AUDIT AND ASSURANCE

Compiled Solutions for possible Audit Risk

Questions.
S.N. Audit Risk Audit Response
1. A new accounting system introduced Review the transfer controls in place and
Identification - A new accounting assess their effectiveness to confirm that
system was introduced which had the data has been completely and
been tested prior to implementation accurately transferred.
but further testing was not done after
implementation.
Explanation - The data from the old
system should be completely and
accurately transferred to the new
system and testing should be done
after implementation.
There is a possible risk that errors
might have occurred during the
transfer which might misstate the
accounting records generated by the
new accounting system.
2. Development cost capitalized Obtain the breakdown of the cost and
Identification - A new development assess whether all costs meet the
commenced and the total amount was capitalization criteria. If not request the
capitalized. management to make necessary
Explanation - According to IAS 38 adjustments in accordance with IAS 38.
'Intangible Assets', Only those costs
that meet the capitalization criteria
should be capitalized.'
There is a possible risk that all costs do
not meet the capitalization criteria
which might overstate intangible
assets and understate research
expenses.
3. Amortization cost Recalculate the amortization cost and
Identification - The development confirm that the amount has been correctly
process was approved and the charged to profit or loss as amortization
commercial production of drinks expense.
commenced on 1 May 20X5.
Explanation - According to IAS 38
'Intangible Assets', The development
costs should be capitalised from the
date of commercial production and
amortisation should be recognised
over the useful life.
 There is a possible risk that the
management might have missed this
treatment which might understate
amortization cost and overstate
intangible assets.
4. Inventory valuation Review the delivery and shipping
Identification - Co has inventories that documentation to establish NRV and assess
the directors believe can be sold to an whether the NRV is higher than cost to
international customer at a price that confirm inventory is valued in line with IAS
marginally exceeds costs but Co will be 2.
responsible for all costs relating to the
delivery and shipping of goods.
Explanation - According to IAS 2
'Inventory', Inventories are valued at
the lower of cost and NRV.'
Since the Co incurs delivery and
shipping costs, there is a possible risk
that the NRV might be lower than cost
which might overstate inventory and
understate Expenses.
5. Staff and training costs for PPE to Discuss with management the rationale for
bring it on present working condition including the staff and training cost within
Identification - Co has included the wages and salaries expense and ensure that
significant staff and training costs in the cost is treated in accordance with IAS
preparing the site for a new machine 16.
which has been included on wages and
salary expenses.
Explanation - According to IAS 16
'Property, Plant and Equipment', The
purchase cost and directly attributable
cost relating to the PPE should be
capitalized.
Since staff and training costs are
Directly attributable cost, there is an
indication that the PPE has been
understated and wages and salary
expense has been overstated.
6. Extension of useful life Discuss with management the rationale for
Identification -During the year, the increasing the useful life and assess its
directors of the Co decided to extend reasonableness.
the useful lives of plant and machinery
by an average of five years despite the
fact that the old machinery was sold at
a significant loss.
 Explanation - According to IAS 16
'Property, Plant and Equipment', The
useful life of PPE should be reviewed
annually and the increase should be
based on a reasonable assumption.
Since the old machinery was sold at a
loss, the increase in useful life does not
seem reasonable. There is a possible
risk that the depreciation expense
might be understated and plant and
machinery might be overstated.
7. Fraudulent purchase (Personal use Inspect the non-current asset register and
assets) verify the assets with the authorized
Identification - A member of the purchase invoice to confirm only the assets
finance team fraudulently purchased purchased for business use are capitalized.
non-current assets for private use. Co
started the investigation of the fraud
by reconciling the physical asset to
non-current asset register but the
reconciliation had not been completed
by the year end.
Explanation - Only those assets that
are purchased for business use should
be included in the non-current asset
register.
There is a possible risk that the non-
current asset register might contain
assets purchased for personal use that
might overstate non-current assets.

8. New supplier costs not accounted Enquire with management rationale for
Identification - Co entered into a contract not accounting the cost and request for
with a new supplier and committed to a necessary adjustments.
minimum order quantity of 150,000
bottles per month for 12 months. No
costs have been accounted for to date.
Explanation - The costs of the order
received by the year-end should be
accounted for as trade payables.
If not done so, there is a possible risk that
the purchases and trade payables might
be understated.
9. Legal claim Review the correspondence from the
lawyer about the likelihood of the claim
 Identification - Co's previous supplier has to succeed and ensure 0.3m provision has
launched a legal claim against the Co for been accounted.
the breach of a contract. Lawyers have
indicated that it is likely to lose the case
and have estimated the amount payable
to be in the region of $0.3m.
Explanation - According to IAS 37
'Provisions, Contingent Liabilities, and
Contingent Assets', If the likelihood of the
claim to succeed is probable, a provision
should be created of the estimated
amount.'
There is a possible risk that the provision
might not have been created which might
understate provision liability and
expenses.
10. Interest bearing loan Obtain the breakdown of the cost of
Identification - The Co obtained an $1.2m and assess whether the amount
interest bank loan of $1.2m repayable payable within the year is classed as
over the next three years in arrears. current liability and the other amount as
Explanation - The loan amount should be non-current liability.
correctly split between current liability
and non-current liability.
If not done so, there is a possible risk that
the current and non-current liability
might be misstated.
11. Loan covenant Maintain professional skepticism and be
Identification –In order to maintain a alert to the risk over revenue recognition
bank loan, the Co agreed to maintain a and the use of subjective judgments that
minimum net profit margin and meet might affect profit.
specific sales targets.
Explanation - Because of the terms of the
agreement, management might get tend
to manipulate sales and profit figures by
overstating revenue and through the use
of subjective judgments.
There is a possible risk that the profits
and sales might be overstated and
expenses understated.
12. Refund Liability Review the level of post-year-end returns
Identification - The company has a and compare it with the refund liability
returns policy which allows the customer created to assess the adequacy of refund
to return goods within 28 days of liability.
 purchase. Historically, 5% of customers
return goods within the return period.
Explanation - According to IFRS 15
'Revenue Recognition', Revenue should
only be recognized when all the
performance obligations are satisfied.
Adequate refund liability should be
created based on past returns.
There is a possible risk that adequate
refund liability might not be created
which might understate refund liability
and overstate revenue.

13. Warranty provision Review the level of post-year-end

Identification - The company provides a warranty claims and compare it with the
six months warranty on its products. It is warranty provision created to confirm the
anticipated that the warranty provision reduction is reasonable.
for the year will be lower than the prior
year as the directors are confident that
the products sold are built to a high
quality.
Explanation - The warranty provision
should be adequate and based on a
reasonable assumption. The company
doesn't manufacture the products it sells,
so the reduction in warranty doesn't
seem reasonable.
There is a possible risk that the warranty
provision and expenses might be
understated.

14. Goods in transit Enquire with management the point at

Identification - The goods shipped from a which inventory is recorded and confirm
supplier of appliances based in Asia are that goods in transit are accounted.
shipped by sea and are usually in transit
for up to one month. The Co has the
responsibility for goods in transit from
the point of return.
Explanation - The goods should be
recorded from the point of dispatch.
If the goods in transit have not been
recorded, there is a possible risk that the
 inventory and payables might be
understated.
15. Inventory count Review the inventory count procedure
Identification - The central warehouse documentation of sites not visited to
and all 20 branches will be carrying out a ensure the inventory are counted and
full year-end inventory count on 31 valued correctly.
August and it is expected that the value
of inventory in Co's financial statements
will be $0.95m.
Explanation - It is unlikely that the audit
team will visit all 20 sites. Sufficient
appropriate evidence might not be
obtained regarding inventory valuation
from the sites not visited.
As a result, there is an increased
detection risk.

16. Allowances for receivables Inspect the post-year-end cash receipts

Identification - The company's and the aged receivables listing to assess
receivables collection period is an the adequacy of the allowance for
average of 55 days, whereas the receivables booked.
company's target is 42 days. The finance
directors believe it is unlikely that any
increase in the allowance for receivables
will be necessary at the year-end as
compared to the prior year.
Explanation - Higher receivables
collection period than target indicates a
higher chance of irrecoverability of
receivables.
If an additional allowance is not made,
there is a possible risk that the
receivables might be overstated and the
allowance for receivables might be
understated.
17. Payables ledger fraud Discuss with management the process
Identification - A payable ledger adopted for identifying and quantifying
supervisor has diverted funds from the the fraud to confirm whole fraud has
company's bank account using a fictitious been quantified and written off.
supplier on the payables ledger. The
value of the fraud will be recognized as
an expense in the statement of profit or
loss.
 Explanation - There is a possible risk that
the full impact of the fraud has not been
quantified which might overstate
payables and understate expenses.

18. Incomplete purchases and payables Review the unprocessed invoices to

Identification - Since the dismissal of the identify if they relate to the pre-year-end
supervisor, purchase invoices have not and confirm they have been correctly
been recorded in the payables ledger and accrued for at the year-end.
it is unlikely that this backlog of inventory
will be covered by the year-end.
Explanation - All the purchase invoices
relating to the year should be recorded in
the payables ledger by the year-end.
If not done so, there is a possible risk that
the purchases and trade payables might
be understated.
19. Capitalization of training cost Discuss with management the rationale
Identification - The company purchased a for including the staff training cost within
new automated dispatch system and PPE and ensure adjustments are made in
$0.9m was recognized as an addition to accordance with IAS 16.
Property, Plant and Equipment. The
capitalized cost includes purchase price of
$0.6m, installation cost of $0.2m and
training cost of $0.1m.
Explanation - According to IAS 16
'Property, Plant and Equipment', Only
directly attributable costs incurred in
bringing the PPE to the required location
and condition should be capitalized.
Since staff training costs are not directly
attributable, there is an indication that
the PPE has been overstated and
expenses have been understated.'

20. Going Concern Disclosure Undertake detailed going concern testing

Identification - The company's overdraft to ensure that the going concern basis is
facility has increased significantly and at reasonable. Review the adequacy of
one point went over the agreed limit of going concern disclosures in the financial
$0.7m. A decision will be made in statements.
November 20X5 as to whether the bank
will continue to provide this overdraft
facility, which the company is dependent
on.
 Explanation - As the company is highly
dependent on the overdraft as well as
receivable days are also drastically
increasing, if the bank stops providing this
facility there will be doubts over the
company's ability to continue as a going
concern.
There is a possible risk that these
uncertainties might not be adequately
disclosed in the financial statements.

21. New client Obtain an understanding of the company

Identification - Co is a new client. and the risks of material misstatement
Explanation - The audit team is unfamiliar including a detailed team briefing to
with the accounting policies, transactions, cover the key areas of risk.
and system of internal controls of the Co.
As a result, there is an increased
detection risk.
22. Director's bonuses Maintain professional skepticism and be
Identification - The directors are very alert to the risk over revenue recognition
pleased with the forecast performance and subjective judgments that might
for the year as the directors are paid a affect profit.
bonus based on a percentage of profit
before tax.
Explanation - The directors aiming to
increase bonuses and might tend to
manipulate profits by overstating
revenue and through the use of
subjective judgments.
There is a possible risk that the profit
might be overstated.
23. Revenue Recognition Review the accounting treatment of the
Identification - Co is undertaking 25% deposit and confirm that the amount
construction of playground at 16 sites. has been correctly recognised as deferred
Customers pay a 25% deposit on signing a income.
contract, with the balance payable when
the control of the playground is
transferred to the customer.
Explanation - According to IFRS 15
'Revenue Recognition', Revenue should
only be recognised when all the
performance obligations are satisfied.
The advance deposit should be treated as
deferred income.
 There is a possible risk that the 25%
deposit might be recognised as revenue
which might overstate revenue and
understate deferred income.
24. Prepayment on Non-current Assets Review the accounting treatment of the
Identification - The Co contracted to deposit paid and confirm that it has been
purchase new machinery costing $2.4m correctly recorded as a prepayment.
and paid $1m on signing the contract to
secure the machinery. The delivery is now
scheduled to be in October 20X5.
Explanation - According to IAS 16
'Property, Plant and Machinery', Only
physically existing assets at the year-end
should be capitalised. The asset wasn't
delivered by the year-end, so $1m should
be treated as prepayment.
There is a possible risk that $1m has been
capitalised which might overstate PPE
and understate prepayment.
25. Right issue Recalculate the split of share capital and
Identification - The Co made a rights share premium and agree it with the
issue to existing shareholders at a price of journal entries made to record the right
$0.75 for each $0.50 share. issue to confirm the split is correct.
Explanation - Since the right shares are
issued at a premium, the value of shares
should be properly split between share
capital and share premium element.
If not done so, there is a possible risk that
the share capital and share premium
might be misstated.
26. Outsourced payroll function Review the auditor's report for service
Identification - The Co's payroll function organization and determine the
is outsourced to an external service effectiveness of the internal controls in
organisation which is responsible for all place over payroll processing.
elements of payroll processing and
maintenance of payroll records.
Explanation - The auditors might not
obtain sufficient appropriate evidence
regarding the payroll calculation at the
Co.
As a result, errors in payroll records might
go undetected. There is an increased
detection risk.
27. Director's remuneration disclosure Review the disclosures to confirm that
Identification - The Co's directors the additional information regarding the
correctly disclosed their remuneration director's remuneration has been
details in line with IFRS standards. disclosed in the financial statements.
However, local legislation in the country
requires more extensive disclosure.
Explanation - Where the local legislation
is more comprehensive, the Co should
comply with the local legislation.
The disclosure might be incomplete if the
requirements of local legislation have not
been followed.
28. Temporary Accountant Discuss with management about the
Identification - The Co's financial competency of the financial accountant
accountant was taken ill, so the Co to assess the risk of misstatements in the
recruited a temporary financial financial statements.
accountant in early June 20X5 who will
prepare the draft financial statements.
Explanation - The financial accountant
recruited might not be competent or
familiar with the transactions of the Co
As a result, there is a possible risk that
the financial statement contains errors
and misstatements.
29. Risk of manipulation Maintain professional skepticism and be
Identification - The Co is looking to raise alert to the risk over revenue recognition
finance through bank loan and the bank and subjective judgments that might
has asked for a copy of audited year-end affect assets and profits.
financial statements by the year end. The
directors are keen to report strong results
to obtain this financing.
Explanation - The directors might tend to
manipulate asset and profit figures by
overstating revenue or through the use of
provisions and subjective estimates.
There is a possible risk that the assets and
profits might be overstated.
30. Redundancy provision Review the provision ledger and confirm
Identification - Four staff were made that the redundancy provision has been
redundant. The payroll department has created for the termination costs.
calculated the level of termination costs
associated with the redundancy and they
will be paid in the July 20X5 payroll run.
 Explanation - As the redundancy was
announced before the year-end, a
redundancy provision has to be made as
there is a present obligation for probable
future outflow under IAS 37 'Provisions,
Contingent Liabilities and Contingent
Assets'.
There is a possible risk that the
redundancy provision might not be made
which might understate provisions and
expenses.
31. Credit note Discuss with management if the credit
Identification - The Co sold a batch of note has been issued and adjustments
chemicals for $120,000, the customers made to the receivables and sales prior to
returned those chemicals because it was year-end.
not in line with customer specifications. A
credit note is yet to be issued.
Explanation - The credit note should be
issued and adjustments to the sales and
receivables should be made by the year-
end.
There is a possible risk that credit note
might not be recorded which might
overstate receivables and sales.
32. Payment run Enquire with management the rationale
Identification - The Co usually pays its for including the payment as an
suppliers by the end of each month. unpresented item to confirm that
However, the payment run for May 20X5 adjustments to payable has been made at
was not made until 1 June 20X5. The the year-end.
payment run is shown as an unpresented
item on the year-end reconciliation.
Explanation – As the payment run has
not been made till 1st June which is post-
year end, there is a possible indication of
window dressing as co. have recorded it
to be paid.
There is a possible risk that the payables
and bank balance might be understated.
33. Refund liability Review the level of returns made for a
Identification - Co sales tyers to period of 60 days to assess the return
customers on a sale or return basis. rate and confirm that the refund liability
Under the terms of the agreement, is adequately booked.
customers have 60 days to return without
penalty. The finance director historically
 assumed a return rate of 10% but now
intends to change it to 5%.
Explanation - According to IFRS 15
'Revenue Recognition', Revenue should
only be recognised when all the
performance obligations are satisfied.
Adequate refund liability should be
created for the chance of returns.
There is a possible risk that refund
liability might not be adequate which
might overstate revenue and understate
refund liability.
34. Depreciation policy Enquire the management about the
Identification - The Co conducted a depreciation policy of the plant and
review of its plant and machinery. As a machinery and assess its reasonableness
part of this review, surplus items of plant to ensure correct depreciation is charged.
and machinery were sold, resulting in a
loss on disposal of $160,000.
Explanation - Significant profit or loss on
disposal indicates that the depreciation
policy of the Co for plant and machinery
might not be appropriate.
There is a possible risk that the
depreciation expenses might be
understated and assets overstated.
35. Fraudulent transactions Discuss with management the process
Identification - The finance controller was applied to identify and quantify the
alleged that she has carried out a number fraudulent transactions to confirm all
of fraudulent transactions against the fraud has been quantified and written off
company. The Co has only recently to profit or loss.
started to investigate the extent of fraud
in order to quantify it.
Explanation - The full impact of the fraud
should be quantified and any additional
transactions should be written off to
profit or loss.
There is a possible risk that all fraud
might not have been uncovered which
might result in errors and misstatements
in the financial statements.
36. Legal claim for dismissal Obtain correspondence from the Co's
Identification - The finance controller of lawyer about the likelihood of the claim
the Co was dismissed. She has threatened to succeed and confirm that the claim has
to sue the company for unfair dismissal.
 Explanation - According to IAS 37 been accounted for in accordance with
'Provisions, Contingent Liabilities and IAS 37.
Contingent Assets', A provision should be
made if the payment is probable and if
possible, it should be disclosed in the
financial statements.'
There is a possible risk that the provision
has not been made which might
understate provisions and expenses or
the disclosure might be incomplete.
37. Rectification costs Review the supporting documentation to
Identification - A problem occurred establish NRV and assess whether it is
during the production of a significant higher than the cost. If not request the
batch of tires. The issues were identified management to make adjustments in
prior to any goods being dispatched and accordance with IAS 2.
the management is investigating whether
the issues can be rectified and sold.
Explanation - According to IAS 2
'Inventory', Inventories should be valued
at the lower of cost and NRV.
Rectification cost might mean that the
NRV of inventory might be lower than its
cost which might overstate inventory.
38. Purchase control deficiency Perform detailed testing over the
Identification - The report to purchase cycle to confirm the accuracy
management issued by the Co following and completeness of purchase and
the last year's audit highlighted payable balances.
significant deficiencies relating to Co's
purchase cycle.
Explanation - If the deficiencies have not
been rectified this year, the controls over
the purchase cycle may still be weak.
There is a possible risk that the purchases
and payable balances might contain
errors leading to misstatement.
39. Bonus issue Review the journal entry made to record
Identification - The Co is undertaking the the bonus issue and confirm that it has
bonus issue of its $0.50 equity shares. been correctly recorded. Review the
Explanation - The share capital should be disclosures to ensure they are adequately
increased by the value of the shares and made.
o the reserve should be decreased by the
same amount. Disclosures about the
bonus issue should be made.
 If not done so, there is a possible risk
that the share capital and the reserve
might be misstated or the disclosures
might be incomplete.
40. Reliance on Internal audit Perform audit procedures on some of the
Identification - Co has an Internal work of the IA department to assess the
Audit(IA) department which undertakes level of reliance that can be put on
controls testing across a network of control tests.
stores. The audit manager has discussed
with the finance director that the
external audit team may rely on the
controls testing which is undertaken by
IA.
Explanation - Reliance might be placed
on poorly performed and irrelevant
testing and the audit team might form
wrong opinion on the effectiveness of
controls.
There is a possible risk that the audit
team might perform fewer substantive
testing than required which increases
detection risk.
41. Misclassification of expenses Review the classification of cost between
Identification - The gross profit margin is the cost of sales and operating expenses
expected to increase from 56% to 60% and compare it with the previous year to
and the operating profit margin is ensure consistency.
predicted to decrease from 21% to 18%.
Explanation - The increase in the gross
profit margin is significant and
inconsistent with the decrease in
operating profit margin.
There is a possible risk that some of the
cost of sales might be included in
operating expenses which might
understate cost of sales and overstate
operating expenses.
42. Inventory valuation Compare the selling price less average
Identification - Co values inventory in line profit margin for a sample of inventory
with the industry practice, which is to use with their cost to confirm the value is a
selling price less average profit margin. close approximation to cost.
The directors consider it to be a close
approximation to cost.
Explanation - IAS 2 allows the valuation
of inventory at selling price less average
 profit margin if the value approximates
cost.
There is a possible risk that the valuation
might not be a close approximation of
cost which might misstate inventory.
43. Perpetual inventory system Review the controls in place over the
Identification - The Co undertakes perpetual inventory count and the
monthly perpetual inventory counts, each adjustments to confirm all lines of
of which covers one-twelfth of all lines in inventory are counted and correct
stores and the warehouse. adjustments are made.
Explanation - Under the perpetual
inventory count, all the lines of inventory
should be counted at least once a year
and adjustments to the inventory records
should be made on a timely basis.
There is a possible risk that all lines of
inventory might not be counted which
might understate inventory.
44. Inventory record exceptions Discuss with management about the
Identification - As a part of the interim exceptions as it might not be possible to
audit, an audit junior attended the place reliance on the inventory and a full
perpetual inventory count at one of the year-end inventory count might be
warehouses and noted that there were a required at the year-end.
large number of exceptions where the
inventory records showed a higher
quantity than the physical inventory
present in the warehouse.
Explanation - The year-end inventory will
be based on these inventory records so,
there is a possible risk that the inventory
might be overstated.
45. Obsolete PPE Discuss with management about the
Identification - During the year, IA depreciation policy and asses its
performed a review of non-current assets reasonableness. Inspect the non-current
physically present in around one-third of asset register to confirm obsolete assets
the company's stores. A number of assets have been removed and written off to
that had not been fully depreciated were profit or loss.
identified as obsolete.
Explanation - This is an indication that
the depreciation policy of the Co
regarding non-current assets is not
appropriate. The obsolete assets should
be written off to profit or loss.
 There is a possible risk that the
depreciation expenses might be
understated and non-current assets
might be overstated
46. Advertising expenditure Discuss with management the rationale
Identification - The company launched a for including the cost in current assets
TV advertising campaign and the and confirm that the cost has been
directors have indicated $0.7m relating to correctly expensed to profit or loss.
the advertisement will be recognised as
current assets.
Explanation - The advertising expenditure
incurred during the year should be
expensed to profit or loss as operating
expenses.
There is an indication that these costs
might be recognised as current assets,
which might overstate current assets and
understate operating expenses.
47. Data transfer Review the transfer controls in place and
Identification - The Co maintained its assess their effectiveness to confirm that
own payroll records until 30 April 20X5, at all data has been completely and
which point the records were transferred accurately transferred.
to an external service organisation.
Explanation - The data should be
completely and accurately transferred
from the Co to the external service
organisation.
There is a possible risk that errors might
occur during the transfer which might
misstate the payroll costs calculated.

48. Stock Exchange Listing Maintain professional skepticism and be

Identification - The Co intends to alert to the risk over manipulation,
undertake stock exchange listing in the especially over revenue recognition and
next 12 months. subjective estimates.
Explanation - To be listed on a stock
exchange, the Co should show a strong
financial position and performance. The
directors might manipulate profit and
asset figures by overstating revenue or
through the use of subjective judgment
to show better results.
There is a possible risk that the profit and
assets might be overstated.
49. Price Promise Review the claim made for a period of
Identification - Co made a price promise one month and compare it with the
that the difference between the refund liability made to confirm adequate
competitor's price and the price refund liability is made.
purchased will be refunded if claimed
within one month. The company intends
to include a refund liability of $0.25m for
one month.
Explanation - According to IFRS 15
"Revenue Recognition', Revenue should
only be recognised when all performance
obligations are fulfilled. Adequate refund
liabilities should be made for one month
period.
There is a possible risk that refund
liability might not be adequate which
might overstate revenue and understate
refund liability.
50. Supplier statement reconciliation Perform detailed testing over the payable
Identification - For the period until balances to confirm the payable balance
replacement of financial accountant, no is accurate.
supplier statements reconciliation or
payable ledger control account
reconciliation were performed.
Explanations - Reconciliations are a form
of controls that help to detect errors and
misstatements in payables balances.
If not performed, there is a high risk that
the payables balances contain errors
leading to misstatements.
51. Going concern uncertainties Perform going concern testing along with
Identification - The payables payment the review of cash flow forecast to ensure
period has increased from 40 to 58 days. going concern basis is reasonable. Review
The current ratio has decreased from the disclosures to ensure adequate
3.08 to 1.65. The quick ratio has disclosures have been made.
decreased from 1.97 to 0.99.
Explanation - These are all indications of
the reduction in cash flow of the
company which might lead to going
concern uncertainties or difficulties.
There is a possible risk that these going
concern uncertainties have not been
adequately disclosed in the financial
statements.
52. General overheads Discuss with management the rationale
Identification - The inventory cost for including general overhead in cost of
comprises the purchase price of raw inventory and ensure the cost of
materials and cost of conversion, inventory is in accordance with IAS 2.
including labour, production and general
overheads.
Explanation - According to IAS 2
'Inventory', Only purchase cost,
production overheads and directly
attributable cost can be capitalised.
General overheads donot meet this
criteria.
There is an indication that the general
overheads are included in cost which has
overstated inventory and understated
expenses.
53. Year-end adjustments Review the adjustments in detail and
Identification - The company plans to agree with supporting documentation
conduct full inventory counts at the from the inventory count to confirm
warehouse on 2,3 and 4 October and any adjustments are correctly made.
necessary adjustments will be made to
reflect post-year-end movements of
inventory.
Explanation - The adjustments should be
correctly made such that the inventory
valuation only includes inventory that
existed at the year-end.
If not so, there is a possible risk that the
inventory might be misstated.
54. Patent cost expensed Discuss with management the rationale
Identification - The Co paid $1.1m to for expensing purchase cost of patent and
purchase a patent with useful life of 3 confirm the adjustments are made in
years, the cost has been expensed in the accordance with IAS 38.
current year statement of profit or loss.
Explanation - According to IAS 38
'Intangible Assets', The cost of purchase
of intangible assets should be capitalised.'
There is an indication that the purchase
price has been expensed which has
overstated expenses and understated
Intangible Assets.
55. Contingent Assets Review the correspondence from the
Identification - The receivable balance of liquidators and assess the likelihood of
$0.9m was written off by Co and it was
 likely that the 40% of balance owed receipt to confirm it has been correctly
would be received. The Co plans to treated in accordance with IAS 37.
recognise $360000 in the financial
statements.
Explanation - According to IAS 37
'Provisions, Contingent Liabilities and
Contingent Assets', The receipts can only
be recognised if the likelihood of receipt
is virtually certain.
The likelihood of receipt is only probable
which should be disclosed as a contingent
asset.
There is a possible risk that the asset
might be overstated.
56. Work in progress(Construction) Discuss with management the process
Identification - The prior year's financial adopted to calculate percentage
statements recognise the work in completion of WIP to confirm the WIP is
progress of 1.8m which comprised correctly valued at the year-end.
property construction in progress as well
as ongoing maintenance service.
Explanation - There is likely to be a
material level of WIP at the year-end
which needs to be assessed at the year-
end. The percentage completion of the
WIP is difficult to ascertain as it involves
subjective judgments.
There is a possible risk that the
percentage completion is not correctly
calculated which might misstate WIP.
57. Trade payables Perform detailed testing over the
Identification - Preliminary analytical payables at the year-end to ensure their
review of the management accounts completeness and accuracy.
shows a payables payment period of 56
for June 20X5, compared to 87 days for
September 20X4. It is anticipated that the
year-end payables payment period will be
even lower.
Explanation - The forecast profit is higher
than last year which indicates an increase
in trade. Also, the cash flow position had
deteriorated, so it is unusual for the
payables payment period to be
decreased.
 There is a possible risk that the payables
balance contains errors leading to
understatement of payables.
58. Warehouse Acquisition Inspect the title deeds and review the
Identification - The Co has recently date of ownership to ascertain if the
entered into a transaction to purchase a warehouse was physically present at the
new warehouse costing $3.2m. The Co's year-end. If not, review the asset register
legal advisers are working to ensure that and confirm the asset is not included in
the legal process will be completed by the the register.
year-end.
Explanation - According to IAS 16
'Property, Plant and Equipment', Only
physically existing assets at the year-end
should be capitalised.
If the legal process had not been
completed at the year-end and the
warehouse had been capitalised, there is
a possible risk that PPE might be
overstated.
59. Irredeemable preference shares Review the accounting records to confirm
Identification - The company issued $5 that the irredeemable shares have been
million of irredeemable preference shares correctly classified as equity.
to finance the warehouse purchase.
Explanation - Since the shares are
irredeemable, it should be classified as
equity rather than non-current liability.
There is a possible risk that the share
might not be classed correctly, which
might overstate non-current liability and
understate equity.
60. Increase in useful life Discuss with the finance director the
Identification - The finance director has rationale for increasing the useful life of
increased the useful economic lives of the asset and assess its reasonableness.
fixtures and fittings from three to four
years.
Explanation - According to IAS
16'Property, Plant and Equipment, the
useful life of PPE should be reviewed
annually and any increase or decrease
should be based on reasonable
assumption.
There is a possible risk that the increase
in useful life is not reasonable which
might understate depreciation and
 overstate fixtures and fittings for the
period.
61. Audit time table The timetable should be confirmed with
Identification - The finance director has the finance director. If it is to be reduced,
requested that the audit be completed in then consideration should be given to
a shorter timescale. performing an interim audit to reduce the
Explanation - Because of the reduction in pressure on the final audit.
the audit timescale, the audit team might
be under pressure and therefore might
not be able to perform detailed audit
procedures to obtain sufficient
appropriate evidence.
As a result, There is an increased
detection risk.
62. Proposed Dividend Discuss the issue with the management
Identification - The Co is intending to and confirm that the dividend has not
propose a final dividend once the been included as a liability in the 20X5
financial statements are finalised. financial statements. Review the
Explanation - To be in line with IAS 10 disclosure to ensure the dividends have
'Events After Reporting Period', the been disclosed.
dividends should not be recorded in the
20X5 year's financial statement because
the obligation only arises once the
dividend is announced. The dividend
should only be disclosed.
There is a possible risk that the dividend
is included in 20X5 financial statements
which might overstate liability.

63. Goods in transit (Responsibility not Enquire with managers the point at which
transferred) the goods are recorded and ensure that
Identification - The Co purchases goods the goods in transit are not recorded.
from suppliers in South Asia and these
goods are shipped to the company's
warehouse. The goods are usually in
transit for two weeks and the company
correctly records the goods when
received.
Explanation - The goods and the related
payables should be recorded by the
company when goods are received in the
warehouse.
 There is a possible risk that the goods in
transit are recorded in inventory which
might overstate inventory and payables.
64. Inventory (Sold at a discount) Review the post-year-end sales of the old
Identification - The old models have to be phone and assess whether the NRV is
sold at a significant discount as the higher than the cost. If not request the
customers usually want the latest model. management to make adjustments in line
The Co has a number of older models in with IAS 2.
inventory.
Explanation - According to IAS 2
'Inventory', Inventory should be valued at
the lower of cost and NRV.
Since the old phones are to be sold at a
discount, the NRV might be lower than
the cost.
There is a possible risk that the inventory
might be overstated.
65. Movements in inventory Review sample of the goods receipt notes
Identification - The movements of and goods despatch notes received
inventory in and out of the warehouse during the inventory count and follow
during the inventory count was not through the inventory records to confirm
controlled. that they are correctly recorded.
Explanation - Because the movement of
inventory was uncontrolled, some
inventory might be counted twice, while
some might not be counted at all.
There is a possible risk that the inventory
might be misstated.
66. Sales return Obtain a sample of post-year-end sales
Identification - Since the year-end there returns, identify which relates to the pre-
has been an increased number of sales year-end, and confirm that these sales
returns and in the month of May over have been removed from sales and
$0.5 million of goods sold in April were included in inventory.
returned.
Explanation - Since the goods returned
relates to the pre-year-end, the value of
the returned goods should be removed
from revenue and the inventory should
be reinstated.
If not done so, there is a possible risk that
the revenue might be overstated and
inventory understated
67. Inventory(Written down to scrap value) Enquire with management the rationale
Identification - There was a fire in one of for assigning the scarp value of $0.2m
the warehouses. Inventory of $0.9m was and assess its reasonableness.
damaged and this has been written down
to its scrap value of $0.2m.
Explanation - The write-down should be
charged to profit or loss and the scrap
value should be reasonable.
There is a possible risk that the scrap
value is not reasonable and that might
overstate the inventory.
68. Contingent Asset Discuss with management the rationale
Identification - An insurance claim has for recognizing $0.7m within the profit or
been submitted for the difference of loss and confirm that the proceed is
$0.7m. Venus is still waiting to hear from treated in accordance with IAS 37.
the insurance company with regard to
this claim but has included the insurance
proceeds within the statement of profit
or loss.
Explanation - According to IAS 37
'Provisions, Contingent Liabilities and
Contingent Assets', An asset should only
be recognised when the receipt is
virtually certain. Since the proceed is still
not certain, it should not be recognised.
There is an indication that $0.7m has
been recognised which has overstated
provisions and expenses.
68. Bank reconciliation Undertake detailed testing on the
Identification - The finance director has reconciliations and agree it with the
informed the audit manager that the May supporting documentation to confirm the
and June bank reconciliations each contained bank balances are accurate.
unreconciled differences; however, he
considers the overall differences involved to
be immaterial.
Explanation - The reconciliation might
contain significant errors that might cancel
off each other to give small unreconciled
differences.
If the differences are not fully reconciled,
there is a possible risk that the cash balances
might be misstated.
69 Work in progress Perform detailed cut-off testing over the
Identification - The company undertakes year-end WIP to confirm that it is correctly
continuous production in its factory, valued at the year-end.
 therefore at the year-end, it is anticipated
that the WIP will be approximately $950,000.
Explanation - The value of WIP should be
correctly assessed at the year-end. As the
process of valuing WIP is complex, the cut-off
of WIP might not be correctly calculated.
So, there is a possible risk that WIP might be
misstated.
70. Obsolete Inventory Review the aged inventory report and
Identification - During the interim audit, it perform cost and NRV testing for a sample of
was noted that there were some lines of old items to assess whether a write-down is
inventory that according to the records were required.
at least 90 days old. In addition, the inventory
holding period has increased from 47 days to
54 days.
Explanation - There may have been an
increase in slow-moving inventory and some
inventory might be obsolete which needs to
be written down.
There is a possible risk that obsolete
inventory has not been written down that
might overtstate inventory.
71. Branch records Discuss with management the significance of
Identification - There are four additional sites the accounting records maintained at the
where some records are maintained and four sites and consider visiting some of these
these sites are not visited during the interim sites during the final audit.
audit. The records for the site are
incorporated monthly through an interface to
the general ledger.
Explanation - As the auditors did not visit
these sites, they might not obtain sufficient
appropriate evidence over the completeness
and accuracy of the accounting records held
at these sites.
As a result, there is an increased detection
risk.