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Advanced Auditing
Final Examination 4 June 2012 Summer 2012 100 marks – 3 hours Module F Additional reading time – 15 minutes
Q. 1 You have been appointed as the auditor of Tee Pharmaceuticals Limited (TPL) for the year ended 31 March 2012. An extract from the draft financial statements is presented below:
Income statement 2012 2011 Rs. in million Revenue 48,970 47, Finance charges 3,000 1, Profit after tax 70 600
Statement of financial position 2012 2011 Rs. in million Intangible assets 7,000 3, Stocks 27,000 15, Trade receivables 13,800 11, Share capital (Rs. 10 each) 20,000 20, Retained earnings 1,170 1, Long term loans 10,500 3, Short term loans 27,000 15,
During the planning process, you have gathered the following information: (i) TPL’s operations were highly successful until 2008. However, due to increased competition the profitability has reduced significantly over the last four years. Consequently, the company has embarked upon an ambitious plan whereby it has taken the following steps:
- Three new products have been introduced for which patent rights have been purchased. The new products were introduced in the market in December 2011.
- A new plant has been acquired which is expected to reduce the cost of production significantly.
- The above measures have been financed through a bank loan against hypothecation of stocks and trade receivables.
(ii) TPL has had a dispute with a major distributor who alleges that products were delivered in damaged packets and the quantities therein were short as compared to the numbers mentioned on the packets.
(iii) A franchisor has initiated a legal action against the company on grounds of infringements of patent rights.
(iv) TPL had entered into a one year agreement with a foreign supplier for supply of raw material. On 20 April 2012 the government of the country in which the supplier is registered, has initiated legal proceedings against that supplier for breach of quality standards. Consequently, the government of the country in which TPL is operating has banned all imports from that supplier.
Required: Identify the audit risks that exist in the above scenario and the manner in which you would address those risks, during the audit under the following headings: (i) Raw materials (iii) Intangibles (ii) Trade receivables (iv) Liquidity issues (19 marks)
Q. 2 The following situations have arisen at different audit clients of your firm:
(a) Zafar Technology Limited (ZTL), a listed company, is engaged in the manufacture of compressors used in electrical appliances. During the conduct of the audit for the year ended 31 March 2012, a team member has discovered a letter dated 18 March 2012 from Sartaj Electronics Limited (SEL) which states that SEL will not pay the current outstanding invoices as according to it the compressors supplied by ZTL are of an incorrect specification.
ZTL’s Technical Director believes that the problem arose due to changes in the design of appliances produced by SEL and not because of faulty production by ZTL. However, both the companies have agreed to refer the matter to arbitration.
Sales to SEL account for approximately 25% of the revenue of ZTL and the balance due from SEL as at 31 March 2012 amounted to Rs. 3.12 million. The profit after taxation of ZTL is Rs. 25 million with an asset base of Rs. 150 million. (07 marks)
(b) The directors’ report of XCP Limited states without any further explanation that the 20% increase in profit as compared to the previous year is due to increase in sales and austerity measures introduced by the management. The income statement for the year shows an increase in profits and sales amounting to Rs. 20 million and Rs. 8 million respectively whereas the costs have reduced by Rs. 12 million. A review of your working papers however indicates that costs have reduced mainly on account of reduction in import duty on certain raw materials. (04 marks)
(c) IPL is a manufacturer of diversified products and has factories in seven major cities of the country. The demand for some of its products has been falling and the company wants to concentrate on its core products only. Consequently, it has decided to close three of its factories and has made a provision of Rs. 30 million in respect of redundancies and restructuring. The directors’ report for the year ended 31 May 2012 comprehensively discusses the restructuring plan and states that the factories in Lahore and Multan would be closed in the months of July and September 2012 respectively. The third factory will be closed before December 2012 however, the location of that factory will be decided in November 2012.
The profit after taxation of IPL according to its draft financial statements for the year ended 31 May 2012 is Rs. 80 million. (06 marks)
Required: Discuss the matters which the auditor should consider for each of the above situations and the possible impact thereof on the respective audit reports.
Q. 3 You are the quality control partner in Wiew and Company, Chartered Accountants. You have been assigned additional responsibilities for assessment of risks associated with the firm’s existing and proposed clients. At present, the following matters are under your consideration:
(a) The government has invited ‘expression of interest’ for selling its strategic shares in Iqbal Limited (IL). One of your clients’ Zain Limited is interested in the deal and has requested your firm to carry out a due diligence exercise. Mian Limited has also approached your firm for carrying out a business valuation of IL.
(b) JKL Limited, a listed audit client of your firm, has been in dispute with a supplier. JKL is of the view that it has suffered losses on account of breach of contract by that supplier. JKL intends to file a suit in a civil court and has asked you to estimate the amount of damages that may be claimed and provide a detailed calculation thereof.
Required: Discuss the categories of threats involved in each of the above situations and advise the partners as regards the possible course of action that may be followed. (16 marks)
Q. 7 Mr. Mahmood is the engagement partner for the audit of Khyber Limited (KL), a listed company. In a meeting of the partners of the firm he had declared that Better Life Trust (BLT), in which he is a trustee, intends to purchase fifty thousand shares of KL from the open market.
Required: (a) State how should the firm deal with the above situation. ( 07 marks)
(b) What would the firm’s response be if Mr. Mahmood inadvertently fails to disclose the above fact before the purchase of shares and it comes to the knowledge of the firm after the shares have been purchased? (05 marks)
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