QUESTION 1

This scenario relates to five requirements.

It is 1 July 20X5. You are an audit supervisor of Apple & Co and are in the process of
reviewing extracts of the systems documentation which has been completed on the payroll
cycle of Castle Courier Co, as well as preparing the audit programmes for the forthcoming
final audit for the year ending 30 September 20X5. Castle Courier Co is a package
delivery company which operates from a large distribution centre.

Payroll
The company employs 200 staff of whom 120 of these staff are delivery drivers. All staff
work a standard eight-hour shift each day and are paid monthly. All staff members are
required to clock-in and out using a sequentially numbered key card which contains their
unique employee number and name. Sequence checks on the key cards and the data
recorded in the clocking-in system are carried out by the human resources (HR)
supervisor on a regular basis. The clocking-in process is monitored by a camera on entry
to the distribution centre and weekly checks are carried out by the HR department who
review the video footage to ensure that no staff member clocks-in for someone else.
Recordings are kept in date order in the HR department and logged on a spreadsheet
together with the name of the person who has reviewed the footage. The clocking-in
system is directly linked to the payroll system and information regarding the hours
worked by the staff is automatically transferred into the payroll system. The payroll
system then automatically calculates gross pay, deductions and net pay. The payroll clerk
confirms that the transfer of hours and calculations has been done correctly by
recalculating a sample of employees’ gross to net pay. A payroll supervisor then reviews
this check which is evidenced by the supervisor’s signature.
All staff are entitled to 22 days holiday a year. Employees are paid for any holiday which
has not been taken at the end of the year. Department managers are required to approve
all holiday requests by authorising employees' holiday forms, however this does not
always occur. The payroll system is password-protected, and the password is changed on
a monthly basis by the payroll manager using a random password generator. Once the
payroll has been agreed by the payroll supervisor, the payroll clerk provides details of the
net pay due to each employee to the financial controller who then prepares and authorises
the bank transfer to be paid to the employees’ bank accounts.
Each month, as part of the month-end procedures, the finance director undertakes a
payroll control account reconciliation and investigates any differences to ensure that the
payroll figures have been posted into the accounting records correctly. The company’s
HR department is responsible for processing starters and leavers using a joiner/leaver
form to notify the payroll department of the change. On receipt of the joiner/leaver form
a payroll clerk updates the payroll system. An edit report is generated which records the
changes made but this report is not reviewed. Two staff members from the HR department
have been absent for some time due to illness. As a result, the operations manager has
processed six newly recruited temporary delivery drivers and instructed the payroll
department to set up the new employees.
Delivery drivers are sometimes required to work overtime, particularly in busy periods.
Where overtime is necessary, the operations manager has to authorize overtime in excess
of five hours per week. Some temporary delivery drivers receive their wages in cash. The
delivery driver collects their pay packet from the finance department when it is ready.
The member of staff in the finance department will ask for the delivery driver’s name to
check that there is a pay packet prepared and, if there is, they provide the delivery driver
with their pay packet.
The company has to pay employment taxes to the tax authority by the end of each month.
Each month the payroll supervisor calculates the total liability due to the tax authority
and this is then passed to the financial controller who checks the calculations prior to the
payment being made. To encourage delivery drivers to make deliveries on time, the
company pays a discretionary bonus to delivery drivers on a quarterly basis. The
operations manager decides on the bonus to be paid and notifies the payroll clerk in
writing every quarter as to who will receive a bonus and how much it will be. As delivery
drivers spend the majority of their day driving the company vehicles, they are required
by law to take a 15-minute paid break in the morning and afternoon, as well as a one-hour
lunch break. The company has no way of monitoring the length of these breaks as the
delivery drivers are out on deliveries.

Required;
(a) Describe the following methods for documenting internal control systems and for
each explain a DISADVANTAGE of using this method.

(b) Identify and explain FOUR KEY CONTROLS in Castle Courier Co’s payroll
system which the auditor may seek to place reliance on; and
(c) Describe a TEST OF CONTROL the auditor should perform to assess if each of
these key controls is operating effectively.
(d) Identify and explain SIX DEFICIENCIES in Castle Courier Co’s payroll system
and provide a control recommendation to address each of these deficiencies.
(e) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Castle Courier Co’s payroll expense.
QUESTION 2
This scenario relates to three requirements.

It is 1 July 20X5. You are an audit supervisor with Woodward & Co and you are in the
process of planning the audit of Corley Appliances Co, a company which sells domestic
electrical appliances such as fridge freezers, TVs and washing machines. The company’s
year end is 31 August 20X5 and forecast revenue for the year is $12.2m, total assets are
$6.8m and profit before tax is $2.8m. The audit manager held a meeting with the finance
director and the notes from that meeting are provided below:
Notes from meeting with finance director
The company operates nationwide with 20 branches located across the country and sells
goods to members of the public and to retailers. The company has a returns policy which
allows a customer to return goods within 28 days of purchase if they are not satisfied with
the product. Historically, 5% of customers return goods within the return period. The
company also provides a six-month warranty on its products which requires Corley
Appliances Co to repair any defects, at its own cost, which arise within the warranty
period. It is anticipated that the warranty provision in the draft financial statements will
be lower than the prior year as the directors are confident the products sold by the
company are built to a very high standard.
The company is based in Europe and its main supplier of appliances is based in Asia.
Goods are shipped to the company’s central warehouse by sea and are usually in transit
for up to one month. Corley Appliances Co has responsibility for goods in transit from
the point of dispatch by the supplier. The central warehouse and all 20 branches will be
carrying out a full year-end inventory count on 31 August 20X5 and it is expected that
the value of inventory in Corley Appliances Co’s financial statements will be $0.95m.
Over the last six months, the finance director has noticed that the company's receivables
collection period is now an average of 55 days, whereas the company’s target is 42 days.
The credit controller has informed the finance director that she is confident that all
receivables will eventually pay as increases in receivables collection periods are starting
to become common in the industry. The finance director believes it is unlikely that any
increase in the allowance for receivables will be necessary at the year end as compared to
the prior year.
In June 20X5, a fraud was uncovered in the finance department. A payables ledger
supervisor had diverted funds from the company’s bank account using a fictitious supplier
on the payables ledger. The employee was immediately dismissed, and the value of the
fraud will be recognised as an expense in the statement of profit or loss. Since the
dismissal of the supervisor, purchase invoices have not been recorded in the payables
ledger and it is unlikely that this backlog of invoices will be cleared by the year end.
During the year, the company purchased and installed a new automated dispatch system
for its central warehouse. The cost of the dispatch system was $0.9m and has been
recognised as an addition to property, plant and equipment. These capitalised costs
include the purchase price of $0.6m, installation costs of $0.2m and staff training costs of
$0.1m.
Due to the costs incurred in purchasing the new dispatch system and the increase in the
receivables collection period, the company’s overdraft facility has increased significantly
and at one point went over the agreed limit of $0.7m in early June 20X5. The bank has
expressed concern about the way that the company is operating its bank overdraft and a
decision will be made in November 20X5 as to whether the bank will continue to provide
this overdraft facility, which the company is dependent on. The auditor’s report is due to
be signed in October 20X5.

ISA 210 Agreeing the Terms of Audit Engagements states that auditors should only
accept, or continue an existing audit engagement, if the preconditions for an audit are
present.

Required;
a) Describe the PRECONDITIONS required for an audit.

b) Describe SEVEN audit risks and explain the auditor’s response to each risk in
planning the audit of Corley Appliances Co.
c) Define the term ‘professional scepticism’ and explain TWO examples from the
audit of Corley Appliances Co where the auditor should apply professional
scepticism.
QUESTION 3
This scenario relates to four requirements.
It is 1 July 20X5. Purrfect Co manufactures and sells a variety of food for dogs and cats.
Your firm, Kirano & Co, has audited the company for a number of years. You are about
to commence the final audit for the year ended 31 March 20X5 and the draft financial
statements show profit before tax of $23.1m and total assets of $99.2m.
Vego Dog - inventory valuation
Purrfect Co launched a new brand of vegan dog food, Vego Dog, in December 20X4 but
sales have been lower than expected and the directors are considering a discounted sales
price. Vego Dog products are valued using a standard costing method and the standard
cost comprises raw materials, labour costs and production overheads. As at 31 March
20X5, Vego Dog products with a standard cost of $2.4m were included as finished goods
in inventory.
Receivable - Ellah Co
One of Purrfect Co’s major customers, Ellah Co, operates a chain of pet stores with 23
stores across the country. There have been reports in the press for several months that
Ellah Co’s sales and profits have been falling and, in March 20X5, Ellah Co announced
that 11 of its stores were to close in May 20X5. As at 31 March 20X5, Purrfect Co’s trade
receivables included $2.6m outstanding from Ellah Co and no allowance has been
included for this balance at the year end.
Contamination - legal claims
On 25 February 20X5, it was discovered that a batch of canned cat food had been
contaminated with insecticide, which could be harmful to cats. This batch had been
dispatched in November 20X4 to 247 retail stores. By 31 March 20X5, Purrfect Co had
received legal claims totalling $1.9m from consumers whose cats had eaten the
contaminated food.
The final audit is now nearing completion. The audit team is satisfied that legal claims
received to date have been appropriately reflected in the financial statements. However,
Purrfect Co’s lawyer has advised you that it is possible that significant additional legal
claims may be made by customers in future in respect of the contamination. The audit
engagement partner has confirmed that this is a contingent liability that requires
disclosure. The finance director has agreed to disclose some detail of the potential claims
in the financial statements but the audit team is yet to confirm the adequacy of these
disclosures.

a) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the matters identified regarding the
inventory valuation of Vego Dog products.
b) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the receivable balance due from Ellah Co.
c) Describe substantive procedures the auditor should perform to obtain sufficient and
appropriate audit evidence in relation to the legal claims following the
contamination.

d) Discuss the issue and describe the impact on the auditor’s report of Purrfect Co of
both adequate AND inadequate disclosure of the contingent liability.
QUESTION 4
This scenario relates to four requirements.
It is 1 July 20X5. You are an audit supervisor with Bannock & Co and are responsible for
planning the audit of a new client, Esk Co, for the year ending 31 August 20X5. Your
audit manager recently met with the finance director of Esk Co and has provided you with
the following planning meeting notes and financial statement extracts:
Planning meeting notes
Esk Co is a manufacturer and wholesaler of plumbing supplies. It operates from two
warehouses which are situated in the north and south of the country. Extracts from the
forecast financial statements for the year ending 31 August 20X5 and the final financial
statements for 20X4 are as follows:

In September 20X4, Esk Co purchased a patent for $2.6m which gives it the exclusive
right to manufacture a waste disposal system for a four-year period. The purchase cost
capitalised comprises the cost of the patent and other costs such as legal fees and
administrative costs incurred in negotiating the contract. In order to finance this purchase,
Esk Co obtained an interest-bearing bank loan of $2.5m during the year. The bank loan
is payable in five equal annual instalments, with the first instalment due to be paid on 1
September 20X5.
The payables ledger clerk has recently discovered a batch of supplier invoices that had
been mis-coded and therefore had not been recorded as trade payables. This error has now
been corrected but investigations are still ongoing to determine how this happened and
whether any other batches of invoices have been mis-coded.
There was a fire in the south warehouse in June 20X5 which resulted in damaged
inventory. An inventory count immediately following the fire identified that inventory
costing $1.1m required to be fully written off. The damaged inventory has not yet been
replaced as there is sufficient inventory in the north warehouse to satisfy demand. The
directors have raised a claim against Esk Co's insurance company to cover the full extent
of the lost inventory. Although no confirmation has been received from the insurance
company, the directors are confident that the full amount claimed of $1.1m will be
received and have included this amount as other receivables within current assets.
Esk Co's sales staff receive bonuses if they meet sales targets each quarter. A higher level
of sales bonus is available in the quarter to 31 August each year as a reward for efforts
during the year as a whole. Esk Co offers its regular customers discounts of up to 10%,
which are negotiated and documented by the sales director. This year, in order to easily
monitor the amount of the customer discounts, they have been recorded separately as an
expense in cost of sales. In previous years, revenue has been recorded net of the discount.
The manager in Esk Co's credit control department has been off work since December
20X4 due to ill health and has been replaced by an inexperienced temporary manager. As
a result, Esk Co has not been monitoring the ageing of its receivables and only follows
up on outstanding invoices when the system alerts credit control that a customer invoice
has been outstanding for 90 days or more. The standard credit terms are 30 days.
During the year, Esk Co was informed by the tax authorities that it was under
investigation for a breach of legislation relating to sales tax. Esk Co has appointed a tax
consultant who has advised that there does appear to have been a breach of tax legislation
and has estimated that a fine and penalty totalling $0.6m will be payable. The directors
do not intend to record anything in the financial statements until final notification is
provided by the tax authority, which is due to be received on 31 January 20X6.

ISA 210 Agreeing the Terms of Audit Engagements requires an auditor to establish
whether the preconditions for an audit are present prior to accepting an audit engagement.
a) Describe the PRECONDITIONS for an audit that Bannock & Co should have
established prior to accepting the audit of Esk Co.

b) Using the table below, calculate the following FOUR ratios, for BOTH years, to
assist you in planning the audit of Esk Co: gross profit margin, inventory holding
period, receivables collection period and payables payment period.

c) Using the information provided and the ratios calculated, describe EIGHT audit
risks and explain the auditor's response to each risk, in planning the audit of Esk
Co.
d) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Esk Co's trade receivables.
QUESTION 5
This scenario relates to four requirements.
It is 1 July 20X5. You are an audit supervisor with Walsh & Co. You are currently
reviewing notes in relation to the internal controls in place at your client, Whittaker Co.
Whittaker Co manufactures and sells luxury bed linen wholesale to the hotel trade and
direct to the public from its factory store. It has a year ending 31 August 20X5.
Sales
Whittaker Co implemented a new sales system in May 20X5. The new system was fully
tested prior to its implementation and will be run in parallel with the old system until the
year end. Whittaker Co's internal audit (IA) department is responsible for comparing the
output from the old and new systems, investigating any discrepancies and making
recommendations for further action.
The company operates a fully automated credit check process for all its new hotel
customers. The automated system generates a credit limit for each new customer which
the sales director approves before the customer can place any orders. She evidences her
approval in the system.
On a monthly basis, the receivables ledger clerk downloads the aged receivables report
and reviews it for outstanding debts. In line with Whittaker Co's credit control policy, any
debts which are greater than 30 days overdue are then passed to the credit control
department which contacts the customers to resolve any issues and recover the debt. Also
on a monthly basis, the accounts clerk reconciles the receivables ledger control account
to the receivables ledger in order to verify the month end receivables balance. Any
reconciling items are documented, errors are corrected on a timely basis and then the
reconciliations are reviewed and approved by the financial controller.
Payroll
Whittaker Co has a human resources (HR) department which is responsible for processing
joiners and leavers, including preparing and sending authorised joiners forms to the
payroll department so that new employees can be set up correctly on the payroll system.
However, when additional staff are required at short notice, joiners forms are not
completed and instead, the production supervisor notifies the payroll department by email
on the day they commence employment.
Staff are required to work overtime on a regular basis in order to meet production targets.
Overtime is paid monthly in arrears, at the end of the month in which it is worked. All
overtime reports are reviewed on a quarterly basis by the production supervisor after the
overtime has been paid. Reviews of overtime reports are evidenced by signature of the
production director.
The payroll system automatically calculates wages and deductions for all employees
based on standing data. The standing data is reviewed regularly to ensure it is still accurate
however no checks are performed on the monthly payroll calculations.
In May each year, all employees receive a bonus, the amount of which varies depending
upon their performance. The payroll department receives written notification from the
HR manager of the bonus, based only on his view of the employees' performance in the
year. The bonuses for 20X5 were input into the payroll system by the payroll clerk. After
May's payroll had been processed, a small number of employees notified the payroll
department that the bonus they had been paid did not agree to their bonus confirmation
letter. This was corrected in June 20X5.
Bank
Whittaker Co uses an internet banking system which requires a two-step verification
process. A password is required to log on to the system. An additional passcode is then
required to set up new payees or to withdraw funds. The login details including the
password and the passcode are saved in a shared file which is accessible to all payables
ledger staff in the accounts department.
The accounts clerk undertakes the bank reconciliations on a weekly basis. The reconciling
items are documented and sent to the financial controller for review. The financial
controller only investigates the reconciling items if the sum of these items is significant.

Auditors are required, under ISA 265 Communicating Deficiencies in Internal Control to
Those Charged with Governance and Management, to communicate in writing to those
charged with governance any significant deficiencies in internal control.
a) Describe FOUR matters the auditor may consider in determining whether a
deficiency in internal control is significant.

b) In respect of the SALES system of Whittaker Co:

1. Identify and explain THREE DIRECT CONTROLS on which the auditor
may seek to place reliance; and
2. Describe a TEST OF CONTROL the auditor should perform to assess if
each of these direct controls is operating effectively.
c) Identify and explain FIVE DEFICIENCIES in Whittaker Co’s PAYROLL and
BANK systems and provide a control recommendation to address each of these
deficiencies.
QUESTION 6
This scenario relates to two requirements.
It is 1 July 20X5. You are an audit supervisor with Indigo & Co and are planning the audit
of your client, Lapis Co, for the year ending 30 September 20X5. Forecast profit before
tax for the year is $68.9m and forecast revenue is $192.3m. The audit manager has
attended a planning meeting with the finance director and has provided you with the
following notes of the meeting:
Planning meeting notes
Lapis Co manufactures televisions at six factories located across Europe and purchases
most of its raw materials from overseas suppliers. These raw materials are shipped
directly to one of the company’s factories and the goods are usually in transit for up to
six weeks. Lapis Co has responsibility for goods in transit from the point of dispatch by
the supplier. The company’s internal audit department undertakes controls testing across
all factories, visiting each site at least once every year. The audit manager has discussed
with the finance director that the external audit team may rely on the controls testing
which is carried out by the internal audit department.
The company sells televisions to wholesale customers and directly to individual members
of the public via the company’s website. A significant wholesale customer has recently
informed Lapis Co that it is experiencing financial difficulties, however the finance
director indicated that an allowance for receivables is not required in the year-end
financial statements.
Lapis Co offers customers a three-year warranty on any new televisions purchased. The
finance director has confirmed that the warranty provision for the year ended 30
September 20X5 will remain at a similar level to the prior year. In December 20X4 Lapis
Co changed one of its television speaker suppliers to a cheaper alternative. This has
resulted in an increase in warranty claims for television speaker deficiencies.
In May 20X5, a payroll clerk was dismissed after it was discovered that they had carried
out a number of fraudulent transactions. Controls have since been implemented to prevent
this reoccurring.
The finance director has informed the audit manager that she only intends to disclose the
amount of remuneration payable to each director in the financial statements. Local
legislation in the country in which Lapis Co is based requires disclosure of the names of
the directors and the total amount of remuneration payable to each director.
One of Lapis Co’s suppliers is offering the company an annual rebate on the condition
that it purchases a minimum number of units by 30 September 20X5. The amount of the
rebate will be claimed in November 20X5. It is likely from orders placed to date and
forecast orders that Lapis Co will exceed the minimum volume required to claim this
rebate, therefore, it is anticipated that the draft financial statements will include a
receivable of $0.8m.
Lapis Co is developing a new smart television model. All $1.6m of costs incurred to date
will be capitalised within intangible assets by the year end. The model is still under
development and it is not anticipated that it will be available for commercial production
until 20X6.
In order to finance the development of the new smart television model, Lapis Co secured
a $2.5m interest-bearing bank loan in April 20X5. This is repayable in arrears over four
years in quarterly instalments.
The directors of Lapis Co are intending to propose a final dividend once the financial
statements are finalised.

Required;
a) In line with ISA 220 Quality Management for an Audit of Financial Statements,
describe the auditor's responsibilities in relation to supervising and reviewing the
work performed during the external audit of Lapis Co.
• Assigning appropriate personnel with the necessary skills and competence to
perform audit procedures effectively.
• Providing clear instructions and guidance to audit team members regarding the
objectives, scope, and timing of their work.
• Monitoring the progress of audit activities to ensure they are conducted in
accordance with applicable auditing standards and regulatory requirements.
• Reviewing the work performed by audit team members to assess its adequacy and
compliance with auditing standards, including the identification of significant
risks and corresponding audit responses.
b) Describe EIGHT audit risks and explain the auditor’s response to each risk in
planning the audit of Lapis Co.
1. Inventory Valuation:
✓ Risk Explanation: Given the multiple factories and overseas suppliers, there's a
risk of misstatement in inventory valuation due to goods in transit and changes in
suppliers.
✓ Response Explanation: The auditor should perform substantive procedures such
as inventory observation to physically verify the existence and condition of
inventory. Confirmations with suppliers can validate the quantities and costs of
goods in transit. Analytical procedures can help assess the reasonableness of
inventory valuation based on historical data and industry benchmarks.

2. Revenue Recognition:
✓ Risk Explanation: The risk arises from the possibility of improper revenue
recognition due to sales to financially distressed wholesale customers.
✓ Response Explanation: To address this risk, the auditor should test the
collectability of receivables by assessing the financial health of the wholesale
customers. Reviewing sales contracts and assessing the creditworthiness of
customers can provide evidence of proper revenue recognition. Analyzing
historical trends and comparing revenue figures with industry benchmarks can
further validate the reasonableness of reported revenues.

3. Warranty Provision:
✓ Risk Explanation: There's a risk of understatement of warranty provision due to
increased warranty claims resulting from changes in suppliers.
✓ Response Explanation: The auditor should review historical warranty claims to
assess their accuracy and completeness. Comparing warranty expense ratios to
prior periods and industry averages can help identify any anomalies. Evaluating
the adequacy of the warranty provision by considering the impact of changes in
suppliers on warranty expenses is crucial to ensure proper financial reporting.

4. Fraudulent Transactions:
✓ Risk Explanation: The risk stems from previous incidents of fraudulent
transactions by the payroll clerk.
✓ Response Explanation: To address this risk, the auditor should evaluate the
effectiveness of controls implemented to prevent fraudulent transactions, such as
segregation of duties and authorization procedures. Detailed testing of payroll
transactions, including sample testing and data analytics, can help detect any
irregularities. Considering the need for forensic procedures to uncover any
potential fraud is essential for ensuring the integrity of financial reporting.

5. Related Party Transactions:

✓ Risk Explanation: There's a risk of undisclosed related party transactions, such as
the rebate arrangement with suppliers.
✓ Response Explanation: The auditor should obtain a list of related parties from
management and review agreements for related party transactions. Assessing the
fairness of terms and disclosures related to such transactions is crucial.
Scrutinizing the adequacy of disclosures in the financial statements regarding
related party transactions ensures transparency and compliance with accounting
standards.

6. Intangible Assets:
✓ Risk Explanation: The risk involves improper capitalization of costs related to the
development of the new smart television model.
✓ Response Explanation: The auditor should evaluate management's criteria for
capitalization of intangible assets, ensuring compliance with relevant accounting
standards. Reviewing project documentation and assessing the likelihood of
future economic benefits from the new product is essential. Scrutinizing the
capitalization process to ensure costs meet the criteria for recognition as
intangible assets is crucial for accurate financial reporting.

7. Bank Loan Compliance:

✓ Risk Explanation: There's a risk of non-compliance with terms of the bank loan
agreement, which could impact the financial statements.
✓ Response Explanation: The auditor should obtain and review the bank loan
agreements to understand the terms and conditions. Performing calculations to
verify compliance with repayment terms, including the timing and amounts of
quarterly installments, is essential. Assessing the impact of any non-compliance
on the financial statements and disclosing such matters appropriately ensures
transparency and compliance with accounting standards.
8. Dividend Declaration:
✓ Risk Explanation: The risk involves improper dividend declaration, which could
affect the financial position of the company.
✓ Response Explanation: The auditor should evaluate the legality and
appropriateness of proposed dividends based on applicable laws and regulations.
Reviewing board minutes and assessing the impact of dividends on the company's
financial position and performance is crucial. Ensuring compliance with relevant
regulations regarding dividend declaration and disclosure in the financial
statements is essential for accurate and transparent reporting.
QUESTION 7
This scenario relates to five requirements.
It is 1 July 20X5. You are an audit supervisor of Owl & Co, responsible for the final audit
of Heron Co for the year ended 31 May 20X5 which is due to commence shortly. Heron
Co is a manufacturer of colour dyes used in the textile industry. Its draft financial
statements show total assets of $65.4m and profit before tax of $8.9m. The following
matters have been brought to your attention:
Additions to plant and equipment
Heron Co incurred significant capital expenditure in the year as it purchased a new
manufacturing line. All costs incurred in the purchase and installation of the
manufacturing line have been recognised as plant and equipment within non-current
assets. The amount capitalised of $3.6m includes the purchase price of $2.7m, delivery
and installation costs of $0.3m, refundable purchase tax of $0.5m and $0.1m incurred in
training staff on how to operate the new plant and equipment.
In addition to the $3.6m capitalised, Heron Co incurred costs of $0.2m testing the quality
of the dye being produced by the new manufacturing line. The finance director has also
capitalised this cost within plant and equipment. Heron Co started using the new
manufacturing line in December 20X4 and it has a useful life of eight years.
Bank balances
The bank figure included in Heron Co’s draft financial statements comprises four bank
account balances: an overdraft of $2.4m which is the company’s main current account
and a total of $0.6m relating to three savings accounts. The finance director has informed
the audit team that all four accounts have been reconciled as at the year end.
Provision for legal claim
Parrot Co, a customer of Heron Co, has made a claim for $0.8m against the company.
Parrot Co is claiming that a customised yellow dye purchased from Heron Co in March
20X5 was sub-standard and that, as a result, Parrot Co had to scrap a large batch of clothes
it was producing. The finance director has included a provision of $0.6m in the draft
financial statements for the year ended 31 May 20X5 as she believes that this is the likely
sum to be paid to settle the claim. The yellow dye was not sold to any other customers
and Heron Co does not hold any inventory of the dye at the year end.

Required;
a) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to the matters identified regarding
Heron Co’s ADDITIONS to plant and equipment.
• Obtain and review purchase invoices, contracts, and other relevant documentation
to verify the accuracy and completeness of the capital expenditure.
• Physically inspect the new manufacturing line to confirm its existence, condition,
and functionality.
• Test controls over capital expenditure by assessing approval processes,
authorization limits, and documentation retention practices.
• Reconcile the total capitalized amount to detailed cost breakdowns, ensuring all
relevant costs are appropriately included.
• Evaluate the reasonableness of the useful life assigned to the new manufacturing
line based on technical specifications and industry standards.
b) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Heron Co’s bank balances.
• Obtain bank confirmations directly from the banks holding the accounts to verify
the accuracy and ownership of the reported balances.
• Review bank reconciliations prepared by Heron Co, investigating any reconciling
items or discrepancies identified.
• Perform analytical procedures on bank transactions and balances to identify
unusual fluctuations or patterns.
• Inspect bank statements and other relevant documentation provided by Heron Co
to verify the accuracy of reported balances and transactions.
c) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Heron Co’s provision for the legal
claim.

• Review legal documentation related to the claim, including correspondence, legal

opinions, and settlement agreements.
• Evaluate the reasonableness of management's estimate for the provision by
assessing the basis and assumptions used.
• Consider subsequent events or developments related to the legal claim up to the
date of the auditor's report.
• Compare the provision amount to similar settled claims or industry benchmarks to
assess its reasonableness and consistency.
QUESTION 8
This scenario relates to six requirements.
It is 1 July 20X5. Daley Co, a listed company, manufactures double glazed windows and
doors. The company's year end is 30 September 20X5. You are an audit supervisor with
Cooper & Co and you are in the process of reviewing the following extracts from the
internal controls documentation in preparation for the forthcoming audit:
Payroll
The company employs 210 staff in its factory who are paid on a weekly basis by bank
transfer. Factory staff have key cards and are required to swipe in and out at the beginning
and end of their shift. This process is supervised. Hours worked by employees are
recorded electronically using the key card system which is linked to the payroll system.
Each week the hours worked are automatically transferred to the payroll system. As the
process is automated, no checks over this transfer are performed.
The payroll is run on a weekly basis and the system automatically calculates the wages to
be paid. On a sample basis, a payroll clerk checks gross to net pay calculations and
compares these to the system-generated balances to ensure the accuracy of the payroll
system. If any changes to the payroll data are required, the payroll clerk makes the
amendment. An edit report of any amendments is produced weekly by the system but is
not reviewed.
Non-current assets
Daley Co has a head office and ten factories, with a warehouse included at each factory.
The company has an internal audit (IA) department which carries out a comparison
between all of the assets recorded on the non-current assets register to those physically
present in each of Daley Co's 21 sites. This year's programme of visits, which has been
planned and carried out on the same basis as previous years, means that by 30 September
20X5, IA will only have completed this comparison at one factory and one warehouse.
During the year, the financial controller changed the company’s capitalization accounting
policy. In accordance with the revised policy, only items of a capital nature exceeding
$20,000 are accounted for as additions to non-current assets in the statement of financial
position. Any non-current assets purchased below $20,000 are written off to the statement
of profit or loss as an expense.
Bank and cash
On a weekly basis, a bank payments list is generated for supplier payments. The finance
director reviews the total amount of the bank payments list and authorises it. She then
passes it to the financial controller who processes it for payment.
Daley Co incurs a lot of petty cash expenditure and the finance department maintains a
petty cash float of $500 which is kept in the safe. It is used for making any sundry
purchases by the company. When staff wish to purchase sundry items, the required sum
of cash is given to the staff member who signs for it. The staff member is required to
return any excess money to the finance department but there is currently no requirement
for receipts to be provided.
The cashier reconciles the main current account on a monthly basis as this contains the
highest levels of activity and reconciles the remaining three bank accounts every three
months. The reconciliations are reviewed by the finance director who evidences this
review.
ISA 315 (Revised 2019) Identifying and Assessing the Risks of Material Misstatement
states that an entity's system of internal control consists of five components: control
environment, the entity's risk assessment process, the entity's process to monitor the
system of internal control, the information system and communication and control
activities.
During the year, the Chair of Daley Co resigned due to his other commitments and Fred
Johnson, who is the chief executive of the company, took over this role. Fred has recently
written to all shareholders to inform them that any questions or
comments they may have could only be raised at the company’s annual general meeting
and that any other communication with the board is not possible.
The executive directors' remuneration is set by the remuneration committee. The non-
executive directors’ remuneration is set by the board and is based on pre-tax profit targets
which are agreed by the board at the start of each financial year. As the board is of the
view that the internal control environment is very effective, an audit committee has not
been established.
Required;
a) Using the table below, describe the five components of an entity's system of
internal control.
b) In respect of the system of internal control of Daley Co:
i. Identify and explain FIVE deficiencies;
ii. Recommend a control to address each of these deficiencies; and
iii. Describe a TEST OF CONTROL the external auditors should perform to
assess if each of these controls, if implemented, is operating effectively.
c) Describe substantive procedures the auditor should perform to obtain sufficient
and appropriate audit evidence in relation to Daley Co's bank balances.

d) Describe THREE corporate governance deficiencies faced by Daley Co and

provide a recommendation to address each deficiency to ensure compliance with
corporate governance principles.
PAST YEAR QUESTIONS
QUESTION 9
QUESTION 10
QUESTION 11
QUESTION 12