AUDIT PRACTICE

PROFESSIONAL 2 EXAMINATION - AUGUST 2008

NOTES
You are required to answer Questions 1 and 2 and any two out of Questions 3 to 5.
(If you provide answers to all of Questions 3 to 5, you must draw a clearly distinguishable line through the
answer not to be marked. Otherwise, only the first two answers to hand for these three questions will be
marked.)

TIME ALLOWED:
3.5 hours, plus 10 minutes to read the paper.

INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book.

Marks for each question are shown. The pass mark required is 50% in total over the whole paper.

Start your answer to each question on a new page.

You are reminded that candidates are expected to pay particular attention to their communication skills
and care must be taken regarding the format and literacy of the solutions. The marking system will take
into account the content of the candidates' answers and the extent to which answers are supported with
relevant legislation, case law or examples where appropriate.

List on the cover of each answer booklet, in the space provided, the number of each question(s)
attempted.

The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

AUDIT PRACTICE
PROFESSIONAL 2 EXAMINATION - AUGUST 2008

Time allowed: 3.5 hours plus 10 minutes to read the paper. Answer Questions 1 and 2
and any two out of Questions 3, 4 and 5.

1. Merrimore plc is a company in the medical technology industry, which produces “innovative solutions” for
dental problems including bridges, crowns, tooth implants, and dentures. It is listed on the Irish Stock
Exchange and on the Alternative Investment Market (AIM) in London.

It has incurred expenditure during the year ended 31 May 2008 on the development of a new type of flexible
denture which it is claimed will relieve much of the suffering experienced by denture wearers in terms of sore
gums, slippage etc. The Directors wish to carry forward the development expenditure indefinitely as they
feel that the company will benefit from the new denture for many years.

The product range is being developed and expanded because profits have been declining over the last few
years owing to the non-competitive nature of the earlier products made by the company. The company has
sold many of its non-current assets during the year and purchased new machinery, which will enable the
companyʼs productivity to increase.

The Directors decided not to fund the above expenditure using outside finance but to generate the
necessary resources internally by taking extended credit from its suppliers and utilising its liquid funds held
at the bank. The company also sold part of its investments, which are made up of shares of public limited
companies. These investments are purely trade investments and none of them have subsidiary, associate
or joint venture status.

One of the reasons for this method of financing the expenditure was that the company already has a loan
of €45M outstanding which has been included in the figure for current liabilities. This loan is secured on the
non-current assets of the company and is repayable over ten years. The sale of non-current assets and
investments did not yield as much as was expected and a small loss on sale of €1.2M has been included
in the income statement as part of the amounts shown for ʻother expensesʼ. ( N.B. The Income Statement
is not shown in the question.)

The company had the remaining non-current assets re-valued by a professional valuer, at the year-end. The
company has credited the gain on non-current assets to the revaluation reserve. The Directors felt that the
shareholders should share in the gain on the revaluation of the non-current assets and increased the
proposed dividend accordingly. The Directors hold 52.8% of the share capital of the company and none of
the Directors individually own less than 11.2%.

In May 2008, the Directors began negotiations with Gula Ltd., a small company which has developed a
specialist range of electronic equipment designed for use by dentists. This equipment is designed to replace
the traditional moulds used to take measurements in the mouth and hence shape the crowns, bridges etc.
It is said to be more comfortable for the patient, more accurate, and quicker. Shares in Gula are owned
equally by its Technical Director and the Marketing Director. By the end of August, negotiations had reached
an advanced stage but the Directors of Merrimore are most anxious not to make any mention of this in the
financial statements for the year ended 31 May 2008. They say that there are three reasons for this:

1. It does not concern the year ended 31 May 2008 since nothing material had happened by that date.
2. The information is extremely commercially sensitive and publicising it now could jeopardise the deal
or give a rival the opportunity to bid.
3. No decision has been taken on how the take-over will be structured or financed.

Page 1
REQUIREMENT:

In a memo dated 28 August 2008 to your Audit Partner Marty King, you are asked to focus on the
identification, ranking and treatment of four key audit planning issues (KAPIs), which potentially represent a
risk of material misstatement in the financial statements due to important developments in Merrimoreʼs
environment/organisation/activities/operations, particularly if unusual or complex in nature.

You will begin your memo with a brief review of the overall impact of the above important
developments on each of the audit risk equation components. (6 marks)
●

This will be followed by your identification and treatment of each KAPI by order of importance. You
should state your overall planned audit approach for each KAPI. You should list the key internal
●

controls and the specific audit procedures to be executed. These will be based on the key financial
statement assertions that you have identified as relevant.
(20 marks)

You will end your memo with a brief review of pertinent audit management and other matters.
(4 marks)
●

Your answer should demonstrate your exercise of professional judgment and understanding of an audit-risk
based approach and will take into account the above case information provided. This would include financial
statement risks associated with the Merrimore prepared summary balance sheet in the Appendix, whose
unaudited data you are to consider as reasonable unless your understanding of the case information and
applicable International Financial Reporting Standards directs you otherwise.
[Total: 30 Marks]

Appendix – Summary MERRIMORE Balance Sheet

MERRIMORE
DRAFT BALANCE SHEET AS AT 31 MAY 2008

2008(Draft) 2007(Audited)
€ ʻ000 € ʻ000
Non-current assets
Development expenditure 61,340 –
Property, plant & equipment 98,276 72,000
Investments 84,200 102,465
243,816 174,465
Current assets
Inventory 59,195 68,360
Receivables 185,536 152,106
Cash at bank and in hand 4,495 65,789
249,226 286,255
493,042 460,720
Capital and reserves
Share capital 90,000 90,000
Share premium account 12,000 12,000
Revaluation reserve 29,650 19,050
Accumulated profit 22,000 71,454
153,650 192,504
Non-current liabilities
Provisions for liabilities and charges 55,216 50,000
Deferred taxation 4,046 2,000

Current liabilities 280,130 216,216

493,042 460,720

Page 2
2. Tower Executive Residences (TER) is an Irish registered company that owns and operates a 50 luxury self-
catering apartment complex in Dublin, which it leases out on a short-term basis, primarily to wealthy
individuals. Each unit is fully equipped and cleaned once a week by TER staff. TER has an agreement with
the local technical college to employ its students free-of-charge to repair broken furniture and equipment,
which includes TVs and sofas. TER is managed by three members of the Tower family (Joe, Jen and Jay),
who sit on its seven-Member Board along with representatives of other investors. TER is partly financed by
a loan from Allied Bank of Ireland, (ABI).

TER celebrated its 6th anniversary in its financial year ending 30 April 2008, by opening a new 25-apartment
wing. It procured the new room furniture and equipment from a non-EU manufacturer instead of from the
original Irish supplier because of the great price deal it received (€200,000 per apartment versus €400,000
previously). The equipment and furniture arrived on 1 May 2007 and was installed by representatives of the
manufacturer that week. TER has just prepared its draft financial statements, and notes relevant to its
property, furniture and equipment are reproduced below:

Note 1 – Accounting Policy

Apartment Furniture and Equipment, including televisions and sofas, is acquired at cost and depreciated on
a linear basis over its estimated useful life i.e. 25 years

Note 7 – Apartment Furniture & Equipment (AFE)

Cost €millions
Balance at 1 May 2007 20.0
Additions 5.0
Disposals -
Balance at 30 April 2008 25.0
Accumulated Depreciation
Balance at 1 May 2007 (4.0)
Charge for the year (1.0)
Balance at 30 April 2008 (5.0)
Net Book Value at 30 April 2008 20.0
Net Book Value at 1 May 2007 16.0

You note an unrecorded lawsuit for €5 million in damages initiated in March 2008 by a patron claiming injury,
allegedly from inhaling gas that leaked from an oven during her stay in one of the apartments in the new
wing prior to the year end.

REQUIREMENT:

Address the following audit issues; keeping in mind your audit firm employs a risk-based audit approach:

(a) In relation to the audit of TERʼs Apartment Furniture and Equipment:

i) List four key control procedures that would provide you with assurance as to the existence of
these assets, stating why such control procedures are of particular importance to TER.
(5 marks)

ii) In addition to existence, justify two other critical financial statement assertions for Apartment
Furniture and Equipment, and discuss one key substantive audit procedure each that you would
perform at, or near, year-end to validate the assertion (exclude depreciation analysis from your
consideration). (5 marks)

iii) Outline the audit procedures you would perform to assess the reasonableness of the related
depreciation charge and briefly discuss your conclusion and any subsequent course of action.
(5 marks)

Page 3
 (b) In relation to the audit of the €5 million lawsuit stemming from the alleged gas leak:

i) Briefly discuss how a lack of business risk assessment and proper procurement control
procedures can contribute to potential lawsuit occurrence and asset devaluation. (5 marks)

ii) Briefly justify the three key financial statement assertions you would seek to verify and discuss
two appropriate audit procedures you would accordingly employ. (5 marks)

(c) Discuss three practice management reasons that would direct an auditor to properly document, on
working papers, the work he/she performs. (5 marks)

[Total: 30 Marks]

3. Kilkenny Premium Beers (KPB) is a producer of Irish premium specialty beers, employing a workforce of
100 staff and generating sales of €60 million for its most recent financial year ending 30 June 2008.

On 1 July 2007, KPB converted from a wholly-owned production subsidiary of the Duff International Beer
Company to an Irish registered private company. It is owned by some two hundred shareholders including
its three-member Senior Management Team, all of whom are engineers and have been managing the KPB
brewery since 2000. KPB will now be operating at an armʼs length from Duff, with Duffʼs distribution
company agreeing to buy 50% of KPBʼs production until 2010.

Your Audit Firm, Coole and Waters (C&W) CPA, had been appointed as the Statutory Auditor of KPBʼs 2008
annual accounts and you have just completed your initial planning meeting with KPBʼs Audit Committee. You
note that two corporate control functions previously exercised for KPBʼs benefit by Duffʼs head office had
not been established in the new KPB company, namely an internal audit function (IAF) and a business risk
identification, assessment and monitoring policy and process (BRIAMPP).

You indicated that an IAF and a BRIAMPP are both key internal control components and are essential to
corporate governance for Irish companies, with the Directors ultimately responsible for their proper
operation. You also noted that one of the main roles of an IAF is its assessment of its entityʼs BRIAMPP.

The Chairman of the Audit Committee has asked you, Chris Coole CPA - KPB Audit Engagement Partner,
to produce a report to be presented before the Audit Committee outlining why and how it should establish
an IAF and BRIAMPP, stating how C&W CPA could contribute to their successful operation through the
conduct of their statutory audit.

REQUIREMENT:

As Chris Coole CPA, KPB Audit Engagement Partner, prepare a report to the KPB Audit Committee in which
you address the above issues, guided by the following focus and format and keeping in mind that your firm
employs a risk based audit approach:

(a) Discuss why Directors have a corporate governance duty regarding the maintenance of a proper
BRIAMPP, incorporating in your answer two business risks (other than production quality) specifically
faced by KPB. (5 marks)

(b) Discuss two types of non-financial audits that an IAF could perform on a BRIAMPP in order to enable
Directors to discharge their corporate governance duty as regards BRIAMPP. (5 marks)

(c) State two statutory corporate governance duties that Directors could use an IAF to assist them in their
discharge of such duties, stating the name of the applicable laws and listing the other three key
internal control components not identified in this case that they would assess. (5 marks)

(d) Discuss how C&W CPA can assist the Directors with regard to the proper operation of KPBʼs IAF and
BRIAMPP through the performance of a statutory audit. (5 marks)

[Total: 20 Marks]

Page 4
4. Home Energy from Wind (HEW) is an Irish registered company that assembles and installs wind energy
generating units for homes and which is owned, directed and managed by Robert and Roseanne Green,
husband and wife. Robert, a professional engineer, directs the assembly and installation activities, while
Roseanne, a professional accountant, will direct all other activities.

HEW was founded on 1 January 2008, upon receipt of a €2 million grant from the European Union (EU) to
finance the start-up of the companyʼs operations, with regards to production labour, initial working capital
costs and capital expenditure. The EU has agreed to provide further €2 million fund allotments at the
beginning of HEWʼs 2009 to 2011 financial years subject to compliance with the EU funding agreement in
relation to the previous yearsʼ allotment.

HEW will need more funding to finance its future growth. In this regard HEW has approached your Audit
Firm, Allen & Atkinson (A&A) CPA, to prepare and audit its financial statements and books of account in
order to secure the next allotments of €2 million from the EU, as well as a bank loan from the Allied Bank
of Ireland (ABI). HEW has provisionally recorded the 2008 €2 million allotment as revenue in its year to date
accounts for 2008.

In addition to the above funding matters, Mr. and Mrs. Green would like your assistance in vetting potential
new major wholesaler and retailer customers of HEW, some of whom are audit customers of the other
offices of A&A CPA. HEW anticipates realising revenue of €10 million in 2008.

REQUIREMENT:

As Gerry Allen CPA, HEW Audit Engagement Partner, prepare a report to Robert and Roseanne Green in
which you address the above issues, guided by the following focus and format and keeping in mind that your
firm employs a risk based audit approach:

(a) Regarding the independent audit assurance needs of ABI, the EU, Robert and Roseanne Green
briefly justify the different independent audit assurance needs of each party and describe the
assurance reports that would most appropriately match their needs, noting any relevant
considerations in the case. (10 marks)

(b) Regarding the roles requested by Robert and Roseanne Green of A&A CPA as HEWʼs Financial
Statement Auditors:

i) Briefly justify the appropriateness of A&A CPA preparing and auditing HEWʼs books of account
and financial statements. Also briefly justify how these roles should be allocated. (4 marks)

ii) Briefly discuss the appropriateness of assisting HEW in vetting new customers, including
existing audit customers of A&A CPA, indicating how this service should be performed.
(4 marks)

iii) Briefly describe the course(s) of action that must be followed before A&A CPA can commence
its independent assurance of HEWʼs financial statements. (2 marks)

[Total: 20 Marks]

Page 5
5. Smart Software Systems Solutions (S4) is a private Irish registered company, employing a workforce of 60,
which develops, implements and maintains software products and services for businesses and
governments. This debt-free company posted a net profit of €1.0 million on revenues of €30 million for its
most recent financial year ending 30 March 2008.

S4 is currently owned by its three Senior Managers Kelly Sims - Chief Executive Office (CEO), Chris Porter
– Deputy CEO (Product Developments) and Joey Carter – Deputy CEO (Technical Operations), who
together with five Operational Managers constitute the Senior Management Team.

A recently completed study by a consulting firm for S4 recommended that it acquire similar companies in
the next two years in order to develop profitably. These acquisitions are to be financed firstly by taking the
company public on the Irish Stock Exchange (ISE) and then by borrowings.

The Board of Directors approved these recommendations. Its Chairman, Kelly Sims approached you,
Francis Fanning CPA, S4 audit engagement partner at Fanning and Forbes (F&F) CPA to conduct a review
of existing corporate governance practices at S4 in relation to the requirements set by ISE for its listed
companies. You know that the ISE requires its listed companies to state whether they comply with the
principles of the Combined Code on Corporate Governance, with no such requirements mandatory for
private companies like S4, although their adherence is highly desirable.

Corporate Governance at S4
Corporate Governance at S4 is exercised by a nine-member Board of Directors comprising the eight Senior
Management members and Ray Burns, a retired and well respected radio and television current affairs
expert. Board members are appointed for a period of five years, with their current term expiring at the
completion of the General Meeting to approve the 30 March 2008 accounts.

The Board of Directors meets three times a year in order to discharge their responsibilities, including the
approval and review of financial statements. The Board is supported in its work by four Board Committees
and by other necessary corporate governance structures. The four committees are, respectively, the
Nomination Committee, the Remuneration Committee, The Audit Committee, and the Acquisitions
Committee. Each committee is chaired by Ray Burns and consists of three members (apart from the Chair).
All Directors are remunerated for their services, and their remuneration is disclosed in the Annual Report.

REQUIREMENT:

(a) As Francis Fanning CPA, S4 Audit Engagement Partner, prepare a report to the Board Chairman in
which you address the above issues, guided by the following focus and format and keeping in mind
that your firm employs a risk based audit approach:

(i) Identify four S4 current corporate governance practices that would not comply with ISE
requirements, together with your recommendations for compliance. Preface your answer by a
brief explanation of whether the need for corporate governance is greater for publicly listed
companies than for privately owner-managed ones like S4. (4 marks)

(ii) Discuss whether the audit workload and fee will increase as a result of S4 going public.
(4 marks)

(iii) State whether a higher level of quality control (QC) standards will be exercised by the audit
partner as a result of S4 going public and discuss the three categories of QC procedures that
the audit engagement partner would continue to perform during the conduct of the audit.
(6 marks)

(b) Discuss the audit procedures your firm would carry out in order to verify related party transactions in
the case of a company such as S4. Why is the identification of such transactions particularly
important? (6 marks)

[Total: 20 Marks]

END OF PAPER

Page 6
 SUGGESTED SOLUTIONS
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

AUDIT PRACTICE
PROFESSIONAL 2 EXAMINATION - AUGUST 2008

SOLUTION 1

Date: 28 August 2007

To: Marty King CPA - MERRIMORE audit engagement partner
From: Chris Bishop CPA - MERRIMORE audit engagement manager
Re: KAPIs – 2007-2008 financial year 31 May 2008 year end

Setting of audit risk equation components levels

Acceptable audit risk level decreased due to:
Significant worsening in MERRIMOREʼs financial situation– considerable development expenditure capitalized
(IAS 38); revaluation of fixed assets (IAS 16)
Assessed inherent risk level increased due to:
Worsening financial situation and possible transactions motivated by above.
Assessed control risk level increased due to:
Apparent inadequate governance structures for listed company.
Acceptable detection risk level accordingly significantly decreased meaning:
More extensive, detailed audit procedures particularly as regards high risk of misstatement items: revaluations
and development expenditure

KAPI 1 – Significant expenditure on development expenditure – provisions of IAS 38

MERRIMORE has capitalised considerable expenditure on the development of the new range of flexible
dentures. This now represents an asset of more than €61m which is material (possibly fundamental) to the
companyʼs financial position. IAS 38 lays down the basis on which development costs may be carried forward.
They may be carried forward only if, and to the extent that, they represent an asset that is likely to generate
probable future economic benefits for the company. It would contravene the prudence concept to carry forward
expenditure that is not reasonably expected to generate future benefits.

IAS 38 lays down the criteria which must apply if expenditure is to be carried forward.

The relevant audit tests are as follows.

(i) The auditors should obtain from the client a breakdown of the figure for development expenditure that
makes it possible to trace the amounts spent to the nominal ledger and the final accounts.

(ii) Tests of controls should be performed to ensure that a system exists for controlling the authorising and
recording of development expenditure, and that the system is operating adequately. (This work may be
covered where practicable by the audit tests performed on the company's purchases and payroll systems.)

(iii) Individual amounts should be vouched by reference to supporting documentation. The relevant
documentation will vary according to the type of expenditure, but tests might include the following.

(1) Agree purchases to requisitions, orders, goods received notes, invoices, cashbook and bank
statement.
(2) Agree labour costs to the payroll and to supporting evidence, such as time sheets or job cards.

(3) If overheads have been included in the development figure, ensure that they have been calculated
on a basis consistent with that used generally by the company.

Page 7
 The auditors will wish to set a materiality level for testing individual items; this will have to be
established when the breakdown of the total figure is known. For instance, it may be possible to
restrict testing considerably if one or two large invoices represent the bulk of the relevant
expenditure.

(iv) The arithmetical accuracy of the schedule of expenditure should be checked.

(v) The auditors should ensure that there has been no double-counting, that is, that development items
capitalised have not also been charged as an expense in the profit and loss account.

(vi) Finally, the auditors should carry out a review of the development figure in order to be satisfied that it is
reasonable and consistent with what else is known about the company and its business.

KAPI 2 –Valuation of assets: Revaluation of non-current assets; possible impairment of investments

Merrimore has revalued certain non-current assets by an amount in excess of €10M. We need to ensure that this
revaluation is appropriate. We also need to note that the Directors assertion that the shareholders should share
in the revaluation is inappropriate as a revaluation does not constitute a realized gain. Conversely, there is some
evidence that the trade investments may be impaired. We may need to conduct an impairment review in this
regard.
The following audit procedures may be performed to verify the revaluation gain arising on non current assets.

(i) Ensure that the valuer appears to be appropriately qualified and independent of the company. If these
conditions are not fulfilled, the auditors will need to consider their possible impact on the results of the
valuation.

(ii) By reference to the instructions given to the valuer and the valuer's report, ensure that the valuation has
been performed on a basis reasonable and consistent with previous valuations.

(iii) Check that profits or losses on individual non current assets have been correctly calculated by reference
to the non-current asset register and the detailed analysis of the revaluation.

(iv) Check the arithmetical accuracy of the compilation of the revaluation schedule and of the calculation of
asset profits and losses.

KAPI 3: MERRIMOREʼs ability to continue as a going concern:

Financial
- Significant worsening of MERRIMOREʼs liquidity as evidenced by following liquidity ratio calculations.

Current assets 31 May 2008 31 May 2007

current liabilities (249/280) = 0.89 (286/216) = 1.32
Cash balance 4.5M 65.7M
Acid Test Ratio (249-59)/280 =0.67:1 (286-68)/216=1:1

- Note: It appears that a long term loan may have been misclassified as a current liability.

IC (Internal control) – entityʼs ability to continue as a going concern

1. Verify that directors will urgently monitor MERRIMOREʼs true financial situation.

FAR (Financial Accounting and Reporting)- entityʼs ability to continue as a going concern
1. Look at cash flow projections and supporting analysis, including existing and projected sales revenue /
consider likelihood of bank extending loan or capital injections.
2. Depending on the extent of going concern difficulties, need to consider the following impact on audit
reporting:
- Requirement that client prepare financial statements on a non-going concern basis (Balance Sheet:
liquidation values); (Income Statement: cash flow basis): if not – adverse opinion.
- Requirement that client prepare financial statements on a going concern basis with the inclusion in
the audit report of a fundamental uncertainty paragraph.

Page 8
KAPI 4: Potential take-over of GULA
This is potentially significant in at least 3 respects.

Firstly, it is a non-adjusting post balance sheet event which under IAS 10 should be disclosed in the financial
statements. If not disclosed, then qualified Audit Report on grounds of disagreement may be necessary.

Secondly, the listing rules of the Stock Exchange may require the matter to be disclosed. At the very least, the
directors should be made aware of the possibility.

Thirdly, this will impact on going concern considerations (see KAPI 3 above). We need to discuss the matter in
detail with the directors and possibly include in the Letter of Representation.

KAPI 5: Decision to fund the development of new product internally.

The decision to finance development internally has resulted in a large increase in payables and a decrease in
cash and bank balances. This may lead to liquidity problems, especially since the company will still need funds
to finance the new product. These funds will have to be generated either by the sale of further investments, the
raising of a loan from the directors or an outside investor, or by the issue of shares. If funding is not available, the
development expenditure should be written off on the basis that it would not be possible to complete the project.
This would eliminate the profit and loss reserve and would create doubts about the company's status as a going
concern.

[Candidates would be free to combine the KAPIʼs in different ways e.g. KAPI 3 and KAPI 5 could be linked.
Also, the misclassification of long term loan as a current liability mentioned in KAPI 3 could be expanded
into a KAPI of its own emphasising that it gives rise to financial statement risk in relation to the
classification of liabilities. Also KAPI 2 could be split into 2 different KAPIs.].

Pertinent Audit Management and other issues

Under ISA 220 the engagement partner is responsible for the following
overall quality control of the audit engagement;
evaluation of compliance with ethical requirements and independence;
●

acceptance and continuance of client relationships and specific audit engagements;

●

assignment of an engagement team with the appropriate capabilities, competence and time;
●

direction, supervision and performance of the audit engagement in compliance with professional standards
●

and regulatory and legal requirements;

●

ensuring that an engagement quality control review is undertaken for audits of financial statements of listed
entities and resulting issues discussed before the auditor's report is issued.
●

●
ensuring appropriate consultation is undertaken on difficult or contentious matters.

In particular when it coming to staffing an audit the engagement partner is obliged to consider the following:
Independence
Family relationships
●

Business relationships
●

Fee income %
●

Whether firm provides non audit services to client (if so, needs a different audit team)
●

problems/disagreements in past
●

integrity of management
●

type of business and associated risks

●

Clearly in this case we will need to you experienced staff and focus on the KAPIs as indicated above. Also,
because this company is listed a quality control “hot” review is mandatory.

Page 9
SOLUTION 2
(a) Audit of TER apartment furniture and equipment (AFE)

i) Three control procedures that should be in place regarding existence

1. Listing of assets in fixed asset register and periodic inventory count
2. Identification tags placed on equipment / equipment tied down
3. Verification by room service of equipmentʼs existence when cleaning
4. Locked doors for vacant rooms/ CCTV/entry through reception area

Such controls would assist Joe Tower in discharging his duty as a Director to ensure that assets are properly
safeguarded (from intentional or accidental loss).

ii) Existence:
Attend fixed asset count and verify items on fixed asset registrar can be traced to room

Valuation:
Attend fixed asset count and verify that equipment and furniture are in use, not broken or damaged.

Ownership:
Verify ABI bank confirmation to ensure that any outstanding debt has not been secured by mortgages on
apartment furniture and equipment

iii) Procedures performance

Calculation of depreciation is OK as (€ 20 million + € 5 million) / 25 years = € 1,000,000 charge
Accounting of depreciation charge is OK – charged to accumulated depreciation
Consistency of application OK – straight-line method used last year
Reasonableness of straight line method OK – uniform use of apartments
However validity of 25-year depreciation life policy is questionable as this time frame is unrealistic for a business
seeking to provide its customers with modern amenities
Conclusion: need to revise depreciation policy – this will result in higher annual depreciation charges
Course of action:
- discuss with management and stress need to adopt more realistic policy
- Change in accounting estimate will be require prospective treatment
- If no change, might result in qualified opinion if materiality level breached

(b)
i) The operation of deficient equipment, whether as a result of:
- Its non-maintenance/inadequate regular maintenance due to a lack of consideration of business risks as
threats to the companyʼs survival, leading it to take action to address them
- Acquisition of equipment from a non-EU source that has not been certified or tested for compliance with
health and safety standards could potentially result in:
- The writedown of such equipment if the deficiencies cannot be rectified (worst case scenario net realizable
liquidation value as a result of the entity no longer operating as a going concern)
- The occurrence of lawsuits as a result of damage/injuries suffered by customers
Hence, faced with such deficiencies, the auditor would have to obtain higher assurance through
substantive tests (e.g.: consideration of employment of a specialist at year-end to ensure equipment
compliance with Irish/EU health and safety standards)

ii) Profit-seeking entities would seek to under report liabilities and charges, so the auditor here would be concerned
with the proper valuation, completeness and ownership of liability and charges.
Key audit procedure 1:
Confirmation Letter from TERʼs lawyers, confirming the details of the claim and the likelihood of its success and
of the amount claimed, which will dictate its treatment
Key audit procedure 2:
TERʼs senior management representations on this lawsuit and any other lawsuits that it is aware, which would be
contained in a Management Letter received at the conclusion of the audit.

Page 10
(c) Proper documentation on working papers of work performed will:
As regards the current audit
1. Enable the cost-effective review of the working papers, whether by the audit supervisor, manager or
partner, enabling them to ensure that the audit was properly directed and supervised, particularly in relation
to work delegated
2. Enable the cost-effective determination of the appropriate audit opinion to be given and matters to be
raised for discussion with those charged with corporate governance
As regards the future
3. Enable quick referencing of the working paper in the future, in order to provide for the cost-effective
planning of future audits / response to litigation, particularly as regards details of audit problems
encountered, evidence of work performed and conclusions drawn in arriving at the audit opinion.

SOLUTION 3
Coole and Waters CPA
Report to the Board of Directors of SIP

Dear Directors:

Please find attached the report you requested outlining the critical importance of the establishment and operation
of an Internal Audit Function (IAF) and a Business Risk Identification, Assessment and Management Process
(BRIAMP), and how as your statutory auditors, we can contribute to their successful operation.

Corporate governance duty in relation to BRIAMPP

The identification, assessment and management of business risk is intrinsically linked to the Directorsʼ
stewardship duty, in that the business risks entered into by SIP have a direct impact on the investment risk
assumed by SIP shareholders when they acquire shares in SIP, which in a worst-case scenario would lead to the
loss of their investments in SIP if it ceases as a going concern due to the Directors ignorance of such risks.

For example, SIP faces both a contractual risk, in terms of Duff not honoring its obligation to buy 50% of SIPʼs
production, as well as a physical risk, in terms of the health and safety of its employees, both of which could
ultimately lead to SIPʼs failure (inability to operate at break-even level / fines and plant closures) to reach its
profitability and growth targets, which could see the company shutdown in a worst case scenario.

In addition, publicly traded Irish companies must comply with the Combined Code provisions which prescribe that
an appropriate committee of the Board (Risks or if non-existent Audit) must review the Companyʼs control and
risk management systems and report to the Board on its overall findings, making the Board ultimately
responsible. This requirement will have statutory force for both Irish public and large private companies when the
Irish State transposes the 8th EU Directive into Irish law, which mandates such a requirement, by no later than
28 July 2008.

Use of IAF in discharging BRIAMPP and other key corporate governance duties
Since the publication of the Turnbull and Hampel reports on good corporate governance and internal control
practices, it is now widely accepted that one of the key roles of an IAF is to assist Directors in the discharge of
their corporate governance duties relative to BRIAMPP through the conduct of the following two types of audits:
1. Compliance audit execution, whereby Internal Audit would verify that SIPʼs BRIAMPPʼs:
Is in place and in operation in all departments and units.
Functions in accordance with SIP official BRIAMPP.
●

2. Value-For-Money Audit (operational audit) execution

Focusing on the effectiveness of the BRIAMPP, assessing to the extent that the key business risks
relevant to SIPʼs operations and strategies are correctly and successfully identified, assessed and
●

managed.

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Directors would also use an IAF to discharge their corporate governance duties as stipulated in the Companies
Act (1963-2006) in relation to monitoring controls that seek to ensure that:
1. Proper books of accounts are maintained that accurately report the financial position and performance of
the company at all times.
2. Assets are properly safeguarded by reviewing, assessing and where relevant testing the other key internal
control components which focus on the latter comprising:
Control environment -directors and managementʼs functions, attitudes and actions in relation to an
entityʼs internal control and its relative importance.
●

Control activities - policies and procedures such as approval and control of documents.
Information systems with regard to the capturing, processing, accounting and reporting of business
●

transactions.
●

Assistance on IAF and BRIAMPP through the performance of statutory audit.

As Statutory Auditors, we are primarily concerned the risk of material misstatements going undetected in
your financial statements, which would lead us to:
Understand and assess your BRIAMPP for all business risks potentially impacting your financial
statements as such, likely comprising many of such risks you faced but not all.
●

Conduct a preliminary assessment of IAF, to determine the cost-effectiveness of our use of it in

auditing SIPʼs financial statements (assuming they are made available to use for this purpose).
●

As a secondary purpose of our statutory audit, we are please to identify any weaknesses in the form of a
Management Report regarding those aspects of your:
BRIAMPP that we assess, such as the continual and effective application of appropriate policies and
procedures.
●

IAF that we assess, such as the technical proficiency of the work performed by IAF staff members
that we used for the purposes of our statutory audit.
●

However, we wish to emphasize that the ultimate responsibility for the proper function of your BRIAMPP
and IAF lie with the Board of Directors.

Sincerely,
Chris Miller, CPA
Miller and Budweiser, CPA

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SOLUTION 4
Allen and Atkinson CPA
Report to Robert and Roseanne Green, Directors of HEW

Dear Robert and Roseanne:

Please find attached the report you requested regarding the audit assurances and related services that you seek
from us.

Assurance services
We have identified a range of different assurance services based on the specific needs of the various parties
concerned by HEW operations: ABI, European Union (EU) and yourselves, shareholder- managers.

We believe the best form of assurance for the ABI would be a financial audit of HEWʼs annual financial statements
prepared on a going concern basis, as this would provide them with the best type of assurance as to HEWʼs
capability to repay the loan. This would imply a detailed examination of evidence on a test basis in order to for us
to give an opinion as to the truthfulness and fairness of HEWʼs financial statements. ABI would probably only lend
the funds on the basis of a clean or unqualified opinion, which would require us to review your proposed
accounting of the € 2 million grant, which depending on its purposes, may have to be partially deferred to match
against future asset depreciation charges.

We believe that the best form of assurance for the EU would be a compliance audit of your fulfillment of the terms
and agreement of your funding agreement, as compliance with the latter is the basis for which funds are paid to
you. This would likely include an examination of whether the funds allocated were spent on costs (e.g.: production
labour only) and products (e.g.: home sets) as specified in the funding agreement.

We believe that you currently need no assurance for yourselves, as you will be preparing the books of accounts
(see below) and accordingly have access to all the information directly. Please note that you will be required to
have a statutory annual audit of your financial statements once your incorporated business crosses a certain
threshold, currently set at € 7.3 million in sales for financial years ending in 2008.

Our role
Since you are not a listed company we are able to as auditor of your financial statements and to prepare your
books of accounts etc, as statutory law (Companies Act) and our code of professional ethics and conduct does
not forbid us from doing this. Nevertheless, the responsibility for preparing the books of accounts and financial
statements lies with you, the Directors, (once again pursuant to the Companies Act). This, amongst other matters,
will require setting the accounting polices of HEW, which we will be happy to provide you with guidance, on the
understanding that the ultimate decision lies with you.

We would be very happy to assist in vetting potential new major customers by virtue of our role as HEWʼs financial
auditors. This would be accomplished by offering you guidance on appropriate credit control checks for all new
clients, such as obtaining references from their bankers, on the understanding that the ultimate decision regarding
their implementation lies with you. We are bound by confidentiality rules that prevent us from providing you with
any information on another client that we obtained pursuant to providing them with a service.

If you wish to pursue a statutory auditor / client relationship with us, we will first be required to perform our own
set of checks to ensure that HEW and A&A CPA are mutually suitable, after which we must agree on the nature
of the services we agree to perform through the approval of an engagement letter followed, last but not least, by
our appointment by your Board.

Sincerely, Gerry Allen, CPA

OʼReilly and OʼShea CPA

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SOLUTION 5
Fanning & Forbes CPA
Report to Kelly Smith, Chairman of the Board of Directors of S4

Dear Kelly:

Please find below my responses to matters that you raised regarding corporate governance and other audit
issues regarding S4 eventual listing on the Irish Stock Exchange

Corporate governance
Corporate governance is concerned with the management of companies in the best interests of shareholders.
Publicly listed companies, unlike owner-managed private companies such as S4, are owned by one set of
individuals and managed by another set of individuals, who may have conflicting interests with the owners.
Corporate governance helps ensure, through the control and dissemination of information, that such conflicts do
not occur and that the best interests of shareholders are served.

In our review of your existing corporate governance practices, we noted the following practices that do not comply
with the Combined Code together with our recommendations for compliance:

Practices in non-compliance Recommended practice for compliance

1 CEO-Chairman positions held by same person. CEO-Chairman positions should be split between
two persons.
2 Independent directors currently constitute only S4 should increase the number of independent
1 in 9 (12%)of the Board of Directors, below the directors on the Board to a minimum of three (or
minimum 33% set. ideally five).
3 The independent director, Ray Burns, is not of When Ray Burnʼs appointment expires on 30
sufficient calibre to uphold the best interests in June 2008, he should be replaced by a person
shareholders, as he has no experience in executive with suitable business, management and audit
management, business or audit. experience.
4 The appointment term of 5 years exceeds the All subsequent appointments to the Board should
recommended maximum term of 3 years. be for terms not exceeding 3 years.
5 Remuneration and Audit committees are not Remuneration and Audit committees should be
comprised exclusively of independent directors. exclusively comprised of independent directors.

Audit workload
Our audit workload will increase as a result of your company going public due to:
1. The fact that more users (general public shareholders and then borrowers) will be using S4 financial
statements to make economic decisions means that we will be required to lower even further the (very
unlikely) risk of significant misstatements remaining in the financial statements upon completion of the
audit, keeping in mind that it is cost-prohibitive to perform a 100% check.
2. Additional work required by publicly listed companies, including the audit of newly issued share capital and
assurance to be provided on additional reporting requirements such as the Directorsʼ Corporate
Governance Statement, which we must review for reasonableness.
We will strive to ensure to perform our audit in the most cost-effective and with the maximum collaboration with
S4 in order to minimize any increase in audit fees.

Quality control considerations

We will indeed maintain the same high level of quality control standards expected of an audit, with quality control
procedures performed reflecting the complexity and difficulty of audit issues faced rather than the status of the
company per se. I will continue to personally oversee that the following is undertaken properly during the conduct
of the audit:

Direction
I will continue to direct the audit, which will involve holding a meeting with the audit team to inform and discuss
maters with team members, including the risks associated with the audit and our responsibilities.

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 Supervision
I will continue to be exercise the overall supervision of the audit to ensure, among other things, that it is
progressing well, with more practical supervision given within the audit team by senior staff to junior staff.

Review
I will continue to review the overall actual work of the audit team to ensure, among other things, that the work is
performed cost-effectively in accordance with professional standards and regulatory and legal requirements, with
more practical review given within the team by senior staff to junior staff.

Sincerely,
Francis Fanning, CPA
Fanning and Forbes CPA

b) Audit procedures to identify RPTs (IAS 24 and ISA 550)

Review previous years working papers
Review HEWʼs internal procedures for identifying RPTs
●

Enquire of directors and senior management about any known RPTs

●

Verify details of principal shareholders to share register

●

Review minutes of directors meetings, register of directorsʼ interests and tax returns and information
●

supplied to regulatory agencies

●

This is important because RPTʼs that are not at armʼs length may have taken place with the effect of distorting
the financial statements even if all of the transactions that actually took place are correctly recorded. It can
particularly difficult for the auditor to recognise RPTs and the cooperation of management is essential.

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MARKING KEYS

1. Setting of audit risk equation components

2 marks per each of component (4) properly analysed up to a max of 8
Available marks 8
Maximum marks 6

KAPI 1 – Development Expenditure- IAS 38

Significant issue – development of new range of dentures 1
Relevance of IAS 38 1
IAS 38 criteria 3

KAPI 2 – Valuation of assets etc

Gain on non-current assets 1
Revaluation is unrealized gain 2
Procedures on revaluation 2
Other 1

KAPI 3: Going Concern

Liquidity 2
Potential Impairments 2
Impact on Audit Report 2
Other 1

KAPI 4: Take over of GULA

NAPBSE under IAS 10 2
Listing rules of SE 1
Other 1

KAPI 5: Product development internally funded

Large increase in payables etc. 1
Liquidity problems 1
Interaction with KAPI 2 and KAPI 3 2

Possible marks 27
Maximum marks 20

Audit management and other matters

Experienced staff / professional skepticism /ethical requirements 6
Available marks 6
Maximum marks 4

Professional Capabilities
(Memo coherence/clarity, language/ style, issues ranking) up to a maximum of 3

Total available marks 42

Total maximum marks 30

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2.
(a) i) One mark for each control procedure up to a maximum of 4
Facilitate discharge his duties as director (corporate governance) 1
Through safeguarding of assets 1

Available marks 6
Maximum marks 5

(a) ii) One mark for each correct assertion identified up to a max of 3
One mark for each appropriate corresponding procedure up to a max of 3

Available marks 6
Maximum marks 5

(a) iii) One mark for each key audit procedure up to a max of 4
Conclusion – need to revise depreciation policy 1
One mark for each course of action up to a max of 2

Available marks 7
Maximum marks 5

(b) i) Business risk type + explanation of how it could impact if not managed 2
Procurement control + explanation of how it could impact by its absence 2
Discussion of impact on audit approach up to a max of 2

Available marks 6
Maximum marks 5

(b) ii) Undervaluation of liabilities + natural bias of profit seeking entities to max profits 2
Confirmation Letter from TER lawyers + explanation 2
Management Letter from TER Board/Senior Management + explanation 2

Available marks 6
Maximum marks 5

(c) One mark for each practice management reason identified up to a max of 3
One mark for each practice management reason explained up to a max of 3

Available marks 6
Maximum marks 5

Total available marks 37

Total maximum marks 30

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3.
(a) Business risk management ties into the Directorsʼ stewardship duty 1
As business risks entered into impact on SIP shareholders investment risk 1
Lose their investments in SIP if it fails because Directors did not manage BR 1
One and half marks for each business risk identified and explained 3
Requirement for Board committee perform this work for Irish companies listed on ISEQ 1
Irish Law requirement in 2008 for all large private and public companies 1

Available marks 8
Maximum marks 5

(b) Value-for-money (operational) audit + explanation up to a max of 3

Compliance audit + explanation up to a max of 3

Available marks 6
Maximum marks 5

(c) Maintenance of proper book of accounts / safeguarding of assets 2

Companies Act (1990-2006) 1
One mark for each of the remaining three internal control components 3
Available marks 6
Maximum marks 5

(d) Primary purpose of audit is to verify truthfulness and fairness of financial statements 1
Will require assessment of business risk management impacting on FS 1
Will require us to assess the potential usefulness of internal audit as an audit tool 1
Any deficiencies noted re IAF and BRIAMPP with recommendations 1
Will be disclosed in Management Letter addressed to your attention 1
Note Board is ultimately responsible for proper function of IAF and BRIAMPP 1

Available marks 6
Maximum marks 5

Professional Capabilities
(Report coherence/clarity, appropriate language/ style) up to a maximum of 2

Total available marks 28

Total maximum marks 20

4.
(a) One mark for each independent audit assurance need correctly identified per user 3
One mark per each correct justification 3
Explanation of financial statement audit up to a max of 3
Explanation of a compliance audit up to a max of 2
Statutory audit thresholds explanation 1

Available marks 12
Maximum marks 10

(b) i) Problems resulting writing up books of accounts and completing audit 1

Self- Review Threat and Familiarity Threat 2
On the grounds that it might impair the credibility of the financial statements 1
Ultimate responsibility for preparing books of account and FS lies with Directors 1
Auditor can assist by providing guidance on appropriate accounting policies 1

Available marks 6
Maximum marks 4

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(b) ii) Can advise regarding proper credit check controls to be implemented by HEW 1
In the form of bank reference checks 1
Ultimate responsibility for implementation lies with Robert and Roseanne Green 1
Cannot disclose information directly from audit files 11/2
Because of confidentiality rules 11/2

Available marks 6
Maximum marks 4

(b) iii) One mark for each course of action listed up to a maximum of 3

Available marks 3
Maximum marks 2

Professional Capabilities
(Report coherence/clarity, appropriate language/ style) up to a maximum of 2

Total available marks 29

Total maximum marks 20

5.
(i) Corporate governance
Explanation why greater for private companies than publicly listed ones – up to max of 1
1
/2 mark for each corporate governance poor practice identified 2
1
/2 mark for each recommendation to rectify above weakness 2

Available marks 5
Maximum marks 4

(ii) Impact of going public on workload and audit fee

Yes -workload and audit fee will increase 1
Higher audit risk + explanation 2
More matters requiring auditorʼs consideration for publicly listed cos + explanation 2

Available marks 5
Maximum marks 4

(iii) Yes – will be maintained 1

One mark for quality control focus up to a maximum of 3 3
One mark for quality control focus explanation up to a maximum of 3 3

Available marks 7
Maximum marks 6

Professional Capabilities
(Report coherence/clarity, report language/ style) up to a maximum of 2

(b) Procedures to be followed

One mark each to a maximum of 4 4
Reason for importance
Distort financial statements 1
Difficult to uncover 1

Maximum marks 6

Total available marks 25

Total maximum marks 20

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