This 35 mark question was based on planning the audit of a new client – the Adams Group. The Group comprised a parent company, three subsidiaries, one of which was located overseas, and an associate which had been acquired during the year. Information relevant to each of the components of the Group was detailed in the form of narrative notes and draft consolidated financial statements were also provided.

The notes contained information on the Group’s activities, details of inter-company transactions, a portfolio of investment properties held by one of the subsidiaries, a new system introduced in relation to inventory, and a bonus for management based on revenue. Details were also provided in respect of the auditors of the overseas subsidiary, which had retained the services of a small local firm.

The first requirement, for 18 marks, asked candidates to evaluate the audit risks to be considered in planning the audit of the Group. This is a very typical requirement for Question one in the P7 paper, and while it was encouraging to see that many candidates had clearly revised this part of the syllabus, there were many whose answers were extremely disappointing.

The best answers worked through the information provided in the question to identify the various audit risks, and evaluated them by, including an assessment of materiality and a discussion of the significance of the risks identified.

Most candidates proved able to include a discussion of the most obvious of the risks in their briefing notes, including the management bonus, the classification of the associate, the valuation of investment properties and the potential control risk caused by implementing a new system during the year.

Only the better candidates identified the risks arising from the opening balances and comparative information (due to this being a new audit client for the firm), the lack of presentation of income from the associate in the Group statement of profit or loss, the incorrect treatment of the investment property revaluation gains (which should be recognised as part of profit for the year) and the change in the effective tax rate.

The best answers included in their evaluation of each audit risk an identification of the risk factor from the scenario (e.g. the measurement of the investment properties), a determination of materiality where possible given the information in the question, a clear comment on the appropriateness of the accounting treatment where relevant, and the impact on the financial statements (e.g. not cancelling inter-company transactions would lead to overstated revenue, cost of sales, receivables and payables).

The key weakness present in many answers was the poor quality of explanations. Most candidates could identify a reasonable range of risks but could not develop their answer to demonstrate a clear evaluation of that risk, in a suitable structure, like the one discussed above.

For example, having identified that the portfolio of investment properties would give rise to some kind of audit risk, many candidates would then attempt to expand their answer with vague comments such as “there is risk this is not accounted for properly”, “there is risk in the accounting treatment” or “there is risk that IAS 40 will not be followed”. This type of comment does not represent a detailed evaluation of audit risk and does not earn credit.

Other weaknesses seen in many answers included:

• Incorrect materiality calculations or stating that a balance is material without justification; 
• Incorrect analysis of the financial statements provided or incorrect trend calculations, the most common of which was stating that inventory had increased by 50% when it had doubled; 
• Too much emphasis on business risk with no development or discussion of the audit implications; 
• Not using the draft financial statements at all to identify audit risks; 
• Not identifying from the scenario that all Group members use IFRS as their financial reporting framework and report in the same currency, leading to sometimes lengthy discussion of irrelevant matters; 
• Long introductions including definitions of audit risk, showing a lack of appreciation of the fact that the notes are for an audit partner, and general discussions about audit planning; 
• Lack of understanding of certain accounting treatments such as equity accounting for associates and the correct treatment of investment properties; 
• Focussing on goodwill - despite the fact that no goodwill was recognised in the Group financial statements many answers discussed at length that it must be tested for impairment annually; 
• Suggesting that the bonus scheme would lead to manipulation of expenses, when the bonus was based on revenue.

Requirement (aii) was for five marks, and asked candidates to identify and explain any additional information which would be relevant to the evaluation of audit risk. There were some relatively straightforward marks available here, and strong answers suggested that the individual financial statements of the components of the Group would be essential to successfully plan the audit, along with information pertaining to the management bonus scheme, any due diligence report relevant to the acquisition of shares in the associate, and background information such as relevant laws and regulations to which the Group members are subjected.

Weaker answers suggested audit procedures which are not relevant to the planning stage of the audit, or just asked for management representations on matters that were included in the question scenario. A similar requirement was included in Question One of the December 2013 examination, so it was surprising that candidates seemed somewhat unprepared for this requirement.