Levels of Assurance

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Question 5c i ii

(c) Sycamore’s new finance director has read about review engagements and is interested in the possibility of Maple & Co undertaking these in the future. However, she is unsure how these engagements differ from an external audit and how much assurance would be gained from this type of engagement.

Required:
(i) Explain the purpose of review engagements and how these differ from external audits; and (2 marks)

(ii) Describe the level of assurance provided by external audits and review engagements. (2 marks)

Specimen
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MC Question 7

Which of the following statements relate to review engagements?

1 Subject matter is plausible
2 Reasonable assurance
3 Nothing has come to our attention which would indicate that the subject matter contains material misstatements
4 Positive assurance

A. 1 and 3
B. 2 and 4
C. 2 and 3
D. 1 and 4

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Question 1c

Pear International Co (Pear) is a manufacturer of electrical equipment. It has factories across the country and its customer base includes retailers as well as individuals, to whom direct sales are made through their website.

The company’s year end is 30 September 2012. You are an audit supervisor of Apple & Co and are currently reviewing documentation of Pear’s internal control in preparation for the interim audit.

Pear’s website allows individuals to order goods directly, and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.

Goods are despatched via local couriers; however, they do not always record customer signatures as proof that the customer has received the goods. Over the past 12 months there have been customer complaints about the delay between sales orders and receipt of goods.

Pear has investigated these and found that, in each case, the sales order had been entered into the sales system correctly but was not forwarded to the despatch department for fulfilling.

Pear’s retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. These customers place their orders through one of the sales team, who decides on sales discount levels.

Raw materials used in the manufacturing process are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks as well as supervisors.

In the past six months Pear has changed part of its manufacturing process and as a result some new equipment has been purchased, however, there are considerable levels of plant and equipment which are now surplus to requirement.

Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.

Pear’s finance director has expressed an interest in Apple & Co performing other review engagements in addition to the external audit; however, he is unsure how much assurance would be gained via these engagements and how this differs to the assurance provided by an external audit.

Required:

Identify and explain the level of assurance provided by an external audit and other review engagements. (3 marks)

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Question 4d

You are the senior in charge of the audit of Brampton Co for the year ending 31 January 2010 and are currently planning the year-end audit. Brampton specialises in the production of high quality bread of various kinds.

During the interim audit you noted that, in the present economic down-turn, the company has suffered as its costs are increasing and its prices have been higher than its competitors because of lower production runs. One indicator of the problems facing the company is that it has consistently used a bank overdraft facility to finance its activities.

At the time of the interim audit you had discussed with company management what actions were being taken to improve the liquidity of the company and you were informed that the company plans to expand its facilities for producing white bread as this line had maintained its market share. The company has asked its bank for a loan to finance the expansion and also to maintain its working capital generally.

To support its request for a loan, the company has prepared a cash flow forecast for the two years from the end of the reporting period and the internal audit department has reported on the forecast to the board of directors.

However, the bank has said it would like a report from the external auditors to confirm the accuracy of the forecast. Following this request the company has asked you to examine the cash flow forecast and then to report to the bank.

Required:

(d) Explain the kind of assurance you could give in the context of the request by the bank. (4 marks)

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Question 5d

Smithson Co provides scientific services to a wide range of clients. Typical assignments range from testing food for illegal additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.

The annual audit is nearly complete. As audit senior you have reported to the engagement partner that Smithson is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases, where Smithson’s services to assist the prosecution were found to be in error.

Not only did this provide adverse publicity for Smithson, but a number of clients withdrew their contracts. A senior employee then left Smithson, stating lack of investment in new analysis machines was increasing the risk of incorrect information being provided by the company.

A cash flow forecast prepared internally shows Smithson requiring significant additional cash within the next 12 months to maintain even the current level of services. Smithson’s auditors have been asked to provide a negative assurance report on this forecast.

Required:

In the context of the cash flow forecast, define the term ‘negative assurance’ and explain how this differs from the assurance provided by an audit report on statutory financial statements. (4 marks)

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