Series: MAY 2016

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  • 9 Marks

AA – May 2016 – L2 – Q7b – Risk Assessment and Internal Control

Identify business risks for Moovy Magic’s procurement and suggest control strategies.

You are the internal auditor of Moovy Magic Limited, which runs a chain of video rental stores.

The company guarantees that if a video is not available for rental, the customer will get a free rental when that video comes back into inventory. It is not possible for customers to pre-book videos. The company purchases a number of copies of each video, taking the above policy into account, but has no way of monitoring whether their procurement strategy is effective. Procurement decisions are made and auctioned locally, and no central budgets are produced.

You have been asked by the directors to review the procurement and other strategies of the company.

Required:

Identify and explain the potential business risks arising from the above procurement and other strategies. Suggest controls and strategies that the management of Moovy Magic could instigate to mitigate those business risks. (9 Marks)

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  • 6 Marks

AA – May 2016 – L2 – Q7a – Audit Evidence

Identify additional information needed to determine the audit opinion for Musky Fresh Ltd following supplier difficulties.

Musky Fresh Limited has been in existence, for a number of years, importing perfume. The managing director had built up the business using contacts he already had in the industry. The company imports only one brand of perfume which is manufactured exclusively by one company. The perfume is distributed via ‘shops within shops’ at 20 branches of a well-known store. Under this agreement, Musky Fresh Limited pays a percentage of its takings to the store, with a minimum annual payment of N100,000 per store.

The audit is nearing completion, but you have just heard that the Arabian manufacturer is facing serious financial difficulties, and that supplies have ceased.

Required:

a. Set out the further information the auditor would require before reaching his audit opinion. (6 Marks)

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  • 15 Marks

AA – May 2016 – L2 – Q6 – Internal Control Systems

Identify control activities in a trade payables system and the need for substantive procedures.

Control activities may be defined as policies, procedures, and operations that help to enable management directives to be carried out. These activities are detailed procedures designed to prevent, or to detect and correct errors that may arise in processing information.

Required:

a. Set out the five types of control activities and illustrate each one in the context of purchases or trade payables system. (10 Marks)

b. Explain why, even where tests of controls prove satisfactory, substantive procedures can never be completely eliminated. (5 Marks)

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  • 20 Marks

AA – May 2016 – L2 – Q4 – Internal Control Systems

Identification and improvement of control weaknesses in the sales system of Sofa Ltd.

You are carrying out the audit of the sales system of Sofa Limited, a company that manufactures office furniture. The company has annual sales revenue of N150 million. All the shares are owned by Sofi and her husband Andy. Neither is involved in the running of the business. The chairman is responsible for running the business, but does not own any of the company’s shares.

The bookkeeper maintains all the accounting records and prepares the annual financial statements.

A stand-alone computer is used to maintain the accounting records, including those of the sales system. Standard accounting software is used, which was purchased from an independent supplier. For the sales system, a sales ledger is maintained to which sales invoices, credit notes, cash, and discounts are posted. When sales invoices are posted and credit notes are input into the computer, the value is updated in both the sales ledger and the nominal ledger.

You have determined that the documents and personnel involved in the sales ledger are as follows:

  • When order is received by telephone, it is recorded by the sales clerk in the sales department. This is usually done on a notepad.
  • The sales clerk will then pass the sales order to the stores, to the goods outwards department where the office furniture is kept.
  • If the goods ordered are in inventory, then the goods will be loaded onto one of the delivery trucks. A two-part dispatch note will be prepared to accompany the sales order. This is usually done before the stores have received the sales order from the sales department.
  • The goods are delivered to the customer together with the top copy of the goods dispatch note.
  • The driver on his return will inform the sales department that the delivery has been successful and will maintain the last copy of the goods dispatch note in the stores.
  • At the end of the week, the sales department prepares a sales invoice for the customer.
  • When the post is received, it is opened by a staff of the sales department.
    The person opening the post will both make a list of all the cheques
    received and that same person will then go to the bank and bank the
    cheques. Upon return, the remittances and cheque paying-in book are
    passed to the book keeper for updating the receivables ledger.
  • The receivables ledger is reviewed by the book keeper on a monthly basis
    to see which customers are above their credit terms and will inform the
    sales staff who to telephone and chase their debt.

Required:

a. Identify and describe eight weaknesses in the sales system of Sofa Limited. (8 marks)

b. Provide recommendations to rectify each of the weaknesses identified. (8 marks)

c. Explain why segregation of duties is important in an internal control system. (4 marks)

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  • 20 Marks

AA – May 2016 – L2 – Q3 – Ethical Issues in Auditing

Examination of ethical issues in client engagement, fundamental ethical principles, and lawful disclosure obligations for auditors.

You have recently been appointed the auditors of Spicer Plc, a company whose shares are traded on a stock exchange. The directors of Spicer Plc have recommended that you perform the following services:

  • The statutory audit of the annual accounts
  • Taxation services
  • Consultancy services in respect of the implementation of a new information technology system

Your firm has not acted for Spicer Plc before but does act as auditors to one of its major competitors.

Required:
a. Identify and explain the professional and ethical issues that should have been identified by your firm in relation to the provision of the services outlined above to Spicer Plc and describe the safeguards that should be in place in order to address these issues. (11 marks)

b. What are the five fundamental principles of ethics? Briefly explain their meaning. (5 marks)

c. A client’s affairs should not be disclosed to third parties. However, where a client has been guilty of an unlawful act, to whom should the auditor disclose this information, and in what order? (4 marks)

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  • 20 Marks

AA – May 2016 – L2 – Q2 – Planning an Audit

Planning and identifying audit risks for a new client with an increased demand for products, using a standard costing system for inventory valuation.

Sweet Dreams, a limited liability company, is a new audit client and you are at the
planning meeting for the forthcoming audit. The company has grown rapidly and has
May 31 as year-end. The financial statements have not been audited in previous years
since the organization has only just converted from a partnership to a company.
The company’s bankers have requested that an audit be undertaken on the financial
statements for the year ending May 31, 2016. Higher levels of inventory required to
meet the increasing demand for its products have necessitated a request for an increase
in the bank’s overdraft facility.
The company makes beds, buying its materials directly. At the year-end, inventory
comprises raw materials, work-in-progress and finished goods. It does not undertake
continuous inventory counting but does intend to perform a full inventory count on
May 31, 2016. It uses standard costing system to value finished products and work-inprogress.

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  • 30 Marks

AA – May 2016 – L2 – Q1 – The Role and Responsibilities of Auditors

Examines responsibilities in fraud prevention, asset ownership verification, depreciation rates, asset register contents, and revaluation effects.

You are an employee of Ben, Tai & Co., a firm of Chartered Accountants. One of the firm’s clients is Keke Limited, a car rental company whose shares are not traded on a stock exchange. The company has a large fleet of vehicles which it hires out on a contract basis.

The duration of a contract varies from one day to three months. Anybody wishing to hire a car must possess a valid driver’s license. In addition, they must take out insurance with Keke Limited.

You are involved in the audit of non-current assets for the year ended December 31, 2015.

The company’s main non-current assets are:

  • Freehold land and buildings
  • Office equipment (mainly computers)
  • Motor vehicles

The company was formed ten years ago, and all non-current assets (except for land and buildings) are maintained in a non-current assets register. The company depreciates non-current assets at the following rates:

  • Freehold land and buildings: 2% on cost
  • Office equipment: 20% on cost
  • Motor vehicles: 50% on cost

The company has recently revalued its buildings upwards by N200 million. The directors believe that they have fallen victim to a fraudster who has disappeared with a number of the company’s vehicles.

Required:

a. What is the difference between the responsibilities of management and the auditor for the prevention and the detection of fraud? Explain how these responsibilities are carried out. (6 marks)

b. Describe how you would verify the ownership of:
i. Freehold land and buildings
ii. Computers
iii. Motor vehicles
(6 marks)

c. Comment on the appropriateness of the depreciation rates of the non-current assets and their respective effect on the income statement. (6 marks)

d. List the contents of a non-current asset register and describe its usefulness for Keke Limited. (6 marks)

e. Explain the accounting effect of the revaluation of the buildings to the financial statements and the audit work you would perform in this matter. (6 marks)

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  • 9 Marks

FR – May 2016 – L2 – Q7b – Financial Instruments (IAS 32, IFRS 9)

Calculate amortised cost and fair value of a financial liability issued by Anifowose Plc.

Anifowose Plc issued a debt instrument at its fair value of N100 million on January 1, 2013. The debt instrument is to mature in 2017. It has a principal amount of N125 million and carries a fixed interest rate of 4.72%, which is paid annually. The effective interest rate is 10%, and on December 31, 2015, it had a fair value of 105 for every N10 nominal value. The company makes up its accounts to December 31 every year.

Required:

i. Show your computation schedule for the amortised cost of the financial liability up to December 31, 2015, on the assumption that the financial liability is valued at amortised cost.

ii. What is the value of the financial liability as of December 31, 2015, if the fair value option is adopted by Anifowose Plc?

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  • 6 Marks

FR – May 2016 – L2 – Q7a – Financial Instruments (IAS 32, IFRS 9)

Explain fair value and amortised cost measurement of financial assets under IAS 39 with examples of applicable asset classes.

After initial recognition in the Financial Statements, Financial Assets are measured either at fair value or amortised cost according to the provisions of IAS 39 – Financial Instruments: Recognition & Measurement.

Required:

Briefly explain how fair value and amortised costs of financial assets are determined and give one example each of the class of financial assets that can be measured using the methods.

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  • 15 Marks

FR – May 2016 – L2 – Q6 – Inventory Accounting (IAS 2)

Calculate the working capital cycle and assess liquidity using specific ratios for Apapta Limited.

The statement of financial position extract of Apapta Limited is given as follows:

2015 (N’000) 2016 (N’000)
Inventories 3,950 3,250
Receivables 2,151 2,675
Investments (Marketable Securities) 430 375
Cash 565 –
7,460 6,300
Payables amounts due within one year (3,865) (3,755)
3,595 2,545

Payables are analysed as follows:

2015 (N’000) 2016 (N’000)
Trade payables 2,600 2,215
Company Income Tax 695 820
Dividend payable 570 540
Bank overdraft – 180
3,865 3,755

Its profit or loss account extract is as follows:

Item 2015 (N’000) 2016 (N’000)
Sales 17,795 16,715
Cost of sales (12,100) (11,200)
Gross profit 5,695 5,515

Cost of sales is analysed as follows:

2015 (N’000) 2016 (N’000)
Opening inventory 3,250 3,150
Add: Purchase 12,800 11,300
Less: Closing inventory (3,950) (3,250)
Cost of sales 12,100 11,200

In 2014 and 2015, credit sales were 83% of total sales.

Required:

a. Calculate the working capital cycle for 2015 and 2014. (9 Marks)

b. Compute the ratios listed below and comment on the company’s liquidity over the two years.

i. Cash ratio
ii. Current ratio
iii. Quick ratio (6 Marks)

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  • 9 Marks

AA – May 2016 – L2 – Q7b – Risk Assessment and Internal Control

Identify business risks for Moovy Magic’s procurement and suggest control strategies.

You are the internal auditor of Moovy Magic Limited, which runs a chain of video rental stores.

The company guarantees that if a video is not available for rental, the customer will get a free rental when that video comes back into inventory. It is not possible for customers to pre-book videos. The company purchases a number of copies of each video, taking the above policy into account, but has no way of monitoring whether their procurement strategy is effective. Procurement decisions are made and auctioned locally, and no central budgets are produced.

You have been asked by the directors to review the procurement and other strategies of the company.

Required:

Identify and explain the potential business risks arising from the above procurement and other strategies. Suggest controls and strategies that the management of Moovy Magic could instigate to mitigate those business risks. (9 Marks)

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  • 6 Marks

AA – May 2016 – L2 – Q7a – Audit Evidence

Identify additional information needed to determine the audit opinion for Musky Fresh Ltd following supplier difficulties.

Musky Fresh Limited has been in existence, for a number of years, importing perfume. The managing director had built up the business using contacts he already had in the industry. The company imports only one brand of perfume which is manufactured exclusively by one company. The perfume is distributed via ‘shops within shops’ at 20 branches of a well-known store. Under this agreement, Musky Fresh Limited pays a percentage of its takings to the store, with a minimum annual payment of N100,000 per store.

The audit is nearing completion, but you have just heard that the Arabian manufacturer is facing serious financial difficulties, and that supplies have ceased.

Required:

a. Set out the further information the auditor would require before reaching his audit opinion. (6 Marks)

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  • 15 Marks

AA – May 2016 – L2 – Q6 – Internal Control Systems

Identify control activities in a trade payables system and the need for substantive procedures.

Control activities may be defined as policies, procedures, and operations that help to enable management directives to be carried out. These activities are detailed procedures designed to prevent, or to detect and correct errors that may arise in processing information.

Required:

a. Set out the five types of control activities and illustrate each one in the context of purchases or trade payables system. (10 Marks)

b. Explain why, even where tests of controls prove satisfactory, substantive procedures can never be completely eliminated. (5 Marks)

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  • 20 Marks

AA – May 2016 – L2 – Q4 – Internal Control Systems

Identification and improvement of control weaknesses in the sales system of Sofa Ltd.

You are carrying out the audit of the sales system of Sofa Limited, a company that manufactures office furniture. The company has annual sales revenue of N150 million. All the shares are owned by Sofi and her husband Andy. Neither is involved in the running of the business. The chairman is responsible for running the business, but does not own any of the company’s shares.

The bookkeeper maintains all the accounting records and prepares the annual financial statements.

A stand-alone computer is used to maintain the accounting records, including those of the sales system. Standard accounting software is used, which was purchased from an independent supplier. For the sales system, a sales ledger is maintained to which sales invoices, credit notes, cash, and discounts are posted. When sales invoices are posted and credit notes are input into the computer, the value is updated in both the sales ledger and the nominal ledger.

You have determined that the documents and personnel involved in the sales ledger are as follows:

  • When order is received by telephone, it is recorded by the sales clerk in the sales department. This is usually done on a notepad.
  • The sales clerk will then pass the sales order to the stores, to the goods outwards department where the office furniture is kept.
  • If the goods ordered are in inventory, then the goods will be loaded onto one of the delivery trucks. A two-part dispatch note will be prepared to accompany the sales order. This is usually done before the stores have received the sales order from the sales department.
  • The goods are delivered to the customer together with the top copy of the goods dispatch note.
  • The driver on his return will inform the sales department that the delivery has been successful and will maintain the last copy of the goods dispatch note in the stores.
  • At the end of the week, the sales department prepares a sales invoice for the customer.
  • When the post is received, it is opened by a staff of the sales department.
    The person opening the post will both make a list of all the cheques
    received and that same person will then go to the bank and bank the
    cheques. Upon return, the remittances and cheque paying-in book are
    passed to the book keeper for updating the receivables ledger.
  • The receivables ledger is reviewed by the book keeper on a monthly basis
    to see which customers are above their credit terms and will inform the
    sales staff who to telephone and chase their debt.

Required:

a. Identify and describe eight weaknesses in the sales system of Sofa Limited. (8 marks)

b. Provide recommendations to rectify each of the weaknesses identified. (8 marks)

c. Explain why segregation of duties is important in an internal control system. (4 marks)

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  • 20 Marks

AA – May 2016 – L2 – Q3 – Ethical Issues in Auditing

Examination of ethical issues in client engagement, fundamental ethical principles, and lawful disclosure obligations for auditors.

You have recently been appointed the auditors of Spicer Plc, a company whose shares are traded on a stock exchange. The directors of Spicer Plc have recommended that you perform the following services:

  • The statutory audit of the annual accounts
  • Taxation services
  • Consultancy services in respect of the implementation of a new information technology system

Your firm has not acted for Spicer Plc before but does act as auditors to one of its major competitors.

Required:
a. Identify and explain the professional and ethical issues that should have been identified by your firm in relation to the provision of the services outlined above to Spicer Plc and describe the safeguards that should be in place in order to address these issues. (11 marks)

b. What are the five fundamental principles of ethics? Briefly explain their meaning. (5 marks)

c. A client’s affairs should not be disclosed to third parties. However, where a client has been guilty of an unlawful act, to whom should the auditor disclose this information, and in what order? (4 marks)

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  • 20 Marks

AA – May 2016 – L2 – Q2 – Planning an Audit

Planning and identifying audit risks for a new client with an increased demand for products, using a standard costing system for inventory valuation.

Sweet Dreams, a limited liability company, is a new audit client and you are at the
planning meeting for the forthcoming audit. The company has grown rapidly and has
May 31 as year-end. The financial statements have not been audited in previous years
since the organization has only just converted from a partnership to a company.
The company’s bankers have requested that an audit be undertaken on the financial
statements for the year ending May 31, 2016. Higher levels of inventory required to
meet the increasing demand for its products have necessitated a request for an increase
in the bank’s overdraft facility.
The company makes beds, buying its materials directly. At the year-end, inventory
comprises raw materials, work-in-progress and finished goods. It does not undertake
continuous inventory counting but does intend to perform a full inventory count on
May 31, 2016. It uses standard costing system to value finished products and work-inprogress.

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  • 30 Marks

AA – May 2016 – L2 – Q1 – The Role and Responsibilities of Auditors

Examines responsibilities in fraud prevention, asset ownership verification, depreciation rates, asset register contents, and revaluation effects.

You are an employee of Ben, Tai & Co., a firm of Chartered Accountants. One of the firm’s clients is Keke Limited, a car rental company whose shares are not traded on a stock exchange. The company has a large fleet of vehicles which it hires out on a contract basis.

The duration of a contract varies from one day to three months. Anybody wishing to hire a car must possess a valid driver’s license. In addition, they must take out insurance with Keke Limited.

You are involved in the audit of non-current assets for the year ended December 31, 2015.

The company’s main non-current assets are:

  • Freehold land and buildings
  • Office equipment (mainly computers)
  • Motor vehicles

The company was formed ten years ago, and all non-current assets (except for land and buildings) are maintained in a non-current assets register. The company depreciates non-current assets at the following rates:

  • Freehold land and buildings: 2% on cost
  • Office equipment: 20% on cost
  • Motor vehicles: 50% on cost

The company has recently revalued its buildings upwards by N200 million. The directors believe that they have fallen victim to a fraudster who has disappeared with a number of the company’s vehicles.

Required:

a. What is the difference between the responsibilities of management and the auditor for the prevention and the detection of fraud? Explain how these responsibilities are carried out. (6 marks)

b. Describe how you would verify the ownership of:
i. Freehold land and buildings
ii. Computers
iii. Motor vehicles
(6 marks)

c. Comment on the appropriateness of the depreciation rates of the non-current assets and their respective effect on the income statement. (6 marks)

d. List the contents of a non-current asset register and describe its usefulness for Keke Limited. (6 marks)

e. Explain the accounting effect of the revaluation of the buildings to the financial statements and the audit work you would perform in this matter. (6 marks)

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  • 9 Marks

FR – May 2016 – L2 – Q7b – Financial Instruments (IAS 32, IFRS 9)

Calculate amortised cost and fair value of a financial liability issued by Anifowose Plc.

Anifowose Plc issued a debt instrument at its fair value of N100 million on January 1, 2013. The debt instrument is to mature in 2017. It has a principal amount of N125 million and carries a fixed interest rate of 4.72%, which is paid annually. The effective interest rate is 10%, and on December 31, 2015, it had a fair value of 105 for every N10 nominal value. The company makes up its accounts to December 31 every year.

Required:

i. Show your computation schedule for the amortised cost of the financial liability up to December 31, 2015, on the assumption that the financial liability is valued at amortised cost.

ii. What is the value of the financial liability as of December 31, 2015, if the fair value option is adopted by Anifowose Plc?

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  • 6 Marks

FR – May 2016 – L2 – Q7a – Financial Instruments (IAS 32, IFRS 9)

Explain fair value and amortised cost measurement of financial assets under IAS 39 with examples of applicable asset classes.

After initial recognition in the Financial Statements, Financial Assets are measured either at fair value or amortised cost according to the provisions of IAS 39 – Financial Instruments: Recognition & Measurement.

Required:

Briefly explain how fair value and amortised costs of financial assets are determined and give one example each of the class of financial assets that can be measured using the methods.

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  • 15 Marks

FR – May 2016 – L2 – Q6 – Inventory Accounting (IAS 2)

Calculate the working capital cycle and assess liquidity using specific ratios for Apapta Limited.

The statement of financial position extract of Apapta Limited is given as follows:

2015 (N’000) 2016 (N’000)
Inventories 3,950 3,250
Receivables 2,151 2,675
Investments (Marketable Securities) 430 375
Cash 565 –
7,460 6,300
Payables amounts due within one year (3,865) (3,755)
3,595 2,545

Payables are analysed as follows:

2015 (N’000) 2016 (N’000)
Trade payables 2,600 2,215
Company Income Tax 695 820
Dividend payable 570 540
Bank overdraft – 180
3,865 3,755

Its profit or loss account extract is as follows:

Item 2015 (N’000) 2016 (N’000)
Sales 17,795 16,715
Cost of sales (12,100) (11,200)
Gross profit 5,695 5,515

Cost of sales is analysed as follows:

2015 (N’000) 2016 (N’000)
Opening inventory 3,250 3,150
Add: Purchase 12,800 11,300
Less: Closing inventory (3,950) (3,250)
Cost of sales 12,100 11,200

In 2014 and 2015, credit sales were 83% of total sales.

Required:

a. Calculate the working capital cycle for 2015 and 2014. (9 Marks)

b. Compute the ratios listed below and comment on the company’s liquidity over the two years.

i. Cash ratio
ii. Current ratio
iii. Quick ratio (6 Marks)

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