ACCA Strategic

Professional

Advanced Audit and

Assurance (AAA)
(International)

Mock Exam 3
(March/June 2021 Hybrid
Exam) (amended)
Questions

Time allowed 13 hours 15 minutes

ALL THREE questions are compulsory and MUST be attempted

DO NOT OPEN THIS EXAM UNTIL YOU ARE READY TO START UNDER
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ALL THREE questions are compulsory and MUST be
attempted
Question 1
Pale Co 'i

It is 1 July 20X5. You are a manager in the audit department of Chief & Co, a firm of Chartered
Certified Accountants. You ore assigned to the oudit of Pale Co which has a financial year ending
30 September 20X5.
Pole Co manages timber plantations, its core business being the management of timber
plantations and the production and sale of a range of timber products. It is not currently a listed
entity.
The following exhibits provide information relevant to the question:
Partner's email - an email which you hove received from Harvey Rebus, the audit
engagement partner.
2 Background information - information relevant to audit planning.
3 Notes from meeting - summary of business developments discussed at a recent meeting
between the chief finance officer (CFO) and the audit engagement partner.
4 Key performance indicators - a summary of financial and non-financial information.
5 Notes from phone coll - a summary of issues raised by the CFO during a discussion with
the audit engagement partner.
Exhibit 1
Partner's email
To: Audit manager
From: Harvey Rebus, Audit engagement partner
Subject: Audit planning for Pole Co
Date: 1 July 20X5
Hello
I have provided you with some information which you should use to help you in planning the audit
of Pole Co for the financial year ending 30 September20X5.
As you know, Pale Co is a new audit client of our firm. I hope you ore looking forward to working
on this interesting new client which is the first timber company we hove secured as on audit client.
You should also be aware that the management team is planning for Pole Co to achieve a stock
market listing within the next two years.
Based on the analysis I hove done on this industry, it is appropriate for overall materiality to be
based on profit before tax as this is a key focus for investors and providers of finance.
I require you to prepare briefing notes for my own use, in which you:
(a) Evaluate the significant business risks to be considered in planning the audit of Pole Co.
(10 marks)
(b) Evaluate and prioritise the significant audit risks to be considered in planning the audit of
Pale Co for the financial year ending 30 September 20X5. (16 marks)
Note. In relation ta the company's timber plantation asset (referred to in Exhibit 4) ljOU are onl\j
required to consider audit risks relating to changes In fair value. Any other relevant audit risks
relating to the timber plantation asset will be dealt with separately, later in the planning stage of
the audit.

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(c) Design the audit procedures to be performed in relation to the change in foir value of the
timber plantation asset caused by the recent storms. Your procedures should include those
relating to the evaluation of the expert appointed by management and the work they hove
performed. (6 marks)
(d) Using Exhibit 5, explain the ethical issues and other audit planning implications which arise
in relation to the phone coll from the company's chief finance officer, Mork York. (8 marks)
Thank you
Exhibit 2
Background Information
Pale Co owns and manages several large timber plantations. Approximately 5% of the trees ore
harvested each year. The company immediately processes the timber which is harvested from
felled trees in its own sawmills (a facility where trees ore processed into logs and other timber
products). The processed timber, which is mainly lags and planks of wood, is then sold to a range
of customers including construction companies and furniture manufacturers. Approximately 30%
of the timber is exported.
Your firm was appointed as auditor to Pale Co in Morch 20X5 following the resignation of the
previous auditor, Hare Associates indicating that their reason for resignation bring to your
attention regarding the audit.
Pole Co has small internal audit department with two staff who report to the company's CFO, as
the company does not have and audit committee.
Exhibit 3
Notes from meeting
Meeting date: 10 June 20X5
Attendees: Harvey Rebus, audit engagement partner
Mork York, chief finance officer (CFO)
Ac counting policies
Mork York confirms that Pole Co applies the requirements of IAS® 41 Agriculture as follows:
• Standing timber, which means trees which ore growing in the timber plantation prior to
being felled, are biological assets, measured at fair value less costs to sell. The change in
fair value less costs to sell is included in profit or loss for the period in which it arises.
• Felled trees ore agricultural produce which ore measured at fair value less costs to sell at
the point of harvest. Immediately ofter felling, trees ore processed, so that the value of
felled trees awaiting processing is minimal at any point in time.
• Processed timber such as logs ore measured in accordance with IAS 2 Inventories.
A technical expert from the audit firm hos confirmed that the accounting policies outlined above
appear appropriate in the context of Pole Co's activities.
International expansion
Pole Co's operations ore currently all based in its home jurisdiction. However, the board hos
recently approved the acquisition of several large areas of tropical rainforest in Farland, a remote
developing country. The expansion will allow the company to process new types of timber for
which there is significant demand from luxury furniture manufacturers. The acquisition of the
areas of the rainforest will cost $25 million and the purchase is due to toke place in August 20X5.
The cost of $25 million is equivalent to the fair value of the rainforest. Farland uses the some
currency as Pole Co so the expansion is not creating any foreign exchange risk exposure to the
company.

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The purchase is being funded through a share issue to existing and new shareholders, who are
mainly family members of the Pale family, who established the company 20 years ago. A share
issue was the only option for funding the international expansion as the company is at the limit of
its bank borrowing agreement.
An international development agency has agreed to provide a grant of $20 million to assist Pale
Co in its Farland expansion, on condition that the expansion represents sustainable and ethical 'i
business practice. The grant is provided specifically for training the local workforce and building
accommodation for the workforce in a town near to the rainforest.
The grant is due to be received in September 20X5 and relevant expenditure will commence in
November 20X5. Mark York is planning to recognise half of the amount received as income in this
year's financial statements, on the basis that it "will cover some of management's expenses in
planning the international expansion".
Gold Standard
The company is proud to have recently been awarded an industry 'Gold Standard' accreditation
for its sustainable timber management. To achieve the Gold Standard, which denotes the highest
possible level of sustainable timber management and ethical business practice, the company
must adhere ta a number of strict standards. This includes maintaining the biodiversity of the
timber plantation, ensuring that rare species of tree are not harvested, and that animal habitats
within the timber plantation are preserved. To maintain the Gold Standard accreditation, one
condition is that at least 80% of timber said must be harvested according to the strict standards
set by industry regulators. The Gold Standard applies to all of the company's activities, including
the Farland expansion.
Contract with Ro1:1al Co
The company's revenue has increased this year, largely due to it signing a significant contract
with a new customer, Royal Co. The contract was signed on the basis of Pale Ca receiving the
Gold Standard accreditation for its timber.
Legal case
A group of employees has recently commenced legal action against the company, claiming that
breaches of health and safety guidelines regularly take place. The company has made same
redundancies this year, which has put pressure an the remaining staff ta work harder in order to
maintain productivity; the employees are alleging that this has caused an increase in the number
of accidents at work, some of which have resulted in fatalities. The company's management and
legal advisors believe that the legal claim, which amounts to $19 million, is unjustified and will not
be successful. Mark York does not intend to recognise a provision for the claim or make any
disclosure in the financial statements in relation to this issue as it is at such an early stage in the
legal proceedings.
News report
Mark informed us that a news report has emerged in Farland, alleging that Pale Co paid a
government official a sum of $15,000 in order to secure the purchase of tropical rainforest which
is taking place next month. Mark wanted to make us aware of the story, which is spreading
quickly on social media, and to inform us that these incentive payments are routine business
practice in Farland.
Use of expert - change In fair value due to recent storms
In the last month, several storms caused damage to some areas of timber plantation. An
independent expert has been appointment by management to determine the extent of damage
caused and to quantify any financial implications, including determination of the change in fair
value of the standing trees which have been damaged by the storm. The expert's report indicates
a large number of trees have been completely destroyed, and many have been badly damaged.
Based on the expert's report, management has determined that a reduction in fair value of $7·5
million should be recognised in respect of the timber plantation asset recognised in the statement
of financial position.

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Exhibit It
Ke1:1 performance Indicators
The information in the table below will be published as port of the Annual Report, in a section
titled 'Key results for the year', which forms port of management's commentary on the company's
[Link] financial information is before recognising the change in fair value of the timber
plantation caused by the recent storm, and also before accounting for the government grant.
Projected Actual
30September 30September %
20X5 20X4 change
$million $million
22·0 40·3 +5•5%
Operating profit 16·5 21·0 +4•8%
Profit before tax 12.5 +32%
Social and environmental ke1:1 performance 82%
indicators: 85%
%timber harvested in line with 'Gold Standard'
Number of employees 1,300 1,420
Total staff days lost due to accidents at work 78 65
You ore also provided with the following information relating to balances which ore extracted from
management accounts as at 30June 20X5:
Total assets - $550million (20X4- $540.5million)
Timber plantation -$500million (20X4-$490million)-thisomount, relating to standing
timber, isbeforeoccounting foronychongeinvoluecousedby therecentstorms referredtoin
Exhibit 3.
Cash - $4·5million (20X4 - $6·8million) - cash levels ore depleted this year due to inflationary
pressures and demands for higher wages from our employees ,which we hove met.
Exhibit 5
Notes from phone coll
Notes from a phone coll yesterday between Harvey Rebus, audit engagement partner and Mork
York.
Request from Mark York
Pole Co publishes a wide range of non-financial social and environmental Key Performance
Indicators (KPls)as port of the Annual Report, including the three shown as port of Exhibit 4. Mork
hos asked if our firm con provide assurance on these KPls as port of performing the annual audit.
Mork hos suggested that in order to pay for this extra work, the agreed audit fee will be increased
by 20%,assuming that the assurance provided on the KPls is favourable.
Required
Respond to the instructions in the email from the audit engagement partner. (ltO marks)
Note. The split of the mark allocation is shown in Exhibit 1 - Partner's email.
Professional morks will be awarded for the demonstration of skill in communication, analysis and
evaluation, professional scepticism and judgement and commercial acumen in your answer.
(10 marks)
(Total .. 50 marks)

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Questlon2
It is 1 July 20X5. You are an audit manager in James & Co, a firm of Chartered Certified
Accountants. Your role includes performing post-issuance audit quality reviews, and you are
currently reviewing the audit of the Bond Group (the Group), which had a financial year ended 31
January 20X5, and in respect of which an unmodified audit opinion was issued last month. The
Group supplies computer components, specialising in graphics cards. 'i
You ore reviewing the Group audit file as well as the audit nles for three of the Group's
subsidiaries. All three of these subsidiaries are significant components of the Group and have a
financial year end of 31 January 20X5. Each subsidiary's audit opinion was also unmodified.
You have been provided with the following exhibits, which provide information about the Bond
Group and the points you have identified for each subsidiary in the group:
Cameron Co - points you have identified from your review of the information provided by
the compcnent auditor.
2 Dean Co - points you have identified during your audit quality review.
3 Horner Co - pcints you have identified during your audit quality review.
Exhibit 1
Cameron Co
Your firm audits all Group companies with the exception of Cameron Co, a subsidiary which was
acquired during the financial year.
Cameron Co was acquired by the Group in April 20X't, and is audited by Correy Associates, a
small local firm. Cameron Co also outsources its internal audit function to Correy Associates. The
section of the external audit working papers provided by Carrey Associates and relevant to
internal controls contains very little documentation other than a cross reference to the files
maintained by the internal audit team, and a statement that 'we con rely on the internal controls
as they were tested by our firm in Moy 20X't'.
In respect of Carrey Associated, the Group audit working papers contain the following statement:
'our firm con rely on the of Correy Associates, as one of Jomes & Co's audit partners left the firm to
become on audit partner at Carrey Associates, and he was involved with the audit of Cameron Co'.
Other than some background about Carrey Associates which hod been printed off from the firm's
website to provide background information, there is nothing else on file in relation to the firm.
The Group audit working papers also include a note relating to the consolidation of Cameron Co
into the Group financial statements. Cameron Co prepares its individual financial statements
using local accounting rules, which is allowed under notional regulation; it does not use IFRS®
Standards which is applied by the rest of the Group. The Group audit partner commented in the
working papers that 'local accounting rules ore very similar to IFRS Standards so there is no need
to perform any additional audit work in relation to the consolidation of Cameron Co due to it
using different accounting policies to the rest of the Group'.
Exhlblt2
Dean Co
Deon Co owns a small number of shores in Carden Co, amounting to a 2% shareholding. The
investment is accounted for as a financial asset at fair value through profit or loss, as required by
IFRS® 9 Finoncio/ Instruments. Carden Co's shores ore not traded in a active market, and the
value of $68,000 which is recognised in Deon Co's financial statements in management's
estimate of fair value, based on on offer received for the shareholding in April 20X't.
The audit team checked the arithmetic of management's computation but did not obtain further
audit evidence, because according to the audit conclusion 'the value of the shareholding is below
the Group materiality level'. The latest financial statements of Carden Co, prepared to 31
January 20X5, ore included in the audit file to provide 'background information', and show that
the company hos net assets of $550,000.

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Exhibit 3
Horner Co
During the audit of Horner Co, the audit team become aware of o breach of doto protection
regulation, whereby on employee of the company hod mode its customer database available to a
third party. This disclosure is in contravention of the regulation.
The audit working papers refer briefly to this situation, and conclude that 'it hos little to do with
the audit, as no one outside of the company is aware'. No further investigation were mode by the
audit team, and the audit manager noted in the working papers that 'the matter does not need to
be discussed any further with Horner Co's or the Group's management teams as I hove received
assurance that the person responsible for the breach of regulation hos been dismissed'.

Required
In relation to the matters described in Exhibits 1, 2 and 3, comment on the quality of the planning
and performance of the Group audit and the audit of the components of the Group, discussing
the quality management and other professional issues raised in respect of:

(a) Cameron Co (8 marks)

(b) Deon Co (5 marks)
(c) Horner Co (J marks)
Professional marks will be awarded for the demonstration of skill in analysis and evaluation,
professional scepticism and judgment, and commercial acumen in your answer (5 marks)
(Total= 25 marks)

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Question 3
It is 1 July 20X5. You are a manager in Beth S Co, a firm of Chartered Certified Accountants,
responsible for the audit of Matty Co for the year ended 31 March 20X5.
You have been provided with the following exhibits:
'i
Audit completion review - provides details of matters which hove been brought to your
attention by the audit supervisor.

2. Update and draft auditor's report - provides an update on the outcome of initial
discussions with the client and details of the auditor's report which has now been drafted
by the audit supervisor.

Exhibit 1
Audit completion review
Matty Co is a listed transport company which provides train and bus services for the public on a
national basis. The audit of Matty Co for the year ended 31 March 20X5 is nearly complete and
you ore reviewing the audit working papers. Matty Co is a new audit client for Beth S Co this
year. The previous auditors issued an unmodified opinion on the financial statements for the year
ended 31 Morch 20X4.
Matty Co's draft financial statements recognise revenue of $60·1 million (20X4 - $94·3 million),
profit before tax of $10·5 million (20X4 - $22·1 million) and total assets of $28·4 million (20X4 -
$31-1 million). Materiality hos been set by the audit engagement partner at $1.05million.

The audit supervisor hos brought the following matters to your attention:

Railway operating licence and going concern

Matty Co hos operated a notional railway service for the last 19 years. Matty Co's notional railway
operations have been the subject of adverse publicity over the last 12 months in relation to the
unreliability of its services including the late running of its trains.

The licence to operate the national railway is put out to tender by the national government every
five years. Matty Co's existing licence is due for renewal on 28 February 20X6. The current
tendering process is approaching completion and despite the recent operational problems, Matty
Co was informed on 30 June 20X5 that the company was the government's preferred option. This
was on the understanding that the company would address the recent criticisms of its poor
service levels. The company was also informed that the tender would still be subject to a detailed
review in one month's time prior to its being awarded. The national railway generated $40·2
million of revenue in 20X5 ($47·2 million in 20X4) and contributed pre-tax profit of $11·2 million
this year ($13·3 million in 20X4).

Purchased customer list

On 1 April 20X4, Matty Co paid $6·9 million to acquire the customer list of Jess Coaches, a
business which was terminating its operations. Jess Coaches hires out coaches and drivers to
private and public sector customers. Its customer list includes many highly reputable listed
companies and government bodies with a customer relationship and trading history going back
more than 30 years.

On the basis of this trading history and the associated customer loyalty, the management of
Matty Co assessed the useful life of the customer list as indefinite. The draft statement of
financial position as at 31 March 20X5 recognises the customer list as on intangible asset at a
total carrying amount of $6·9million.
In the second half of the reporting period, however, two of Jess Coaches' largest clients moved to
a new competitor. The management of Matty Co believe that while it would be difficult to identify
a sales value for the customer list at the reporting date, they estimate the value in use of the
customer list to be $7.2 million.

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Exhibit 2
Update and draft auditor's report
It is now 22 July 20X5 and all matters, in relation to the purchased customer list hove now been
satisfactory resolved.
Following the submission of a customer petition to the government complaining about the
company's poor service levels, on 19 July 20X5 the government reieoswed a statement announcing
that it hod withdrawn Matty Co's preferred bidder status and was reopening the tender process
for the notional railway licence.

The company's finance director hos provided details of a short disclosure note he plans to include
in the financial statements which refers to the uncertainties in relation to the current status of the
tender and possible going concern issues which might arise for the company as a result. The
disclosure note concludes with a statement that the management of Matty Co is very confident
that the company will be successful in the tender process and that it will retain the notional
railway licence for at least a further five years.

Required
( a) Using the information in Exhibit 1, comment on the matters to be considered and explain
the audit evidence you would expect to find during your review of the audit working papers
on 1 July 20X5, in relation to the issues identified.

Note. The following mark allocation is provided as guidance for this requirement:

(i) Railway operating licence and going concern (7 marks)

(ii) Purchased customer list (8 marks)
(15 marks)
(b) With reference to Exhibit 2, and assuming that no further adjustments will be mode to the
financial statements in relation to the railway operating licence, evaluate the
appropriateness of the draft auditor's report produced by the audit supervisor.
(5 marks)
Professional marks will be awarded for the demonstration of skill in analysis and evaluation,
professional scepticism and judgment, and commercial acumen in your answer (5 marks)

(Total= 25 marks)

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Answers

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A plan of attack
If this hod been the real Advanced Audit and Assurance exam and you hod been told to turn over
and begin, what would hove been going through your mind?
An important thing to soy (while there is still time) is that it is vital to hove a good breadth of
knowledge of the syllabus because the question requirements for each question will relate to
different areas of the AAA syllabus. However, don't panic. Below we provide guidance on how to
approach the exam.

Approaching the answer

It is vital that you attempt all the questions in the exam to increase your chances of passing. The
best way to do this is to make sure you stick to the time allocation for each question - both in
total and for each of the question ports. The worst thing you con do is run over time in one
question and then find that you don't hove enough time for the remaining questions, leading you
to miss out on some of the easier marks in those questions.
Section A consists of one long case-study style question set at the planning stage of the audit.
This may contain detailed information such as extracts from financial statements and audit
working papers. A range of requirements will be set for this question, but will only cover areas
from syllabus areas A to D inclusive.
Question 1 is for 50 marks, all set at the planning stage in the context of a single scenario, here
dealing with the audit of a large group. As it is a very long question, it is important that you break
it down into its component ports as this will make it easier to manage - and enable you to
ollocote your time to each of them.
Section B contains two more compulsory questions, and may be set on any area of the AAA
syllabus.
Question 2, for 25 marks, featured a trio of audits to review for quality management and other
professional issues.
Question 3 offers 25 marks that were set in a developing scenario, asking first for the required
audit evidence, and then for on evaluation of a draft auditor's report.

Forget about it!

And don't worry if you found the exam difficult. More than likely other candidates will too. If this
were the real thing you would need to forget the exom the minute you left the exam hall and think
about the next one. Or, if it is the lost one, celebrate!

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Question 1

Workbook references. Chopters 6, 7 and 9.

Top tips. Your general approach should be to read the requirement carefully, and then to work
through the question noting down issues (audit risks) as they occur to you.
Part (a) asked for you to evaluate business risks. This is a standard AAA requirement, but one that
only tends to come up every few sittings. What is slightly unusual here is that you ore asked for
the business risks 'to be considered in planning the audit', which may appear to confuse matters
slightly. In reality, though, the auditor should consider the business risks being faced by the
company as port of their understanding of the entity, which is what you ore being asked to do
here.
Port (b) was the expected requirement to evaluate significant audit risks.. It is very important that
you notice the instruction to consider only the risks in relation to the fair value of the timber
plantation asset, as risks relating to other aspects of this asset will not earn marks.
Part (c) asked for audit procedures. Here it is important that your procedures address the points
asked for in the requirement - simply listing lots of irrelevant procedures will not score many
marks in your exam.
Finally port (d) asked you to consider ethics and other planning issues. As usual, it is important
that you answer both ports of the requirement here, although in reality the issues ore connected
as they all arise out of the exhibit you ore asked to focus on.
Easy marks. There should be marks available for adopting the correct format for your briefing
notes, and these ore well worth the time it takes to get them.

H®ii:1-Hi:M::iHI...______________________________
Marks
(a) Business risks
Up to 2 marks for each business risk evaluated. In addition, ½
mark for each relevant trend or calculation which form port of a
relevant explanation of the risk (max 2 marks).
• International expansion
• Gold Standard accreditation
• Legal case
• Damage to assets caused by storm
• Liquidity
• Industrial action
• Incentive payment
Maximum 10
(b) Audit risks
Up to 3 marks for each audit risk evaluated unless otherwise
indicated. Marks may be awarded for other, relevant risks not
included in the marking guide.
Appropriate materiality calculations (max 2 marks) and justified
materiality level should be awarded to a maximum of I mark.
In addition, ½ mark for each relevant trend or calculation which
form port of a relevant explanation of the risk (max 2 marks).
• New client (up to 2 marks)
• Going concern

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Marks
• Government grant (up to 4 marks)
• Change in fair value of standing trees
• Legal case
• Pressure on results
• Corporate governance (up to 2 marks)
Maximum 16
(c) Audit procedures
1 mark for each well explained audit procedure, examples of
which include:
• Obtain the expert's report on the value of the storm-
damaged timber plantation to understand methodology
and overall results.
• Discuss the expert's methodology and assumptions with
management to confirm their rationale and compliance
with accounting requirements.
• Obtain confirmation of the expert's qualifications and
experience.
• Obtain confirmation that the expert is independent .
• Visit the site of the storm damage to form a view on the
scale of the destruction.
• Discuss with management the actions which have been
taken in response to the storm.
• Obtain any documentation relating to the potential sale
of damaged trees.
• From the non-current asset register, confirm the carrying
amount of the standing trees prior to any change in fair
value being recognised.
• Consider whether the use of an auditor's expert is
necessary to provide sufficient and appropriate evidence
given the materiality of the figures.
• Develop an auditor's estimate of the change in fair value
and compare to management's estimate.
• Obtain a copy of the company's insurance policy and
review the terms and conditions to confirm whether the
storm damage is covered by insurance.
Maximum 6
(d) Ethical and audit planning implications
1 mark for each point discussed:
• KPls are 'other information' which the auditor must review
for material inconsistencies
• Self-review threat to objectivity (additional credit to be
awarded for other relevant threats to objectivity
explained)
• Assurance can be provided on the KPls if safeguards can
reduce threat to an acceptable level
• Example of safeguard e.g. separate team to perform the
work, separate partner review

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Marks
• Fee for the assurance work must be separate from the
audit fee
• Fee for audit cannot be on a contingent basis
• Fee for assurance work can be on a contingent basis but
more prudent if not on that basis
• Competence issues due to specialist nature of the work
• Resource issues i.e. staff availability to perform the work
Maximum 8
Professional marks
Communication
• Briefing note format and structure - use of headings/sub­
headings and an introduction
• Style, language and clarity - appropriate layout and tone of
briefing notes, presentation of materiality and relevant
calculations, appropriate use of the CBE tools, easy to follow
and understand
• Effectiveness and clarity of communication - answer is relevant
and tailored to the scenario
• Adherence to the specific requests made by the audit
engagement partner
Analysis and evaluation
• Appropriate use of the information to determine and apply
suitable calculations
• Appropriate use of the information relating to the fair valuation
exercise on the forest asset to design appropriate audit
procedures
• Effective prioritisation of the results of the audit risk evaluation
to demonstrate the likelihood and magnitude of risks and to
facilitate the allocation of appropriate responses
• Balanced discussion of the issues connected to the auditor's
responsibilities in relation to ethical decisions when considering
non-assurance engagements for on audit client.
Professional scepticism and professional judgement
• Appropriate application of professional judgement to draw
conclusions and make informed decisions following recognition
of unusual or unexpected movements, missing/incomplete
information or challenging presented information as part of the
risk evaluation
• Determination and justification of a suitable materiality level,
appropriately and consistently applied
• Identification of possible management bias and consideration of
the impact on the financial statements and the possible reasons
for management's preference for certain accounting treatments
• Effective application of technical and ethical guidance to
effectively challenge and critically assess how management hos
responded to the legal claim and the adequacy of any provision
or disclosure requirements.

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Marks
Commercial acumen
• Use of effective examples and/or calculations from the scenario
to illustrate points or recommendations
• Appropriate use of the industry information to evaluate business
risks
• Recognition of the increased risks to the future competitiveness
of the company given the information provided in the scenario
and any impact on going concern.
Maximum 10
Total 50

Briefing notes
To: Harvey Rebus, audit engagement partner
From: Audit manager
Subject: Audit planning In relation to Pole Co
Dote: 1 July 20X5
Introduction
These briefing notes have been prepared to assist in planning the audit of Pale Co. The notes
begin with an evaluation of the business risks facing the company and continue by evaluating the
audit risks which should be considered in planning the audit. The notes also include the
recommended principal audit procedures which have been designed in respect of a change in fair
value to the company's timber plantation following a recent storm. Finally, the notes discuss
some ethical and other professional issues arising from a recent phone call with the company's
chief finance officer (CFO) which impact on our audit planning.

(a) Business risks

International expansion
The expansion into Farland introduces a business risk in that the company will be
managing operations in a foreign country for the first time. Farland is remote, so it may be
difficult for Pale Co's management team to plan regular visits to the new operations, so
establishing robust management oversight and controls could be difficult. In addition,
Farland may have different laws and regulations compared to the company's home
jurisdiction, so there is a heightened risk of non-compliance. Even the type of trees growing
in the rainforest will be different, and management may not have experience in their
harvesting, processing and the sale of timber products. All of these issues create a risk that
the international expansion may not be successful, and at the same time will represent a
drain on management's time and resources. Operations in the home country of Pale Co
may suffer as a result.
Gold Standard accreditation
There is a risk that the Gold Standard accreditation may not be renewed, with implications
for reputation, and more specifically for the new contract with Royal Co, which largely
accounts for an increase of 5.5% in the company's revenue this year. Several of the Key
Performance Indicators (KPls) which need to be met to retain the Geld Standard seem to be
in jeopard!,J , for example there has been a decline in the percentaqe of timber which is
harvested in line with Gold Standard requirements, and the projected metric of 82% is only
just above the required level of 80%. In addition, the Gold Standard is linked to ethical
business practice, and there are some indications that the company's business ethics is
questionable - for example the legal case being brought by employees and the incentive
payment made to a government official. If the Geld Standard accreditation is lost, Royal
Co, and other customers may cancel contracts, resulting in a loss of revenue and cash
flow.

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Legal case
The legal action against the company by its own employees is a significant risk. If the issue
becomes public knowledge there will be reputotionol problems, and the amount that is
being claimed, $19 million, exceeds the company's cash balance. If the legal claim were to
go against the company, it would struggle to find the funds to pay the damages given that
it is already at the limit of its borrowing arrangements. The situation could also indicate
poor governance of the company, if decisions ore being mode which puts the lives of
employees at risk and results in days lost due to accidents at work, and the matter seems
to be dismissed as unimportant by the management team and legal advisors.
Damage to assets caused by storms
The recent storms hove caused significant damage to the company's timber plantation
asset. Unpredictable weather patterns could cause further harm or even totally destroy the
company's timber plantations. Assuming that trees will be replanted to replace the damage
caused by the storm, it con toke many years for trees to grow to a horvestoble size, so the
company faces a significant depletion of its future cash inflows for years to come. This risk
is very difficult to mitigate, perhaps the diversification into tropical rainforest is a way to
reduce the risk exposure of the company's operations being concentrated in one
geographical area.
Liquidity
The financial information provided indicates that the company's liquidity position hos
deteriorated over the year. The company hos only $4.5 million of cash - a reduction of
33.8% compared to the end of the lost financial year. While this hos been explained as due
to inflationary pressures, management should be doing more to maintain a reasonable
level of cash in order to properly manage its working capitol. The company may become
unable to meet obligations as they foll due especially if the industrial action continues to
restrict the possibility of export soles which account for 30% of the company's revenue.
Industrial action
The industrial action at the country's ports hos already meant lost soles, and as explained
above, there is a risk that revenue and cash inflows will continue to be negatively impacted.
Export soles account for 30% of total revenue, approximately $12.75 million, making this a
potentially very significant issue should the industrial action continue. Customers may
begin to look elsewhere for their supply of timber, leading to cancelled future orders and
contracts.
There is also on issue that the increased storage of timber which is awaiting export to
foreign customers will incur additional storage costs.
Incentive payment
The fact that the payment is being reported in the media indicates that there is something
unusual about the payment and in fact, the incentive payment could be a bribe. The
reputotionol risk to the company is high, especially given that it should be adhering to a
high standard of business ethics in accordance with its Gold Standard accreditation.
Customers may not wish to associate themselves with a supplier which engages with
unethical and possibly illegal payments. The company could face legal action if indeed the
payment is a bribe, and aside from this exacerbating the reputotionol risk, it hos very little
cash available to pay any fine or penalty imposed.
If the incentive payment is a bribe, there could be implications for the government grant,
which contains stipulations regarding ethical business practices. In the worst case the
grant may need to be repaid if the terms and conditions ore found not to hove been
complied with.
Tutorial note. Credit will be awarded for discussion of other relevant business risks, for
example, the solvency issue raised by it being at the limit of its borrowing agreement, the
lock of cash other than relating to the government grant available for establishing
operations in Farland, the lock of on audit committee and independent internal audit team,
the reputotionol damage which may be caused by the legal case and incentive payment,
and the inflationary pressures which will make costs hard to control.

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(b) Evaluation of audit risks
Materlallt1:1
For the purposes of these briefing notes, the following overall materiality level will be used
to assess the significance of identified risks and as requested this has been based on the
profitability of the company.
Benchmarks
5 - 10% of profit before tax= range of $825,000 - $1,650,000
This benchmark is only a starting point for determining planning materiality and
professional judgement will need to be applied in determining a final level to be applied
during the course of the audit. This is the first year that Chief & Co has audited the
company, which increases detection risk, together with the specialisms of auditing an
agricultural business. Therefore, materiality hos been based on 7.5% of profit before tax ot
$1,237,500 and has been set at $1,250,000.
Financial anal1,1sls
Revenue is projected to increase by 5.5%, and profit before tax by 32% which suggest that
there is o significant decrease, and potential understatement, in expected costs,
potentially due to the interpretation of accounting policies or judgments made by
management in respect of the fair value of the forest and provisions regarding legal claims.
There is a risk that expenses are understated and assets (namely the forest) ore overstated.
New client
This is the first year that Chief & Co has audited the company, which increases detection
risk, os our firm does not hove experience with the client, making it more difficult to detect
material misstatements.
In addition, there is a risk that opening balances and comparative information may not be
correct. The prior year figures were not audited by Chief & Co, therefore we should plan to
audit the opening balances carefully, in accordance with ISA 510 Initial Audit Engagements
- Opening Balances, to ensure that opening balances and comparative information ore
both free from material misstatement.

Tutorial note. Credit will also be awarded for discussion of Pale Co operating in a
specialised industry, which could create a detection risk given the audit firm's lack of
experience in auditing clients in this industry.

Going concern
There ore several indicators that despite its projected increase in revenue and profit, the
company faces going concern problems. These indicators include, but are not limited to,
operational problems including the destroyed timber plantation and industrial action,
reputational damage caused by the legal claim and possible illegal payment, financial
problems caused by lock of cash and the fact that its results ore likely to be much worse
than that projected by management when the decrease in foir value of the destroyed
timber plantation is token into account.
IAS 1 Presentation of Financial Statements requires that management provide o note to the
financial statements which discusses any material uncertainty over the company's ability
to continue as a going concern. If management fails to disclose this note, or provides the
note but with inadequate detail, then the requirements of IAS 1 may not have been
followed, creating a significant audit risk.
Government grant
A government grant of S20 million has been awarded to Pale Co. this is significantly above
the materiality threshold which hos been determined ot $1.25million. Mark York hos
suggested that he will recognise $10 million of the amount received in profit for the year -
projected profit before tox (before ony adjustments) is $16.5 million so increasing the profit
by this amount would be highly material to the financial statements.

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The audit risk relates to whether this should be recognised as income in the current
accounting period. IAS® 20 Accounting for Government Grants and Disclosure of
Government Assistance requires that government grants ore recognised in profit or loss on
a systematic basis over the periods in which the entity recognises expenses for the related
costs for which the grants ore intended to compensate. Mork York is planning to recognise
half of the grant as income this year, however, this is not appropriately justified. The grant
hos not been awarded to compensate for management time in planning the international
expansion so the appropriate accounting treatment would seem to be that the entire
amount of the grant should be recognised as deferred income in this financial year, as the
expenditure for which the grant is specifically provided hos not yet been incurred.
Therefore, there is a risk that the company will recognise the income too early, leading to
overstated profit ond understated liabilities.

Tutorial note. Credit will also be awarded for discussion relating to the company's use of
the grant for building accommodation for employees, and relevant audit risks e.g. the
recognition of the accommodation as Property, Plant and Equipment and treatment of the
port of the grant relating to the construction of assets.
There could be a further issue in that the terms of the grant may require complete or partial
repayment if the conditions of the grant ore not satisfied, for example if Pole Co does not
retain its Gold Standard accreditation or if the circumstances of the employees' legal case
is considered to be indicative of unethical business practice by the company. The company
should evaluate whether the terms ore likely to be met, and if not, should consider whether
it would be appropriate to recognise a provision or disclose a contingent liability in the
notes to the financial statements. According to IAS 37 Provisions, Contingent Liabilities and
Contingent Assets a provision should be recognised where a present obligation exists as a
result of a post event which con be reliably measured and is probable to result in on
outflow of economic benefit.
The risk is therefore that this hos not been considered by management, leading possibly to
understated liabilities or inadequate disclosure as required by IAS 37.
Reduction In fair value of timber plantation
The company's timber plantation asset, prior to recognising any change in foir value, is
highly material based on the threshold calculated of $1.25million.
The company hos correctly obtained on expert's opinion on the change in fair value of the
destroyed and damaged trees caused by the storm. The expert's valuation hos helped
management to determine that a reduction in fair value of $7.5 million should be
recognised in the financial statements within profit. This amount is material as it meets the
threshold materiality rote. When the loss in value is recognised, it will reduce the projected
profit from $16.5million to $9million. There is a risk that management will not recognise the
fair value adjustment in full due to the impact it will hove on profit. This is therefore a
significant issue for the audit planning.
There is a risk that the expert's valuation is not appropriate, for example if the expert does
not hove appropriate expertise to perform this specialist valuation, which would lead to
issues in whether the valuation con be relied upon. In addition, the expert hos considered
only the value of the destroyed and damaged trees and not considered any other impact
of the storm, for example if other assets such as roods and buildings hove been affected by
the storm and should be tested for impairment.
Therefore, based on the issues discussed above, there is a risk that the loss is not fully
recognised in profit for the year, and the carrying amount of non-current assets is
overstated.
Legal case
The legal case could also give rise to a risk of understated liabilities or inadequate
disclosure if the company foils to provide for the $19 million claimed by employees or to
disclose the matter as a contingent liability. It will be a matter of significant judgement to
decide whether the legal claim is likely to go against Pole Co or not at this early stage,
however the matter is material and therefore warrants careful consideration. Due to its
sensitive nature, the auditor may also consider the issue to be material by nature.

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Pressure on results
The company is not a listed entity, but the existing and new shareholders will be looking for
o return on their investment in the form of a dividend payment. In addition, in the run up to
a potential stock market flotation there will be pressure for the company to show goad
financial performance. The company also has ambitious international expansion plans.
Pressure to return a better performance creates an incentive for management bias which
means that management may use earnings management techniques, or other methods of
creative accounting, to create a healthier picture of financial performance than is actually
the case. This creates an inherent risk of material misstatement, at the financial statement
level.
The fact that the projected profit before tax is 32% higher than the previous year's figure
could indicate that operating expenses are understated. Management bias could also have
led to some of the accounting treatments suggested by Mark York, which work to improve
the company's profit for the year.
Corporate governance
The company does not have to comply with corporate governance requirements as it is not
a listed entity. However, it is good practice to have an established audit committee,
especially for a large company like Pale Co which is seeking a stock market flotation in the
relatively near future. The internal audit team is small and lacking in independence as they
report directly to the CFO. This means that the scope of their work is likely to be quite
limited due to insufficient resources, and any recommendations made could potentially be
ignored by Mark York. This has implications for controls over financial reporting, which
could be deficient, and increases control risk. There is a high scope for errors in financial
reporting processes and for deliberate manipulation of balances and transactions, as the
internal audit team does not have sufficient resources for thorough monitoring and
reporting.
Impact of the audit risks on the engagement planning
The audit risks have been considered with regard to the estimated magnitude and
likelihood of any misstatement, as well as taking into consideration any associated
detection risk. Both the potential adjustments to the fair value of the forest asset
($7.5million) and the adjustment to the proposed accounting treatment of the government
grant ($10million) clearly meet the threshold materiality of $1.25million, and in aggregate,
they would reduce the estimated profit to a loss of $1.5million. Ensuring the appropriate
disclosures and accounting treatment in respect of the legal claim (which may result, upon
investigation, in a further increase in the loss by up to $19million) is also a material item by
amount of it exceeding the materiality threshold. Chief & Ca will need to ensure that they
have sufficient staff and resources available, including but not limited to, an assessment of
the validity of the legal claim and a review of the valuation of the forest.
(c) Change in fair value of the timber plantation asset
• Obtain the expert's report on the value of the destroyed and damaged timber
plantation to:
Gain understanding and allow evaluation of the methodology and
assumptions used, e.g. the basis of determining the amount of any income
which may be generated from the timber to be salvaged from damaged trees.
Confirm the geographical extent of damage by the storm.
Confirm the basis of determining whether trees have been completely
destroyed or damaged.
• Discuss the expert's methodology and assumptions with management to confirm
their rationale and compliance with the measurement requirements of IAS 41.
• Obtain confirmation of the expert's qualifications and experience in assessing storm
damage to timber plantation assets and quantifying financial losses.
• Obtain confirmation that the expert is independent from Pale Co and its
management team.

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• If possible, visit the site of the storm domoge to form a view on the scale of the
destruction and to evaluate whether any assets other than the trees hove been
destroyed or damaged.
• Discuss with management the actions which hove been token in response to the
storm, e.g. the extent of progress mode to clear the destroyed trees and horvest the
domoged trees.
• Obtain any documentation relating to any potential $Ole of domoged tree$, e.g.
customer orders, to confirm any realisable value of damaged trees.
• From the non-current asset register, confirm the carrying amount of the standing
trees prior to any change in fair value being recognised.
• Consider whether the use of on auditor's expert is necessary to provide sufficient
and appropriate evidence given the materiality of the figures.
• Develop an auditor's estimate of the fair value of the timber plantation, in
accordance with the IAS 41 requirements, and compare to management's estimate
of the change in fair value.
• Obtain a copy of the company's insurance policy and review the terms and
conditions to confirm whether the storm damage is covered by insurance.
(d) Ethical Issues
Assurance on Key Performance Indicators (KPls)
There are several issues to consider with regard to providing this service. A significant issue
relates to auditor objectivity. The KPls include financial and non-financial metrics. The
financial metrics, including revenue, operating profit and profit before tax will be extracted
from, or reconciled to, the figures as shown in the audited financial statements.
While the KPls will not form part of the audited financial statements, they will be published
in the Annual Report and therefore form part of the 'other information' in relation to which
the auditor has responsibilities under ISA 720 The Auditor's Responsibilities Relating to
Other Information. ISA 720 requires that auditors read other information in order to identify
any material inconsistencies between the financial statements and the other information.
There is therefore a potential self-review threat to objectivity in that the audit firm has been
asked to provide assurance on these KPls which would be read by the audit team as part of
their review of other information. The team performing the assurance work would be
reluctant to raise queries or highlight errors which may have been made during the external
audit when reading the other information.
Tutorial note. Credit will be awarded for discussion of other relevant threats to objectivity
created by providing an assurance service on the KPls, including the advocacy threat and
self-interest threats.
The IESBA International Code of Ethics for Professional Accountants (the Code) provides
guidance when auditors provide additional services to on audit client. Chief & Co needs to
evaluate the significance of the threat and consider whether any safeguards can reduce
the threat to an acceptable level. For example, a partner who is independent should be
involved in reviewing the audit work performed.
There is also on ethical issue in respect to the fee proposed by Pale Co for the assurance
engagement. If the firm decides to take on the engagement, it should be treated as an
engagement separate from the audit and with a separate fee charged for the work and
confirmed in a separate engagement letter. The suggestion to simply amend and increase
the audit fee and to determine it on a contingent basis, as in the fee is only payable if the
assuranc e is favourable� is not appropriate. Contingent fees con give rise too self-interest
threat, as it is in the financial interest of the audit firm to give a favourable assurance
opinion in order to secure the income. The Code prohibits the use of contingent fees for
audit services, but they are allowed for other types of work, depending on factors such as
the nature of the engagement and the range of possible fee outcomes. The most prudent
course of action, should Chief & Co take on the engagement, would be to charge the fee
on a non-contingent basis, separate from the audit fee, to remove any ethical issues
relating to the fee.

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Aside from ethical issues, Chief & Co must also consider whether they hove the
competence to perform the work. Providing assurance on non-financial KPls is quite a
specialist area, and it could be that the audit firm does not hove the appropriate levels of
expertise and experience to provide a quality service. In particular, the firm would need to
ensure that it fully understands the Gold Standard accreditation. Given that this is a
specialised industry, and this is the first client which Chief & Co has in the industry, it is
questionable whether the firm hos the competence to carry out the work.
Aside from competence, the firm should also consider whether it has resources in terms of
staff availability to complete the work to the desired deadline and to perform appropriate
reviews of the work which hos been completed.
Conclusion
These briefing notes highlight that the company faces significant business risk, in
particular in relation to its financial position and the recent storm damage. There ore a
number of significant audit risks which will need to be carefully considered during the
planning of the audit, to ensure that on appropriate audit strategy is devised. Going
concern should be a key focus of the audit. We need to perform detailed work on the highly
material change in fair value of the timber plantation due to the recent storm, as detailed
in the notes. Finally, there ore several ethical matters to be discussed with management
and incorporated into our audit planning. The assurance engagement on the company's
KPls should only go ahead once all ethical implications hove been carefully evaluated and
appropriate safeguards put in place.

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Question 2

Workbook references. Chapters 2, It, 6 and 7.

Top tips. This question is set at the review stage, requiring you to think critically about the quality
of the audit work that has been performed.

It is a good idea here to make reference to the technical guidance that is available on quality
management (namely ISA 220, and ISQM 1 and 2) where this is relevant. Although it is the case
that many of the marks at this level are going to come out of the scenario, the examining team
has commented time and again on the relative lack of knowledge displayed by candidates when
it comes to auditing standards.

The question itself was probably of average difficulty for AAA. Candidates tend to enjoy criticising
the performance of an audit, but the key to doing well here was to make this criticism as incisive
as possible, referring to technical standards where possible in order to highlight the gap between
what has happened and what should have happened.

Easy marks. The were some fairly easy paints to be made in relation to the laws and regulations
in part (c).

H@ii:I-H:H::ii-1111�----------------------------
Marks
Generally, up to 2 marks for each well explained paint
(a) Cameron Co
• Internal audit - self-review threat and lack of professional
scepticism (1 mark)
• Internal audit - insufficient audit work on internal controls
including no understanding or evaluation of year-end
controls obtained
• Internal audit - threat of assuming management
responsibility and general risk that ethical code has not
been followed by Correy Associates
• Timing and reliance an controls testing
• Group audit firm has not evaluated Correy Associates or
obtained understanding of the firm
• Na audit work performed by Group audit team on
Cameron Co's different accounting policies - Group
consolidation could be misstated
• Implications of former partner joining the component
audit firm - familiarity and over reliance (1 mark)
• Possible lack of competence of the Group audit partner (1
mark)
Maximum 8
(b) Dean Co
• Lack of application of professional scepticism regarding
valuation of financial asset
• Asset likely to be overvalued - could hove material impact
on Dean Co's financial statements
• Inappropriate application of Group materiality at
component level
Maximum 8

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Marks
(c) Horner Co
• Auditor is incorrect and laws and regulations do impact
the audit and financial statements
• Auditor needs to gain understanding of applicable laws
and regulations
• Further evidence should be obtained, and the matter
discussed with Group management
• Provisions for fines and penalties have not been
considered
• Auditor may have a legal duty to disclose, or consider
disclosing in the public interest
• The audit firm may wish to seek legal advice regarding the
situation (1 mark)
Maximum 7
Professional marks
Analysis and Evaluation
• Effective appraisal of the information to make suitable
recommendations for appropriate courses of action
• Appropriate assessment of the ethical and professional issues
relating to the assignment, using examples where relevant to
support overall comments
Professional scepticism and professional judgment
• Effective challenge and critical assessment of the conduct and
extent of the audit work and evidence obtained with appropriate
conclusions.
• Demonstration of the ability to probe into the reasons for quality
issues including the identification of missing information or
additional information which would be required
• Appropriate application of professional judgement to draw
conclusions and make informed decisions about the actions
which are appropriate in the context and stage of the
engagement.
Commercial acumen
• Appropriate recognition of the potential impact of breaches of
laws and regulations on the Group as a whole or the legal
implications for James &Co
• Assessment of the conclusions from the quality review on the
audit engagement and any potential impact on the reputation
of James &Co
Maximum 5
Total 25

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(a) Cameron Co
There ore problems indicated by the review in relation to both the audit of Cameron Co's
individual financial statements by Correy Associates, and in the way the Group auditor
hos dealt with the issue of there being a new component auditor involved in the Group.
Internal audit
First, it is not appropriate that Correy Associates hos relied on the work performed by the
internal audit team. A significant self-review threat to the objectivity of Correy Associates
arises from the firm providing both internal and external audit services to Cameron Co. The
IESBA International Code of Ethics for Professional Accountants suggests that providing on
audit client with on internal audit service creates a significant self-review threat because in
subsequent audits the audit team will use the internal audit work performed, leading to
potential over-reliance. There is therefore a risk that the audit hos not been performed with
sufficient objectivity and professional scepticism. In addition, it is not clear whether
appropriate safeguards ore in place to reduce the threats to on acceptable level, for
example by ensuring that the two services were provided by separate teams.
There is a risk that insufficient audit evidence hos been obtained over internal controls.
This is a breach of ISA 315 (Revised 2019) Identifying and Assessing the Risk of Material
Misstatement, which requires the auditor to obtain an understanding of the internal
controls relevant to the audit, including on evaluation of the design and implementation of
the internal controls. It appears that this audit work hos not been performed at all, due to
over-reliance.
There is a further issue with the timing of when the internal controls hod been tested, which
took place in Moy 20X't. The financial year ended on 31 January 20X5, so it appears that
the controls hod not been evaluated for the lost eight months of the financial year. ISA 330
The Auditor's Responses to Assessed Risks, states that if the auditor intends to rely on
controls over a period of time the tests performed must be able to provide audit evidence
that the control operated effectively over that period. This exacerbates the risk discussed
above, as there could hove been significant changes in internal controls during that period,
which hod not been identified by the external audit team.
This raises concerns over the quality of the audit which hos been performed by Correy
Associates. Given that Cameron Co is a significant component of the Group, any material
misstatements which have not been detected by the component auditor could hove
implications for the Group financial statements, which could also be materially misstated.
In addition to the self-review threat to objectivity, a threat of management responsibility
arises, whereby the audit firm is making decisions and using judgment which is properly
the responsibility of management. An audit firm should not assume management
responsibility. This raises concern over Correy Associates general approach to ethical
issues, and whether the ethical threats raised hove been properly evaluated by the firm.
Group auditor evaluation of Correy Associates
The comment mode in the Group audit working papers indicates that there hos been no
understanding obtained by the Group auditor in relation to the component auditors. This is
a significant quality management problem and a breach of ISA 600 Special Considerations
- Audits of Group Financial Statements (Including the Work of Component Auditors) which
requires that the group audit team obtain on understanding of the component auditor and
be involved with the component auditor's risk assessment to identify risks of material
misstatement. This is especially the case given that Cameron Co is a new component of the
group, and this is Jomes 8 Co's first experience of working with Correy Associates.
The fact that on audit partner hos left Jomes 8 Co to work as on audit partner at Correy
Associates hos no bearing on whether Jomes 8 Co should hove obtained on appropriate
understanding of Correy Associates. An understanding of whether Correy Associates follow
the some ethical framework as the rest of the Group and on understanding of their
competence is required. It appears that the Group audit hos been conducted without this
necessary understanding being obtained, which is a breach of ISA 600.

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In addition, a familiarity threat to objectivity arises because of the connection that the
Group audit team will hove with the audit partner now working for Correy Associates and
who worked on the audit of Cameron Co. The familiarity threat means that the Group
audit team may hove over-relied on the work of the component auditor and foiled to apply
appropriate professional scepticism.
Use of local accounting rules
Cameron Co uses local accounting rules in its individual financial statements. which is
acceptable. However, for the purpose of consolidation, the some accounting policies must
be applied across all Group companies, as required by IFRS 3 Business Combinations. The
fact that the Group audit partner hos concluded that no work is needed in relation to the
accounting policies indicates poor quality audit work and insufficient audit evidence hos
been obtained. Adjustments may hove been necessary to Cameron Co's balances and
transactions prior to consolidation; with no audit work being performed to assess whether
this is the case there is a risk of material misstatement in the Group financial statements.
The fact that it is the Group audit partner who reached this conclusion indicates a lock of
competence and raises concerns over the quality of the audit as a whole.
(b) Deon Co
Insufficient audit evidence hos been obtained in relation to the financial asset. The audit
team should not just hove accepted management's valuation of $68,000, which could be
based on inappropriate assumptions. An offer of $68,000 may hove been received, but this
hos also not been verified by the audit team. As there is no active market for the shores,
fair value should be based on on exit price at the measurement dote and should reflect
assumptions which market participants would use including risk. Even if the offer was
genuinely received, this is not on appropriate basis for valuation of shores, especially given
that the offer was mode nine months before the year end. An appropriate level of
professional scepticism hos not been used in the audit of the financial asset.
Fair values should be determined close to the financial year end, and the $68,000 might
reflect out-of-dote perceptions of the value of Carden Co. From the information provided,
it seems that the financial asset could be impaired and is likely to be overstated in value.
Deon Co's 2% shareholding is recognised at $68,000; however, 2% of the net assets of
Carden Co at 31 January 20X5 amounts to only $11,000. If the financial asset is
overvalued, then any necessary adjustment would hove a profit implication, and this is not
mentioned in the audit working papers.
Using Group materiality in the audit of a subsidiary is not appropriate. The value of the
financial asset is less than Group materiality, but it might be material to Deon Co's
individual financial statements. It is not clear that the individual audit team determined on
appropriate level of materiality as port of their planning of the individual company audit.
The Group audit team should determine component materiality to be used by component
auditors in their audit of subsidiary balances and transactions, and component materiality
should be lower than materiality for the Group financial statements as a whole. Therefore,
it seems likely that the Group audit team hos not communicated on appropriate level of
component materiality to the team auditing Deon Co.
While the possible adjustments in relation to the financial asset ore not material to the
Group, they could be material to Deon Co's individual financial statements, and there is a
risk that on inappropriate audit opinion hos been issued in relation to this subsidiary's
individual financial statements.
(c) Horner Co
There hos been a breach of relevant low and regulations. The audit team should hove
considered the requirements of ISA 250 Consideration of Lows and Regulations in on Audit
of Financial Statements. ISA 250 states that while it is management's responsibility to
ensure that the entity's operations are conducted in accordance with the provisions of lows
and regulations, the auditor does hove some responsibility in relation to compliance with
lows and regulations, especially where a non-compliance hos on impact on the financial
statements.

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The auditor is required by ISA 315 (Revised 2019) to gain on understanding of the legal and
regulatory framework in which the audited entity operates. This will help the auditor to
identify non-compliance and to assess the implications of non-compliance. Therefore, the
auditor should ensure that a full knowledge and understanding of the relevant data
protection lows and regulations is obtained in order to evaluate the implications of non­
compliance.
ISA 250 requires that when non-compliance is identified or suspected, the auditor shall
obtoin on understanding of the noture of the oct ond the circumstances in which it hos
occurred, and further information to evaluate the possible effect on the financial
statements. Therefore, procedures should hove been performed to obtain evidence about
the suspected non-compliance, for example, to discuss the breach with management to
understand how it happened, whether due to deliberate action or unintentional mistake,
and who wos responsible. In addition, the audit team should hove performed further
procedures, for example discussion with the company's legal advisors to understand the
legal consequences of the breach. From the information provided it seems that the audit
team foiled to obtain more information or evidence due to their belief that the situation hod
little to do with the audit. The audit hos therefore not been performed appropriately, as the
requirements of ISA 250 hove not been followed. The matter could be immaterial in
monetary terms, but without further investigation, it is not possible for the audit team to
reach this conclusion. However, in many jurisdictions fines and penalties associated with
data protection breaches ore often significant. Also, the matter could be material by
nature, so regardless of the monetary amounts involved, further work should hove been
performed.
ISA 250 requires the matter to be discussed with management and where appropriate with
those charged with governance. It appears that some discussion was held, as the audit
manager is aware that the employee hos been dismissed. However, the discussions should
hove been fully documented and raised to the level of Group management, as the matter
could impact on the Group and not just on Horner Co.
The audit team should hove considered the potential implications for the financial
statements. The non-compliance could lead to regulatory authorities imposing fines or
penalties on the Group, which may need to be provided for in both the individual and
Group financial statements. Audit procedures should hove been performed to determine
the amount, materiality and probability of payment of any such fine or penalty imposed.
The individual and Group financial statements could be materially misstated and given
that on unmodified audit opinion hos already been issued, this is a significant issue for
Jomes & Co to now consider.
In terms of reporting non-compliance to the relevant regulatory authorities, ISA 250
requires the auditor to determine whether they hove a responsibility to report the identified
or suspected non-compliance to parties outside the entity. In the event that management
or those charged with governance of the company or the Group foil to make the necessary
disclosures to the regulatory authorities, Jomes & Co should consider whether they should
make the disclosure. This will depend on matters including whether there is a legal duty to
disclose or whether it is considered to be in the public interest to do so. It seems that this
hos not been considered so for, but the audit firm con still make any necessary disclosures.
The Code requires auditors to comply with the principle of confidentiality, and if disclosure
were to be mode by the auditor, it would be advisable to seek legal advice on the matter.
Further advice on disclosure in the public interest is given in the Code, which gives
examples of situations where disclosure might be appropriate. These examples include
references to on entity being involved in bribery and breaches of regulation which might
impact adversely on public health and safety. The Code also clarifies that in exceptional
circumstances where the auditor believes there may be on imminent breach of a low or
re!'.)ulotion, the� mo� need to disclose the matter immediate!� to on appropriate outhorit�.
The decision to disclose will always be a matter for the auditor's judgement and where the
disclosure is mode in good faith, it will not constitute a breach of the duty of
confidentiality.
Tutorlal note. Credit will also be awarded for discussion of relevant ethical threats to
objectivity which may arise in relation to the non-compliance, including intimidation and
self-interest threats.

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Question 3

Workbook references. Chapters 8, 10 and 11.

Top tips. This question is set at the completion stage, and asked for audit evidence in relation to
two areas, and then moved on to consider the auditor's report.

The scenario for port (a) was foirly clear about the potential for the first issue to affect going
concern. Notice how the model answer makes use of some carefully-chosen numbers to
investigate the issue.

Regarding the second issue, you ore again given a little bit of a steer towards the relevant
accounting issue (the application of IAS 38). If you were unsure of the accounting guidance in this
area then you will need to spend some time making sure that you ore comfortable with the
material in the workbook, as this type of question could very easily come up in your exam.

In relation to the auditor's report in part (b), you needed to have a clear understanding of the
relevant ISAs. Thankfully many candidates find this to be a friendly area of the AAA syllabus, so
this should hove been one of the nicer requirements in the exam.

Easy marks. The were some fairly easy points to be made in relation to structure of the auditor's
report in port (b).

H®il:i·H&:M:+■------------------------------
Marks
(a) Matters and evidence
Generally, up to 1 mark for each matter explained and each
piece of evidence recommended.
(i) Railway llcence
Matters
• Management should disclose material uncertainties
and auditor should assess adequacy of this
disclosure
• Significant uncertainty exists over renewal of
licence
• Materiality of notional railway licence contribution
to revenue/profit
• Without notional railway licence, company would
be loss-making
• Company hos deteriorating performance, declining
revenue, profit and assets
• Company may be unable to renew copex and
maintain liquidity
Evidence
• A review of the press reports in relation to the late
running of Matty Co's trains and the quality of its
service to assess the seriousness and significance of
the issue.
• A review of any correspondence files between Matty
Co and the government transport deportment in
order to identify any developments in the licence
renewal process and consider their impact on the
likely renewal of the licence.

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Marks
• Notes of discussions held between the auditor and
the management of Matty Co in relation to any
contingency plans if the company foils to secure
the national railway licence; for example, any other
licences or opportunities which may exist in the
market and any emergency sources of finance
which might be available to the company.
• A review of the company's board minutes for
evidence of management discussion of the status of
the tender process and of any contingency plans.
• A review and analysis of budgets and cash flow
forecasts by the auditor in order to assess the
ability of the company to survive as a going
concern for the foreseeable future.
• Copies of the company's bank facilities reviewed to
assess the feasibility of the company's ability to
operate within them should they be unsuccessful in
winning the contract.
• Written representations from management in
relation to the status of the tender process and
management's expectations of its expected
outcome.
Maximum 7
(ii) Purchase of customer list
Matters
• Materiality of customer list (1/2 mark)
• Accounting rules of intangible assets with indefinite
life
• Assessment is matter of significant judgement and
high audit risk
• Indefinite useful life must be substantiated
• Must test intangible with indefinite useful life
annually for impairment
• Accounting rule for impairment review
• Possible manipulation by management to avoid
impairment loss
• Loss of two major customers/new competitor­
possible impairment indicators
• If recoverable amount is less than carrying amount,
impairment loss should be recognised in P/L for
year.
Evidence
• A copy of the purchase agreement to identify the
details of the acquisition including the purchase
consideration, the assets acquired, and the dote of
the acquisition agreed to the detail included in the
accounting records.
• Agreement of the purchase consideration of $6.9
million to the company's cash book and bank
statement to confirm purchase price.

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Marks
• A review of Jess Coaches' trading history and any
market research which hos been performed on the
ability of the purchased customer list for evidence
of how it will generate future revenue for Matty Co.
• A copy of the client's schedule calculating the value
in use of the purchased customer list as $7.2 million
and a confirmation of the schedule's mathematical
accuracy
• A review and assessment of the company's cash
flow forecast which hos been used to support the
value in use of $7.2 million agreed to the value in
use calculation.
• A discussion with management in relation to the
basis of the calculation of value in use and on
assessment by the auditor of the reasonableness of
management's key assumptions
• A sensitivity analysis performed by the auditor
varying these key assumptions and on assessment
of the materiality of the potential impact of varying
the assumptions on the calculation of the value in
use of the customer list.
• A review of Matty Co's management accounts for
the reporting period and for the post reporting dote
period to dote in order to identify and quantify the
cash flows generated by Jess Coaches customer
list and any significant variances investigated.
• A comparison of the discount rote used in the value
in use calculation to published market rotes and
notes of discussions with management in relation to
the basis of any adjustments mode by
management, in order to ensure that on
appropriate rote hos been used
• Written representations from management
confirming that to the best of its knowledge, the
assumptions used in the calculation of value in use
ore reasonable, appropriate and that in its opinion,
the purchased customer list is not impaired and its
carrying amount is foirly stated.
Maximum 8
(b) Appropriateness of draft auditor's report
Generally, 1 mark for each reporting implication explained.
• Inappropriate disclosure - modified opinion due to
material misstatement
• Opinion would be qualified or adverse based on auditor's
judgement of pervasiveness.
• Discussion of pervasiveness - disclosure paragraph may
lock detail/ be contradictory.
• If disclosures not adequate, matter should be detailed in
'Basis for Qualified/ Adverse Opinion' paragraph
• Disclosure adequate, uncertainties should be disclosed in
separate section/ 'Material Uncertainties related to Going
Concern /Not KAM

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Marks
• KAM disclosures required for high-risk areas, significant
judgements and the effect of significant events or
transactions that occurred during the period
• Inclusion as KAM - carrying amount of customer list/
management's conclusion that intangibles not impaired
Maximum 5
Professional marks
Anal11sls and evaluation
• Identification of omissions from the analysis or further analysis
which could be carried out in respect of the railway operating
licence and the purchased customer list.
• Balanced assessment of the information to determine the
appropriate audit opinion in the circumstances
Professional scepticism and Judgement
• Effective challenge and critical assessment of information,
evidence and assumptions supplied and demonstration of
professional judgement in identifying appropriate evidence to
support conclusions for the audit engagement team.
• Appropriate application of professional scepticism and
judgement to draw conclusions and make informed decisions
which ore appropriate in the context of the engagement.
Commercial acumen
• Appropriate recognition of the wider implications of the
information obtained during the audit regarding the railway
licence, and the potential impact for Matty Co.
Maximum 5
Total 25

(a) Matters and evidence

(i) Rallwa11 operating licence
Matters
Uncertainties In relation to going concern
IAS 1 Presentation of Financial Statements requires management to disclose material
uncertainties in relation to going concern and ISA 570 (Revised) Going Concern
requires the auditor to assess the adequacy of this disclosure. Therefore, the principal
matter raised by the unresolved status of the licence tender is the potential impact on
Matty Co's financial performance and financial position if the company is
unsuccessful in the tender process. This in turn creates uncertainties in relation to the
going concern status of the company. The licence is due for renewal on 28 February
20X6 which is 11 months from the reporting dote and therefore within the foreseeable
future for the purpose of the going concern review. Although the company hos been
informed that it is the preferred bidder, there ore still significant doubts as to whether
the licence will be renewed given the government's requirement that the company
addresses the recent criticisms and the pending review in one month's time.

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The revenue generated from the national railway licence represents 66.9% of Matty
Ca's revenue for year and is highly material to the company's statement of profit or
loss for the year and critical to its operations. It is also significant that the national
railway licence contributed profit before tax of $11.2 million which is 106.7% of this
year's profit; without this contribution to the company's profit this year, the
company would be loss-making. In addition to these considerations, even with the
inclusion of the national railway licence in this year's results, Matty Co's
performance is deteriorating as evidenced by its declining revenue (dawn by 36.3%)
and profit before tax (down by 52.5%). The company's assets are also down by 8.7%
on the prior year which may be indicative of a business which is struggling to renew
its capital expenditure and maintains its liquidity.
Evidence
• A review of the press reports in relation to the late running of Matty Co's trains
and the quality of its service to assess the seriousness and significance of the
issue.
• A review of any correspondence files between Matty Co and the government
transport department in order to identify any developments in the licence
renewal process and consider their impact on the likely renewal of the licence.
• Notes of discussions held between the auditor and the management of Matty
Co in relation to any contingency plans if the company foils to secure the
notional railway licence; for example, any other licences or opportunities
which may exist in the market and any emergency sources of finance which
might be available to the company.
• A review of the company's board minutes for evidence of management
discussion of the status of the tender process and of any contingency plans.
• A review and analysis of budgets and cash flow forecasts by the auditor in
order to assess the ability of the company to survive as a going concern for
the foreseeable future.
• Copies of the company's bank facilities reviewed to assess the feasibility of
the company's ability to operate within them should they be unsuccessful in
winning the contract.
• Written representations from management in relation to the status of the
tender process and management's expectations of its expected outcome.
(ii) Purchased customer list
Matters
Assessment of useful life
The carrying amount of the customer list purchased from Jess Coaches is highly
material to Matty Co's draft statement of financial position as it exceeds the
materiality threshold set by the partner of $1.05million. According to IA$ 38
Intangible Assets, a reporting entity should recognise intangible assets initially at
cost and should assess whether an intangible asset's useful life is finite or indefinite.
An assessment of a useful life as indefinite is only appropriate if on an analysis of all
of the relevant factors, there is no foreseeable limit to the period over which the
intangible is expected to generate net cash inflows for the entity. This assessment
requires a significant level of judgement to be exercised and the subjectivity of the
carrying amount creates a high level of risk for the auditor. In this case, the trading
history of Jess Coaches prior to its acquisition by Matty Co may provide some
evidence that there is no foreseeable limit to the period over which the purchased
customer list can be expected to generate cash flows. However, this assumption
needs to be assessed carefully by the auditor. Intangible assets with on indefinite life
should not be amortised according to IAS 38.

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Impairment review
IAS 38 also requires a reporting entity to test intangibles with an indefinite useful life
annually for impairment. This impairment review would involve a comparison of the
carrying amount of the customer list to its recoverable amount which, given the
difficulty in identifying a sales value for the customer list, is likely to be based on an
assessment of its value in use. The assessment of value in use is a highly subjective
exercise which involves an estimate of the future cash flows the entity expects to
derive from the customer list, expectations about possible variations in the amount or
timing of these future cash flows and the time value of money represented by the
current market risk-free rate of interest. Management's assessment of value in use as
$7.2 million appears to be very close to the asset's carrying amount of $6.9 million
and it is possible that management may have manipulated its assumption to avoid
the recognition of an impairment loss. The auditor will therefore need to carefully
review and consider management's assessment of value in use and the assumptions
implicit in its calculation.

In addition to these considerations, the emergence of a new competitor which is

capable of taking major customers away from Jess Coaches and the loss of two key
customers already, are indicators that the intangible asset may indeed be impaired.
If the recoverable amount of the intangibles is therefore less than their total carrying
amount of $6.9 million at the reporting date, an impairment loss should be
recognised in the statement of profit or loss for the year and the intangibles should
be written down accordingly.

Evidence
• A copy of the purchase agreement to identify the details of the acquisition
including the purchase consideration, the assets acquired, and the date of the
acquisition agreed to the detail included in the accounting records.
• Agreement of the purchase consideration of $6.9 million to the company's
cash book and bank statement to confirm purchase price.
• A review of Jess Coaches' trading history ond any morket research which has
been performed on the ability of the purchased customer list for evidence of
how it will generate future revenue for Matty Co.
• A copy of the client's schedule calculating the value in use of the purchased
customer list as $7.2 million and a confirmation of the schedule's
mothematicol accuracy.
• A review and assessment of the company's cash flow forecast which has been
used to support the value in use of $7.2 million agreed to the value in use
calculation.
• A discussion with management in relation to the basis of the calculation of
value in use and an assessment by the auditor of the reasonableness of
management's key assumptions.
• A sensitivity analysis performed by the auditor varying these key assumptions
and an assessment of the materiality of the potential impact of varying the
assumptions on the calculation of the value in use of the customer list.
• A review of Matty Co's management accounts for the reporting period and for
the post reporting date period to date in order to identify and quantify the
cash flows generated by Jess Coaches' customer list and any significant
variances investigated.
• A comparison of the discount rate used in the value in use calculation to
published market rates and notes of discussions with management in relation
to the basis of any adjustments made by management, in order to ensure that
an appropriate rate has been used.

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• Written representations from management confirming that to the best of its
knowledge, the assumptions used in the calculation of value in use are
reasonable and appropriate and that in its opinion, the purchased customer
list is not impaired and its carrying amount is fairly stated.

(b) Appropriateness of the draft auditor's report

The finance director has agreed to include a short note to the financial statements to
disclose information relating to the material uncertainty relating to going concern. The note
must be reviewed for completeness and if the auditor assesses that the client's disclosure is
not adequate, a modified audit opinion would be appropriate in relation to a material
misstatement as a result of the inadequate disclosure.
The form of the opinion would be qualified 'except for' or adverse depending on the
auditor's judgement of the matter's pervasiveness to the financial statements. In this case,
adverse may be the appropriate form of audit opinion given that the disclosure note is
described as 'short' and that management may appear to negate the significance of the
uncertainties by stating that they ore 'very confident' that they will be successful in the
tender process. A full description of the status of the tender negotiations os at the dote of
the auditor's report and their potential impact on the financial statements should then be
detailed in the 'Basis for Qualified or Adverse Opinion' paragraph.
However, if on the other hand, the outcome of the auditor's assessment is that the client's
financial statement disclosures ore considered by the auditor to be appropriate, the
material uncertainty in relation to going concern should be disclosed in a separate section
entitled 'Material Uncertainties related to Going Concern' which should appear
immediately below the 'Basis for Opinion Paragraph' and not in the Key Audit Matters
(KAM) section of the auditor's report. According to ISA 570, the Material Uncertainty
Related to Going Concern section should:
• Draw attention to the note in the financial statements which discloses the going
concern issue; and
• State that these events or conditions indicate that a material uncertainty exists
which may cost significant doubt on the entity's ability to continue as a going
concern and that the that auditor's opinion is not modified in respect of the matter.
Matty Co is a listed entity and according to ISA 701 Communicating Key Audit Matters in
the Independent Auditor's Report, KAM disclosures ore required in the auditor's report for
high-risk areas, significant judgements and the effect of significant events or transactions
which occurred during the period. The assessment of the useful life of the customer list as
indefinite and management's conclusion that the intangibles ore not impaired, ore areas of
both significant judgement and high risk given the materiality of the intangibles. The
auditor should consider disclosing these matters in the KAM section of the auditor's report.

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