CL 1 – Mock Examination 02

• Section 1:10 multiple choice questions (MCQs)
• Section 2: 4 questions
• Section 3: 2 questions

Question 02

You are the audit senior conducting  the  audit  of  Fabrica  (Pvt)  Ltd  (FL).  FL  is  the  Sri Lanka’s largest knit fabric manufacturer and it offers wide solutions in knitting, dyeing, finishing and printing. Manufacturing activities of FL are carried out in three plants at Seethawaka Export Processing Zone (EPZ). The year-end of FL is 31 October 2020. The following information has been communicated to you by the audit manager during the team meeting held on 15 October 2020.                                                                                                                                                                     

Inventory count

• FL’s raw materials and finished goods are stored in two separate warehouses located in the same EPZ. Each warehouse is expected to contain significant levels of inventory at the year-end.
• FL plans to take inventory counts on 31 October 2020 in all of its warehouses. The plants will continue production until 4 pm on 31 October 2020 as FL has to complete a large order which is scheduled to be dispatched to the customer by the 31 October
• The raw material warehouse will not receive any raw materials during the count date. However, as there will be material issues to the plants, the plants production supervisors have been instructed to forward material requisitions to stores before 9 am on 31 October 2020. Requisitions will not be accepted thereafter until the count is over.

Trade receivables

• The draft financial statements for the 11 months ended 30 September 2020 recognised trade receivables to be Rs. 800 million, which is considered to be a significant balance in the financial statements.
• As part of the audit approach, a positive receivables circularisation of trade receivables is to be undertaken.

Lak Haritha is a TV reality show, popular among Sri Lankans. It evaluates businesses on their CSR projects to protect the environment and awards Rs. 10 million to the winner with the best environmental conservation project.

Your audit client ABC PLC is interested in sending an application to appear in the TV show. The completed application must be signed by the Board of Directors and addressed to the producers of the TV show.

Clear written guidelines on completion of the application and rules for applicants are provided in the application itself. The application is in an appropriate format. It provides details on the nature of the project, expenditure incurred, how the applicant measured the impact on the environment (i.e. KPIs) and comparison of KPIs against set targets.

The producers of the TV show require the application to be accompanied by an audit report issued by a professional accountant on the accuracy of the information on the above application.

You are the auditor in-charge of this year’s audit engagement of ABC PLC and the finance director contacted you seeking professional advice and guidance.

Required:
(a) Assess whether your firm can perform an assurance engagement in the above scenario, considering whether the engagement exhibits all of the characteristics of an assurance engagement. (6 marks)

You are the audit manager of S&S Associates, a firm of Chartered Accountants. Currently the firm has more than 200 audit clients of which 5 are listed companies.

In your capacity as a manager, you have been asked to perform a post-issuance quality review of the audit file of Knitwear PLC (KPLC) for the year ended 31 March 2020. You were not involved in the audit of KPLC. While reviewing the file you have observed the following.

• The audit team consisted of 4 trainee staff (with less than 2 years of experience), a manager (CA Sri Lanka corporate level student) and the engagement partner (fellow member of CA Sri Lanka).
• Audit of KPLC was considered as a high-risk audit. There were no modifications to the audit plan during the
• Audit supervisor of the previous year’s audit had joined KPLC as an accountant soon after the commencement of the audit. The supervisor’s role of the audit had not been filled due to staff
• Detailed audit work has been carried out by trainee
• The audit manager has reviewed the audit working papers towards the completion of the audit
• There was no evidence of review by the engagement partner in the audit working paper
• An unmodified opinion   has   been   expressed   by   the   engagement   partner   on 5 May 2020.

During the discussion with the engagement partner of KPLC, you noted that a peer review had been carried out on the audit file of KPLC for the year ended 31 March 2018. It had identified the areas that require immediate corrective action; however, those deficiencies still exist in the current-year audit file.

Based on the above concerns raised by you, the partners of the firm requested you to develop a formal, set of quality standards for the firm, in order to ensure that the audits comply with professional standards, applicable legal and regulatory requirements and to ensure that the auditor's report issued is appropriate in the circumstances.

Required:
(a) Using element of system quality control, explain four (04) issues raised by you in respect of the audit of KPLC for the year ended 31 March 2020. ( 6 marks)

You have completed the statutory audit of Best Rating (Pvt) Ltd (BRL) for the year ended 30 June 2020. BRL is a credit rating agency licensed by the Securities and Exchange Commission of Sri Lanka (SEC). BRL collects and stores a significant amount of sensitive and confidential information of their clients.

One month after the completion of the statutory audit of BRL, you have communicated the internal control deficiencies observed during the audit to the board of directors and management through the management letter. However, these matters have not been communicated to the management during the course of the audit.

The following are the extracts of material deficiencies reported in the management letter in respect of IT general controls.

• More than 25% of the user accounts during the audit testing had weak passwords. In a number of instances these accounts are used to access critical systems and information via remote access without any additional
• BRL databases were not ‘patched’ with critical software updates released by the vendors.
• The virus protection tool has been installed on workstations but have not been updated regularly.
• Although firewalls are in place, they have not been configured correctly.
• BRL’s user endpoint devices are configured to copy data to external data storage devices.

Question 06

You are the audit senior  for  the  audit  of  Auto  Mart  PLC  (AM)  for  the  year  ended 31 March 2020. You have gathered the following information during the planning stage of the audit.

AM is engaged in assembling motor cars for the domestic market under the brand name of “Saga”. AM imports more than 60% of it’s vehicle parts from China. The balance 40% is imported from a company in Bangladesh that is owned by a Director of AM.

The company in Bangladesh also imports most of its raw materials from China. Due to the COVID-19 pandemic which began in early-January 2020, the company had brought in restrictive measures when trading with China. This has resulted in a shortage of raw material causing   low   production   during   the   last   quarter   of   the   year   ended   31 March 2020.

AM sells its vehicles through a dealer network spread across the country. A significant drop in sales has been experienced during 31 March 2020 due to an increased supply of low-priced imported second hand vehicles.

AM runs three service stations at which Saga vehicles are serviced and repaired. These service stations accumulate large quantities of used oil which is disposed into adjacent bare lands. During a discussion with the Factory Manager you have realised that AM has been sued by the Environmental Authority for breach of legislation regarding the disposal of harmful waste. The law requires AM to clean up the contaminated lands.

AM has a significant amount of plant and machinery which is used to assemble its products. These machines have been used in the operation for more than 10 years. During the year, a comprehensive review of each component of plant and machinery has been performed in order to check how the efficiency can be improved. During this review an assessment was made as to whether a minor repair, extensive refurbishment or a complete replacement is required. The review report has revealed that AM had incurred Rs. 2  billion as  expenses  for  plant  and  machinery.  You  have  noted  that  Rs. 2 billion has been capitalised under property, plant and equipment.

You have also gathered the following information during the execution of the audit.

Legal cases

AM has been sued by a number of customers because of a brake failure in vehicles that they have sold during 31 March 2019. This has occurred due to a substandard part imported from the Bangladesh company. AM is trying to settle these claims out of court to avoid bad publicity. As per the correspondence with the customers who have lodged claims, the estimated claim expenses would amount to Rs. 150 million.

Rebate expenses

AM is giving rebates to their dealers. Your team is analysing the current year revenue and rebate expenses. The company policy from the year 2015 onwards is to limit the rebate expense to 5% of the invoice value. During the risk assessment process, your team has not identified any reason for change in the rebate percentage during the year from the past years. However, your team considered that some variation is possible due to the nature of that expense.

The  following  information  in  respect  of  the  rebate expense  for  the  year   ended   31 March 2020 and previous four years have been gathered by your team.

Stiches PLC (SP) is a company listed on the Colombo Stock Exchange. It exports lace to top US and European–based luxury womenswear brands. One of its major US customers has recently received heavy negative publicity due to defective womenswear containing formaldehyde that caused severe rashes on women who wore them. The US–based customer has experienced a substantial decline in their business. As at end of 2019, it was heavily in debt and was selling off core items of property, plant and equipment to finance its operations.

Although management performed an assessment of impairment, it concluded that no impairment was necessary as the US-based customer promised to restructure its business and therefore pay its dues in the future.

Perera is a Partner of JM Associates, a firm of chartered accountants. He has a sister who regularly trades in the stock market. Profits from share trading is her major source of income. On 1 September 2018, she invested Rs. 2 million in ordinary shares of SP.

Perera was appointed as the Engagement Partner of the statutory audit of SP for the year ended 30 June 2020. Perera has lost contact with his sister for some time. He became aware of the investment held by the sister when the audit was in progress. However Perera did not disclose the investment to JM Associates or the Audit Committee of SP.

The date that the financial statements would be authorised for issue was expected to be 30   October   2020.   Perera  started   reviewing   the   audit   team’s  working papers  on 17 October 2020. He noted that management’s assessment of impairment of the US-based customer’s receivable balance was inadequate and a provision for impairment would be necessary. The effects of impairment would exceed overall materiality.

Perera suddenly remembered his sister’s equity investment and his failure to disclose this fact to both JM Associates and the Audit Committee. He also recalled that his sister had recently suffered a heart attack. Therefore, he was deeply concerned that his sister would not be able to cope with a financial loss, if share prices were to go down significantly.

Given the above situation, he decided not to escalate the inadequate provision for impairment to the audit committee for necessary action.