data analytics software corporate reporting question paper

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Data Analytics Software

Corporate Reporting

Question Paper

Practice Question 6


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Question 1 Assume that the date is 28 February 2019. You are part of the PCG audit team that has just commenced the final audit visit for Elephant. Emily Francis the PCG engagement manager for the Elephant audit gives you the following briefing: “You will have reviewed the interim audit information prepared by Vijay Shankar after the audit planning visit. You will also have familiarised yourself with the data for Elephant for the 11 months ended 30 November 2018. “Data for December 2018 has now been imported into the data analytics software from Elephant’s nominal ledger, so the full year nominal ledger data for the year ended 31 December 2018 is now available. Materiality has been set at £30,000. “I have had a meeting with Frank Wright, Elephant’s financial director. There are two specific matters arising from this meeting that we need to focus on (Exhibit 1). “Also, the Elephant board is concerned about the effect of further weakening of the Chinese yuan on the outcome of the contract with Rino Ltd. The board has provided an illustrative example of a currency forward to mitigate this exposure. The example was prepared by Frank Wright before he went on sick leave (Exhibit 2). “I am also concerned about the comments made by Tracey Bashir in the note included in her description of the results of audit procedures on expenses carried out at the interim audit visit. “I have set out instructions for you in a separate document (Exhibit 3).” Requirement Respond to the instructions from Emily. Use your firm’s Digital Audit Software to identify transactions and balances to support your answers where appropriate.

Total: 40 Marks Ignore any adjustments for current and deferred taxation


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Exhibit 1: Matters arising from meeting with Frank Wright – prepared by Emily Francis. Matter 1 – Contract with Rino Ltd

Frank explained that on 1 December 2018, Elephant agreed a large contract with a Chinese company, Rino Ltd, for the supply of a digital marketing campaign in the UK and Europe. He explained that Elephant had not dealt with Rino before and insisted on the payment of a substantial deposit being invoiced at the commencement of the contract. Rino agreed to the payment of deposit with a value of £100,000 but insisted that the contract be denominated in Chinese yuan (CNY). Therefore, the total contract transaction price was set at CNY2.7 million when the contract was agreed on 1 December 2018. The deposit was also invoiced in yuan for an amount equivalent to £100,000 at the prevailing exchange rate on 1 December 2018 of exactly 9 yuan to the British pound. Therefore, on 1 December 2018, Elephant invoiced Rino CNY900,000 in respect of the deposit. Frank posted a transaction to recognise the deposit as an overseas receivable, but incorrectly recorded the description as relating to a brand management contract with another client, Spooks. The remainder of the contract price is due for payment 30 days after performance of the contract is accepted by Rino. Elephant expects contract acceptance to occur in August 2019. On 31 December 2018, the exchange rate was £1 = CNY10.2 Frank stated that, at 31 December 2018, he estimated the total overall costs incurred and forecast to be incurred in relation to the contract with Rino over the contract’s life at £270,000. All costs in relation to the Rino contract will be incurred by Elephant in the UK. Matter 2 – Expenses with inadequate documentation I also discussed with Frank the fact that, at the interim audit visit, expense transactions had been identified with inadequate supporting documentation. In response, Frank informed me that the accounts department generally do not question expense claims made by Elephant’s directors. He also mentioned that, although there were expense claim authorisation and approval procedures, this was not applied to directors’ claims, as there was no one more senior to approve them. Frank also pointed out that the items I raised with him were for small amounts that had no real effect on the financial statements. Exhibit 2: Illustrative example – currency forward prepared by Frank Wright Due to the fall in value of the Chinese yuan, the Elephant board has become very concerned about foreign exchange risk related to the receipt of the remaining transaction price.


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Assume that on 1 March 2019, Elephant enters into a six-month currency forward to sell 1.8 million yuan at an exchange rate of 10.35 yuan to the British pound. This has the effect of

removing Elephant’s exposure to fluctuations in the value of the remaining contract price expected to be received on 1 September 2019. Assume the spot exchange rates are: £1 = CNY10.1 on 1 March 2019 £1 = CNY9.4 on 1 September 2019. Elephant will designate the value of the spot element of the currency forward as the hedging

instrument. Assume the change in the value of the forward related to financing cost (forward

points) between the forward’s inception and 1 September 2019 is £4,304.

Elephant has decided to treat the currency forward as a cash flow hedge.

Exhibit 3: The audit engagement manager, Emily Francis’ instructions – audit of Elephant for the year ended 31 December 2018 1. In respect of the three issues identified by Tracey Bashir (Exhibit A) from substantive testing

of expenses at the interim audit visit:

• Identify and explain the key audit risks for the audit of Elephant for the year ended 31 December 2018. Use the data analytics software to identify further specific transactions in relation to these issues which require investigation. Include any additional information that you require from Elephant’s management.

• Identify and explain any weaknesses in the substantive audit procedures on expenses carried out by Tracey Bashir at the interim audit (Advance information, Exhibit B.) Include an evaluation of the audit implications of Tracey’s comment on materiality (Issue 1) and her conclusion.

2. In respect of the contract with Rino discussed with Frank Wright (Exhibit 1)

• Set out and explain the appropriate financial reporting treatment for the year ending 31 December 2018 for the overseas receivable arising from the deposit on the Rino Ltd contract. Provide appropriate journals.

• Explain the financial reporting implications arising from the information provided by Frank regarding the expected cost for the contract with Rino Ltd. Set out the audit procedures that you would undertake in relation to this matter.


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3. Set out and explain the appropriate financial reporting treatment for the year ending 31 December 2019 for the illustrative example of a currency forward prepared by Frank Wright (Exhibit 2). Include journal entries.


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Solution notes

1 Identify and explain the key audit risks for the audit of Elephant for the year ended 31 December 2018. Use the data analytics software to identify further specific transactions in relation to these issues which require further investigation. Include any additional information that you require from Elephant’s management.

Issue 1: Inadequate supporting documentation

The description for two of the expense items identified includes the phrase ‘private travel’.

This suggests that these may not be valid business expense. This risk is increased by the

lack of supporting documentation.

The other transaction is described as a ‘three-night holiday’. It is difficult to see how

expenditure of this nature would be related to Elephant’s business. Therefore, this is also

likely to not be a valid business expense. The written request for payment from Jerry

Holmes, a director, does not provide any justification for payment. More information should

be sought from management to clarify the nature of this expenditure and management

asked for the rationale for its recognition as an expense.

All three of the items identified by Tracey may be examples of a staff member claiming

expenses for personal expenditure and would result in an overstatement of expenses.

If such a claim for personal expenditure as a business expense is determined as having

been made with intention to deceive it is likely to constitute a fraud by the individual

concerned, one of Elephant’s directors, involved to misappropriate company funds.

The three items can be identified in the nominal ledger using the data analytics software.

From the information available in the data analytics software, it can be determined that all

three transactions were posted by Andrea Bloggs. Two of the three transactions refer to

‘JH’ as the individual incurring the ‘private’ expenditure. JH appears to stand for Jerry

Holme to whom Andrea Bloggs is married. The fact that a member of the accounts team is

posting expenses incurred by their spouse is a risk factor for fraud unless adequately

mitigated by appropriate internal controls such as authorisation.


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Frank’s dismissive response to the inadequate documentation in relation to the sample

items and attitude to items claimed by directors is indicative of a key audit risk of

management override of internal controls over expenses and represents another fraud risk

factor.

A review, using the data analytics software of transactions posted by Andrea in the four

expense accounts sampled by Tracey reveals a large number of entries with a description

including ‘JH’. Although, none of these transactions has a narrative description suggesting

that these are not valid business expenses it does indicate that Andrea frequently posts

transactions for her husband.

The Detect module can be used to search for transactions containing the word ‘private’.

Performing this search reveals three further transactions in addition to those identified by

Tracey. Two of these have the description ‘Virgin train – JH/private travel’ and are for very

low values. The other is described as ‘Archduke Restaurant – JH/Private food’ with a

transaction value of £160 and posted by Andrea to account 26530 – Car Loan 7. An

explanation for this transaction and why it is posted to this account should be sought.

Issue 2: Expenses included in loan balances

The debiting of vehicle related expenses such as fuel and servicing to various Car loan

accounts rather than appropriate expense accounts may result in understatement of

expenses and overstatement of profit. Debiting these amounts to Car loan accounts would

only be appropriate if the amounts are ultimately repayable to Elephant by the employee

that incurred them. If this not the case, then there is a key audit risk that assets are

overstated and possibly that expenses are understated.

Frank stated that the board expects that the results for 2018 will exceed those for the year

ended 31 December 2017 and this may represent an incentive to overstate profit.

Reviewing the three Car loan accounts highlighted by Tracey in the digital audit software

shows a large number of transactions of this nature can be identified. For example:


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Transaction Id

Description

Amount

Account

Effective date

Posted by

NOM059315

Shell Chesterfield – GMJan/Fuel

53 26524 10/12/2018

FWRIGHT

NOM 059316

Shell Preston – GMJan/Fuel

34 26524 11/12/2018

FWRIGHT

NOM053982

North Road – GMJan/Fuel

68 26524 26/12/2018

TPOTTS

[Note: In the examination it is not possible to cut and paste extracts from the data analytics

software. So, if providing example transactions enough information should be included in

your answer to identify these transactions.]

These transactions have narrative descriptions that suggest that the amounts recorded

relate to items that should be either be expensed to profit or loss or are personal

expenditure by the individual employees.

Although the individual amounts are typically low value there are a large number of them

and may be collectively an amount in excess of materiality given the size of the Car loan

balances.

Issue 3: Large item posted by trainee

A limit of £30,000 has been put in place for transactions that Emma Davids, the accounts

trainee is permitted to post. Tracey has identified that this internal control has been broken.


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Using the Detect module (Large Value) it is possible to identify the transactions posted by

Emma that exceeded £30,000. It can be seen that Emma posted 11 transactions in excess of

the £30,000 limit during 2018. The total of these transactions was £451,310.

All but one of these transactions is described as a transfer, with the transaction posted in

November being a tax refund from HMRC.

The reasons why these transactions have been posted by Emma should be sought,

The fact that transactions have been posted by Emma in excess of the limit indicates a weak

internal control environment with inadequate supervision and ineffective operations of controls.

This is a key audit risk because a weak internal control environment increases the risk of

misstatement in the financial statements. The identification of a weak control environment may

require that decisions related to risk assessment and the determination of materiality are

revisited.

Identify and explain any weaknesses in the substantive audit procedures on

expenses carried out by Tracey Bashir at the interim audit (Advance information,

Exhibit B.) Include an evaluation of the audit implications of Tracey’s comment on

materiality (Issue 1) and her conclusion.

Tracey’s conclusion to her work indicates that she was uncertain and struggled with the

audit procedures she had been assigned. The audit senior was apparently unavailable to

supervise the work she carried out. Given the recent commencement of her apprenticeship

with PCG, it is very unlikely that Tracey had sufficient experience or technical competence

to carry out the procedures without supervision.

This lack of supervision has led Tracey to seek assistance from John Smith, a member of

the client’s accounts staff.

Whilst making enquiries and seeking information from client staff is a normal and

acceptable practice, it appears that in this case the assistance provided may have led to the

involvement of a member of the client’s staff in conducting audit procedures.

The involvement of John Smith in the work assigned to Tracey is problematic. The auditor

is responsible for designing and carrying out audit procedures and Tracey’s note suggests


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John’s assistance has led to his involvement in carrying out audit procedures. This is most

evident from his involvement in the selection of samples.

This is a serious weakness in the procedures carried out by Tracey. Client involvement in

sample selection creates a risk that sample items are cherry picked or problematic items

avoided. Samples should be selected by the auditor, with no possibility of interference from

the client.

It is also unclear as to the basis on which Tracey selected specific accounts to sample and

omitted others. This may have been at random, or at least not on a systematic basis and is

thus a serious weakness in the procedures carried out and may undermine the conclusion

drawn by Tracey that expenses are not misstated. There is also a risk that her choice of

account selection was influenced by John Smith

ISQC (UK) 1 Quality Control for Firms that Perform Audits and Reviews of Financial

Statements and other Assurance and Related Services Engagements lists human

resources as an element of a firm’s quality control system. The fact that Tracey appears to

have been left to perform a task without supervision for which she lacks sufficient

experience and knowledge suggests a human resources failure.

Ultimately, it is the engagement partner’s responsibility to ensure that appropriate staff are

allocated to each engagement team. However, allocation of tasks to audit staff is typically

delegated to the audit senior or other individual responsible for the day-to-day management

of the onsite audit visit.

Characteristics that should have be considered in assigning Tracey to this task should have

encompassed:

• An understanding of practical experience with similar engagements

• Appropriate technical knowledge

• Knowledge of the relevant industry

• Ability to apply professional judgement

Since Tracey has only very recently started work and has received very limited training, this

implies that she is unlikely to have satisfied these criteria.

Given her very limited experience Tracey should have been more closely supervised and

given more specific instructions for any work he was asked to do. The fact that the audit

senior was occupied on another client has resulted in a failure to adequately supervise her.


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ISA (UK) 220 Quality Control for an Audit of Financial Statements identifies that supervision

includes the need to consider the competence and capabilities of individual members of the

audit team and ensure that individuals understand instructions given. It could be argued

that this requirement has not been satisfied in respect of Tracey.

If the work carried out is not adequately reviewed by a more experienced member of the

audit team there may be an adverse impact on audit quality.

Regarding the comment on materiality, the items identified by Tracey are not material and

would likely be beneath the threshold to be considered trivial. As such, based on their value

the auditor would not need to include these within the total of aggregate misstatements to

determine its materiality.

However, these amounts may suggest fraud has occurred and despite the low value of the

amounts concerned under ISA 240 the auditor has a duty to respond appropriately to fraud

or suspected fraud identified during the audit. Furthermore, ISA 240 states that if the auditor

has identified that a fraud may exist, this must be communicated as soon as practicable to

those charged with governance. This is particularly difficult in this circumstance because

many of the transactions relate to transactions with directors.

Also, as directors, they are key management personnel and in accordance with IAS24

these are Related Party Transactions which are material by nature, even where they are

small.

Despite the small size of the items identified, consideration should still be given as to

whether these are indicative of significant deficiencies in the design or implementation of

controls. If this is determined to be the case it may be necessary to revisit decisions made

by the auditor in relation to materiality and risk assessment. In addition, the auditor should

make relevant parties such as Elephant’s management aware of these deficiencies.


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2. Set out and explain the appropriate financial reporting treatment for the year ending

31 December 2018 for the overseas receivable arising from the Rino Ltd contract.

Provide appropriate journals.

The amount of £100,000 recorded in relation to the deposit on the Rino contract represents the right to receive CNY900,000 expressed in Elephant’s functional currency, British pounds. Initial recognition has taken place at the spot rate of 9 yuan to the pound prevailing on 1 December. This transaction with Id number SRC006973, posted by Frank, can be identified within the data analytics software indicating the following entries occurred on 1 December 2018: Dr £100,000 51020 – Overseas sales Cr £100,000 21020 - Overseas receivable This receivable represents a monetary item and as such, must be retranslated at the closing rate on subsequent measurement at the year end in accordance with IAS 21. The prevailing spot rate for the yuan against the pound at the year end is 10.2 giving a retranslated value for the receivable of £88,235. The change in the carrying amount of the receivable of £11,765 represents a foreign exchange loss and is recorded in SOPL. Dr SOPL - Foreign exchange loss Cr SOFP - Overseas receivable There may also be an issue related to whether the amount of the deposit should all be recognised in revenue for the year ending 31 December 2018. In order to determine this further information would be required from management regarding the performance obligations of the contract and the extent to which services had been provided to Rino prior to the year end.

Explain the financial reporting implications for the financial statements for the year ended 31 December 2018 arising from the information provided by Frank regarding the expected cost for the contract with Rino Ltd. Set out the audit procedures that you would undertake in relation to this matter.

Account 21020 Overseas Receivable indicates a single transaction related to the recognition of the receivable related to the Rino deposit. This indicates that this amount is outstanding at the year end. Therefore, using the prevailing exchange rate at 31 December 2018 the total expected sterling value of the total transaction price of the Rino contract is £2.7miilion/10.2 = £264,706.


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This amount can be compared to the total expected costs for the contract. This is stated by Frank in the meeting with Emily to be £270,000. This indicates that at the 31 December 2018 the Rino contract is expected to generate a loss of £5,294.

IAS 37 defines an onerous contract as a contract where the unavoidable costs of meeting

the contract obligations exceed the expected economic benefits to be received.

On this basis the contract with Rino would be considered to be onerous. IAS 37 requires that a provision be established for an onerous contract. The provision should be equal to the amount by which unavoidable costs are expected to exceed economic benefits. The amount of excess unavoidable costs is included in profit or loss for the year. Therefore, Elephant should recognise a provision for the Rino contract of £5,294. This amount is not material, but is clearly non-trivial. Audit procedures in relation to this matter include:

• Obtain a copy of the contract with Rino and confirm total transaction price

• Confirm exchange rate at 31 December 2018 to reliable external information source (eg FT or Bloomberg)

• Request a listing of costs incurred on the contract to date

• Request a calculation of how the figure of £270,000 for total costs has been arrived at

• Examine supporting documentation for sample of costs incurred recorded to confirm related to Rino contract

• Obtain original cost budget for the Rino contract and identify cost variances against costs to date in order to identify possible cost overruns

• Review forecasts for future costs to identify whether all expected categories of cost are included

• Enquire of management as to whether Rino contract is progressing in line with schedule

• Identify any key milestones to date and enquire as to whether they were achieved on time

• Determine whether projected total costs include an allocation of overheads attributable to fulfilling the contract.

• Review correspondence with Rino for indication of disputes or other matters that could lead to further cost escalation


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3. Set out and explain the appropriate financial reporting treatment for the year ending 31 December 2019 for the illustrative example of a currency forward prepared by Frank Wright (Exhibit 2). Include journal entries.

Elephant intends to designate the spot element of the forward contract as the hedging

instrument. The sterling value of the yuan cash flow related to the payment of the remainder

of the transaction price of the Rino contract will be the hedged item. These represent an

eligible hedging instrument and eligible hedged item under IFRS 9.

In order to adopt hedge accounting further conditions must be satisfied in addition to the

hedging relationship consisting of eligible hedging instrument and hedged item.

Elephant must demonstrate that the hedging relationship between the currency forward and

the expected yuan receipt from Rino meets hedge effectiveness requirements of IFRS 9.

These require that an economic relationship exists between the hedged item and the

hedging instrument. Therefore, the currency forward must be expected to generate

offsetting changes in value to those related to the yuan receipt from Rino.

Also, credit risk must not dominate the value changes in either hedging instrument or

hedged item. This is likely to be satisfied by the proposed hedge in this case.

The final requirement for hedge effectiveness is that the hedge put in place must reflect the

hedge ratio of the hedging relationship. Since changes in value of both hedged item and

hedging instrument reflect to the effect of the exchange rate for yuan against the pound on

same yuan amount this condition is satisfied.

Elephant must also formally designate and document the hedging relationship at the

inception of the hedge and the entity’s risk management objective and strategy for

undertaking the hedge. The documentation must identify both hedged item and hedging

instrument, the nature of the hedged risk and state how the hedge effectiveness will be

assessed against the requirements.

Elephant’s expected receipt of 1,800,000 yuan on 1 September 2019 following Rino’s

acceptance of the contract is a firm commitment. This could be treated as a cash flow or a

fair value hedge. Elephant has elected to treat it as a cash flow hedge. The currency

forward protects the sterling value of the yuan receipt.

No entries are required on entering the currency forward on 1 March 2019 as a currency

forward will be conducted at the market forward exchange rate. A forward or futures

contract at market price always has a fair value of zero on inception.

On 1 September 2019, the loss from settling the currency forward will be £17,576

(1.8m/10.35 – 1.8m/9.4). Of this amount a loss of £4,034 relates to the forward points


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(financing cost) and the remainder of £13,542 (17,576 – 4,034) is attributable to the change

in the spot exchange rate.

As this is a cash flow hedge the change in the hedging instrument (the element of the

forward related to the spot value) is debited to OCI. The financing cost related to the

forward points is debited to profit or loss.

Journals:

Dr OCI – cash flow hedge reserve 13,272

Dr SOPL financing cost 4,304

Cr Cash 17,576 (cost to settle forward)

The hedged item is received in the same year, when this occurs the amount in OCI is

transferred to SOPL.

Cr OCI – cash flow hedge reserve 13,272

Dr SOPL 13,272

If we assume that Rino pays 1.8 million yuan on the 1 September, the sterling value net of

the hedge would be 1,800,000/9.4 – 13,272 = £178,217. This is an effective exchange rate

of 1,800,000/178,217 = 10.1 – the same as the spot rate at the inception of the hedge –

indicating 100% hedge effectiveness.


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APPENDIX TO THE ANSWER: Practice question - Elephant

The following section explains the audit software screens used and the navigation methods but is

not itself part of the answer. (Note: the data analytics software screens cannot be cut and pasted

from the software into your answer in the CR exam).

(1)

Issue 1

Select the Other Direct Costs within Expenses in Account View.

In stacked bar charts set both variables to effective period and click on May


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Scroll through list of transactions to identify transaction for £3,200

Follow same procedure highlighting 61085 – Travel and Subs on jobs, clicking in March in Stacked

Bar Charts for to identify transaction details for the other two transactions with inadequate

documentation.


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Select the four accounts sampled by Tracey in Expenses in Account View


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Click on to reveal transactions and Click on to filter for Andrea Bloggs’ postings


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Scrolling through reveals frequent clusters of transactions mentioning JH eg

[Note: Prior to attempting the question all transactions posted by Andrea in the four sampled

accounts in the 11 month data could also have been downloaded by clicking on and specifying

the four sampled accounts and Andrea as the poster.]

Selecting excel as the format exports the transactions in this form in an Excel spreadsheet


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These transactions are then available for scrutiny as per the extract below

(Note that reports form the AI 11 month data can only be downloaded for scrutiny prior to the

examination, not in the examination itself.)

The Detect module could be used to search for transactions with a description including the word

‘private’. First in Detect click on then select Configure Settings in the menu


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Then specify ‘Private’ as a Keyword and click confirm.


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The list of transactions including ‘Private’ will be available under the Keyword in Description

routine.

Click on Detail to reveal transactions.


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[Note: Reports based on changes to configuration will take time for Inflo to prepare and thus are

best performed on the 11 month data prior to the examination.]

Issue 2

Select the three Car loan accounts identified by Tracey in Account View


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Click on to reveal transactions and scroll through to note prevalence of transactions related to

fuel etc.


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Issue 3

Use Large Value routine and select Visualise


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In Graph by User click on bar corresponding to Emma Davids.


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This reveals all transactions posted by Emma of £30,000 or more.


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(2)

In Assets in Account View an account 21020 – Overseas Receivable can be identified.


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Click on to reveal transaction


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Click on transaction Id to identify double entry

[Note: As is often the case with Inflo there are several other ways that this transaction could have

been found. For example, by using the Large Value routine in Detect selecting Visualise and then

examining the large value transactions relating to December.]

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