,27
report reporting requirements for a given scenario. to SLAuS 705, 701 and SLAuS 570
5.4 Emphasis of 5.4.1 Apply emphasis of matter and other matter for a SLAuS 706 23,25 6,9,23
matters and given scenario of audit reporting.
other matters
(SLAuS 706)
5.5 Special 5.5.1 Apply special purpose audits including audit of single Includes both SLAuS 800 and 805 26 16
purpose audit financial statements/elements to a given scenario.
5.6 Other 5.6.1 Explain auditor's responsibility towards other Fair understanding of the 17
information information included in documents containing auditor's responsibilities relating
audited financial statements. to other information contained in
an annual report (SLAuS 720)
xxii
E. Evaluating Audit Evidence and Audit Reporting
5.7 Review 5.7.1 Explain procedures required in conducting review Fair understanding of application 16
engagements engagements. of review engagement and that
the procedures used in a review
engagement is limited compared
to an audit of financial statements
(SLSRE 2400, SLSRE 2410)
xxii
F. Assurance and Related Services
6.1 Assurance 6.1.1 Apply framework for assurance engagements in Understanding of the definition, 22,26 16, 26, 28
framework identifying and accepting assurance engagements. elements, scope of and
preconditions for an assurance
engagement
6.2 Assurance 6.2.1 Apply Sri Lanka Standard on Assurance Engagement Fair knowledge about application 22,26
engagements together with subject matter specific assurance of SLSAE 3000 for general subject
standards to provide reasonable or limited assurance matters and subject matter
as required in the engagement circumstances. specific assurance standards
including prospective financial
statements
6.3 Related 6.3.1 Apply Sri Lanka Standard on Related Services relating Fair understanding of the SLSRE
services to agreed up on procedures and compilation as 4400 & SLSRE 4410
required by engagement circumstances.
6.4 Reporting 6.4.1 Outline key elements of reports used in assurance
and related services.

7.1 Framework for 7.1.1 Demonstrate the elements of the framework for audit Understanding of the definition 21,27,28
audit quality quality. and elements of the quality
framework
xxiv
7.2 System of 7.2.1 Demonstrate the elements of a system of quality Fair understanding of the 27,28
quality controls controls of the firm. importance of elements of quality
controls of the firm based on
SLQC 1
7.3 Audit quality 7.3.1 Explain the requirements to implement quality Fair understanding of the 27,28
control procedures at the audit engagement level importance of elements of quality
including the engagement quality control review. controls of the firm based on
SLAuS 220
7.4 Threats to 7.4.1 Analyse threats applicable to professional Part B of Code of Ethics 28,29,30,31,32, 5,25,26,28
compliance accountants in public practice in complying with (Section200 to 270) 33
with fundamental and ethical principle.
fundamental
and ethical
principles
7.5 Auditors 7.5.1 Apply conceptual framework approach to analyse Fair understanding of the 29,32 25,26
independence threats relating to auditors independence. importance of auditors
independence including the scope
of applicability and specific issues
dealt in Section 290-100 to 148)
7.5.2 Evaluate threats associated with provision of non- Threats associated with provision
assurance service and methods of mitigating such of non-assurance service and
threats. methods of mitigating such
threats
7.5.3 Apply conceptual framework approach to evaluate (Section 290-164- to 219)
specific non-assurance services.
xxv
H. Professional Practice of Internal Audit
8.1 International 8.1.1 Recognise the importance of professional practice in Core principles for the 28, 29
professional internal audit using the elements of the International professional practice of internal
practice Professional Practice Framework (IPPF) of the auditing
Institute of Internal Auditors.
framework Definition of internal auditing
Code of ethics
International standards for the
professional practice of internal
auditing
8.2 Internal audit 8.2.1 Propose an internal audit charter to govern an Key elements and mandatory
charter internal audit function for a given entity considering nature of the Charter based on IIA
entity specific circumstances. standard
8.3 Audit universe 8.3.1 Develop an audit universe and a plan aligned to
and plan organisations strategies, objectives and risks.
8.4 Risk role of 8.4.1 Advise the extent to which internal auditor can IIA position paper-role of internal
internal support risk management initiatives of an entity auditor in risk management (ERM
auditor using assurance and advisory services. FAN)
8.5 Managing an 8.5.1 Outline key considerations in setting engagement Ability to apply IIA performance
internal audit objectives, engagement planning and conducting an standards applicable to
internal audit engagement for a given business engagement objectives, planning
scenario.
and performance of an internal
audit taking into account
engagement specific issues eg
fraud risk, IT controls, possibility
of using data analytics etc
xxvi
H. Professional Practice of Internal Audit
8.6 Governance 8.6.1 Advise on the process of structuring a governance Understanding key elements of a
and culture audit and a culture audit. governance and culture audit and
audit approach to be followed in the
audit
8.7 Audit 8.7.1 Advise on the oversight role to be played by the audit Application of SLAuS 610
committee and committee in ensuring the independence and
internal audit effectiveness of internal audit function.
8.7.2 Advice on the extent to which external auditor can

rely on the work of internal audit.
xxvii
xxviii
| Questions
Section 1: Objective Test Questions

Questions 1 to 60 in this section cover all areas of the syllabus with each question
worth 2 marks. There will be 10 of this question type on the exam paper.
1 Amerasekera & Co audits Futtalam Ltd. In accordance with CA Sri Lanka

Code of Ethics, which TWO of the following circumstances would constitute a
threat to objectivity?
(1) An employee of Amerasekera & Co owns shares in Futtalam Ltd but is
not part of the audit team
(2) The best friend of the engagement partner owns a significant indirect
financial interest in Futtalam Ltd
(3) The audit manager of Amerasekera & Co owns a small number of
shares in Futtalam Ltd
(4) The husband of the audit partner owns shares in Futtalam Ltd
A (1) and (2)
B (1) and (4)
C (2) and (3)
D (3) and (4) (2 marks)
2 Gunawardena Partners & Co is the statutory auditor of Wattala Ltd a

company listed on the Colombo stock exchange.
Which of the following services is Gunawardena & Co prohibited from
providing to Wattala Ltd under any circumstances?
A Provision of bookkeeping services
B Assistance in the resolution of tax disputes
C Internal audit services
D Valuation services (2 marks)
3 What are the two elements of the risk of material misstatement at the
assertion level?
A Inherent risk and detection risk
B Audit risk and detection risk
C Inherent risk and control risk
D Detection risk and control risk (2 marks)
CA Sri Lanka 3
Questions
4 Abayakoon Ltd. is an oil and gas company mining for crude oil reserves in
sub-Saharan Africa. In the external audit of Abayakoon Ltd, to which of the
following might specific performance materiality levels apply?
(1) Directors' remuneration
(2) Exploration and development costs
(3) The financial statements as a whole – to reduce to an appropriately low
level the probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial statements as a
whole
(4) The financial statements as a whole – to determine whether
misstatements identified during the audit should be accumulated and
communicated to management
A (1), (2) and (3)
B (1), (2) and (4)
C (1) and (2)
D (2) and (4) (2 marks)
5 The auditor of Herath Ltd. wishes to reduce audit risk. Which of the
following actions could the auditor take to achieve this?
(1) Increase sample sizes
(2) Reduce control risk
(3) Assign more experienced staff to the engagement team
A (1) only
B (2) only
C (1) and (3)
D (2) and (3) (2 marks)
6 When gaining an understanding of the specific business operations of an

audit client which of the following matters would an auditor need to
consider?
A Accounting principles and industry specific practices relevant to the
client's business
B Acquisitions or disposals of the client's business activities
C Leasing of property, plant or equipment for use in the client's business
D Products or services and markets of the client's business (2 marks)
4 CA Sri Lanka
CL1 Advanced A udit and A ssur ance | Questions
7 The audit team of which you are a member is in the process of documenting
the audit client's system of internal controls. You wish to assess what
specific errors or frauds may occur, in order to identify the key controls that
the team will then need to test during control testing.
Which of the following methods for recording control systems should you
use?
A ICQ
B ICEQ
C Narrative notes
D Flowcharts (2 marks)
8 Application controls relate to procedures used to initiate, record, process

and report transactions and other financial data.
Which two of the following are application controls?
(1) Records of program changes
(2) Virus checks
(3) Batch reconciliations
(4) Document counts
A (1) and (2)
B (1) and (4)
C (2) and (3)
D (3) and (4) (2 marks)
9 One of the control objectives of the sales system of Karunaratne Ltd. is to

ensure that goods and services are sold to credit-worthy customers.
Which of the following control activities would assist Karunaratne Ltd in
achieving this objective?
A All sales orders are based on authorised price lists.
B Credit limits are checked before sales orders are accepted.
C Overdue debts are chased each month by the credit controller.
D The aged debt listing is reviewed by the finance director on a monthly
basis. (2 marks)
CA Sri Lanka 5
Questions
10 The auditor of Jayatilleka Ltd has identified that Jayatilleka Ltd. does not
match dispatch notes to sales invoices as part of the controls in the sales
system.
What is the potential consequence of this deficiency?
A Customer orders may not be fulfilled accurately.
B Sales and trade receivables may be overstated.
C Sales and trade receivables may be understated.
D Sales invoices may be posted inaccurately in the receivables control
account. (2 marks)
11 The external auditor has identified a deficiency in the internal controls of

Dahanayake Ltd.
Which of the following factors would indicate that the deficiency is a
significant deficiency in accordance with SLAuS 265 Communicating
Deficiencies in Internal Control to Those Charged with Governance and
Management?
(1) The likelihood of the deficiency leading to material misstatement is low
(2) There is a risk of fraud
(3) The number of transactions affected by the deficiency is low
(4) The deficiency interacts with other deficiencies identified
A (1) and (2)
B (1) and (3)
C (2) and (4)
D (3) and (4) (2 marks)
12 The sales invoices of Pathirana Ltd. are matched to dispatch notes with any
mismatched items investigated before they are recorded in the sales day
book.
Which of the following control objectives does this help to achieve?
A It ensures that sales and receivables are valid and accurate.
B It ensures that all goods dispatched are recognised as sales and
receivables.
C It ensures that all goods ordered by customers are dispatched.
D It ensures that customers do not exceed their credit limits. (2 marks)
6 CA Sri Lanka
13 To ensure that the recorded sales transactions represent goods that have
actually been despatched, Jayawickrama Ltd's sales system only records
sales if there is matching despatch documentation.
Which of the following would be an appropriate test of control to confirm
that the control is operating effectively?
A For a sample of sales invoices, verify that there are matching goods
despatched notes.
B For a sample of goods despatched notes, verify that there are matching
sales invoices.
C Verify that the numerical sequence of sales invoices is complete.
D Inspect the open-order file for unfulfilled orders. (2 marks)
14 As the external auditor of Gamage Ltd, you have performed analytical

procedures which have highlighted a 40% increase in revenue compared to
the previous period.
Which further audit procedures would you perform in response to this?
(1) For a sample of sales invoices around the period end, inspect the dates
and compare with the dates of goods despatch and the dates recorded
in the sales and receivables ledger to confirm the application of correct
cut-off.
(2) Trace a sample of shipping documentation to sales invoices and into
the sales and receivables ledger.
(3) For a sample of sales transactions recorded in the ledger, vouch the
sales invoice back to customer orders and shipping documentation.
(4) For a sample of sales invoices, examine for proper classification into
revenue accounts.
A (1) and (2)
B (1) and (3)
C (2) and (4)
D (3) and (4) (2 marks)
CA Sri Lanka 7
Questions
15 The draft financial statements of Silva Ltd. show the following information:
Rs'000
Revenue 420
Cost of sales 270
Gross profit 150
Trade receivables 160
Trade payables 130
What is the receivables collection period?
A 139 days
B 175 days
C 758 days
D 958 days (2 marks)
16 The auditor of Pathirana Ltd. is planning the audit work on trade receivables.
Which of the following procedures could not be performed by using
computer-assisted audit techniques?
A Selection of a sample of receivables for confirmation
B Calculation of receivables collection period
C Production of receivables confirmation letters
D Evaluation of the adequacy of the allowance for irrecoverable
receivables (2 marks)
17 Wijeratne Ltd. has an internal audit function. The external auditor has
concluded that the internal audit function does not apply a systematic and
disciplined approach to its work.
How does this affect the extent to which the external auditor can rely on the
work of the internal audit function?
A The external auditor must not use the work of the internal audit
function.
B The external auditor can use the work of the internal audit function
provided the individuals have been assessed as competent.
C The external auditor can use the work of the internal audit function
provided the organisational status of the function supports its
objectivity.
D The external auditor can use work performed by the internal audit
function which relates to low risk areas of the external audit only.
(2 marks)
8 CA Sri Lanka
18 The auditor of Gemunu Ltd. is performing audit procedures to confirm the

company's ownership of motor vehicles.
Which of the following would provide the most persuasive evidence of this?
A Physical inspection of the motor vehicles
B Inspection of vehicle registration documents
C Checking that the motor vehicles are recorded in the non-current asset
register
D Review of vehicle insurance documentation (2 marks)
19 The auditor of Cooray Ltd. has performed purchases cut-off procedures and
has identified that in two material instances goods received prior to the
inventory count have not been included on the schedule of 'goods received
not invoiced'. At the period end purchase invoices have not been received.
What is the auditor's conclusion based on this evidence?
A Inventory is overstated and liabilities are understated.
B Inventory is understated and liabilities are understated.
C Inventory is overstated and liabilities are overstated.
D Inventory is understated and liabilities are overstated. (2 marks)
20 Mendis Ltd. has a year end of 31 December 20X4. The auditor has identified
that management's assessment of Mendis Ltd's ability to continue as a going
concern covers the period to 30 June 20X5.
What action should the auditor take?
A Request that management extends the assessment period to
30 September 20X5
B Request that management extends the assessment period to
31 December 20X5
C Request that management extends the assessment period to
31 December 20X6
D No action is required provided the auditor is satisfied with
management's assessment to 30 June 20X5 (2 marks)
21 SLAuS 700 (Revised) Forming an Opinion and Reporting on Financial

Statements sets out the basic elements of an auditor's report.
Which of the following is not included in an unmodified auditor's report?
A Management's responsibility for the financial statements
B Auditors' responsibilities
C Audit opinion
D Deficiencies of internal controls (2 marks)
CA Sri Lanka 9
Questions
22 The statement of financial position of Rajapaksa Ltd. includes a material

amount of Rs200,000 in respect of costs capitalised in the year as
development expenditure. The auditor has concluded that these costs are
research expenditure.
If the auditor is to issue an unmodified opinion which financial statements
will require adjustment?
A Statement of financial position only
B Statement of profit or loss only
C Statement of financial position and statement of profit or loss
D Neither the statement of financial position nor the statement of profit
or loss (2 marks)
23 Due to disruptions caused by the recent transition to a new accounting

system, one month of Herath Ltd's inventory records have been lost. The
auditors performing the statutory audit for the twelve-month period have
determined that the possible effects of undetected misstatements could be
material, but not pervasive.
What form of audit opinion would the auditor give?
A Unmodified opinion with an emphasis of matter paragraph
B Qualified opinion
C Adverse opinion
D Disclaimer of opinion (2 marks)
24 Chandrasiri Ltd. has a substantial bank loan which is due to mature in 20X7,
and the company plans to negotiate for a new loan in March 20X7. The
auditors concluded that the company's use of the going concern assumption
in the financial statements for the year ended 31 December 20X6 is
appropriate. However, they believe there is a material uncertainty related to
going concern, which has been appropriately disclosed in the financial
statements.
What action should the auditor take with regards to going concern in the
auditor's report?
A Express an unmodified opinion and describe the material uncertainty
in the other matter paragraph
B Express an unmodified opinion and describe the material uncertainty
in the material uncertainty related to going concern paragraph
C Express a modified opinion and describe the material uncertainty in
the emphasis of matter paragraph
D Express a qualified opinion and describe the material uncertainty in
the basis for qualified opinion paragraph (2 marks)
10 CA Sri Lanka
25 Which of the following is likely to be carried out as part of an engagement

quality control review for a listed entity?
(1) Review of audit working paper files to ensure that the audit has been
performed in accordance with professional standards and regulatory
and legal requirements
(2) Review of selected audit documentation relating to significant audit
judgements
(3) Review of the engagement team's evaluation of the firm's
independence towards the audit
(4) Consideration of whether appropriate consultations have taken place
on differences of opinion/contentious matters
A (1) and (3)
B (2) and (4)
C (1), (2) and (4)
D (2), (3) and (4) (2 marks)
Vimukthi Ltd.
The following scenario relates to questions 26 to 30
Vimukthi Ltd. has a year end of 31 December 20X6. The detailed audit work has
been concluded and you have been asked to complete the review stage of the
audit. The auditor's report is due to be signed by the audit partner on 15 March
20X7. The annual report, which includes the financial statements and other
information, will be issued on 31 March 20X7. The audit file includes details of an
ongoing legal claim against Vimukthi Ltd. . You are satisfied with its treatment as a
contingent liability and that the details have been fully disclosed in the financial
statements.
26 You have requested written representations from the directors of Vimukthi
Ltd. but have not yet received them.
By which date must the written representations letter be dated and signed
by the directors of Vimukthi Ltd.?
A 31 December 20X6
B 15 March 20X7
C 31 March 20X7
D Any date between 16-13 March 20X7 (2 marks)
CA Sri Lanka 11
Questions
27 The following subsequent events took place relating to Vimukthi Ltd.:

(1) On 1 February a fraud was identified which had resulted in the
financial statements being materially misstated.
(2) On 20 March 20X7 inventory which was held at the year end was sold
at a material amount below its carrying amount as stated in the
financial statements at 31 December 20X6.
For which of these events would you be required to obtain sufficient
appropriate evidence to enable you to determine whether they have been
properly reflected in the financial statements at 31 December 20X6?
A 1 only
B 2 only
C 1 and 2
D Neither 1 nor 2 (2 marks)
28 Your review of the audit file shows that a number of misstatements have
been identified during the course of the detailed audit work.
Which of the following statements correctly describes the auditor's
responsibility to communicate these to Vimukthi Ltd.?
A All misstatements, both corrected and uncorrected must be
communicated to those charged with governance.
B Only corrected misstatements must be communicated to those charged
with governance.
C All misstatements other than those which are clearly trivial must be
communicated to the appropriate level of management.
D Only material uncorrected misstatements are communicated to the
appropriate level of management. (2 marks)
12 CA Sri Lanka
29 The annual report of Vimukthi Ltd. includes a summary of key financial

results. You have reviewed this other information and have concluded that it
is inconsistent with the financial statements. Your investigations have shown
that it is the other information, not the financial statements, which is
materially misstated. The directors of Vimukthi Ltd. have refused to correct
the summary.
How should this be addressed in the auditor's report?
A An Other Matter paragraph would be included outlining the material
misstatement
B The Other Information section will state that the auditors have
concluded that a misstatement of the other information exists
C The auditor's opinion will be qualified on the basis of a material
misstatement
D This matter would not be addressed in the auditor's report as the
material misstatement is not in the financial statements (2 marks)
30 The audit partner has concluded that the going concern basis of accounting
is appropriate but a material uncertainty exists due to the ongoing legal
claim against Vimukthi Ltd.
What form of audit opinion will be issued and how will the material
uncertainty be disclosed in the auditor's report?
Audit opinion Disclosure
A Modified Emphasis of Matter paragraph
B Unmodified Material Uncertainty Related to Going Concern section
C Modified Material Uncertainty Related to Going Concern section
D Unmodified Emphasis of Matter paragraph (2 marks)
Ratwatte Ltd.
The following scenario relates to questions 31–35.
You are an audit senior of Jayakody & Co and have worked on the external audit of
Ratwatte Ltd., an unlisted company, since your firm was appointed external
auditor two years ago.
Ratwatte Ltd. owns a chain of nine restaurants and is a successful company.
Ratwatte Ltd. has always been subject to national hygiene regulations, especially
in relation to the food preparation process. Non-compliance can result in a large
fine or closure of the restaurant concerned.
The board of Ratwatte Ltd. has recently notified you that the national hygiene
regulations have been updated and are now much more stringent and onerous
than before.
CA Sri Lanka 13
Questions
With this in mind, the board has asked your firm to conduct a review of Ratwatte
Ltd's compliance with hygiene regulations, in order to allow the board to assess
whether the appropriate processes have been implemented at each of the nine
restaurants. The review is not expected to include the provision of accounting
advice or the preparation of figures in the financial statements.
The work is likely to be very lucrative. Your firm has sufficient experience to
undertake the above review engagement.
31 Despite running a successful company, the board has often needed to be
reminded of some fundamental principles and you often have to explain key
concepts.
Which of the following statements best defines the external audit?
The external audit is an exercise carried out by auditors in order to
give an opinion on whether the financial statements of a company are
fairly presented.
The external audit is an exercise carried out in order to give an opinion
on the effectiveness of a company's internal control system.
The purpose of the external audit is to identify areas of deficiency
within a company and to make recommendations to mitigate those
deficiencies.
The external audit provides negative assurance on the truth and
fairness of a company's financial statements.
32 The board has also struggled to differentiate between its responsibilities and
those of the external auditor in circumstances such as the prevention and
detection of fraud and error, and compliance with regulations.
Which of the following statements best describes Jayakody & Co's
responsibility regarding Ratwatte Ltd's compliance with hygiene
regulations, in line with SLAuS 250 Consideration of Laws and Regulations in
an Audit of Financial Statements?
YHT & Co should actively prevent and detect non-compliance with the
regulations.
YHT & Co should perform specific audit procedures to identify possible
non-compliance.
YHT & Co should obtain sufficient appropriate audit evidence about
BJM's compliance with the regulations as they have a direct effect on
the financial statements.
YHT & Co does not have any responsibility as the hygiene regulations
do not have a direct effect on the financial statements.
14 CA Sri Lanka
33 The partner responsible for the review of hygiene compliance has informed
you that the engagement is an assurance engagement.
Which of the following would NOT have been relevant to the partner in
forming this opinion?
The existence of a three-party relationship
The existence of suitable criteria
The determination of materiality
The subject matter
34 The partner responsible for the review engagement has asked you to tell him
what level of assurance you believe Jayakody & Co should provide, and also
what type of opinion the firm should give.
What is the level of assurance and type of opinion that can be provided on
this review engagement?
Level of assurance Report wording
Reasonable Positive
Reasonable Negative
Limited Positive
Limited Negative
35 The audit engagement partner has told you that the independence threats
arising from Jayakode & Co performing the review engagement should be
monitored carefully.
Which of the following is likely to cause the audit engagement partner most
concern?
According to the CA Sri Lanka Code of Ethics, Jayakody & Co is
prohibited from providing other assurance services to an audit client.
The review engagement is likely to give rise to a self-review threat, as
the outcomes of the review could form the basis of the financial
statements which the audit team will audit.
The lucrative nature of the review engagement may make the external
audit team less inclined to require management to make adjustments
or to issue a modified audit opinion, for fear of losing the review
engagement.
If the new review engagement causes Jayakody & Co's fee income from
Ratwatte Ltd. to exceed 15% of the firm's total fees, the CA Sri Lanka
Code of Ethics states that the new engagement must be turned down.
(Total = 10 marks)
CA Sri Lanka 15
Questions
Bridgford
You are an audit senior of Cooray & Co and your firm has recently been appointed
as the auditor to Bridgford Products (Bridgford), a large company which sells
televisions, DVD players and Blu-ray Disc players to electrical retailers.
You are planning the audit for the year ended 31 January 20X9 and your audit
manager has asked you to produce both the audit strategy document and the
detailed audit plan, including an assessment of materiality.
In order to assist you in your planning work you have visited Bridgford, where you
obtained the following information.
Sales have increased during the year ended 31 January 20X9 following a move to
attract new customers by offering extended credit. The new credit arrangements
allow customers three months' credit, rather than the one-month credit period
allowed previously. As a result of this change, you have calculated that the
receivables collection period has increased from 49 days to 127 days.
Bridgford installed a new computerised inventory control system, which began
operating on 1 June 20X8. Since the inventory control system records both
inventory movements and current inventory quantities, Bridgford is proposing to
use the inventory quantities on the computer to value the inventory at the year
end rather than carrying out an inventory count.
The production director informed you that in the last month or so there have been
reliability problems with the company's products which have resulted in some
customers refusing to pay for the products.
As part of the planning process you also undertake a risk assessment. Based on
the information you have obtained to date you have identified several audit risks
which you feel your team will need to address. The first risk relates to the
extended credit terms offered by Bridgford to its customers, and the recent
product reliability problems resulting in customers' refusal to pay.
A second audit risk relates to the computerised inventory control system which
was implemented on 1 June 20X8. You are concerned about whether data was
accurately transferred into the new system, and whether it is sufficiently reliable
to determine the quantity of inventory for the year-end financial statements.
16 CA Sri Lanka
36 The audit manager has requested that you cover a number of specified areas
in the audit planning documentation.
For each area, indicate whether the information would be included in the
audit strategy document or in the detailed audit plan.
Audit
strategy Detailed
Area document audit plan
(1) The availability of the client's data and
staff (including internal audit)
(2) The allocation of responsibility for
specific audit procedures to audit team
members
(3) The audit procedures to be undertaken
for each area of the financial statements
(4) The potential for using computer-
assisted audit techniques (CAATs) to
gather evidence
37 You have set the level of materiality for the financial statements as a whole,
and now need to determine performance materiality.
Which of the following statements about performance materiality is NOT
true?
Performance materiality is used to reduce the risk that the aggregate of
uncorrected and undetected misstatements exceeds materiality for the
financial statements as a whole to an acceptable level.
Performance materiality refers to the amounts set by the auditor at
higher than the materiality level for particular classes of transactions,
account balances or disclosures where the materiality level might
otherwise mean that such items are not tested.
Once the level of materiality for the financial statements as a whole has
been set, a lower level of performance materiality is determined by the
auditor using their professional judgement.
The performance materiality level is affected by the auditor's
understanding of the entity and the nature and extent of misstatements
identified in prior audits.
CA Sri Lanka 17
Questions
38 SLAuS 520 Analytical Procedures states that where analytical procedures

identify fluctuations or relationships that are inconsistent with other
relevant information or that differ significantly from the expected results,
the auditor shall investigate the reason for this.
Which of the following auditor responses to the increase in the receivables
collection period of Bridgford is the LEAST relevant?
Make enquiries of management to understand the likely reason why
the receivables collection period exceeds the extended credit period
Perform detailed substantive testing on the aged receivables listing, to
determine whether any amounts should be written off
Perform a trend analysis on current year and prior year monthly
revenue, to identify whether revenue is overstated as a result of fraud
or error
Perform further working capital ratio analysis, to determine the effect
of the extended credit on Bridgford's cash position
39 Which of the following statements summarises your key concern regarding

the risk relating to the extended credit terms and refusal of certain
customers to pay?
That the directors may have prepared Bridgford's financial statements
on the going concern basis when this is not applicable
That the financial statements include amounts due from credit
customers which are not valid debts
That there are balances due from credit customers which have not been
included in the financial statements
That the financial statements include balances due from credit
customers which are not recoverable
18 CA Sri Lanka
40 Which TWO of the following procedures are relevant responses to the risk
that inventory quantities are misstated by the new computerised inventory
system?
Review a sample of purchase requisitions to determine whether the
quantity of inventory held per the inventory system was verified
before the requisition was approved
Determine how often inventory counts are performed and the level of
corrections required to the inventory system
Review sales prices of inventory sold after the year end to identify
inventory where cost exceeds net realisable value
Test the operation of the inventory system using CAATs
(Total = 10 marks)
South
You are an audit senior of De Alwis & Co, and your firm has recently been
appointed as the auditor to South, a private company that runs seven
supermarkets in Sri Lanka. You are currently planning your firm's audit of South
and are shortly due to make a preliminary visit to South's head office.
Four months before the year end, the company installed a new till system in all
supermarkets. The new till system is linked to the accounting system at head
office and automatically posts transactions to the accounting system. Previously
journals were made manually based on totals on till rolls. The cost of the new till
system which South has capitalised as a non-current asset.
The audit engagement partner has also said that she has is concerned that the new
till system may not be reliable, and that consequently not all sales have been
recorded, resulting in an understatement of revenue. She is also concerned that
staff may not yet be familiar with the system, leading to an increased risk of errors
relating to data entry.
Finally, after a number of people living close to one of South's stores became
seriously ill, the source of the illness was traced back to meat the customers had
purchased from South. Legal proceedings were commenced against South by a
number of customers during the financial year, demanding $1m in compensation.
CA Sri Lanka 19
Questions
41 Indicate which TWO of the following statements describe the objectives of

planning the audit of South.
To ensure appropriate attention is devoted to important areas of the

audit
To assist in the co-ordination of work done by any auditor's experts
To ensure that the audit engagement is only accepted if this is

permissible by the CA Sri Lanka Code of Ethics
To ensure the audit is completed within budget restraints
42 You are about to begin work on the share capital section of the South audit
file.
Match each of the following audit procedures to the financial statement
assertion to which it is most closely related.
Procedure Assertion
Recalculate the closing Presentation

balance on the share
capital account
Review financial Completeness

statement notes
Review Memorandum and Accuracy,

Articles of Association and valuation and
compare their allocation
requirements with issued
share capital
Read minutes of board Existence

meetings for evidence of
share issues
20 CA Sri Lanka
43 In relation to the capitalised costs of the new till system, you are concerned
that South may have included within the capitalised costs some items which
are revenue in nature, leading to the overstatement of non-current assets.
Which of the following statements is a valid response to this audit risk?
Obtain a copy of the training manual relating to the new till system and
discuss with directors the extent of training staff have received on the
new system
Agree the capitalised costs from the trial balance back to invoices to
confirm their value
Inspect invoices capitalised within the cost of the new till system to
determine whether they are directly attributable to the cost of the new
till system
Recalculate the depreciation charged on the new till system
44 The audit engagement partner has stated that the new till system may not be
reliable. Which TWO of the following statements represent valid responses
to this audit risk?
Perform analytical procedures by comparing daily/weekly sales by
store with both the prior year and with expectations, in order to
determine whether any unusual patterns have occurred following the
installation of the new system
Vouch the sales revenue per the system to the till receipts to confirm
the accuracy of the sales
Obtain a copy of the training manual relating to the new till system and
discuss with directors the extent of training staff have received on the
new system
Agree sales revenue from till receipts to the cashbook to determine the
accuracy of till receipts
CA Sri Lanka 21
Questions
45 You plan to review the legal correspondence relating to the claims made by
those customers to whom South sold contaminated meat.
Which TWO of the following are valid objectives of this audit procedure?
To determine whether South's reputation will have been damaged
within the local area
To confirm whether there are deficiencies in South's internal controls
relating to food hygiene
To assess whether a provision for customer compensation is required
in South's financial statements
To determine whether disclosure of the nature and financial effect of
the legal claim is required in South's financial statements
(Total = 10 marks)
Madugalle Ltd.
You are an audit senior of IBN & Co and you are planning the audit of Madugalle
Air Services Ltd (Madugalle) for the year ended 31 December 20X3.
Madugalle is a company that provides specialist helicopter support to public
services, such as the police force and the ambulance service. Madugalle has four
of these contracts, which contain very similar terms and are equal in value.
Madugalle owns and maintains the helicopter fleet which is held at cost. Each
aircraft carries specialist equipment and is operated by a highly skilled specialist
pilot. Under the terms of these contracts Madugalle charges the customer an
annual fee to cover the maintenance, storage and testing of the aircraft and
equipment. The annual fee is payable in advance each year with the first annual
payment being paid on the date the contract commences.
Madugalle has not purchased any new helicopters during the year to 31
December 20X3; however, there has been a lot of refitting, replacement and
adding of specialist equipment to some of the existing aircraft. This has been
necessary to keep up with the latest developments in search and rescue, and to
maintain the aircraft to the high standard required under the contracts in place.
The original purchase of each aircraft was funded with a secured loan carrying
substantial interest charges. The loan is in the process of being renegotiated and
the bank has indicated that finance costs will increase further. Furthermore, the
directors have told you that Madugalle 's contract with the police force expires in
March 20X4, at a time when, in the wake of government cuts, the police are trying
to substantially reduce the amount they pay. It is thought that the contract will be
put out to tender, and it is possible that another aircraft provider may also bid for
the contract.
22 CA Sri Lanka
Madugalle also holds around $2 million of aircraft spares which are included
within inventory. Madugalle sells the aircraft spares to amateur flying
associations. Aircraft spares which are not sold after three years are scrapped.
Approximately one-quarter of this value is made up of specialist equipment taken
out of aircraft when it was replaced by newer or more advanced equipment. Such
specialist equipment is transferred from non-current assets to inventory without
adjustment, and continues to be recognised at amortised cost.
46 In relation to the identical contracts, which of the following statements
summarises a key audit risk?
Madugalle's assets could be undervalued if the market value of the
helicopter fleet exceeds its cost.
Madugalle could breach the terms of its contracts with its customers
and be liable to pay penalties, so provisions may be understated.
Revenue may be overstated if it is recognised according to the contract

date rather than over the relevant accounting period.
An expert valuer is required to value the helicopters in the financial
statements.
47 Given the large amount of refitting of existing aircraft, you are concerned
that property, plant and equipment may be overstated in the financial
statements.
Indicate which TWO of the following statements represent valid responses
to this audit risk?
Perform a proof in total calculation of the depreciation charge for the
year and investigate any significant differences
Review minutes of training meetings to determine whether the pilots
have been trained how to use the specialist equipment
Obtain a breakdown of the capitalised costs and agree a sample of
items to invoices to determine the nature of the expenditure
Inspect management's review of whether the value of the aircraft has
been impaired
CA Sri Lanka 23
Questions
48 In relation to Madugalle 's secured loan, which is the MOST important audit
risk that should be documented in the detailed audit plan?
Disclosure relating to the secured loan may be omitted from the
financial statements.
Madugalle 's going concern status may be at risk if the contract is not
renewed.
Interest charges may be understated.
The bank will rely on the audited financial statements when deciding
whether to renew the loan.
49 Which TWO of the following are valid responses to the fact that Madugalle 's
contract with the police force is due for renewal?
Review Madugalle 's contracts with its other three customers to
determine whether they contain a break clause, in order to determine
the likelihood of losing any further contracts to other aircraft providers
Contact the police force directly and request confirmation as to
whether the contract is to be renewed
Review the short-term and long-term funding facilities which are
available to Madugalle
Consider whether the financial statements contain appropriate
disclosures in relation to the matter
50 In relation to the aircraft spares held by Madugalle , indicate which of the

following correctly describe areas of audit concern?
Audit concern Not audit concern
Non-current assets
Inventory
Completeness
Accuracy, valuation and
allocation
(Total = 10 marks)
24 CA Sri Lanka
Weerawansa
You are an audit manager, auditing the financial statements of Weerawansa
Engineering plc, a listed company, for the year ended 30 April 20X7.
Weerawansa 's management has provided you with a schedule of the realisable
values of the inventories. A full inventory count was carried out at 30 April 20X7.
Audit tests have confirmed that the inventory counts are accurate and there are
no purchases or sales cut-off errors.
One of the company's factories was closed on 30 April 20X7. The plant and
equipment and inventories were to be sold. By the time the audit work
commenced in June 20X7, most of the inventory had been sold.
You have instructed the audit junior to evaluate the valuation of the inventory
related to the closing factory at the year end. The audit junior has sent you a list of
planned audit procedures.
On 17 March 20X7, Weerawansa 's managing director was dismissed for gross
misconduct. It was decided that the managing director's salary should stop from
that date, and that no redundancy or compensation payments should be made.
The managing director has claimed unfair dismissal and is taking legal action
against the company to obtain compensation for loss of his employment. The
managing director says he has a service contract with the company which would
entitle him to two years' salary at the date of dismissal. The directors believe that
there is a 35% chance of the managing director succeeding in his claim.
The financial statements for the year ended 30 April 20X7 record the resignation
of the director. However, they do not mention his dismissal and no provision for
any damages has been included in the financial statements.
51 Which TWO of the following statements are true regarding the auditor's
attendance at the inventory count?
It is the auditor's responsibility to organise the inventory count.
The auditor observes client staff to determine whether inventory count

procedures are being followed.
The auditor reviews procedures for identifying damaged, obsolete and
slow-moving inventory.
If the results of the auditors' test counts are not satisfactory, the
auditor should insist that the inventory is recounted.
CA Sri Lanka 25
Questions
52 Which of the audit procedures below is NOT appropriate in auditing the

valuation assertion for Weerawansa 's inventory?
Agree the selling prices of inventory sold since the year end to sales
invoices and the cash book.
Assess the reasonableness of management's point estimates of
realisable value of inventory that has not yet been sold by reviewing
sales before the year end, comparing the values with inventory that has
been sold since the year end and considering offers made which have
not yet been finalised.
For a sample of inventory sold just before and just after the year end,
match dates of sales invoices/date posted to ledgers with date on
related goods dispatched notes.
For unsold inventory, assess reasonableness of provisions for selling
expenses by comparison of selling expenses with inventory sold.
53 Using the lists below, complete the sentence below to show the correct
accounting treatment for the legal claim made by the managing director for
unfair dismissal and the reason for this treatment.
The legal claim should because
.
Options for blanks:
First blank:
be recorded as a provision
not be recorded as a provision but disclosed as a contingent liability
Second blank:
a present obligation exists, but the outflow of economic resources is not
probable
a possible obligation exists, depending on whether or not some uncertain
future event occurs
26 CA Sri Lanka
54 Which of the following audit procedures is likely to provide the auditor with
the MOST reliable audit evidence regarding the legal claim?
Review the minutes of the disciplinary hearing to understand whether
the company has acted in accordance with employment legislation and
its internal rules
Review correspondence between the company and its lawyers
regarding the likely outcome of the case
Request a written representation from management supporting their
assertion that the claim will not be successful
Send an enquiry letter to Weerawansa 's lawyers to obtain their view
as to the probability of the claim being successful
55 The dismissal of Weerawansa 's managing director has alerted you to the
possibility that the company may not have complied with employment
regulations. You therefore need to determine the impact that such
non-compliance may have on the audit.
SLAuS 250 Consideration of Laws and Regulations in an Audit of Financial
Statements sets out the responsibilities of the auditor in relation to the
entity's compliance with laws and regulations.
Which of the following responsibilities is CORRECT regarding the
responsibilities of Weerawansa 's auditors in relation to compliance with
employment regulations?
To obtain sufficient appropriate evidence regarding compliance, as
they have a direct effect on the financial statements
To perform specific audit procedures to identify possible non-
compliance
The auditors do not have any responsibility, as the employment
regulations do not have a direct effect on the financial statements
To prevent and detect all non-compliance with the regulations
(Total = 10 marks)
CA Sri Lanka 27
Questions
Gemunu & Silva

You are the audit manager of Savage & Co. It is a busy time of year for you as you
have several ongoing audit clients at the moment and you are in the process of
dealing with a number of outstanding issues and queries from members of your
audit teams.
Gemunu Ltd. (Gemunu )
Gemunu is a pharmaceutical company. The fieldwork has been completed and you
are currently reviewing the audit file. The audit senior is not sure how to deal with
the following issue.
Gemunu has incurred $2.1m and development expenditure of $3.2m during the
year, all of which has been capitalised as an intangible asset. Profit before tax is
$26.3m.
Silva Ltd. (Silva )
The fieldwork on this audit is also complete with the exception of the following
issue which the audit senior has been unable to deal with.
Silva 's computerised wages program is backed up daily; however, for a period of
two months the wages records and back-ups have been corrupted, and therefore
cannot be accessed. Wages and salaries for these 2 months are $1.1m. Profit
before tax is $10m.
56 You have just received a phone call from one particular audit senior who is
unsure about the steps to take in relation to uncorrected misstatements.
Which of the following statements correctly describe the auditor's
responsibility in respect of misstatements?
SLAuS 450 Evaluation of Misstatements Identified During the Audit
states that the auditor only has a responsibility to accumulate material
misstatements identified during the audit.
Where misstatements are not material the auditor should request that
management correct the misstatements in the following accounting
period.
If management refuses to correct some or all of the misstatements, the
auditor should consider the implications of this for their audit opinion.
A written representation should be requested from management to
confirm whether they believe that the effects of the unadjusted
misstatements are immaterial, both individually and in aggregate, to
the financial statements as a whole.
28 CA Sri Lanka
57 Which of the following audit procedures should be performed in order to

form a conclusion on whether an amendment is required to Gemunu 's
financial statements in respect of the research and development
expenditure?
(1) Discuss the requirements of SLFRS 38 Intangible Assets with the
directors in order to determine whether they understand the required
accounting treatment of research and development expenditure
(2) Obtain a breakdown of the Rs5.3m capitalised as an intangible asset
and agree to supporting documentation to determine the nature of the
projects to which the expenditure relates
(3) Review minutes of board meetings to determine whether the
expenditure was authorised
(4) Visit the laboratory where the current research is being undertaken
and to confirm occurrence of the research expenditure
1 and 2
1 and 4
2 and 3
3 and 4
58 Which of the following options correctly summarises the impact on the

auditor's report for Gemunu if the issue remains unresolved?
Unmodified opinion with key audit matters paragraph
Qualified opinion with key audit matters paragraph explaining the

issue
Qualified opinion
Adverse opinion
59 Which of the following correctly summarises the effect of the issue relating
to the wages balance in the financial statements of Silva ?
Material Financial statement impact
No Liabilities to tax authorities may be

understated
No Profit may be overstated
Yes Wages may be materially misstated
Yes Proper accounting records have not been
kept
CA Sri Lanka 29
Questions
60 Based on the above information, which of the following options correctly

summarises the impact of the wages and salaries issue on the auditor's
report for Silva?
Audit opinion Disclosure in the auditor's report
Qualified Basis for qualified opinion
Disclaimer Basis for disclaimer of opinion
Qualified Key audit matters section
Qualified Emphasis of matter
(Total = 10 marks)
30 CA Sri Lanka
Section 2: 10 Mark Structured Response Questions

Part A Governance and Internal Control Frameworks
Questions 1 to 4 in this section cover Governance and Internal Control
Frameworks, the subject of Chapters 1 to 3 of the Study Text.
1 Jafna Flowers
Jafna Flowers sells flowers wholesale. Customers telephone the company and
their orders are taken by clerks who take details of the flowers to be delivered, the
address to which they are to be delivered, and account details of the customer.
The clerks input these details into the company's computer system (whilst the
order is being taken) which is integrated with the company's inventory control
system. The company's standard credit terms are payment one month from the
order (all orders are dispatched within 48 hours) and most customers pay by
bank transfer. An accounts receivable ledger is maintained and statements are
sent to customers once a month. Credit limits are set by the credit controller
according to a standard formula and are automatically applied by the computer
system, as are the prices of flowers.
Required
Explain, including their purpose, the internal controls you might expect to see in
the sales system at Jafna Flowers over the:
(1) Receipt, processing and recording of orders (6 marks)
(2) Collection of cash (4 marks)
(LO 1.2.1) (Total = 10 marks)
2 Lily Window Glass Plc

Lily Window Glass Plc (Lily) is a glass manufacturer, which operates from a large
production facility, where it undertakes continuous production 24 hours a day,
seven days a week. Also on this site are two warehouses, where the company's
raw materials and finished goods are stored. Lily's year end is 31 December.
Lily is finalising the arrangements for the year-end inventory count, which is to be
undertaken on 31 December 20X2. The finished windows are stored within 20
aisles of the first warehouse. The second warehouse is for large piles of raw
materials, such as sand, used in the manufacture of glass. The following
arrangements have been made for the inventory count:
The warehouse manager will supervise the count as he is most familiar with the
inventory. There will be ten teams of counters and each team will contain two
members of staff, one from the finance and one from the manufacturing
CA Sri Lanka 31
Questions
department. None of the warehouse staff, other than the manager, will be involved
in the count.
Each team will count an aisle of finished goods by counting up and then down
each aisle. As this process is systematic, it is not felt that the team will need to flag
areas once counted. Once the team has finished counting an aisle, they will hand in
their sheets and be given a set for another aisle of the warehouse. In addition to
the above, to assist with the inventory counting, there will be two teams of
counters from the internal audit department and they will perform inventory
counts.
The count sheets are sequentially numbered, and the product codes and
descriptions are printed on them but no quantities. If the counters identify any
inventory which is not on their sheets, then they are to enter the item on a
separate sheet, which is not numbered. Once all counting is complete, the
sequence of the sheets is checked and any additional sheets are also handed in at
this stage. All sheets are completed in ink.
Any damaged goods identified by the counters will be too heavy to move to a
central location, hence they are to be left where they are but the counter is to
make a note on the inventory sheets detailing the level of damage.
As Lily undertakes continuous production, there will continue to be movements of
raw materials and finished goods in and out of the warehouse during the count.
These will be kept to a minimum where possible.
The level of work-in-progress in the manufacturing plant is to be assessed by the
warehouse manager. It is likely that this will be an immaterial balance. In addition,
the raw materials quantities are to be approximated by measuring the height and
width of the raw material piles. In the past this task has been undertaken by a
specialist; however, the warehouse manager feels confident that he can perform
this task.
Required
For the inventory count arrangements of Lily Window Glass Plc:
(1) Explain five deficiencies.
(2) Discuss any recommendations you would make to address each deficiency.
The total marks will be split equally between each part.
(LO 1.2.1, 1.2.2, 1.2.3) (10 marks)
32 CA Sri Lanka
3 SouthLea Plc
SouthLea Plc is a construction company (building houses, offices and hotels)
employing a large number of workers on various construction sites. The internal
audit department of SouthLea Plc is currently reviewing cash wages systems
within the company.
The following information is available concerning the wages systems:
(i) Hours worked are recorded using a clocking in/out system. On arriving for
work and at the end of each days work, each worker enters their unique
employee number on a keypad.
(ii) Workers on each site are controlled by a foreman. The foreman has a record
of all employee numbers and can issue temporary numbers for new
employees.
(iii) Any overtime is calculated by the computerised wages system and added to
the standard pay.
(iv) The two staff in the wages department make amendments to the
computerised wages system in respect of employee holidays, illness, as well
as setting up and maintaining all employee records.
(v) The computerised wages system calculates deductions from gross pay, such
as employee taxes, and net pay. Finally, a list of net cash payments for each
employee is produced.
(vi) Cash is delivered to the wages office by secure courier.
(vii) The two staff place cash into wages packets for each employee along with a
handwritten note of gross pay, deductions and net pay. The packets are
given to the foreman for distribution to the individual employees.
Required
(1) Explain the deficiencies in SouthLea Plc's system of internal control over the
wages system that could lead to misstatements in the financial statements.
(5 marks)
(5 marks)
(LO 1.2.1, 1.2.2, 1.2.3) (Total = 10 marks)
CA Sri Lanka 33
Questions
4 Matalas Ltd
Matalas Ltd sells cars, car parts and petrol from 25 different locations in one
country. Each branch has up to 20 staff working there, although most of the
accounting systems are designed and implemented from the company's head
office. All accounting systems, apart from petty cash, are computerised.
You are an audit manager in the internal audit department of Matalas. You are
currently auditing the petty cash systems at the different branches. Your initial
systems notes on petty cash contain the following information:
(i) The average petty cash balance at each branch is Rs. 5,000.
(ii) Average monthly expenditure is Rs. 1,538, with transaction amounts ranging
from Rs. 1 to RS. 500.
(iii) Petty cash is kept in a lockable box on a bookcase in the accounts office.
(iv) Vouchers for expenditure are signed by the person incurring that
expenditure to confirm they have received re-imbursement from petty cash.
(v) Vouchers are recorded in the petty cash book by the accounts clerk; each
voucher records the date, reason for the expenditure, amount of expenditure
and person incurring that expenditure.
(vi) Petty cash is counted every month by the accounts clerk, who is in charge of
the cash. The petty cash balance is then reimbursed using the 'imprest'
system and the journal entry produced to record expenditure in the general
ledger.
(vii) The cheque to reimburse petty cash is signed by the accountant at the
branch at the same time as the journal entry to the general ledger is
reviewed.
Required
(1) Explain five internal control deficiencies in the petty cash system at Matalas
(Pvt) Ltd. (5 marks)
(5 marks)
(LO 1.2.1, 1.2.2, 1.2.3) (Total = 10 marks)
34 CA Sri Lanka
Part B Audit Planning Risk Assessment

Questions 5 to 11 cover Audit Planning Risk Assessment, the subject of Chapters 4
to 6 of the Study Text.
5 Favorita Plc
You are the auditor of Favorita Plc. During the audit of the financial statements
for the year to 30 September 20X4, you discovered the following items:
(i) An invoice for Rs. 3,000 for repairs was incorrectly posted to the equipment
account in the statement of financial position. As a result, equipment is
stated at Rs. 1,230,000 rather than the correct figure of Rs. 1,227,000 and
profit is stated at Rs. 240,000 instead of the correct amount of Rs. 237,000.
(ii) An invoice for Rs. 80,000 received from a supplier for services received just
before the year end has not been recorded in the books and records. Trade
payables in the statement of financial position are stated as Rs. 1.2 million.
(iii) An illegal payment of Rs. 2,500 was made during the year as a bribe to an
overseas customer. This was recorded as 'miscellaneous expenses'.
Required
(1) Explain how the auditor should determine materiality when planning an
audit. (4 marks)
(2) Assess, for each of the three items identified above, irrespective of whether
they have resulted in material misstatements of the financial statements of
Favorita Plc. (6 marks)
(LO 2.3.1, 2.4.1) (Total = 10 marks)
6 Paranthan Ltd
You are the auditor of Paranthan Ltd, a family-owned manufacturing company.
You have obtained the following information.
(i) The company is being sued by an employee who suffered an accident at
work. The case is still ongoing but if the company is found to be liable the
damages are likely to be substantial.
(ii) Trading conditions have been tough over the last twelve months. In order to
retain customers Paranthan has relaxed its terms on which credit is given
and has extended payment terms from 60 days to 90 days.
(iii) Paranthan has experienced a number of technical difficulties with one of its
production lines. This has resulted in high levels of returns of one of its key
products, with customers complaining about the poor quality.
CA Sri Lanka 35
Questions
(iv) The company implemented a new IT system during the year. You have
discovered that this was not fully tested before it went live.
(v) Paranthan has used a local supplier of raw materials since the business was
started. However, during the current year, the supplier went out of business..
A new supplier has been found but the company is based in Europe and
invoices Paranthan in Euros.
Required
(1) Explain the business risks faced by Paranthan for each of the factors listed
above. (5 marks)
(2) Explain the risk of material misstatement which could result from each
business risk you have identified in (1) and identify whether this is at the
assertion or financial statement level. (5 marks)
(LO 2.3.1, 2.4.2, 2.5.1) (Total = 10 marks)
7 Zak Ltd
Zak (Pvt) Ltd (Zak) sells garden sheds and furniture from 15 retail outlets. Sales
are made to individuals, with transactions being in the form of cash and debit
cards. All items purchased are delivered to the customer using Zak's own delivery
vans; most sheds are too big for individuals to transport in their own motor
vehicles. The directors of Zak indicate that the company has had a difficult year,
but are pleased to present some acceptable results to the members.
The statements of profit or loss for the last two financial years are shown below:
Statements of profit or loss
31 March 31 March
20X5 20X4
Rs'000 Rs'000
Revenue 7,482 6,364
Cost of sales (3,520) (4,253)
Gross profit 3,962 2,111
Operating expenses
Administration (1,235) (1,320)
Selling and distribution (981) (689)
Interest payable (101) 105)
Investment income 145 –
Profit/(loss) before tax 1,790 (3)
Statement of financial position ( extract)
Cash and bank 253 (950)
36 CA Sri Lanka
Required
Analyse the financial statements of Zak as part of your risk assessment
procedures to identify and provide a possible explanation for unusual changes in
the statement of profit or loss.
(LO 2.3.1) (10 marks)
8 Sleeptight Ltd
You are an audit senior for Mills & Co and are in the process of planning the audit
of Sleeptight (Pvt) Ltd (Sleeptight), which has been an audit client of Mills & Co for
several years.
Sleeptight's principal activity is the manufacture and sale of expensive high-
quality beds. Each bed is crafted by hand in the company's workshop, and
personalised in accordance with each customer's specific requirements.
The shares in Sleeptight are owned by the two joint Managing Directors who are
sisters, Anna and Anita Silva. Both have a number of other business interests. As a
result, they only spend a few days a week working at the company and rely on the
small accounts department to keep the finances in order and to keep them
informed. There is no finance director but the financial controller is a qualified
accountant.
Sleeptight requires customers who place an order to pay a deposit of 40% of the
total order value at the time the order is placed. The beds will take 4 to 8 weeks to
build, and the remaining 60% of the order value is due within a week of the final
delivery. Risks and rewards of ownership of the beds do not pass to the customer
until the beds are delivered and signed for. Beds also come with a two year
guarantee and the financial controller has made a provision in respect of the
expected costs to be incurred in relation to beds still under guarantee.
The company undertakes a full count of raw materials at the year end. The
quantities are recorded on inventory sheets and the financial controller assigns
the costs based on the cost assigned in the previous year or, if there was no cost
last year, using the latest invoice. Most beds are made of oak or other durable
woods and the cost of these raw materials is known to fluctuate considerably.
It is expected that work in progress will be insignificant this year, but there will be
a material amount of finished goods awaiting dispatch. Anna Silva will estimate
the value of these finished goods and has said she will take into account the order
value when doing so.
CA Sri Lanka 37
Questions
Required
(1) Analyse the above information to identify five audit risks. (5 marks)
(2) Outline the auditor's response to each risk in planning the audit of
Sleeptight. (5 marks)
(LO 2.3.1, 2.5.1) (Total = 10 marks)
9 Ja-Ela Ltd
You are an audit senior working for Sams & Co and are now commencing the
planning of the annual audit of Ja-Ela (Pvt) Ltd (Ja-Ela), which owns and runs a
chain of gastro pubs. The date is 4 December 20X9 and Ja-Ela's year end is 31
December 20X9.
Ja-Ela has proved to be very popular in recent years. This year, it saw its revenue
from sales of food and drink increase by 15% compared to the previous year. In
view of its success, the directors are considering plans to expand the business by
acquiring other pubs in the region. 70% of Ja-Ela's takings are paid in cash, with
the remainder being paid by credit card.
For the first time this year, Ja-Ela has outsourced its payroll function to a firm of
accountants called Ricks & Co. Payroll costs form a substantial cost in Ja-Ela's
statement of profit or loss. Ricks & Co prepares the payroll records and updates it
for starters and leavers based on information provided by Ja-Ela.
A series of payroll reports are securely e-mailed to Ja-Ela each month and
reviewed by the appropriate management. Payments are made to employees on
the basis of a net pay report provided and journals are put through to reflect the
wages costs and related liabilities.
Required
(1) State the purpose of three of the main sections of an audit strategy
document and for each section, provide an example relevant to Ja-Ela.
(6 marks)
(2) Explain the audit team's responsibilities in relation to obtaining an
understanding of the services provided by Ricks & Co when planning the
audit of Ja-Ela. (4 marks)
(LO 2.2.1, 2.3.1) (Total = 10 marks)
38 CA Sri Lanka
10 Matale Products
Your firm, Bandara & Co, has been appointed as the auditor of Matale Products, a
large company. The company sells televisions, DVD players and Blu-ray Disc
players to electrical retailers.
You are planning the audit for the year ended 31 January 20X9. The audit for the
year ended 31 January 20X8 was carried out by another firm of auditors.
Information obtained from a client visit
During a recent visit to the company you obtained the following information.
(i) The company installed a new computerised inventory control system which
has operated from 1 June 20X8. As the inventory control system records
inventory movements and current inventory quantities, the company is
proposing:
· To use the inventory quantities on the computer to value the inventory
at the year-end
· Not to carry out an inventory count at the year-end
(ii) You are aware there have been reliability problems with the company's
products, which have resulted in legal claims being brought against the
company by customers, and customers refusing to pay for the products.
(iii) Sales have increased during the year ended 31 January 20X9 by attracting
new customers and offering extended credit. The new credit arrangements
allow customers three months credit before their debt becomes overdue,
rather than the one month credit period allowed previously. As a result of
this change, the average trade receivables age has increased from 1.6 to 4.1
months.
Required
(1) State why it is important for auditors to plan their audit work. (4 marks)
(2) Identify THREE matters you will consider in planning the audit and explain
the further action you will take concerning the information you obtained
during your recent visit to the company. (6marks)
(LO 2.2.1, 2.3.1) (Total = 10 marks)
CA Sri Lanka 39
Questions
11 Regulation
An audit senior has been working on the audit of properties, including storage
facility warehouses. Customers rent individual self-contained storage areas of a
warehouse, for which they are given keys allowing access by the customer at any
time. The company’s employees rarely enter the customers' storage areas.
It seems the company's policy for storage contracts which generate revenue of
less than Rs10,000, is that very little documentation is required, and the nature of
the items being stored is not always known.
While visiting one of the warehouses the audit senior noted what appeared to be
potentially hazardous chemicals, stored in large metal drums marked with
warning signs. When asked about the items being stored, the warehouse
management became refused to answer any questions or allow the audit senior to
ask any other employees about the large metal drums and suggested the audit
senior did not mention the storage of these items to management.
Required
Discuss the implications of the audit seniors finding for the completion of the
audit, commenting on the auditor's responsibilities in relation to laws and
regulations, and on any ethical matters arising.
(LO 2.8, 5.2) (10 marks)
Part C Gathering Audit Evidence

Questions 12 to 18 cover Gathering Audit Evidence, the subject of Chapters 7 to 14
of the Study Text.
12 Buttala (Pvt) Ltd

Buttala (Pvt) Ltd (Buttala) is a large engineering company. The manufacturing
process is capital intensive and the company holds a wide variety of plant and
equipment.
The finance director prepares a detailed non-current assets budget annually. This
annual budget, which is approved by the full board, is held on computer file and is
the authority for the issue of a purchase order.
When the item of plant and equipment is delivered to the company, a pre-
numbered goods received note (GRN) is prepared, a copy of which is sent to the
accounting department, and used to update the non-current assets budget to
reflect the movement. At the same time as the purchase invoice enters the
purchasing system, a computerised non-current assets register is updated.
40 CA Sri Lanka
The internal audit department tests on a sample basis the operation of the system
from budget preparation to entry in the non-current assets register.
As part of your work as external auditor, you are reviewing the non-current assets
audit programme of the internal auditors and notice that the basis of their testing
is a representative sample of purchase invoices. They use this to test entries in the
non-current assets register and the updating movements on the annual budget.
Required
(1) Describe FOUR methods of selecting a sample of items to test from a
population in accordance with SLAuS 530 Audit Sampling. (4 marks)
(2) Explain why the internal audit work performed is not a good test for
completeness. (3 marks)
(3) State a more appropriate test to prove completeness of the non-current
assets records, including the non-current assets register. (3 marks)
(LO 3.1.1, 3.4.1, 4.3.1) (Total = 10 marks)
CA Sri Lanka 41
Questions
13 Uva Toys (Pvt) Ltd

Uva Toys (Pvt) Ltd (Uva) manufactures toys. It has been an audit client of your
firm for several years. As an audit senior, you are involved in the Uva audit for the
first time.
The company operates a perpetual inventory counting system. While looking at
the prior year audit files, you note that numerous misstatements were identified
by the audit team in respect of purchases cut-off, prompting adjustments to be
made in last year's financial statements.
Required
(1) Explain briefly why cut-off is an important issue in the audit of inventory.
(4 marks)
(2) Describe the audit work that auditors would carry out to satisfy themselves
that inventory is fairly stated, where a company uses a perpetual inventory
counting system. (6 marks)
14 Badulla Ltd.
Badulla, a limited liability company, distributes domestic electrical equipment
from one warehouse. Customers are mainly installers of such equipment, but
there is a 'cash and carry' counter in the warehouse for retail customers. The
warehouse staff are responsible for raising invoices and credit notes relating to
credit sales as well as handling cash sales.
You have carried out your interim audit in respect of the year ending 31 December
20X0 which included a circularisation of 80 trade accounts receivable as at 30
September 20X0, selected from a total credit customer list of 1,000. Replies were
received from all customers circularised. The interim audit work disclosed the
following.
(i) Of the 80 customers' accounts circularised, eight disagreed but could be
reconciled by bringing into account payments stated by the customers
concerned to have been made before 30 September 20X0 but which in each
case were recorded in Badulla's books between 14 and 18 days after the
dates stated by the customers as the date of payment.
(ii) Your tests suggested that some 25% of credit customers were allowed
settlement discounts of 2.5% although payments were consistently received
after the latest date eligible for discount.
(iii) A large number of credit notes were raised representing approximately 12%
of the total number of invoices raised. A review of the copy credit notes
indicated that they usually arose from arithmetical and pricing errors on
invoices raised.
42 CA Sri Lanka
Required
Explain the work you would plan to carry out at the final audit on trade
receivables at 31 December 20X0.
(LO 3.1.1, 3.2.1) (10 marks)
15 Rocks Forever
You are the audit manager in the firm of Cooray & Co and are planning the audit of
Rocks Forever. Rocks Forever purchases diamond jewelry from three
manufacturers, then sells the jewelry. The jewelry is sold from its four shops.
Inventory is the largest account on the statement of financial position, with each of
the four shops holding material amounts. Due to the high value of the inventory,
all shops will be visited and test counts performed.
With the permission of the directors of Rocks Forever, you have hired UJ, a firm of
specialist diamond valuers who will also be in attendance. UJ will verify that the
jewelry is, in fact, made from diamonds and that the jewelry is saleable with
respect to current trends in fashion. UJ will also suggest, on a sample basis, the
value of specific items of jewelry.
Counting will be carried out by shop staff in teams of two using pre-numbered
count sheets.
Required
(1) Discuss the factors you should consider when placing reliance on the work
of UJ. (5 marks)
(2) Outline the audit procedures you should perform to ensure that jewelry
inventory is valued correctly. (5 marks)
(LO 2.7.1, 3.1.1) (Total = 10 marks)
16 Panadura Ltd
Panadura Ltd (Panadura) is a reseller of sports equipment, specialising in racquet
sports such as tennis, squash and badminton. The company purchases equipment
from a variety of different suppliers and then resells this using the Internet as the
only selling media. The company has over 150 different types of racquets available
in inventory, each identified via a unique product code.
Customers place their orders directly on the internet site. Most orders are for one
or two racquets only. The ordering/sales software automatically verifies the order
details, customer address and credit card information prior to orders being
verified and goods being dispatched. The integrity of the ordering system is
checked regularly by ArcherWeb, an independent internet service company.
CA Sri Lanka 43
Questions
You are the audit manager working for the external auditors of Panadura, and you
have just started planning the audit of the sales system of the company. You have
decided to use test data to check the input of details into the sales system. This
will involve entering dummy orders into the Panadura system from an online
terminal.
Required
(1) Explain four advantages of CAATs. (4 marks)
(2) Discuss the test data you will use in your audit of the financial statements of
Panadura to confirm the completeness and accuracy of input into the sales
system, clearly explaining the reason for each item of data. (6 marks)
17 Jaffna Oil Plc

You are the external auditor of Jaffna Oil Plc (Jaffna Oil) for the year ended 31
March 20X1. Jaffna Oil operates 12 petrol stations in Colombo. As well as selling
petrol, each petrol station also has a convenience shop and a car washing facility.
Each petrol station is responsible for its own inventory procurement and
produces monthly management accounts, which are sent to the central accounts
department at Jaffna Oil.
Required
(1) Define the term analytical procedures, and describe how they can be used
during the various stages of an audit. (3 marks)
(2) Describe THREE analytical procedures the external auditor could perform
to confirm Jaffna Oil's revenue and profit. (3 marks)
(3) Describe substantive procedures the external auditor should adopt to verify
each of the following assertions:
(i) the valuation of inventory (2 marks)
(ii) the completeness of payables (2 marks)
(LO 3.5.1, 3.1.1) (Total = 10 marks)
18 Mankulam Cakes Ltd

Mankulam Cakes Ltd (Mankulam) is a manufacturer of baked goods. 85% of the
equity shares in the company are owned by Albert Mankulam, with the remaining
15% being shared throughout the remainder of the Mankulam family, with no
other family member owning more than 2%.
Mankulam owns 100% of the equity shares in Celebration Cakes Ltd, a company
which specialises in cakes for special occasions such as birthdays and weddings.
44 CA Sri Lanka
Beautiful Biscuits (Pvt) Ltd is 100% owned by Albert Mankulam's wife, Anita. This
company currently rents a factory from Mankulam.
Required
(1) Explain why related party transactions are relevant to an understanding of
the financial statements. (2 marks)
(2) Explain the related party relationships of Mankulam, using the definition of
a related party in SLAuS 550 Related Parties. (3 marks)
(3) State FIVE audit procedures which would be performed in order to identify
related party transactions. (5 marks)
CA Sri Lanka 45
Questions
Part D Auditing in a digital environment

Question 19 covers Auditing in a digital environment, the subject of Chapter 15 in
the Study Text. Also, see Question 29 in Section C.
19 E-Spark Ltd
You are an audit manager at Appuhamy Auditors, and are responsible for the audit
of E-Spark Ltd, a manufacturer and distributor of electrical components. The audit
is nearing completion, but a number of issues have been encountered.
1. The client has seen exponential growth in sales over the past few years and
the number of transactions occurring across all areas of the business has
increased substantially. During the audit fieldwork stage, it took the
engagement team almost double the time of previous years to sample and
test an appropriate number of items across the audit.
2. One of the junior auditors left several files and laptop computer in their car
overnight, and the car and contents were stolen. The fieldwork was nearing
completion, and the bulk of the working papers were lost in the incident. The
lost audit procedure had to be reperformed at a substantial cost to the firm.
Required
(1) Explain how Robotic Process Automation and data analytics might have
been used to reduce the time spent on the audit of E-Spark. (4 marks)
(2) Outline the benefits of cloud-based working papers and audit software to
Endeavour Auditors. (4 marks)
(3) Briefly explain the impact that the use of blockchain technology by client
organisations may have on audit firms.
(LO 4.1.1, 4.2.1) (2 marks)
46 CA Sri Lanka
Part E Evaluating evidence and Audit Reporting

Questions 20 to 25 cover Evaluating evidence and Audit Reporting , the subject of
Chapter 16 of the Study Text.
20 Moratuwa National Bakeries

Your firm acts as auditor of Moratuwa National Bakeries (Moratuwa). The finance
director has prepared financial statements of the company for year to 31
December 20X9 which show a pre-tax profit of Rs. 450,000. You have been
advised that the board of directors has approved the financial statements and
decided that no amendments should be made thereto.
As partner responsible for the audit you have noted the following matters during
your review of the financial statements and the audit working papers:
(i) The freehold property which was included at cost in previous years'
statement of financial position, has now been restated at a professional
valuation of Rs. 1,250,000 carried out during the year. You are satisfied with
the valuation, the relevant figures have been correctly adjusted and the
necessary information disclosed in the notes to the financial statements.
(2 marks)
(ii) An amount of Rs. 45,000 due from a customer in respect of sales during the
year is included in receivables but, from information made available to you,
you conclude that no part of this debt will be recovered. No allowance has
been made against this amount. (4 marks)
(iii) The financial statements do not disclose the fact that a director was indebted
to the company for an amount of Rs. 23,000 during a period of six weeks
commencing 1 February 20X9. (4 marks)
Required
Explain how each of the above will impact on the auditor's report.
21 Mendes and Vimukithi

You are the audit manager of Wijuratne & Co and you are currently reviewing the
audit files for several of your clients for which the audit fieldwork is complete. The
audit seniors have raised the following issues:
Mendes (Pvt) Ltd
Mendes (Pvt) Ltd is a pharmaceutical company and has incurred research
expenditure of Rs. 2.1m and development expenditure of Rs. 3.2m during the year
This has all been capitalised as an intangible asset. Profit before tax is Rs. 26.3m.
CA Sri Lanka 47
Questions
Vimukithi (Pvt) Ltd

Vimukithi (Pvt) Ltd's computerised wages program is backed up daily. However
for a period of two months the wages records and the back-ups have been
corrupted and therefore cannot be accessed. Wages and salaries for these two
months are Rs. 1.1m. Profit before tax is Rs. 10m.
Required
(1) Explain the meaning of pervasiveness in the context of a modified audit
report (2 marks)
(2) For each of the clients above:
(i) Analyse the issue, including an assessment of whether it is material.
(4 marks)
(ii) Explain the impact on the auditor's report if the issue remains
unresolved. (4 marks)
(LO 5.1.1, 5.3.1) (Total = 10 marks)
22 Daisy & Fuchsia

You are the audit manager of Violet & Co and you are currently reviewing the
audit files for several of your clients for which the audit fieldwork is complete. The
audit seniors have raised the following issues:
Daisy Designs (Pvt) Ltd (Daisy)
Daisy's year end is 30 September, however, subsequent to the year end the
company's sales ledger has been corrupted by a computer virus. Daisy's finance
director was able to produce the financial statements prior to this occurring;
however, the audit team has been unable to access the sales ledger to undertake
detailed testing of revenue or year-end receivables. All other accounting records
are unaffected and there are no backups available for the sales ledger. Daisy's
revenue is Rs. 15.6m, its receivables are Rs. 3.4m and profit before tax is Rs. 2m.
Fuchsia Enterprises (Pvt) Ltd (Fuchsia)
Fuchsia has experienced difficult trading conditions and as a result it has lost
significant market share. The cash flow forecast has been reviewed during the
audit fieldwork and it shows a significant net cash outflow. Management are
confident that further funding can be obtained and so have prepared the financial
statements on a going concern basis with no additional disclosures; the audit
senior is highly sceptical about this. The prior year financial statements showed a
profit before tax of Rs. 1.2m; however, the current year loss before tax is Rs. 4.4m
and the forecast net cash outflow for the next 12 months is Rs. 3.2m.
48 CA Sri Lanka
Required
For each of the two issues:
(1) Analyse the issue, including an assessment of whether it is material.
(5 marks)
(2) Outline the impact on the auditor's report if the issue remains unresolved.
(5 marks)
(LO 5.1.1, 5.3.1) (Total = 10 marks)
23 Builders Merchants Plc

You are the auditor of Builders Merchants Plc, a company which distributes
materials to the construction industry from eight branches in the south of the
country, and you are currently finalising the audit for the year ended 31 March
20X1. Your audits tests have proved satisfactory with the exception of the
following three matters.
(i) The physical inventory count sheets for one of the branches were lost before
they were made available to you, and you have not been able to confirm the
inventory quantities and values for this branch by alternative methods. The
directors have valued this part of the inventory at Rs. 75,000 and this figure
is included in the overall inventory valuation of Rs. 640,000.
(ii) Included in trade receivables, which total Rs. 580,000, is a debt amounting to
Rs. 45,000 from a customer which went into liquidation on 15 June 20X1.
You have ascertained from the liquidator that your client is unlikely to
receive a distribution. The statement of profit or loss for the year shows a
pre-tax profit of Rs. 100,000 but the directors are not prepared to provide
for this debt.
(iii) A substantial claim has been lodged against the company by a major
customer. The matter is fully explained in the notes to the accounts, but no
provision has been made for legal costs or compensation payable as it is not
possible to determine with reasonable accuracy the amounts, if any, which
may become payable. The directors have received legal advice which
appears to be reliable in indicating that the claim can be successfully
defended.
Required
(1) Explain which matters may be referred to in an emphasis of matter
paragraph. (1 mark)
(2) Analyse how the above items will influence the auditor's report you will
issue. (9 marks)
(LO 5.1.1, 5.4.1) (Total = 10 marks)
CA Sri Lanka 49
Questions
24 Hood Enterprises (Pvt) Ltd

You are the audit manager of Hood Enterprises (Pvt) Ltd (Hood).
Extracts from the draft auditor's report produced by an audit junior are given
below:
'We have audited the accompanying financial statements of Hood which
comprise… We have also evaluated the overall adequacy of the presentation of
information in the company's annual report.'
Auditor's Responsibility
'…We conducted our audit in accordance with Auditing Standards. Those
standards require that we comply with ethical requirements and plan and
perform the audit so that we can confirm the financial statements are free from
material misstatement. The directors however are wholly responsible for the
accuracy of the financial statements and no liability for errors can be accepted by
the auditor.
An audit involves performing procedures to obtain as much audit evidence as
possible in the time available about the amounts and disclosures in the financial
statements.
An audit also includes evaluating the appropriateness of accounting policies used
and the reasonableness of all accounting estimates made by management as well
as evaluating the presentation of the financial statements…'
Required
Explain FIVE errors in the above extract.
(LO 5.3.1, 5.6.1) (10 marks)
25 Glitch
Your firm is responsible for the audit of Glitch a listed company with a year ended
30 September 20X9. The draft financial statements recognise profit for the year of
Rs30 million. The audit for the year end is nearing completion. The following
matters have been discussed with management who have confirmed they will not
be adjusted in the financial statements:
1. In August 20X9 a major customer went into administration with a receivable
balance of Rs5 million which is still included in trade receivables at the year
end.
2. A court case began in June 20X9 involving an ex-employee who is suing
Glitch for unfair dismissal and damages of Rs400,000 are expected to be
paid. The financial statements include a note stating the potential damages
however, no adjustment has been made.
50 CA Sri Lanka
A junior staff member of the audit team has produced a draft auditor's
report for your review, an extract of which is shown below:
Basis for opinion and disclaimer of opinion
We have performed our audit based on a materiality level of Rs3 million. Our
audit procedures have proven conclusively that trade receivables are
materially misstated. The finance director of Glitch Limited has refused to
make an adjustment to provide for the outstanding trade receivable balance.
In our opinion the financial statements of Glitch are materially misstated and
we therefore express a disclaimer of opinion.
Key audit matters
The audit team spent considerable time working on Glitch Ltd's revenue
recognition policies, which are highly complicated. We were concerned that
Glitch might recognise revenue too early, but in our opinion revenue is
presented fairly in accordance with LKAS 18.
Emphasis of Matter paragraph
There is an outstanding legal case where an ex-employee is claiming
Rs400,000 in damages which is not included as a provision. In our opinion
this amount should be adjusted for and recognised as a provision so
represents as breach of LKAS 37.
Required
Comment on the auditor's report for the year ended 30 September 20X9
suggesting any required changes.
(LO 5.1, 5.2, 5.3, 5.4) (Total = 10 marks)
CA Sri Lanka 51
Questions
Part F Assurance and Related Services

Questions 26 to 27 cover Assurance and Related Services, the subject of Chapter
17 of the Study Text.
26 Batulo Ltd
You are a partner in a medium sized firm of chartered accountants. The following
opportunities have arisen.
(i) A major audit client, Lilac Co, is seeking loan finance from its bank to fund an
expansion into a new factory. The expansion should result in an increase in
capacity of 30%. Lilac has conducted market research and is confident that
they will be able to sell the added output. The financial director has recently
telephoned you and mentioned that the bank are keen to obtain a reference
from the audit firm, relating to Lilac's ability to repay the loan and whether
the business plan is reasonable. He said 'they just need their forms filled, for
their files. They know we can repay. We're one of their best clients.' Your
audit team is about to commence the audit for the year ended 31 March
20X8.
Required
Comment on the matters you would consider in relation to giving such a
reference to the bank. (5 marks)
(ii) The finance director of Laurel Co, another audit client, telephoned you
yesterday. He recently attended a half-day course on the importance of
corporate governance run by your firm. Laurel's long term plans include the
possibility of flotation on a stock exchange. The finance director has told the
other directors the issues discussed at the course and they feel that it might
be a good idea to engage the firm to undertake an assurance engagement to
assess risk management and the internal control system at Laurel Co.
Required
Comment on the matters you would consider in relation to accepting and
planning such an engagement. (5 marks)
(LO 5.5, 6.1, 6.2) (Total = 10 marks)
52 CA Sri Lanka
27 Verity
Verity, a limited liability company, has a credit facility with Cranley Bank of
Rs900m. The facility is due to expire on 31 December 20X1. The overdraft in the
recently audited statement of financial position at 30 September 20X1 is Rs825m.
The directors of Verity have started negotiations with their bankers for a renewal
of the facility and to increase the amount to Rs1,350m. To support this request the
bank has asked Verity to provide a business plan for the coming 12 months
consisting of a cash flow forecast supported by a forecast statement of profit or
loss and other comprehensive income and statement of financial position. The
management of Verity has produced a cash flow forecast for the period 1
October 20X1 to 30 September 20X2 and, at the request of the bank, has asked the
auditor to examine and report on it. The audit manager, who has recently
completed Verity's audit, has been asked to make a preliminary examination of
the cash flow forecast and supporting material and she has noted the following
observations.
(i) The cash flows from sales are based on the assumption of an overall increase
in sales of 24% compared to the previous financial year. Analysis shows that
this is based on an increase in selling price of 5% and an increase in the
volume of sales of 18%. Just over a quarter of all Verity's sales are made to
foreign customers.
(ii) The cost of sales in the recently audited statement of profit or loss and other
comprehensive income to 30 September 20X1 was 80% of sales revenue,
giving a gross profit of 20%. In the forecast statement of profit or loss and
other comprehensive income for the year to 30 September 20X2 the cost of
sales has fallen to 72%, giving a gross profit of 28%. Manufacturing costs are
made up of approximately one third each of materials, labour and
production overheads.
(iii) The trade receivables collection period used in the cash flow forecast to 30
September 20X2 is 61 days. In the year to 30 September 20X1 this period
averaged 93 days. Management has stated that it is its intention to inform all
customers of a new standard 60-day credit period. In addition an early
settlement discount of 1% will apply to customers who settle their account
within 30 days of the statement. Conversely the credit period for trade
payables has been extended from an average of 45 days in the current year
to 90 days in the forecast.
(iv) The cash flow forecast showed that the maximum credit required during the
period would rise to nearly Rs1,350m in August 20X2.
CA Sri Lanka 53
Questions
Required
(1) Describe the general matters an auditor should consider before accepting an
engagement as a reporting accountant on forecast financial information.
(5 marks)
(2) Detail the procedures that the reporting accountant should undertake in
relation to the cash flow forecast of Verity for the year to 30 September
20X2. (5 marks)
(LO 6.1.1, 6.2.1) (10 marks)
54 CA Sri Lanka
Part G Audit Quality and Ethics Questions 28 to 33 cover Audit Quality and
Ethics, the subject of Chapter 17 of the Study Text.
28 Maho (Pvt) Ltd

You are a manager in the audit firm of Ali & Co; and this is the first time you have
worked on one of the firm's established clients, Maho (Pvt) Ltd. The main activity
of Maho (Pvt) Ltd is providing investment advice to individuals regarding saving
for retirement, purchase of shares and securities and investing in tax efficient
savings schemes. Maho (Pvt) Ltd is regulated by the relevant financial services
authority.
You have been asked to start the audit planning for Maho (Pvt) Ltd, by Mr Son, a
partner in Ali & Co. Mr Son has been the engagement partner for Maho (Pvt) Ltd,
for the previous nine years and so has excellent knowledge of the client. Mr Son
has informed you that he would like his daughter Zoe to be part of the audit team
this year; Zoe is currently studying for her first set of business level papers for her
professional qualification. Mr Son also informs you that Mr Far, the audit senior,
received investment advice from Maho (Pvt) Ltd during the year and intends to
receive advice next year too.
In an initial meeting with the finance director of Maho (Pvt) Ltd, you learn that the
audit team will not be entertained on Maho (Pvt) Ltd's yacht this year as this could
appear to be an attempt to influence the opinion of the audit. Instead, the finance
director has arranged a balloon flight costing less than one-tenth of the expense of
using the yacht and hopes this will be acceptable. The director also states that the
fee for taxation services this year should be based on a percentage of tax saved
and trusts that your firm will accept a fixed fee for representing Maho (Pvt) Ltd in
a dispute regarding the amount of sales tax payable to the taxation authorities.
Required
(1) Analyse the ethical threats which may affect the auditor of Maho (Pvt) Ltd.
(4 marks)
(2) Outline how the effect of each threat identified in (a) above can be
mitigated. (4 marks)
(3) Assess the extent to which the auditor is responsible for Maho's compliance
with financial services regulation. (2 Marks)
(LO 7.4.1, 2.8.1) (Total = 10 marks)
CA Sri Lanka 55
Questions
29 Independence
The following issues have been identified by the ethics partner in the audit firm of
Shantha & Co:
(i) The audit manager in charge of the audit assignment of Gemunu (Pvt) Ltd
holds 1,000 ordinary shares in the company (total shares in issue –
100,000). The audit partner holds no shares.
(ii) The recurring audit fee receivable from Devapiria (Pvt) Ltd is Rs. 100,000.
The total fee income of the audit firm is Rs. 700,000.
(iii) The audit senior in charge of the audit of Margot Bank Plc has a personal
loan from the bank of Rs. 2,000 on which she is currently paying 12%
interest.
(iv) An audit partner is responsible for two audit assignments, Prassana (Pvt)
Ltd and Sirisenna (Pvt) Ltd. Prasanna (Pvt) Ltd has recently tendered for a
contract with Sirisenna (Pvt) Ltd for the supply of material quantities of
goods over a number of years. Sirisenna (Pvt) Ltd has asked the audit
partner to advise on the matter.
Required
(1) Explain why the ethical principle of independence is particularly relevant to
auditors. (3 marks)
(2) Analyse the above situations in the context of the independence of the
auditor, showing clearly the principles involved. (7 marks)
(LO 7.4.1, 7.5.1) (Total = 10 marks)
30 De Abrew Plc
You are an audit manager in Senasinge & Co, a firm of Chartered Accountants. You
are preparing the engagement letter for the audit of De Abrew Plc, for the year
ending 30 June 20X6.
De Abrew Plc has grown rapidly over the past few years, and is now one of your
firm's most important clients. Ancients Plc has been an audit client for eight years
and Senasinge & Co has provided audit, taxation and management consultancy
advice during this time. The client has been satisfied with the services provided,
although the taxation fee for the period to 31 December 20X5 remains unpaid.
Audit personnel available for this year's audit are most of the staff from last year,
including Mr Mendis, an audit partner and Mr Pillans, an audit senior. You are
aware that Allyson Mendis, the daughter of Mr Mendis, has recently been
appointed as financial director at Ancients Plc.
56 CA Sri Lanka
To celebrate her new appointment, Allyson has suggested taking all of the audit
staff out to an expensive restaurant prior to the start of the audit work for this
year.
Required
(1) Analyse the threats to independence arising in carrying out your audit of
De Abrew Plc for the year ending 30 June 20X6 (6 marks)
(2) Outline ways of mitigating each of the threats you identify. (4 marks)
(LO 7.4.1) (Total =10 marks)
31 Devapriya & Co
Devapriya & Co (Devapriya) is a firm of Chartered Accountants which has seen its
revenue decline steadily over the past few years. The firm is looking to increase its
revenue and client base and so has developed a new advertising strategy where it
has guaranteed that its audits will minimise disruption to companies as they will
not last longer than two weeks. In addition, Devapriya has offered all new audit
clients a free accounts preparation service for the first year of the engagement, as
it is believed that time spent on the audit will be reduced if the firm has produced
the financial statements.
The firm is seeking to reduce audit costs and has therefore decided not to update
the engagement letters of existing clients, on the basis that these letters do not
tend to change much on a yearly basis. One of Devapriya's existing clients has
proposed that this year's audit fee should be based on a percentage of their final
pre-tax profit. The partners are excited about this option as they believe it will
increase the overall audit fee.
Required
(1) Analyse FOUR ethical threats which arise from the above actions of
Devapriya & Co. (5 marks)
(2) Outline, for each threats identified in (1) the steps which Devapriya & Co
should adopt to reduce the threats arising. (5 marks)
(LO 2.1, 7.4.1) (Total = 10 marks)
CA Sri Lanka 57
Questions
32 Dharsha and Saram

You are the senior partner with Dharsha and Saram, a medium-sized accountancy
and audit firm. You and your partners are keen to expand the business, and have
actively been seeking new audit clients. As a result, you find yourself with three
potential new clients:
Colombo (Pvt) Ltd recently removed its previous auditor, Kandy & Co, as the
directors were unhappy with the level of service provided. Your firm approached
Kandy & Co, but they refused to give you professional clearance or the usual
handover information. The reason they gave you is that they are still owed fees
from Colombo (Pvt) Ltd.
The sister of one of the firm's partners has recently set up a small company, Galle
(Pvt) Ltd. Because she is keen to help her family, and knows that Dharsha and
Saram are looking to expand, she has asked the firm to become Galle (Pvt) Ltd's
auditor.
For several years, you have prepared the financial statements for Negombo (Pvt)
Ltd. Although the company is small enough to take advantage of the small
company audit exemption, the bank has now requested that Negombo (Pvt) Ltd
should have their annual accounts audited. Negombo (Pvt) Ltd's directors have
asked Dharsha and Saram to carry out the audit in future as well as preparing the
company's financial statements.
Required
Analyse whether Dharsha and Saram should accept appointment in the case of
each company identified above.
(LO 7.4.1, 7.5.3) (10 marks)
33 Estarellas Plc
You have been the auditor of manufacturing company Estarellas Plc for many
years. The company is being taken to court for illegally polluting the river near
one of its factories.
Although you were unaware that the company's practice of discharging pollution
into the river was illegal, you were aware that it was happening. In fact, the audit
files contain details about the company's production methods which would
certainly prove that they are guilty.
The court has asked you to provide them with any information which you have
related to this matter. The directors of Estarellas have forbidden you from
handing the documents over to the court claiming that you have no right to
provide the court with this information as it is confidential.
58 CA Sri Lanka
Required
(1) Outline the requirements for auditors to maintain confidentiality in respect
of client information. (4 marks)
(2) Outline the circumstances where an auditor may be required or permitted
to disclose confidential information about a client and what the auditor must
do in respect of the audit documents for Estarellas. (6 marks)
CA Sri Lanka 59
Questions

Long questions
Questions 1 to 29 are 20-mark questions, each covering several different areas of
the syllabus.
1 Puttalam (Pvt) Ltd

Introduction
Puttalam (Pvt) Ltd (Puttalam) assembles specialist motor vehicles such as lorries,
buses and trucks. The company owns four assembly plants to which parts are
delivered and assembled into the motor vehicles.
Wages system – shift workers
Shift-workers arrive for work at about 7.00 am and 'clock in' using an electronic
identification card. The card is scanned by the time recording system and each
production shift-worker's identification number is read from their card by the
scanner. Shift-workers are paid from the time of logging in. The logging in process
is not monitored as it is assumed that shift-workers would not work without first
logging in on the time recording system.
At least 400 vehicles have to be manufactured each day by each work group. The
workers normally work a standard eight hour day, but if necessary, overtime is
worked to complete the day's quota of vehicles. The shift foreman is not required
to monitor the extent of any overtime working although the foreman does ensure
workers are not taking unnecessary or prolonged breaks which would
automatically increase the amount of overtime worked. Shift-workers log off at
the end of each shift by re-scanning their identification card.
Payment of wages
Details of hours worked each week are sent electronically to the payroll
department, where hours worked are allocated by the computerised wages
system to each employee's wages records. Staff in the payroll department
compare hours worked from the time recording system to the computerised
wages system and enter a code word to confirm the accuracy of transfer. The code
word also acts as authorisation to calculate net wages. The code word is the name
of a domestic cat belonging to the department head and is therefore generally
known around the department.
Each week the computerised wages system calculates:
(i) Gross wages, using the standard rate and overtime rates per hour for each
employee
(ii) Statutory deductions from wages
(iii) Net pay
60 CA Sri Lanka
The list of net pay for each employee is sent over Puttalam's internal network to
the accounts department. In the accounts department, an accounts clerk ensures
that employee bank details are on file. The clerk then authorises and makes
payment to those employees using Puttalam's online banking systems. Every few
weeks, the financial accountant reviews the total amount of wages made to ensure
that the management accounts are accurate.
Salaries system – shift managers
All shift managers are paid an annual salary; there are no overtime payments.
Salaries were increased in July by 3% and an annual bonus of 5% of salary was
paid in November.
Required
(1) Analyse the wages system of Puttalam and write a report to management
which includes:
(i) FIVE deficiencies in that system.
(ii) The possible effect of each deficiency.
(iii) A recommendation to alleviate each deficiency. (17 marks)
(2) Explain THREE substantive analytical procedures you should perform on
the shift managers' salary system. (3 marks)
(LO 1.2, 3.5) (Total = 20 marks)
2 Mannar (Pvt) Ltd

Introduction
Mannar (Pvt) Ltd (Mannar) is a manufacturer of children's building block toys;
they have been trading for over 35 years and they sell to a wide variety of
customers including large and small toy retailers across the country. The
company's year end is 31 March 20X1.
The company has a large manufacturing plant, four large warehouses and a head
office. Upon manufacture, the toys are stored in one of the warehouses until they
are dispatched to customers. The company does not have an internal audit
department.
Sales ordering, goods dispatched and invoicing
Each customer has a unique customer account number and this is used to enter
sales orders when they are received in writing from customers. The orders are
entered by an order clerk and the system automatically checks that the goods are
available and that the order will not take the customer over their credit limit. For
new customers, a sales manager completes a credit application; this is checked
through a credit agency and a credit limit entered into the system by the credit
controller. The company has a price list, which is updated twice a year. Larger
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customers are entitled to a discount; this is agreed by the sales director and set up
within the customer master file.
Once the order is entered an acceptance is automatically sent to the customer by
mail/email confirming the goods ordered and a likely dispatch date. The order is
then sorted by address of customer. The warehouse closest to the customer
receives the order electronically and a dispatch list and sequentially numbered
goods dispatch notes (GDNs) are automatically generated. The warehouse team
pack the goods from the dispatch list and, before they are sent out, a second
member of the team double checks the dispatch list to the GDN, which
accompanies the goods.
Once dispatched, a copy of the GDN is sent to the accounts team at head office and
a sequentially numbered sales invoice is raised and checked to the GDN.
Periodically a computer sequence check is performed for any missing sales invoice
numbers.
Fraud
During the year a material fraud was uncovered. It involved cash/cheque receipts
from customers being diverted into employees' personal accounts. In order to
cover up the fraud, receipts from subsequent unrelated customers would then be
recorded against the earlier outstanding receivable balances and this cycle of
fraud would continue.
The fraud occurred because two members of staff 'who were related' colluded.
One processed cash receipts and prepared the weekly bank reconciliation; the
other employee recorded customer receipts in the sales ledger. An unrelated sales
ledger clerk was supposed to send out monthly customer statements but this was
not performed. The bank reconciliations each had a small unreconciled amount
but no-one reviewed the reconciliations after they were prepared. The fraud was
only uncovered when the two employees went on holiday at the same time and it
was discovered that cash receipts from different customers were being applied to
older receivable balances to hide the earlier sums stolen.
Required
(1) Explain FIVE tests of controls the auditor would normally carry out on the
sales system of Mannar, including the objective for each test. (10 marks)
(2) Outline THREE substantive procedures the auditor should perform to
confirm Mannar's year-end receivables balance. (3 marks)
(3) Explain FOUR controls which Mannar should implement to reduce the risk
of fraud occurring again and, for each control, outline how it would mitigate
the risk. (4 marks)
(4) Outline THREE substantive procedures the auditor should perform to
confirm Tinkerbell's revenue. (3 marks)
(LO 1.2, 1.3, 2.5, 3.1) (Total = 20 marks)
62 CA Sri Lanka
3 Pear Plc
Pear Plc (Pear) is a manufacturer of electrical equipment. It has factories across
the country and its customer base includes retailers as well as individuals, to
whom direct sales are made through their website. The company's year end is 31
March 20X2. You are an audit supervisor of Apple & Co and are currently
reviewing documentation of Pear's internal control in preparation for the interim
audit.
Pear's website allows individuals to order goods directly, and full payment is
taken in advance. Currently the website is not integrated into the inventory
system and inventory levels are not checked at the time when orders are placed.
Goods are dispatched via local couriers, however they do not always record
customer signatures as proof that the customer has received the goods. Over the
past 12 months there have been customer complaints about the delay between
sales orders and receipt of goods. Pear has investigated these and found that, in
each case, the sales order had been entered into the sales system correctly but
was not forwarded to the dispatch department for fulfilling.
Pear's retail customers undergo credit checks prior to being accepted and credit
limits are set accordingly by sales ledger clerks. These customers place their
orders through one of the sales team, who decides on sales discount levels.
Raw materials used in the manufacturing process are purchased from a wide
range of suppliers. As a result of staff changes in the purchase ledger department,
supplier statement reconciliations are no longer performed. Additionally, changes
to supplier details in the purchase ledger master file can be undertaken by
purchase ledger clerks as well as supervisors.
In the past six months Pear has changed part of its manufacturing process and as a
result some new equipment has been purchased, however, there are considerable
levels of plant and equipment which are now surplus to requirement. Purchase
requisitions for all new equipment have been authorised by production
supervisors and little has been done to reduce the surplus of old equipment.
Required
(1) Explain the auditor's responsibilities in relation to an entity's system of
internal controls. (2 marks)
(2) Outline, in respect of the internal control of Pear:
(i) Four deficiencies.
(ii) A control to address each of these deficiencies.
(iii) A test of control Apple & Co would perform to assess if each of these
controls is operating effectively. (12 marks)
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(3) Outline substantive procedures you should perform at the year end to
confirm each of the following for plant and equipment:
(i) Additions
(ii) Disposals (6 marks)
(LO 1.2.2, 1.3.1, 2.5.1, 3.1.2) (Total = 20 marks)
4 Tempest (Pvt) Ltd

You are the audit manager in charge of the audit of Tempest (Pvt) Ltd (Tempest).
The company's year end is 31 March, and Tempest has been a client for seven
years. The company purchases and resells fittings for ships including anchors,
compasses, rudders, sails etc. Clients vary in size from small businesses making
yachts to large companies maintaining large luxury cruise ships. No
manufacturing takes place in Tempest.
Information on the company's financial performance is available as follows:
20X7 Forecast 20X6 Actual
RS. '000 RS. '000
Revenue 45,928 40,825
Cost of sales (37,998) (31,874)
Administration costs (4,994) (4,758)
Distribution costs (2,500) (2,500)
Net profit 436 1,693
Non-current assets (at carrying amount) 3,600 4,500
Current assets
Inventory 200 1,278
Receivables 6,000 4,052
Cash and bank 500 1,590
Total assets 10,300 11,420
Capital and reserves

Share capital 1,000 1,000
Accumulated profits 5,300 5,764
Total shareholders' funds 6,300 6,764
Non-current liabilities 1,000 2,058
Current liabilities 3,000 2,598
10,300 11,420
64 CA Sri Lanka
Other information
The industry that Tempest trades in has seen moderate growth of 7% over the last
year.
• Non-current assets mainly relate to company premises for storing inventory.
Ten delivery vehicles are owned with a carrying amount of Rs. 300,000.
• One of the directors purchased a yacht during the year.
• Inventory is stored in ten different locations across the country, with your
firm again having offices close to seven of those locations.
• A computerised inventory control system was introduced in January 20X7.
Inventory balances are now obtainable directly from the computer system.
The client does not intend to count inventory at the year-end but rely
instead on the computerised inventory control system.
Required
(1) Explain why it is important to plan an audit, giving examples to illustrate
your answer. (5 marks)
(2) Assess the appropriate value of materiality for the financial statements as a
whole. (3 marks)
(3) Analyse the high risk areas of the audit of Tempest. (5 marks)
(4) Suggest the overall audit approach which should be taken in respect of the
issues you have identified. (7 marks)
(LO 2.2.1, 2.4.1, 2.3.1, 2.5.1) (Total = 20 marks)
5 Ajantha Plc
Ajantha Plc (Ajantha) develops, manufactures and sells a range of pharmaceuticals
and has a wide customer base across Europe and Asia. You are the audit manager
of Nate & Co and you are planning the audit of Ajantha whose financial year end is
31 March. You attended a planning meeting with the finance director and
engagement partner and are now reviewing the meeting notes in order to produce
the audit strategy and plan. Revenue for the year is forecast at Rs. 25 million.
During the year the company spent Rs. 2.2 million on developing several new
products. Some of these are in the early stages of development whilst others are
nearing completion. The finance director has confirmed that all projects are likely
to be successful and so he is intending to capitalise the full Rs. 2.2 million.
Once products have completed the development stage, Ajantha begins
manufacturing them. At the year end it is anticipated that there will be significant
levels of work in progress. In addition the company uses a standard costing
method to value inventory; the standard costs are set when a product is first
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manufactured and are not usually updated. In order to fulfil customer orders
promptly, Ajantha has warehouses for finished goods located across Europe and
Asia; approximately one third of these are third party warehouses where Ajantha
just rents space.
In September a new accounting package was introduced. This is a bespoke system
developed by the information technology (IT) manager. The old and new packages
were not run in parallel as it was felt that this would be too onerous for the
accounting team. Two months after the system changeover the IT manager left the
company; a new manager has been recruited but is not due to start work until
January.
In order to fund the development of new products, Ajantha has restructured its
finance and raised Rs. 1 million through issuing shares and Rs. 2.5 million through
a long-term loan. There are bank covenants attached to the loan, the main one
relating to a minimum level of total assets. If these covenants are breached then
the loan becomes immediately repayable. The company has a policy of revaluing
land and buildings, and the finance director has announced that all land and
buildings will be revalued as at the year end.
The reporting timetable for audit completion of Ajantha is quite short, and the
finance director would like to report results even earlier this year.
Required
(1) Outline the auditor's ethical responsibilities with regard to client
confidentiality and when they have a right or responsibility to disclose client
information. (4 marks)
(2) Analyse the audit risks from the information above. (6 marks)
(3) Outline the auditor's response to each identified risk in planning the audit of
Ajantha. (6 marks)
(4) Outline substantive procedures you should perform to obtain sufficient
appropriate evidence in relation to:
(i) Inventory held at the third party warehouses
(ii) Use of standard costs for inventory valuation (4 marks)
(LO 7.4.1, 2.3.1, 2.5.1, 3.1.1) (Total = 20 marks)
66 CA Sri Lanka
6 Glo-warm
Glo-Warm (Pvt) Ltd (Glo-warm), manufactures various heating products which it
sells to both high street and catalogue retailers.
The statement of financial position for the years ended 20X7 and 20X6 are set out
below. Last year, materiality for the financial statements as a whole was set at Rs.
10,000.
20X7 20X6
Rs'000 Rs'000 Rs'000 Rs'000
Non-current assets
Tangible non-current assets 20 21
Investments 2 2
Current assets
Inventory 52 179
Receivables 78 136
Cash at bank 12 34
Cash in hand 1 1
143 350
Total assets 165 373
Current liabilities
Trade payables 121 133
Bank loan 5 5
126 138
Long-term liabilities
Bank loan 20 25
Provision* 20 –
Capital and reserves

Share capital 2 2
Reserves (3) 208
Total liabilities 165 373
*The provision of Rs. 20,000 consists entirely of a warranty provision.
Required
(1) Discuss whether the materiality level for the financial statements as a whole
used in 20X6 will be appropriate for this year's audit, giving reasons for your
answer. (3 marks)
(2) Analyse the statement of financial position given above and state the areas
in which audit work should be concentrated, giving reasons in each case.
(12 marks)
(3) Outline the impact on the auditor's report if the auditor concludes, on
completion of the audit, that there is a material uncertainty regarding going
concern. (5 marks)
(LO 2.2.1, 2.4.1, 2.3.1, 5.4.1) (Total = 20 marks)
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7 Shantha Holidays
Shantha Holidays is an independent travel agency. It does not operate holidays
itself. It takes commission on holidays sold to customers through its chain of high
street shops. Staff are partly paid on a commission basis. Well-established tour
operators run the holidays that Shantha Holidays sells. The networked
reservations system through which holidays are booked and the computerised
accounting system are both well-established systems used by many independent
travel agencies.
Payments by customers, including deposits, are accepted in cash and by debit and
credit card. Shantha Holidays is legally required to pay an amount of money
(based on its total sales for the year) into a central fund maintained to compensate
customers if the agency should cease operations.
(1) Explain how an internal audit function helps an entity deal with the risk of
fraud and error. (5 marks)
(2) Discuss the responsibilities of external auditors in respect of the risk of
fraud and error in an audit of financial statements. (9 marks)
(3) Analyse the nature of the risks affecting Shantha Holidays which arise from
fraud and error. (6 marks)
8 Minty Cola Plc

Minty Cola Plc (Minty) manufactures fizzy drinks such as cola and lemonade as
well as other soft drinks and its year end is 31 March 20X3. You are the audit
manager of Premaratne & Co and are currently planning the audit of Minty. You
attended the planning meeting with the engagement partner and finance director
last week and recorded the minutes from the meeting shown below. You are
reviewing these as part of the process of preparing the audit strategy.
Minutes of planning meeting for Minty
Minty's trading results have been strong this year and the company is forecasting
revenue of Rs. 85 million, which is an increase from the previous year. The
company has invested significantly in the cola and fizzy drinks production process
at the factory. This resulted in expenditure of Rs. 5 million on updating, repairing
and replacing a significant amount of the machinery used in the production
process.
As the level of production has increased, the company has expanded the number
of warehouses it uses to store inventory. It now utilises 15 warehouses; some are
owned by Minty and some are rented from third parties. There will be inventory
counts taking place at all 15 of these sites at the year end.
68 CA Sri Lanka
A new accounting general ledger has been introduced at the beginning of the year,
with the old and new systems being run in parallel for a period of two months.
As a result of the increase in revenue, Minty has recently recruited a new credit
controller to chase outstanding receivables. The finance director thinks it is not
necessary to continue to maintain an allowance for receivables and so has
released the opening allowance of Rs. 1.5 million.
In addition, Minty has incurred expenditure of Rs. 4.5 million on developing a new
brand of fizzy soft drinks. The company started this process in January 20X3 and
is close to launching the new product into the market place. The finance director
stated that there was a problem in November in the mixing of raw materials
within the production process which resulted in a large batch of cola products
tasting different. A number of these products were sold; however, due to
complaints by customers about the flavour, no further sales of these goods have
been made. No adjustment has been made to the valuation of the damaged
inventory, which will still be held at cost of Rs. 1 million at the year end.
As in previous years, the management of Minty is due to be paid a significant
annual bonus based on the value of year-end total assets.
Required
(1) Analyse the minutes provided, to identify SIX audit risks relevant to
planning the audit of Minty Cola Plc. (6 marks)
(2) Outline the auditor's response to each risk in planning the audit of Minty
Cola Plc (6 marks)
(3) Outline substantive procedures the audit team should perform to obtain
sufficient and appropriate audit evidence in relation to the following three
matters:
(i) The treatment of the Rs. 5 million expenditure incurred on improving
the factory production process (3 marks)
(ii) The release of the Rs. 1.5 million allowance for receivables (3 marks)
(iii) The damaged inventory (2 marks)
(LO 1.1.1, 2.3.1, 3.1.1) (Total = 20 marks)
9 Vakarai (Pvt) Ltd

You are the audit senior of Vaas & Co and are planning the audit of Vakarai (Pvt)
Ltd (Vakarai) for the year ended 31 March 20X4. The company produces printers
and has been a client of your firm for two years. Your audit manager has already
had a planning meeting with the finance director. He has provided you with the
following notes of his meeting and financial statement extracts.
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Vakarai's management were disappointed with the 20X3 results and so in 20X4
undertook a number of strategies to improve the trading results. This included the
introduction of a generous sales-related bonus scheme for their salesmen and a
high profile advertising campaign. In addition, as market conditions are difficult
for their customers, they have extended the credit period given to them.
The finance director of Vakarai has reviewed the inventory valuation policy and
has included additional overheads incurred this year as he considers them to be
production related.
The finance director has calculated a few key ratios for Vakarai; the gross profit
margin has increased from 44.4% to 52.2% and receivables days have increased
from 61 days to 71 days. He is happy with the 20X4 results and feels that they are
a good reflection of the improved trading levels.
Financial statement extracts for year ended 31 March
DRAFT ACTUAL
20X4 20X3
Rs Mn Rs Mn
Revenue 23.0 18.0
Cost of sales (11.0) (10.0)
Gross profit 12.0 8.0
Operating expenses (7.5) (4.0)
Profit before interest and taxation 4.5 4.0
Inventory 2.1 1.6
Receivables 4.5 3.0
Cash – 2.3
Trade payables 1.6 1.2
Overdraft 0.9 –
Required
(1) Analyse the information above to identify FIVE audit risks. Your answer
should include the calculation of two additional ratios for both years.
(7 marks)
(2) Outline the auditor's response to each risk in planning the audit of Vakarai.
(5 marks)
(3) Outline the procedures that Vaas & Co should perform in assessing whether
or not the company is a going concern. (4 marks)
(4) Explain the possible auditor's reports that can be issued where the going
concern status of a company is called into question. (4 marks)
(LO 2.3.1, 2.5.1, 3.6.1, 3.7.1, 5.3.1, 5.4.1) (Total = 20 marks)
70 CA Sri Lanka
10 Fonseca Distributors (Pvt) Ltd

Fonseca Distributors (Pvt) Ltd (Fenton) is a small company which maintains its
sales, purchase and general ledgers on a small PC, using a standard computerised
accounting package. The company buys products from large manufacturers and
sells them to shops which either sell or hire them to the general public. The
products include drain clearing machines, portable generators, garden cultivators
and wallpaper strippers.
You have been asked to carry out an audit of the general ledger system to verify
that items are accurately recorded in the year. At the end of the year, the general
ledger produces a trial balance, which is used to prepare the annual accounts.
The company employs a bookkeeper, who is responsible for posting the sales and
purchase ledgers, and maintaining the general ledger. Data is posted to the
general ledger as follows.
(a) At the start of the financial year, all the balances on the general ledger
accounts are set to zero (using the standard year-end procedure of the
computer package).
(b) The following procedures relate to purchase transactions.
(i) When invoices are posted to the purchase ledger, the purchase analysis
code (for the general ledger), the purchases value and the sales tax
value are entered. The total invoice value is posted to the purchase
ledger.
(ii) At the end of the month, the computer posts the following items to the
general ledger.
– The total of each category of invoice expense and sales tax for
purchase invoices and credit notes posted in the month (at the
same time the computer prints details of the individual invoices
making up the total of each invoice expense and sales tax for the
month).
– The total of purchase ledger cash payments, discount received
and adjustments posted to the purchase ledger in the month (the
computer prints details of the individual items comprising the
total cash discount and adjustments for the month).
– Where there is no account in the general ledger relating to the
items being posted, the computer posts the items to a payables
suspense account. Also, all adjustments are posted to the
suspense account.
(c) Sales ledger data is posted to the general ledger in a similar way to purchase
ledger data.
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(d) Journals are posted manually to the general ledger for:

(i) The opening balances at the start of the year
(ii) Other cash book items (other than sales and purchase ledger cash)
(iii) Petty cash payments
(iv) Wages analysis (details are obtained from the computerised payroll
system)
(v) Adjustments, which include:
– Correction of errors
– Dealing with items in the sale and purchase ledger suspense
accounts (adjustments posted to the ledger, and items where
there is no account in the general ledger)
All these journals are written manually in an accounts journal book, and they
must be authorised by the managing director before posting. The opening
balances are posted to the general ledger when the previous year's accounts
have been approved by the auditors. Although the employee wages are
calculated using another computer package, the total wages expense is
posted to the general ledger manually. The wages expense is calculated from
the payroll's monthly summary, using a spreadsheet package, and the wages
expense is analysed into directors, sales, warehouse and office wages (or
salaries).
Required
(1) Outline the audit procedures you would perform to verify the key assertions
for purchases transactions which are posted to the general ledger.
(5 marks)
(2) Outline the audit procedures you would perform to verify the key assertions
for journals posted to the general ledger, including adjusting journals.
(10 marks)
(3) Outline any other tests you would perform to verify the key assertions for
the year-end balances on the general ledger. (5 marks)
(LO 3.1.1, 3.3.1) (Total = 20 marks)
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11 Kelanyia Joinery (Pvt) Ltd

Kelanyia Joinery (Pvt) Ltd (Kelanyia ), which is owned by its directors,
manufactures wooden window frames, doors and staircases for houses. It has
prepared draft accounts for the year ended 31 March 20X6 and you are concerned
that they indicate serious going concern problems. The statements of profit or loss
and statements of financial position for the last five years (each ended 31 March)
are given below.
STATEMENT OF PROFIT OR LOSS
20X2 20X3 20X4 20X5 20X6
Rs'000 Rs'000 Rs'000 Rs'000 Rs'000
Sales 625 787 1,121 1,661 1,881
Cost of sales (478) (701) (962) (1,326) (1,510)
Gross profit 147 86 159 335 371
Other expenses (88) (86) (161) (240) (288)
Interest (6) (9) (58) (90) (117)
Net profit/(loss) 53 (9) (60) 5 (34)
STATEMENT OF FINANCIAL POSITION
20X2 20X3 20X4 20X5 20X6
Rs'000 Rs'000 Rs'000 Rs'000 Rs'000

Assets
Current assets
Inventory 67 133 181 307 449
Trade accounts receivable 91 240 303 313 364
158 373 484 620 813
Net current assets 89 161 544 600 587
Total assets 247 534 1,028 1,220 1,400
Liabilities and shareholders' funds
Current liabilities
Trade accounts payable 90 317 355 490 641
Bank overdraft 10 65 211 269 365
Lease creditor 14 28 98 92 59
114 410 664 851 1,065
Non-current loan – – 300 300 300
114 410 964 1,151 1,365
Shareholders' funds
Share capital 17 17 17 17 17
Reserves 116 107 47 52 18
133 124 64 69 35
Total liabilities and shareholders' funds 247 534 1,028 1,220 1,400
The company has been in business for about 15 years. In January 20X3 it decided
to build a new factory on a site leased from the local authority which would allow
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a major increase in sales. This new factory with new equipment was completed a
year later. The factory was financed by a non-current loan of Rs. 300,000 from a
merchant bank and an increase in the bank overdraft.
The loan from the merchant bank is secured by a fixed charge on the leasehold
factory and the bank overdraft is secured by a second charge on the leasehold
factory, a fixed charge on the other non-current assets and a floating charge on the
current assets.
The company purchases its main raw material, wood, from timber wholesalers. It
sells around 75% of its production to about 12 local and national builders of new
houses. The remaining sales are mainly to smaller builders, with a very few sales
to local builders merchants.
On 1 April 20X6, a local builder went into liquidation. The builder had a trade
receivable of Rs. 15,000 owing to Kelanyia at year end. The day after the auditor's
report was signed a fire destroyed one of Kelanyia's factories. The financial
statements had not yet been issued.
Required
(1) Outline the responsibilities of auditors for the discovery of (i) the builder
that went into liquidation after year end and (ii) the fire at Kelanyia's
factory. For each event explain whether it is an adjusting or non-adjusting
event. (6 marks)
(2) Assess the financial statements above so as to identify the factors which
indicate that the company may not be a going concern. You should also
highlight certain figures and calculate relevant ratios in the accounts.
(8 marks)
(3) Outline the procedures you would carry out to determine whether the
company is a going concern. (6 marks)
(LO 2.6.1, 3.1.1, 3.5.1, 3.6.1, 3.7.1) (Total = 20 marks)
12 Turbo Plc
You are an audit senior for Purnell & Co, and Turbo Plc (Turbo) is a longstanding
audit client of your firm. You have started the planning for the audit of Turbo for
the year ended 31 March 20X1. You have obtained the following information from
the previous year's file and from preliminary discussions with management.
Background and revenue sources
Turbo is a magazine publisher. It publishes a number of titles, all of which are
weekly or monthly car and motorcycle magazines. The magazines are sold to
supermarkets and newsagents who then sell them to the general public. Turbo
generates its income in two ways: from the sale of the magazines themselves and
74 CA Sri Lanka
from selling advertising space in the magazines to companies who want to

promote their cars or motorcycles. The revenue split has typically been around
50% in total for each sale type.
The key advertisers are large household names in the car and motorcycle
industry. Turbo has to negotiate contracts with these advertisers for the provision
of advertising space. These contracts can vary in length and can range from
between one month and six months. The contract will set out all details of the
arrangement including the price of the adverts, the number or size of the adverts
and how often the advertisements will appear. An invoice is raised on the date of
the first advertisement and the advertisers pay within ten days of this for shorter
contracts. For six month contracts the advertising fees are paid for by Turbo's
customers in two instalments (half of the fee on the first date of advertising and
the rest after three months). If recurring contracts have not been re-signed by the
date advertising is meant to start Turbo raises an invoice based on the last
contract and the paperwork is sorted out later. A few of the larger contracts run
up to 31 March 20X1.
In respect of the magazine sales Turbo offers the supermarkets and newsagents
up to 45 days credit but many of the newsagents are struggling financially and
tend to take longer than this to pay their invoices.
Trading conditions
In the last ten years the market for the magazines has become more and more
competitive resulting in Turbo needing to discount magazine prices. There is also
increasing pressure from online competition and Turbo's revenue has been
gradually decreasing over the last few years. This year has been a particularly bad
year because difficult economic conditions have resulted in reductions in
advertising revenue because many of the car and motorcycle manufacturers that
advertise in the magazines have seen their marketing budgets slashed and have
renegotiated their contract terms.
Other relevant information
Turbo does not employ journalists or photographers for their magazines. Instead
they use the best self-employed journalists, commentators and photographers in
the industry. However due to their numerous commitments, these freelancers
often get behind on their paperwork and don't get round to sending in their
invoices to Turbo until a month or more after they have written their article or
provided the photos requested.
Turbo prints its own magazines and as a result has a significant amount of plant
and equipment. Turbo has been around for a number of years now and the
equipment had become quite old and inefficient compared to that used by newly
formed competitors. As a result in December 20X0 extensive refurbishment of the
printing equipment took place and this expenditure will be material to the
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financial statements. The heavy investment in refurbishment and declining

revenues has seen Turbo operate close to its overdraft limit during the last six
months. Although there is likely to be a small profit for the year, the management
accounts for last six months show an operating loss.
The company would like to apply for a bank loan to ease cash flow concerns and
has discussed this with its bank. However the initial response from the bank was
not overwhelmingly positive due to the competitive market Turbo operates in. As
a result Turbo needs to produce a cash flow forecast for the bank showing where
the cash will be generated to pay back any loan. The bank also wants to see
audited financial statements for the year to 31 March 20X1 before the end of April
20X1.
Required
(1) Explain the difference between the overall audit strategy and the audit plan
and outline the key contents of the overall audit strategy document.
(4 marks)
(2) Define 'performance materiality', contrasting it with materiality for the
financial statements as a whole. Recommend an appropriate materiality
benchmark to be used in the audit of Turbo, giving reasons. (4 marks)
(3) Analyse the information provided, so as to (i) identify SIX risks of material
misstatement and (ii) outline the auditor's response to each risk in planning
the audit of Turbo. (12 marks)
(LO 2.2.1, 2.4.1, 2.3.1, 2.5.1, 3.2.1) (Total = 20 marks)
13 Ratnapura Manufacturing (Pvt) Ltd

You are the audit assistant assigned to the audit of Ratnapura Manufacturing (Pvt)
Ltd (Ratnapura). The audit senior has asked you to plan the audit of non-current
assets. He has provisionally assessed materiality at Rs. 72,000.
Ratnapura maintains a register of non-current assets. The management
accountant reconciles a sample of entries to physical assets and vice versa on a
three-monthly basis. Authorisation is required for all capital purchases. Items
valued less than Rs. 10,000 can be authorised by the production manager, but
items costing more than Rs. 10,000 must be authorised by the Managing Director.
The purchasing department will not place an order for capital goods unless it has
been duly signed.
The company has invested in a large amount of new plant this year in connection
with an eight year project for a government department.
76 CA Sri Lanka
The management accountant has provided you with the following schedule of
non-current assets:
Land and Plant and Motor
buildings equipment Computers vehicles Total
Rs. Rs. Rs. Rs. Rs.
Cost
At 31 March 20X6 500,000* 75,034 30,207 54,723 659,964
Additions 250,729 1,154 251,883
At 31 March 20X7 500,000 325,763 31,361 54,723 911,847
Accumulated depreciation
At 31 March 20X6 128,000 45,354 21,893 25,937 221,184
Charge for the year 8,000 28,340 2,367 13,081 51,788
At 31 March 20X7 136,000 73,694 24,260 39,018 272,972
Carrying amount
At 31 March 20X7 364,000 252,069 7,101 15,705 638,875
At 31 March 20X6 372,000 29,680 8,314 28,786 438,780
*Of which, Rs. 100,000 relates to land.
Required
(1) Analyse the risks relating to the audit of the tangible non-current assets
under the headings of inherent risk, control risk and detection risk., drawing
a conclusion about the overall risk of the audit. (You are not required to
perform any calculations). (4 marks)
(2) Explain the factors that influence the sufficiency and reliability of audit
evidence. (4 marks)
(3) Outline the audit procedures you would undertake on non-current assets in
respect of the following assertions:
(i) Existence (4 marks)
(ii) Valuation (excluding depreciation) (4 marks)
(iii) Completeness (4 marks)
(LO 2.3.1, 3.1.1) (Total = 20 marks)
14 Snu
Snu is a family-owned company which retails beds, mattresses and other bedroom
furniture items. The company's year-end is 31 December 20X3. The only full
inventory count takes place at the year-end. The company maintains up-to-date
computerised inventory records.
Where the company delivers goods to customers, a deposit is taken from the
customer and customers are invoiced for the balance after the delivery. Some
goods that are in inventory at the year-end have already been paid for in full –
customers who collect goods themselves pay by cash or credit card.
CA Sri Lanka 77
Questions
Staff at the company's warehouse and shop will conduct the year-end count. The
shop and warehouse are open seven days a week except for two important public
holidays during the year, one of which is 1 January. The company is very busy in
the week prior to the inventory count but the shops will close at 15.00 hours on
31 December and staff will work until 17.00 hours to prepare the inventory for
counting. The company has a high turnover of staff. The following inventory
counting instructions have been provided to staff at Snu.
(i) The inventory count will take place on 1 January 20X4 commencing at 09.00
hours. No movement of inventory will take place on that day.
(ii) The count will be supervised by Mr Sneg, the inventory controller. All staff
will be provided with pre-printed, pre-numbered inventory counting sheets
that are produced by the computerised system. Mr Sneg will ensure that all
sheets are issued, and that all are collected at the end of the count.
(iii) Counters will work on their own, because there are insufficient staff for them
to work in pairs, but they will be supervised by Mr Sneg and Mrs Zapad, an
experienced shop manager who will make checks on the work performed by
counters. Staff will count inventory with which they are most familiar in
order to ensure that the count is completed as quickly and efficiently as
possible.
(iv) Any inventory that is known to be old, slow-moving or already sold will be
highlighted on the sheets. Staff are required to highlight any inventory that
appears to be soiled or damaged.
(v) All inventory items counted will have a piece of paper attached to them that
will show that they have been counted.
(vi) All inventory that has been delivered to customers but that has not yet been
paid for in full will be added back to the inventory quantities by Mr Sneg.
Required
(1) Discuss why year-end inventory counting is important to the auditors of
organisations that do not have perpetual inventory systems. (4 marks)
(2) Analyse the principal risks associated with the financial statement
assertions relating to inventory. (4 marks)
(3) Outline (i) the deficiencies in Snu's inventory counting instructions, (ii) the
implications of those deficiencies, and (iii) why these deficiencies are
difficult to overcome. (12 marks)
(LO 3.1.2, 2.3.1, 1.2.3) (Total = 20 marks)
78 CA Sri Lanka
15 Homes'r'Us
Homes'r'Us is a large listed construction company based in the north of the
country, whose activities encompass house building and development. Its annual
revenue is Rs550m and profit before tax is Rs70m.
You are the audit senior involved with the audit of Homes'r'Us for the year ended
31 December 20X7. The following matters have come to your attention during the
review stage of the audit in April 20X8:
(i) Customer going into liquidation
One of Homes'r'Us's major commercial customers has gone into liquidation
shortly after the year end. As at the year end, the customer owed the
company Rs7.5m.
(ii) Claim for unfair dismissal
One of the company's construction workers, Basil Evans, was dismissed in
November 20X7 after turning up to work under the influence of alcohol. In
December 20X7, Mr Evans began a case against the company for unfair
dismissal. Lawyers for the company have advised that it will be highly
unlikely that he will be successful in his claim.
(iii) In March 20X8 a fire was started by vandals at one of the company's ten
storage depots, destroying Rs1m worth of building materials.
Required
For each of the three events at Homes'r'Us mentioned above:
(1) Describe the additional audit procedures you will carry out. (7 marks)
(2) State whether the financial statements will need to be amended and explain
your reasoning. (7 marks)
(3) Discuss the potential impact on the auditor's report, fully explaining your
answers. (6 marks)
(LO 5.1.1, 5.3.1) (Total = 20 marks)
CA Sri Lanka 79
Questions
16 Chandan
Chandan, a private limited liability company owned by equity investors and
registered in Sri Lanka. It is the parent of a major conglomerate of businesses
across different market sectors including food retailing, restaurants and hotels,
manufacturing and professional training, It has extended its operations
throughout Asia and most recently to Africa, where it is expanding rapidly.
You are a manager in Chileshe, a firm of CA Sri Lanka accountants. You have been
approached by Felix Chandan, the chief finance officer of Chandan, relating to a
bid that Chandan is proposing to make for the purchase of Zafi Training Institute
(ZTI) to expand its professional training division. Also, you have been asked to
explain the impact of new Sri Lanka Government Regulator audit requirements for
its restaurant company. You have ascertained the following from a briefing note
received from Felix.
Acquisition of a training company
ZTI provides training in management, communications and marketing to a wide
range of corporate clients, including multi-nationals. The 'ZTI' name is well
regarded in its areas of expertise. ZTI is currently wholly-owned by Frontiers, an
international publisher of textbooks, whose shares are quoted on a recognised
stock exchange. ZTI has a National and an International business.
The National business comprises 11 training centres. The audited financial
statements show revenue of Rs37.5m and profit before taxation of Rs3.9m for this
geographic segment for the year to 30 June 20X8. Most of the National business's
premises are owned or held on long leases. Trainers in the National business are
mainly full-time employees. Receivables related to the national business amount
to Rs21.3m.
The International business has five training centres in Africa and Asia. For these
segments, revenue amounted to Rs18.9m and profit before tax Rs7.2m for the
year to 30 June 20X8. Most of the International business's premises are held on
operating leases. International trade receivables at 30 June 20X8 amounted to
Rs11.1m. Although the International centres employ some full-time trainers, the
majority of trainers provide their services as freelance consultants.
Chandan is particularly concerned about the recoverability and validity of the
receivables balances in relation to both the national and international centres and
has enquired about the possibility of Chileshe carrying out agreed upon
procedures on receivables on its behalf.
New audit regulation for restaurant industry
There is some discussion in the news that the Sri Lanka government may extend
regulation of the Food preparation industry and require a separate set of audited
accounts by prepared under a fair presentation framework which will be provided
80 CA Sri Lanka
and defined by the regulator to comply with new government regulations. This
framework is likely to require additional disclosures of food preparation health
and safety procedures and expenditure although no further details are known at
this stage.
The Board of Directors would like to understand the requirement for a further
audit engagement which may be required by SLAuS 800 Special Considerations—
Audits of Financial Statements prepared in accordance with Special Purpose
Frameworks, and request that Chileshe prepare a summary of its main
requirements.
Required
(1) Describe the nature and purpose of agreed upon procedures. (3 marks)
(2) Explain the matters which the auditor should consider before accepting an
engagement to conduct the agreed upon procedures. (6 marks)
(3) Illustrate what procedures may be appropriate in the agreed upon
procedures engagement outlined. (4 marks)
(4) Explain the principle special purpose framework audit engagement and
auditor’s report disclosures that the Chileshe will needs to include in their
auditor’s report to the Sri Lanka Regulator in line with the requirements of
SLAuS 800. (7 marks)
(LO 5.5.1, 5.7.1, 6.1.1, 6.2.1) (Total = 20 marks)
CA Sri Lanka 81
Questions
17 Axis & Co
You are the manager responsible for four audit clients of Axis & Co, a firm of
Chartered Accountants. The year end in each case is 30 June 20X8.
You are currently reviewing the audit working paper files and the audit seniors'
recommendations for the auditor's reports. Details are as follows.
(1) Lorenze Co has changed its accounting policy for goodwill during the year
from the inventory valuation method to annual impairment testing. No
disclosure of this change has been given in the financial statements. The
carrying amount of goodwill in the statement of financial position as at
30 June 20X8 is the same as at 30 June 20X7 as management's impairment
test shows that it is not impaired.
The audit senior has concluded that a qualification is not required but
suggests that attention can be drawn to the change by way of an emphasis of
matter paragraph. (4 marks)
(2) The directors' report of Abrupt Co states that investment property rental
forms a major part of revenue. However, a note to the financial statements
shows that property rental represents only 1.6% of total revenue for the
year. The audit senior is satisfied that the revenue figures are correct.
The audit senior has noted that an unmodified opinion should be given as
the audit opinion does not extend to the directors' report. (4 marks)
(3) Audit work on the after-date bank transactions of Jingle Co has identified a
transfer of cash from Bell Co. The audit senior assigned to the audit of Jingle
has documented that Jingle's finance director explained that Bell
commenced trading on 7 July 20X8, after being set up as a wholly-owned
foreign subsidiary of Jingle.
The audit senior has noted that although no other evidence has been
obtained an unmodified opinion is appropriate because the matter does not
impact on the current year's financial statements. (4 marks)
Required
For each situation, recommend the suitability or otherwise of the audit senior's
proposals for the auditor's reports. Where you disagree, recommend what audit
modification (if any) should be given instead.
Note. The mark allocation is shown against each of the three issues.
(4) You are responsible for answering technical queries from other managers
and partners of your firm. An audit partner left the following note on your
desk this morning.
82 CA Sri Lanka
(i) 'I am about to draft the audit report for my client, Sycamore Co. I am
going on holiday tomorrow and want to have the audit report signed
and dated before I leave. The only thing outstanding is the written
representation from management – I have verbally confirmed the
contents with the finance director who agreed to send the
representations to the audit manager within the next few days. I
presume this is acceptable?' (4 marks)
(ii) 'We are auditing Sycamore Co for the first time. The prior period
financial statements were audited by another firm. We are aware that
the auditor's report on the prior period was qualified due to a material
misstatement of trade receivables. We have obtained sufficient
appropriate evidence that the matter giving rise to the misstatement
has been resolved and I am happy to issue an unmodified opinion. But
should I refer to the prior year modification in this year's auditor's
report?' (4 marks)
Required
Advise on the audit partner's comments. (Total = 20 marks)
(LO 2.5, 2.6, 5.6)
18 Colombo
You are a manager in Sambora & Co, responsible for the audit of the Colombo
Group (the Group), which is listed. The Group's main activity is steel
manufacturing and it comprises a parent company and five subsidiaries. Sambora
& Co currently audits all components of the Group.
You are working on the audit of the Group's financial statements for the year
ended 30 June 20X2.
At the planning stage, materiality was initially determined to be Rs. 900,000, and
was calculated based on the assumption that the Colombo Group is a high risk
client due to its listed status. During the audit, a number of issues arose which
meant that it was necessary to revise the materiality level for the financial
statements as a whole. The revised level of materiality is now determined to be Rs.
700,000. One of the audit juniors was unsure as to why the materiality level had
been revised.
The audit senior has provided you with the draft consolidated financial
statements and accompanying notes which summarise the key audit findings and
some background information.
The Group's draft consolidated financial statements, with notes referenced to key
audit findings, are shown below.
CA Sri Lanka 83
Questions
DRAFT CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME
30 June 20X2 30 June 20X1
Notes Draft Actual
Rs'000 Rs'000
Revenue 1 98,795 103,100
Cost of sales (75,250) (74,560)
Operating expenses 2 (14,900) (17,500)
Operating profit 8,645 11,040
Share of profit of associate 1,010 900
Finance costs (380) (340)
Profit before tax 9,275 11,600
Taxation (3,200) (3,500)
Profit for the year 6,075 8,100
Other comprehensive income/expense for
the year, net of tax:
Gains on property revaluation 3 800 –
Actuarial losses on defined benefit plan 4 (1,100) (200)
Other comprehensive income/expense (300) (200)
Total comprehensive income for the year 5,775 7,900
Notes. Key audit findings – Statement of profit or loss and other
comprehensive income
1 Revenue has been stable for all components of the Group with the exception
of one subsidiary, Galle Plc, which has recognised a 25% decrease in
revenue.
2 Operating expenses for the year to June 20X2 is shown net of a profit on a
property disposal of Rs. 2 million. Our evidence includes agreeing the cash
receipts to bank statement and sale documentation, and we have confirmed
that the property has been removed from the non-current asset register.
3 The property revaluation relates to the Group's head office. The audit team
have not obtained evidence on the revaluation, as the gain was immaterial
based on the initial calculation of materiality.
4 The actuarial loss is attributed to an unexpected stock market crash. The
Group's pension plan is managed by Axle Plc – a firm of independent fund
managers who maintain the necessary accounting records relating to the
plan. Axle Plc has supplied written representation as to the value of the
defined benefit plan's assets and liabilities at 30 June 20X2. No other audit
work has been performed other than to agree the figure from the financial
statements to supporting documentation supplied by Axle Plc.
DRAFT CONSOLIDATED STATEMENT OF FINANCIAL POSITION
84 CA Sri Lanka
30 June 30 June
20X2 20X1
Notes Draft Actual
Rs'000 Rs'000
ASSETS
Non-current assets
Property, plant and equipment 81,800 76,300
Goodwill 5 5,350 5,350
Investment in associate 6 4,230 4,230
Assets classified as held for sale 7 7,800 –
99,180 85,880
Current assets
Inventory 8,600 8,000
Cash and cash equivalents 2,100 2,420
19,240 18,220
Total assets 118,420 104,100
EQUITY AND LIABILITIES
Equity
Revaluation reserve 3,300 2,500
Retained earnings 33,600 29,400
Non-controlling interest 8 4,350 4,000
Total equity 53,750 48,400
Non-current liabilities
Defined benefit pension plan 10,820 9,250
Long-term borrowings 9 43,000 35,000
Deferred tax 1,950 1,350
Total non-current liabilities 55,770 45,600
Current liabilities
Trade and other payables 6,200 7,300
Provisions 2,700 2,800
Total current liabilities 8,900 10,100
Total liabilities 64,670 55,700
Total equity and liabilities 118,420 104,100
Notes. Key audit findings – Statement of financial position
5 The goodwill relates to each of the subsidiaries in the Group. Management
has confirmed in writing that goodwill is stated correctly, and our other
audit procedure was to arithmetically check the impairment review
conducted by management.
6 The associate is a 30% holding in Moratuwa Plc, purchased to provide
investment income. The audit team have not obtained evidence regarding
CA Sri Lanka 85
Questions
the associate as there is no movement in the amount recognised in the

statement of financial position.
7 The assets held for sale relate to a trading division of one of the subsidiaries,
which represents one third of that subsidiary's net assets. The sale of the
division was announced in May 20X2, and is expected to be complete by
31 December 20X2. Audit evidence obtained includes a review of the sales
agreement and confirmation from the buyer, obtained in July 20X2, that the
sale will take place.
8 Two of the Group's subsidiaries are partly owned by shareholders external
to the Group.
9 A loan of Rs. 8 million was taken out in October 20X1, carrying an interest
rate of 2%, payable annually in arrears. The terms of the loan have been
confirmed to documentation provided by the bank.
Required
(1) Advise the audit junior as to why there may be a need to reassess
materiality as the audit progresses. (4 marks)
(2) Evaluate whether the key audit findings indicate a risk of misstatement and
the adequacy of audit evidence obtained. (16 marks)
(LO 2.2, 2.3, 2.4) (Total = 20 marks)
19 Beech
You are a manager in the audit department of Beech & Co, responsible for the
audits of Fir Plc (Fir), Spruce Plc (Spruce), Pine Plc (Pine) and Oak Plc (Oak). Each
company has a financial year ended 31 July 20X9, and the audits of all companies
are nearing completion. The following issues have arisen in relation to the audit of
accounting estimates and fair values.
(1) Fir Plc
Fir is a company involved in energy production. It owns several nuclear
power stations, which have a remaining estimated useful life of 20 years. Fir
intends to decommission the power stations at the end of their useful life
and the statement of financial position at 31 July 20X9 recognises a material
provision in respect of decommissioning costs of Rs. 97 million (20X0 –
Rs. 110 million). A brief note to the financial statements discloses the
opening and closing value of the provision but no other information is
provided.
86 CA Sri Lanka
Required
Evaluate the matters that should be considered, and the audit evidence you
should expect to find in your file review in respect of the decommissioning
provision. (5 marks)
(2) Spruce Plc
Spruce is also involved in energy production. It has a trading division which
manages a portfolio of complex financial instruments such as derivatives.
The portfolio is material to the financial statements. Due to the specialist
nature of these financial instruments, an auditor's expert was engaged to
assist in obtaining sufficient appropriate audit evidence relating to the fair
value of the financial instruments. The objectivity, capabilities and
competence of the expert were confirmed prior to their engagement.
Required
Advise of the procedures that should be performed in evaluating the
adequacy of the auditor's expert's work. (5 marks)
(3) Pine Plc
Pine operates a warehousing and distribution service, and owns 120
properties. During the year ended 31 July 20X9, management changed its
estimate of the useful life of all properties, extending the life on average by
ten years. The financial statements contain a retrospective adjustment,
which increases opening non-current assets and equity by a material
amount. Information in respect of the change in estimate has not been
disclosed in the notes to the financial statements.
Required
Advise of the potential implications for the auditor's report of the accounting
treatment of the change in accounting estimates. (5 marks)
(4) Poppy Plc
Poppy Plc is a manufacturing company. In the last year, several investment
properties have been purchased to utilise surplus funds and to provide
rental income. The properties have been revalued at the year end in
accordance with LKAS 40 Investment property, they are recognised on the
statement of financial position at a fair value of Rs. 8 million, and the total
assets of Poppy are Rs. 160 million at 31 July 20X9. An external valuer has
been used to provide the fair value for each property.
Required
Propose the principal audit procedures to be performed on the valuation of
the investment properties. (5 marks)
Note. Assume it is 5 December 20X9.
CA Sri Lanka 87
Questions
(LO 2.2, 2.3, 2.4, 2.6, 2.7, 3.7) (Total 20 = marks)
20 Gills Group
You are a senior audit manager in Dolphin & Co, responsible for the audit of the
Gills Group, which has been an audit client for several years. The group companies
all have a financial year ending 30 June 20Y0, and you are currently planning the
final audit of the consolidated financial statements. The group’s operations focus
on the manufacture and marketing of confectionery and savoury snacks.
Information about several matters relevant to the group audit is given below.
These matters are all potentially material to the consolidated financial statements.
None of the companies in the group are listed.
Gills Co
This is a non-trading parent company, which wholly owns three subsidiaries –
Shark Co, Barracuda Co and Piranha Co, all of which are involved with the core
manufacturing and marketing operations of the group. This year, the directors
decided to diversify the group’s activities in order to reduce risk exposure. Non-
controlling interests representing long-term investments have been made in two
companies – an internet-based travel agent, and a chain of pet shops. In the
consolidated statement of financial position, these investments are accounted for
as associates, as Gills Co is able to exert significant influence over the companies.
As part of their remuneration, the directors of Gills Co receive a bonus based on
the profit before tax of the group. In April 20Y0, the group finance director
resigned from office after a disagreement with the chief executive officer over
changes to accounting estimates. A new group finance director is yet to be
appointed.
Shark Co
This company manufactures and distributes chocolate bars and cakes. In July
20X9, production was relocated to a new, very large factory. One of the conditions
of the planning permission for the new factory is that Shark Co must, at the end of
the useful life of the factory, dismantle the premises and repair any environmental
damage caused to the land on which it is situated.
Barracuda Co
This company’s operations involve the manufacture and distribution of packaged
nuts and dried fruit. The government paid a grant in November 20X9 to Barracuda
Co, to assist with costs associated with installing new, environmentally friendly,
packing lines in its factories. The packing lines must reduce energy use by 25% as
part of the conditions of the grant, and they began operating in February 20Y0.
Piranha Co
88 CA Sri Lanka
This company is a new and significant acquisition, purchased in January 20Y0. It is

located overseas, in Wetland, a developing country, and has been purchased to
supply cocoa beans, a major ingredient for the goods produced by Shark Co. It is
now supplying approximately half of the ingredients used in Shark Co’s
manufacturing. Wetland has not adopted International Financial Reporting
Standards, meaning that Piranha Co’s financial statements are prepared using
local accounting rules. The company uses local currency to measure and present
its financial statements.
Further information
Your firm audits all components of the group.
CA Sri Lanka 89
Questions
You have just received the following email from Gregory Chiluba, the audit
engagement partner.
Required
Identify, explain and evaluate the principal audit risks (20 marks)
(LO 2.2, 2.3, 2.4, 2.5 2.6)
21 Dragon Group
You are a newly-qualified audit supervisor in Unicorn & Co, a global firm of
Chartered Accountants, with offices in over 150 countries across the world. You
work in a department within the firm which specialises in the audit of retail
companies.
Unicorn & Co has been invited to tender for the Dragon Group audit (including the
audit of all subsidiaries). The Dragon Group is a large group of companies
operating in the furniture retail trade. The group has expanded rapidly in the last
three years, by acquiring several subsidiaries each year. The management of the
parent company, Dragon Plc, has decided to put the audit of the group and all
subsidiaries out to tender, as the current audit firm is not seeking re-election. The
financial year end of the Dragon Group is 30 September 20X9. A senior partner in
your department has recently held a meeting with the group finance director, in
which the current group structure, recent acquisitions and the group’s plans for
future expansion were discussed. The partner has produced the following notes of
this meeting.
Meeting notes – Dragon Group

Group structure
The parent company owns 20 subsidiaries, all of which are wholly owned. Half of
the subsidiaries are located in this country, and half overseas. Most of the foreign
subsidiaries report under the same financial reporting framework as Dragon Plc,
but several prepare financial statements using local accounting rules.
Acquisitions during the year
Two companies were purchased in March 20X9, both located in this country:
· Mermaid Pvt Ltd, a company which operates 20 furniture retail outlets. The
audit opinion expressed by the incumbent auditor on the financial
statements for the year ended 30 September 20X8 was modified by a
material misstatement over the non-disclosure of a contingent liability. The
contingent liability relates to a court case which is still ongoing.
· Minotaur Plc, a large company, whose operations are distribution and
warehousing. This represents a diversification away from retail, and it is
90 CA Sri Lanka
hoped that the Dragon Group will benefit from significant economies of scale
as a result of the acquisition.
CA Sri Lanka 91
Questions
Other matters
The acquisitive strategy of the group over the last few years has led to significant
growth. Group revenue has increased by 25% in the last three years, and is
predicted to increase by a further 35% in the next four years as the acquisition of
more subsidiaries is planned. The Dragon Group has raised finance for the
acquisitions in the past by becoming listed on the stock exchanges of three
different countries. A new listing on a foreign stock exchange is planned for
January 20Y0. For this reason, management would like the group audit completed
by 31 December 20X9.
At the meeting the finance director of Dragon requested whether, if Unicorn & Co
were appointed as auditors, a certain audit senior, Kia Nelson, could be assigned
to the audit team. On further investigation it transpires that Kia Nelson is the
sister of Dragon’s financial controller.
Required
(1) Recommend the principal matters to be included in the firm’s tender
document to provide the audit service to the Dragon Group. (10 marks)
(2) Evaluate the matters that should be considered before accepting the audit
engagement, in the event of Unicorn & Co being successful in the tender.
(6 marks)
(3) Evaluate the ethical and other professional issues raised in respect of the
finance director’s request for Kia Nelson to be included in the audit team.
(4 marks)
(LO 2.2, 2.3, 2.4, 3.1, 7.1-7.5) (Total = 20 marks)
22 Faster Jets
Faster Jets Co is an airline company and is a new audit client of Brown & Co. You
are responsible for the audit of the financial statements for the year ended 30
November 20Y0. The draft financial statements recognise revenue of Rs1,500
million and total assets of Rs2,500 million.
(a) The purpose of SLAuS 510 Initial Audit Engagements – Opening Balances is to
establish standards and provide guidance regarding opening balances when
the financial statements are audited for the first time or when the financial
statements for the prior period were audited by another auditor.
Required
Explain the auditor's reporting responsibilities that are specific to initial
engagements.
(6 marks)
92 CA Sri Lanka
(b) During the year, Faster Jets Co purchased several large plots of land located
near major airports at a cost of Rs125 million. The land is currently rented
out and is classified as investment property, which is recognised in the draft
financial statements at a fair value of Rs145 million. The audit partner has
suggested the use of an auditor's expert to obtain evidence in respect of the
fair value of the land.
Required
In respect of the land recognised as investment property:
(i) Explain the additional information which you require to plan the audit
of the land; and
(ii) Explain the matters to be considered in assessing the reliance which
can be placed on the work of an auditor's expert.
(14 marks)
(LO 2.6, 2.7, 3.3, 5.1) (Total = 20 marks)
23 Lychee
(1) You are the manager responsible for the audit of Lychee Co, a manufacturing
company with a year ended 30 September 20X9.
The financial statements of Lychee show revenue for the year ended 30
September 20X9 of Rs. 3,500 million, net profit of Rs. 700 million, and total
assets at the year-end are Rs. 18,500 million.
Additionally, Lychee has a small subsidiary called Pomelo Co which is
audited by another firm of auditors. Reliance is placed on the audit report
of the this firm, there are no concerns and no modification to the group
audit report is required. Pomelo Co has generated revenue for the year
ended 30 September 20X9 of Rs. 420 million, net profit of Rs. 65 million,
and total assets at the year-end are Rs. 1,900 million.
The draft audit opinion for the group and for the parent, Lychee are both
unmodified.
The finance director of Lychee Co telephoned you this morning to tell you
about the announcement yesterday, of a significant restructuring of Lychee
Co, which will take place over the next six months. The restructuring will
involve the closure of a factory, and its relocation to another part of the
country. There will be some redundancies and the estimated cost of closure
is Rs. 58 million. The financial statements have not been amended in respect
of this matter.
CA Sri Lanka 93
Questions
Required
In respect of the announcement of the restructuring:
(i) Comment on the financial reporting implications, and advise the
further audit procedures to be performed; and (6 marks)
(ii) Recommend the actions to be taken by the auditor if the financial
statements are not amended (4 marks)
(2) The finance director is aware that there is guidance for auditors relating to
audit reports in SLAuS 706 Emphasis of Matter Paragraphs and Other Matter
Paragraphs in the Independent Auditor's Report. The audit partner has asked
you to
Required
(i) Explain the purpose of an emphasis of matter paragraph and draft a
suitable emphasis of matter paragraph on the basis that the financial
statements fully and adequately disclose the expected restructuring
and factory closure costs. (5 marks)
(ii) Explain the purpose of an other matter paragraph and draft a suitable
other matter paragraph to bring to the readers’ attention that Pomelo
Co is audited by another firm of auditors. (5 marks)
(LO 5.3, 5.4) (Total = 20 marks)
24 Willow
Willow Pvt Ltd (Willow) is a print supplier to businesses, printing catalogues,
leaflets, training manuals and stationery to order. It specialises in using 100%
recycled paper in its printing, a fact which is promoted heavily in its advertising.
You are a senior audit manager in Bark & Co, and you have just been placed in
charge of the audit of Willow Co. The audit for the year ended 31 August 20X1 is
nearing completion, and you are reviewing a summary of outstanding issues:
Summary of issues for manager's attention, prepared by audit senior
Materiality has been determined as follows.
• Rs. 800,000 for assets and liabilities
• Rs. 250,000 for income and expenses
Issues related to audit work performed:
(i) Audit work on inventory
Audit procedures performed at the inventory count indicated that printed
inventory items with a value of Rs. 130,000 were potentially obsolete. These
94 CA Sri Lanka
items were mainly out of date training manuals. The finance director, Cherry
Laurel, has not written off this inventory as she argues that the paper on
which the items are printed can be recycled and used again in future printing
orders. However, the items appear not to be recyclable as they are coated in
plastic. The junior who performed the audit work on inventory has
requested a written representation from management to confirm that the
items can be recycled and no further procedures relevant to these items
have been performed.
(ii) Audit work on provisions
Willow is involved in a court case with a competitor, Aspen Pvt Ltd (Aspen),
which alleges that a design used in Willow's printed material copies one of
Aspen's designs which are protected under copyright. Our evidence obtained
is a verbal confirmation from Willow's lawyers that a claim of Rs. 125,000
has been made against Willow, which is probable to be paid. Cherry Laurel
has not made a provision, arguing that it is immaterial. Cherry refused our
request to ask the lawyers to confirm their opinion on the matter in writing,
saying it is not worth bothering the lawyers again on such a trivial matter.
(iii) Audit work on current assets
Willow made a loan of Rs. 6,000 to Cherry Laurel, the finance director, on 30
June 20X1. The amount is recognised as a current asset. The loan carries an
interest rate of 4% which we have confirmed to be the market rate for short-
term loans and we have concluded that the loan is an arm's length
transaction. Cherry has provided written confirmation that she intends to
repay the loan by 31 March 20X2. The only other audit work performed was
to agree the cash payment to the cash book. Details of the loan made to
Cherry have not been separately disclosed in the financial statements.
Other issues for your attention:
Property revaluations
Willow currently adopts an accounting policy of recognising properties at cost.
During the audit of non-current assets Willow's property manager said that the
company is considering a change of accounting policy so that properties would be
recognised at fair value from 1 January 20X2.
Non-current asset register
The audit of non-current assets was delayed by a week. We had asked for the non-
current asset register reconciliation to be completed by the client prior to
commencement of our audit procedures on non-current assets, but it seems that
the person responsible for the reconciliation went on holiday having forgotten to
prepare the reconciliation. This happened on last year's audit as well, and the
issue was discussed with the audit committee at that time.
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Questions
Procurement procedures
We found during our testing of trade payables that an approved supplier list is not
maintained, and invoices received are not always matched back to goods received
notes. This was mentioned to the procurement manager, who said that suppliers
are switched fairly often, depending on which supplier is the cheapest, so it would
be difficult to maintain an up-to-date approved supplier list.
Financial controller
Mia Fern, Willow’s financial controller, owns a holiday home overseas. It appears
that she offered the audit team free use of the holiday home for three weeks after
the audit, as a reward for the team's hard work. She also bought lunch for the
audit team on most days.
Required
(1) Evaluate the audit implications of the three issues related to the audit work
raised by the audit senior. You should consider the sufficiency of evidence
obtained, any necessary adjustments to the financial statements and the
impact on the audit report if any necessary adjustments are not made.
(15 marks)
(2) Advise on the matters, other than the three issues related to the audit work
raised by the audit senior, which should be brought to the attention of
Willow’s audit committee. (5 marks)
(LO 5.1, 5.2, 5.3) (Total = 20 marks)
25 Lapwing
You are a manager in Lapwing & Co. One of your audit clients is Hawk Plc (Hawk)
which operates commercial real estate properties typically comprising several
floors of retail units and leisure facilities such as cinemas and health clubs, which
are rented out to provide rental income.
Your firm has just been approached to provide an additional engagement for
Hawk, to review and provide a report on the company's business plan, including
forecast financial statements for the 12-month period to 31 May 20X3. Hawk is in
the process of negotiating a new bank loan of Rs. 30 million and the report on the
business plan is at the request of the bank. It is anticipated that the loan would be
advanced in August 20X2 and would carry an interest rate of 4%. The report
would be provided by your firm's business advisory department.
96 CA Sri Lanka
Extracts from the forecast financial statements included in the business plan are
given below.
STATEMENT OF PROFIT OR LOSS (EXTRACT)
Notes FORECAST UNAUDITED
12 months to 12 months to
31 May 20X3 31 May 20X2
Rs'000 Rs'000
Revenue 25,000 20,600
Operating expenses (16,550) (14,420)
Operating profit 8,450 6,180
Profit on disposal of Beak Retail 1 4,720 –
Finance costs (2,650) (1,690)
Profit before tax 10,520 4,490
STATEMENT OF FINANCIAL POSITION
Notes FORECAST UNAUDITED
31 May 20X3 31 May 20X2
Assets Rs'000 Rs'000
Non-current assets
Property, plant and equipment 2 330,150 293,000
Current assets
Inventory 500 450
Cash and cash equivalents 2,250 3,750
6,350 7,500
Total assets 336,500 300,500
Equity and liabilities
Equity
Retained earnings 93,400 92,600
Total equity 198,400 192,600
Non-current liabilities
Long-term borrowings 2 82,500 52,500
Deferred tax 50,000 50,000
Current liabilities
Trade payables 5,600 5,400
Total liabilities 138,100 107,900
Total equity and liabilities 336,500 300,500
CA Sri Lanka 97
Questions
Notes
1 Beak Retail is a retail park which is underperforming. Its sale is currently
being negotiated, and is expected to take place in September 20X2.
2 Hawk Plc is planning to invest the cash raised from the bank loan in a new
retail and leisure park which is being developed jointly with another
company, Kestrel Plc.
Required
(1) Evaluate the matters that should be considered in agreeing the terms of the
engagement to provide a report on Hawk’s business plan. (6 marks)
(2) Recommend the procedures that should be performed in order to examine
and report on the forecast financial statements of Hawk for the year to 31
May 20X3. (10 marks)
(3) Advise on the ethical issues which are relevant when providing other
services to an audit client. (4 marks)
(LO 6.1-6.4. 7.4, 7.5) (Total 20 = marks)
26 Baltimore
You are a manager in the business advisory department of Goleen & Co. Baltimore
owns auditors cannot perform other assurance services to ensure independence
of the statutory audit. Therefore, Baltimore have approached Goleen & Co. to
provide agreed upon procedures assurance to Baltimore Plc (Baltimore) relating
the to the potential acquisition is Mizzen Pvt Ltd.
Baltimore is a book publisher specialising in publishing textbooks and academic
journals. In the last few years the market has changed significantly, with the
majority of customers purchasing books from online sellers. This has led to a
reduction in profits, and the company has recognised that it needs to diversify its
product range in order to survive. As a result of this, Baltimore has decided to
offer a subscription-based website to customers, which would provide the
customer with unlimited access to its full range of textbooks and journals online in
exchange for an annual subscription fee for each year for subscription.
On investigating how to set up this website, Baltimore found that it lacked
sufficient knowledge and resources to develop this themselves and began to look
for another company which had the necessary skills, with a view to acquiring the
company. It has identified Mizzen Pvt Ltd (Mizzen), which provides an online
publishing platform for readers of digital books, as a potential acquisition.
Baltimore has approached the bank for a loan which will be used to finance the
acquisition if it goes ahead.
98 CA Sri Lanka
Baltimore is seeking agreed upon procedures assurance Goleen & Co to support its
finance application to the bank, should it decided to proceed with the acquisition.
Potential acquisition of Mizzen by Baltimore

Mizzen was established four years ago by two university graduates, Vic Sandhu
and Lou Lien, who secured funds from a venture capitalist company, BizGrow, to
set up the company. Vic and Lou created a new type of website interface which has
proven extremely popular, and which led to the company growing rapidly and
building a good reputation. They continue to innovate and have won awards for
website design. Vic and Lou have a minority shareholding in Mizzen.
Mizzen employs 50 people and operates from premises owned by BizGrow, for
which a nominal rent of Rs. 1,000 is paid annually. The company uses few assets
other than computer equipment and fixtures and fittings. The biggest expense is
wages and salaries and due to increased demand for website development,
freelance specialists have been used in the last six months. According to the most
recent audited financial statements, Mizzen has a bank balance of Rs. 500,000.
The company has three revenue streams:
(i) Developing and maintaining websites for corporate customers. Mizzen
charges a one-off fee to its customers for the initial development of a website
and for maintaining the website for two years. The amount of this fee
depends on the size and complexity of the website and averages at
Rs. 10,000 per website. The customer can then choose to pay another one-off
fee, averaging Rs. 2,000, for Mizzen to provide maintenance for a further five
years.
(ii) Mizzen has also developed a subscription-based website on which it
provides access to technical material for computer specialists. Customers
pay an annual fee of Rs. 250 which gives them unlimited access to the
website. This accounts for approximately 30% of Mizzen's total revenue.
(iii) The company has built up several customer databases which are made
available, for a fee, to other companies for marketing purposes. This is the
smallest revenue stream, accounting for approximately 20% of Mizzen's
total revenue.
CA Sri Lanka 99
Questions
Extracts from audited financial statements of Mizzen Pvt Ltd

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
Year ended Year ended Year ended Year ended
30 30 30 30
September September September September
20X3 20X2 20X1 20X0
Rs'000 Rs'000 Rs'000 Rs'000
Revenue 4,268 3,450 2,150 500
Operating expenses (2,118) (2,010) (1,290) (1,000)
Operating profit/(loss) 2,150 1,440 860 (500)
Finance costs (250) (250) (250) –
Profit/(loss) before tax 1,900 1,190 610 (500)
Tax expense (475) (300) (140) –
Profit/(loss) for the 1,425 890 470 (500)
year
There were no items of other comprehensive income recognised in any year.
Required
(1) Advise on the matters which you would focus on in your agreed upon
procedures audit of Mizzen Pvt Ltd for your client, Baltimore, and
recommend the additional information which you will need to perform this
assurance engagement. (15 marks)
(2) Advise on the type of conclusion which would be issued for an agreed upon
procedures report in comparison to an audit report. (2 marks)
Expansion of Goleen & Co services
On a completely separate matter, Goleen & Co is considering expanding the range
of services offered by its business advisory department. Ingrid Sharapova, a senior
manager, has suggested that the firm could offer a recruitment advisory service to
its current audit clients, specialising in the recruitment of finance professionals.
Goleen & Co would charge a fee for this service based on the salary of the
employee recruited. Ingrid Sharapova worked as a recruitment consultant for a
year before deciding to train as an accountant.
(3) Evaluate the ethical and practice management implications of the proposal
by Goleen & Co to offer recruitment advisory services to its existing audit
clients. (3 marks)
(LO 6.1, 6.3, 6.4, 7.4, 7.5) (Total = 20 marks)
100 CA Sri Lanka

27 Banana
You are a manager in Grape & Co. You have been temporarily assigned as audit
manager to the audit of Banana Pvt Ltd (Banana), because the engagement
manager has been taken ill. The final audit of Banana for the year ended
30 September 20X9 is nearing completion, and you are now reviewing the audit
files and discussing the audit with the junior members of the audit team. Banana
designs and manufactures equipment such as cranes and scaffolding, which are
used in the construction industry. The equipment usually follows a standard
design, but sometimes Banana designs specific items for customers according to
contractually agreed specifications. The draft financial statements show revenue
of Rs. 12.5 million, net profit of Rs. 400,000, and total assets of Rs. 78 million.
The following information has come to your attention during your review of the
audit files.
During the year, a new range of manufacturing plant was introduced to the
factories operated by Banana. All factory employees received training from an
external training firm on how to safely operate the machinery, at a total cost of
Rs. 500,000. The training costs have been capitalised into the cost of the new
machinery, as the finance director argues that the training is necessary in order
for the machinery to generate an economic benefit. After the year end, Cherry Pvt
Ltd (Cherry), a major customer with whom Banana has several significant
contracts, announced its insolvency, and that procedures to shut down the
company had commenced. The administrators of Cherry have suggested that the
company may be able to pay approximately 25% of the amounts owed to its trade
payables (creditors). A trade receivable of Rs. 300,000 is recognised on Banana's
statement of financial position in respect of this customer.
In addition, one of the junior members of the audit team voiced concerns over
how the audit had been managed. The junior said the following:
'I have only worked on two audits prior to being assigned the audit team of
Banana. I was expecting to attend a meeting at the start of the audit, where the
partner and other senior members of the audit team discussed the audit, but no
meeting was held. In addition, the audit manager has been away on holiday for
three weeks, and left a senior in charge. However, the senior was busy with other
assignments, so was not always available.
CA Sri Lanka 101

Questions
'I was given the task of auditing the goodwill which arose on an acquisition made
during the year. I also worked on the audit of inventory, and attended the
inventory count, which was quite complicated, as Banana has a lot of work-in-
progress. I tried to be as useful as possible during the count, and helped the
client's staff count some of the raw materials. As I had been to the inventory count,
I was asked by the audit senior to challenge the finance director regarding the
adequacy of the provision against inventory, which the senior felt was
significantly understated.
'Lastly, we found that we were running out of time to complete our audit
procedures. The audit senior advised that we should reduce the sample sizes used
in our tests as a way of saving time. He also suggested that if we picked an item as
part of our sample for which it would be time consuming to find the relevant
evidence, then we should pick a different item which would be quicker to audit.'
Required
(1) Evaluate the matters to be considered and the audit evidence you should
expect to find during your file review in respect of:
(i) The training costs that have been capitalised into the cost of the new
machinery
(ii) The trade receivable recognised in relation to Cherry (12 marks)
(2) Evaluate the junior’s concerns regarding the management of the audit of
Banana. (8 marks)
(LO 5.2, 5.3, 7.1, 7.2, 7.3) (Total = 20 marks)
28 Retriever
Kennel & Co is the external audit provider for the Retriever Group (the Group), a
manufacturer of mobile phones and laptop computers. The Group obtained a stock
exchange listing in July 20X9. The audit of the consolidated financial statements
for the year ended 28 February 20Y0 is nearing completion.
You are a manager in the audit department of Kennel & Co, responsible for
conducting engagement quality control reviews on listed audit clients. You have
discussed the Group audit with some of the junior members of the audit team, one
of whom made the following comments about how it was planned and carried out:
"The audit has been quite time-pressured. The audit manager told the juniors not
to perform some of the planned audit procedures on items such as directors'
emoluments and share capital as they are considered to be low risk. He also
instructed us not to use the firm's statistical sampling methods in selecting trade
102 CA Sri Lanka

receivables balances for testing, as it would be quicker to pick the sample based
on our own judgement.
Two of the juniors were given the tasks of auditing trade payables and going
concern. The audit manager asked us to review each other's work as it would be
good training for us, and he didn't have time to review everything.
I was discussing the Group's tax position with the financial controller, when she
said that she was struggling to calculate the deferred tax asset that should be
recognised. The deferred tax asset has arisen because several of the Group's
subsidiaries have been loss-making this year, creating unutilised tax losses. As I
had just studied deferred tax at college I did the calculation of the Group's
deferred tax position for her. The audit manager said this saved time as we now
would not have to audit the deferred tax figure.
The financial controller also asked for my advice as to how the tax losses could be
utilised by the Group in the future. I provided her with some tax planning
recommendations, for which she was very grateful."
In addition, the audit committee of the Group has contacted Kennel & Co to
discuss an incident that took place on 1 June 20YO. On that date, there was a
burglary at the Group's warehouse where inventory is stored prior to despatch to
customers. CCTV filmed the thieves loading a lorry belonging to the Group with
boxes containing finished goods. The last inventory count took place on 30 April
20Y0.
The Group has insurance cover in place and Kennel & Co's internal audit service
has been asked to undertake a special investigation in order to determine the
amount to be claimed in respect of the burglary. The insurance covers the cost of
assets lost as a result of thefts.
It is thought that the amount of the claim will be immaterial to the Group's
financial statements, and there is no ethical threat in Kennel & Co's internal audit
services providing the services requested.
Additionally, Retriever Group would like to extend its overdraft facility and its
banker, Golden Bank, has asked for confirmation that account payables liabilities
as at 28 February 20YO of Rs. 15 million are fairly stated. Retriever Group would
like an auditor to undergo further agreed-upon procedures to confirm the
accounts payable balance with individual suppliers to Golden Bank in a separate
report.
Required
(1) Evaluate the quality control, ethical and other professional matters arising
in respect of the planning and performance of the group audit. (10 marks)
(2) Advise on the matters to be considered and the steps to be taken in planning
the internal audit special investigation. (4 marks)
CA Sri Lanka 103

Questions
(3) Recommend the audit procedures to be performed in determining the

amount of the claim. (4 marks)
(4) Explain the main reporting requirements of an agreed upon procedures
engagement and provide a draft report format for the required accounts
payable report to Retriever Group and Golden Bank which will need to be
agreed as part of engagement acceptance. (7 marks)
(LO 3.4, 6.3, 7.1-7.5, 8.1-8.7) (Total = 25 marks)
29 Megabon Plc
Viastrom & Co has just been appointed as the auditor of Megabon Plc, a large
insurance company, for the year ending 31 January 20X0. During the year,
Megabon has made a substantial investment in a new internal audit software
system. This system enables the internal audit team to run real time internal
auditing procedures on any area of the transaction processing and accounting
system. The software is designed to identify any anomalous transactions and
thereby reduce the risk of fraud and error. For the year to date, 50% more errors
have been detected than the finance staff discovered in the previous year.
In a separate project, Megabon has purchased an automated investment decision
making programme that has enabled Megabon to reduce its team of 160 analysts
to 20. The analysts had previously been responsible for instigating the company's
investments, managing the overall liquidity position of the company, and
recording the company's performance. This software uses machine learning based
artificial intelligence on an initial set of parameters around risk levels and
liquidity requirements to attempt to maximise investment returns.
The investments that are chosen by the system are enacted and settled using a
blockchain ledger. The blockchain was set up by a group of global securities
exchanges with the aim of providing a single system to invest in shares, bonds,
commodities and other stocks traded on various exchanges around the world. The
blockchain ledger also records investment transactions and provides real time
investment data.
The blockchain ledger uses 'blocks' of information with a unique encrypted code
for each, to store and record information on a digital 'chain' once the transaction is
completed. The blockchain transaction is recorded and distributed across a large
network of computers but cannot be edited by the exchange or investment
companies providing a control around the validity and completeness of
transactions.
The blockchain is accessed by many global investment companies who have
successfully a rigorous application process which includes minimum liquidity and
IT security requirements..
104 CA Sri Lanka

The benefit of accessing the blockchain is that it allows for almost real-time
settlement that had previously taken several days and thus frees up liquidity for
the company and allows much greater agility to quicker alter its investment
strategy. In addition, information produced is fully encrypted and cannot be
altered before it feeds directly into the company’s financial reporting system to
track gains and losses on investments, and to automatically value investments and
provide automated liquidity analysis and other investment trading data in real
time.
Megabon holds a large amount of its customers' data, including banking details,
and is concerned at recent news reports of data breaches at similar companies.
Required
(1) Discuss the potential impact of the following new systems on the external
auditor of Megabon PLC.
(i) New internal audit software system.
(ii) Automated investment decision making software; and
(iii) Blockchain ledger
(15 marks)
(2) Explain TWO cyber-security risks that a Megabon Plc faces and suggest how
they could mitigate against those risks.
(5 marks)
(LO 4.1.1, 4.4.1) (Total = 20 marks)
CA Sri Lanka 105

Answers
CL1 Advanced A udit A nd Assurance | Answers
82 CA Sri Lanka
CL1 Advanced A udit and A ssur ance | Answers
Part 1 Objective Test Questions

Questions 1 to 60 are short form objective test questions covering all areas of the
syllabus. You will see this type of question in Section A of the exam.
1 D The CA Sri Lanka Code of Ethics (s. 290) does not allow the following to
have a direct or indirect material financial interest in a client: the audit
firm, a member of the audit team and an immediate family member of a
member of the audit team.
2 A Valuation for an immaterial matter can be undertaken for a public

interest entity provided safeguards exist, such as second partner
review and the use of separate personnel for the valuation and the
audit. Assistance can be given in tax disputes provided the firm is not
acting as an advocate of the client and the effect of the matter is
material to the financial statements. Internal audit services can be
provided except where this would result in the audit firm's personnel
assuming management responsibility.
3 C The risk of material misstatement at the assertion level is made up of

inherent risk and control risk. Detection risk is the risk that the
auditor's procedures will not detect a misstatement that exists in an
assertion that could be material. Audit risk is the risk that the auditor
gives an inappropriate audit opinion when the financial statements are
materially misstated. Audit risk is made up of inherent risk, control risk
and detection risk (AR = IR × CR × DR)
4 A Performance materiality may be set for particular classes of

transactions, account balances or disclosures. Directors' remuneration
is an account where law and regulation affect users' expectations
regarding disclosure. A lower level of performance materiality
therefore should be applied. Exploration and development costs are
material due to the industry in which the company operates, and
therefore merits a lower performance materiality level.
SLAuS 320, Materiality in Planning and Performing an Audit requires
performance materiality to be set to reduce to an appropriately low
level the probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial statements as a
whole. All uncorrected misstatements should be cumulated and
communicated to management, unless they are clearly trivial.
5 C The auditor cannot affect control risk or inherent risk. The auditor can
reduce audit risk by manipulating detection risk. Increasing sample
sizes and assigning more experienced staff to the audit will both reduce
detection risk and therefore audit risk.
CA Sri Lanka 83
Answers
6 D The matters mentioned in option D relate specifically to business

operations. The matters mentioned in the other options relate
specifically to financial reporting A, investments B and financing C.
7 B ICEQs would be best suited to help auditors identify the key controls
for controls testing. ICQs focus on whether the desirable controls are
present, and so would not identify the areas at risk of specific errors or
frauds. Narrative notes describe and explain the system, but their
detailed nature makes it difficult to identify control exceptions at a
glance. Flowcharts also describe the system but do not highlight
exceptions.
8 D Records of program changes and virus checks are general IT controls.
9 B This means that customers are not able to exceed their credit limits
and are therefore more likely to be able to pay. A helps to ensure that
goods are sold at the right price. C & D are effective controls regarding
the recovery of debts but do not prevent sales being made to customers
who are unlikely to pay as the sale has already been made by this stage.
10 C The matching of dispatch notes to an invoice ensures that for all goods
dispatched an invoice has been raised. If this is not the case sales and
trade receivables may be understated. For answer B an appropriate
control would be to match dispatch notes to invoices. Matching
dispatch notes and invoices would not prevent orders being dispatched
incorrectly (A) or prevent invoices being input incorrectly (D).
11 C This is in accordance with guidance given in SLAuS 265,

Communicating Deficiencies in Internal Control to Those Charged with
Governance and Management. If the likelihood of material
misstatement and the number of transactions affected by the
deficiency is low, the deficiency is unlikely to be judged to be
significant.
12 A The control helps to ensure sales are valid as sales are only recognised
for goods which have been dispatched.
13 A The direction of the test is important here. The sample is taken from
sales invoices, as this tests whether each sales order has been fulfilled
(the assertion of occurrence). If the sample is taken from goods
despatched notes, this would instead confirm whether the goods sold
had been correctly invoiced (the assertion of completeness). C and D
both test for completeness.
14 B The risk here is the overstatement of sales revenue. Audit procedure 1

tests for cut-off, where potential errors may cause revenue to be
overstated. Audit procedure 3 is a test of occurrence, also focusing on
the overstatement of revenue. Audit procedure 2 tests for
completeness, so therefore identifies the understatement of revenue
84 CA Sri Lanka
instead. Audit procedure 4 relates to classification – this assertion has

no impact on the overall revenue balance.
15 A (160/420) ´ 365
16 D Computer-assisted audit techniques cannot replace the skill of

judgement used by the auditor.
17 A In accordance with SLAuS 610 Using the Work of Internal Auditors the
external auditor is prohibited from using the work of internal audit in
this situation as the risks to the quality of the evidence provided are
too great.
18 B The vehicle registration document records the details of the legal

registered owner of the vehicle.
19 B As the goods have been received, the goods must be recognised as an

asset and the liability for the goods must be recognised at the period
end. As a purchase invoice has not been received and the invoice
amount has not been accrued for, liabilities are understated. This
implies that the corresponding asset (inventory) is also understated.
20 B Where the period used by management to determine whether the

entity is a going concern is less than 12 months from the period end,
the auditor should request that management extends the assessment
period to at least 12 months from the period end (SLAuS 570 Going
concern: para. 13).
21 D The basic elements of the auditor's report are title, addressee,

introductory paragraph, management's responsibility for financial
statements, auditor's responsibility, opinion paragraph, other
reporting responsibilities, auditor's signature, date of the report and
auditor's address.
22 C Both statements are materially misstated as the asset must be written

off reducing the profit for the year. An unmodified opinion can only be
issued if both statements are adjusted.
23 B A qualified opinion is appropriate, because the matter is considered to

be material, but not pervasive. An unmodified opinion with an
emphasis of matter paragraph is not relevant: it serves to draw the
attention of users to a matter appropriately presented or disclosed in
the financial statements, which is fundamental to the users'
understanding of the financial statements.
24 B The matter should be described in a material uncertainty related to

going concern paragraph, in accordance with SLAuS 570 (: para. 19)
Going concern. The other matter paragraph is used to refer to a matter
that is not presented or disclosed in the financial statements: the
material uncertainty is disclosed in this case, so that would not be
CA Sri Lanka 85
Answers
appropriate. The emphasis of matter paragraph does not modify the

audit opinion. As the going concern assumption is appropriate and
there is adequate disclosure, the audit opinion should not be modified.
25 D The review of audit working paper files to ensure that the audit has
been performed in accordance with professional standards and
regulatory and legal requirements is carried out by the audit
engagement partner.
Vimukthi Ltd.
26 B In accordance with SLAuS 580, Written Representations, written

representations must be dated as near as is practicable, but not after,
the date of the auditor's report.
C and D are after the date of the auditor's report therefore would not
be relevant audit evidence in forming the audit opinion.
A is possible as it is before 15 March but does not answer the question
which is asking for the latest date on which they can be signed.
27 A SLAuS 560, Subsequent Events requires auditors to obtain sufficient

appropriate evidence of events occurring between the date of the
financial statements (31 December 20X6) and the date of the auditor's
report (15 March 20X7).
Event 2 takes place after 15 March 20X7 therefore B and C are
incorrect. The auditor does have a responsibility in respect of Event 1
therefore D is incorrect.
28 C All misstatements accumulated during the audit must be

communicated to the appropriate level of management SLAuS 450,
Evaluation of Misstatements Identified during the Audit, Accumulated
misstatements are all misstatements except those which are clearly
trivial.
D is incorrect as it only refers to material uncorrected misstatements
being communicated.
Uncorrected misstatements only are communicated to those charged
with governance, therefore A and B are incorrect.
29 B SLAuS 720, The Auditors Responsibilities Relating to Other Information

in Documents Containing Audited Financial Statements requires the
inclusion of an Other Information section in the auditor's report.
A and D are incorrect as the matter is addressed in the auditor's report
but not in an Emphasis of Matter paragraph.
86 CA Sri Lanka
C is incorrect as the audit opinion is on the financial statements, not the

other information.
30 B The audit opinion is not modified as the auditor agrees with the
treatment of the claim and the disclosure is adequate. There is a
material uncertainty re going concern and in accordance with SLAuS
570, Going Concern this is addressed in the Material Uncertainty
Related to Going Concern section of the auditor's report.
A and C are incorrect as the audit opinion would not be modified as the
financial statements are not mis-stated and sufficient audit evidence
has been obtained.
D is incorrect as an Emphasis of Matter paragraph is not used to
disclose a material uncertainty related to going concern.
Ratwatte Ltd.
31 The correct answer is: The external audit is an exercise carried out by
auditors in order to give an opinion on whether the financial statements of a
company are fairly presented.
The external audit is carried out by external auditors, who are independent
of the company so that they can provide an independent opinion on whether
the company's financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework. The principal
aim of the audit is not in relation to the control system in place or to identify
other areas of deficiency, although deficiencies and recommendations may
be suggested by the external auditors as a by-product of the external audit in
a report to management at the conclusion of the audit.
32 The correct answer is: Jayakody & Co should perform specific audit
procedures to identify possible non-compliance.
SLAuS 250, Consideration of Laws and Regulations in an Audit of Financial
Statements distinguishes between regulations which have a direct effect on
the financial statements (in the sense of directly affecting the determination
of balances) and those which do not have a direct effect but can still have a
material effect (such as an operating licence).
The hygiene regulations do not have a direct effect but they may have a
material effect. The external auditor must therefore perform audit
procedures to help identify any non-compliance which might have a material
effect on the financial statements, ie any breaches of the hygiene regulations
that could result in material fines or restaurant closures.
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Answers
33 The correct answer is: The determination of materiality

This review engagement is an example of an assurance engagement. There
are five elements to an assurance engagement: criteria, report, evidence,
subject matter and three-party relationship (CREST) (IFAC, 2016).
34 The correct answer is: Limited; Negative.

A review engagement, such as a review of compliance with hygiene
regulations, is an assurance engagement where the practitioner carries out
limited procedures on Ratwatte's internal controls relating to hygiene
compliance.
As the procedures are limited, the practitioner will gain only enough
evidence to provide a negative expression of opinion. This means the
practitioner gives assurance that nothing has come to their attention which
indicates that Ratwatte's internal controls relating to hygiene compliance are
not, in all material respects, compliant with national regulation.
35 The correct answer is: The lucrative nature of the review engagement may
make the external audit team less inclined to require management to make
adjustments or to issue a modified audit opinion, for fear of losing the review
engagement.
The fees from the review engagement are likely to be very lucrative, so there
is a risk that Jayakody & Co will not seek adjustments during the external
audit process for fear of upsetting the board of Ratwatte and losing the
review engagement work.
The provision of non-audit services to unlisted audit clients is not
specifically prohibited. While Jayakody & Co should be alert to self-review
threats, in this case it seems unlikely: the scenario states that the review
engagement does not include the provision of accounting advice or the
preparation of figures in the financial statements. A firm is not required to
turn down work when a 15% limit is exceeded. Where fee income from a
listed audit client is expected to exceed 15% of the audit firm's total fee
revenue, this fact should be disclosed to those charged with governance and
a separate review may be required (The Institute of Chartered Accountants
of Sri Lanka Code of Ethics para. 290.217). However, the 15% fee cap is not a
major concern to YHT & Co in this instance because Ratwatte is unlisted.
88 CA Sri Lanka
Bridgford
36 The correct answer is:
Audit
strategy Detailed
Area document audit plan
(1) The availability of the client's data and X
staff (including internal audit)
(2) The allocation of responsibility for X
specific audit procedures to audit team
members
(3) The audit procedures to be undertaken X
for each area of the financial statements
(4) The potential for using computer-assisted X
audit techniques (CAATs) to gather
evidence
The audit strategy includes areas such as identifying the characteristics of

the engagement, the reporting objectives, timing and nature of
communications, knowledge gained from previous audits and during the
preliminary risk assessments and the nature, timing and extent of resources
in terms of using appropriate personnel.
The availability of the client's data and staff (including internal audit) and
the potential for using CAATs are included in the characteristics of the
engagement.
The auditor will take the overall audit strategy and convert it into a more
detailed audit plan. This will include the allocation of work to audit team
members and the audit procedures to be undertaken for each area of the

Performance materiality refers to the amounts set by the auditor at higher
than the materiality level for particular classes of transactions, account
balances or disclosures where the materiality level might otherwise mean
that such items are not tested.
The auditor sets performance materiality at an amount which is lower than
the materiality level for the financial statements as a whole. This is so that
the impact of misstatements for particular classes of transactions, account
balances or disclosures will be considered even if they are not material to
the financial statements as a whole SLAuS 320, Materiality in Planning and
Performing an Audit.
CA Sri Lanka 89
Answers

Perform a trend analysis on current year and prior year monthly revenue, to
identify whether revenue is overstated as a result of fraud or error
An overstatement of revenue would result in a reduction, not an increase in
the receivables collection period.

That the financial statements include balances due from credit customers
which are not recoverable
The audit risk relates to the concern about receivables taking 127 days to
settle their invoices rather than the permitted 90 days (3-month credit
terms), and that some customers are refusing to pay for products due to the
reliability issues encountered. This means that the financial statements may
include balances from receivables that are not recoverable. This would result
in an overstatement of assets, and gives rise to concerns about the valuation
of receivables.
Despite the worsening working capital position indicated by the increase in
the receivables collection period, on its own it is unlikely to give rise to
doubts over Bridgford's going concern status.
40 The correct answers are:

Determine how often inventory counts are performed and the level of
corrections required to the inventory system
Test the operation of the inventory system using CAATs
The risk which has been identified relates to inventory quantities. Testing
the operation of the inventory system using CAATs and reviewing the level
of corrections required to the system would provide evidence regarding the
operation of the system used to record the number of units of inventory
held.
Reviewing purchase requisitions is a test to determine whether
authorisation controls are in place to prevent orders of unnecessary items.
The comparison of cost and net realisable value is a valid audit test, however
it provides evidence regarding the valuation of inventory rather than
quantity.
90 CA Sri Lanka
South
41 The correct answers are: To ensure appropriate attention is devoted to
important areas of the audit; To assist in the co-ordination of work done by
any auditor's experts.
The main aim of planning is not to ensure the audit is completed within
budget restraints, but to ensure that it is carried out in an effective manner
as described by the other statements (SLAuS 300, Planning an Audit of
Financial Statements).
The determination of whether the audit engagement is ethically acceptable
should have been done before the planning stage, and is not therefore an
objective of planning.
Procedure Assertion
Review financial statement Presentation

notes
Read minutes of board Completeness

meetings for evidence of
share issues
Recalculate the closing Accuracy, valuation

balance on the share capital and allocation
account
Review Memorandum and Existence

Articles of Association and
compare their requirements
with issued share capital
Comparing issued share capital with the Memorandum and Articles of

Association relates to existence because 'equity' that is not issued pursuant
to those documents does not legally exist.
43 The correct answer is: Inspect invoices capitalised within the cost of the new
till system to determine whether they are directly attributable to the cost of
the new till system
The audit risk relates to the concern that South may have capitalised costs
which are revenue in nature. As such the appropriate response is to review
the invoices which have been capitalised not just for their amount but also to
determine the nature of the expense to which the invoice relates.
CA Sri Lanka 91
Answers
44 The correct answers are: Perform analytical procedures by comparing

daily/weekly sales by store with both the prior year and with expectations,
in order to determine whether any unusual patterns have occurred following
the installation of the new system; Obtain a copy of the training manual
relating to the new till system and discuss with directors the extent of
training staff have received on the new system.
The audit risk relates to the concern that the system may not be reliable, that
not all invoices have been recorded and that staff may not be familiar with
the system.
Vouching the revenue per the system back to till receipts is not a valid
response to the audit risk. Given that one concern is that revenue is
understated, testing should be from the till receipts to the system to ensure
that all sales have been recorded. Similarly, agreeing revenue from till
receipts to the cashbook is also the wrong way around – this test should
begin with the cashbook in order to test for completeness.
45 The correct answers are: To assess whether a provision for customer

compensation is required in South's financial statements; To determine
whether disclosure of the nature and financial effect of the legal claim is
required in South's financial statements.
The concern over deficiencies in South's internal controls is a valid concern,
but the review of legal correspondence is unlikely to be an appropriate
response to this as the auditor would need to review internal controls. The
impact on the reputation of South is also a valid concern as it could have
implications for the viability of the company but again it is unlikely that
information specifically relating to this would be available in the legal
correspondence reviewed.
Madugalle Ltd.
46 The correct answer is: Revenue may be overstated if it is recognised
according to the contract date rather than over the relevant accounting
period.
There is a risk that the revenue for the annual fees is not properly recognised
in the period to which it relates, leading to revenue (and deferred income)
being materially misstated in the financial statements. Revenue should be
recognised according to the accounting period in which the related
performance obligations of the contract are met.
92 CA Sri Lanka
47 The correct answers are: Obtain a breakdown of the capitalised costs and
agree a sample of items to invoices to determine the nature of the
expenditure; Inspect management's review of whether the value of the
aircraft has been impaired.
The auditor should obtain a breakdown of the capitalised costs and vouch
them back to invoices to determine whether they relate to a capital or
revenue expense. They can then determine whether they have been
recognised appropriately in accordance with SLFRS 16 Property, Plant and
Equipment.
The large amount of refitting work could also indicate that something is
wrong with the aircraft and that their value has become impaired.
48 The correct answer is: Madugalle's going concern status may be at risk if the
contract is not renewed.
The key risk here is going concern. It is possible that the company will lose
one of only four customers. In addition, a bank loan is being renegotiated
and it is expected that costs will increase. This may threaten Madugalle's
ability to continue as a going concern.
49 The correct answers are: Review Madugalle's contracts with its other three
customers to determine whether they contain a break clause, in order to
determine the likelihood of losing any further contracts to other aircraft
providers; Review the short-term and long-term funding facilities which are
available to Madugalle.
The main risk here is to the going concern assumption, if Madugalle loses
other key sources of revenue. The auditor would therefore want to consider
whether this is likely, by reviewing the other contracts. If, as appears likely,
they do, then Madugalle would need a source of funding to survive.
It would not be appropriate to contact an audit client's customer directly in
relation to a matter such as this.
The issue of disclosure would only need to be considered once the going
concern status of Madugalle had been determined.

Audit concern Not audit concern
Non-current assets a
Inventory a
Completeness a
Accuracy, valuation and a
allocation
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Specialist equipment has been removed from the aircraft and is now
included in inventory. Inventory should be valued at the lower of cost and
net realisable value, not at amortised cost. The fact that the equipment has
been replaced suggests that its net realisable value is lower than its cost.
This may mean that inventory is overstated in the financial statements.
Weerawansa
The auditor observes client staff to determine whether inventory count
procedures are being followed.
The auditor reviews procedures for identifying damaged, obsolete and slow-
moving inventory.
Management is responsible for organising the inventory count, not the
auditor. If the results of the auditor's test counts are not satisfactory, the
auditor can request that inventory is recounted, but the auditor cannot insist
on a recount. However, if management refuses the auditor's request then the
auditor will need to consider the implications of this on the auditor's report.

For a sample of inventory sold just before and just after the year end, match
dates of sales invoices/date posted to ledgers with date on related goods
dispatched notes.
All of the suggested audit procedures test the valuation assumption, except
for matching the dates of sales invoices with the dates on the related goods
dispatched notes, which is an audit procedure around cut-off.

The legal claim should not be recorded as a provision but disclosed as a
contingent liability because a present obligation exists, but the outflow
of economic resources is not probable.
Management believe that there is a 35% chance of the claim succeeding. For
an event to be 'probable', it should be more likely than not to occur (ie a 50%
probability) (SLFRS 37). In this case, the outflow of economic resources is
therefore not probable, so a provision should not be recognised. A present
obligation (not a possible obligation) exists, since the former managing
director has sued Weerawansa for unfair dismissal. It is because the
likelihood of him succeeding in his claim is not probable that the claim
should be treated as a contingent liability instead of a provision.
94 CA Sri Lanka

Send an enquiry letter to Weerawansa's lawyers to obtain their view as to
the probability of the claim being successful
Independent third-party audit evidence is generally considered to be more
reliable than client generated or auditor-generated audit evidence. Although
all the procedures are valid, only the written confirmation from
Weerawansa's lawyers provides an expert, third-party confirmation on the
likelihood of the claim being successful. It is also sent directly to the auditor
rather than to the client.
55 To perform specific procedures to identify possible non-compliance

SLAuS 250, Consideration of Laws and Regulations in an Audit of Financial
Statements distinguishes between those laws and regulations which have a
direct effect on the financial statements, and those which have an indirect
effect. For those which do not have a direct effect on the financial statements
the auditor must undertake specified audit procedures to help identify
non-compliance with laws and regulations that may have a material effect on
the financial statements (SLAuS 250, Consideration of Laws and Regulations
in an Audit of Financial Statements).
Gemunu & Silva

56 The correct answer is: A written representation should be requested from
management to confirm whether they believe that the effects of the
unadjusted misstatements are immaterial, both individually and in
aggregate, to the financial statements as a whole
SLAuS 450 Evaluation of Misstatements Identified During the Audit states that
the auditor has a responsibility to accumulate misstatements identified
during the audit, other than those that are clearly trivial (SLAuS 450).
All the accumulated misstatements should be communicated to the
appropriate level of management on a timely basis (SLAuS 450). The auditor
must request that management correct the misstatements.
If management refuses to correct some or all of the misstatements, the
auditor must obtain an understanding of the reasons for not making the
corrections, and take these into account when determining whether the
financial statements are free from material misstatement (SLAuS 450). This
may affect the auditor's opinion if this results in the financial statements
being materially misstated, but the refusal to correct the misstatements does
not affect the opinion.
The auditor should determine whether uncorrected misstatements are
material, both individually and in aggregate (SLAuS 450).
CA Sri Lanka 95
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57 The correct answer is: 1 and 2

Audit procedures should focus on determining the extent of research
expenditure which has been incorrectly capitalised.
Whilst it is generally important to authorise expenditure, the issue is not
authorisation or occurrence but its classification.
58 The correct answer is: Qualified opinion

Research expenditure of Rs2.1m has been capitalised within intangible
assets. This accounting treatment is incorrect, as SLFRS 38 Intangible Assets
requires research expenditure to be expensed to profit or loss (SLFRS 38).
The error is material as it represents 8% of profit before tax
(Rs2.1m/Rs26.3m).
Management should adjust the financial statements by removing the Rs2.1m
research expenditure from intangibles and debiting the amount to profit or
loss.
If management refuse to make the adjustment, the auditor's opinion will
need to be modified. As the error is material but not pervasive, a qualified
opinion would seem appropriate.
The basis of opinion section would need to include a paragraph explaining
the misstatement and its effect on the financial statements. The opinion
paragraph would be qualified 'except for'.

Material Financial statement impact
Yes Wages may be materially misstated
Two months' worth of wages records have been lost and so audit evidence
has not been gained in relation to this expense. Wages and salaries for the 2-
month period represent 11% of profit before tax (Rs1.1m/Rs10m) and so
wages and salaries may be materially misstated.
Audit opinion Disclosure in the auditor's report

Qualified Basis for qualified opinion
The auditors should seek alternative audit procedures to audit the wages
and salaries account. If no alternative audit procedures are possible, the loss
of data would constitute a lack of sufficient appropriate audit evidence.
The auditors will need to modify the auditor's opinion on the basis that they
are unable to obtain sufficient appropriate evidence in relation to a material
96 CA Sri Lanka
amount in the financial statements. As the two months' salary and wages are
not pervasive, a qualified opinion would seem appropriate.
The basis of opinion section would require an explanation of the insufficient
audit evidence in relation to wages and salaries. The opinion paragraph
would be qualified on the grounds of an inability to obtain sufficient
appropriate audit evidence.
CA Sri Lanka 97
Answers
Section 2: 10 Mark Structured Response Questions

Part A Governance and Internal Control Frameworks
Questions 1 to 4 in this section cover Governance and Internal Control
Frameworks, the subject of Chapters 1 to 3 of the Study Text.
1 Jafna Flowers
Internal control activities
(1) Receipts, processing and recording of orders
All orders should be recorded on pre-printed sequentially numbered
documentation. This could be a four part document, one copy being the
order, one copy being the dispatch note, one copy being sent to the customer
as evidence of the order and the last copy retained by the accounts
receivable clerk.
To ensure completeness of orders a sequence check should be performed on
the documents either manually or by computer. Any missing documents
should be traced.
As the clerk inputs the order the system should automatically check whether
the customer remains within its credit limit. Any orders which exceed the
credit limit should be rejected.
In exceptional circumstances where credit limits are to be exceeded this
should be authorised by the department manager. Orders should also be
rejected if the customer has a significantly overdue balance.
As the order is being input the system should check whether the item
required is in inventory. This is possible as the ordering and inventories
systems are integrated. If items are unavailable the order should be rejected.
This will enable the clerk to inform the customer which will enhance
customer service.
Periodically an independent review should be performed of the standing
data on the system. A sample of credit limits should be checked to ensure
that they have been calculated in accordance with the standard formula. Any
breaches should be investigated. Similarly the price of flowers should be
matched against an up to date price list.
Sales invoices should be posted automatically to the sales daybook and
accounts receivable ledger. An accounts receivable control account
reconciliation should be performed on a monthly basis and any
discrepancies should be investigated and dealt with.
98 CA Sri Lanka
Customer statements should be generated by the system automatically. Any

queries raised by the customer on receipt of these should be investigated
promptly. Any resulting credit notes should be authorised.
(2) Collection of cash
Details of all bank transfers received should be input into the cash
book/bank control account and the accounts receivable ledger and accounts
receivable control account.
Entries in the accounts receivable ledger should be matched against specific
invoices. Any unallocated cash should be investigated via an exception
report.
On a monthly basis a bank reconciliation should be performed. Together
with the accounts receivable control account reconciliation and the following
up of queries on customer statements this will help to ensure that the cash is
correctly recorded and allocated.
On a monthly basis an aged receivables listing should be generated. The
company should have procedures in place for the chasing of debts which the
credit controller would follow ranging from a telephone reminder to the
threat of legal action.
2 Lily Window Glass Plc

(Note: Only five deficiencies and five related recommendations are needed to gain
10 marks.)
(1) Deficiency (2) Recommendation

The warehouse manager will supervise the An independent supervisor should be
inventory count and is not independent as assigned, such as a manager from the
he has overall responsibility for the internal audit department.
inventory. He therefore has an incentive to
conceal or fail to report any issues that
could reflect badly upon him.
Aisles or areas counted will not be flagged. Once areas have been counted they
This could result in items being double should be flagged. At the end of the
counted or not counted at all. count the supervisor should check all
areas have been flagged and therefore
counted.
There is no-one who is independent Instead of the internal auditors being
reviewing controls over the count or test involved in the count itself, they should
counting to assess the accuracy of the perform secondary test counts and
counts. review controls over the count.
CA Sri Lanka 99
Answers

Damaged goods are being left in their Damaged goods should be clearly
location rather than being stored marked as such during the count and
separately. This makes it more difficult for at the end of the count they should be
finance to assess the level of damage to the moved to a central location. A manager
goods and establish the level of write down from the finance team should then
needed. Also, if not moved, damaged goods inspect these damaged goods to assess
could be sold by mistake. the level of allowance or write down
needed.
Due to the continuous production process, Although it is not practicable to disrupt
there will be movement of goods in and out the continuous production process,
of the warehouse during the count, raw materials (RM) required for 31
increasing the risk of double counting or December should be estimated and
failing to count inventory. This could mean separated from the remainder of
inventory in the financial statements is inventory. These materials should be
under or overstated. included as part of work-in-progress
(WIP).
Goods manufactured on 31 December
should be stored separately, and at the
end of the count should be counted
once and included as finished goods.
Goods received from suppliers should
also be stored separately, counted
once at the end and included in RM.
Goods dispatched to customers should
be kept to a minimum during the
count.
The warehouse manager is going to A specialist should be used assess the
estimate WIP levels. The warehouse work-in-progress.
manager is unlikely to have the necessary
experience to estimate the WIP levels
which is something the factory manager
would be more familiar with. Alternatively
a specialist may be needed to make the
estimate. This could ultimately result in an
inaccurate WIP balance in the financial
statements.
100 CA Sri Lanka


The warehouse manager is going to As in previous years, a specialist
approximate RM quantities. Although he is should assess the quantities of raw
familiar with the RM, and on the basis that materials, or at least check the
a specialist has been required in the past, warehouse manager's estimate to give
the warehouse manager may not have the comfort that the manager's estimates
necessary skill and experience to carry out will be reasonable going forward.
these measurements. This could result in
an inaccurate RM balance in the financial
statements.
There is no indication that inventory Inventory sheets should be signed by
sheets are signed or initialled by the both team members once an aisle is
counting team, nor a record kept of which completed. The supervisor should
team counted which area. This means it check the sheets are signed when
will be difficult to follow up on any handed in.
anomalies noted, as the identity of the
counters may not be known.
Inventory not listed on the sheets is to be Every team should be given a blank
entered onto separate sheets. These sheets sheet on which they can enter any
are not sequentially numbered and the inventory counted which is not on
supervisor will be unable to ensure the their sheets. The blank sheets should
completeness of all inventory sheets. be sequentially numbered with any
unused sheets returned at the end of
the count. The supervisor should then
check the sequence of all sheets.
The responsibilities of each of the two staff For each area one team member
members within a counting team is should be asked to count and the
unclear. It does not appear that one has second member asked to check that
been told to count and the other to check. the inventory has been counted
Therefore errors in counting may not be correctly. The roles of each can then be
picked up. reversed for the next area.
CA Sri Lanka 101

Answers
3 SouthLea Plc
Wages system – deficiencies and recommended controls
(Note: only 5 weaknesses and recommendations are required.)
(1) Deficiency (2) Internal control recommendation

The foreman is in a position to set up The issue of new employee numbers
fictitious employees on the wages should be authorised by a manager and
system as he has authority to issue supported by employee contract letters
temporary employee numbers. This etc.
would allow him to collect cash
wages for such bogus employees.
Employees could clock in a long time The foreman or another manager should
before starting work or clock out too supervise clocking in and out at the start
late in order to obtain wages for of a shift.
hours they have not worked. Before wages are paid, management
should compare hours logged in the
system to budget and previous months
and investigate any unexpected increases.
The two wages clerks are responsible The list of personnel should be matched
for the set up and maintenance of all with the payroll by a manager and all new
employee records. They could employee records should be authorised
therefore, in collusion, set up bogus before being set up on the system.
employees and collect cash wages
from them.
The wages clerks are responsible for Any amendments to standing data on the
making amendments to holidays and wages system should be done by an
illness etc. They could make authorised manager so that unauthorised
unauthorised amendments which amendments are not made. A log of
affect individual staff members' pay. amendments should be regularly
reviewed.
The computer system calculates A payslip should be generated by the
gross pay and any deductions but computer system and included in the
these are hand-written by the wages wage packet to reduce the chance of
clerks for the staff pay packets, so errors in deductions and gross pay being
errors could be made and incorrect made.
wages issued.
102 CA Sri Lanka

(1) Deficiency (2) Internal control recommendation

The computer automatically One of the wages clerks should check the
calculates gross pay and deductions, gross pay and deductions for a sample of
however there is no check to ensure employees to gain assurance that the
the calculations are accurate. computer is calculating amounts
correctly.
Management should compare gross pay
and deductions to budget and prior
months and any unexpected differences
should be investigated.
The foreman distributes cash wages The distribution of wages should be
to the employees. He could therefore overseen by another manager. Unclaimed
misappropriate any wages not wages should be noted on a form and
claimed. returned to the wages department.
4 Matalas (Pvt) Ltd

(Note: Only 5 deficiencies and controls are required.)
(1) Deficiency (2) Control

The amount of cash held in the petty The amount of the petty cash balance at
cash box is high (Rs. 5,000) in each branch should be reviewed. Based
comparison to the average monthly on an average monthly expense of
expenditure of (Rs. 1,538). This Rs. 1,538, a balance of Rs. 2,000 would
increases the risk that the cash will be seem reasonable.
stolen or that errors will be made in
counting.
The petty cash box is not physically The petty cash box should be kept in
secure as it is kept on a bookcase in the the branch safe or in a locked drawer in
accounts office. This increases the risk the accountant's desk.
of theft.
Reimbursement for petty cash All petty cash claims should be
expenditure takes place without supported by a receipt.
evidence of the expenditure being
incurred eg receipt. This may result in
false claims being made.
The petty cash vouchers are not All petty cash vouchers should be
authorised – they are only signed by the authorised by the accounts clerk.
individual claiming reimbursement.
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(1) Deficiency (2) Control

In some instances significant items are Expenditure over a certain limit (eg
purchased through petty cash (up to Rs. Rs. 50) should be authorised in
500). These are not authorised prior to advance.
the purchase being made. This could
result in unnecessary expense being
incurred.
There is no indication that the vouchers Petty cash vouchers should be pre-
are pre-numbered, meaning that the numbered. On entry into the petty cash
branch cannot confirm completeness of book the sequential numbering should
the vouchers. Unauthorised claims be checked to ensure that all
could be made and then blamed on expenditure has been completely
missing vouchers. recorded.
There is a lack of segregation of duties. The accountant should check the petty
The petty cash is counted by the cash count to confirm the accuracy of
accounts clerk who is also responsible the balance and ensure that the asset is
for the cash balance. There is no safeguarded.
additional independent check on the
petty cash balance.
Whilst the accountant confirms that the The petty cash vouchers should be
cheque to reimburse petty cash agrees reviewed by the accountant to confirm
to the journal entry to the general that the monthly petty cash
ledger, the petty cash vouchers are not expenditure agrees to the
reviewed to support the amounts reimbursement cheque and journal
involved. entries.
104 CA Sri Lanka

Part B Audit Planning and Risk Assessment

Questions 5 to 10 cover Audit Planning Risk Assessment, the subject of Chapters 4
to 6 of the Study Text.
5 Favorita Plc
(1) During planning, the auditor must establish materiality for the financial
statements as a whole. However, if there are classes of transactions, account
balances or disclosures for which misstatements less than materiality for the
financial statements as a whole could reasonably be expected to influence
the economic decisions of users taken on the basis of the financial
statements, the auditor must also determine materiality levels to be applied
to these.
The auditor must also determine performance materiality in order to assess
the risks of material misstatement and to determine the nature, timing and
extent of further audit procedures. Determining materiality for the financial
statements as a whole involves the exercise of professional judgement.
Generally, a percentage is applied to a chosen benchmark as a starting point
for determining materiality for the financial statements as a whole. The
following factors may affect the identification of an appropriate benchmark:
· Elements of the financial statements (eg assets, liabilities, equity,
revenue, expenses)
· Whether there are items on which users tend to focus
· Nature of the entity, industry and economic environment
· Entity's ownership structure and financing
· Relative volatility of the benchmark
Materiality also has qualitative aspects. Some misstatements may fall under
the quantified materiality level, but are still considered material overall due
to their qualitative effects.
(2) (i) In this case, the financial statements are presented fairly and are not
materially misstated. This is because the Rs. 3,000 difference in assets
and net income will not make a difference to the financial statement
users (being an error of only 0.2% of equipment and 1.25% of profit).
The difference is therefore not material.
(ii) In this case, the financial statements are materially misstated. This is
mainly because profit is overstated by Rs.80,000 – a factor which
would make a difference to the users of the financial statements being
33.5% of profit. Trade payables are also understated by a significant
amount (6.7%), although the amount is not material.
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(iii) Here, even though the amount involved is relatively small, the item is
likely to be material, as illegal payments, if they are found out, could
harm the company's reputations, its operations and its share price. The
matter could therefore be considered qualitatively material, even
though it is not quantitatively so.
6 Paranthan Ltd
(1) Business risks
Factor (i)
Depending on the outcome of the court case the legal proceedings could
result in a significant cash outflow to the business. This may result in cash
flow problems making it difficult for the business to settle its liabilities. The
reputation of the company as an employer may also be damaged making it
difficult for the company to employ staff of the highest calibre.
Factor (ii)
The tough trading conditions indicate that the company may be struggling to
maintain its market share. Revenue and profitability may be affected as a
result. The business may suffer losses if sales are made to customers who are
not creditworthy and fail to pay for the goods they have purchased.
Extending the credit terms will have an adverse cash flow effect increasing
the risk of cash flow problems.
Factor (iii)
The high levels of returns will reduce revenue and profitability. The
company may have to incur costs to rectify the problems or may have to
write off the costs if the items are to be scrapped. The loss of customer
goodwill is also an issue which may affect levels of sales and profits in the
short to medium term. The company will need to incur costs in order to
rectify the issues with the faulty production line.
Factor (iv)
There is a risk that the new system is not operating effectively. Information
may be of poor quality and management may make incorrect decisions if the
information on which they are basing them is either incomplete or incorrect.
These decisions could affect any aspect of the business.
Factor (v)
The new supplier may not be reliable which may result in raw material not
being available when required, exacerbated by the longer delivery times
from Europe. This may cause disruption to the manufacturing process and
may mean that the company is not able to fulfil orders on time. The company
is also exposed to the risk of exchange rate fluctuations as the supplier
invoices in Euros.
106 CA Sri Lanka

(2) Risks of material misstatement

Factor (i)
The ongoing litigation increases the risk that liabilities may be understated if
the financial statements fail to include a liability for damages where there is
an obligation to pay these. Disclosures may be inadequate if there is a
contingent liability in respect of the damages which is not properly
disclosed.
This is a risk of material misstatement at the assertion level since only one
balance is affected.
Factor (ii)
There is an increased risk that receivables may be overstated as the relaxing
of credit checks increases the likelihood that credit is given to customers
who cannot pay. Extending the credit terms may also affect recoverability of
receivables as this may attract customers who have cash flow difficulties,
and therefore need to take advantage of the extended terms. This is a risk of
material misstatement at the assertion level since only one balance is
affected.
Factor (iii)
The increased levels of returns increases the risk of overstatement of
inventories. In accordance with LKAS 2 Inventories inventory must be valued
at the lower of cost and net realisable value. Inventory which has been
returned may need to be scrapped or may need to be repaired. In either case
net realisable value will need to be considered. The value of other inventory
produced on this production line also needs to be considered. There is also a
risk that inventory provisions are understated if no allowance has been
made for items sold which are likely to be returned due to the same fault.
This is a risk of material misstatement at the assertion level since only one
balance is affected.
Factor (iv)
The lack of testing of the new system increases the risk of material
misstatement throughout the financial statements. It increases the risk that
the information produced by the system is unreliable. It may contain errors
and/or it may be incomplete.
This is a risk of material misstatement at the financial statement level since
all balances in the financial statements are affected.
Factor (v)
The added complexity of exchange rate translation calculations increases the
risk of misstatement in the financial statements. The transactions should be
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accounted for in accordance with LKAS 21 The Effects of Changes in Foreign

Exchange Rates. Balances potentially affected include purchases, inventory
and trade payables.
This is a risk of material misstatement at the financial statement level since
many balances in the financial statements are affected.
7 Zak Ltd
Revenue
Although the directors have indicated that the company has had a difficult year,
revenue has increased from the previous year by 18%. The auditors need to
establish the reason for this increase as it does not correlate with the directors'
comments.
Cost of sales
Cost of sales has fallen by 17% in comparison to the previous year – this is strange
given that revenue has increased, as one would expect cost of sales to similarly
increase. The reason for this decrease needs to be ascertained. It could be as a
result of closing inventory being undervalued.
Gross profit
Gross profit has increased dramatically by 88% in comparison to the previous
year. The reason for this needs to be established, given that revenue has increased
but cost of sales has decreased.
Administration costs
Administration costs have fallen slightly by 6%. This appears unusual given that
revenue has increased from the previous year, as one would expect the increased
revenue to lead to increased administration costs. Expenditure in this area may be
understated perhaps as a result of incorrect cut-off being applied.
Selling and distribution costs
Selling and distribution costs have increased significantly by 42%. An increase is
expected given that revenue has also increased, however the increase is not
comparable. There may have been a misallocation between administration and
selling and distribution costs – again this will need to be investigated thoroughly.
Interest payable
It is surprising that Zak has a reasonable cash surplus this year but still continues
to pay a similar level of interest. The interest payable may be overstated and the
reasons for interest payments not decreasing despite the absence of the large
overdrawn balance seen last year must be established. One explanation for this
might be a cash injection immediately prior to the year end.
108 CA Sri Lanka

8 Sleeptight Ltd
(1) Audit risk (2) Auditor's response
The directors only work part-time at The controls will need to be documented
Sleeptight and there is no finance director. and evaluated. If these are weak the level
This may promote a weak control of substantive testing will need to be
environment, resulting in undetected increased accordingly.
errors or frauds.
SLFRS 15 requires the revenue to be Enquire of management the point at which
recognised when control of the good revenue is actually recognised, and review
passes to the customer. The requirement the system of accounting for deposits to
for customers to pay 40% on ordering and ensure they are not included in revenue
the remainder following delivery could until goods delivered and signed for.
result in revenue recorded before it should For a sample of transactions within 8
be, if the deposit is recorded as a sale and weeks of the year end, ensure the revenue
not deferred until delivery. The deposit recorded is only in respect of beds
should be treated as a liability until control delivered to customers in the same period
passes on delivery per SLFRS 15 and then and ensure they have been signed for.
recognised as revenue on delivery.
Recognising the deposit as revenue before
delivery of the bed would result in revenue
being overstated.
Alternatively, revenue could be
understated if the revenue is only
recognised when the final payment is
received, rather than on delivery of the
bed.
LKAS 37 requires that if there is a legal Establish the basis of the amount provided
obligation that is probable to result in an for and assumptions made by the financial
outflow of economic benefit of a reliably controller.
measured amount then a provision should Re-perform any calculations and establish
be made. The two year guarantee on the the level of warranty costs in the year, and
beds therefore gives rise to a provision, the compare with the previous provision.
measurement of which involves a high Review the level of repair costs incurred
degree judgement, and therefore carries a post year-end and use these to assess the
risk of misstatement. reasonableness of the provision.
The current year raw materials costs for For a sample of materials to include the
materials also in inventory last year are cost of wood, compare material costs to
based on prices at least a year old. They actual prices on invoices. Investigate and
should be based on the actual cost or resolve any significant differences and
reasonable average cost. Given that prices evaluate the potential impact on the
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fluctuate the value of year end raw inventory value in the financial statements.
materials may be over or undervalued due
to price rises/decreases occurring during
the year.
The finished goods value is to be estimated For beds awaiting dispatch, establish the
by Anna Silva, who appears to be basing lower of cost and NRV and compare with
her estimate on order value rather that the figures provided by Anna Silva.
applying the LKAS 2 rule that goods should Investigate any differences evaluate the
be valued at the lower of cost and NRV. potential impact on the inventory value in
This could result in inventory being the financial statements.
overstated in the financial statements.
The directors only work part-time at The controls will need to be documented
Sleeptight and there is no finance director. and evaluated. If these are weak the level
This may promote a weak control of substantive testing will need to be
environment, resulting in undetected increased accordingly.
errors or frauds.
The requirement for customers to pay 40% Enquire of management the point at which
on ordering and the remainder following revenue is actually recognised, and review
delivery could result in revenue recorded the system of accounting for deposits to
before it should be, if the deposit is ensure they are not included in revenue
recorded as a sale and not deferred until until goods delivered and signed for.
delivery. This would result in revenue For a sample of transactions within 8
being overstated. weeks of the year end, ensure the revenue
Alternatively, revenue could be recorded is only in respect of beds
understated if the revenue is only delivered to customers in the same period
recognised when the final payment is and ensure they have been signed for.
received, rather than on delivery of the
bed.
The two year guarantee on the beds gives Establish the basis of the amount provided
rise to a provision, the measurement of for and assumptions made by the financial
which involves a high degree judgement, controller.
and therefore carries a risk of Re-perform any calculations and establish
misstatement. the level of warranty costs in the year, and
compare with the previous provision.
Review the level of repair costs incurred
post year-end and use these to assess the
reasonableness of the provision.
The current year raw materials costs for For a sample of materials to include the
110 CA Sri Lanka


materials also in inventory last year are cost of wood, compare material costs to
based on prices at least a year old. They actual prices on invoices. Investigate and
should be based on the actual cost or resolve any significant differences and
reasonable average cost. Given that prices evaluate the potential impact on the
fluctuate the value of year end raw inventory value in the financial statements.
materials may be over or undervalued due
to price rises/decreases occurring during
the year.
The finished goods value is to be estimated For beds awaiting dispatch, establish the
by Anna Silva, who appears to be basing lower of cost and NRV and compare with
her estimate on order value rather that the figures provided by Anna Silva.
applying the LKAS 2 rule that goods should Investigate any differences evaluate the
be valued at the lower of cost and NRV. potential impact on the inventory value in
This could result in inventory being the financial statements.
overstated in the financial statements.
9 Ja-Ela Ltd
(1) Audit strategy document
Section Purpose Example relevant to Ja-Ela
Characteristics of Provides details of the Ja-Ela runs a chain of gastro pubs. As
the engagement industry and a result, it will need to comply with
regulatory significant food hygiene and health
environment the and safety regulations.
client operates in. The payroll function has been
Describes the entity's outsourced this year and evidence
activities. might not be readily available. The
auditors may need to arrange this in
advance.
Ja-Ela is growing and it will need to
be determined whether the
appropriate financial reporting
framework is SLFRS or SLFRS for
SME.
If the planned acquisition takes
place before year-end, sufficient
time and suitably qualified
resources will be needed to audit it
and ensure the correct disclosures
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Section Purpose Example relevant to Ja-Ela

are made in the financial
statements. Materiality will be
greater if Ja-Ela expands and this
will have an impact of the extent of
audit testing. The pubs being
acquired are all local, so the audit
team are unlikely to have difficulty
travelling to them for the purposes
of the audit.
Reporting Provides details of the The audit is being planned less than
objectives, timing client's reporting a month before the end of the period
of the audit dates, the proposed to be audited. It may be necessary to
engagement and timetable and dates schedule an initial meeting with
nature of for proposed meetings management before the year end, to
communications with management. ensure any necessary year-end
testing can be carried out (eg non-
current asset verification, food and
beverages inventory count.)
Significant factors, Identifies areas where Ja-Ela makes cash sales. This
preliminary there is a greater risk increases the susceptibility to fraud.
engagement of material An approach which can
activities, and misstatement and a appropriately test the completeness
knowledge gained greater susceptibility of income is needed.
on other to fraud. Details
engagements management's
commitment to
design,
implementation and
maintenance of a
sound internal control
environment. Details
the basis for setting
materiality.
(2) Audit team's responsibilities to obtain an understanding of the services

provided
Ricks & Co is a service organisation because it is an external organisation
that provides a service to Ja-Ela that could be done internally (it is managing
the payroll function for Ja-Ela). Under SLAuS 402 Audit considerations
relating to an entity using a service organisation, Ja-Ela is the user entity and
Sams & Co is the user auditor.
112 CA Sri Lanka

As the user auditor, Sams & Co must obtain an understanding of the services
provided by the service organisation (Ricks & Co) including:
(i) The nature of the services provided and the significance of these to the
Ja-Ela, including the effect on Ja-Ela's internal control
(ii) The nature and materiality of transactions processed or financial
reporting processes affected
(iii) The degree of interaction between Ricks & Co and Ja-Ela
(iv) The nature of the relationship including the contractual terms in place
between Ricks & Co and Ja-Ela
When obtaining an understanding of the internal control relevant to the
audit, Sams & Co must evaluate the design and implementation of relevant
controls at Ja-Ela that relate to the services provided by Ricks & Co.
10 Matale Products
(1) Auditors should plan their work so that:
(i) Attention is devoted towards the key audit areas. These will be areas
which are large in materiality terms, where there is significant risk of
material misstatement, or which have had significant problems in
previous years.
(ii) Staff are briefed. The audit strategy should provide enough detail about
the client to enable staff to carry out the detailed work effectively.
Budgets should ensure that appropriate time is spent on each audit
area.
(iii) The efficiency of the audit process should be enhanced. Good planning
should ensure that the right staff are selected, that information
technology is used appropriately, and that maximum use is made of
schedules prepared by the client and of the work of internal audit if
applicable.
(iv) The timing of the audit is appropriate. Staff will need to be available to
carry out an inventory count and circularisation of receivables at the
year-end. If use is to be made of work done by the client or internal
audit, then this work will need to have been completed in time for the
final audit. The timing should also allow sufficient time for the audit to
be completed so that the financial statements can be signed on the date
desired by the client.
(v) Review is facilitated. Setting out an audit plan and budgets at the
planning stage means that the reviewer has measures against which
the work can be examined at the end of the assignment.
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(2)
Matters to consider Further action
Whether data was accurately The auditor will need to determine the
transferred in to the new system on process by which information was input in
1 June 20X8 and whether the to the new system and the level of testing
computerised inventory system is which was done by the client to ascertain the
reliable for determining the quantity accuracy of the transfer.
of inventory at the year end. The auditor will also need to document the
new system.
If they are to rely on to gather audit evidence
they will also need to test the system using
computer assisted audit techniques.
Whether there are provisions The auditor should consider the outcome of
required in the financial statements any legal action in the post year end period
which have not been provided for, in order to determine whether any write
as a result of the production downs need to be made to the carrying
problems. amounts of both receivables and inventory
These could relate to provisions for and whether provision for legal claims is
legal claims by customers, necessary.
allowances against receivables (if
customers refuse to pay for
defective goods) and provisions to
reduce the carrying amount of
inventory to the lower of cost and
net realisable value.
Whether the extended credit offered The auditor should examine Matale's cash
to new customers may lead Matale flow position at the year end and its cash
to experience cash flow difficulties flow forecasts for the future (at least 12
and ultimately raise concern over months) in order to assess whether it is
the entity's ability to continue as a likely to struggle to meet its obligations as
going concern. they fall due.
They should also consider whether there is a
risk that the extended credit terms may
mean that there is an increase risk that
receivables may not be recoverable.
114 CA Sri Lanka

11 Regulation
The storage of the potentially hazardous chemicals raises concerns that the
company being audited may not be complying with regulations such as health and
safety legislation. The auditor needs to consider the requirements of SLAUS 250
Consideration of Laws and Regulations in an Audit of Financial Statements and the
Sri Lanka Code of Ethics. It is management's responsibility to ensure that the
entity's operations are conducted in accordance with the provisions of laws and
regulation. However, the auditor does have some responsibility, especially where
Non-Compliance with Laws and Regulations ('NOCLAR') has an effect on the
The auditor is required by SLAUS 315 Understanding the entity and its
environment and assessing the risks of material misstatement to obtain an
understanding of the legal and regulatory framework in which the audited entity
operates. This will help the auditor to identify NOCLAR and to assess its
implications. Therefore, the auditor should obtain a full knowledge and
understanding of the laws and regulations relevant to the storage of items in the
company's warehouses, focusing on health and safety issues and the implications
of NOCLAR.
SLAUS 250 requires that when NOCLAR is identified or suspected, the auditor
shall obtain an understanding of the nature of the act and of the circumstances in
which it has occurred, and further information to evaluate the possible effect on
the financial statements. Therefore, procedures should be performed to obtain
evidence about the suspected non-compliance, and to identify any further
instances of NOCLAR in the company's other warehouses.
Management may not be aware that the warehouse manager is allowing the
storage of these potentially hazardous items. SLAUS 250 requires the matter to be
discussed with management, and, where appropriate, with those charged with
governance. The Sri Lanka Code of Ethics requires the NOCLAR to be
communicated with the most appropriate level of management, ie at least one
level above the person involved. The auditor must therefore ignore the warehouse
manager's threats and communicate the suspected NOCLAR. Given the potential
severity of the situation, and that the chemicals may not be safe, there is the risk of
injury to the company's employees or the general public, so the matter should be
communicated as soon as possible.
The auditor needs to consider the potential implications for the financial
statements. The NOCLAR could lead to regulatory authorities imposing fines or
penalties on the company, which may need to be provided for directly in the
financial statements. Audit procedures should be performed to determine the
amount, materiality and probability of payment of any such fine or penalty
imposed.
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In terms of reporting NOCLAR to the relevant regulatory authorities, SLAUS 250

requires the auditor to determine whether they have a responsibility to report the
identified or suspected NOCLAR to parties outside the entity. In the event that
management or those charged with governance of the company fail to make the
necessary disclosures to the regulatory authorities, the auditor should consider
whether they should make the disclosure. This will depend on matters including
whether there is a legal duty to disclose or whether it is considered to be in the
public interest to do so. Confidentiality is also an issue, and if disclosure were to
be made by the auditor, it would be advisable to seek legal advice on the matter.
This is very much a worst case scenario, however, as the company's management
is likely to make the necessary disclosures, and should be encouraged by the
auditor to do so.
There is also an ethical issue arising from the warehouse manager's aggressive
attitude and threatening behaviour. It would seem that the manager has
something to hide, and that he was the only person who knew about the storage of
the chemicals. He may have been bribed to allow the storage of the dangerous
chemicals. His behaviour amounts to intimidation of the auditor, which is not
acceptable behaviour, and those charged with governance should be alerted to the
situation which arose. SLAUS 260 Communication of audit matters with those
charged with governance requires the auditor to communicate significant
difficulties encountered during the audit, which may include examples of lack of
co-operation with the auditor, and imposed limitations on auditors performing
their work.
The final issue is that the company should review its policy of requiring limited
documentation for contracts less than Rs10,000. This would seem to be
inappropriate because it may lead to other instances of unknown items being
stored in the company's warehouses. This would seem to be a significant control
deficiency, and should be reported to those charged with governance in
accordance with both SLAUS 260. The auditor could recommend improvements to
the controls over the storage of items which should prevent any further
non-compliance with laws and regulations from occurring.
116 CA Sri Lanka

Part C Gathering Audit Evidence

Questions 12 to 18 cover Gathering Audit Evidence, the subject of Chapters 7 to 14
of the Study Text.
12 Buttala (Pvt) Ltd

(1) Sampling methods
Methods of selecting a sample acceptable according to SLAuS 530 Audit
Sampling:
Random selection ensures that all items in the population have an equal
chance of selection, eg by use of random number tables or random number
generators.
Systematic selection involves selecting items using a constant interval
between selections, the first interval having a random start.
Haphazard selection is selection of a sample without following any
particular structured technique. It may be an alternative to random selection
provided auditors are satisfied that the sample is representative of the entire
population.
Block selection may be used to check whether certain items have particular
characteristics. For example an auditor may use a sample of 50 consecutive
cheques to test whether cheques are signed by authorised signatories rather
than picking 50 single cheques throughout the year.
(2) Purchase invoice based testing
Comparing a representative sample of purchase invoices to non-current
assets register and the annual budget proves only that those particular
invoices are accurately recorded and gives little evidence over completeness.
Purchase invoices form the basis of the entries on the asset register (they are
updated simultaneously) and testing one to the other will not detect missing
purchase invoices.
Similarly testing from the invoices to the budget will only aid in highlighting
an asset not recorded on the budget if that asset was delivered and the
invoice was received. However it will not identify missing asset entries for
items that have been delivered but no purchase invoice has received.
(3) Appropriate completeness test
The audit team could use a CAAT to compare the non-current asset register
to purchase orders, goods received notes and invoices. This will test for
completeness by identifying any assets not included in the non-current asset
register for which purchase orders, good received notes or invoices exist.
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Additionally, in order to test completeness of non-current asset records

effectively, a sample should be selected from assets which physically exist.
This sample should be agreed to the non-current asset register to ensure
assets in the factory are included in the financial records.
The auditors should also perform a review of the repair and maintenance
account to assess whether any items have been expensed when they should
have been capitalised. A sample of items should be agreed to invoice to
ensure they have been expensed appropriately.
13 Uva Toys (Pvt) Ltd

(1) Importance of cut-off in the audit of inventory
All purchases, transfers and sales of inventory must be recorded in the
correct accounting period as inventory can be a material figure for many
companies, particularly those engaged in manufacturing.
The points of purchase and receipt of goods and services are particularly
important in order to ensure that cut-off has been correctly applied. The
transfer of completed work-in-progress to finished goods is also important
as is the sale and dispatch of such goods.
Incorrect cut-off can result in misstatements in the financial statements at
the year-end and this can be of particular concern where inventory is
material.
Auditors therefore need to consider whether the management of the entity
being audited have implemented adequate cut-off procedures to ensure that
movements into and out of inventory are properly identified and reflected in
the accounting records and ultimately in the financial statements.
(2) Perpetual inventory counting systems
Where a perpetual inventory system is in place, the auditors should carry
out the following work:
• Talk to management to establish whether all inventory lines are
counted at least once a year.
• Inspect inventory records to confirm that adequate inventory records
are kept up-to-date.
• Review procedures and instructions for inventory counting and test
counts to ensure they are as rigorous as those for a year-end inventory
count.
• Observe inventory counts being carried out during the year to ensure
they are carried out properly and that instructions are followed.
118 CA Sri Lanka

• Where differences are found between inventory records and physical

inventory, review procedures for investigating them to ensure all
discrepancies are followed-up and resolved and that corrections are
authorised by a manager not taking part in the count.
• Review the year's inventory counts to confirm the extent of counting,
the treatment of differences and the overall accuracy of records, and to
decide whether a full year-end count will be necessary.
• Perform cut-off testing and analytical review to gain further comfort
over the accuracy of the year-end figure for inventory in the financial
statements.
(Note: Only 6 points are required.)
14 Badulla Ltd
Audit work on trade accounts receivable at the final audit
(i) Second circularisation
(1) Consider circularising all trade receivables accounts, or at least a larger
sample than before of accounts not circularised at 30 September.
(2) Circularise and investigate disagreeing replies. Discover if reasons are
similar to those given at 30 September circularisation.
(ii) To gain further evidence about the rights and obligations and existence of
receivables
(1) Check the sales invoices which make up the balances with backing
documentation, for example purchase orders and despatch notes (if the
latter exist).
(2) Ascertain extent of cash received from customers after the year-end;
reconcile the individual invoices to ensure that no discrepancies exist.
(3) Obtain explanations for invoices remaining unpaid after subsequent
invoices have been paid.
To gain evidence about the valuation of receivables, I would review the cash
received after-date and would also carry out the following tests.
(1) Check calculation of outstanding invoices.
(2) Carry out further tests on settlement discounts and ascertain whether
the position has improved or deteriorated since the time of the interim
audit.
(3) Confirm necessity/adequacy of provision against write-off of specific
debts by review of correspondence, solicitors' debt collection, agencies'
letters, liquidation statements.
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(4) Consider whether amounts owed may be not recovered where there
have been round sum payments on account or invoices unpaid after
subsequent invoices paid.
(5) Review customer files/correspondence from solicitors and
circularisation results for evidence of potential bad debts.
(6) Confirm the accuracy of allowances for irrecoverable receivables made
in the past.
I would check the completeness of receivables by carrying out cut-off tests at
31 December to ensure that all goods leaving the premises by that date (and
only those) have been included in sales. I would also check that all returns of
goods after the year-end relating to 20X0 sales have been correctly recorded.
Other general tests include:
(1) Agree the opening balance on the sales ledger control account with the
previous year's working papers to ensure all the necessary
adjustments were put through last year.
(2) Scrutinise sales ledger control for unusual entries.
(3) Check list of trade account receivables balances to and from sales
ledger, and reconcile with sales ledger control account.
(4) Carry out analytical procedures, particularly reviewing changes in the
receivables turnover period, and changes in the age profile of
receivables.
(5) Check that trade receivables have been separately disclosed in the
notes to the accounts.
15 Rocks Forever
(1) Factors to consider
• The need for an auditor's expert
The auditor must consider the risk of material misstatement and
whether there is the required expertise within the audit firm. In this
case, as inventory is material and this is the only client in the diamond
industry which the firm has, it would seem appropriate to use an
expert. This need is increased by the specialised nature of the client's
business.
• The competence of the expert
The expert should be a member of a relevant professional body. The
auditor should also consider the individual's experience and reputation
in his field.
120 CA Sri Lanka

• The objectivity of the expert

The opinion of UJ could be clouded if, for example, they were related in
some manner to Rocks Forever. This could be a personal relationship
or one of financial dependence.
• The scope of the expert's work
If the auditor is to rely on this evidence it must be relevant to the audit
of inventory. In this case UJ is considering issues which will impact on
the valuation of inventory. This is of great importance to the auditor
and is therefore relevant.
• Evaluation of the work performed
The auditor will need to assess the quality of the work performed by
the expert. The auditor will consider the following:
– Source data used
– Assumptions and methods used and their consistency with
previous years
– The consistency of the results of UJ's work with other audit
evidence taking into account UJ's overall knowledge of the
business.
In spite of the fact that the auditor's expertise is limited in this field UJ
may test the data used by UJ. For example comparative price
information may be available from other shops or industry sources.
(2) Inventory valuation: audit procedures
The key principle is that inventory should be valued at the lower of cost and
net realisable value.
Cost
For a sample of items agree the cost price to the original purchase invoice.
Care should be taken to ensure that the invoice relates specifically to the
item in question.
Net realisable value
Review the report produced by UJ for any indication that items are fake.
(This is unlikely to be the case but should be confirmed.)
For a sample of items sold after the year end verify that the sales price
exceeds cost. Where this is not the case the item should be written down to
its net realisable value.
Confirm that items valued by the valuer have been included in the inventory
total at this valuation. If there are discrepancies the inventory balance
should be revised to include UJ's valuation.
Obtain a schedule of the ageing of inventory. For items identified as slow
moving discuss with management the need to make an allowance.
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16 Panadura (Pvt) Ltd

(1) Advantages of Computer-Assisted Audit Techniques (CAATs)
Time savings
Potentially time-consuming procedures, such as checking casts of ledgers,
can be carried out much more quickly using CAATs.
Reduction in risk
Larger samples can be tested, giving greater confidence that material errors
have not been missed.
Testing programmed controls
Without CAATs many controls within computerised systems cannot be
tested, as they may not produce any documentary evidence. This gives
greater flexibility of approach.
Cost effective
Many CAATs have low set-up costs, such as where information is
downloaded from the client's system onto the auditor's copy of the same
system. Even where CAATs have had to be written specially for a particular
audit, the on-going costs will be minimal as they can be reused until the
client changes its systems.
(2)
Test data Reason
Order for unusually high quantities, This would identify whether any
eg 20 racquets reject controls requiring special
authorisation for large orders are
effective. This control would also
prompt the customer to recheck the
quantity if they had accidentally
keyed in the wrong quantity.
Orders with fields left blank This would give evidence as to
whether orders could be accepted
that prove impossible to deliver
because, for example, the name of the
town has been omitted from the
delivery address.
Orders with invalid credit card This will identify whether the
details controls over the ordering system
will protect the company from losses
arising from credit card frauds.
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Test data Reason

Orders with details of customers on This will identify whether the
retailers' 'blacklists' or of cards that company has effective procedures to
have been reported as stolen ensure that their system is regularly
updated for security. This should
reduce the risk of bad debts.
Order with invalid inventory code This will show whether the system
will alert the customer to the code
error and prompt them to check it.
This should ensure that the correct
goods are dispatched.
Order with complete and valid This order should be accepted by the
details system so will allow the auditor to
inspect the order confirmation to
determine whether the order details
are transferred accurately into the
dispatch system.
17 Jaffna Oil Plc

(1) Analytical procedures
• Analytical procedures involve the evaluation of financial information
by comparing it with financial and non-financial data and investigating
fluctuations/relationships which are inconsistent with other
information.
• They are used at the planning stage of an audit to identify unusual
trends/ variances which may indicate audit risks.
• They can be used as a substantive audit procedure to gain audit
evidence. For example, reviewing the receivables collection period in
the current period compared to the prior year may highlight that
customers are taking longer to pay their balances, which in turn
suggests there may be balances that need an allowance made against
them.
• Finally they are used at the final review stage, where the audit senior/
manager must ensure they have sufficient appropriate evidence for the
trends shown in the completed financial statements.
(2) Three examples of analytical procedures
• Obtain a breakdown of monthly sales per petrol station analysed
according to income from fuel sales, shop sales and the car wash and
compare to other petrol stations in the company. Investigate significant
variances.
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• Compare the profit margins for fuel sales across each of the petrol
stations and investigate significant differences.
• Determine the average mark up charged on petrol and diesel from
management. Apply this mark up to the costs recorded and estimate
expected revenue. Compare estimated revenue with recorded revenue
and investigate significant differences.
(3) (i) Valuation of inventory (note only 2 procedures were required)
• For a sample of invoices received from oil suppliers/ other
suppliers vouch the cost of goods to invoices.
• If cost approximation is used, discuss method of cost
approximation with management (for example average cost) and
compare to current oil prices to ensure that the use of a cost
approximation is appropriate.
• For a sample of shop sales made post year end, agree sales price
to invoices to confirm the net realisable value of inventory is
greater than cost.
(ii) Completeness of payables
• Analytically review the level of payables this year compared to
prior year and discuss any balances that seem artificially low with
management.
• Request that Jaffna Oil Plc send a circularisation letter/
confirmation to the oil/ petrol supply company asking them to
send a reply to the auditor stating the balance owed by Jaffna Oil
to them at the year end.
• Review the cash book post year end for significant payments to
suppliers, trace large payments to the year end payables listing to
ensure they relate to balances for payments made to suppliers
post year end. Discuss any large payments not on the year end
listing to determine why these amounts were paid.
• For shop suppliers, calculate the payables payment period,
compare to prior year and investigate significant differences.
18 Mankulam Cakes Ltd

(1) Users of financial statements assume that the financial information they are
reading reflects transactions which have been carried out on an arms length
basis, ie on normal commercial terms, and between entities that are not
connected. If this is not the case then the way that the users may interpret
the information could be altered.
124 CA Sri Lanka

In order for the financial statements to reflect the transactions fairly and for
them to give a true and fair view, the users must be given all the information
they need to understand the nature of the transactions. This is why
disclosure of certain related party relationships and transactions is required.
(2) In accordance with the definition of a related party in SLAuS 550, Related
Parties, Albert Mankulam is a related party of Mankulam as he controls the
entity through his ownership of the majority of the ordinary share capital.
The other members of his family would not be seen as related parties as they
do not have sufficient shares to exercise control.
Celebration Cakes would be a related party of Mankulam as it is controlled
by Mankulam. This control is achieved through the ownership of 100% of
the equity shares.
Beautiful Biscuits would also be seen as a related party of Mankulam, even
though Mankulam does not own any shares directly. This is on the basis that
both Mankulam and Beautiful Biscuits are under common control through
having owners who are close family members. This because Mankulam is
controlled by Albert Mankulam and Beautiful Biscuits is controlled by his
wife, Anita.
(3) Audit procedures would include the following:
• Obtaining an understanding of Mankulam's system for identifying
related parties and related party transactions
• Reviewing prior year working papers for names of known related
parties
• Enquiring of management about any changes since the prior period
• Reviewing minutes of meeting of shareholders and directors
• Reviewing the register of directors' interests and other statutory
records
• Enquiring of management as to whether transactions have taken place
• Reviewing invoices and correspondence from lawyers
(Note: Only five procedures required for full marks)
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Part D Auditing in a digital environment

Question 19 covers Auditing in a digital environment, the subject of Chapter 15 in
the Study Text.
19 E-Spark Ltd
(1) Robotic Process Automation (RPA) is the use of software to complete
rules-based tasks more efficiently than is possible using manual processes.
Data analytics is the examination of data to try to identify patterns, trends
or correlations. As the quantity of data created by businesses has increased,
it has become more and more necessary to evolve ways of processing and
making sense of it. The combination of these can enable the auditor to use an
automated system to carry out data analytics on client information.
The automated, digital nature of RPA and data analytics means that the
auditor is able to test many more transactions and make a more accurate
assessment of controls. In some cases it is possible to test 100% of
transactions and look for fraud or error across the entire population rather
than undertaking a risk assessment and selecting a sample to test.
In the case of the audit of E-Spark it would appear that Endeavour Auditing
had difficulty completing the required testing due to the number of
transactions having increased. The use of RPA and data analytics would have
automated that process, reducing the time taken to carry out testing,
improving the accuracy of the results and potentially enabling the auditor to
test more items than would have previously been tested.
This does require the auditor to have sufficient technical knowledge to
implement RPA software, together with an investment in the software itself.
It also requires the integration of the client data into the automation
software to enable the testing to take place. However, if these issues can be
overcome, then the speed and quality of the audit are likely to increase.
(2) Cloud-based audit working papers are generated through the use of cloud
based software that both facilitates collaboration between the audit team,
and enables more efficient management of working papers.
The cloud-based nature of the system means that problems such as loss of
physical working papers would no longer exist, as the working papers would
be stored on the cloud and would always therefore be backed up. The loss of
the physical device when the audit junior's car was stolen is also no longer
such a problem (so long as the device is encrypted), since the working
papers are not stored on the device itself.
Other benefits include the following.
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The availability of real-time dashboards that enable audit managers to

quickly assess the status of the audit at a glance, and to take corrective action
where problems arise.
The integration of up-to-date auditing standards and requirements means
that compliance is made easier for the audit firm
The application of state of the art security and encryption standards, which
reduces the risk of storing data in comparison with storage on local hard
drives.
The working papers are accessible and can be collaborated on by all
members of the audit team in real-time.
(3) Block Chain uses 'blocks' of information with a unique code for each, to
store and record information on a digital 'chain' once verified. The
blockchain is recorded and distributed across a large network of computers
and cannot be edited.
The fact that the information is verified and then cannot be edited has been
claimed by some to have the potential to reduce the need for external audit,
as the block chain can be guaranteed to be 'correct' as it is immutable.
Whilst the blockchain can provide evidence both of a transaction having
occurred and of details about it, there will still be a need for judgement about
whether the transaction was authorised, whether it was with a related party
or was even fraudulent, and whether it has been accounted for appropriately
in accordance with Sri Lanka accounting standards. The auditor will
therefore need to assess the reliability of the information on the blockchain
together with its suitability for accounting purposes.
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Part E Evaluating Evidence and Audit Reporting

Questions 20 to 25 covers Evaluating Evidence and Audit Reporting, the subject of
Chapter 16 of the Study Text.
20 Moratuwa National Bakeries

Impact on audit report
(i) Freehold property
In past years this property has been shown in the statement at its original
cost, whereas it is now restated at Rs. 1,250,000 as professionally valued
during the year. The auditor is satisfied as to the basis of the revaluation,
adjustment to and disclosure made in the financial statements. As a result of
the audit evidence obtained no further reference to the property revaluation
will be required in the auditor's report.
(ii) Allowance for doubtful debts
No part of the debt of Rs. 45,000 outstanding is expected to be recovered by
the company. The financial statements which the directors have approved
include no allowance for this debt and contain a misstatement. This
misstatement is 10% of pre-tax profit so is material to the financial
statements. Since it only impacts upon one area of the financial statements, it
is not pervasive. The auditor's opinion will therefore need to be qualified due
to a material misstatement in the financial statements.
The opinion section of the auditor's report will be headed 'Qualified Opinion'
and will state that 'In our opinion, except for the failure to make such
allowance, the financial statements present fairly, in all material respects, (or
give a true and fair view of) the state of the company's affairs and its results.'
The opinion will be followed by a 'Basis for Qualified Opinion' paragraph
which will explain that no allowance has been made against an amount of
Rs. 45,000 owing by the customer which audit work has found to be
irrecoverable.
(iii) Loan to a director
The director's indebtedness of Rs. 23,000 which existed during a six week
period has not been disclosed in the financial statements in accordance with
LKAS 24 Related Party Transactions. This amount is material at 5.1% of
profit before tax. If the directors refuse to amend the financial statements
the auditor's report must be modified with a qualified opinion. The issue is
not pervasive to the financial statements since it only impacts one area and
thus an adverse opinion is not appropriate.
128 CA Sri Lanka

The opinion section of the auditor's report will be headed 'Qualified Opinion'
and will state that 'In our opinion, the financial statements, except for the
information specified above, are presented fairly in all material respects (or
give a true and fair view) in accordance with the applicable financial
reporting framework.'
The opinion paragraph will be followed by a 'Basis for Qualified Opinion'
paragraph which will explain the reason for the qualification and also
quantify the amount of the loan, any interest and the zero outstanding
balance at the year-end.
21 Mendes and Vimukithi

(1) Pervasiveness
The impact of a material misstatement or omission is pervasive if the
material misstatements or omissions:
• Are not confined to specific elements, accounts or items: or
• Only impact on one element, account or item but this represents a
substantial proportion of the financial statements; or
• Relate to disclosures which are fundamental to the users'
understanding of the financial statements.
(2) Auditor's reports
Mendes (Pvt) Ltd
Research expenditure of Rs. 2.1m has been capitalised within intangible
assets. This is incorrect, as LKAS 38 Intangible Assets requires research
expenditure to be expensed to profit or loss.
The error is material as it represents 8% of profit before tax
(Rs. 2.1m/Rs. 26.3m). Management should adjust the financial statements by
removing the research expenditure from intangibles and debiting the
amount to profit or loss.
If management refuse to make the adjustment, the auditor's report will need
to be modified. As the error is material but not pervasive, a qualified opinion
would seem appropriate on the grounds that the financial statements are
materially misstated.
The opinion paragraph would be qualified 'except for'. The basis of opinion
section would need to include a paragraph explaining the misstatement and
its effect on the financial statements.
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Vimukithi (Pvt) Ltd

Two months' worth of wages records have been lost. The auditor should
seek alternative audit procedures to audit the wages and salaries account. If
no alternative audit procedures are possible, the loss of data would
constitute an inability to obtain sufficient appropriate audit evidence.
Wages and salaries for the two month period represents 11% of profit
before tax (Rs. 1.1m/Rs. 10m). Therefore, if alternative audit procedures are
not possible, the inability to obtain evidence would be material.
The auditors will need to modify the auditor's report on the basis that they
are unable to obtain sufficient appropriate evidence in relation to a material
amount in the financial statements. As the two months' salary and wages are
not pervasive, a qualified opinion would seem appropriate.
The opinion paragraph would be qualified 'except for'. The basis of opinion
section would require an explanation of the lack of sufficient appropriate
evidence in relation to wages and salaries.
22 Daisy & Fuchsia

Daisy
(1) The company's sales ledger was corrupted by a computer virus so it has not
been possible to carry out detailed procedures on receivables and the
related revenue. Unless there is an alternative way of confirming revenue
and receivables the auditor will have been unable to obtain sufficient
appropriate evidence over two very material areas of the financial
statements. Receivables of Rs. 3.4m are in excess of profit before tax (PBT) of
Rs. 2m. Revenue, at Rs. 15.6m is nearly eight times PBT.
(2) The auditor is unable to obtain sufficient appropriate evidence over the two
highly material areas of receivables and revenue. More than one area is
affected and this, together with the magnitude of the areas unable to be
tested, means the possible effects of any misstatement could be pervasive.
Therefore a disclaimer of opinion is necessary.
A basis for disclaimer of opinion paragraph explaining the inability to obtain
evidence over revenue and receivables will be included before the opinion
paragraph. The disclaimer of opinion in the opinion paragraph will state
Violet & Co were unable to form an opinion on the financial statements.
Fuchsia
(1) The financial statements have been prepared on a going concern basis, even
though there are indications that the company is not a going concern.
Fuchsia has experienced difficult trading conditions, has lost market share
and its cash flow forecast for the coming year shows a significant cash
130 CA Sri Lanka

outflow of Rs. 3.2m. This anticipated outflow of Rs. 3.2m is 73% of the
current year loss (Rs. 3.2/Rs. 4.4m) and is therefore a material issue. In any
case, the basis of preparation of the accounts is a material issue and
pervasive, as it impacts on many financial statement areas.
(2) If Violet & Co conclude the going concern basis is inappropriate then the
financial statements have been prepared on the wrong basis and are
misleading. The effects of this would be pervasive and an adverse opinion
would be issued.
The adverse opinion in the opinion paragraph will be an adverse opinion and
will state that the financial statements are not presented fairly in all material
respects (or do not give a true and fair view). A basis for adverse opinion
paragraph will be included after the opinion paragraph to explain that the
going concern assumption has been applied when it should not have been.
If management can demonstrate that the going concern basis is appropriate,
they should still provide disclosures in light of the uncertainty over going
concern. As there are no disclosures the financial statements will be
materially misstated even if the going concern basis is appropriate and the
audit opinion should be modified. This lack of disclosure would probably be
considered material but not pervasive and so a qualified opinion would be
issued. If the lack of disclosure were considered pervasive, then an adverse
opinion would be given.
23 Builders Merchants Plc

(1) A matter referred to in an emphasis of matter paragraph is one which is
appropriately presented or disclosed in the financial statements that in the
auditor's judgement is of such importance that it is fundamental to users'
understanding of the financial statements. The emphasis of matter
paragraph is used to draw attention to the disclosure of this issue in the
(2) Impact on audit report
(i) This represents a potential material inability to obtain sufficient
appropriate audit evidence because the 'missing' inventory represents
12% of the total. The auditor would expect all inventory counting
sheets to be available. The auditor's opinion would therefore be
modified.
The qualified opinion paragraph would state that except for the
material misstatement in relation to this inventory, the financial
statements are fairly presented in all material respects (or give a true
and fair view). The auditor's report would include a basis of qualified
opinion paragraph after the opinion paragraph which would refer to
the fact that the inventory counting sheets for this depot were lost.
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The auditor's report would also state that in relation to inventory

quantities:
• All information and explanations considered necessary were not
obtained; and
• The auditor was unable to determine whether proper accounting
records were kept.
(ii) This represents a material misstatement. The debt represents 8% of
the total receivables balance and 45% of the profit for the year.
The auditor's opinion would therefore be modified. A qualified opinion
would be issued on the grounds of a material misstatement
The qualified opinion paragraph would state that except for the
material misstatement in respect of this allowance the financial
statements are presented fairly, in all material respects (or give a true
and fair view), in accordance with the applicable financial reporting
framework.
The basis of qualified opinion paragraph would refer to the fact that
the customer is in liquidation and there is little prospect of payment. It
would also state that net assets and profits are overstated by
Rs. 45,000.
(iii) The auditors need to determine whether the legal claim is a material
matter and even whether it is pervasive to the financial statements as a
whole. For example, if the customer involved is a major customer, it
could be that an adverse outcome could affect the going concern basis
of the company.
It appears that the disclosure in the financial statements is adequate
and there appears to be no basis on which to make a provision in the
financial statements. However, the auditor's report will be affected by
the fact that there is an uncertainty affecting the business. The auditor
will have to decide whether the inherent uncertainty is fundamental to
users' understanding. If so, the auditor's report should include a going
concern section beneath the basis for opinion section with details of
this matter and a reference to the disclosure in the financial
statements. It should also state that the auditor's opinion on the
financial statements is not modified in relation to this matter.
132 CA Sri Lanka

24 Hood Enterprises (Pvt) Ltd

Errors in the report extract
(i) 'Presentation of information in the company's annual report'
The auditor's legal responsibilities relate to the financial statements, which
comprise the primary statements plus the supporting notes. They do not
extend to any other information, for example a chairman's statement, or 5-
year summary. To make this clear, this section should refer only to the
(ii) 'The auditor's responsibilities relating to other information in documents
containing audited financial statements'
Under SLAuS 720, The Auditors Responsibilities Relating to Other Information
in Documents Containing Audited Financial Statements, the auditor has a
responsibility to read the other information to identify whether there are
any inconsistencies with the financial statements or anything that is
misleading, but the primary opinion is given on the financial statements
only.
(iii) 'In accordance with Auditing Standards'
The report should specify exactly which auditing standards have been used
so that there is no risk that readers misunderstand how the audit has been
done. It should specify that the audit has been performed in accordance with
Sri Lanka Auditing Standards.
(iv) 'Evaluating ….the reasonableness of all accounting estimates'
It is inappropriate to imply that the auditor has considered every estimate
made by management. This is unlikely to be true because auditors do not
look at every single transaction and item in the financial statements; it is the
duty of the auditor to give assurance only on whether the financial
statements are free from material misstatement.
(v) *'As much audit evidence as possible in the time available'
This phrase is inappropriate because it implies that the auditor has not had
time to obtain all the evidence that is needed. The auditor is expected to
obtain sufficient appropriate audit evidence on which to base conclusions.
The auditor should have planned the audit so as to obtain sufficient
appropriate audit evidence. The time available is not a relevant
consideration.
(vi) 'Confirm'
This word should not be used because it implies a greater degree of certainty
than is possible based on normal audit procedures. The certainty implied by
the word 'confirm' may expose the auditor to negligence claims if it turns out
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that there are any material errors in the financial statements. A more
accurate description of the level of assurance given by an audit is 'reasonable
assurance'.
(vii) 'No liability for errors can be accepted by the auditor'
This disclaimer at first might appear to be useful in protecting the auditor
against liability. However, the view is that general disclaimers should not be
included in audit reports, as their use would tend to devalue the audit
opinion.
(viii) 'The directors are wholly responsible for the accuracy of the financial
statements'
This statement should not appear in the auditor's responsibility section of
the report. The details of management's responsibilities are differently
worded and should appear in an earlier separate section of the report
outlining the responsibility of management for the preparation of the
(Note: Only five errors required for full marks)
25 Glitch
There are several problems with the draft auditor's report.
Layout
The draft report contains a paragraph entitled 'Basis for opinion and
disclaimer of opinion'. SLAUSs require two separate sections here, headed
'Basis for Opinion' and 'Opinion'.
The 'Basis for Opinion' section should be placed immediately after the
'Opinion' section, and its adjusted to say whether qualified or adverse.
Wording of report
A description of the scope of the audit is required but not the materiality
level used as not required.
The paragraph states that 'procedures have proven conclusively that trade
receivables are materially misstated'. This is misleading. Audit procedures
provide reasonable assurance which is not the same as 'proven conclusively'.
The basis for modification paragraph should state the amount of the
potential adjustment to receivables, along with its financial impact.
The paragraph includes the finance director by name. The statement that eh
financial director refused to make an adjustment may leave the auditor open
to legal damages if proven untrue by the courts.
134 CA Sri Lanka

Opinion
An inappropriate auditor's opinion has been given here. The draft report is
correct that an unmodified opinion would be inappropriate because a
material amount of the balance should be written-off. At 30% of profit, any
write-off of the receivable would be material.
However, the receivable is unlikely to be judged as pervasive to the financial
statements, so the level of modification is wrong. The opinion should the
qualified on the grounds of there being a material misstatement.
Key audit matters (KAMs)
SLAUS 701 Communicating Key Audit Matters in the Independent Auditor's
requires the auditor to include specified introductory language at the start of
the KAMs section of the report. This has not been included here. The
auditor's responsibilities section of the report would also discuss KAMs
which is not included here, so needs to be checked.
SLAUS 701 requires the description of each KAM to include why the matter
was considered to be a KAM and how the matter was addressed and the
report includes neither of these points.
The draft report should state the factors that led the auditor to conclude that
revenue recognition would require significant auditor attention and describe
how the auditor addressed the assessed risks of material misstatement and
procedures performed
Emphasis of Matter (EoM)
The use of an EoM paragraph is inappropriate. An EoM is used to refer to a
matter which is already correctly disclosed in the financial statements, but
which is in need of extra emphasis by the auditor. By contrast, here the EoM
refers to a provision not included in the financial statements which is a
misstatement. Rs400,000 is not material, so the draft report is correct not to
modify the opinion in this respect. Ideally, Glitch should adjust and provide
for this amount. If they do not, although it is immaterial on its own, it may
become material alongside other uncorrected misstatements.
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Part F Assurance and Related Services

Questions 27 to 28 cover Assurance and Related Services, the subject of Chapter
17 of the Study Text.
26 Batulo Ltd
(a) Lilac
An audit engagement partner would have to consider the following things
before issuing a reference on behalf of a client.
(i) Is any additional work required to give such a reference?
(ii) If so, the need to contact the bank and discuss whether a separate
engagement might be appropriate.
(iii) The inherent uncertainty of future income and expenditure and
therefore the high risk which is associated with giving such an opinion.
(iv) The difficulty of issuing an opinion on current solvency. The auditors
are about to commence the audit for the past year, meaning they will
be investigating information up to 15 months' old.
(v) The fact that a duty of care to the bank is likely to arise if such a
reference is given.
(vi) The need for disclaimers of liability, therefore, which will need to be
reasonable in order to have legal force, perhaps the need for legal
advice before such disclaimer is made.
(vii) Any need to negotiate a liability cap, although a disclaimer of liability
should be sufficient/more appropriate.
(viii) Need for written clarification of the status of the reference, that is,
explanation that there has been no engagement between the parties,
that no fee has been paid, that it is given to the best of knowledge at the
time.
(ix) The form of the reference. It is likely to be inappropriate to sign a
bank's pre-printed document. The audit firm may have a standard
reference document of its own, or may choose to compose each one
according to the facts of the situation.
(b) Laurel
The directors of Laurel have expressed an interest in engaging the audit firm
to undertake an assurance engagement in relation to their risk management
and controls.
The following matters will be relevant.
136 CA Sri Lanka

Acceptance
Independence
The audit firm has to consider the issue of independence. It is vital that the
provision of other services to the audit client does not impair their
objectivity towards the audit. The CA Sri Lanka Code of Ethics states that
provision of other services may impair objectivity.
The CA Sri Lanka Code of Ethics outlines that whether a threat to objectivity
exists when providing any professional service will depend upon the
particular circumstances of the engagement, and on the nature of the work
that the professional accountant in public practice is performing.
The amount that audit independence would be affected will depend on the
exact nature of the service provided (see below). However, an assignment
testing the operation of controls could be complimentary to the audit.
Nature of the service
The firm would not be able to accept the engagement as it has been currently
set out. An assurance engagement should exhibit certain elements, key of
which are subject matter, suitable criteria and an engagement process. It is
very difficult to give assurance on the effectiveness of risk management, as
there are no recognised criteria by which to judge it. However, the firm could
provide an assurance service checking that controls are designed according
to management criteria and they operate according to management policy,
for example. This would need discussing and agreeing in writing before the
engagement could be accepted.
Planning
In terms of planning such an engagement, once the details of the engagement
had been agreed, the following matters would be relevant:
(i) Is the firm sufficiently independent of the client to conduct the
assurance service objectively? It may be that the fact that the company
is an audit client would impair their objectivity towards this
engagement.
(ii) Are all the elements of an assurance engagement present? This has
been discussed above.
(iii) Have the firm and the parties agreed terms? In this case, the assurance
service is likely to be carried out to benefit shareholders, so it may be
necessary for a vote to be passed in general meeting to approve the
service.
(iv) Are the criteria for assessing the subject matter suitable? In this case,
management policy would be a suitable criterion for evaluating the
operation of systems.
CA Sri Lanka 137

Answers
(v) The auditor must assess the materiality and risk of the engagement.
These should be incorporated into a fee and into the detailed
procedures planned for the engagement.
(vi) What form of report is required by the parties? There is no such thing
as a standard report, so it is important for the parties to agree upon the
format of the report that will be produced at the end of the
engagement.
27 Verity
(a) SLAuS 3400 covers the examination of prospective financial information.
The factors that will affect the accountants' decision on whether to accept
appointment are:
(i) Previous experience of client
The accountants should draw on their knowledge of the client as
gained during the audit. In particular they will be interested in the
willingness of the client to provide information, the integrity and
knowledge of the directors, and the reliability of the forecasts prepared
for financial accounting purposes, for example for assessment of going
concern or deferred tax.
(ii) How prepared
The accountants will need to consider how the forecast is being
prepared, in particular:
(1) How the forecast was compiled, and the staff who compiled it
(2) The extent to which the forecast is based on assumptions
consistent with past events. The details given suggest that a more
optimistic view is being taken than is warranted by the
company's record in recent years.
(3) Whether the forecast represents management's best estimate of
achievable results, or whether it represents hopeful targets or is
based on certain hypothetical events taking place
(4) How the forecast takes account of factors which may invalidate
the assumptions made
(5) The complexity of the forecast and the level of detail available
supporting the forecast.
(iii) Examination of prospective financial information report
138 CA Sri Lanka

The report must include:

· A statement that management are responsible for the prospective
financial information including the assumptions on which the
prospective financial information is based. In this case, this will be a
cash flow forecast.
· A statement of negative assurance is provided which means nothing
has come to the attention of the auditor which indicates the cash
flows forecast is not prepared on the basis of the assumptions stated
by management. For example, a negative assurance report may
state, based on the auditor’s examination of evidence supporting
the assumptions, nothing has come to the auditor’s attention which
causes them to believe the assumptions do not provide a reasonable
basis for the cash flow forecast.
· The report will also provide an opinion whether the cash flow
forecast and its assumptions have been properly prepared in
accordance with Sri Lanka Accounting Standards.
(iv) Users
The report is restricted to those parties that have agreed to the
procedures to be performed since others, unaware of the reasons for
the procedures, may misinterpret the results.
(b) A major concern of the reporting accountant will be the assumptions on
which the report is based. The level of evidence required will depend on the
terms of the accountants' report, but some evidence will be required on the
major assumptions made in the forecast.
(Only five procedures are required)
(i) Sales. It might be expected that the price increase would result in some
lost sales, so extra sales will be needed from other customers to make
up for the sales lost as well as achieving the planned increase. The
auditor will need to focus on the plans to achieve that increase.
Increases might be a result of a change in the sales mix or new
products or customers; if these changes have already occurred, the
accountants should consider what effect they have already had.
Increased marketing and promotional activity may also be necessary,
and this would need to occur rapidly in order to achieve the desired
effect. This activity will probably be reflected in increased costs, and
the accountants will need to check that these have been included in the
forecast.
CA Sri Lanka 139

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(ii) Cost of sales. The accountants will need to consider whether economies
have been planned to improve margins, whether these economies are
likely to be achieved, and whether there will be consequential other
costs that need to be reflected in the plan. For example reduction in the
labour force is likely to mean redundancy costs, investment in more up-
to-date plant and equipment to mean capital investment costs.
(iii) Trade receivables. The accountants should consider whether the
decrease in settlement period is likely to be achieved. They should
consider whether emphasising new credit limits and prompt
settlement discounts will help achieve the required target, and also the
effectiveness of any other measures the company takes, for example
tighter checks on new customers and more rigorous pursuit of slow
payers. In particular the accountants will need to review the position of
foreign customers, as they may be less flexible in reducing settlement
periods. The accountants should also check that the consequences of
the prompt settlement discount, a reduction in amounts received, have
been reflected in the forecast. For foreign customers, the accountants
should also check any exchange rate effects have been reflected in the
forecast.
(iv) Trade payables. The accountants should check that the increase in
payable days will not breach terms of business with suppliers, leading
to possible supply problems or withdrawal of credit terms and
demands for immediate cash payments. They should also check that
the forecast reflects other possible consequences of the increase, for
example a loss of early settlement discounts.
(v) Maximum finance. The accountants should check whether the
estimated increase in finance is reasonable or whether other sources
will be required, either because the Rs1,350m is an under-estimate or
because other existing sources of finance will need to be repaid. The
accountants should check that the consequences of the increase,
particularly an increased interest burden, have been reflected. They
should consider also whether the forecast shows that the company will
be able to make the repayments comfortably, or whether the forecast
margins are tight.
The accountants should also check that the forecast is internally
consistent, for example that increased sales correspond with increased
purchases, and reflects all non-trading cash flows. Consistency with
forecasts made for other purposes, for example management
accounting budgets, should also be checked.
140 CA Sri Lanka

Part G Audit Quality and Ethics Questions 28 to 33 cover Audit Quality and
Ethics, the subject of Chapter 17 of the Study Text.
28 Maho (Pvt) Ltd

Threats and safeguards
(1) Ethical threats (2) Possible safeguards

Familiarity
Mr Son has been the engagement Mr Son should be rotated off the audit.
partner for Maho for the past nine Ethical guidance states that for listed
years. This gives rise to a familiarity companies, engagement partners should be
threat because of his long rotated after no more than seven years and
association with this one client not return to that client until a further
which could impair his objectivity period of two years has elapsed. Although
and independence. Maho is not stated as listed, partner rotation
should still be implemented in order to
reduce the familiarity threat.
Mr Son's daughter Zoe will be part of Whilst Mr Son is still the engagement
the audit team of Maho. This also partner for this audit, his daughter should
gives rise to a familiarity threat not be part of the audit team of Maho.
because her father is the
engagement partner and this may
impair objectivity. There is also a
type of self-review threat, in that Mr
Son will be reviewing his daughter's
work and may not wish to highlight
any errors she makes.
Intimidation
There may be an intimidation threat The engagement partner should explain to
from the Finance Director of Maho the Finance Director that although his firm
who has made a statement regarding can provide taxation services to Maho, the
the calculation of the fees for fees charged must be based on the time
taxation services. The audit firm may spent on the work.
feel that it has to accept this in order
to keep Maho as a tax client.
CA Sri Lanka 141

Answers
(1) Ethical threats (2) Possible safeguards

Advocacy
An advocacy threat may arise as the There are no safeguards which could be put
Finance Director is expecting Ali & in place to mitigate this threat and so the
Co to represent his company in a firm must decline to represent Maho in this
dispute with the taxation authorities. dispute.
Self-review
The firm also provides taxation Depending on the level of the threat, Maho
services to Maho and this may give could use separate engagement teams for
rise to a self-review threat as staff the audit and tax work to mitigate any threat
may end up reviewing their own arising.
work. The extent of the threat will
depend on the nature of the services
and in particular how any matters
advised on will be reflected in the
Self-interest
Mr Far, the audit senior, received If Mr Far paid for the services received from
investment advice from the company Maho as any other customer would (and at
and intends to do so in the future. A the same rate), there is potentially no
self-interest threat may arise as a problem. However, this should be discussed
result which could impair his with the engagement and ethics partners
objectivity. and he may be advised not to use the
services of Maho in the future.
The client is expecting the tax fee to There are no safeguards that can be put in
be based on a percentage of tax place to mitigate this threat and so the firm
saved – this is a form of contingent should not agree to the proposed fee
fees. This gives rise to a self-interest arrangement for taxation services.
threat because the firm will want to
save as much tax as possible in order
to charge as high a tax fee as
possible.
The client has arranged a balloon The CA Sri Lanka Code of Ethics for
flight for the audit team. This could Professional Accountants states that gifts and
give rise to a self-interest threat in hospitality should only be accepted where
the form of gifts and hospitality. the value is clearly insignificant. In this case,
it would be appropriate to decline the
balloon flight so as not to impair the firm's
independence.
142 CA Sri Lanka

(3) The responsibility of the auditor depends on the nature of the regulations.
For those regulations that have a direct impact on material amounts and
disclosures in the financial statements the auditor is required to obtain
sufficient appropriate evidence that they have been complied with.
For those laws and regulations which do not have a direct effect on the
financial statements but where non-compliance could lead to material
misstatements in the financial statements, the auditor should undertake
audit procedures to help identify non-compliance.
29 Independence
(1) Auditors are engaged to provide an independent report on the truth and
fairness of the financial statements to shareholders. A company's audited
financial statements are relied upon by shareholders in making decisions
about their investment. Other stakeholders will also rely on the audited
financial statements in making economic decisions, for example, a bank may
use the audited financial statements to ensure loan covenants are being met.
If the auditor's report is to have credibility to stakeholders then it is vital
that the auditor is independent of any concern on which he is required to
report. Auditors must be independent and also be seen to be independent in
order to promote the credibility of their report. An independent auditor's
report will increase the confidence of all stakeholders in the company.
(2) (i) The audit partner has no shareholdings in the client company and so,
all other things being equal, he could be seen as giving an objective
audit opinion. However, the audit manager does have a shareholding in
the client company which, while not material to the company (at 1% of
issued share capital), could be material to the audit manager and
certainly might be seen to influence his ability to give an impartial
opinion in relation to the company's affairs. In fact the CA Sri Lanka
Code of Ethics ('Code') does not permit a member of the audit team to
have a direct financial interest in an audit client. As the partner will
inevitably have to rely upon the work completed and controlled by the
audit manager it is clearly undesirable for the manager to have such a
financial involvement in the client's affairs. The audit manager should
either be excluded from the audit team or requested to dispose of his
shares.
(ii) The Code states that when a firm receives a high proportion of its fee
income from just one audit client a self-interest or intimidation threat.
The reason for this is that the fear of losing a major client, and thus a
substantial proportion of fee income, could prejudice the auditor's
objectivity and make him more likely to bow to pressures from the
client.
CA Sri Lanka 143

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The audit fee from Janet (Pvt) Ltd contributes some 14.3% of the total
fees income of the practice which is a significant proportion.
Depending on the other fees the firm would need to assess the threats
to independence taking into account the operating structure of the firm
and the significance of the client to the firm both qualitatively and
quantitatively. The firm should consider what safeguards are necessary
and these may include reducing the dependency on the client,
arranging independent quality control reviews or consulting a third
party on key judgements. The firm would need to keep this situation
under constant review.
(iii) As another instance of where financial involvement in a client's affairs
could be seen to impair an auditor's objectivity, the Code recommends
that between an auditor and a client, there should be no loans or
guarantees in respect of loans either way. Any such financial
involvement could be seen to impair the auditor's judgement either
because of a client putting pressure on the auditor or because of the
auditor's own fear of suffering some financial loss.
However, the Code does allow for one exception in making the above
recommendation and that is where the loan is in the normal course of
business and on normal commercial terms. It is part of a bank's normal
business to make personal loans and if the rate of interest being paid
by the audit senior appears to be a commercial rate of interest, this
transaction is unlikely to be seen as impairing the auditor's
independence.
(iv) The Code also considers the problems that can be created when
conflicts of interest arise between different clients and between clients
and the auditor's own business interests. It concludes that every effort
should be made to avoid conflicts of interest arising and that it would
be unethical for an accountant to act in a situation where he knew that
a conflict of interest existed.
The situation described in the question is a good example of the type of
conflict of interest with which the Code is concerned. The audit partner
must not act as advisor to Jean (Pvt) Ltd if the threats to independence
and confidentiality are too high and cannot be reduced or eliminated
via the application of safeguards. Permission must be sought from
Harry (Pvt) Ltd before the audit partner can advise Jean (Pvt) Ltd on
the tender. If permission is granted, additional safeguards may also be
necessary such as the use of separate engagement teams,
confidentiality agreements or the review of safeguards by an
independent individual. The audit partner cannot act as advisor if
permission is refused by Harry (Pvt) Ltd.
144 CA Sri Lanka

The audit partner can only advise Jean (Pvt) Ltd with regard to the
contract tender received from Harry (Pvt) Ltd if all threats can be
eliminated or reduced to an acceptable level via the application of
safeguards. If not, the auditor should explain the professional reasons
why he is unable to act on this occasion and suggest that Jean (Pvt) Ltd
seek advice from another firm of accountants.
30 De Abrew Plc
(1) Threats to independence
Tax Fees Outstanding
There are taxation fees outstanding from De Abrew Plc for work that was
done six months previously. In effect, Senasinge & Co are providing an
interest-free loan to De Abrew Plc. This can threaten independence and
objectivity of the audit firm as it may not want to modify the audit opinion in
case the outstanding fees are not paid.
Fee Dependence
De Abrew Plc is one of Senasinge & Co's most important clients and the firm
provides other services to this client as well as audit, including taxation
services. Also the company is growing rapidly. Objectivity and independence
may be threatened where a significant proportion of fees are from one client
as a self-interest threat is created.
Relationship to Financial Director of De Abrew Plc
Allyson Mendis, the daughter of Mr Mendis, has recently been appointed the
Financial Director of De Abrew. The independence of Mr Mendis could be
threatened because of their close family relationship. The extent of the
threat depends on the position the immediate family member holds with the
client and the role of the professional on the assurance team.
As Financial Director, Allyson has direct influence over the financial
statements and as engagement partner, Mr Mendis has ultimate
responsibility for the audit opinion, so there is a clear threat to objectivity
and independence.
Meal
The fact that Allyson Mendis wants to take the audit team out for an
expensive meal before the audit commences could be considered a threat to
independence as it might influence the audit team's decisions once they start
the audit of the financial statements. The ethics rules state that gifts or
hospitality from the client should not be accepted unless the value is clearly
insignificant.
CA Sri Lanka 145

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(2) Ways of mitigating the threats

Audit Partner
This threat could (and should) be addressed by appointing another audit
partner to the audit of De Abrew Plc and rotating partners at suitable
intervals thereafter.
Tax Fees Outstanding
This can be addressed by discussing the issue with the directors of De Abrew
Plc and finding out why the fees have not been paid. If the fee is still not paid
the firm should consider delaying the start of the audit work or even the
possibility of resigning.
Fee Dependence
This threat could be mitigated by reviewing the total of the audit and
recurring fee income from De Abrew Plc as a percentage of Senasinge & Co's
total fee income on a regular basis and possibly limiting the provision of the
other services if deemed necessary to maintain independence.
Relationship to Financial Director of De Abrew plc
As Financial Director, Allyson has direct influence over the financial
statements and as engagement partner, Mr Mendis has ultimate
responsibility for the audit opinion, so there is a clear threat to objectivity
and independence.
This threat to independence could (and should) be mitigated by the
appointment of another audit partner to this client.
Meal
This threat could be mitigated by declining the invitation.
31 Devapriya & Co
Ethical threats and steps to mitigate the threats
(1) Ethical threats (2) Steps to mitigate threats

Devapriya guarantees that its audits will Devapriya should retract the 'two-week
not last longer than two weeks. guarantee' immediately, and explain to its
The amount of time required to audit clients that the duration of audits will
complete an audit depends upon the depend upon the level of complexity and
nature of each audit client's business threat associated with each business. The
and the level of associated threat. To completion date of the audit will be agreed
restrict the duration of all audits to two with each client at the planning stage, but this
weeks, regardless of the level of may need to change if any circumstances
complexity and risks of the business, cause the auditor to re-evaluate the
will result in sufficient and appropriate company's level of assessed threat.
146 CA Sri Lanka

(1) Ethical threats (2) Steps to mitigate threats

audit evidence not being obtained.
Devapriya would be at risk of giving
incorrect audit opinions, leading to
possible litigation.
Devapriya is offering a free accounts Devapriya should ensure that a separate team
preparation service to new audit clients. is allocated to the accounts preparation work.
The preparation of the accounts, which It must not offer the accounts preparation
the firm will then audit, gives rise to a service to listed clients.
self-review threat. In addition, the fact It is important that the firm demonstrates
that the accounts preparation service is that appropriate time and appropriately-
offered for free may be considered low- qualified staff are assigned to its audit
balling. engagements, and that the SLAuS are adhered
to.
Devapriya has decided not to update the Devapriya should review the need for
engagement letters of existing clients. updating engagement letters on an annual
This goes against the requirements of basis.
SLAuS 210, Agreeing the Terms of Audit
Engagements.
An existing client has suggested that its Devapriya should decline the client's
audit fee should be based on a proposal, and explain that audit fees would be
percentage of its final pre-tax profit. based on the level work required to obtain
This constitutes a contingent fee. sufficient appropriate audit evidence.
Contingent fee structures create a self-
interest threat which cannot be
mitigated. They are therefore prohibited
by the Code of Ethics for Professional
Accountants.
32 Dharsha and Saram

Colombo (Pvt) Ltd
In this case, the company wishes to switch auditor because of their concerns with
the level of service provided. This is a perfectly legitimate reason for wishing to
switch auditor, and companies are increasingly being encouraged to change
auditors when they are unhappy with their existing auditor.
Where the previous auditors have fees owed to them, as in this case, the new
auditors need not decline the appointment purely for this reason. Dharsha and
Saram should decide how far they are prepared to help Kandy & Co recover their
fees, as well as whether or not they should accept appointment.
CA Sri Lanka 147

Answers
Kandy & Co should hand over all the books and papers which are owned by
Colombo (Pvt) Ltd, unless they have a legal right to hold on to these because of the
unpaid fees. Co-operation between the old and new auditor is a matter of
professional etiquette, and should Kandy & Co continue to refuse to be helpful,
Dharsha and Saram are free to decide whether or not to take up the appointment
if they suspect there might be something untoward.
Galle (Pvt) Ltd
In this case, Dharsha and Saram should decline the request to be appointed as
auditor. An auditor's objectivity could easily be threatened as a consequence of a
close family relationship. Almost as importantly, even if the auditor were able to
maintain objectivity, the appointment would appear to third parties to be
inappropriate. Galle has been set up by the sister of one of Dharsha and Saram's
partners, which is considered a close family relationship, as would parents and
adult children.
If the relationship was more distant, and the relative was not in a position to
influence the financial statements, it might be possible to carry out an audit. For
example, if a distant cousin of the partner was a junior in Galle's marketing
department, it is likely that Dharsha and Saram would be able to take up the
appointment, although it might be advised to make sure that another audit
partner was appointed as the reporting partner.
Negombo (Pvt) Ltd
If the company was listed, it would not be possible for Dharsha and Saram to be
involved in the preparation of the financial statements, as well as carrying out the
audit. However, as the company is not listed, the firm is allowed under current
rules to provide a client with accounting services as well as the audit. In practice,
many firms will ask one member of staff to carry out the accounts preparation
work, and another to carry out the actual audit. A suitable safeguard in this case
would be to have separate teams for the accounts preparation and audit work.
33 Estarellas Plc
(1) The principle of confidentiality imposes obligations on professional
accountants, including auditors. Specifically, auditors must refrain from:
(i) Disclosing outside the audit firm confidential information acquired as a
result of professional and business relationships without proper and
specific authority, or unless there is a legal or professional right or duty
to disclose; and
(ii) Using confidential information acquired as a result of professional and
business relationships to their personal advantage or the advantage of
third parties.
148 CA Sri Lanka

An auditor shall maintain confidentiality even in a social environment.

The auditor shall be alert to the possibility of inadvertent disclosure,
particularly to a close business associate or a close or immediate family
member.
An auditor shall maintain confidentiality of information disclosed by a
prospective client or employer. An auditor shall also maintain
confidentiality of information within the audit firm or employing
organisation.
Auditors shall take reasonable steps to ensure that staff under their
control and persons from whom advice and assistance is obtained
respect the professional accountant's duty of confidentiality.
The need to comply with the principle of confidentiality continues even
after the end of relationships between an auditor and a client or
employer. When an auditor changes employment or acquires a new
client, the auditor is entitled to use prior experience, but shall not use
or disclose any confidential information either acquired or received as
a result of a professional or business relationship.
(2) The following are circumstances where auditors are or may be required to
disclose confidential information or when such disclosure may be
appropriate:
(i) Disclosure is permitted by law and is authorised by the client or the
employer;
(ii) Disclosure is required by law, for example:
• Production of documents or other provision of evidence in the
course of legal proceedings; or
• Disclosure to the appropriate public authorities of infringements
of the law that come to light; and
(iii) There is a professional duty or right to disclose, when not prohibited
by law:
• To comply with the quality review of a member body or
professional body;
• To respond to an inquiry or investigation by a member body or
regulatory body;
• To protect the professional interests of a professional accountant
in legal proceedings; or
• To comply with technical standards and ethics requirements.
In this case, disclosure is required by law to provide evidence in the course
of legal proceedings, and so the auditor shall override the directors'
objections, and must hand over the relevant documents to the court.
CA Sri Lanka 149

Answers

Long questions
Questions 1 to 28 are 20-mark questions, each covering several different areas of
the syllabus.
1 Puttalam (Pvt) Ltd

(1) Wages system management letter
ABC & Co
Chartered Accountants
29 High Street
The Board of Directors Colombo
Puttalam Pvt Ltd
10 Low Street
Colombo December
20X8
Dear Sirs,
Deficiencies in internal control
We set out in this letter deficiencies in the wages system, which we identified
as a result of our review of the accounting systems and procedures operated
by your company during our recent audit. The matters dealt with in this
letter came to our notice during the conduct of our normal audit procedures
which are designed primarily for the purpose of expressing our opinion on
the financial statements. There may be other weaknesses which we did not
identify.
(i) Deficiency (ii) Consequence of (iii) Recommendation

deficiency
Shift workers can log in Workers can be paid even if The shift manager should
and out just by using they are not working because agree the number of
their electronic the time recording system workers with the
identification cards. logs them in and out when computer records at the
their cards are scanned and start and end of the shift.
they are paid from and to
this time.
Overtime is not Workers could be paid at All requests for overtime
authorised overtime rates when they are must be authorised by
appropriately or not actually working and the shift manager.
monitored. could collude with the shift Overtime costs should
foreman for extra overtime also be monitored
150 CA Sri Lanka

(i) Deficiency (ii) Consequence of (iii) Recommendation

deficiency
without actually working it. regularly.
The code word for the Unauthorised individuals The code word should be
time recording system could log onto the system changed immediately to
is generally known and enter extra hours so that one containing random
within the department. they are paid more than they letters and numbers. The
should be. Fictitious system should be set up
employees could also be set so that the code word has
up on the system. to be changed on a
regular basis, such as
every six weeks.
Payments into Unauthorised payments into The payroll should be
workers' bank workers' and fictitious bank authorised by the Finance
accounts are made by accounts could be made. Director or another
one member of senior manager prior to
accounts staff, without payments being made.
any authorisation.
Review of wages There is no regular The Finance Director
payments is done monitoring of wages by should review payroll
every few weeks by the senior management. costs on a weekly basis so
financial accountant, that he can assess
seemingly on an ad hoc whether they are
basis. reasonable and any
unusual amounts can be
investigated.
This letter has been produced for the sole use of your company. It must not
be disclosed to a third party, or quoted or referred to, without our written
consent. No responsibility is assumed by us to any other person.
We should like to take this opportunity of thanking your staff for their
co-operation and assistance during the course of our audit.
Yours faithfully
ABC & Co
(2) Substantive analytical procedures
(i) Perform a proof in total of the salaries charge for the year using the
prior year charge and increasing it for the pay increase and taking
account of any starters or leavers in the period.
The figures should be comparable with the exception of the salary
increase and any starters or leavers in the year.
CA Sri Lanka 151

Answers
(ii) Perform a comparison of the annual charge to the prior year and to the
budgeted figure. Where the variance is significant, investigate further
to ascertain why.
The figures should be comparable with the exception of the salary
increase of 3%.
(iii) Review monthly salaries month by month.
The figures should be about the same each month, except for July and
November when the pay rise and annual bonus were paid respectively.
Any starters or leavers would also be reflected in the relevant month.
2 Mannar (Pvt) Ltd

(1) Mannar – Tests of control and test objectives for the sales cycle
(Note: only 5 tests are required).
Test of control Test objective

Enter an order for a fictitious customer To ensure that orders are only accepted
account number and ensure the system and processed for valid customers.
does not accept it.
Inspect a sample of processed credit To ensure that goods are only supplied
applications from the credit agency and to customers with acceptable credit
ensure the same credit limit appears in ratings.
the sales system.
For a sample of invoices, agree that To ensure that goods are only sold at
current prices have been used by authorised prices.
comparing them with prices shown on
the current price list.
For a sample of invoices showing To ensure that sales discounts are only
discounts, agree the discount terms provided to those customers the sales
back to the customer master file director has authorised.
information.
For a sample of orders ensure that an To ensure that all orders are recorded
order acceptance email or letter was completely and accurately.
generated.
Visit a warehouse and observe whether To ensure that goods are dispatched
all goods are double checked against correctly to customers and are of an
the GDN and dispatch list before adequate quality.
sending out.
152 CA Sri Lanka

Test of control Test objective

With the client's permission, attempt to To ensure that goods are not supplied
enter a sales order which will take a to poor credit risks.
customer over the agreed credit limit
and ensure the order is rejected as
expected.
Attempt to process an order with a To ensure that sales discounts are only
sales discount for a customer not provided to valid customers.
normally entitled to discounts to assess
the application controls.
Observe the sales order clerk To ensure that all orders are recorded
processing orders and look for proof completely and accurately.
that the order acceptance is
automatically generated (eg e-mail in
sent folder)
Inspect a sample of GDNs and agree that To ensure that all goods dispatched are
a valid sales invoice has been correctly correctly invoiced.
raised.
Review the latest report from the To ensure completeness of income for
computer sequence check of sales goods dispatched.
invoices for omissions and establish the
action taken in respect of any omissions
found.
(2) Substantive procedures to confirm Mannar's year-end receivables

balance
• Circularise trade receivables for a representative sample of the year-
end balances. If authorised by Mannar's management, send an e-mail
or reminder letter to follow up non-responses.
• Review cash receipts after the year-end in respect of pre year-end
receivable balances to establish if anything is still outstanding. Where
amounts are unpaid investigate whether an allowance is needed.
• Review the reconciliation of the receivables ledger control account
(sales ledger control account) to the list of receivables (sales ledger)
balances and investigate unusual reconciling items.
• Review the aged receivables report to identify any old balances and
discuss the probability of recovery with the credit controller to assess
the need for an allowance.
CA Sri Lanka 153

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• Calculate average receivable days and compare this to prior year and
expectations, investigating any significant differences.
• Select a sample of goods dispatched notes just before and just after the
year end ensure the related invoices are recorded in the correct
accounting period.
• Review a sample of credit notes raised after the year end to identify
any that relate to pre year-end transactions and confirm that they have
not been included in receivables.
• Review the aged receivables ledger for any credit balances and inquire
of management whether these should be reclassified as payables.
• For slow moving/aged balances, review customer correspondence files
to assess whether there are any invoices in dispute which require an
allowance.
• Review board minutes to assess whether there are any material
disputed receivables.
• Select a sample of year-end receivable balances and agree back to a
valid GDN and sales order to ensure existence.
(Note: only 3 tests are required)
(3) Controls to reduce the risk of fraud re-occurring and explanation of
how the risk is mitigated
(Note: only 4 controls are required)
Control Explanation of how risk is mitigated
by control
Related members of staff should not be The risk of related staff colluding and
allowed to work in the same being able to commit a fraud without
department where they can seek to easily being discovered will be reduced.
override segregation of duty controls.
Customer statements should be sent Customers receiving statements may
out each month to all customers. The notice anomalies in the allocation of
receivables ledger supervisor should payments (either timing or amount)
check that all customers have been sent and may alert the company of these
statements. anomalies. This may draw attention to
the sort of fraud that occurred at
Mannar (known as 'teeming and
lading').
154 CA Sri Lanka

Control Explanation of how risk is mitigated

by control
Bank reconciliations should be Any compensating material balances
reviewed regularly by an appropriate netted off to a small difference on the
level of management who is not bank reconciliation will be discovered
involved in its preparation. quickly, increasing the probability of
Unreconciled amounts should be uncovering fraud on a timely basis.
investigated and resolved at the time of
review.
Two members of staff should process This would mean another collusion
cash receipts. would be necessary (on top of the one
that has already occurred) to steal cash
receipts. This therefore reduces the risk
of re-occurrence.
Staff within the finance department Rotation will act as a deterrent to fraud.
should rotate duties on a regular basis. This is because staff will be less likely to
commit fraudulent activities due to an
increased risk of the next person to be
rotated to their position uncovering any
wrongdoing.
The receivables ledger should be This will increase the chance of
reconciled to the receivables ledger discovering errors in the receivable
control account on at least a monthly balances and help to create a strong
basis. The reconciliation should be control environment likely to deter
reviewed by a responsible official and fraud.
anomalies investigated.
Management should consider The presence of an internal audit
establishing an internal audit department would help to deter
department to assess and monitor the employees committing fraud and
effectiveness of controls, identify any identification of fraud would be more
deficiencies, and carry out specific likely due to ongoing monitoring of
fraud investigations. internal controls.
(4) Substantive procedures to confirm Mannar's revenue

• Compare the total revenue with that reported in previous years and the
budget for the current year and investigate any significant fluctuations.
• For a sample of customer orders, trace the details to the related
dispatch notes and sales invoices and ensure there is a sale recorded in
respect of each (to test the completeness of revenue).
CA Sri Lanka 155

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• For a sample of sales invoices for larger customers, recalculate the

discounts allowed to ensure that these are accurate.
• Select a sample of dispatch notes in the month immediately before and
month immediately after the year end. Trace these through to the
related sales invoices and resultant accounting entries to ensure each
sale was recorded in the appropriate period.
• Obtain an analysis of sales by major categories of toys manufactured
and compare this to the prior year breakdown and discuss any unusual
movements with management.
• Calculate the gross profit margin for Mannar for the year and compare
this to the previous year and expectations. Investigate any significant
fluctuations.
• Recalculate the sales tax for a sample of invoices and ensure that the
sales tax has been correctly applied to the sales invoice.
• Select a sample of credit notes issued after the year end and trace these
through to the related sales invoices to ensure sales returns were
recorded in the proper period.
(Note: only 3 procedures are required.)
3 Pear Plc
(1) The auditor should obtain an understanding of internal controls relevant to
the audit.
They should:
• Obtain an understanding of the entity and the risks it is exposed to
• Ascertain the nature of the entity's internal control system and assess
the impact of this on the level of audit risk
• Decide whether the internal control system is sufficient to gather audit
evidence through tests of control with reduced substantive testing or
whether full substantive testing is required
• Report any significant deficiencies in internal control to those charged
with governance
156 CA Sri Lanka

(2) Internal controls
(i) Deficiency (ii) Control (iii) Test of control

As the website is not The website and the Test data should be
integrated with the inventory system input into the order
inventory system, should be integrated so system via the website
inventory levels are not that inventory levels are for items which are
checked before an order checked before the both in inventory and
is accepted. order is processed. For out of inventory. Only
This means that orders items which are not in orders for items in
may be accepted when inventory customers inventory should be
goods are not in should be given an processed. Those out of
inventory resulting in indication of how long inventory should be
delay in delivery. This the delay will be. indicated as such.
could lead to loss of
customer goodwill
and/or loss of sales.
Local couriers do not Pear should bring the A sample of dispatches
always obtain proof of matter to the attention made by the courier
receipt of goods from of the courier companies should be
customers. companies and remind taken. These should be
Customers could claim them of the importance matched to goods
that they have not of obtaining a customer dispatched notes
received the goods signature on delivery of returned by the couriers
when in fact they have the goods. Pear could and reviewed for
and Pear may have to refuse to pay for any evidence of a signature.
dispatch the goods deliveries which are
again. made without a
signature.
Sales orders are not When goods are For a sample of orders
always fulfilled dispatched the sales which are not on the
promptly. order and dispatch note unmatched item report
This may harm the should be matched as agree to the dispatch
reputation of the evidence that the order note and verify that the
company and result in has been fulfilled. date of delivery is
lost sales. within the time limit set
by the company.
Unmatched orders Review the report of
should be flagged by the unmatched items to
system after a assess whether there is
predetermined period still a significant delay.
Discuss the report with
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eg one week. A report of the supervisor and
unmatched items obtain an explanation as
should be reviewed by a to why sales orders are
supervisor and still outstanding.
outstanding items
followed up.
Credit limits are set by Credit limits should be The credit limits of a
the sales ledger clerks. set by the sales ledger sample of new
The sales ledger clerks department supervisor customers should be
are unlikely to be senior or manager, or another looked at to ensure that
enough to make this suitably senior member they are within the
type of decision. Also as of staff. guidelines set and that
more than one clerk is they have been
involved inconsistent authorised by the
decisions may be taken. relevant senior member
If limits are too high this of staff.
may lead to
irrecoverable debts. If
limits are too low sales
may be lost as a result.
Sales discounts are A standard discount The discount policy
determined by policy should be put in document should be
individual members of place by the sales reviewed to confirm
the sales team. director to be that it has been drawn
This increases the risk implemented by the up by the sales director
that inappropriately sales staff. This should and is regularly
high discounts may be be reviewed on a assessed.
given by the sales staff regular basis. Any A sample of sales should
in order to achieve a discounts in excess of be selected and any
sale. Profits would be these amounts should discounts given should
reduced as a result. be authorised by the be agreed to the
sales manager or sales discount policy.
director. Where the discount
exceeds the set limit
evidence of
authorisation by an
appropriate member of
staff should be
inspected.
158 CA Sri Lanka


Supplier statement Supplier statement Review the
reconciliations are not reconciliations should reconciliations to
performed. be performed on a ensure that they are
This may mean that monthly basis. Any being performed on a
there are errors in the major discrepancies monthly basis and that
purchases and payables should be reviewed by a significant issues are
accounts which are not senior member of staff. being followed up by a
identified. senior member of staff.
The purchase ledger Only the supervisor Attempts should be

master file can be should be able to made to change
changed by the change standing data on standing data on the
purchase ledger clerks. the master file. master file using the
This increases the risk Hierarchical passwords hierarchical passwords.
of error as master file should be used allowing Only passwords with
information may be clerks to access the the appropriate
updated incorrectly. It master file but not to authority should allow
also increases the risk change the data. the data to be changed.
of fraud as fictitious A report of changes to
suppliers could be standing data on the The report of changes to
created and bogus master file should be the master file should
payments made. produced on a monthly be inspected for
basis and reviewed by a evidence of review by a
senior staff member eg suitable senior member
the purchasing of staff.
manager. This review
should be evidenced by
signature.
Pear has surplus plant A capital expenditure Select a sample of
and equipment. plan needs to be capital expenditure
This indicates an developed by senior forms and verify that
inefficient use of management which the details comply with
company resources. For details not only the management policy.
example these items requirements for new
could be sold and cash plant and machinery
reinvested. but also details plans for
Inspect the plant and
the disposal of old or
equipment review
surplus items.
document and follow
The factory manager
through the treatment
should perform a
of old or surplus items.
documented review of
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the plant and
equipment held by Pear
on a regular basis (eg
quarterly) to identify
old or surplus items.
Purchase requisitions Capital expenditure Obtain a sample of
for new equipment are limits should be set so capital expenditure
authorised by that major items of forms and ensure that
production supervisors. capital expenditure are authorisation has been
Production supervisors authorised by the made by staff of an
are not senior enough to board. Production appropriate level based
authorise major items supervisors should only on the limits set.
of capital expenditure. be able to authorise the
The company may be purchase of low value
committed to the items. Capital
purchase of capital expenditure authorised
items not required. by production
supervisors should be
reviewed on a regular
basis by senior
management.
(Note: Only four deficiencies are required to achieve full marks)

(3) Substantive procedures
(i) Additions
• Cast the list of additions and agree the details to the non-current
assets register to ensure that additions have been completely
recorded
• For a sample of additions physically inspect the asset to confirm
existence
• For a sample of additions agree the cost of the asset to the
purchase invoice to confirm their value
• For a sample of additions verify that the purchase invoice is made
out in the name of Pear International to confirm rights and
obligations
• Review the nature of additions to confirm that revenue
expenditure has not been capitalised in error.
160 CA Sri Lanka

(ii) Disposals
• Cast the list of disposals and agree the details to the non-current
assets register
• For a sample of disposals agree the sale proceeds to supporting
documentation and trace receipt of payment to the cash book and
bank statements
• Recalculate profits or losses on disposal and confirm that they
have been correctly recorded
(Note: Only Six tests were required to achieve full marks)
4 Tempest
(1) Audit planning is important for the following reasons:
• It ensures that appropriate attention is devoted to important areas of
the audit. For example, overall materiality and performance materiality
will be assessed at the planning stage and this will mean that when the
detailed audit plan is drawn up, more procedures will be directed
towards the most significant figures in the financial statements.
• Planning should mean that potential problems are identified and
resolved on a timely basis. This could be in the sense of identifying
financial statement risks at an early stage, so allowing plenty of time to
gather sufficient relevant evidence. It could also relate to identifying
practical problems relating to the gathering of evidence and resolving
those through actions such as involving other experts being built into
the detailed audit plan.
• Planning helps ensure that the audit is organised and managed in an
effective and efficient manner. This could relate to, for example,
ascertaining from the client when particular pieces of information will
be available so that the timings of the audit are organised so as to
minimise waste of staff time and costs.
• Planning assists in the proper assignment of work to engagement team
members. Once the main risk areas have been identified at the
planning stage, the engagement partner can then make sure that staff
with suitable experience and knowledge are allocated to the
engagement team.
• Planning facilitates direction, supervision and review of the work done
by team members. Once procedures have been designed and allocated
to members of the team, it is easier for the manager and partner to
decide when work should be completed and ready for review. It will
also make it easier for them to assess during the audit whether work is
going according to the original plan and budget.
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(2) Materiality for the financial statements as a whole

Preliminary calculations of materiality for the financial statements as a
whole are based on the forecast financial statements and are set out below.
These materiality levels will need to be reassessed when the actual financial
statements for the year ended 31 March 20X7 are available and performance
materiality levels will also need to be determined.
Materiality for statement of profit or loss items should be set in the region of
Rs. 40,000 (being at the upper end of the range based on profit before tax).
Materiality for statement of financial position items should be set in the
region of Rs. 200,000, based on total assets.
Materiality levels for the financial statements as a whole are generally lower
than those for the prior year, suggesting performance materiality levels will
also be lower. This is likely to increase sample sizes for procedures; this is
appropriate in light of the indications that there may an increased risk of
error this year.
Materiality calculations
½ -1% of revenue (½% ´ 45,928 – 1% ´ 45,928) 230 to 459
5-10% of profit before tax (5% ´ 436 – 10% ´ 436) 22 to 44
1-2% of total assets (1% ´ 10,300 – 2% ´ 10,300) 103 to 206
(3) Higher risk areas
(i) Inventory
The forecast year end inventory figure is significantly lower than in the
prior year. Coupled with the mid-year change in the accounting system
for inventory there is a risk of material error in inventory quantities or
valuation.
(ii) Sales
Sales are forecast to have increased by 12% over the prior year.
Compared to the average year on year growth of only 7% for the
industry in general there is a risk that sales may be overstated.
(iii) Profit
Gross profit margin has fallen to 17.3% (20X6 21.9%) and net profit
margin has fallen to 0.9% (20X6 4.1%). This could indicate errors in
cut off or allocation or that the company has been cutting prices in
order to win market share and has let profitability suffer. Although
there is no specific indication of immediate going concern difficulties,
this strategy may not be sustainable in the longer term.
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(iv) Receivables
Days' sales in receivables are forecast to have increased to 47 days (36
days in 20X6). This may indicate problems with the recoverability of
the receivables and a risk that impairments in value of the receivables'
balances are not recognised.
(v) Non-current assets
There is a decrease in this balance of Rs. 900,000. This is far in excess
of what could be explained by depreciation of assets that comprise
mainly properties. It may be that there have been disposals in the year.
This raises the possibility of incorrect accounting or inadequate
disclosures.
Also in relation to the non-current assets, if the inventory balance has
genuinely decreased to approximately 15% of its previous level, some
of the storage locations may be redundant. It could be that the
reduction relates to impairment write-downs and it could be the case
that further write-downs are needed.
(vi) Related party transactions
Given the information that one of the directors purchased a yacht
during the year it may be that he has purchased fittings from Tempest.
There is a risk that any related party transactions have not been fully
disclosed.
(4) Audit approach
Wherever possible, evidence should be obtained from tests of control so that
detailed substantive procedures can be reduced.
Special emphasis will be needed in respect of inventory accounting.
Procedures will include:
• Obtaining an understanding of how the transfer of balances to the new
system was carried out. Direct testing of balances from the old to new
systems may be needed as well as reviewing evidence of control
procedures carried out by the client at the point of changeover.
• A sample of sales and purchase transactions should be traced through
the new system to establish whether additions to and deletions from
inventory are being made correctly.
• Test counts of inventory at the various locations should be performed
at the year-end and agreed to the inventory records as at that date.
Testing of items in the statement of profit or loss will need to include:
• Consideration of the revenue recognition policies being used
• Cut-off testing on sales and costs of sales
• Comparison of expense classifications from year to year
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The review of events after the reporting period should focus on:
• Any substantial adjustments to the inventory figure
• Evidence of recoverability of receivable balances
• Any information suggesting further reductions in profitability of the
business
• Management accounts and cash flow projections for the post year end
period
5 Ajantha
(1) Confidentiality
Due to confidentiality requirements set out in the Code of Ethics for
Professional Accountants, members have an obligation to refrain from
disclosing information acquired in the course of professional work unless
their client gives permission for them to do so. Confidentiality is an implied
term of auditors' contracts with their clients and this obligation continues
even after the professional relationship between the auditor and client has
ended.
The following are exceptions to this rule, where auditors are or may be
required to disclose confidential information or when such disclosure may
be appropriate:
(i) Disclosure is permitted by law and is authorised by the client or the
employer;
(ii) Disclosure is required by law, for example:
• Production of documents or other provision of evidence in the
course of legal proceedings; or
• Disclosure to the appropriate public authorities of infringements
of the law that come to light; and
(iii) There is a professional duty or right to disclose, when not prohibited
by law:
• To comply with the quality review of a member body or
professional body;
• To respond to an inquiry or investigation by a member body or
regulatory body;
• To protect the professional interests of a professional accountant
in legal proceedings; or
• To comply with technical standards and ethics requirements.
164 CA Sri Lanka

Audit risks and responses

(Note: Only 6 risks and responses are required for full marks)
(2) Audit risk (3) Response

Ajantha's finance director intends to An analysis showing developments costs
capitalise the Rs. 2.2 million of in relation to each product should be
development expenditure incurred. This obtained and reviewed. Testing should
material amount should only be be carried out to ensure the technical
capitalised if the related product is likely and commercial feasibility of each
to generate future profits. There is a risk product and where it can't be proven
that at least some of the expenditure that future economic benefits will result
does not meet the criteria. This will from the product developed, the related
mean assets and profits are overstated. costs should be expensed.
At the year end it is anticipated that Nate & Co should assess their ability to
there will be significant levels of work in gain the required level of evidence and if
progress, likely to constitute a material it is not sufficient, they should approach
balance. The pharmaceuticals an independent expert to value the work
production process is likely to be in progress. This should be arranged
complex and the audit team may not be after obtaining consent from Ajantha's
sufficiently qualified to assess the management and in time for the year-
quantity and value of work in progress. end inventory count.
Therefore they may be unable to gain
sufficient evidence over a material area
of the financial statements.
Ajantha uses standard costing to value Standard costs used for inventory
inventory and under LKAS 2 Inventories valuation should be compared to actual
the standard cost method may be used cost for an appropriate sample of
for convenience, but only if the results inventory items. Any significant
approximate actual cost. However, variations should be discussed with
standard costs have not been updated management to gain evidence that the
since the product was first valuation is reasonable and inventory is
manufactured, leading to a risk that fairly stated.
standard costs are out of date. If they
are, this could mean inventory is over or
under valued in the statement of
financial position.
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Approximately one-third of the Additional procedures, including
warehouses storing finished goods for attending inventory counts at third
Ajantha belong to third parties. party warehouses, will be required to
Sufficient and appropriate audit ensure that inventory quantities have
evidence will need to be obtained to been confirmed across all locations.
confirm the quantities of inventory held
in these locations in order to verify
existence and completeness.
In September a new accounting package The new system will need to be fully
was introduced. The fact the two documented by the audit team including
systems were not run in parallel relevant controls. Testing should be
increases the risk that errors occurring performed to ensure the closing data on
during the changeover were not the old system was correctly transferred
highlighted, and all areas of the financial as the opening data on the new system,
statements could potentially be affected. and that transactions have not been
duplicated on both systems and
therefore include twice.
The IT manager who developed the This audit team will need to ascertain
bespoke system left the company two from the finance director how this risk
months after the changeover and his of misstatement is being mitigated.
replacement is not due to start until just During the audit the audit team should
before the year end. Without an IT remain alert throughout the audit for
manager's support in the interim, errors evidence of errors, particularly when
may occur and may not be picked up due testing transactions occurring between
to a lack of knowledge or experience of September and March.
the system. This could potentially result
in misstatements in many areas of the
Rs. 1 million of equity finance and The audit team must the treatment of
Rs. 2.5 million of long-term loans have this finance is correct. Disclosures
been raised during the year. The relating to the equity and loan finance
accounting treatment and disclosure of should be reviewed to ensure
these can be complex with the equity compliance with relevant LKASs.
finance to be allocated to share capital,
and the loan to be properly presented as
a non-current liability. Disclosures need
to be sufficient to comply with LKASs.
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The loan has covenants attached to it. If Obtain and review (or re-perform)
these are breached then the loan would covenant calculations to identify any
be repayable straight away and would breaches. If there are any, then the
need to be classified as a current likelihood of the bank demanding
liability, potentially resulting in a net repayment will need to be assessed and
current liability position on the the potential impact on the company
statement of financial position. If the considered. The need to avoid breaching
company did not have sufficient cash the covenants reinforces the audit
available to repay the loan balance the team's need to maintain professional
going concern status of the company scepticism in areas that could be
could be threatened. manipulated.
The finance director has announced that Review the reasonableness of the
all land and buildings will be revalued as valuation and assess the competence,
at the year end. The revaluation surplus experience and independence of the
or deficit is likely to be material and if individual performing the valuation. The
the revaluation is not carried out and surplus/deficit should be recalculated to
recorded in accordance with LKAS 16 ensure that land and buildings are
Property, Plant and Equipment, non- included at a reasonable amount in the
current assets may be under or overstatement of financial position.
valued.
The already short reporting timetable If it is confirmed with the finance
for Ajantha is likely to be reduced. This director that the time available at the
could increase detection risk because final audit is to be reduced then the
there is pressure on the team to obtain ability of the team to gather sufficient
sufficient and appropriate evidence in a appropriate evidence should be
shorter time scale, which could assessed. If it is not realistically possible
adversely influence judgement on the to perform all the required work at a
size of samples and the extent of work final audit then an interim audit should
needed. take place in late February or early
March to reduce the level of work to be
done at the final audit.
(4) (i) Substantive procedures for inventory held at third party

warehouses
• Attend any inventory count at the third party warehouses to
review the controls in operation, to ensure the completeness and
existence of inventory and to perform any necessary test counts.
• Request direct written confirmation of quantities of inventory
balances held at year end from the third party warehouse
providers and request confirmation of any damaged or slow
moving goods.
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• Review any available reports by the auditors of the third parties

owning the warehouses in relation to the adequacy of controls
over inventory.
• Inspect any documentation relating to third party inventory.
(ii) Substantive procedures to confirm standard costs used for
inventory valuation
• Obtain an analysis of the standard costs used in inventory
valuation and compare them with the costs shown on actual
invoices or in wages records to see if they are reasonable
• Analyse the variances between standard and actual costs and
discuss the reason for these with management and the action
taken in respect of any variances.
• Discuss with management how standard costs are formulated and
applied to the inventory valuation, and the procedures in place to
ensure these are updated to account for movements in actual cost
when necessary.
(Note: 4 points only are required.)
6 Glo-warm
(1) Materiality for the financial statements as a whole
It is never appropriate to apply the prior year's materiality figure to the
current year figures. Materiality should be reassessed each year.
If the financial position has not changed much and the results are
comparable with the prior year, it is possible that the materiality assessed
year-on-year is very similar, but this does not mean that the auditors should
not assess it for each audit. When assessing materiality, the auditor must
consider all known factors at the current date. In this case, the financial
position has changed considerably, increasing the risk of the audit, which
may lower materiality itself.
As the position on the statement of financial position has changed
considerably, when materiality is assessed, it is unlikely that it will be similar
to the prior year. Using the information available, materiality is likely to be
assessed extremely low in monetary terms, due to the overall decrease in
assets and the loss that appears to have been made in the year. It is also
possible that given the current position, the figures on the statement of
financial position will not be used to assess materiality in this year.
168 CA Sri Lanka

(2) Specific audit areas of risk

A review of this statement of financial position suggests that audit work
should be directed to the following areas:
Going concern
Total assets have fallen from Rs. 373,000 to Rs. 165,000. Although the
statement of profit or loss has not been reviewed, the statement of financial
position shows a retained loss for the year of Rs. 211,000.
Net assets show a reduction in both inventory and receivables, which
suggests a decrease in activity, although trade payables do not seem to have
fallen so considerably. However, this could be accounted for by Glo-Warm
not paying its suppliers in a similar fashion to the previous year. It will be
necessary to review the statement of profit or loss to substantiate whether
activity has reduced.
The cash position has also worsened, with cash falling by Rs. 22,000. The
statement of cash flows should reveal more detail about this fall. However,
the company has paid off Rs. 5,000 of its bank loan, reducing overall net
debt.
In summary, audit work should be directed at going concern as several
indicators of going concern problems exist on the statement of financial
position. This will be further amplified when the statement of profit or loss is
available.
Inventory
Inventory has been mentioned above in the context of going concern. Audit
work should be directed at inventory specifically as this balance has fallen
significantly from the previous year, which seems odd in a manufacturing
company.
There is no suggestion on the statement of financial position for why this
should be so (for example, receivables are not correspondingly high,
suggesting high pre-year end sales, and payables are not correspondingly
low, suggesting low pre-year end purchases).
It may be that the inventory count did not include every item of inventory.
Alternatively it could simply point to a fall in activity (discussed above).
Warranty provision
A provision of Rs. 20,000 has been included in 20X6 for warranties. The
reasons for this must be investigated and the auditors must check that it has
been accounted for correctly.
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It seems odd that a warranty provision should suddenly appear on a

statement of financial position. It suggests a change in the terms of contracts
given to customers, or a change in the customers themselves (with different
terms then applying).
Alternatively it suggests that LKAS 37 has been wrongly applied in the
current year, or should have been applied in the previous year, and was not.
Other material items
As stated above, given the indications of loss and the reduction in total asset
value, it is likely that materiality will be assessed low in monetary terms. In
this case, most balances on the statement of financial position are likely to be
material (excluding investments and cash-in-hand which appear to be very
low risk).
However, as the bank loan is likely to be substantiated by good audit
evidence, the most risky of the other balances are trade receivables and
trade payables, for reasons discussed above in going concern.
More detail is required to make a judgement about the risk of tangible non-
current assets.
(3) The impact of the material uncertainty regarding going concern depends on
whether the situation has been adequately disclosed in the financial
statements.
If the situation has been adequately disclosed then, in accordance with
SLAuS 570, a section should be included in the auditor's report headed
'Material uncertainty related to going concern'. The section should highlight
the importance of the issue. The audit opinion would not be modified in this
respect.
If the situation has not been adequately disclosed the audit report would be
modified on the grounds that the lack of disclosure has led to a material
misstatement in the financial statements. This is likely to be considered
material, and so a qualified report would be given.
If the lack of disclosure was considered to be both material and pervasive,
such that the financial statements could not be considered to give a true and
fair view, then an adverse report should be given.
170 CA Sri Lanka

7 Shantha Holidays
(1) Internal audit and the risk of fraud and error
(i) The management of an entity have the primary responsibility of
preventing and detecting fraud and error. An internal audit function
may assist them in this responsibility. The role of the internal audit
function in respect of fraud and error will be decided by the entity's
management but is likely to include some of the following:
• Risk assessment – the internal audit function may carry out risk
assessments identifying the main risks of fraud and error or may
review that process if it is carried out by management.
• Control recommendations – internal audit reports may
recommend controls to address the risks of fraud and error
identified by management.
• Control procedures – the internal audit function may be
involved in carrying out certain control functions such as
counting cash or inventories and comparing to book records. It
may be management's objective to detect even low value frauds
and misappropriations.
• Monitoring controls – the internal audit function may perform
procedures to monitor whether the control procedures
implemented by management are operating effectively. This
could involve inspecting documents for evidence of appropriate
authorisation or using test data to check the operation of
computerised controls.
(ii) It would not be appropriate for the internal audit function to be
involved in all of these areas in a particular entity, as they would
effectively be checking their own work thus undermining their
credibility.
(iii) The existence of an internal audit function within an entity is likely to
act as a deterrent against fraud and error.
(2) External audit and the risk of fraud and error
(i) Responsibility. The ultimate responsibility of external auditors is to
give an opinion on the truth and fairness of the financial statements.
This means that the auditors give reasonable assurance that the
financial statements are free from material misstatement.
(ii) Professional scepticism. The auditor is responsible for maintaining
professional scepticism throughout the audit, considering the
possibility of management override of controls, and recognising that
audit procedures effective for detecting errors may not be effective for
detecting fraud.
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(iii) Discussion. The members of the audit team must also discuss the
possibility of the entity's financial statements containing material
misstatements resulting from fraud or error.
(iv) Risk assessment. When obtaining an understanding of the entity, the
external auditor will consider any indications of frauds that may lead to
material misstatements. This would involve inquiries of management,
internal audit (if applicable) and analytical procedures. Any risks of
material misstatement due to fraud will be treated as significant risks.
(v) Responses to assessed risk. The auditor must determine overall
responses to address the assessed risks of material misstatement due
to fraud at the financial statement level. This will involve:
• Assigning and supervising staff responsible taking into account
their knowledge, skill and ability
• Evaluating whether the accounting policies may be indicative of
fraudulent financial reporting
• Incorporating unpredictability in the selection of the nature,
timing and extent of audit procedures
(vi) Specific audit procedures. Irrespective of the auditor's assessment of
the risks of management override, audit procedures must be
performed which test the appropriateness of journals and other
adjustments. Accounting estimates must be reviewed for bias and,
where significant transactions appear to be outside the normal course
of business, the auditor must consider if they are concealing a fraud or
are themselves fraudulent entries.
(vii) Written representations. The external auditor must obtain written
representations from management:
• Acknowledging their responsibility for the design,
implementation and maintenance of internal control to prevent
and detect fraud.
• That they have disclosed to the auditor management's
assessment of the risk of fraud in the financial statements.
• That they have disclosed to the auditor their knowledge of
fraud/suspected fraud involving management, employees with
significant roles in internal control, and others where fraud could
have a material effect on the financial statements.
• They have disclosed to the auditor their knowledge of any
allegations of fraud/suspected fraud.
172 CA Sri Lanka

(viii) Limitations. It is not reasonable to expect external auditors to identify

all instances of material misstatements where fraud is involved even
when the audit is properly planned and performed in accordance with
the Sri Lankan auditing standards. Where a fraud has been perpetrated,
particularly if it is at management level, it is likely to be carefully
concealed and collusion may be involved.
(ix) Reporting. Where the external auditor detects or suspects that a fraud
has occurred, this should be reported to the appropriate level of
management. In certain circumstances, for example in matters subject
to legislation such as money laundering, the auditor may have to report
to external bodies.
(3) Risks affecting Shantha Holidays arising from fraud and error
(i) Staff are paid on a commission basis. This may result in deliberate
overstatement of sales figures as individuals try to inflate their own
income.
(ii) The use of the networked reservations system introduces the risk that
information may be lost or corrupted in transmission.
(iii) Errors may occur in the computerised accounting system if the controls
within that system are not operating effectively. It may also be the case
that certain employees have discovered how to circumvent the controls
and are able to amend records perhaps to hide misappropriations of
assets.
(iv) Some payments are received in cash. This introduces the risk that cash
may be misappropriated and the records falsified to conceal this.
(v) The amount that the entity is required to pay in to the central
compensation fund is based on the sales figure for the year. There may
be management bias towards understating sales to reduce the amounts
payable or delaying revenue recognition thus deferring the due date of
the payment.
(vi) Customers may attempt to defraud Shantha holidays by using stolen
credit or debit cards.
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Answers
8 Minty Cola Plc

Audit risk and response
Significant investment in updating the Review a breakdown of costs and carry
cola and fizzy drinks production out substantive testing on a sample of
process: risk that capital and revenue the expenditure.
expenditure is incorrectly classified,
leading to over- or under-statement of
non-current assets and profit or loss
expense.
Inventory being held at a larger number Attend inventory counts at the locations
of different locations, some of which are where the greatest proportion of
not owned by Minty: risk that inventory inventory is held, or where there have
is misstated. The spread of geographical been a history of errors.
location increases the risk that the Review supporting documentation from
inventory count procedures may be all warehouses to confirm ownership of
inconsistent. the inventory, particularly inventory
held by third parties.
A new general ledger being introduced: Analytical procedures and comparisons
risk of records being incomplete and with prior year trends, to identify any
increased risk of errors as a result of areas where figures in the financial
staff being unaccustomed to the system. statements appear to be inconsistent.
Agree the opening balances to prior year

closing balances, to confirm that they
have been correctly recorded in the new
system.
Substantive testing of a sample of
transactions and balances recorded over
the transitional period and immediately
after.
Substantive testing of any accounts
identified by analytical procedures as
unexpected.
New general ledger: increased detection Document and test the new system.
risk as the related system of internal Review management reports produced
controls has not been documented and over the transitional period to identify
tested by the auditor. any issues with the recording of
financial information.
174 CA Sri Lanka


Release of the allowance for receivables: Obtain documentation from
risk that truly irrecoverable debts are management to support the release of
no longer provided for, giving rise to the the allowance.
overstatement of profit and receivables. Make enquiries of the new credit
controller to gain an understanding of
the likelihood of recovering the Rs. 1.5m
of receivables.
Carry out extended testing of post year-
end cash receipts and review the aged
receivables ledger to determine the
need for an allowance.
Rs. 4.5m expenditure on the Obtain a breakdown of development
development of a new fizzy drink costs and research costs. Undertake
product: risk that research costs detailed testing to determine the nature
(required to be expensed under LKAS of the costs.
38 Intangible Assets) and development Make enquiries of management
costs (to be capitalised) are incorrectly regarding the basis on which the costs
classified, giving rise to the have been classified.
overstatement of intangible assets and
understatement of expenses.
Defective cola products remain unsold Carry out detailed testing of the cost and
and no adjustments have been made: NRV of the defective cola products to
risk that inventory is overstated. determine the level of inventory write-
off required.
There is a risk that customers would be Obtain details of any credit notes issued
unwilling to pay for the defective batch and returns in relation to the cola
of cola products, causing receivables to products and agree them to revenue and
be further overstated. receivables.
Obtain correspondence with major
retail customers to whom the cola
products have been sold, and identify
whether any discounts/credit notes
have been agreed.
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The management is paid a bonus based Apply professional scepticism
on the value of the company's assets: throughout the audit.
risk that the value of assets is overstated Review management assumptions in
through inappropriate judgements relation to accounting estimates.
applied in accounting estimates (such as Work to a lower level of performance
the releasing of the allowance for materiality to assets susceptible to
receivables). judgement (for example, receivables,
non-current assets and intangible
assets).
(Note: Only 6 risks and responses are required)

(i) Rs. 5m expenditure on improving the factory production process
• Obtain a schedule of the Rs. 5m expenditure and check that it
casts
• Agree items in the schedule to invoices to ascertain that items
have been correctly classified
• Inspect the result of work done where necessary
• Agree items on the schedule to the non-current assets register
and statement of profit or loss, respectively
(ii) Release of Rs. 1.5m allowance for receivables
• Enquire of the finance director the rationale for releasing the
allowance
• Review the aged receivables listing to identify old outstanding
receivables balances, and discuss the likelihood of payment with
the credit controller
• Obtain details of receipts after the year-end
• Review correspondence with customers to identify any balances
in dispute
• Review board meeting minutes for evidence of doubts concerning
the recovery of any receivable balances
• Based on the above procedures, calculate the potential level of
unrecoverable receivables and assess whether this is material.
Discuss the adjustment with management
176 CA Sri Lanka

(iii) Damaged inventory

• Obtain a schedule of the Rs. 1m damaged inventory and cast
• Attend the inventory count. Inspect the damaged goods and agree
the quantity to the schedule
• Discuss with management the company's plans for the damaged
goods – whether they are to be scrapped or whether any net
realisable value can still be assigned to them
• Obtain the sales invoices for any damaged goods sold post year-
end to assess the net realisable value
• Determine the cost of the inventory by obtaining supporting
documentation with regards to the raw material, labour and
attributed overhead costs.
• Quantify the level of adjustment required to value the damaged
inventory at the lower of cost and net realisable value and discuss
with management
9 Vakarai (Pvt) Ltd

(1) (i) Additional ratios
20X4 20X3
Operating PBT/Revenue 4.5/23 = 19.6% 4/18 = 22.2%
margin
Inventory Inventories/COS 2.1/11 ´ 365 = 70 1.6/10 ´ 365 = 58 days
days ´ 365 days days
Payable days Payables/COS 1.6/11 ´ 365 = 53 1.2/10 ´ 365 = 44 days

´ 365 days days
Current ratio Current 6.6/2.5 = 2.6 6.9/1.2 = 5.8

assets/Current
liabilities
Quick ratio (Current assets – (6.6 – 2.1)/2.5 = (6.9 – 1.6)/1.2 = 4.4
inventories)/Cur 1.8
rent liabilities
(Note: Only two ratios were required.)
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Audit risks and responses:
(1) Audit risk (2) Audit response

Management were disappointed with The audit team will need to remain
the 20X3 results and are under alert to the risk of creative accounting
pressure to improve the trading throughout the audit. It is important
results in 20X4. There is a risk that that they exercise professional
management have a greater incentive scepticism and evaluate any
to manipulate the results by adopting assumptions made by management in
a more aggressive approach in auditing accounting estimates.
relation to accounting estimates (ie Current year balances should be
provisions). compared to the prior year to
highlight any unusual trends.
A generous sales-related bonus Increased sales cut-off testing will be
scheme has been introduced for the required. Post year-end sales returns
company's salesmen. This increases should be reviewed, as they may
the risk of misstatements arising provide evidence of incorrect cut-off.
from sales cut-off as the sales staff
seek to maximise their bonus.
Revenue has grown by 28%, while Inquiries should be made of
cost of sales has only increased by management regarding the reason
10%. The gross profit margin has why cost of sales has not increased in
increased significantly. Although the line with sales. Substantive
bonus scheme and the advertising procedures should be performed on
campaign may explain the growth in an increased sample of costs, with an
revenue, the fact that the cost of sales aim to identify any costs omitted or
has seen a corresponding increase misclassified.
need to be investigated.
Although the gross margin has The classification of costs between
increased from 44.4% to 52.2%, the cost of sales and operating expenses
operating margin has decreased from will be compared with the prior year
22.2% to 19.6%. This trend is to ensure consistency.
unusual. While the bonus scheme and A detailed breakdown of operating
advertising campaign could account expenses and cost of sales should be
for some of the increase in operating reviewed for evidence of
expenses, there is a possibility that misclassification.
costs may have been misclassified The main components of costs of
from cost of sales to operating sales and operating expenses should
expenses. be identified and compared to the
prior year. Any unusual trends (for
example, significant costs in the prior
178 CA Sri Lanka

(1) Audit risk (2) Audit response

year not present in the current year,
and vice versa) should be discussed
with management.
The inventory valuation policy has The change in the inventory valuation
been changed, with additional policy should be discussed with
overheads to be included within management. The additional
inventory. overheads included should be
Inventory days have increased from reviewed, to confirm that they are
58 to 70 days. related to production.
There is a risk that inventory is Detailed cost and net realisable value
overvalued. testing should be performed and the
aged inventory report should be
reviewed to assess whether a write-
down is required.
Receivables days have increased from Extended post year-end cash receipts
61 to 71 days and management have testing and a review of the aged
extended the credit period given to receivables ledger should be
customers. performed to assess the need for any
This leads to an increased risk of write-offs or provision.
unrecoverable receivables.
The current ratio and quick ratio Detailed going concern testing to be
have both decreased significantly. In performed during the audit. Cash
addition, the company's positive cash flow forecasts covering at least
balance of Rs. 2.3m in 20X3 has twelve months from the year end
become an overdraft of Rs. 0.9m. should be reviewed, and the
Taken together with the growth in assumptions discussed with
revenue and the increase in operating management.
expenses, this may indicate
overtrading. A going concern risk
should be considered.
(Note: only five risks and responses were required.)

(3) Going concern procedures
• Obtain Vakarai's cash flow forecast and review the cash payments and
receipts. Assess the assumptions for reasonableness and discuss the
findings with management to understand if the company will have
sufficient cash flows.
• Review any current agreements with the bank to determine whether
any covenants in relation to the overdraft have been breached.
CA Sri Lanka 179

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• Read minutes of the meetings of shareholders, the board of directors

and important committees for reference to financing difficulties and for
evidence of any future financing plans.
• Review the company's post year-end sales and order book to assess the
levels of trade. Evaluate whether the revenue figures in the cash flow
forecast are reasonable.
• Review post year-end correspondence with suppliers to identify any
restriction in credit that may not be reflected in the cash flow forecasts.
• Inquire of the lawyers of Vakarai as to the existence of litigation and
claims.
• Perform audit tests in relation to subsequent events to identify any
items that might indicate or mitigate the risk of going concern not
being appropriate.
• Review post year end management accounts to assess if it is in line
with cash flow forecast.
• Consider whether any additional disclosures as required by LKAS 1
Presentation of Financial Statements in relation to material
uncertainties over going concern should be made in the financial
statements.
• Confirm the existence, legality and enforceability of arrangements to
provide or maintain financial support with related and third parties
and assess the financial ability of such parties to provide additional
funds.
• Consider Vakarai's position concerning any unfulfilled customer
orders.
• Obtain a written representation confirming the director's view that
Vakarai is a going concern.
(Note: only four procedures were required.)
(4) Auditor's reports
(i) Where the use of the going concern assumption is appropriate but a
material uncertainty exists, provided that the auditor agrees with the
basis of preparation of the accounts and the situation is adequately
disclosed, an unmodified opinion is issued. The audit report will
however include a going concern paragraph highlighting the
uncertainty to the user and referring them to the details in the
disclosure note.
(ii) Where the material uncertainty exists but the situation is not
adequately disclosed the opinion should be modified on the grounds
180 CA Sri Lanka

that there is insufficient disclosure and the financial statements are

materially misstated. Depending on the specific circumstances this may
be a qualified 'except for' or adverse opinion.
(iii) If in the auditor's judgement the company will not be able to continue
as a going concern and the financial statements have been prepared on
a going concern basis the auditor shall express an adverse opinion.
(iv) If the auditors are unable to form an opinion because they were not
able to obtain sufficient appropriate audit evidence they shall issue an
'except for' qualified opinion or a disclaimer.
(v) If management is unwilling to extend its assessment where the period
considered is less than twelve months from the reporting date the
auditor shall consider the need to modify the opinion as a result of not
obtaining this evidence. As this constitutes a lack of audit evidence, a
qualified opinion or disclaimer is required.
10 Fonseca Distributors (Pvt) Ltd

(1) Purchase transactions posted to the general ledger
I have been asked to verify whether items are being accurately recorded in
the general ledger of Fonseca Distributors in the year. CAATs will need to be
used when carrying out substantive testing over the computerised elements
of system, for example in extracting listings of invoices from the purchases
ledger and matching these to the general ledger postings. For manual
postings, samples of supporting documentation will need to be observed and
enquiries made of management if any anomalies are found.
Valuation/accuracy
An examination of the analysis and coding of purchase invoices will be
carried out to establish the level of accuracy achieved.
Presentation and classification
When carrying out the above examination of the analysis and coding of
purchase invoices, particular care will be taken to see that the expense
category 'purchases' is correctly identified and coded from invoices and is
not confused with other categories, for example stationery, rates, gas and
telephone.
Completeness
I would verify that the bookkeeper was up to date with the monthly posting
of all purchases transactions to the general ledger.
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Specific tests on purchase transactions will include the following:

(i) Purchase transactions will be traced from the invoice to the general
ledger and the analysis and analysis code will be checked.
(ii) The total invoice value will be traced to the general ledger.
(iii) The category of invoice expense and the expense amount will be
examined to confirm that it appears correctly on the detailed computer
list for the month concerned.
(iv) The total of the items on the detailed list will be matched to the general
ledger.
Any errors would be fully investigated as to their type, cause, materiality and
pattern.
The tests on the detailed list and total postings of cash payments, discounts
received and adjustments will follow the same procedure as for invoices and
credit notes. The monthly cash book total will be agreed to the total posted
from the purchase ledger to the general ledger.
Occurrence
Large variations between actual and budget on expense categories should be
examined further to verify that they are not due to errors in analysis, coding
or posting. Incorrect analysis and/or coding may be indicated where the
expense category is high or low in comparison with its budget to date.
Transactions will be traced backwards from the entries in the general ledger
making up the monthly total posted to the purchase ledger back to both the
detailed analysis and the individual invoice. The amount of the invoice
expense will be agreed with the amount posted to the general ledger. Any
errors would be fully investigated as to their type, cause, materiality and
pattern.
(2) Journals posted to the general ledger
To verify key assertions for journals posted to the general ledger I would
carry out the following tests:
• Firstly, I would check the opening balances at the start of the financial
year from the opening trial balance back to the closing entries on the
previous year's accounts. After this, each item would be agreed to the
general ledger ensuring that both the value and analysis are correct.
These opening postings should be the first entries in the new
accounting year as all general ledger balances should have been set to
zero, and this should be confirmed.
182 CA Sri Lanka

• Other cash book items would be agreed to the general ledger to

confirm that postings are correct as to value and expense category.
Large items would require a larger sample size and large, unusual or
suspicious items should all be checked and evidenced by supporting
documentation or Board approval.
• The year-end balances of cash and bank on the general ledger should
be agreed with the year-end balances in the cash book. This would
require the last month to be scrutinised as the closing balances at all
previous month-ends will have been agreed already.
• The tests on petty cash payments transactions would include the
following:
(i) Check that transactions are supported by vouchers and correctly
posted to the right general ledger account. This would include
checking that transactions are valid and coded to the correct
expense category.
(ii) Check that petty cash transactions are within any limits,
regarding the type of expenditure or maximum value, established
by management.
(iii) Agree that the petty cash balance in the general ledger at the end
of each month and at the financial year-end matches with the
balance in the petty cash book.
• The wages expense is posted manually to the general ledger from the
monthly payroll summaries by means of a journal. To verify that the
journals are correctly posted I would select several journals and check
the following matters:
(i) The totals of the analysis columns on the monthly summary
shown on the spreadsheet should be posted to the journal, and
forwarded to the general ledger.
(ii) The breakdown of wages expense into directors and the several
departmental categories will be checked. The correct
identification of directors' pay is important as this requires
statutory disclosure. I would obtain the current list of directors. I
would add up the totals in the analysis columns to confirm the
summary total and consider its reasonableness.
(iii) Amounts owing at the year-end for income tax, accrued pay and
other deductions will be verified and any reconciliation drawn up
by the bookkeeper agreed.
(iv) Any additions to, or amendments of, weekly wages records
posted to the general ledger through the adjustments journal will
be fully investigated and their validity established.
(v) The analysis of wages expense for the year will be compared with
the budget and an explanation will be sought for any significant
variances.
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• Adjustment journals are potentially a high-risk area and any tests

would include the following:
(i) Check that all the manually written adjustment journals were
authorised by the managing director and supported by
documentation and proper narratives.
(ii) Check journals are posted in numerical order and there should be
no missing numbers gaps in the postings.
(iii) Examine all large adjustments and the reasons given for the
errors. These will be traced to the general ledger to ensure that
postings do correct the errors.
(iv) Investigate closely recurring errors to establish their cause and
whether these can be avoided in future by management action.
(v) Examine the purchase ledger suspense account (payables
suspense) and trace all postings in and out.
(vi) Where there was no account in the general ledger, agree back to
the purchase invoice, establish the account number and verify
that the item has been posted from the suspense account to the
correct account.
(vii) Where the adjustment is due to the wrong account number being
used, agree that the journal correctly transfers the item to the
right account.
(viii) Where the bookkeeper has created contra entries between the
purchase ledger and the sales ledger, check that the
supplier/customer company concerned is posted with a purchase
ledger and sales ledger contra of the same value.
(ix) All other adjustments will be checked for validity and supporting
documentation. Reasons will be established for postings that
increase or reduce purchase ledger balances.
(3) Year-end balances on the general ledger
Year-end balances on the general ledger would be tested as follows:
(i) Any balances remaining on the purchase ledger and sales ledger
suspense accounts should be itemised on a supporting schedule and
the existence of each item justified.
(ii) General ledger balances for the cash book, petty cash book, sales ledger
and purchase ledger should agree to, or be reconciled to, the cash book,
petty cash book, total sales ledger and total purchase ledger balances at
the year-end. I will investigate further to confirm that any difference is
reconciled and explained. It may be that further adjustments are
required to reduce or eliminate a difference.
(iii) All non-current asset movements should be checked, including
purchases, sales, revaluations and depreciation.
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(iv) All outstanding liabilities should be verified and their size reviewed for
reasonableness.
(v) The bank reconciliation should establish the correctness of balances on
all types of bank account, ie loan, current, deposit, special transactions
and so on.
(vi) A review of the financial statements would be carried out to ensure
that material changes in assets, expenses, revenues, liabilities and
share capital are justified and explained. Justification would be sought
in both relative and absolute terms.
11 Kelanyia Joinery (Pvt) Ltd

(1) (i) Builder in liquidation after year end
SLAuS 560 Subsequent Events states that the auditor shall perform
audit procedures designed to obtain sufficient appropriate audit
evidence that all events up to the date of his report that may require
adjustment or disclosure in the financial statements have been
identified. Since the customer went into liquidation after year end but
before the audit report was signed, the auditor does have a
responsibility to look for events of this kind.
This could be achieved by, for example, reading minutes of board
meetings, reviewing the entity's latest interim accounts, reviewing
procedures that management have for identifying subsequent events,
and obtaining written representations that all subsequent events
requiring adjustment or disclosure have been adjusted or disclosed.
The customer going into liquidation represents an adjusting event
under LKAS 10 Events after the Reporting Period. The trade receivable
of Rs. 15,000 needs to be adjusted since the liquidation confirms that
the loss existed at the year end date.
(ii) Fire at factory after auditor's report has been signed
The auditor has no obligation to undertake audit procedures or make
inquiries regarding the financial statements after the date of the
auditor's report. It is the responsibility of Kelanyia's management to
inform the auditors of the fire at the factory. If Kelanyia do make the
auditors aware of the factory fire, the auditors shall consider whether
the financial statements need amending, discuss the matter with
management and take appropriate action. If the financial statements
are amended, a new audit report must be issued. If management
refuses to make any amendments required, the auditor shall modify
the audit opinion.
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Under LKAS 10 Events after the Reporting Period, the factory fire is a
non-adjusting event as it is not indicative of conditions that existed at
the reporting date. Since the factory fire is a non-adjusting event, no
amendments to the figures given in the financial statements are
necessary. Note that although this is a non-adjusting event, the
financial statements may still need to be amended to include a
disclosure describing the factory fire.
(2) The various factors in the accounts which may be indicative of going concern
problems are as follows:
(i) Only losses or low profits are being made and the company is not
generating sufficient funds to finance the expansion required.
(ii) There has been a dramatic increase in the level of overdraft over the
last year and there seems little prospect of the borrowing being
reduced and the security is threatened.
(iii) There are signs of overtrading as the expansion has been financed by
borrowings and the increase in current assets is being financed by
trade accounts payable.
(iv) The leverage is low and decreasing, with very little security being
available for the loans.
(v) There is a low current ratio and short-term funds are being used to
finance long-term assets.
(vi) The liquidity ratio is low and decreasing and the company's ability to
meet its liabilities on demand must be very questionable.
(vii) Inventory levels are increasing, suggesting that one or more of the
following problems may exist: deteriorating sales, poor inventory
control, obsolete or slow-moving inventories.
(viii) The value and age of trade accounts payable are increasing; some
suppliers are probably having to wait a considerable time before being
paid and it can only be a matter of time before pressure is put on the
company by one or more of its creditors.
(ix) High and increasing interest charges make the company very
vulnerable, especially in a period of recession and high interest rates.
(x) The fluctuating gross profit would suggest that the company's profit
margins are under pressure. The present level of gross profit does not
seem sufficient given the company's high level of expenses.
186 CA Sri Lanka

Workings
The following significant accounting ratios are based on the accounts provided in
the question.
20X2 20X3 20X4 20X5 20X6
Gross profit (%) 23.50 10.90 14.20 20.20 19.70
Other expenses: sales (%) 14.10 10.90 14.40 14.40 15.30
Interest: sales (%) 0.90 1.10 5.20 5.50 6.20
Net profit (%) 8.50 (1.10) (5.40) 0.30 (1.80)
Current ratio 1.39 0.91 0.73 0.73 0.76
Liquidity ratio 0.80 0.59 0.46 0.37 0.34
Leverage (%) 84.71 57.14 9.52 9.45 4.83
Inventory (months) 1.68 2.28 2.26 2.77 3.57
Receivables (months) 1.75 3.66 3.24 2.26 2.32
Payables (months) 2.26 5.43 4.43 4.43 5.09
(3) The other important steps to be taken by the auditors in determining
whether or not the company may be properly regarded as a going concern at
the year-end would include:
(i) Review carefully the cash and profit forecasts for the next year to see if
they suggested any improvement in the company's position.
(ii) Seek some evidence that the company's bank is prepared to continue
supporting the company.
(iii) Review the level of post year-end trading to see if this supports the
forecasts and show any signs of improvement in the company's
position.
(iv) Examine correspondence files for any evidence that suppliers might be
putting pressure on the company for repayment of monies owing.
(v) Consider how the company's position compares with similar
companies in the same business.
(vi) Discuss generally the situation with management and review any
recovery plans which they may have in mind.
(vii) Discuss the impact of the factory fire with management, including
whether the company has an insurance policy for the factory building
or any business interruption insurance.
12 Turbo Plc
(1) The overall audit strategy is a document that outlines the general strategy of
the audit. It sets the direction of the audit, describes the expected scope and
conduct of the audit and provides guidance for the development of the audit
plan.
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The audit plan is a more detailed document than the overall audit strategy
and includes instructions to the audit team that set out the audit procedures
the auditors intend to adopt. The audit plan may also contain references to
other matters such as audit objectives, timing, sample sizes and the basis of
selection for each account area. It also serves as a means to control and
record the proper execution of the audit work.
Key contents of an overall audit strategy:
• Section on understanding the company's environment
• Section on understanding the company's accounting and internal
control system
• Risk and materiality considerations
• Nature, timing and extent of audit procedures
• Section on co-ordination, direction, supervision and review
• Any other matters
(2) Performance materiality
Performance materiality is the amount or amounts set by the auditor at less
than materiality for the financial statements as a whole (see below) to
reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality for the
financial statements as a whole.
It also refers to the amount or amounts set by the auditor at less than the
materiality level or levels for particular classes of transactions, account
balances or disclosures.
Materiality for the financial statements as a whole
The materiality level for the financial statements as a whole is set for the
purposes of evaluating the effect of misstatements on the financial
statements and will generally exceed performance materiality levels used
while carrying out audit procedures.
Misstatements are considered material to the financial statements as a
whole if they, individually or in aggregate, could reasonably be expected to
influence the economic decisions of users. Therefore a misstatement in
isolation that exceeds performance materiality may not necessarily be
considered material to the financial statements as a whole.
Determining materiality for the financial statements as a whole involves the
exercise of professional judgement but generally a percentage is applied to a
chosen benchmark) as a starting point for determining materiality for the
financial statements as a whole (eg 5% of profit before tax).
188 CA Sri Lanka

When setting all materiality levels and judging the materiality of

misstatements the auditor will consider both qualitative and quantitative
effects.
Factors influencing the materiality benchmark for Turbo
Turbo's revenue has been declining and the company is expected to make a
small profit this year. The company owns a large number of assets in the
form of printing equipment. Since revenue and profits have been volatile and
the company has a large asset base, total assets may be the most appropriate
benchmark for determining materiality.
When calculating materiality using total assets a benchmark of 1-2% is used.
The auditors will use their judgment in deciding whether to set materiality at
the lower or higher end of this scale. The fact that Turbo is a longstanding
client may persuade the auditors to set materiality at the higher end of this
scale, particularly if Turbo is known to have a strong control environment
with few audit adjustments in prior years. However, given that the auditors
are aware the bank will be using the financial statements in making a
decision on the loan, they may be more inclined to set materiality at the
lower end of the scale this year. Therefore, 1% of total assets is the
recommended benchmark for materiality in the audit of Turbo.
(4) Risks and responses
Risk Response(s) to risk

SLFRS 15 requires that revenue on In relation to a sample of contracts in
contracts delivered over time by place at the year-end or commencing
stage of completion of the contract. near to the year end, it should be
Contracts for adverts may span the checked that revenue is recognised in
year end and the timing of the financial statements according to
invoicing does not necessarily the timing embedded in the contract
reflect the timing of adverts. for the adverts. Any deferred or
Invoicing for half or the whole accrued income should be
contract coincides with the advert recalculated and traced to the
start date which is not necessarily financial statements.
the stage of completion as required
by SLFRS 15. Therefore, there is a
risk that sales are recognised early,
overstating revenue in the financial
statements.
If recurring contracts have not Procedures planned for the audit
been re-signed by the date should include a review of renewal
advertising is meant to start an invoices close to the year end and
invoice is raised for the same these should be traced to contracts to
amount as before, but it is known ensure the correct amount and
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that key customers are proportion of revenue has been
renegotiating contracts. Key included in respect of these.
contracts are to be renewed on 31
March and invoiced amounts for
these may not reflect the revenue
due if contracts are still being
negotiated.
Receivables may be overvalued as The auditors should undertake
newsagents are taking credit external confirmation of receivables
beyond the agreed 45 day limit. balance to ensure they exist and
This could indicate poor credit extend cash-after-date testing to test
control which could result in recoverability of receivables.
uncollectable receivable balances. Customer correspondence files
should be reviewed for evidence of
any disputes.
Journalists' and photographers' Review payments made to journalists
invoices are often received after or photographers after the year end
their services have been provided. to identify any payments which relate
As a result liabilities and related to pre year-end articles/pictures.
costs may be incomplete,
understating the amounts included
in the financial statements.
There is a risk that Turbo may not Ask management for their assessment
be a going concern due to falling as to whether Turbo is a going
revenues, losses and poor cash concern and how they arrived at their
flow. conclusions, and obtain written
representation on their conclusion.
Review any contracts that have
recently been renegotiated and
compare to previous contract to
ascertain the extent to which
revenues are falling.
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Turbo's bank intends to rely on the Particular attention should be
audited financial statements when directed to judgmental areas in the
making a decision to provide loan financial statements (eg any
finance. As a result, management provisions reversed and revenue
have an incentive to overstate recognition policies).
profits by manipulating balances An independent partner review
which are reliant on an element of should be undertaken for judgmental
judgment. areas of the financial statements.
Material refurbishment of printing An analysis of the refurbishment costs
equipment has taken place and should be reviewed and traced to
there is a risk some repair costs invoices. The invoice descriptions and
have been included as non-current supporting documents should be
assets and vice-versa. Non-current reviewed so as to assess the nature of
assets and repair costs could be the expenditure.
misstated. Once established as either capital or
revenue, it should be traced to the
general ledger and the financial
statements to ensure it has been
classified correctly as an asset or
repairs.
The potential going concern issues The auditor should ensure that the
and the reliance of the bank on the whole team is aware of the higher risk
unaudited financial statements nature of the engagement and are
increase the risk of fraud within suitably qualified and experienced to
Turbo. There is an incentive for work on the engagement.
management to manipulate the The whole team should act with
financial statements as mentioned increased professional scepticism
above with the opportunity throughout the audit and retain
provided during the production of awareness of the risk in all areas of
the financial statements and the the financial statements.
potential for justification on the High risk areas such as Revenue
basis of keeping the business should be sufficiently considered with
solvent means that all key factors an assumption that revenue
for increase fraud risk are present. recognition in particular is high risk
unless there is evidence available to
the contrary.
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13 Ratnapura Manufacturing (Pvt) Ltd

(1) Risk in the tangible non-current asset audit
Control risk
The controls over non-current assets at Ratnapura appear to be strong. The
company maintains and reconciles a non-current asset register and there are
authorisation procedures in operation. These controls should be tested, and
if they prove effective, control risk could be assessed low.
Inherent risk
The tangible non-current assets are material on the basis of the proposed
materiality level. There has been a substantial movement on the plant and
equipment account this year, but this appears to be supported by the
information given by the management accountant. There appear to be no
disposals in the year, which may indicate that they have been omitted, or
that obsolete items are included in the register. It is also unclear whether
land is being depreciated. It would be inappropriate if it was being
depreciated. Overall, the inherent risk seems to be medium.
Detection risk
Given that inherent risk has been assessed as moderate and control risk has
been assessed as low, detection risk will be assessed as higher. However,
there is usually good evidence in relation to the existence and valuation of
non-current assets and these are the key assertions which the auditors are
interested in. There will also be scope to carry out good analytical
procedures, such as proof-in-total of depreciation.
Conclusion
The audit of non-current assets appears to be medium to low risk.
(2) The sufficiency of audit evidence relates to the quantity of evidence required
by the auditor.
The sufficiency of audit evidence is influenced by:
• The risk assessment of the audit – a high risk audit will require more
evidence to be gathered.
• The materiality of the item – a material item will require more audit
evidence.
• The results of audit procedures – where results of audit procedures are
consistent with each other and assess the auditor's initial expectations
then less additional audit evidence is required.
The reliability of audit evidence is influenced by the source of the audit
evidence.
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• Audit evidence from external sources is more reliable than that

obtained from the entity's records because it is from an independent
source.
• Evidence obtained directly by auditors is more reliable than that
obtained indirectly.
• Evidence in the form of documents (paper or electronic) or written
representations are more reliable than oral representations, since oral
representations can be retracted.
(3) Audit procedures
(i) Existence
In many cases it is self-evident that land and buildings exist. However,
it is important for the auditors to verify all components of land and
buildings contained within the statement of financial position, if they
are on a site different to the one which the auditors are primarily
attending, for example.
The other classes of asset should be inspected. A sample of assets from
the register should be agreed to the physical asset. The auditors should
make use of any identification marks on assets recorded in the register,
for example, security tags or bar codes which are kept on assets to
distinguish them. The auditor should inspect the condition of the assets
and ensure that they are in use.
The motor vehicles should be reconciled in terms of number of vehicles
existing at the opening and closing positions.
For all the above assets, the external auditor should also review the
insurance provision for the assets. This gives third party evidence of
the existence of assets as the insurer would not insure an asset which
did not exist.
(ii) Valuation (excluding depreciation)
Land and buildings appear to be stated at historic cost as the schedule
does not contain the words 'at valuation'. The auditors should confirm
that this is the case with the management accountant. The cost can
then be agreed to brought forward figures as there have been no
additions in the year. These figures will have been audited in the
previous year. If the assets are held at valuation, the auditors must
ensure that the requirements of LKAS 16 in relation to revaluations are
being complied with.
Similarly, as there have been no movements in the year, motor vehicles
can be agreed to the opening position.
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To audit the valuation of plant and computers, the auditors should

agree the opening position. They should then obtain a schedule of
additions to non-current assets, which can be agreed to purchase
invoices to verify valuation.
Lastly, the auditors should investigate whether the cost figures include
any fully-written down assets. This is implied by the fact that the
depreciation charge on plant, excluding additions, is low. If so, the
auditor should find out whether these assets are still in use, and if not,
consider whether they should be excluded from the cost and
accumulated depreciation figures contained within the notes to the
accounts. Excluding them would have a net effect on the reported
figure of Rs. 0.
(iii) Completeness
The schedule of non-current assets prepared should be reconciled to:
• The opening position (that is, the previous statement of financial
position)
• The closing position (what is disclosed in the financial
statements)
• The underlying records (the nominal ledger)
If the non-current asset register contains details of the cost and
accumulated depreciation of each asset, the register should also be
reconciled to the schedule. Explanations should be sought for any
differences.
The additions of the schedule should also be checked to ensure that the
opening and closing positions reconcile within the schedule.
The auditors should also carry out a test on some of the individual
additions, tracing the transaction through the system, from purchase
orders to delivery notes and invoices and through the ledgers to the
financial statements to ensure that additions have been included
completely.
14 Snu
(1) Importance of year-end inventory counts
Auditors are required to obtain sufficient appropriate evidence to support
the inventory figure stated in the accounts. This is particularly relevant
where inventories are material to the financial statements. Where perpetual
inventory systems are not maintained the year-end count is the most reliable
means by which the auditor can obtain the following audit evidence:
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• Quantity and existence of inventory

• An indication of the value of inventory and the means by which
management identify slow and obsolete items
• Cut-off details
• The overall control environment in which the inventory system
operates
• Evidence of fraud or misappropriation
(2) Principal risks associated with the financial statement assertions for
inventory
One of the risks associated with inventory is its appropriate valuation.
Inventory should be valued at the lower of cost and net realisable value per
LKAS 2 Inventories. Inventory can be a material figure in the financial
statements of many entities, particularly manufacturing companies, and
therefore appropriate valuation of inventory is very important, particularly
for obsolete and slow-moving items. The valuation can also be a matter of
judgement and this increases the risk associated with inventory.
Inventory in the statement of financial position must exist – this is another
key assertion. Inventory can be subject to theft and misappropriation, and is
often held at more than one location, and so controls to safeguard it are very
important.
Cut-off is another key issue for inventory. All purchases, transfers and sales
of inventory must be recorded in the correct accounting period as again
inventory can be a material figure for many companies. Incorrect cut-off can
result in misstatements in the financial statements at the year-end and this
can be of particular concern where inventory is material. Auditors therefore
need to consider whether the management of the entity being audited have
implemented adequate cut-off procedures to ensure that movements into
and out of inventory are properly identified and reflected in the accounting
records and ultimately in the financial statements.
(3)
Deficiency and implication Why difficult to overcome
The count is due to take place on As the company operates seven days
New Year's Day. This is unlikely to a week it would be difficult to find
be popular with staff. Resentment an alternative date for the inventory
and a desire to get the job done as count. In addition it is at this time of
quickly as possible may mean that year to coincide with the company's
the counts are not done thoroughly. December year end. It would be
There is also little time given to expensive and difficult to find
preparation before the count, a alternative staff to perform the task
problem exacerbated by the fact that and it is unlikely that the business
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both the shops and warehouse are will change its year end simply
very busy in the period leading up to because the inventory count is
the count. inconvenient. It may be possible to
perform the count a week before or
a week after the year end and roll
forward/back the inventory
calculation. This would involve
closing the business for an extra day
and would also involve a degree of
reliance on inventory records.
There is a lack of segregation of In some respects this situation could
duties. Mr Sneg is the inventory be resolved if an alternative senior
controller as well as being the count member of staff were made the
supervisor and count checker. This inventory supervisor. However in
means that he is responsible for the family businesses it is common for a
physical assets as well as small number of loyal and trusted
maintaining the book records. It staff to bear the majority of the
would be possible therefore for responsibility. There is likely to be
Mr Sneg to cover up theft of strong resistance from Mr Sneg
inventory or mistakes made by himself who would feel that his good
himself. This situation affects the character was being questioned.
control environment of the overall Other senior members of staff are
performance of the inventory count. also likely to be reluctant to take on
a role for which they may feel they
have little experience and
understanding.
Counters will work on their own. Where there is a limited number of
Normally counts should be staff it may be difficult to work in
performed by pairs of counters as pairs and get the count completed in
this reduces the risk of error. the available time scale. Due to the
timing of the count it will not be easy
to get staff from other areas of the
business to volunteer to take part.
There is a high turnover of staff. Where staff turnover is high it is
Counters are likely to be difficult to resolve the problem of
inexperienced and may not be inexperience in the short term.
motivated to do a good job. Management could consider the
factors which contribute to staff
leaving eg poor pay to determine
whether these can be addressed in
the medium term. However
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warehouse work is often unskilled
and therefore an element of staff
turnover is inevitable.
The treatment of inventory There is no reason why this matter
delivered to customers that has not cannot be dealt with. The treatment
yet been paid for is incorrect. The of inventory not paid for should be
inventory should not be added back corrected.
and the unpaid balances should be
included as receivables. If this is not
done, inventory will be overstated
and receivables understated.
15 Homes'r'Us
(i) Customer going into liquidation
Audit procedures
· Assess the likelihood of recovery of this amount by discussion with the
directors of Homes'r'Us.
· Confirm the amount of the amount outstanding as at the year end by
inspection of the receivables ledger and correspondence with the
customer.
· Review any correspondence between the company and the customer to
assess the likelihood of recovery of any amounts.
· Obtain a written representation point regarding the amount
outstanding from the customer from the directors of Homes'r'Us.
· Confirm the details of the bankruptcy to documents received by
Homes'r'Us from the liquidator.
Impact on financial statements
The financial statements will need to be amended, as this is an example of an
adjusting event after the reporting period. It provides additional information
concerning the recoverability of the debt at the reporting date.
Revenue, profit and net assets will all be overstated by Rs7.5m if the
accounts are not adjusted. The amount represents 10.7% of profit before tax
and 1.4% of revenue so is clearly material.
An adjustment is required in the financial statements to reduce the
receivables balance and profits.
Effect on auditor's report
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The effect of the matter on the financial statements is clearly material. If the
adjustments required are made, then there would be no effect on the
auditor's report.
If the directors refused to make the adjustment required, the audit opinion
would be modified on the basis that the accounts are not free from material
misstatement and a qualified 'except for' opinion would be issued, as the
matter is material but not pervasive.
(ii) Claim for unfair dismissal
Audit procedures
· Discuss the case for unfair dismissal with the directors of Homes'r'Us
to find out background of case, date when claim was lodged and
assessment of success.
· Review lawyer's correspondence regarding this case, as it may have an
impact for next year's audit.
· Review any press reports in the local or national papers about this
claim against the company.
· Review minutes of board meetings regarding this case and any other
claim cases against the company.
· Obtain written representations on this matter from the directors of
Homes'r'Us.
A provision for this claim is not required since the requirements for
recognising a provision under LKAS 37 Provisions, Contingent Liabilities and
Contingent Assets are not met. Under LKAS 37 (para. 14), a provision should
be recognised when there is a present obligation as a result of a past event, it
is probable that a transfer of economic benefits will be required to settle it
and a reliable estimate can be made.
In this case, it appears unlikely that Mr Evans will be successful in his claim
and so no provision should be recognised in the financial statements for the
year ended 31 December 20X7.
Disclosure of a contingent liability is also unlikely to be required since the
possibility of any transfer in settlement appears to be remote.
There would be no effect on the auditor's report as a result of this matter, as
no amendment would be required to the financial statements. An unmodified
report on the financial statements could therefore be issued.
(iii) Fire
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Audit procedures
· Discuss fire with management of Homes'r'Us to clarify facts of the
situation.
· Read minutes of board meetings and any reports submitted by
insurers.
· Review insurance documents to confirm that damage cause by the fire
is covered.
The fire at the storage depot is a non-adjusting event after the reporting
period – it does not relate to conditions which existed at the year end. It is
unlikely that the fire is significant enough to impact on the going concern of
the company. Disclosure of the event surrounding the fire should be made,
together with an estimate of the financial effect.
Provided that adequate disclosure has been made of the event and its
financial impact, there would be no need to modify the audit opinion as a
result of this incident. An emphasis of matter paragraph drawing attention to
this issue is unlikely to be required, unless it is viewed as being fundamental
to the users' understanding.
16 Chandan
Top tips. This is an example of an exam question examining an assurance service

that the candidate may not be familiar with. In such a situation, some might panic
and earn no marks. Make sure that you apply the basic principles of assurance
provision that you have learnt and your common sense and business knowledge
and be one of the candidates who gives an 'excellent' answer. Make sure you read
all parts of the question. In this case, even if parts (a) and (b) put you off, any
business advisor who had not studied for this paper should have been able to gain
marks in parts (b) and (c). For part (d), simply explain the need for a separate
audit engagement and likely alterations to the statutory auditor’s report to
recognise a different framework of preparation.
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Answers
(a) Agreed Upon Procedures

In an engagement to perform agreed-upon procedures, an auditor is engaged
to carry out those procedures of an audit nature to which the auditor and the
entity and any appropriate third parties have agreed and to report on factual
findings. The auditor is not providing assurance over the matter and the
report will not express an opinion.
The recipients of the report must therefore form their own conclusions from
the report by the auditor. The report is restricted to those parties that have
agreed to the procedures to be performed since others, unaware of the
reasons for the procedures, may misinterpret the results.
In this case, the auditor will carry out agreed procedures over the validity of
the receivables balance as directed by the client and provide them with a
report outlining the results of such testing. Chandan will then draw their
own conclusions based on that report as to what actions may be appropriate
or not.
(b) Matters to consider
· Whether there are any ethical reasons why the work cannot be
undertaken
For example if there is a close relationship between Felix Chandan and
any of the partners of Chileshe objectivity would be impaired.
· Whether there are any conflicts of interest
This would be the case if Chileshe was already acting on behalf of
another client also interested in acquiring ZTI.
· Whether Chileshe has the relevant expertise in this type of work
and this type of industry
Availability of resources and timing of deadlines would also need to be
considered, particularly if work will need to be carried out on the
international businesses in Africa and Asia.
· Why Chileshe has been approached to perform the work
Often in this case it would be the company's auditors who are asked to
perform the work on the target company. Chileshe will need to
consider the size of the fee and the ability to obtain additional work as
a result of this review.
· Status of Felix Chanda
As chief finance officer it is not clear if he is acting with the authority of
the main board.
· The nature of the assignment
200 CA Sri Lanka

Felix Chanda has asked Chileshe to 'advise' on a bid. Whilst Chileshe

can provide relevant information about factors affecting the bid, it
would not be appropriate for the firm to take executive decisions.
Ultimately the decision to purchase ZTI must be taken by the board.
· The scope of the assignment
The precise terms of the agreed upon procedures would need to be
clarified to ensure that the extent of the engagement is understood by
both parties. Chileshe will need to be clear that the report provided will
not provide an opinion but will report on the facts uncovered with
conclusions to be drawn by the user.
· Availability of information
This will depend on the access that Chileshe will be given to the
records of ZTI. The procedures to be carried out will rely on ZTI
providing the information that Chileshe will require in order to
undertake the procedures required.
· Relationship with Chanda's auditors
Chileshe should be free to communicate with the auditors of Chanda to
inform them of their intention to carry out the agreed upon procedures
and to ask them to confirm whether there are any reasons why they
should not accept the assignment.
(c) Procedures to carry out:
• Review after-date cash receipts by inspecting bank statements and cash
receipts documentation.
• Examine the customer's account and customer correspondence to assess
whether the balance outstanding represents specific invoices and confirm
their validity.
• Examine the underlying documentation (purchase order, despatch
documentation, duplicate sales invoice etc).
• Enquire from management explanations for invoices remaining unpaid
after subsequent ones have been paid.
• Observe whether the balance on the account is growing and if so, find out
why by discussing with management.
• Compare the aged analysis of receivables from the aged receivables listing
to the previous year.
• Review the adequacy of the allowance for uncollectable accounts through
discussion with management.
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• Compare the irrecoverable debt expense as a % of sales to the previous year

and/or to industry data
• Compare the allowance for uncollectable accounts as a % of receivables or
credit sales to the previous year and/or to industry data.
(d) Principle requirements of SLAuS 800, Audits of Financial Statements
prepared in accordance with Special Purpose Frameworks
Terms of Engagement
The terms of the audit engagement will be separate to the statutory audit and
reflect the managements responsibility for the financial statements prepared
under the expected fair presentation framework provided by the regulator.
Audit Planning and risk assessment
The auditor must plan for the special framework regulator required audit as a
separate engagement to the statutory audit. Given that management will be
implementing a new reporting framework for the first time then audit risk is likely
to be raised. Separate materiality needs to be determined based on this level of
risk and sufficient and appropriate audit testing must be planned to address this
risk
Also, SLAuS 800 provides a number of requirements for a special purpose
frameworks auditor’s report.
Basis of Preparation
The auditor’s report must state that the financial statements have been prepared
by management based on fair representation framework provided and required
by the Sri Lanka Government regulator.
Managements responsibilities
The auditor’s report must state that management is responsible for the
preparation of the regulator required financial statements prepared under the
regulators fair presentation framework.
In addition, the auditor’s report must state that management have determined
that necessary internal control is in place to enable the preparation of regulator
required financial statements that are free from material misstatement.
Auditors responsibilities
The auditor’s report must state that an audit has been performed to obtain
reasonable assurance that the regulator required financial statements are free
from material misstatement.
Auditors opinion
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The audit opinion will confirm whether or not the financial statements present
fairly, in all material respects, a true and fair view in accordance with the required
Sri Lanka Government Regulator fair presentation framework.
Basis of Accounting and purpose
The purpose of the financial statement needs to be include included in the
auditor’s report. Here, the auditor’s report will state the financial statements are
prepared to assist the company is meeting the requirements of the Sri Lanka
Government Regulator and clearly state, the financial statements may not be
suitable for another purposes.
Other Matter Paragraph
The other matter paragraph is reserved for anything the auditor is required to
disclose, which isn’t already included in the financial statements. Here, it is helpful
to confirm that company has been audited separately in accordance with Sri Lanka
Accounting Standards for statutory auditing purposes.
17 Axis & Co
(1) Lorenze Co
The company has changed its accounting policy for goodwill during the year
and failed to disclose this in the financial statements. In accordance with
LKAS 8 Accounting policies, changes in accounting estimates and errors, the
change in policy should be disclosed in the accounts.
An unmodified opinion on the financial statements with the inclusion of an
emphasis of matter paragraph is therefore not suitable as the opinion should
be modified on the grounds of a misstatement regarding disclosure –
depending on the materiality of the issue, the modification would either be
qualified ('except for') (if material) or adverse (if pervasive).
(2) Abrupt Co
Although the auditors are not required to provide an opinion on other
information in documents containing financial statements, they are required
to read the other information and consider its consistency with the accounts
in accordance with SLAuS 720 The auditor's responsibility in relation to other
information in documents containing audited financial statements.
There is a material inconsistency between the financial statements and what
is stated in the directors' report. It is the directors' report that contains the
misstatement. If the directors refuse amend their report so that it is
consistent with the accounts, then although an unmodified opinion on the
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financial statements can be issued, an Other Matter paragraph should be

included in the report to highlight this inconsistency.
(3) Jingle Co
A wholly-owned subsidiary of Jingle has commenced trading on 7 July 20X8,
subsequent to Jingle's year end. It is not clear whether the company was
incorporated prior to 30 June 20X8.
The auditors should obtain more information about Bell. It should be possible to
obtain details about its registration from the companies' registry. If this
information is unavailable, this would represent an inability to obtain
sufficient appropriate audit evidence in respect of which the auditors would
have to qualify their auditor's opinion in respect of it.
If the company was incorporated after 30 June 20X8, it requires disclosure in
the financial statements as a non-adjusting event after the end of the
reporting period. If these disclosures are not made, the auditors would have
to qualify the auditor's opinion for 20X8 due to a misstatement regarding the
disclosure. However, assuming the subsidiary was accounted for correctly in
the 20X9 financial statements, the 20X9 auditor's report would be
unaffected.
If the company was incorporated before 30 June 20X8 then the subsidiary
needs to be consolidated in Jingle's financial statements and the relevant
disclosures have to be made. If this is not the case, then the auditor's opinion
for 20X8 would have to be qualified over a misstatement in respect of the
accounting treatment of the subsidiary Bell. This would also result in the
20X9 auditor's opinion having to be qualified over the same issue if it was
not corrected, as the problem would affect the comparative financial
information in the following year.
(4) (i) SLAuS 700 Forming an opinion and reporting on financial statements
requires that the audit report only be signed once sufficient
appropriate audit evidence has been obtained on financial statements.
Written representations from management are audit evidence, so
logically there is not sufficient appropriate audit evidence until these
are received.
It is therefore not appropriate to sign the report and date it before
these are received.
(ii) It is not generally appropriate to refer to third parties in an auditor's
report, as this may give the impression that someone other than the
auditor is responsible for the report.
However, SLAuS 710 Comparative information – corresponding figures
and comparative financial statements permits reference to be made to a
predecessor auditor's report; this is the auditor's own choice.
204 CA Sri Lanka

This reference should be made in an Other Matter paragraph, included

directly after the Opinion paragraph, which states that the financial
statements for the prior period were audited by a predecessor auditor,
states what opinion was expressed, and the date of their report.
18 Colombo
(1) Revising materiality
Auditors must reassess materiality if they become aware of new information
that would have resulted in a different materiality level being set at the
planning stage.
Planning materiality is likely to have been based on draft financial
statements, but during the course of the audit it could become clear that the
final financial statements will be substantially different. For example, the
carrying amount of assets held at fair value could be much lower than
originally expected, which would affect the amounts in the statement of
financial position. In that case, the auditor would need to set materiality
again, on the basis of the actual results and position.
Alternatively, something could happen during the audit, eg the client could
decide to dispose of a subsidiary. This could change the appropriate
materiality level, as well as performance materiality. The auditor should take
this into account and revise materiality.
(2) Statement of profit or loss and other comprehensive income
Galle revenue
Galle's 25% drop in revenue indicates that goodwill relating to this
subsidiary may be impaired. There is a risk that this goodwill has not been
impaired when it should have been.
Property disposal
At Rs. 2 Mn, the property disposal is material.
The option to repurchase the property in five years' time points to the
possibility that this could not be a genuine sale, but a finance arrangement
whose economic substance is that of a secured loan. In this case the audit
evidence obtained is inadequate, and further evidence needs to be obtained
to determine the substance of the transaction.
If this is indeed a secured loan (in substance), then the asset will be
recognised in the statement of financial position, and the cash receipt will be
recognised as a loan (liability). Finance costs will be accrued over the period
of the loan – five years.
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If this is the case, then profit has been materially overstated, and liabilities
understated.
Property revaluation
The gain of Rs. 800,000 was just below initial materiality of Rs. 900,000, but
above the current materiality level of Rs. 700,000. Audit procedures must
now be performed in this area, as it is possible that there could be a material
misstatement here.
Actuarial loss
The actuarial losses are material, at Rs. 1.1 Mn, as is the defined benefit
liability of Rs. 10.82 Mn.
Axle Plc is a service organisation, and SLAuS 402 Audit considerations
relating to an entity using a service organisation requires the auditor to
obtain an understanding of this organisation. This can be obtained:
· From the Group itself, we should gain an understanding of how Axle Plc
arrives at its valuation, its systems and its controls.
· By obtaining a report from the auditor of Axle Plc (the service auditor),
which contains an opinion on the description of Axle Plc's systems and
controls.
This has not been done, and we have no information about how the plan
assets and liabilities were valued, or how reliable their valuation might be.
The audit team must therefore obtain this information before the service
organisation's representation can be relied upon.
Goodwill impairment
There is an indicator that goodwill relating to the Galle subsidiary is
impaired, but this does not appear to have been considered by the audit
team. Audit procedures must be performed on the assumptions used by
management in conducting this review. The reasons why the 25% fall in
revenue has not resulted in impairment must be specifically addressed.
Associate
The statement of profit or loss includes Rs. 1.01 Mn share of profit of
associate. The figure in the statement of financial position should include (at
a minimum) the amount brought forward, plus any profit attributable, less
any dividends received. It is thus highly unlikely that this figure would not
have changed since last year.
Trading division held for sale
The division held for sale is part of a subsidiary. Therefore, some of the
goodwill relating to this subsidiary may need to be reclassified as part of the
disposal group of assets held for sale. Although it is possible that no goodwill
206 CA Sri Lanka

will need to be reclassified, evidence needs to be obtained that this is the

case.
The statement of financial position contains one line within assets for 'assets
classified as held for sale'. This disclosure is incorrect: the assets held for
sale should be a separate section within 'assets'.
It appears that this Rs. 7.8 Mn could be a net figure, which again is incorrect
– there should also be a separate section within 'liabilities' showing the
liabilities from the disposal group. Audit procedures should be performed to
ascertain whether this in fact a net figure, in order to get the classification
right.
Although there are assets held for sale from a trading division, the statement
or profit or loss shows no discontinued operations. SLFRS 5 Non-current
Assets Held for Sale and Discontinued Operations requires the post-tax profit
or loss of discontinued operations to be shown as a single line. This appears
to be a material misstatement, and audit procedures should be performed to
determine whether it is or not – whether there are any discontinued
operations.
Non-controlling interest
There is no disclosure in relation to the non-controlling interest in the
statement of profit or loss and other comprehensive income. Both profit for
the year and total comprehensive income attributable to the non-controlling
interest should be disclosed.
New loan
Finance costs should be included of Rs. 8 Mn × 2% × 9 / 12 = Rs. 120,000.
However, finance costs have only risen by Rs. 40,000. No loans appear to
have been paid off during the year, as long-term borrowings have increased
by exactly the Rs. 8 Mn received for the new loan. Therefore, finance costs
appear to be understated.
The amount is not material in itself, but should be accumulated together
with any other misstatements that are discovered as they could become
material in aggregate.
19 Beech
(1) Fir Plc
Matters to consider
LKAS 16 Property, plant and equipment requires that where there is an
obligation to dismantle an asset, then the costs of doing so should be
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provided for, and included in the cost of the asset. The question here is
whether an obligation exists in accordance with LKAS 37 Provisions,
contingent assets and contingent liabilities. It is not sufficient for Fir merely to
'intend' to incur the costs, rather; there must be a legal or constructive
obligation as a result of a past event. If there is no such obligation, then no
provision should be recognised.
The provision should be for the present value of the future outflow of
economic benefits. Measuring a provision for costs to be incurred in 20-
years' time is inherently risky. For example, the cost to be incurred may only
be an estimate; the remaining useful life of the power stations is definitely
just an estimate; the selection of a discount rate to calculate the present
value involves judgement and is therefore not certain.
The provision has decreased in value since last year, which is unusual as
provisions normally increase over time as the present value is built up. This
could mean that circumstances have changed, or may signal new
measurement assumptions being made. It may also be a sign of profit-
smoothing, as earnings have effectively been shifted from last year's
statement of profit or loss into this year's. The reasons for this need to be
investigated.
The note to the financial statements does not conform to LKAS 37's
requirement to provide narrative information, including disclosure of the
reasons for making the provision together with any uncertainties in relation
to them. The notes should also analyse the movement in the year. Unless this
is remedied then this is a material misstatement which may lead to a
qualified audit opinion.
Audit evidence
· Review of evidence that there is an obligation to dismantle, eg from
regulatory authorities.
· Review of management's calculations used to measure the provision,
considering their consistency with other audit evidence obtained (eg
that the remaining life of the assets is 20 years).
· Review of documentation supporting management's assumptions (eg
to support the estimated cost of decommissioning).
· Discussion with management about reasons for the fall in the
provision, and evaluation of these reasons (eg regarding SLFRS,
knowledge of the entity).
(2) Spruce Plc
The expert should have been provided with clear written instructions
covering the objectives of the work and any specific issues to address. The
208 CA Sri Lanka

first procedure would therefore be assessing whether the work done meets
these objectives, whether it has been performed in accordance with any
standards specified, and that it is consistent with the applicable financial
reporting framework.
The expert's work should be reviewed to confirm that the correct source
data was used, and that it relates to the right financial instruments in the
right period. Any assumptions made by the expert should be compared with
eg similar assumptions used by management in preparing the financial
statements.
Any evidence contained in the report should be reviewed for consistency
with our understanding of the entity and with other audit evidence obtained.
Evidence used by the expert should be agreed to supporting documentation,
and any calculations contained in the work should be reperformed, eg fair
value movements.
The appropriateness of any models used by the expert should be evaluated.
(3) Pine Plc
LKAS 8 Accounting policies, changes in accounting estimates and errors
requires a change in accounting estimate to be accounted for prospectively,
not retrospectively as has been done here; retrospective accounting should
only be used for a change in accounting policy.
There should be no change to opening assets or equity; these are therefore
materially misstated here (overstatement). The extension of the properties'
useful life would probably decrease the depreciation expense, resulting in an
overstatement of profit. Also it is not clear why all of the properties' useful
lives have been extended; LKAS 16 requires that the useful life is the period
over which an asset is expected to be used. There is a risk that the useful
lives used are not appropriate, and that the financial statements are
LKAS 8 requires disclosure of the nature and amount of the change in
estimate; as this has not been done, there is a material misstatement in
respect of LKAS 8's disclosure requirements.
The matter should be discussed with management, who should be asked to
amend the financial statements. If satisfactory amendments are not made
then the auditor's report will contain a qualified opinion. This will be 'except
for' a material misstatement, as the amount is material but not pervasive.
The opinion paragraph in the auditor's report is headed 'Qualified opinion'.
Immediately before this is a paragraph headed 'Basis for qualified opinion',
which describes the matter giving rise to the qualification and quantifies the
effects of the misstatement.
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(4) Poppy Plc

· Inspection of the written instructions given to the valuer by Poppy
which should include the objectives and scope of the work, the
intended use of the valuer's work and the extent of the valuer's access
to records and files.
· Consideration of the assumptions and methods used by the valuer to
ensure they are reasonable based on other audit evidence and the
auditor's previous knowledge of Poppy.
· An evaluation of the method used to measure fair value to ensure
consistency with LKAS 40.
· Examination of the valuation report to ensure each property has been
valued consistently and that the date of valuation is reasonably close to
Poppy's year end.
· Physical inspection of the valuation properties to ensure their
condition is in line with the valuation report.
· Inspection of purchase documentation for the investment properties to
ensure that any revaluations made in the year of purchase are
reasonable and not significantly different from the purchase price.
· A review of subsequent events for additional evidence on the valuation
of the investment properties.
· Written representations from management concerning the
reasonableness of any stated assumptions in determining fair value.
· Evaluate the appropriateness of that expert's work as audit evidence
for the relevant assertion.
20 Gills Group
These notes consider the principal audit risks to be considered in planning
the audit of the Gills Group financial statements for June 20Y0.
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Gills Co
Non-controlling interests
There is an inherent risk that these investments have been classified
incorrectly as associates. LKAS 28 Investments in associates and joint
ventures requires Gills to have significant influence over the investee. If this
is not the case, the investments should be treated as trade investments.
Alternatively they may be joint arrangements if control is shared jointly with
one or more other entities.
These two investments are in areas quite different from the group's core
activity. There is thus a risk that the group's finance team may not have
applied appropriate accounting policies – e.g. deferring revenue for the
travel agent – resulting in misstatement of the group accounts.
Bonuses and accounting estimates
The existence of profit-based bonuses for directors represents an inherent
risk of manipulation, with income and profit being overstated, and expenses
being understated.
The fact that the group finance director left after a disagreement over
accounting estimates may indicate that senior management have indeed
attempted to manipulate the financial statements. It is crucial that
professional scepticism is exercised in this area. There is a risk that LKAS 8
Accounting policies, changes in accounting estimates and errors has not been
adhered to, for instance if change in accounting policy has been mistaken for
a change in accounting estimate.
Group finance director resigned
There is a risk that the financial statements, and in particular the
consolidation, have not been properly prepared in the absence of a finance
director overseeing the preparation process.
Moreover, the audit team may find it difficult to obtain appropriate
explanations from management if there is no finance director, or if a new one
is appointed who is not responsible for the accounts being audited.
Shark Co
New factory
The relocation to a new, very large factory may represent an increase in
Shark's operational gearing, which may create a business risk to going
concern if cash flow problems result. These could be exacerbated by any
teething problems resulting from the new factory.
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Dismantling costs
LKAS 16 Property, plant and equipment requires the dismantling costs to be
capitalised as non-current assets, and a provision created against them.
Account should be taken of the effect of discounting if this is material, and a
finance charge included in the statement of profit or loss to represent the
unwinding of the discount. The risk is that the provision has not been
created, and that assets and liabilities are therefore understated, and that the
depreciation expense is understated, which would result in profit being
overstated. There is also a risk that the provision has not been measured
correctly in accordance with LKAS 37 Provisions, contingent liabilities and
contingent assets, e.g. in respect of the effect of discounting.
Barracuda Co
Government grant
LKAS 20 Accounting for government grants and disclosure of government
assistance requires that the grant income is matched to the costs it is
intended to compensate for. This will result in deferred revenue being held
on the statement of financial position. There is a risk that this has not been
done, leading to liabilities being understated and profit being overstated.
LKAS 20 also requires that a grant is recognised only when there is
reasonable assurance that Barracuda will meet the condition specified by the
government. Where there is doubt over this, a provision should be
recognised in line with LKAS 37. The risk is that this has not been done, and
that liabilities are understated and profits overstated.
Piranha Co
Consolidation
The subsidiary was acquired mid-year, and there is a risk that its results
have not been consolidated from the correct date. If they are included from
too early a date and the company is profitable, then group profits may be
overstated.
The acquisition should be accounted for in line with SLFRS 3 Business
combinations. There is a risk that goodwill has not been calculated correctly,
and that the fair values of Piranha Co's assets and liabilities have not be
estimated reliably.
Accounting standards
Piranha Co's accounts must be restated so that they are in line with the
group's accounting policies, which should conform to SLFRS. This is a risky
process, particularly in the absence of a group finance director, and there is a
risk that Piranha Co's accounts may not be in line with SLFRS.
Intra-group trading
212 CA Sri Lanka

Piranha Co supplies about half of Shark Co's ingredients. There are therefore
a significant number of intra-group transactions which need to be eliminated
from the group accounts. There may also be inventories containing
unrealised profit, which needs to be provided for. The risk is that this has not
been done, potentially overstating revenues, expenses, assets and liabilities.
Conclusion
There are a number of risks which must be addressed during the planning of
the audit of the Gills Group financial statements for June 20Y0.
21 Dragon Group
(1) Matters to include in the tender document
Fees
The proposed fee should be included, along with an explanation of how it is
calculated. This would include details of the charge-out rates of the staff
likely to be used on the audit, along with estimates of the amount of time the
audit would be likely to take.
Dragon Group's needs and how Unicorn & Co could meet them
(i) An explanation of the need for each subsidiary (as well as Dragon Plc)
to have its own individual audit, and for the consolidated financial
statements then to be audited too.
That Unicorn & Co is a large firm and would be capable of auditing a
large group such as this.
(ii) The Dragon Group may also need some non-audit services (see below).
That Unicorn & Co can provide a variety of non-audit services, should
they be required.
(iii) Several subsidiaries prepare accounts under local accounting rules, so
the auditor of these
That Unicorn & Co is a global firm with offices in over 150 countries. It
would well placed to audit under local accounting rules, and to audit
their consolidation into the group accounts.
(iv) The Dragon Group operates in the furniture retail trade.
That Unicorn & Co has a specialist retail department and therefore has
the experience to audit the group efficiently.
Proposed audit approach
This section should include a description of the methodology to be used in
the audit. For instance:
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(i) How the firm would acquire knowledge of the business

(ii) Methods used in planning and risk assessment
(iii) Procedures used to gather audit evidence
Brief outline of Unicorn & Co
A short history of the firm, including a description of its organisational
structure, the services it can offer and the locations in which it operates.
Other services
A description of any other services Unicorn & Co can offer, such as offering
advice in relation to the proposed stock exchange listing. Careful
consideration should be given to ethical requirements relating to
independence when offering other services to a potential audit client.
Key staff
Details of the proposed engagement partner and of his experience that is
relevant to this audit. Details should also be given of the approximate size
and composition of the audit team, together with a description of the
relevant experience of key members of that team.
Communication with management
An outline of the various communications will be made to management over
the course of the audit. This may include information on the way in which
these reports could add value to the Dragon Group's business, for instance
the production of a written report on the effectiveness of internal control
procedures.
Timing
Details should be provided of the timeframe envisaged for the various
aspects of the audit. This might include details of when the subsidiaries
would be audited, when the consolidation process would be audited, and an
estimate of by when the group audit opinion could be completed.
Conclusion
This is a large, transnational group, carrying a high level of risk. Unicorn &
Co should take on the audit only once it is sure that it is able to do so, and is
assured of a fee that adequately compensates it for the level of risk involved
in undertaking the audit.
(2) Matters to consider before accepting engagement
Size of Dragon Group
The Dragon Group is large and expanding group of companies, and would
therefore require a high level of resources to audit. Unicorn & Co must
consider whether it has sufficient staff available to audit a growing group of
this size.
214 CA Sri Lanka

Overseas subsidiaries
Half of the subsidiaries are located overseas. Unicorn & Co has a large
number of overseas offices which could perform some or all of the overseas
audits. However, these offices may not all have specialist retail audit
departments, so consideration needs to be given to whether there is enough
experienced staff to carry out the audit.
If some of the overseas audit work needs to be done by auditors outside of
Unicorn & Co, then this work would need to be evaluated in order to express
an opinion on the group financial statements.
Relevant expertise
As Unicorn & Co has a department specialising in retail audits, it is likely that
it will have sufficient expertise in this country.
As a large auditing firm, it is also likely that Unicorn & Co will have staff
sufficiently experienced in auditing the consolidation process to audit the
consolidation of the Dragon Group's results.
Time pressure
The group's year end is 30 September 20X9, and management wants the audit
completed by 31 December 20X9. This represents a tight deadline, given that
the audit involves a large number of subsidiaries located in several different
countries and reporting under a number of different accounting rules. The
fact that this would be the first year that Unicorn & Co would have audited
the group also makes the deadline tight. There is also a possibility that
management do not fully understand what is required for an audit.
Planned listing
Management are planning a new listing on a foreign stock exchange. This
will increase the risk of management manipulation of the accounts, as
management may under pressure to report favourable results. Audit risk is
also increased by the fact that as a result of the listing, the financial
statements will be subject to heavy scrutiny by regulators.
Previous auditor
Unicorn & Co should consider the reason for the group seeking to change its
auditor, as this might affect the decision to accept the engagement. On the
face of it, it appears likely that the quickly-growing group has outgrown its
previous auditors, but Unicorn & Co should still seek to obtain the reason for
the change from the previous auditors.
Mermaid Pvt Ltd
Mermaid Pvt Ltd's previous auditors expressed a qualified audit opinion.
Unicorn & Co should gather information about the related contingent
liability, part of which would involve contacting the previous auditors.
CA Sri Lanka 215

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Management's refusal to disclose the contingent liability may indicate a lack

of integrity on their part, which would increase audit risk. Consideration
then needs to be given to whether any future non-disclosure would be
material to the group financial statements.
Minotaur Plc
Minotaur Plc operates in a different business area from the rest of the group,
so Unicorn & Co must consider whether it has staff available with the
appropriate level of expertise. This difficulty should be straightforward for a
firm of Unicorn & Co's size to overcome.
(3) Ethical and professional issues
There are a number of possible threats to Unicorn & Co's independence here:
· Familiarity: Kia may fail to exercise professional scepticism.
· Intimidation: the financial controller may be able to intimidate and
influence Kia's work.
· Self-interest: Kia may have an interest in not causing problems for her
relative, and may be unwilling to challenge them if required to do so.
To assess the severity of the threat, the degree of influence held by the family
member and by Kia must be considered. As financial controller and audit
senior respectively, both would have some influence over the financial
statements. It would therefore be unlikely that Kia would be able to be
assigned to this audit engagement.
Furthermore, allocation of staff to audit teams should be the decision of
Unicorn & Co alone. Staff should be allocated on the basis of their experience
and skills. There is a risk of the audit team possessing an inappropriate mix
of experience and skills for this audit if Unicorn & Co were not able to select
the audit team, which may impair audit quality. It is therefore crucial that
Unicorn & Co exercise a free choice over the composition of the audit team.
22 Faster Jets
(a) SLAUS 510 Initial engagements—opening balances covers auditor
responsibilities for initial engagements. The auditor must obtain sufficient,
appropriate audit evidence that the opening balances do not contain
misstatements that materially affect the current period's financial
statements. The auditor must obtain evidence that the prior period's closing
balances have been brought forward correctly to the current period or have
been restated, if appropriate. The auditor should also obtain sufficient,
appropriate audit evidence that appropriate accounting policies are
216 CA Sri Lanka

consistently applied or changes in accounting policies have been properly

accounted for and adequately disclosed.
If this evidence cannot be obtained, the auditor's report should include a
qualified opinion (inability to obtain sufficient appropriate audit evidence)
or a disclaimer of opinion or, in those jurisdictions where it is permitted, a
qualified opinion or disclaimer of opinion regarding the results of
operations, and an unmodified opinion on the financial position.
If the opening balances contain misstatements that could materially affect
the current period's financial statements, the auditor should inform the
client's management and the predecessor auditor. If the effect of the
misstatement is not properly accounted for and disclosed, a qualified or
adverse opinion will be expressed.
If the current period's accounting policies have not been consistently applied
to the opening balances and the change not accounted for properly and
disclosed, a qualified or adverse opinion will be expressed.
If the prior period's auditor's report was modified, the auditor should
consider the effect of this on the current period's financial statements. If the
modification remains relevant and material to the current period's accounts
then the current period's auditor's report should also be modified.
An Other Matter paragraph should be included in the auditor's report in the
case of the prior period financial statements not having been audited at all,
or having been audited by another auditor. This is irrespective of whether or
not they are materially misstated, and does not relieve the auditor of the
need to obtain sufficient appropriate audit evidence on opening balances.
(b) (i) Additional information includes:
· Details of the reason for the purchase, to understand the business
purpose, eg whether the land is held for capital appreciation. This
will help determine whether it is classified correctly as
investment property.
· Whether management has any specific plans for how Faster Jets
Co may make use of the land in the future, eg to construct
buildings and if so, what their purpose will be.
· The date of purchase, to ascertain how long it has taken for the
land to increase in value and whether this is in line with the
auditor's understanding of the entity and its environment.
· Whether the land was purchased for cash, or if finance was taken
out to raise the Rs125 million paid.
· Details of who is renting the land, in order to establish whether
the arrangement is with a related party.
· The type of rental arrangement, to determine whether it
represents a lease.
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· What the land is being used for. As the legal owner, Faster Jets Co
should be aware of its use and any associated risks, eg activities
close to airports may convey security risks, eg terrorism.
· The location of the purchased land, in order to plan the logistics
of the audit.
· Whether the company holds any other investment property, and
if so, whether it is also held at fair value. This will help determine
whether the accounting treatment is consistent for all investment
property.
· Information on management's reasoning behind the accounting
policy choice to measure the land at fair value.
· Details of who holds the title deeds to the land as this may need to
be inspected.
(ii) SLAUS 620 Using the work of an expert covers reliance on the audit
work on an expert and the standard set out the requirements in respect
of independence, competence and scope of work on which reliance by
the auditor is placed.
Independence
The auditor must evaluate whether the expert is independent of the
client, and so should enquire into whether they have any interests or
relationships which may threaten their independence.
For example, the expert must not be connected to Faster Jets Co, and
must not be a related party of anyone having influence over its
financial statements. Less reliance will be placed on their work if they
are not independent.
Competence
The expert's competence must be evaluated, eg by considering whether
they are members of any relevant professional bodies. The expert's
relevant experience should also be considered. An expert with
extensive experience of valuing land and investment properties will be
more reliable than a newly-qualified one with relatively little
experience.
In this case, an expert valuer may be a Chartered Surveyor, which
would give the auditor confidence in the reliability of their work.
Scope of work
The auditor should agree the scope of the work with the expert, include
its objectives, how it will be used (in relation to the audit), the
methodology and any key assumptions to be used. These assumptions
should agree with the auditor's understanding of the entity and its
environment.
218 CA Sri Lanka

The scope should be agreed at the start of the engagement. If the expert
deviates from it, then their work will be less useful to the auditor.
Conclusions
The auditor considers the source data used by the expert, focusing
whether it is reliable and consistent with the auditor's understanding.
The auditor then evaluates the conclusions drawn by expert, and
whether they are warranted by the evidence obtained. Any
inconsistencies should be investigated.
23 Lychee
(1) (i) The restructuring does not relate to conditions at the reporting date, so
under LKAS 10 this is not an adjusting event. LKAS 10 requires that this
event be disclosed in the financial statements, usually by way of a note
explaining the event and its financial effect.
Audit procedures would include:
· Verifying that management have included a note disclosing this
event in the financial statements, and that it is drafted in line with
LKAS 10
· Agreeing the estimated cost of the closure to underlying
calculations and supporting documentation, such as staff
employment contracts
· Reviewing the announcement for details, and agree these details
to the disclosures made in the financial statements
· Reviewing board minutes for details of the plan and to verify that
it has been approved by the board
· Discussing the reasons for the plan with management and
consider whether it is consistent with the auditor's knowledge of
the business
(ii) If the financial statements are not amended then they are not in
accordance with LKAS 10. Considering the materiality of the cost of
closure:
Based on revenue: Rs. 58m/Rs. 3.500m = 1.66%
Based on profit: Rs. 58m/Rs. 700m = 8.3%
Based on assets: Rs. 58m/Rs. 18,500m = <1%
The cost of closure is material to the statement of profit or loss, so non-
disclosure of this event is a material misstatement. In line with SLAuS
705 Modifications to the Opinion in the Independent Auditor's Report,
the auditor should express a qualified 'except for' opinion, as the
CA Sri Lanka 219

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misstatement is material but not so pervasive as to render the

statement of profit or loss meaningless.
The auditor's report should contain a paragraph discussing the reasons
for the modified opinion, in which the auditor would explain the nature
of the costs not disclosed, state the financial effect of the costs and state
that this is in breach of LKAS 10. It would also be helpful for the auditor
to state that this does not affect profit for the year, but is a disclosure
only.
(2) (i) An Emphasis of Matter (EoM) paragraph is a paragraph in the auditor's
report that is appropriately presented or disclosed, but which is so
important that special emphasis is needed for users.
An EoM is different from a modification to the auditor's opinion. An
EoM paragraph does not modify the opinion; indeed, it should state
clearly that this is the case. An auditor should only include an EoM if
s/he has sufficient appropriate audit evidence that the matter is not
The EoM should provide a clear reference to the matter, and to where
the appropriate disclosures and other information can be found in the
In this case of Lychee, a draft EoM paragraph may state:
Emphasis of Matter
We draw attention to note [x] to the financial statements which
describes and sets of the expected costs of the restructuring of Lychee
Co, which is occurring after the 31 March year end and which will take
place over the next six months. The restructuring will involve the
closure of a factory, and its relocation to another part of the country
closure of the factory. Our opinion is not modified in this respect.
(ii) An Other Matter (OM) paragraph has in common with the EoM the fact
that it does not modify the auditor's opinion. However, whereas the
EoM refers to a matter within the financial statements, an OM refers to
information that is rightly not present in the financial statements, but
which is so important for users' understanding of them that it needs to
be highlighted in the auditor's report.
The OM provides the means for the auditor to communicate with users,
and should state explicitly that the matter referred to is not required to
be included in the financial statements. In this case of Lychee, a draft
OM paragraph may state:
Other Matter
220 CA Sri Lanka

The financial statements of Pomelo Co. show revenue of Rs. 420

million, net profit of Rs. 65 million or the year ended 30 September
20X9 and had total assets at the year-end of Rs. 1,900 million and
were audited by another firm of auditors, whose reports have been
furnished. Our opinion has been solely on the reports of the other
auditors and our opinion is not modified in this respect of this matter.
24 Willow
(1) Matters raised by audit senior
(i) Inventory
This area is not material to net assets or to income and expenses, but
could become so in combination with any other immaterial
misstatements detected. Unless this is the case, there would be no
effect on the audit report.
LKAS 2 Inventories requires inventory to be measured at the lower of
cost and net realisable value (NRV). If the NRV is zero, then an expense
of Rs. 130,000 will be incurred, reducing both and assets by the same
amount.
SLAuS 580 Written representations states that a written representation
is not of itself sufficient appropriate audit evidence. Therefore further
evidence must be obtained.
The assertion that must be tested here is that NRV is not less than Rs.
130,000. The finance director's claim that the inventory can be
recycled would therefore need to be supported by evidence that the
NRV of this recycled inventory would not be less than Rs. 130,000.
Further procedures include:
· Making enquiries from an operations director to ascertain
whether or not the materials could be recycled.
· Obtaining documentary evidence of the costs of recycling
together with the potential selling price of recycled materials.
· Reviewing invoices raised after the period end for evidence that
the materials have in fact been recycled and sold on.
(ii) Provisions
This area is not material to net assets or to income and expenses, but
could become so in combination with any other immaterial
misstatements detected.
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LKAS 37 Provisions, contingent liabilities and contingent assets requires

that a provision be recognised where it is probable that there would be
an outflow of resources embodying economic benefits, as is the case
here. If this adjustment is not made then liabilities and expenses are
both understated. There is also unlikely to be adequate disclosure of
the circumstances surrounding the case.
When combined with the inventory misstatement, the result is a total
misstatement of Rs. 255,000, which is material to income and
expenses. If neither adjustment is made then the audit opinion is
qualified.
The verbal confirmation that the case will probably be paid is not
sufficient, and written confirmation from the lawyers is required. The
finance director's refusal to provide this evidence may constitute a
limitation on the scope of the audit if the evidence cannot be obtained
elsewhere, and throws into question management's integrity. This
should trigger a re-assessment of any written representations from
management relied on elsewhere in the audit, for example in relation
to inventory.
· Review correspondence with lawyers for evidence regarding the
outcome of the legal claim.
· Review board minutes for evidence about the claim.
(iii) Current assets
A loan to a director is material by nature, irrespective of its monetary
value. In line with LKAS 24 Related party disclosures Cherry is key
management personnel and thus a related party. The financial
statements must therefore disclose the loan principal amount, the
amount outstanding at the year end, together with the terms of the
loan including details of any security offered.
As the loan is not disclosed in the financial statements, there is a
material misstatement in respect of LKAS 24. If no adjustment is made
then the audit opinion is qualified.
It is possible that the interest payment has not been made or accrued
for. If not, then interest of 4% ´ Rs. 6,000 = Rs. 40 should be accrued
(the adjustment is immaterial).
· Review the written terms of the loan to confirm the interest rate
and any other conditions.
222 CA Sri Lanka

· Review list of accruals to see whether interest has been accrued.

(2) Property
A move from recognising properties at cost to at fair value would be
acceptable in line with LKAS 16 Property, plant and equipment, as long as it
is applied across an entire class of assets. The committee should be aware of
the benefits and drawbacks of such a change. Benefits include more relevant
information on the values of properties, and quicker recognition of fair value
gains in the financial statements. But the drawbacks include the need to
remeasure fair value at each period end. It may also be necessary to employ
an external expert to estimate fair values, which could be costly.
Asset register
The delay in receiving the non-current asset register would have impaired
audit efficiency, and potentially resulted in greater audit costs and therefore
fees.
The fact that the issue was discussed with the committee last year but then
recurred, suggests some sort of controls failure; either the last year's
discussion was not acted upon by the committee, or at some other point. In
both cases the reason for this needs to be ascertained.
The fact the financial controller has been on holiday at the start of the audit
for two years running is not just unhelpful, but may be a cause for concern eg
indicative of fraudulent behaviour.
Procurement
No explanation is actually given for why invoices are not matched to goods
received notes; there is no reason why this cannot be done if suppliers are
changed frequently, for example. Without this control, it is possible that
invoices are paid without goods ever being received. There is also a risk of
fraud if this is done intentionally, either delivering goods to another address
or using dummy invoices. The committee should seek to improve controls in
this area as a matter of some urgency.
Frequently switching suppliers is not itself a problem, but again this would
not seem to totally preclude maintaining a list of approved suppliers – it only
means that such a list would be a long one. If totally new suppliers really are
being used so frequently, then there may be issues with quality rather than
price.
There are a number of ethical issues here. First, the offer of three weeks' use
of her holiday home needs to be considered in light of the CA Sri Lanka Code
of Ethics requirements on gifts and hospitality. In this case the value of the
offer is likely to mean that no safeguards could prevent the auditors'
independence being impaired, so the offer should be declined. If the team
considers that Mia Fern intends to influence the outcome of the audit by
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making the offer, then this casts doubt on her integrity. The audit committee
should be notified of this situation.
The gifts of lunches are unlikely to impair independence as they are likely to
be of an insignificant monetary value. Provided that this is the case, they may
be accepted.
25 Lapwing
(1) The terms of the engagement to report on the business plan should be
agreed in an separate engagement letter to the statutory audit for this
assurance engagement. The following matters should be considered.
Intended use of the business plan
It should be confirmed that the report will be provided to the bank, as this
may establish Lapwing & Co as potentially liable to the bank.
Distribution of report
Clarification should be sought over whether the report will be distributed to
any other parties. It may be necessary for the report to include a liability
disclaimer.
Elements of business plan covered
The engagement is to report on the business plan, but clarification is needed
about whether this means the business plan as a whole, or merely the
forecast financial statements included in it. This will affect the extent of
Lapwing & Co's possible liability, and the extent of procedures required.
Nature of assumptions
It should be clarified whether the plan's assumptions are best estimates or
hypothetical. If the assumptions are clearly unrealistic, then SLSAE 3400 The
examination of prospective financial information states that the auditor
should not accept the engagement.
Period covered
The forecast financial statements are for 12 months. It should be clarified
that this is the only period on which assurance is to be provided.
Clarification is also needed over whether the other elements of the business
plan refer to only this period.
Fees and practical matters
The level of fees should be confirmed, together with billing arrangements.
Practical matters to confirm include the timing of the report, which will
224 CA Sri Lanka

enable Lapwing & Co to ensure that it has adequate resources (eg staff)
available to perform the engagement.
Form of report
The planned form of the report should be agreed in advance in order to
avoid any misunderstandings. The report would use a negative form of
words to provide limited assurance.
Respective responsibilities
It should be confirmed that management is responsible for preparing the
business plan, and for providing the auditor with all relevant information.
(2) General procedures
· Re-perform calculations to check arithmetical accuracy.
· Agree unaudited figures for period to May 20X2 to management
accounts to assess their reliability.
· Confirm that accounting policies applied consistently between the
periods and audited financial statements.
· Assess accuracy of past forecasts by comparison with actual figures.
· Consider reasonableness of trends in light of auditor's understanding
of Hawk.
· Review correspondence with bank about negotiated terms of the loan,
and confirm major terms and interest rate directly with bank.
Statement of profit or loss
· Discuss 21.4% increase in revenue with management, and consider if
reasonable.
· Operating margin rises from 30% to 33.8%. Ask for explanation from
management and consider if reasonable.
· Discuss sale of Beak Retail, including likelihood of sale and any likely
terms. Review board minutes for details about the sale.
· Recalculate profit on disposal, and agree proceeds to any draft legal
documentation.
· Consider reasonableness of finance costs. New loan should add Rs. 1
Mn (Rs. 30 Mn × 4% × 10 / 12), but finance costs are up by only Rs.
960,000 – need to ascertain the reason for this.
Statement of financial position
· Non-current assets are up Rs. 37.15 Mn, but the loan which financed
this investment was only for Rs. 30 Mn. Enquire about other possible
sources of finance used for this increase.
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· Review reconciliation of movement in non-current assets, confirming

that Beak Retail assets are derecognised.
· Confirm that any assets relating to the joint venture with Kestrel are
accounted for in line with SLFRS 11 Joint arrangements.
· Discuss the planned Rs. 5 Mn increase in equity (is this to help finance
the increase in assets?). Discuss what form this will take (ie rights
issue, or at full market price).
· Agree the increase in non-current assets to capital expenditure
budgets.
· Agree cash figure at May 20X2 to bank reconciliation and statement.
· Receivables days are predicted to fall from 58 days (3,300 / 20,600 ´
365) to 53 days (3,600 / 25,000 ´ 365), improving the company's cash
position. The reasons for this should be discussed with management,
and considered for reasonableness.
· Payables days are predicted to fall from 137 days (5,400 / 14,420 ´
365) to 124 days (5,600 / 16,550 ´ 365), worsening the company's
cash position. The reasons for this should be discussed with
management, and considered for reasonableness.
· Agree the increase in long-term borrowings to documentation obtained
for the new loan
· Discuss the deferred tax provision, and establish why there has been
no movement (which is unexpected, given the capital expenditure).
· Discuss the movement on retained earnings, which have risen only by
Rs. 0.8 Mn, in spite of a profit before tax of Rs. 10.52 Mn. It may be that
a dividend is planned.
(3) Ethical issues
The key issue with the provision of other services is that independence of
the auditor may be impaired as a result. In principle, CA Sri Lanka Code does
not prohibit the provision of other services. However, the fundamental
principles apply to all professional assignments. Therefore the audit firm
must assess the threats to which it is exposed in performing the engagement
and consider whether safeguards are necessary. In this instance appropriate
courses of action would include:
· Ensuring that the review is performed by staff other than those
involved in the audit eg stag in a business advisory department.
· Obtaining a second partner review of the audit opinion.
226 CA Sri Lanka

26 Baltimore
(1) The following are the matters which Goleen & Co should focus on in
providing agreed upon procedures assurance services of Mizzen Pvt Ltd to
Baltimore
Equity owners
It is crucial to determine the identity of Mizzen's majority shareholder. It
appears likely that this is Bizgrow, but further information is needed.
This is important because if Bizgrow does own the shares then it is with
Bizgrow that Baltimore would need to negotiate the purchase of Mizzen. If
Bizgrow does not want to sell its shares then Mizzen cannot be bought.
However, it is unclear how Baltimore came to identify Mizzen as an
acquisition target in the first place, and it is possible that Bizgrow may have
had something to do with this.
Funding
It is noted that Vic and Lou secured funds from Bizgrow. The nature of any
agreement that was made needs to be ascertained, as it is possible that
Mizzen may owe Bizgrow a substantial amount of money. This would be
material to any decision Baltimore might make about the acquisition.
The precise nature of the ongoing relationship between Mizzen and Bizgrow
is unclear. It is possible that Bizgrow is involved with Mizzen at an
operational level. Any agreements between the two parties should be
obtained and scrutinised.
Examination of the statement of profit or loss reveals a finance cost of
Rs. 250,000 which appears to be fixed. It is unlikely that this is interest on a
loan because loan interest would change as the balance is repaid. It is
therefore possible that this is a management charge from Bizgrow, which
would be indicative of ongoing involvement. We would need to understand
the nature of any liabilities Mizzen may have in relation to this charge.
Reputation
Mizzen's good reputation, and its having won awards for website design, is
key evidence for its expertise in this area. This should be verified to external
evidence. Customer satisfaction could be gauged by obtaining the results of
any customer satisfaction surveys that may have been conducted.
Vic and Lou
Vic and Lou appear to be crucial to the success of Mizzen, so Baltimore
would want them to be involved in future. It is not certain, however, that
they would want to be involved with Baltimore and its website, and they
CA Sri Lanka 227

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may wish to concentrate on their own more innovative work. The

acquisition would be much less attractive to Baltimore were they to leave.
Vic and Lou's intentions post-acquisition should be determined. It may be
possible to structure any future deal in such a way that Vic and Lou would be
required to continue working at Mizzen for a set period after the acquisition.
Staff
Mizzen is a business with few tangible assets, which relies heavily on the
expertise of its employees, who may leave after any acquisition – particularly
if Vic and Lou were to leave. It would make little sense to acquire Mizzen for
its staff, only to find that they leave on acquisition.
An organisational structure should be obtained in order to identify
management and key personnel within Mizzen.
It is also possible that Baltimore may wish to restructure Mizzen after
acquisition. In this case it is likely that redundancy payments would need to
be made to staff members losing their jobs. The amount of any possible
liability in this eventuality should be estimated as part of the review.
Freelancers
Mizzen has been using freelancers recently, which may result in a drop in the
quality of work done by comparison with established staff. This should be
investigated as it may affect Mizzen's ostensibly impeccable reputation.
Intangible assets
Mizzen has few assets, but is likely to have important intangible assets which
would form part of any goodwill paid on acquisition. Vic and Lou have
developed new website interfaces, and it should be determined whether any
resulting intellectual property belongs to them personally or to Mizzen.
Valuing these assets is likely to be difficult.
Customer databases should also be valued, which again is likely to be
difficult owing to the absence of any active market for assets of this kind.
Premises
It is apparent that the Rs. 1,000 nominal rent paid to Bizgrow would increase
after the acquisition, so it should be determined what an equivalent market
rent might be for the premises. Alternatively, the premises may no longer be
available, in which case the rent should be ascertained for premises meeting
Mizzen's needs. It may be possible for Mizzen to operate from Baltimore's
premises, in which case any opportunity costs should be considered.
Tangible assets
228 CA Sri Lanka

Mizzen's tangible assets need to be valued, and it should be determined

whether they are owned or held under lease, as it is possible that Mizzen
may be liable for any future lease payments.
Revenue recognition
The first revenue stream should be split into two components, with the
revenue relating to maintenance being recognised as deferred income and
spread over the contract period. There is a risk that revenue is recognised
too early, inflating Mizzen's profit in the short term.
Relevance of revenue
Baltimore needs Mizzen to develop a website for it, and it should be asked
whether Baltimore might be better off simply paying Mizzen Rs. 10,000 to
develop a website rather than acquiring the whole company.
It is clear that Mizzen would have the expertise to do this because it operates
its own subscription-based website. It should therefore be able to create
something of a similar nature for Baltimore.
The third revenue stream in particular does not appear relevant to
Baltimore, and it should be considered how this revenue stream would be
managed after the acquisition.
Revenue increase
Revenue rose 23.7% from 20X2 to 20X3, which is an impressive increase
although it is lower than the 60.4% increase from 20X1 to 20X2. The
question is whether such a growth rate might feasibly be achieved in the
future. It will therefore be necessary to scrutinise Mizzen's forecasts and
plans for future growth.
Operating expenses
Operating expenses in 20X2 were 58.3% of revenue, but only 49.6% in 20X3.
This is unusual, and may be indicative of efficiencies being achieved as
Mizzen grows. It does not, however, tally with the fact that freelancers have
been used this year, which would be expected to increase operating
expenses in relation to revenue.
A detailed review needs to be performed on operating expenses to ensure
that expenses are complete and are recorded accurately.
Cash
Mizzen's cash position should be confirmed to its bank statement. Although
the company is not lacking cash, from its statements of profit or loss one
would expect it to be in a better cash position than it is in. It is possible that
cash has been paid out in dividends to shareholders.
Further information
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· Copy of Mizzen's register of shareholders, to determine the identity of

the majority shareholder.
· Copy of any agreement between Bizgrow and Vic and Lou, to help
understand their ongoing relationship as well as Bizgrow's planned
exit route.
· Agreements of any loans received by Mizzen.
· Full audited financial statements of Mizzen.
· Details of awards won for website design, including press reports,
trade journals, for evidence of Mizzen's good reputation.
· Details of any customer satisfaction surveys conducted by Mizzen.
· Copies of contracts with Vic and Lou.
· Copy of organisational structure.
· Copies of contracts with key employees containing details of any
redundancy payments that might be due in the future, along with other
employee benefits and entitlements that are due to them.
· List of freelance designers used by Mizzen, together with copies of
contracts.
· Details of any copyrights or patents owned by Vic and Lou or Mizzen.
· Copy of rental agreement with Bizgrow, to be scrutinised for details of
possible rental payments after acquisition.
· Details of tangible non-current assets owned or operated by Mizzen.
· Copies of any lease agreements for non-current assets such as
computers or fixtures and fittings.
· Copies of projected financial information for the next year.
· Detailed management accounts, including breakdown of operating
expenses to ascertain reasons for rising operating margin.
· Details of any dividend payments made over the last three years.
(2) Agreed upon procedures type assurance work is covered by SLSRE 4400
Related Services, which is a completely separate assurance engagement to a
statutory audit. No assurance is provided on an agreed-upon procedures
engagement as only factual findings based on procedures performed are
reported. The Directors of Baltimore can then draw their own conclusions
from the findings provided in the agreed-upon procedures assurance report.
By contrast an external auditor's report gives reasonable assurance, which is
a higher level of assurance. This is because review engagements and agreed-
upon procedures engagements involve obtaining less evidence than is
230 CA Sri Lanka

required for an external auditor's report, and conducting procedures which

are less thorough.
The auditor’s report should state the following, as required by SLSRE 4400.
· Identification of the information on which the agreed upon procedures
have been applied.
· A statement that the procedures performed were those agreed with
Baltimore.
· A statement that the agreed upon procedures were performed in line
with SLSRE 4400.
· A listing of the agreed upon procedures performed.
· The purpose of each of the agreed upon performed.
· A description of the auditor’s factual findings including details of any
errors and omissions. Note, no assurance is provided by the auditors as
judgement is left to Baltimore based on the facts presented in the
assurance report.
· A statement that the agreed-upon procedures report extends only to the
information stated and does not constitute a full audit of Mizzen Pvt Ltd.
· A statement that the procedures performed do not constitute either an
audit or a review and so no assurance is expressed.
(3) Professional and ethical issues
Providing a recruitment service to a client is not specifically prohibited by
the CA Sri Lanka Code. However, the Code does say certain threats to
independence could be created. These are examined below.
Self-interest threat
Goleen & Co are considering the provision of recruitment services to audit
clients, earning fees based on a percentage of the salary of the person
recruited. This creates a financial self-interest threat to independence. The
firm may be tempted to recommend an individual to a client in order to earn
a fee, and not consider whether that individual is suited to the role.
Familiarity threat
The provision of recruitment services will create a familiarity threat. During
audits, Goleen & Co will have to assess the work of individuals they helped
recruit. The firm may be or may be perceived to be less likely to criticise or
challenge such individuals because this could discredit their recruitment
services.
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Self-review threat
A self-review threat occurs where an audit firm makes management
decisions for an audit client. Goleen & Co could be seen to be making such
decisions by providing recruitment services to audit clients. The firm could
review candidates' CVs and recommend individuals to interview but the final
decision of who to recruit should always rest with the client.
This threat is increased with the seniority of the individual being recruited,
for example if Goleen & Co were to advise on a new finance director. The
threat could be reduced by only providing services for the recruitment of
junior staff members.
Demand for services
Goleen & Co would need to carry out market research to ensure that there is
a demand for recruitment services before embarking on any new business
venture.
Training costs
The firm should also consider whether it has the time and resources to enter
into a new area of business. Ingrid Sharapova only worked in recruitment for
a year and seems to be the only employee with any experience. She may
require further training in order to recruit finance professionals and update
her skills.
An additional member of staff at Goleen & Co will also require some training
so the recruitment business can be kept running whilst Ingrid is away or on
sick leave.
If successful, the recruitment business may prove too much for Ingrid to
handle alone and the firm will have to either train or hire additional staff to
assist her.
Damage to reputation
Goleen & Co's reputation could be damaged if the quality of recruitment
services is low. This risk can be reduced by setting up the recruitment
services as a separate company.
27 Banana
(1) (i) Matters to consider
Materiality
Rs. 500,000
Materiality on revenue: = 4%
Rs. 12.5 Mn
232 CA Sri Lanka

Rs.500,000
Materiality on net profit: = 125%
Rs.400,000
Rs. 500,000
Materiality on total assets: = <1%
Rs. 78 Mn
The training costs are not material to the statement of financial

position. They would, however, be material to revenue and profit if
they were reclassified as expenses, turning a profit into a loss.
Accounting treatment
The training costs are currently recognised as non-current assets. This
is not in accordance with LKAS 16 Property, plant and equipment, which
states that the costs of training staff should always be treated as an
expense, as they do not meet the definition of an asset, which requires
that the entity has control of the asset. This is very unlikely to be the
case with training costs, as the staff will probably have the right to
leave the company, meaning that Banana would not receive any
subsequent economic benefit from having trained them.
The training costs should be treated as an expense in the statement of
profit or loss.
Audit opinion
If Banana does not amend its financial statements, the audit opinion
will be modified due to a material misstatement. This would probably
be an 'except for' qualification as the misstatement is material but not
pervasive.
Evidence
The file should contain:
· A review of the nature of the expenses themselves to verify that
they are classified correctly and that they are in fact training
costs.
· Testing of entries selected according to sampling procedures
detailed in the audit plan to supporting documentation, such as
purchase invoices, and agreement of payment of related payables
to the cashbook and to bank statements.
· Evidence that a sample (selected according to audit plan) of
entries are included in the accounts in the correct period.
Testing for completeness and that all invoices that should have been
accrued for were in fact accrued for.
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(ii) Matters to consider

Materiality for whole receivable
Rs. 30,000
Materiality on revenue: = 2.4%
Rs. 12.5 Mn
Rs. 300,000
Rs. 400,000
Rs. 300,000
Materiality on total assets: = <1%
Rs. 78 Mn
The receivable is not material to the statement of financial position. It

would, however, be material to the statement of profit or loss if an
impairment loss were recognised in relation to it.
Accounting treatment
SLFRS 9 Financial Instruments requires receivables to be recognised at
fair value. The fair value of the Cherry receivable is the 25% that the
administrators suggest it may be able to pay, ie Rs. 75,000. Rs. 225,000
should therefore be recognised as an impairment loss in the statement
of profit or loss.
Calculating materiality for the impairment loss:
Rs. 225,000
Materiality on revenue: = 1.8%
Rs. 12.5 Mn
Rs. 225,000
Rs. 400,000
This is clearly material to profit for the year.
Inventory
As Cherry is a customer, it is possible that Banana is holding inventory
or work in progress that was ordered by Cherry. Grape & Co needs to
ascertain whether this is the case, and if so whether the inventory can
in fact be sold. If it cannot be, then it may be impaired and should be
written down, recognising the loss in profit for the year.
Audit opinion
If Banana does not amend its financial statements, the audit opinion
will be modified due to a material misstatement. This would probably
be an 'except for' qualification as the misstatement is material but not
pervasive.
If the misstatement in respect of the receivable is taken together with
the misstatement in respect of the training costs, the overall result may
be that Grape & Co judges the statement of profit or loss to be rendered
234 CA Sri Lanka

meaningless (pervasive effect). In this case it would issue an adverse

audit opinion.
Audit evidence
· External documentation confirming the insolvency of Cherry and
the possible repayment of only 25% of the receivable.
· Confirmation from the administrator of the 25% to be paid,
including an indication of when this is likely to happen.
· Agreement of the amount owed from the receivables listing to the
ledger.
· Review of inventory documentation, and evidence of enquiries
made of management, regarding the value and the potential
recoverability of any inventory relating to contracts with Cherry.
· Calculations regarding the amount to be recognised as an
impairment loss.
(2) Selection of engagement staff
The fact that the junior had only worked on two audits before this is not a
problem. However, it is important that they be given work appropriate to
their level of skill and experience. This does not appear to have happened
here, as detailed below.
No audit planning meeting
The audit planning meeting, led by the partner, is a crucial part of the audit.
It is the best way of giving the team an understanding of the client, and
should discuss both the overall strategy and the detailed audit plan, perhaps
going into difficulties that have been experienced in previous years and
which could come up again. The discussion should focus on what individual
members of the team need to do. This is particularly important for less
experienced and junior members of the team.
Audit manager away
The manager should not have given the senior responsibility for the audit
while they were away on holiday for three weeks. It is important that an
audit is properly supervised, and it may have been more appropriate for
another manager to take responsibility for the audit.
Senior busy
Not only is there a question mark over whether they have the experience to
manage the audit, but the senior is also busy with other assignments and
thus unable to devote sufficient time to this one. It is very important that
someone is available to supervise junior members of the audit team. This is
not happening here.
CA Sri Lanka 235

Answers
It is also possible that the lack of attention paid by both the manager and the
senior has led to the misstatements in respect of the trading costs and trade
receivables not being picked up by the audit team.
Junior auditing goodwill and inventory
Goodwill is a complex accounting area to audit, and should not be given to a
junior to do. The same can be said of inventory and in particular work-in-
progress. A junior is very unlikely to have developed the judgement needed
to audit these areas. This seems to be the case here, as shown by the junior's
error at the inventory-take (see below).
Inventory-take
The junior helped the client's staff to count raw materials at the inventory-
take, when they should instead have been observing that the client's staff
were counting them correctly and in accordance with the count procedures.
This would seem to imply that the junior had not been properly briefed on
their responsibilities at the inventory-take, as this is a relatively basic error.
It is likely that more audit evidence will be needed to be done on inventory
as a result of this error.
Junior asked to challenge FD
It is not appropriate for a junior to be asked to challenge a client's finance
director regarding an accounting issue that they are unlikely to understand
fully. This should have been done by either the audit manager or the partner,
as they would be in a position to understand the technical issues involved,
and would carry sufficient authority with the client to make the challenge
effective.
Running out of time to complete procedures
Pressure of time is an important contributor to audit risk. Audit time
budgets should allow staff enough time to complete the audit to the required
quality. It is also possible that the lack of supervision of the audit team's
work has led to the audit being conducted inefficiently, with inadequate
monitoring of progress and discussion of issues as they arise.
Reduction of sample sizes
It is clearly unacceptable to reduce sample sizes as a way of saving time. The
sample sizes detailed in the audit plan should have been designed to gather
sufficient appropriate audit evidence. Reducing the sample size beneath this
point increases detection risk, and the risk of the auditor giving the wrong
opinion.
236 CA Sri Lanka

Basis of sample selection

Selecting a sample on the basis of the ease of finding evidence for an item, is
not an appropriate basis. Indeed, this might actively increase detection risk
as it means by definition that those items for which evidence is not readily
available, or might not even exist, are not tested.
Conclusion
The failures above suggest that this engagement has not been adequately
supervised, and that the audit work performed is inadequate in some areas.
A detailed review should be performed so that any other shortcomings can
be addressed.
Doubt is also cast over the sufficiency of the firm's quality control
procedures. This matter should be referred to the relevant partner for
consideration.
28 Retriever
(1) The Group obtained a listing during the year which means that its financial
statements will be the subject of particular scrutiny. This raises the overall
risk level of this assignment, which means it should be subject to especially
stringent quality control. This does not appear to have been the case.
Engagement quality control review
The fact that there is an engagement quality control review taking place is an
encouraging sign, as it summons the prospect of some of the more egregious
failings of quality control being made good before the auditor's report is
signed.
Time pressure
The existence of time pressure points to poor planning. The purpose of the
audit plan is not only to direct audit work to appropriate areas of the
financial statements, but also to decide on the resources and deadlines
necessary to complete the audit satisfactorily.
Time pressure increases detection risk. Procedures are likely to be rushed,
resulting in a lack of professional scepticism and misstatements going
undetected. This seems to be what has happened here.
Directors' emoluments
The audit manager described these as low risk, but they are material by
nature. Not only are they related party transactions, they carry a high risk of
manipulation as directors may attempt to conceal their remuneration from
shareholders and other users of the financial statements.
CA Sri Lanka 237

Answers
There will also be additional reporting requirements as this is a listed group,

which only increases the risk to the auditor.
Even if they were low risk, planned audit procedures would still need to be
performed. The fact they are high risk only heightens this necessity.
Share capital
If the group were not listed, then share capital might be low risk. However,
the fact it obtained a listing during the year means that share capital could
have changed significantly. This is a highly visible area, and is therefore high
risk.
Sampling method
SLAuS 530 Audit Sampling does allow samples to be selected haphazardly,
which is effectively the exercise of judgement which the manager appears to
be advocating. However, several points can be made against the manager's
advocacy of judgmental sampling.
Firstly, the audit plan prescribes statistical sampling. It is possible to deviate
from the audit plan, but only if this would provide better evidence. Yet this is
not the manager's stated argument, so the suggestion should not have been
made.
Secondly, haphazard sampling requires the exercise of judgement which
juniors are unlikely to possess in view of the fact that their firm usually
samples statistically. There is a risk that juniors will not understand how to
select samples in this way, and will simply select eg large balances.
Thirdly, the manager's claim that haphazard sampling is quicker is
manifestly false. When done properly, haphazard sampling requires the
exercise of judgement and this takes time. Statistical sampling is much
quicker to implement as it is relatively mechanical.
In fact the manager's suggestion that this would save time amounts to an
incitement to the juniors to select the samples without due care, perhaps
only picking the items that are close to hand. This is a serious breach of the
CA Sri Lanka Code of Ethics.
Trade payables
It is acceptable for juniors to be involved in the audit of trade payables,
however the suggestion appears to be that one junior has been made
responsible for the whole of trade payables on a listed company audit. This is
clearly unacceptable, as the junior would possess neither the skills nor the
time to perform the work to a satisfactory standard.
Going concern
Going concern is a difficult area to audit as it usually involves making
judgements about a business's future prospects, which requires substantial
238 CA Sri Lanka

experience. Juniors are very unlikely be able to do this and so should not
have been assigned going concern.
A more senior member of the audit team should have been assigned going
concern, such as the audit manager or partner.
Taken together with trade payables, this reveals a disturbing failure of
direction on the audit, which is a key aspect of quality control.
Review
It may well be good training for juniors to review each other's work, but this
is no substitute for proper supervision and monitoring by more senior
members of the audit team. Being at the same level, juniors are unlikely to be
able to spot any errors or invalid conclusions drawn, so the reviews are
likely to be of little use. Moreover, the juniors are likely to be very familiar
with each other and may be unwilling to criticise each other's work. The
work should have been reviewed by the audit manager.
The financial controller of a listed company should be able to calculate
deferred tax, so the fact that she could not raises issues about the Group's
internal controls. The audit team should therefore revisit the risk
assessment done at the audit planning, as deficient internal controls may
mean that more substantive testing will be required.
The junior should not have been discussing the tax position with the
financial controller in the first place. Given that the time on the audit is so
short, what time there is would be better allocated to performing audit
procedures. This points to a lack of supervision, and also to a need for
further training for the audit junior.
Deferred tax asset
This is a good example of the principle of professional competence and due
care, which the junior appears to have breached. Although the junior has
studied deferred tax in college, they lack the experience to know that in
practice the recognition of deferred tax assets is rare. Given that the Group's
subsidiaries have been suffering losses it is not certain that any such asset
will be recoverable; making the judgement over the asset's recoverability
requires experience that the junior does not yet possess.
The key ethical issue here is that the auditor must not provide accounting
services such as this to listed clients. The self-review threat so created –
whereby the firm would then be auditing accounts that it has itself prepared
– would be deemed by the Code to be insurmountable in this instance.
The audit manager said that this would save time and that the figure would
not need to be audited. This is wrong. Now that the junior has calculated the
CA Sri Lanka 239

Answers
figure it will need to be carefully reviewed and re-performed, and discussed

with the management of the Group. The audit manager's suggestion is
indicative of a lack of due care.
Tax planning
The audit junior should not be providing tax planning recommendations.
This is a non-audit service, which the junior is providing free of charge and
without the required professional skills. There is a self-review threat here
because the tax balances calculated on the basis of the junior's advice would
be included in the audited financial statements. There is a danger that the
junior has been taking management decisions. It would usually be possible
for a tax planning service to be provided to a listed client, but the auditor
would have to put in place safeguards such as separate engagement teams
which clearly do not exist here.
There is a risk that the firm may be the subject of litigation as well as
reputational damage if the client relies on wrong advice given by the junior.
Steps should therefore be taken to inform the Group of the situation and to
prevent it from relying on this advice.
(2) It would be helpful to arrange a meeting with Group management in order to
help obtain an understanding of the theft and the circumstances around it,
and to clarify matters in relation to the engagement.
The objective should be specified precisely, and clarification may be needed
regarding whether quantification is to be made of the amount to be claimed
from the insurer, or of the amount of the loss.
It should be clarified whether the Group wants us to investigate the crime
itself and to identify the perpetrator, as this would be a radically different
type of investigation which may be outside the scope of Kennel & Co's
professional competence.
Clarification should be sought on whether the Group has already made any
calculations of the amount to be claimed, in which case it may simply want
us to audit its calculation. Alternatively it may want us to calculate the loss
ourselves from scratch. This would have an effect on fees, which should also
be discussed at the meeting.
Kennel & Co appears likely to have sufficient resources to conduct the
investigation as it has an internal audit services department. It should,
however, be determined whether the firm has the requisite staff available for
this assignment.
It will be necessary to discuss timings with the Group, and in particular any
planned deadlines for submission of the insurance claim. Any such deadlines
should allow enough time for the work to be completed without sacrificing
240 CA Sri Lanka

quality. This will in turn affect the consideration of whether sufficient

staffing resources are available at the right times.
It must be confirmed that the assurance team will have full access to any
information required to conduct the investigation.
The Group should have reported the theft to the police, and it may be helpful
to obtain a copy of any police reports available. It should be established
whether the perpetrator(s) have been caught, and if so, whether they are
likely to be prosecuted. Kennel & Co should bear in mind that there is a
possibility that the Group might ask it to act as an expert witness if there
were a court case, in which case there may be an advocacy threat to the
firm's independence.
It is possible that the perpetrator(s) have been caught and that some of the
assets have been recovered. This should be ascertained, and any recovered
assets excluded from the calculation of the loss. It is also possible that these
assets may have been damaged, in which case this should be taken into
account.
From the circumstances described it is possible that the thieves may have
been Group employees. This information should be obtained from
management.
Finally, the output of the investigation should be confirmed. The Group may
require a report to the insurance company for example, or alternatively a
report addressed to itself but which it can use for the purposes of the
insurance claim. It should be clarified that the report would not be
distributable to any other parties.
(3) Procedures
· Watch the CCTV to determine the quantity of goods stolen, eg how
many boxes loaded onto lorry.
· If possible determine if the boxes contain mobile phones or laptops.
· Inspect boxes of goods in the warehouse to determine how many
finished goods are in each.
· Agree cost of an individual phone and laptop to accounting records, eg
cost cards.
· Perform inventory count on boxes of goods in the warehouse and
reconcile to latest inventory movements.
· Discuss the case with police to establish if any goods have been
recovered and if this is likely to happen.
· Obtain details of stolen lorry, eg licence plate, and agree the lorry to
non-current asset register.
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Answers
· Review the insurance policy to confirm that assets lost as a result of

thefts are covered and to confirm that the date of the theft falls within
the period insured.
· Determine by inspecting the insurance policy whether there are any
restrictions in the case of thefts perpetrated by Group employees, as
this may affect the amount that can be claimed.
(4) SLAuS 4400 related services engagements to perform agreed-upon

procedures regarding financial statements.
The objective of an agreed-upon procedures engagement is for the auditor to
carry out procedures of an audit nature to which the auditor and the entity
and any appropriate third parties have agreed and to report on factual
findings.
Both Retriever Group and Golden Bank will need to agree on the procedures
performed on the account payable balance and the format of the report as
part of engagement acceptance.
The report provided is not an assurance report, and the auditor does not
provide an opinion. Instead, users of the report assess for themselves the
procedures and findings reported by the auditor and draw their own
conclusions from the auditor’s work.
Agreed upon procedure can cover specific aspects of financial information or
internal controls which are not covered by the statutory audit and where
additional reporting is required. For example, this may be over financial
information disclosed in the annual report, but not audited, such as key
performance indicators, or other summary financial information.
The level of work carried out by the auditor may vary depending on the
extent to which sufficient and appropriate evidence could be obtained.
For any SLAuS 4400, agreed-upon procedures engagement, a report must
include:
· A description of the auditor’s factual findings including sufficient
information of all significant errors and exceptions;
242 CA Sri Lanka

· A statement that the procedures performed do not constitute an

audit or assurance engagement, and therefore no opinion is
expressed.
· A statement that the report is restricted to those parties that have
agreed to the procedures to be performed;
· A statement that the report relates only to accounts payable
information specified and that it does not extend to the entity’s
financial statements taken as a whole.
Explain the main reporting requirements of agreed upon
procedures engagement and provide a draft report format for an
accounts payable report to the management of Retriever Group
which will need to be agreed as part of engagement acceptance.
The following provides a draft report specific to Management Retriever
Group for accounts payable as at 28 February 20Y0.
Report of Factual Findings in Connection with Accounts Payable
We have performed the procedures agreed with the management of
Retriever Group in respect to the accounts payable of Retriever Group of Rs
15 million as at 28 February 20Y0
Our engagement was undertaken in accordance with the Sri Lanka Standard
on Related Services applicable to agreed-upon procedures engagements.
The procedures were performed solely to assist you in evaluating the validity
of the accounts payable and are summarised as follows:
· For the balances listed in this report, we agreed each Accounting payable
balance to the nominal ledger and trial balance for Retriever Group as at
28 February 20Y0.
· We obtained suppliers’ statements or requested suppliers to confirm
balances owing at 28 February 20Y0.
· We compared supplier statements or supplier confirmations to the
amounts the respective balance in Laurel Accounts Payable ledger. For
amounts which did not agree, we obtained account reconciliations from
Laurel and agreed each reconciling item to supporting evidence.
· The findings of this agreed upon procedures engagement are listed below.
[to insert once the agreed upon procedures have been performed]
· The report is restricted to Retriever Group and R Bank as the parties
which have agreed to the procedures to be performed.
CA Sri Lanka 243

Answers
29 Megabon
(i) Internal Audit Software
The internal audit system has the potential to have a substantial impact on
the external audit, through a combination of a reduction in the need for
substantive testing and for tests of control. However, this is based on the
assumptions that the software is working in the way that is expected by
Megabon, and that it does in fact have the claimed capability to identify
anomalous transactions.
SLAuS 610 Using the Work of Internal Auditors does allow the external
auditor to rely on the work of internal audit, but the auditor must first judge
whether it is appropriate to do so. SLAuS 610 allows the work of internal
audit to be used in 'substantive procedures involving limited judgement'.
The nature of the testing carried out by the internal audit software would
seem to fall under this description, so it could be relied upon if the auditor
judged that the system was reliable.
The auditor is required to act with professional scepticism, and to exercise
professional judgement when making an assessment of how much reliance
to place on the systems in place and in internal audit. Viastrom will need to
apply the requirements of SLAuS 610 in determining whether to place
reliance on the work carried out by internal audit. This will require them to
gain an understanding of the software and its capabilities before making a
decision about whether to rely on the results of the testing carried out by it.
Assuming that the system is reliable, the external auditor will have a
significant reduction in the need for substantive testing and could reduce the
time taken to complete the audit.
(ii) Automated Investment Software
The automated investment decision making software is an example of
robotic process automation where software uses pre-determined
parameters and rules to complete invesyment trading decisions more
efficiently and quickly than is possible using manual processes
This software will certainly have an impact on the audit to the extent that it
interacts with the blockchain ledger which feeds into Megabon’s financial
reporting system and in relation to the assessment of going concern. The
treatment of the investments in the financial statements will be based upon
the information that is produced by the automated software, so transactional
integrity will carry greater audit risk and the auditors will need to plan a
244 CA Sri Lanka

greater level of audit work to confirm effectiveness of general IT controls

and authorisation and system access controls to gain sufficient assurance.
The auditor will need to increase reliance on IT security controls to confirm
only transactions are processed within pre-authorised investment policy
trading limits decided by the directors of Megabon. The audit of investment
trading parameters and confirmation of who can access and change
investment trading parameters, in line with authorised personnel, will be
critical. Furthermore, the auditor will need to incorporate the audit of IT
controls designed to prevent and detect hacking and fraud as audit risk in
these areas will be higher with introduction of new systems.
The auditor will need to consider how Computer Assisted Audit Techniques
(CAATs) can test the system transactional data and other information that is
automatically produced by the system to ensure all transactions lie within
authorised investment parameters and are processed completely and
accurately.
Data analytics are also likely to lead to an improvement in audit quality,
although this is of course dependant on data analytics processes being
implemented intelligently. The use of automated data analytics can analyse
overall investment activity to confirm activity lies with accepted parameters
and trends. Automated data analytics can also report specific groups of
transactions which lie outside expected parameters, in terms of high value,
material profit or loss, unexpected trading patterns of investment profit or
loss which exceptional or is unusual given the over market trends at the time
of the transaction.
Automated data analytics may also help the auditors in the following ways:
· Analyses of revenue trends into investment products, region or by
timeframe.
· Matches of investment orders to cash settlement and report exceptions.
· Testing of user codes for any inappropriate combinations of users have been
involved in processing transactions.
Furthermore, the use of test data through the system could be used to test
investment parameters on the system and observe whether it performs in
the way expected by the auditor. It would be essential that the auditor can
ensure that the introduction of test data does not affect actual transaction
data and all test data can be removed.
In addition, the auditor should consider whether the risks associated with
important new systems have been adequately taken into account in the
directors assessment of effective internal controls operating throughout the
year and ongoing going concern.
CA Sri Lanka 245

Answers
The auditors will also need to consider how to acquire, access and store
Megabon’s data in order to carry out data analytics and CAAT’s, and consider
if the audit of data creates any data security or data protection concerns.
(iii) Blockchain transaction recording
The auditor will also need to gain an understanding of the interaction
between Megabon’s financial reporting system and the automation software.
By tracing a number of transactions from purchase of investments by the
system, investment valuation changes due to market changes, sale and cash
settlement and the recording of gains and losses, the auditor will be able to
test whether the system is correctly recording the investment performance.
Where there is a large number of investment transactions the it may be more
efficient for the auditor to use audit software to automate this testing.
The use of block-chain technology theoretically reduces the risk of
misstatement related to the new system as the ledger is unalterable and
cannot be manipulated. Again, it is crucial that the auditor obtain a thorough
understanding of exactly how this system works and has full access to the
ledger.
The 'real time' nature of using blockchain technology to record transactions
means that the auditor will need to consider incorporating continuous
transaction monitoring (CTM) into the audit strategy. The distributed nature
of the technology means that a copy of the blockchain will be instantly
available to the auditor as it is created allowing for real time audit of
transactions, which could be audited against investment policy and
supporting documentation, with checks that investment gains or losses are
accurately recorded.
The auditor will need to consider the need to rely on the work of other
auditors if it cannot satisfactorily audit IT controls around the blockchain.
The blockchain is likely to be audited by a firm on behalf of the exchanges
who operate it. The auditor of Megabon will need to consider the
requirement of SLAUS 600 Using the work of another auditor, in its reliance
on IT controls related to the blockchain ledger.
Ultimately the impact on the audit will be in the risk of misunderstanding the
system or not picking up a problem that exists, leading to the auditor not detecting
a misstatement.
The auditor will need to consider its overall audit approach, reliance on IT
controls and any training needs for its audit staff in order to perform and evaluate
the results of IT based audit techniques.
However, the automated nature of the investment system, the use of blockchain
and reliance on internal audit software may well make it easier to identify errors
and misstatement than the previous manual system as there is less room for
246 CA Sri Lanka

intentional manipulation or human error, which may have a positive effect on

overall audit risk.
(2) Given both the nature of the business and the data held on behalf of
customers, the main cyber security risks to Megabon and ways to mitigate
those risks will be as follows.
Cyber Security Risk Control to Mitigate

Hacking • All networks protected by firewalls.
Hackers gaining access to IT • All user accounts protected by
systems from outside the passwords and user names.
organisation to steal data • Sensitive documents password
protected.
• Access restrictions amongst employees.
• Detailed audit trail of all access to each
area of the system.
Insider Threat • Provision of mandatory training on the
Mistaken or malicious leaking of risk of leaks due to mistakes.
data by employees • Limiting staff access to the system to the
minimum required to undertake their
roles.
• Restrict use of portable storage devices.
• Immediate removal of access for
employees who leave the company.
External disks and Drives • Restrict all such devices to those owned
Loss of data or introduction of and purchased by the company.
threats via external data storage • Restrict the use of company devices with
devices third party computers.
• Track who is using all company owned
devices via a logging system and erase
after use.
• Scan all devices with anti-malware
software each time they are connected
to a company computer.
CA Sri Lanka 247

Mock Exam
CL1 Advanced A udit A nd Assurance | Mock Exam Questions
202 CA Sri Lanka

AAA | Mock Exam Questio ns
SECTION 1
All 10 questions are compulsory.
Each question is worth 2 marks.
Total marks for section 1 is 20 marks.
Recommended time for the section is 36 minutes.
Note. Assume it is 1 July 20X5
You are an audit senior of Viola & Co and are currently conducting the audit of
Poppy Ltd for the year ended 31 March 20X5.
Materiality has been set at Rs50,000, and you are carrying out the detailed
substantive testing on the year-end payables balance. The audit manager has
emphasised that understatement of the trade payables balance is a significant
audit risk.
Below is an extract from the list of supplier statements as at 31 March 20X5 held
by the company and corresponding payables ledger balances at the same date
along with some commentary on the noted differences:
Payables ledger
Supplier Statement balance balance
Rs'000 Rs'000
Carnation Ltd 70 50
Lily Ltd 175 105
Carnation Ltd
The difference in the balance is due to an invoice which is under dispute due to
faulty goods which were returned on 30 March 20X5.
Lily Ltd
The difference in the balance is due to the supplier statement showing an invoice
dated 29 March 20X5 for Rs70,000 which was not recorded in the financial
statements until after the year end. The payables clerk has advised the audit team
that the invoice was not received until 2 April 20X5.
CA Sri Lanka 203

1 The audit manager has asked you to review the full list of trade payables and
select balances on which supplier statement reconciliations will be
performed.
Indicate on the table below if the following items should be included in, or
excluded from, your sample.
Suppliers with material balances at the year end Include Exclude

Suppliers which have a high volume of business Include Exclude
with Poppy Ltd
Major suppliers with nil balances at the year end Include Exclude
Major suppliers where the statement agrees to Include Exclude
the ledger
2 Which of the following audit procedures should be performed in relation to

the balance with Lily Ltd to determine if the payables balance is
understated?
Inspect the goods received note to determine when the goods were
received
Inspect the purchase order to confirm it is dated before the year end
Review the post year end cash book for evidence of payment of the
invoice
Send a confirmation request to Lily Ltd to confirm the outstanding
balance
3 Which of the following audit procedures should be carried out to confirm the
balance owing to Carnation Ltd?
(1) Review post year end credit notes for evidence of acceptance of return
(2) Inspect pre year end goods returned note in respect of the items sent
back to the supplier
(3) Inspect post year end cash book for evidence that the amount has been
settled
1, 2 and 3
1 and 3 only
1 and 2 only
2 and 3 only
204 CA Sri Lanka

4 The audit manager has asked you to review the results of some statistical
sampling testing, which resulted in 20% of the payables balance being
tested.
The testing results indicate that there is a Rs45,000 error in the sample:
Rs20,000 which is due to invoices not being recorded in the correct period
as a result of weak controls and additionally there is a one-off error of
Rs25,000 which was made by a temporary clerk.
What would be an appropriate course of action on the basis of these results?
The error is immaterial and therefore no further work is required.
The effect of the control error should be projected across the whole
population.
Poppy Ltd should be asked to adjust the payables figure by Rs45,000.
A different sample should be selected as these results are not reflective
of the population.
5 To help improve audit efficiency, Viola & Co is considering introducing the

use of computer-assisted audit techniques (CAATs) for some audits. You
have been asked to consider how CAATs could be used during the audit of
Poppy Ltd.
Which of the following is an example of using test data for trade payables
testing?
Selecting a sample of supplier balances for testing using monetary unit
sampling
Recalculating the ageing of trade payables to identify balances which
may be in dispute
Calculation of trade payables payment period to use in analytical
procedures
Inputting dummy purchase invoices into the client system to see if
processed correctly

Note. Assume it is 1 July 20X5
You are an audit manager at Blenkin & Co and are approaching the end of the
audit of Sampson Ltd, which is a large listed retailer. The draft financial
statements currently show a profit before tax of Rs6.5m and revenue of Rs66m for
the financial year ended 31 March 20X5. You have been informed that the finance
director left Sampson Ltd on 28 Feb 20X5.
CA Sri Lanka 205

As part of the subsequent events audit procedures, you reviewed post year end
board meeting minutes and discovered that a legal case for unfair dismissal has
been brought against Sampson Ltd by the finance director. During a discussion
with the human resources (HR) director of Sampson Ltd, you established that the
company received notice of the proposed legal claim on 10 April 20X5.
The HR director told you that Sampson Ltd's lawyers believe that the finance
director's claim is likely to be successful, but estimate that Rs150,000 is the
maximum amount of compensation which would be paid. However, management
does not intend to make any adjustments or disclosures in the financial
statements.
6 Blenkin & Co has a responsibility to perform procedures to obtain sufficient,
appropriate evidence that subsequent events are appropriately reflected in
the financial statements of Sampson Ltd.
Indicate, on the timeline, up until which date the auditor should perform
subsequent events procedures.
The date the The date of The date of the The date the
subsequent approval of the auditor's report financial
events review is financial statements are
performed statement issued
7 If, after the financial statements have been issued, Blenkin & Co becomes
aware of a fact which may have caused its report to be amended, the firm
should consider several possible actions.
Which TWO of the following are appropriate actions for Blenkin & Co to
take?
Discuss the matter with management and, where appropriate, those
charged with governance
Obtain a written representation from management
Consider whether the firm should resign from the engagement
Enquire how management intends to address the matter in the financial
statements where appropriate
206 CA Sri Lanka

8 Which of the following audit procedures should be performed to form a

conclusion as to whether the financial statements require amendment in
relation to the unfair dismissal claim?
(1) Inspect relevant correspondence with Sampson Ltd's lawyers
(2) Write to the finance director to confirm the claim and level of damages
(3) Review the post year end cash book for evidence of payments to the
finance director
(4) Request that management confirm their views in a written
representation
1, 2 and 3
1, 2 and 4
1, 3 and 4
2, 3 and 4
9 You are drafting the auditor's report for Sampson Ltd and the audit
engagement partner has reminded you that the report will need to reflect
the requirements of SLAuS 701 Communicating Key Audit Matters in the
Independent Auditor's Report.
According to SLAuS 701, which of the following should be included in the
'Key audit matters' paragraph in the auditor's report?
Matters which required significant auditor attention
Matters which result in a modification to the audit opinion
All matters which were communicated to those charged with
governance
All matters which are considered to be material to the financial
statements
10 Which of the following audit opinions will be issued if the unfair dismissal
case is NOT adjusted for or disclosed within the financial statements?
A qualified audit opinion as the financial statements are materially
misstated
A qualified audit opinion as the auditor is unable to obtain sufficient
appropriate evidence
An unmodified opinion with an emphasis of matter paragraph
An unmodified audit opinion
CA Sri Lanka 207

SECTION 2
All four questions are compulsory.
11 Zen (Pvt) Ltd

Zen (Pvt) Ltd (Zen) is a new client of Adams and Co, an audit firm. Zen runs a spa,
trading as Zen. The spa is open to non-members and members. Members pay an
annual membership fee that entitles them to 50% off spa rates for individual
treatments and sessions. The spa employs lifeguards, masseuses, beauty
therapists and nursery nurses for its crèche facilities. In addition, there is also an
administrative staff, including a finance controller, who reports to the managing
director, Li Smith (who is also the major shareholder).
The spa has been in business five years. Its major local competitor is Revitalise, a
large members-only spa, which started in business two years ago. Adams and Co
has just been invited to tender for the audit of the company which owns Revitalise.
The finance controller at Zen is Elizabeth Warnapura, who was employed 18
months ago. Since then she has instituted control procedures outlined in a
controls manual and formalised a budgeting system so that budgets are now
prepared and approved annually.
Elizabeth introduced Adams and Co to Li Smith through her husband, Chamani
Warnapura, who is a manager at Adams and Co. The audit engagement partner
assigned to Zen is Carol Gamage. Since agreeing audit terms with Adams and Co, Li
has:
• Invited Carol to advertise to employees of Adams and Co a staff membership
rate, which is 50% of standard membership rates and then entitles the
member to 75% off spa rates.
• Asked Carol if she will sit on the board of directors at Zen as a non-executive
director.
• Asked Carol if the firm will confirm the figures on an insurance claim to be
submitted in respect of a fire in the treatment centre just prior to the year
end.
Required
(1) Analyse FIVE ethical threats which may affect the independence of Adams
and Co's audit of Zen. (5 marks)
(2) Outline for each threat how it might be avoided. (5 marks)
208 CA Sri Lanka

12 Chuck Industries (Pvt) Ltd

Introduction and client background
You are the audit senior of Blair & Co and your team has just completed the
interim audit of Chuck Industries (Pvt) Ltd (Chuck Industries), whose year end is
31 January 20X2. You are in the process of reviewing the systems testing
completed on the payroll cycle, as well as preparing the audit programmes for the
final audit.
Chuck Industries manufactures lights and the manufacturing process is
predominantly automated; however there is a workforce of 85 employees, who
monitor the machines, as well as approximately 50 employees who work in sales
and administration. The company manufactures twenty-four hours a day, seven
days a week.
Below is a description of the payroll system along with deficiencies identified by
the audit team:
Factory workforce
The company operates three shifts every day with employees working eight hours
each. They are required to clock in and out using an employee swipe card, which
identifies the employee number and links into the hours worked report produced
by the computerised payroll system. Employees are paid on an hourly basis for
each hour worked. There is no monitoring/supervision of the clocking in/out
process and an employee was witnessed clocking in several other employees
using their employee swipe cards.
The payroll department calculates on a weekly basis the cash wages to be paid to
the workforce, based on the hours worked report multiplied by the hourly wage
rate, with appropriate tax deductions. These calculations are not checked by
anyone as they are generated by the payroll system.
Each Friday, the payroll department prepares the pay packets and physically
hands these out to the workforce who operate the morning and late afternoon
shifts, upon production of identification. However, for the night shift workers, the
pay packets are given to the factory supervisor to distribute. If any night shift
employees are absent on pay day then the factory supervisor keeps these wages
and returns them to the payroll department on Monday.
Sales and administration staff
The sales and administration staff are paid monthly by bank transfer. Employee
numbers do fluctuate and during July two administration staff joined; however,
due to staff holidays in the HR department, they delayed informing the payroll
department, resulting in incorrect salaries being paid out.
CA Sri Lanka 209

Required
For the deficiencies already identified in the payroll system of Chuck Industries:
(i) Analyse the possible implications of these.
(ii) Outline a recommendation to address each deficiency.
(LO 1.2.2 & 1.2.3) (10 marks)
13 Balotelli Beach Hotel Plc

Balotelli Beach Hotel Plc (Balotelli) operates a hotel providing accommodation,
leisure facilities and restaurants. Its year end was 31 October 20X4. You are the
audit senior of Mario & Co and are currently preparing the audit programmes for
the year end audit of Balotelli. You are reviewing the notes of last week's meeting
between the audit manager and finance director where two material issues were
discussed.
Depreciation
Balotelli incurred significant capital expenditure during the year on updating the
leisure facilities for the hotel. The finance director has proposed that the new
leisure equipment should be depreciated over 10 years using the straight-line
method.
Food poisoning
Balotelli's directors received correspondence in September from a group of
customers who attended a wedding at the hotel. They have alleged that they
suffered severe food poisoning from food eaten at the hotel and are claiming
substantial damages. Balotelli's lawyers have received the claim and believe that
the lawsuit against the company is unlikely to be successful.
Required
(1) Explain the difference between tests of controls and substantive procedures.
(2 marks)
(2) Outline substantive procedures to obtain sufficient and appropriate audit
evidence in relation to the above two issues. (8 marks)
(Note: The total marks will be split equally between each issue.)
210 CA Sri Lanka

14 New Visions
You are the audit manager of Figures & Co and your audit team is coming to the
end of the audit of New Visions, a company which develops and manufactures
glasses which it then sells to major high street opticians.
The audit senior is preparing the financial statements for your final review but has
told you that there are a few outstanding issues. At present, the draft financial
statements for the year ended 31 December 20X1 show a profit before tax of
Rs. 6m.
(i) On 1 October 20X1, New Visions began the commercial production of a new
range of lightweight frames which have been proven to keep their shape
regardless as to how roughly they are treated. Up to 30 September 20X1, the
company had correctly capitalised development costs of Rs. 2 million
relating to this project. The directors feel that the new frames will generate
revenue over the next 3 years with 60% of revenue coming in year 1, 20% in
year 2 and 20% in year 3. The statement of financial position shows the
development costs at their current carrying value of Rs. 2 million. (4 marks)
(ii) The majority of New Visions' revenue relates to credit sales, although this
year the company has made some cash sales for the first time. The audit
senior has not been able to find any supporting documentation to
substantiate the cash sales for the year. Cash sales amount to Rs. 100,000.
(3 marks)
(iii) One credit customer, AJ Plc, owes Rs. 4,500,000 at 31 December 20X1 and
this amount is included in the statement of financial position. At the year
end a receivables confirmation was conducted and a reply received from AJ
Plc confirming the balance owed. To date, no amounts have been received in
relation to the outstanding debt. The audit senior has read the minutes of
board meetings up to the current date and has noted that in February 20X2
AJ Plc contacted New Visions to explain that its business was in extremely
serious financial difficulty. (3 marks)
Required
Analyse each of these issues and outline the impact on the audit report if they
remain unresolved.
(Note: The mark allocation is shown against each of the three issues above.)
CA Sri Lanka 211

SECTION 3
Both questions are compulsory.
15 Kangaroo Construction Plc

You are the audit senior of Rhino & Co and you are planning the audit of Kangaroo
Construction Plc (Kangaroo) for the year ended 31 March 20X3. Kangaroo
specialises in building houses and provides a five-year building warranty to its
customers. Your audit manager has held a planning meeting with the finance
director. He has provided you with the following notes of his meeting and financial
statement extracts:
Kangaroo has had a difficult year; house prices have fallen and, as a result, revenue
has dropped. In order to address this, management has offered significantly
extended credit terms to their customers. However, demand has fallen such that
there are still some completed houses in inventory where the selling price may be
below cost. During the year, whilst calculating depreciation, the directors extended
the useful lives of plant and machinery from three years to five years. This reduced
the annual depreciation charge.
The directors need to meet a target profit before interest and taxation of Rs. 0.5
million in order to be paid their annual bonus. In addition, to try and improve
profits, Kangaroo changed their main material supplier to a cheaper alternative.
This has resulted in some customers claiming on their building warranties for
extensive repairs. To help with operating cash flow, the directors borrowed Rs. 1
million from the bank during the year. This is due for repayment in December 20X3.
Financial statement extracts for year ended 31 March
DRAFT ACTUAL
20X3 20X2
Rs. Mn Rs. Mn
Revenue 12.5 15.0
Cost of sales (7.0) (8.0)
Gross profit 5.5 7.0
Operating expenses (5.0) (5.1)
Profit before interest and taxation 0.5 1.9
Inventory 1.9 1.4
Receivables 3.1 2.0
Cash 0.8 1.9
Trade payables 1.6 1.2
Loan 1.0 –
212 CA Sri Lanka

Required
(1) State the meaning of the concepts of materiality and performance
materiality in accordance with SLAuS 320 Materiality in Planning and
Performing an Audit. (5 marks)
(2) Identify the factors to consider when using analytical procedures at the
planning stage of the audit. (5 marks)
(3) Analyse the information above to identify FIVE audit risks. You may
calculate ratios to help you in your analysis. (5 marks)
(4) Outline the auditor's response to each risk in planning the audit of Kangaroo
Construction Plc. (5 marks)
(LO 2.4.1, 3.5.1 & 2.5.1) (Total = 20 marks)
16 Heanor Wholesale Plc

You have been asked by the manager in charge of the audit of Heanor Wholesale
Plc (Heanor) to verify trade payables and accruals at the company's year-end of 30
April 20X2. The company maintains its purchase ledger, using a standard
purchase ledger accounting package. Purchase invoices are posted to the purchase
ledger after they have been checked to the delivery note and the purchase order
and have been authorised by either the financial director or the managing
director.
The purchase ledger can show for each purchase ledger account:
(a) The unpaid invoices and credit notes
(b) An ageing of the balance into current month, one month, two months and
three or more months
(c) The total balance on the account
Also, the system is able to provide the total of the balances of all the accounts on
the purchase ledger.
Your audit of the purchases system has revealed that the system for recording
receipt of goods is relatively weak. The company does not use goods received
notes, but the supplier's delivery note should be dated by the goods received
department when the goods are received. Your audit tests have revealed that
some delivery notes are not dated by the goods received department. The delivery
note is filed with the purchase invoice in alphabetical order (by supplier).
A full inventory count was carried out at the company's year-end and you are
satisfied that it was counted accurately.
In the company's draft financial statements the value of trade payables and
accruals at 30 April 20X2 are as follows.
CA Sri Lanka 213

Rs.
Trade payables 509,200
Purchase accruals 27,050
536,250
Sundry payables and accruals 59,480
Current liabilities 595,730
Heanor's annual revenue figure is about Rs. 3.5 million and its profit before tax is
Rs. 190,000. The age of payables at 30 April 20X2 is 3.4 months, which is similar to
the previous year. Sundry payables and accruals comprise mainly wages accruals
(including income tax and other deductions) and a sales tax liability of Rs. 20,000.
Required
(1) Explain the purpose of five application controls which you would expect to
see over Heanor's purchase ledger system. (5 marks)
(2) Outline the audit work you will perform to verify trade payables and
purchase accruals. (8 marks)
(3) Outline the audit procedures you will perform to verify sundry payables and
accruals, including the sales tax liability. (7 marks)
(LO 1.3.1, 3.1.1) (Total = 20 marks)
214 CA Sri Lanka

Mock Exam
Answers
CL1 Advanced A udit A nd Assurance | Mock Exam A nswer s
216 CA Sri Lanka

AAA | Mock Exam Answers
SECTION 1
All 10 questions are compulsory.
Each question is worth 2 marks.
1
Suppliers with material balances at the year end Include
Suppliers which have a high volume of business Include
with Poppy Co
Major suppliers with nil balances at the year end Include
Major suppliers where the statement agrees to Exclude
the ledger
Where completeness is the key assertion, the sample should be selected to

verify where the balance may be understated and therefore should include
suppliers with material balances, suppliers with a high volume of business
with Poppy Co and major suppliers with no outstanding balance at the year
end.
2 The correct answer is: Inspect the goods received note to determine when
the goods were received.
In order to determine if the balance with Lily Co is understated, the auditor
should determine if the goods should be included in payables at the year end
by inspecting the goods received note.
3 The correct answer is: 1 and 2 only
To confirm the balance with Carnation Co, the auditor must determine if the
liability exists for the disputed items at the year end by reviewing pre year
end goods returned notes and post year end credit notes to verify that the
goods have been returned and the order cancelled by the supplier.
4 The correct answer is: The effect of the control error should be projected
across the whole population.
Although the error is immaterial, the auditor must reach a conclusion on the
sample selected and in order to do so the effect of the error must be
considered in relation to the whole population.
5 The correct answer is: Inputting dummy purchase invoices into the client
system to see if processed correctly
Test data involves inputting fake transactions into the client's system to test
how the transactions are processed. The other options are examples of audit
software.
CA Sri Lanka 217

6
The date the The date of The date of the The date the
subsequent approval of the auditor's report financial
events review is financial statements are
performed statement issued
ü
As per SLAuS 560 Subsequent Events, the auditor has an active responsibility
to carry out subsequent events procedures between the date of the financial
statements and the date of the auditor's report.
Discuss the matter with management and, where appropriate, those charged
with governance
Enquire how management intends to address the matter in the financial
statements where appropriate
As per SLAuS 560 paragraph 15, in the circumstances described the auditor
should initially discuss the matter with management and understand how
management intends to address the matter in the financial statements.
8 The correct answer is: 1, 3 and 4
The auditor is unlikely to ask the finance director, who is no longer an officer
of the company and the party involved in the claim, to confirm the level of
damages payable. All other procedures would be appropriate.
9 The correct answer is: Matters which required significant auditor attention
As per paragraph 9 of SLAuS 701 Communicating Key Audit matters in the
Independent Auditor's Report, in determining key audit matters, the auditor
shall determine, from the matters communicated to those charged with
governance, those which required significant auditor attention.
10 The correct answer is: An unmodified audit opinion
The maximum damages of Rs150,000 is not material to the financial
statements at 2.3% of profit before tax and 0.2% of revenue. Therefore no
modification to the audit opinion is required.
218 CA Sri Lanka

SECTION 2
All four questions are compulsory.
11 Zen (Pvt) Ltd
(1) Ethical threat (2) Managing threat

Staff membership rates at Zen – self-
interest threat
Such a benefit could cause a self- Auditors are not allowed to accept
interest threat to the audit, because the such benefits unless their value is
recipients may not want to lose their clearly insignificant. In this case, the
benefit, and therefore be biased in value of a reduced membership of a
their audit work or not seek spa is unlikely to be insignificant to
adjustments where there are material audit staff members and therefore
issues in the financial statements. Adams and Co should reject this offer.
Partner invited to sit on the board –
familiarity/ managerial threat
If the partner were to sit on the board Auditors are prohibited by the CA Sri
of directors, there is a risk that the Lanka Code of Ethics for Professional
partner could lose her audit objectivity Accountants from sitting on the boards
as she may start identifying too closely of their clients. Carol Gamage should
with the company and its other explain this to Li Smith and politely
directors. decline the invitation.
There is also a risk that the audit
partner may start making management
decisions at Zen.
Finance controller married to audit
manager – familiarity threat
The finance controller at Zen is Chamani must not be involved in the
married to an audit manager at Adams audit of Zen whilst Elizabeth is finance
and Co. There is no indication that controller. However, it is acceptable for
Chamani Warnapura has any the firm to carry out the audit under
connection to the audit of Zen. Clearly, these conditions.
the personal relationship between
Elizabeth and Chamani Warnapura
means that Chamani could not carry
out this audit objectively.
CA Sri Lanka 219

(1) Ethical threat (2) Managing threat
Assurance re insurance claim –

advocacy threat The partners should discover more
Audit firms must always ensure that about the size and nature of this
accepting other services does not engagement to determine whether it
impact on audit objectivity, whether will affect independence. In particular
due to the amount of fees relating to they should determine whether such
the service or as a result of the nature an engagement would put the firm in
of the service itself. the position of advocating Zen's
position to the insurance firm, as this
could cause an insurmountable barrier
to independence.
They should also monitor the level of
fee income this would earn Adams and
Co from all work performed for Zen.
Where a substantial level of fees is
derived from one client a self-interest
threat arises.
Conflict of interest
Adams and Co has been invited to Adams and Co should disclose to Zen
tender for an audit which will involve that they are in the process of
Zen's major competitor, Revitalise. It is tendering for the audit of a competitor.
appropriate for audit firms to audit If either Zen Co or Revitalise is
competitors, but the clients involved unhappy with this situation then
might feel that there is a threat to Adams and Co will need to decide
client confidentiality and may prefer to which audit they want to secure.
seek other auditors in such a situation. If Adams and Co performs both audits,
they must ensure that they use
separate audit partners and teams and
set up information barriers to maintain
confidentiality.
220 CA Sri Lanka

12 Chuck Industries (Pvt) Ltd

Chuck Industries – payroll system implications and recommendations
(i) Implication (ii) Recommendation

Lack of monitoring of clocking in:
The lack of monitoring of the clocking Clocking in and out should be monitored
in/out process allows other employees to by a supervisor of an appropriate level.
clock in colleagues resulting in a payroll
cost in excess of that expected for the
actual hours worked.
The lack of supervision over clocking in Payment of overtime hours should only be
and out also gives employees the made on authorisation by a supervisor
opportunity to delay clocking out (or to who has reviewed the overtime hours for
clock in before starting work) to increase reasonableness and compared them to
their overtime, leading to invalid payroll production volumes and observed working
costs being incurred. patterns.
The absence of clocking in/out monitoring Formal communications should be made
may result in a weak control environment on the importance and purpose of the
as it promotes an attitude where it is company's policies and procedures in
acceptable to override controls. relation to clocking in and out, and the
importance of adhering to company
controls in general.
Payroll calculations not reviewed:
Since payroll calculations are not checked A payroll supervisor should periodically
and the system is entirely trusted, any recalculate the net pay based on the gross
errors made as a result of standing or pay and expected deductions, then
underlying data being incorrect or compare the result with the computer
occurring during payroll processing would generated figures for a sample of
not be discovered. Overpayments or employees. The review should be
underpayments (and incorrect payroll evidenced by a signature and wages should
costs) may result and lead to losses or not be paid until this signed review is
disgruntled employees. completed.
CA Sri Lanka 221

(i) Implication (ii) Recommendation

Factory supervisor distribution of
wages:
The factory supervisor is trusted with Payroll officials should be available for
substantial cash sums in advance of certain hours during the night shift to
distribution of wages to the night shift. distribute wages.
This cash is susceptible to theft and loss
while not with employees or securely
stored.
The factory supervisor keeps absent Any amounts not paid out on Fridays
employee's wages over the weekend should be kept by payroll in a safe or other
before handing back to payroll and this secure means until Monday when the
further increases the risk of loss or theft of employee can collect from the payroll
cash wages. department.
The supervisor entrusted with the wages is The supervisor should not be responsible
not independent and may take it upon for distribution of cash wages. Payroll
him/herself to reallocate the wages as should distribute these and should
he/she deems necessary. consider the proposal of operating for at
least part of the night shift.
Poor communication of joiners/leavers:
The lack of procedures in place to ensure HR staff duties and responsibilities should
timely notification of joiners/leavers be reallocated when staff are ill or on
means leavers may still be paid in error holiday, including the responsibility of
and joiners may not be paid on time. The immediate communication of new
payroll records will not reflect accurate joiners/leavers to payroll. In addition new
wages costs at least temporarily. joiner forms showing start date should be
completed and authorised and passed to
payroll so they are aware of the need to
update the payroll records.
(Note: Only five well explained implications and five related recommendations
were needed to gain full marks.)
13 Balotelli Beach Hotel Plc

(1) Tests of controls aim to obtain sufficient appropriate evidence that controls
have been operating effectively during the period under audit.
Substantive procedures provide evidence as to whether transactions,
account balances or disclosures are materially misstated. Substantive
procedures include analytical procedures and tests of details.
222 CA Sri Lanka


Depreciation
• Review the reasonableness of the depreciation rates applied to the new
leisure equipment by comparing them to industry averages.
• For a sample of leisure equipment in the non-current asset register,
recalculate the depreciation charge to ascertain its arithmetical
accuracy.
• Make enquiries of management and review the capital expenditure
forecasts to determine whether there are any plans to replace any of
the new leisure equipment. Any plans to replace the equipment within
10 years would indicate a shorter useful life than has been assumed.
• Perform a proof in total calculation for the depreciation charged on the
equipment and discuss any significant fluctuations with management.
• Review gains and losses on the disposal of assets during the year, to
assess the reasonableness of the depreciation policies.
• Review the disclosure of the depreciation charges and policies in the
draft financial statements.
Food poisoning
• Assess whether Balotelli has a present obligation as a result of a past
event by reviewing correspondence from the customers.
• With the client's permission, contact the company's lawyers to obtain
their written opinion on the probability of a successful lawsuit.
• Make enquiries of Balotelli's management and review board minutes to
determine whether the directors believe that the claim will be
successful.
• Review the post year-end payments for evidence of any payments
made to the claimants.
• Inquire of management as to whether a contingent liability will be
disclosed in the financial statements; consider the reasonableness of
this.
• Obtain a written representation confirming management's assessment
of the likely outcome of the lawsuit, and the appropriateness of
accounting treatment adopted for the damages.
• Review the adequacy of any disclosures made in the financial
statements.
CA Sri Lanka 223

14 New Visions
(i) Development costs
The capitalisation of the development costs appears to be appropriate and in
accordance with LKAS 38. However LKAS 38 also states that once the asset is
ready for commercial production/ use, it should be amortised over its useful
life.
To date no amortisation has been charged which is contrary to LKAS 38.
The asset is deemed to have a useful life of 3 years being consumed 60% in
year 1 and 20% in years 2 and 3 and so the financial statements should
therefore show an amortisation charge of:
Rs. 2,000,000 × 60% × 3/12 = Rs. 300,000.
The amortisation charge would reduce both profit before tax and the
carrying value of the asset by Rs. 300,000.
This error amounts to 5% of profit before tax (Rs. 300,000 / Rs. 6,000,000)
and so is likely to be material, hence management should charge the
amortisation in the financial statements.
If management refuse to amend this error then the auditor's report would be
modified. As management has not complied with LKAS 38 and the error is
material but not pervasive then a qualified opinion would be necessary.
The opinion paragraph would be qualified on the grounds that the financial
statements are materially misstated.
A basis for qualified opinion section would need to be included, explaining
the material misstatement in relation to the non-amortisation of
development costs and the effect on the financial statements.
(ii) Cash sales
The auditor is unable to verify the cash sales figure of Rs. 100,000 because
audit evidence is not available.
The balance of cash sales at Rs. 100,000 amounts to 1.7% of profit before tax
(Rs. 100,000 / Rs. 6,000,000) and is therefore not material.
The auditor should include this matter in their 'report to those charged with
governance' and will also need to consider whether the company has, in
general, kept proper accounting records.
Provided that the auditor is confident that proper accounting records have
been maintained, then the auditor should issue an unmodified audit report.
224 CA Sri Lanka

(iii) AJ Plc – receivable

The balance of Rs. 4,500,000 has been confirmed in the year end
confirmation and so audit evidence has been gained in relation to the
existence of and rights and obligations to the debt.
However no monies have been received post year end and so the valuation
of the amount has not been verified.
Given that the customer is suffering extremely serious financial difficulties, it
is unlikely that much of the debt can be recovered.
At 75% of profit before tax (Rs. 4,500,000 / Rs. 6,000,000), the misstatement
is certainly material and is likely to be material and pervasive.
If management refuse to amend this misstatement then the auditor's opinion
would be modified. As management has not written down the debt to its
recoverable amount, and the misstatement is likely to be both material and
pervasive, then an adverse opinion would be necessary.
The adverse opinion section would state that the financial statements 'do not
present fairly' as a result of a material misstatement.
A 'basis for adverse opinion' section would need to be included, explaining
the material misstatement in relation to the overstatement of receivables
and the effect on the financial statements.
CA Sri Lanka 225

SECTION 3
Both questions are compulsory.
15 Kangaroo Construction Plc

(1) Materiality and performance materiality
Materiality is not specifically defined in SLAuS 320 Materiality in planning
and performing an audit but it does state that misstatements are material if
they could reasonably be expected to influence the economic decisions of
users (either individually or in aggregate).
SLAuS 320 also states that judgements about materiality are affected by the
size and/or nature of a misstatement.
Auditors set their own materiality levels, based on their judgement of risk.
During audit planning, the auditor will set materiality for the financial
statements as a whole and this involves the exercise of professional
judgement.
Benchmarks and percentages are often used to calculate a materiality level
for the financial statements as a whole, eg 5% of profit before tax or 1-2% of
total assets, but ultimately, the level of materiality set is down to the
auditor's professional judgement, and may be revised during the course of
the audit.
The auditor also has to set performance materiality, which is lower than
materiality for the financial statements as a whole. Performance materiality
is defined in SLAuS 320 as the amount or amounts set by the auditor at less
than materiality for the financial statements as a whole to reduce to an
appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the financial statements
as a whole.
(2) Factors to consider when using analytical procedures at the planning
stage of the audit
• The objectives of the analytical procedures and the extent to which
their results are reliable
• The degree to which information can be analysed
• The availability of information
• The reliability of the information available
• The relevance of the information available
226 CA Sri Lanka

• The source of the information available

• The comparability of the information available
• Knowledge gained from previous audits
(3) Audit risk and responses

The company offers a five year building As this is a judgemental area, the
warranty on its houses. During the year, auditors need to discuss the basis of
as a result of switching to a cheaper calculating the provision with the
supplier, some customers have claimed directors and assess the reasonableness
on their guarantees. There is a risk that of any assumptions made. They should
the warranty provision is understated also review a sample of guarantees
in the financial statements. claimed during the year and vouch
amounts to repairs invoices. They
should review the level of claims made
in the year and assess whether the
provision needs revising in light of this.
The company has had a difficult year The auditors must discuss with
due to a fall in house prices. Gross directors whether they believe that the
profit margin has fallen by 3% (47% company is still a going concern in light
(7/15 × 100) in 20X2, 44% (5.5/12.5 × of the results of the ratio analysis, and
100) in 20X3 and operating margin has review cash flow forecasts and budgets
fallen significantly from 13% (1.9/15 × for the forthcoming year.
100) to 4% (0.5/12.5 × 100). In
addition, the company has had to take
out a loan of Rs. 1m during the year to
help with operating cash flow. Payables
days have also increased from 55 days
(1.2/8 × 365) to 83 days (1.6/7 × 365),
indicating that the company is having
problems paying suppliers. There is
therefore a risk that the company may
not be a going concern.
Receivables days have increased from The auditors should carry out post year-
49 days (2/15 × 365) to 91 days end testing and cut-off testing on
(3.1/12.5 × 365) as a result of the receivables' balances to verify the
directors increasing the credit terms accuracy of the year-end balance. The
offered to customers. There is a risk auditors should also review the aged
that the receivables' balance at year- receivables listing to identify any
end is materially overstated as balances that need writing off.
customers may not be able to pay.
CA Sri Lanka 227


There is a risk that inventory is Detailed audit work on inventory
overstated in the financial statements should be carried out as this is likely to
as there may be some houses whose be a material balance. An auditor's
selling price is less than cost. Inventory expert may need to be used to
days have also increased from 64 days independently verify the value of
(1.4/8 × 365) to 99 days (1.9/7 × 365). inventory at the year-end.
There is a risk that revenue and costs The auditors need to maintain
have been deliberately misstated in the professional scepticism throughout the
financial statements in order for the audit and carry out detailed cut-off
directors to meet the target profit testing on revenue and expenses to
before interest and taxation figure of confirm that the figures are correctly
Rs. 0.5m so as to get their bonuses stated.
(window dressing). This is also
indicated by the fact that the directors
have changed the useful economic life
of plant and machinery from three to
five years to reduce the depreciation
charge for the year and hence inflate
the profit figure to attain the minimum
target figure.
There is a risk that the depreciation The auditors should discuss the change
charge for the year is understated and and the reasons for it with the directors
non-current assets on the statement of and assess whether it is reasonable or
financial position are overstated as the not. They should also examine a sample
directors have amended the useful of plant and machinery assets to assess
economic life of plant and machinery whether the change is appropriate.
from three to five years.
The company has taken out a loan of The auditors should review the terms of
Rs. 1m from the bank which is the loan agreement to verify the
repayable within a year. There is a risk repayment date and the amount
that this loan has been incorrectly borrowed. They should review the draft
disclosed in the financial statements. It financial statements to confirm the
should be disclosed as a current correct disclosure of the loan.
liability as it is repayable within a year.
(Note: only five audit risks were required.)
228 CA Sri Lanka

16 Heanor Wholesale Plc

(1) Application controls the auditor would expect to see include the following:
• The use of manual or programmed agreement of control totals to
ensure that input of purchase invoices is complete
• Document counts to confirm that all purchase invoices for the relevant
period have been processed. This helps to ensure completeness.
• Programmed data filed checks to ensure the accuracy of input of data
contained on the purchase invoice, for example existence checks on the
company name, the use of permitted ranges.
• Batch reconciliations after processing to ensure that processing of
purchase invoices is complete.
• Cyclical review of standing data and master files to ensure that the data
relating to suppliers is accurate.
(2) Audit work to verify trade payables and purchase accruals would be as
follows.
(i) Purchases cut-off
As goods received notes are not used the normal procedures for
auditing cut-off will need to be adapted.
(1) Examine purchase invoices on either side of the year-end to dated
suppliers delivery note to ensure invoices have been correctly
accrued. (Where the goods received department have not
date-stamped the delivery date it will be necessary to use the
suppliers despatch date.)
(2) Enquire if the goods received department or bought ledger
department are holding any unmatched delivery notes (those
without an invoice) relating to the period before the year-end.
(ii) Completeness, existence and ownership
(1) Select invoices from the trade payables listing and trace to
supporting documentation to ensure that the purchase was for
the purpose of the business.
(2) Reconcile a sample of suppliers' statements with purchase ledger
balances. This will highlight any purchases that have been
omitted. Where there are major accruals for which statements are
not available it may be necessary to carry out a payables'
circularisation. (A circularisation is not normally the primary
procedure to be selected as the supplier's statement provides
more effective evidence and a reconciliation is simpler to carry
out than a circularisation.)
CA Sri Lanka 229

(3) Review balances for unusually low balances with major suppliers.
(4) Compare the ratio of trade payables to purchases and inventory
with the previous year's figures.
(5) Match cash payments posted in purchase ledger accounts before
and after the year-end to cash records to ensure they were posted
in the right period.
(iii) Trade payables listing
(1) Agree the total unpaid invoices and credit notes to balances on
the aged payables listing.
(2) Agree the total of balances on the aged payables listing to the
purchase ledger control account.
(3) Agree the list of balances to individual ledger accounts and vice
versa.
(4) Review the listing for large payable balances and enquire into
reasons for them and action being taken.
(5) Review the control account around the year-end for unusual
items.
(3) Sundry payables and accruals is an area that lends itself to analytical review
and reconciliation techniques, except for liabilities such as income tax and
sales tax which should be checked in detail.
(i) From the sundry payables and accruals listing confirm that the
calculation of accruals is reasonable and verify to subsequent
payments. Income tax and related deductions liabilities should also be
verified to payroll.
(ii) Scrutinise post year-end payments/invoices received to check for
understatement of sundry payables and accruals.
(iii) Ascertain whether any expenditure is likely to be invoiced a long time
after the goods or services are received.
(iv) Compare sundry payable and accruals with prior year balances and
inquire into significant variations.
(v) Check that the sales tax accrual is disclosed at correct amount by
vouching to returns and accounting records.
(vi) Ensure that no non-deductible tax is reclaimed on the return, by
scrutinising it.
(vii) Vouch payments or refunds of sales tax to cash book from sales tax
returns.
230 CA Sri Lanka

(viii) Obtain sales tax returns for the period and check that they have been
properly prepared and filed promptly.
(ix) Test sales tax totals from prime records to monthly/quarterly
summaries and test cast summaries and scrutinise for unusual items.
(x) Review correspondence with taxation authority and results of any
recent control visits.
CA Sri Lanka 231

232 CA Sri Lanka

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PRACTICE & REVISION KIT

CA SRI LANKA CURRICULUM 2020

CL1 ‒ Advanced Audit and

ISBN 9781 5097 3164 0

British Library Cataloguing-in-Publication Data

BPP Learning Media Ltd

The copyright in this publication is owned by

All rights reserved. No part of this publication may be

The contents of this book are intended as a guide and not

Every effort has been made to contact the copyright holders

We are grateful to CA Sri Lanka for permission to reproduce

BPP LEARNING MEDIA

Knowledge Process Verb List Verb Definitions

Tier - 1 Remember Define Describe exactly the nature, scope or meaning

Identify Recognise, establish or select after consideration

List Write the connected items one below

State Express something definitely or clearly

Tier - 2 Calculate/Compute Make a mathematical computation

Recognise To show validity or otherwise, using knowledge

Summarise Give a brief statement of the main points

Classify Allocate into categories

Provide Give illustrations to support or illuminate

Tier - 3 Application Apply Put to practical use

Prioritise Arrange or do in order of importance

Reconcile Make consistent with another

Action verb checklist xiii

Conduct Organize and carry out a task

Display Make evident or noticeable

Perform Do or execute, usually in the sense of

Reconcile Make or prove consistent or compatible

Set Fix or establish

Select Choose from a range of options

Differentiate Constitute a difference that

Write Provide word descriptions to express an opinion

Conclude Form a judgment about, or determine or resolve

Review Study critically with a view

Tier - 6 Synthesis Compile Produce by assembling information

Propose To form or declare a plan or intention

Anticipate Foresee, or experience or realise

Draft Write original material for the scrutiny

Formulate Devise and put into words

Plan Devise the plan for an assurance

Report Give the formal final conclusion for an

Submit Send a completed document to a

Suggest Put forward an idea or give reasons

Synthesize Make or propose a new concepts or ideas

D. Auditing in a Digital Environment

G. Audit Quality and Ethics

8.7.2 Advice on the extent to which external auditor can

Section 1: Objective Test Questions

1 Amerasekera & Co audits Futtalam Ltd. In accordance with CA Sri Lanka

2 Gunawardena Partners & Co is the statutory auditor of Wattala Ltd a

6 When gaining an understanding of the specific business operations of an

8 Application controls relate to procedures used to initiate, record, process

9 One of the control objectives of the sales system of Karunaratne Ltd. is to

11 The external auditor has identified a deficiency in the internal controls of

14 As the external auditor of Gamage Ltd, you have performed analytical

18 The auditor of Gemunu Ltd. is performing audit procedures to confirm the

21 SLAuS 700 (Revised) Forming an Opinion and Reporting on Financial

22 The statement of financial position of Rajapaksa Ltd. includes a material