Part A

An auditor is required to obtain sufficient understanding of each element of a company’s internal control system in order to properly plan the audit of the company’s financial statements and to assess control risk for the assertions included in the account balances.

Required:

(a) Briefly discuss the elements of a company’s internal control system.

(b) How does the sufficiency of evidence differ between procedures to obtain an understanding of internal control and tests of controls?

(c) What are the auditor’s documentation requirements concerning a company’s internal control system and the assessed level of control risk? Explain the choices of methods of documentation.

(d) Explain what is meant by independent checks on performance and give two specific examples.

Part B

The following questions concern the reliability of audit evidence.

Required:

(a) Give two examples of relatively reliable documentation and two examples of less reliable documentation. What characteristics distinguish the two?

(b) Define analytical procedures and explain why they are important evidence even though they are relatively unreliable by themselves.

(C) Under what circumstances is the physical observation of inventory considered relatively unreliable evidence. (Hint: Which management assertion is unlikely to be verified by physical observation?)

(d) Give two examples in which the qualifications of the respondent or the qualifications of the auditor affect the reliability of the evidence.

Part C

The following are 5 independent situations involving audit reports. For each case, describe the type of audit opinion the auditor should issue and explain your reasoning. If more than one type of Opinion may be appropriate, describe the conditions under which each type is chosen.

(a) During the course of your audit of Alex Ltd., you suspect that a material amount of the assets has been misappropriated through fraud. Management of Alex Ltd. refuses to allow you to expand your scope of examination sufficiently to confirm these suspicions.

(b) The market value of your audit client’s investment in a Hong Kong listed company has dropped significantly after the year-end. You consider the amount of decrease is material and the client has not made any adjustment to the year-end amount of the investment.

(c) Your audit client has changed from using the FIFO method of accounting for inventory in previous years to the LIFO basis for valuing inventory in the current year. The amount involved is material.

(d) Due to an argument with the previous auditor, ABC Fashions has employed you as the new auditor after the company’s financial year end. Therefore, you have not carried out the inventory observation (stock take). The accounting records and other evidence were not reliable enough to enable the auditors to obtain satisfactory evidence regarding the company’s inventory balance.

(e) Upon review of the recent history of the useful lives of its fleet of trucks, Apple Ltd. justifiably changed the useful lives for depreciation of its trucks from five years to three years. This change resulted in a material amount of additional depreciation expense.