This 35 mark question involved the Stow Group, which had undergone some reorganisation during the year. A subsidiary had been disposed of, and a new foreign subsidiary had been acquired. Information was provided in the form of notes of a meeting that had been held with the Group’s finance director.

The notes described the acquisition of the foreign subsidiary Zennor Co and the goodwill arising on the acquisition, the disposal of Broadway Co, and gave information about some trading between group companies. In addition, some detail was provided on Zennor Co’s internal audit team.

As is typical in Question One, the requirements were based on planning the audit. The first requirement, for 12 marks, asked candidates to explain the risks of material misstatement to be considered in planning the Group audit, and to comment on materiality.

This type of requirement is standard for P7, many candidates made a reasonable attempt at this requirement. Almost all candidates could at least identify several risks of material misstatement and determine their materiality, however the quality of explanation varied dramatically between scripts.

The best dealt with issues included the acquisition of the new subsidiary, with the majority of candidates correctly retranslating its figures into the Group’s currency and discussing the risks relating to the reatranslation process. Other matters generally well dealt with was the measurement of goodwill on acquisition and the risks associated with the elimination of balances arising on transactions between Group companies.

The main weakness seen in candidate’s answers to this requirement was that of inadequately explained risks of material misstatements. While most candidates could identify a risk, only a small minority could adequately explain the risk.

For example, having identified a risk, say in the recognition of goodwill, some candidates would simple suggest that “this should be accounted for properly” or that “the auditor must ensure that this is calculated properly”, or simply “this needs to be accounted for in accordance with accounting standards”.

Unfortunately this type of comment does not adequately answer the question requirement and where candidates supplied this type of explanation in their answers they would be unlikely to generate sufficient marks to pass this question requirement.

Candidates are reminded that practicing past questions and carefully reviewing the model answers are the best way to prepare for this type of requirement, in order to understand exactly what is being asked for in the question requirement and to develop skill in explaining the risks identified.

Very few candidates picked up on some of the less obvious risks of material misstatement such as the tax implication of the disposal of Broadway.

Other common errors and weaknesses in answering this requirement included:

• Discussing business risks and failing to develop these into risks of material misstatement. 
• Discussing detection risks, which are not part of the risk of material misstatement. 
• Incorrectly calculating the amount of profit that should be consolidated for the subsidiaries during the year. 
• Stating that Zennor Co’s assets and liabilities should be recognised on a time-apportioned basis due to the subsidiary being acquired part way through the year. 
• Stating that goodwill on acquisition should be cancelled out and not recognised in the group accounts because it is an inter-company transaction. 
• Discussing that Broadway Co’s assets and liabilities should be classified as held for sale at the year-end, when in fact the subsidiary had been sold some months prior to the year end. 
• Providing long discussions on the use of component auditors at the year end, which was not relevant to the scenario. 
• Simply saying that a balance is material without demonstrating that this is the case.

Requirement (aii), for 4 marks, asked candidates, in the context of planning the Group audit, to identify further information that would be needed. Answers to this requirement were very mixed. Sound answers identified that information such as the due diligence report on the acquisition of Zennor Co and its previous years financial statements and audit reports would useful in planning the audit, as well as business background given that it is a first-year audit.

Some answers gave audit procedures rather than information requirements, which was not asked for. Again candidates are encouraged to review similar past exam requirements and their model answers to gain an understanding of the type of information that would be useful in planning the audit.