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No. of Pages - 07

No. of Questions - 05

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

CA PROFESSIONAL (STRATEGIC LEVEL II) EXAMINATION -

JUNE 2013

23404 - ADVANCED AUDIT & ASSURANCE

Instructions to candidates:

(1) Time allowed:

Reading and planning : 15 minutes

Writing : 3 hours

(2) Marks : 100 marks

(3) Answer all questions.

(4) Begin each answer on a separate page. Submit all workings.

(5) All answers should be in English Language, in the answer booklets provided.

(6) The examination will be conducted as an open book examination and the following publications

of CA Sri Lanka only will be permitted to be used at the examination hall.

Sri Lanka Auditing Standards & Sri Lanka Standard on Quality Control 1 - 2011

Code of Ethics

Sri Lanka Other Audit Pronouncements - (Sri Lanka Auditing Practice Statement, Sri

Lanka Standards on Assurance Engagement, Sri Lanka Standards on Review

Engagement, Sri Lanka Standards on Related Services)

Sri Lanka Accounting Standards - 2011

Open Book Referential - Student edition (Code of Best Practice on Corporate

Governance, Sri Lanka Accounting Standards - changes with effect from 1/1/2012,

IFRICs and SICs applicable for financial period beginning on or after 1/1/2012)

(7) Students are allowed to bring permitted publications which are highlighted, sidelined or

underlined. Short notes written on the permitted publications will also be allowed. Page tabs

may be used to refer the pages.

(8) Notes, texts books (other than permitted publications) or any other materials will not be allowed.

Photocopies/extracts of the above publications will not be allowed.

(9) Answers written on the answer booklets, graph papers and any other stationery, distributed at the

examination hall, only are considered in marking of answer scripts. Any other attached

documents are not taken into account at the time of marking answer scripts.

(2)

Question No. 01

You are the manager in charge of the audit of Rajesh Hotel PLC.

Rajesh Hotel PLC (“RHP” or “Company”) is a five star hotel located in the northern part of the

country. It was established many decades ago by the grandfather of the current owner. It has 350

rooms and 5 suites and caters for tourists mainly from South Asia. RHP employs more than 500

employees. RHP is not liable to income tax.

The financial statements of the Company have been prepared in accordance with Sri Lanka

Accounting Standards comprising SLFRS and LKAS (hereafter "SLFRS"), as issued by the

Institute of Chartered Accountants of Sri Lanka. For all periods up to and including the year

ended 31 March 2012, the Company prepared its financial statements in accordance with SLASs

effective up to 31 March 2011.

The following extracts have been given from the financial statements for the year ended 31

March 2013 which Company has prepared in accordance with SLFRS effective for the periods

beginning on or after 01 January 2012.

First-time Adoption of SLFRS:

The effect of Company’s transition to SLFRS, is summarised in this note as follows:

A. At the transition date, the Company chose to state the buildings that were at their fair

value as deemed cost; as a part of the transition the Company also reviewed the useful

life of each significant component of buildings.

In addition, with effect from 1 April 2012, the Company reviewed the useful lives of each

significant component of buildings. In the review process, the Company has taken into

account the experience of recent refurbishment. Accordingly, depreciation was calculated

for the year ended 31 March 2013 for each individual significant component of buildings.

B. Leasehold property under previous SLAS was measured at revalued amounts. Based on

SLFRS, this item is now reflected as Prepaid Lease Rent as at historical cost.

C. Certain intangibles recognized based on previous SLAS, were revisited under SLFRS.

Such intangibles that did not qualify to be recognized under SLFRS, were written off.

D. Investment in shares in an entity that was earlier reflected as Investments at Cost under

previous SLAS was shown as Other Non-current Financial Assets Available for-Sale, at

fair value. For the year ended 31 March 2011, the measurement of this investment at fair

value resulted in a fair value loss of Rs. 10 million through Other Comprehensive

Income. The fair value loss was further increased by Rs 0.1 million for the year ended 31

March 2013.

E. Apart from the above, the Company also reclassified Treasury Bills and Short Term

Investments as Held to Maturity- Other Current Financial Assets.

F. Creditors were measured at present value.

(3)

Reconciliation of Equity as at 1 April 2011 (Date of Transition to SLFRS)

Previous Classification Notes Previous

SLASs

Effect of SLFRS

Adoption SLFRS as

at 1 April

2011

New Classification Re-

classification

Re-

measure

ment

Non-Current Assets

Property, Plant and

Equipment A 536 - - 536

Property, Plant and

Equipment

Leasehold Property B 12 - (8) 4 Prepaid Lease Rent

Intangible Assets C 2 - (2) - Intangible Assets

Investments D 11 (11) - -

- 11 (10) 1 Other Non-current

Financial Assets.

561 - (20) 541

Current Assets

Inventories 100 - - 100 Inventories

Trade and Other

Receivables 32 - - 32

Trade and Other

Receivables

Investments D 53 (53) - -

Cash at Bank and in Hand 5 - - 5 Cash & Short Term

Deposits

E -

53 - 53 Other Current

Financial Assets

190 - - 190

Total Assets 751 - (20) 731

Equity & Liabilities

Capital and Reserves

Stated Capital 230 - - 230 Stated Capital

Reserves A,D 307 (299) (18) (10) Reserves

Retained Earnings A,F 81 299 1 381 Retained Earnings

Total Equity 618 - (17) 601

Non-Current Liabilities

Employee Benefit

Liability 5 - - 5

Post-Employment

Benefit Liability

5 - - 5

Current Liabilities

Trade and Other Payables F 128 - (3) 125 Trade and Other

Payables

128 - (3) 125

Total Liabilities 133 - (3) 130

Total Equity and

Liabilities 751 - (20) 731

(4)

Based on the audit planning memorandum, the following matters have been noted by the audit

team.

Extract from Audit Planning Memorandum

1. As we have noted significant audit adjustments in the previous year’s audit arising due to

cut off issues in sales and purchases, we decided to carry out more audit work focusing

on this risk.

2. Inventory count observation is a must as there are third party storages.

3. The Company has remitted USD 1 million to a party for a future marketing arrangement,

for which the Company has not obtained approval from the Exchange Control

Department.

4. It is the Company policy to outsource all activities from recruitment to payment of

salaries in the HR function, to a payroll service provider. Under the current arrangement,

the Company advances a lump sum amount at the end of the first week in a given month

that is used by the payroll service provider to make payroll payments.

Required:

(a) Explain five (5) significant matters that you consider important, from the reconciliation

of assets and liabilities as at the date of transition. Marks will only be awarded for

significant matters.

(10 marks)

(b) State two (2) specific audit focus for each of the matters identified in (a) above.

(10 marks)

(c) Propose two (2) specific audit procedures to the audit team to carry out in connection

with the cut off issue (as identified in item 1 of the Extract from Audit Planning

Memorandum as given above).

(3 marks)

(d) Propose two (2) specific audit procedures in observing the physical count of inventory,

(as identified in item 2 of the Extract from Audit Planning Memorandum as given above).

(3 marks)

(e) Explain the areas to be considered in evaluating the matters connected with the

remittance of USD (as identified in item 3 of the Extract from Audit Planning

Memorandum as given above).

(3 marks)

(f) Propose two (2) specific audit approaches when auditing the outsourced payroll function,

(as identified in item 4 of the Extract from Audit Planning Memorandum as given above).

(3 marks)

(Total 32 marks)

(5)

Question No. 02

You are the manager in charge of the audit of Great Products PLC (GP), listed on the Colombo

Stock Exchange. The following matters have surfaced during the audit that you are required to

bring to the notice of the Partner through a written memorandum.

Required:

Evaluate each issue given in the following paragraphs. Your answer should include a discussion

of the issue, conclusion or a suggested further action on each of the stated issue.

(a) You noticed that GP has shown a balance under other asset termed as “Advances against

expenses of key management personnel”. The CFO being a Chartered Accountant has

mentioned to you to ignore the balances as that are not material and not provided any

information about the nature of the balance.

(4 marks)

(b) The audit team has completed tests of controls in the special cash receipts process. Based

on the audit plan a sample of 25 dates was selected to test the controls based on a

sampling method. In such sample testing, the team noted in four instances that there was

lack of audit evidence whether the particular control has actually happened or not.

(5 marks)

(c) GP carries out different CSR activities under various programs. During the year the

company together with the employees carried out a large scale funds collection campaign

in aid of the Cancer Hospital expansion. Many employees gathered round this activity

with their friends and raised a considerable sum for this worthy cause.

(4 marks)

(d) For the purposes of the audit, your team has identified inventory as a significant area.

Inventory is located in five warehouses in different parts of the country. Four such

warehouses are state-of-the-art logistics hubs with full IT enabled controls. One location

is a third party owned warehouse. All five warehouses carry approximately equal value of

inventories. You have called for a confirmation of inventory held by the third party, and

received a satisfactory response with no differences between the ledger and the third

party documentation. However your audit team has noted in the working papers, a

immaterial difference between one Goods Issued Note submitted by the third party

warehouse and GP’s general ledger. The team has also noted a few comments made by

the internal auditor of GP regarding the inventory items at the third party warehouse,

where samples were verified by the internal auditor close to the year end.

(5 marks)

(Total 18 marks)

(6)

Question No. 03

You are the partner in charge of the audit of Macfree group of companies. The group is family

owned. In order to grow the business, the board structure has been reconstituted recently with the

appointment of executive directors and non - executive directors to the Board of Directors of the

group. Further, professionals have been recruited to hold senior management positions, and they

have been entrusted to make key business decisions and manage the operations of the group. At a recent discussion with the non-executive Chairman and the major shareholder of the group,

you are informed that the directors and senior management are to be offered various incentives to

retain and motivate them to grow the group’s business. Along with attractive remuneration

packages the group is to offer profit bonuses and an employee share option scheme to its senior

managers.

The Chairman is concerned over the confidentiality of remunerations and benefits and wanted to

know what needs to be disclosed under existing accounting standards and regulations.

Prepare a guideline to be issued to Macfree group of companies regarding the disclosures that are

required to be made in relation to remuneration of key management personnel, according to the

existing accounting standards and regulations. The report should refer to the accounting

standards and regulations and provide guidance on the disclosure requirements contained therein.

(15 marks)

Question No. 04

Sennon (Pvt) Limited has been an external audit client of your firm for the last 2 years. The

principal activity of the company is the provision of installation services for telecommunication

companies.

Thushari Silva has been the audit manager of this client for the last 2 years. While finalizing the

audit of Sennon (Pvt) Limited for the year ended 31 March 2013 Thushari was fallen sick and

you have been asked to replace her. You have not handled any work in relation to Sennon prior

to this.

Reviewing the audit file you gather the following information:

The company had previously made losses and its brought forward retained earnings were a

negative Rs. 23 million. The company’s net profit after tax for the year ended 31 March 2013

amounts to Rs. 15 million.

The company is involved in the installation of telecommunication towers and network

equipment. All services carried out by company are based on contracts from telecommunication

companies. The contract provides for the retention of 5% of the contract value, to be held for one

year to cover any installation deficiencies.

On review of correspondence, it was noted that Rs. 1 million of retention funds are not to be

refunded due to installation deficiencies. The directors who are minority shareholders, are

unwilling to amend the financial statements as the amendment will cause the earnings figure to

drop below the level that has to be achieved for them to earn their performance incentives.

(7)

Amounts due from related parties includes an amount of Rs. 5 million due from Sennon

Development (Pvt) Limited (SDL). This amount has been advanced to SDL to pay for a survey

and feasibility study of a property development project. The financial statements of SDL have

not been prepared and audited for the last 2 years as the company has not been able to secure the

land concerned, and SDL has not carried out any other transactions. A confirmation has been

received from SDL for the balance as per their records which reflects a payable to Sennon (Pvt)

Limited of Rs. 4.8 million.

At the final discussion in concluding the audit, the directors of Sennon (Pvt) Limited offer you

the position of head of finance of the group with an attractive remuneration package. They want

you to join the company after completion of the current audit.

Requirements

(a) Based on the above review findings state whether you will modify the audit report.

Explain giving reasons for your conclusions and outline the modification, if any.

(10 marks)

(b) Comment on the conduct of the directors of Sennon (Pvt) Limited and explain why the

integrity of the directors should be considered by your firm when deciding whether to

continue to act as an external auditor for future periods.

(10 marks)

(Total 20 marks)

Question No. 05

You are a partner in Perera & Company. Your firm has been providing internal audit services to

International Services (Pvt.) Ltd (ISL) for the last 2 years. In providing this service you have

built up a professional relationship with the management of ISL.

Your network firm, Perera Corporate Services (Pvt.) Limited (PCSL) is the company secretary of

ISL. All work undertaken by PCSL is managed by Mrs. Silva, a Chartered Secretary.

The statutory audit for the year ended 31 March 2013 is in progress and the directors of ISL have

approached you to obtain an opinion from you regarding a disagreement they have with their

current auditors. They have requested your written opinion so that it may be presented to their

current auditors. Arising from this disagreement with the current auditors, the directors of ISL

have also requested the following services from your firm:

(i) that your firm be appointed the external auditor of ISL ;and

(ii) that you, as the proposed engagement partner, attend the company’s monthly board

meetings.

Requirement

Discuss the potential threats that will arise if you decide to provide the additional services

requested by ISL and describe what safeguards (if any) could be put in place to mitigate those

threats according to the Code of Ethics issued by the Institute of Chartered Accountants.

(15 marks)