This paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted

ACCA FINAL ASSESSMENT Advanced Audit & Assurance December 2013 Time allowed Reading and planning: 15 minutes Writing: 3 hours Paper P7 This paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted Section B TWO questions ONLY to be attempted Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall. Kaplan Publishing/Kaplan Financial

PAPER P7: ADVANCED AUDIT & ASSURANCE Kaplan Financial Limited, 2013 The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials. All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing. 2 KAPLAN PUBLISHINGH

FINAL ASSESSMENT QUESTIONS SECTION A BOTH questions are compulsory and MUST be attempted 1 You are a manager in Acer & Co, responsible for the audit of Cedar Co and Cedar Group, including the audit of one of its subsidiaries, Spruce Co. This is the first year that your firm will be acting as auditor. Cedar Co is a listed company operating in Rootland. Cedar Co own and operate the high pressure gas transmission system, high-voltage electricity system, and local gas distribution networks which distributes gas to around 10 million consumers in Rootland. Cedar Co also owns a number of companies operating in related areas such as Spruce Co which manufactures and installs electricity and gas meters in Rootland and Leafdom, a neighbouring country. You are about to commence planning the audit for the year ending 30 June 2013, and you have received an email from Davidias Juniper, the audit engagement partner. To: Audit Manager From: Davidias Juniper, Audit Partner Subject: Cedar Co Audit Planning Hello (i) (ii) (iii) I would like you to start planning the audit of Cedar Co. As this is the first year that Acer & Co will be acting as auditor for Cedar Co, we need to gain an understanding of the business risks facing this new client. I recently met with Cherry Larches, the finance director of the company. Notes from my meeting are attached. Please prepare briefing notes to be used at a planning meeting with the rest of the audit team, in which you evaluate the business risks facing Cedar Co to be considered when planning the final audit for the year ended 30 June 2013. (11 marks) Using the information provided, identify and explain the risks of material misstatement in the financial statements of Cedar Co. (10 marks) Please also recommend the principal audit procedures to be performed in respect of the recoverability of the deferred tax asset. (4 marks) Notes from meeting with Cherry Larches: Cedar Co audit, year ended 30 June 2013 Spruce Co Spruce Co is a wholly owned subsidiary of Cedar Co, based in neighbouring country Leafdom. Leafdom has not adopted International Financial Reporting Standards, meaning that Spruce Co s financial statements are prepared using local accounting rules. Spruce Co uses the local currency of Leafdom to measure and present its financial statements. Cedar Co and the rest of Cedar Group measures and presents its financial statements in the currency of Rootland. Spruce Co manufactures and installs energy consumption meters, contracting directly with end consumers or building companies who require new or replacement meters to be installed. A non-refundable deposit of 5% of the cost for a meter must be paid on ordering the meter. Customers can choose to pay the full amount then, or pay once they have signed off the installation. Customers can cancel their order up until installation takes place. Spruce Co also contracts directly with Cedar Co; villages and towns not already on the gas network can pay Cedar Co to be connected, and Spruce Co supplies and installs meters on behalf of Cedar Co for the occupants of these towns and villages. Spruce Co was KAPLAN PUBLISHING 3

PAPER P7 : ADVANCED AUDIT AND ASSURANCE acquired by Cedar Co in 2009, and Cedar Co s management have been working hard to reduce the losses incurred by Spruce Co, although to date Spruce Co has not made a profit. Spruce Co has a deferred tax asset relating to unutilised tax losses which accumulated during a loss making period from 2005 to 2009 inclusive. They are confident that future taxable trading profits will be generated in order for the tax losses to be utilised. Past losses cannot be used to offset future profits in other group companies. Cedar Co Rootland does not have sufficient gas resource to support demand and so Cedar Co buys most of its gas in from overseas. The wholesale price for gas can fluctuate significantly depending on economic and political factors in the countries of source, and so Cedar Co uses forward contracts to fix the price. Cedar Co currently sources most of its gas from Branchia, a neighbouring country. Branchia has recently terminated supply to Leafdom, following a comment made by Leafdom s President about the ongoing government opposition in Branchia. The prices Cedar Co charges for use of its gas transmission and distribution networks are determined in accordance with regulator approved price controls, which include a number of incentives and penalty arrangements. The prices agreed with the regulator incorporate an allowance for capital investment. Cedar Co has an ongoing gas mains replacement programme, which it is committed to as part of the agreement with the regulator. Cedar Co is also committed to developing new technologies as the demand for energy sources to replace gas and oil increases. As part of this, Cedar Co acquired a number of plots of land some years ago, in order to build wind farms. Since their acquisition, the rules about where wind farms can be built have changed, and Cedar Co sold a number of these plots at a loss (the rule changes meant that they had no use for the plots). Land is recognised at cost in the statement of financial position. Cedar Co limits exposure to financing risks by restricting the number of loans due to mature in any one year. Cedar Co is currently renegotiating the terms of a loan with one of its banks, following a breach of loan covenants earlier in the year as a result of funds provided to Spruce Co to support it during this loss making phase. The share price of Cedar Co has dropped dramatically since news of the breach arose. Cedar Co is hoping to raise further finance in the next two to three years by issuing further shares. If consumers gas or electricity supply is disrupted, Cedar Co is required by the regulator to award each customer compensation of $30 per day, to a maximum of $1,000, as well as providing support and advice utilising Cedar Co staff who must visit affected customers within 72 hours of loss of supply. Severe winters in recent years in Rootland have caused a number of water mains to freeze and burst (for which Cedar Co is not responsible). The flood damaged gas pipes resulted in a loss of supply in several areas. A number of other companies in the energy industry have had some high profile disasters in recent years, which has put Cedar Co in the public eye, including in Leafland where a gas pipe exploded in a residential area, killing nine people. On a much smaller scale, health and safety is of paramount importance to Cedar Co in any case, as they are regularly visited by the health and safety regulator in Rootland. (a) Respond to the email from the engagement partner. (25 marks) Professional marks will be awarded in part (a), for the format of the answer, and for the clarity of the evaluation. (4 marks) 4 KAPLAN PUBLISHING

FINAL ASSESSMENT QUESTIONS (b) As part of its environmental commitment, Cedar Co wants to establish and to monitor a variety of social and environmental Key Performance Indicators (KPIs) and has asked your firm for some advice. Required: Recommend SIX KPIs which could be used to monitor Cedar Co s social and environmental performance, and outline the nature of evidence that should be available to provide assurance on the accuracy of the KPIs recommended. (6 marks) (Total: 35 marks) 2 You are a senior audit manager in Manhatton & Co, a global firm of Chartered Certified Accountants, with offices in more than 80 countries around the world. This morning you have been reassigned to the audit of Carrie Co, a long-standing audit client of your firm, as the manager previously assigned to the client has been removed following a complaint received from the Finance Director Jon Preston. Carrie Co is an IT services company, established ten years ago. Carrie Co provides IT support, backup and recovery services, IT infrastructure audits and web design. To: Audit Manager From: Audit Partner Regarding: Carrie Co Final Review Hello Thanks for taking on the role of audit manager for the audit of Carrie Co. The audit for the year ended 31 January 2013 is nearly complete, but the audit manager and Finance Director cannot agree on the treatment of a particular matter in the financial statements, and following a formal complaint received from Jon Preston (the Finance Director) about this and a number of other issues, we removed the audit manager. I need you to: (a) (b) Critically evaluate the work that has been completed by the previously assigned audit manager. Relevant details are provided in attachment 1, which contains notes made by her, and placed on the current year audit file. Make sure you include discussion of any ethical matters arising from the notes, and recommend any actions you think necessary. (11 marks) Explain the matters you should consider, and the evidence you would expect to find in respect of the carrying value of the cost of investment of Miranda Co in the financial statements of Carrie Co. Further details of the investment can be found in attachment 2. (7 marks) Attachment 1: Handover Notes: Carrie Co, year ended 31 January 2013, prepared by Samantha Jones, manager previously assigned to the audit. Goodwill on acquisition is understated by $6m, which is material to the financial statements of the Carrie Group. The Finance Director, Jon Preston, does not want to correct the misstatement. He says that it is not material by his calculations and wants to see how we calculated materiality for the audit. I haven t yet provided him with the working papers for materiality, but it may be appropriate to do so in order to demonstrate the need to amend this misstatement. KAPLAN PUBLISHING 5

PAPER P7 : ADVANCED AUDIT AND ASSURANCE Jon has offered to put a written representation together confirming that the misstatement is not material. I think we should make sure he delivers on this, if he continues to refuse to amend the financial statements, to ensure that we have a defence if we are challenged on our unmodified audit opinion. Jon has also asked us not to include a deficiency identified in the payroll cycle in the information we communicate to those charged with governance. A member of staff on secondment from Carrie Co to one of the subsidiaries, Aiden Co, was being paid by both companies by mistake and did not bring the oversight to the attention of management. We are bound by our duty of confidentiality in this disciplinary matter, and Jon believes it is none of the audit committee s business. Jon is not happy that it has taken more than four months following the year end to finalise the audit and would like to agree a shorter timetable and lower fee for next year. He hopes that we can achieve this by increasing the level of reliance we place on the internal audit function. We currently rely on internal audit s documentation and assessment of the operating effectiveness of internal controls, but I suggested to Jon that we do not look at the internal control system at Carrie Co at all, relying entirely on internal audit as they already assess the internal control function as part of their role and so we cannot add value by reviewing internal controls again. Attachment 2: Extract from working paper: Carrie Co, year ended 31 January 2013. Goodwill on acquisition of Miranda Co Prepared by: Aidan Shaw, audit senior 22/03/2013 Reviewed by: Samantha Jones, audit manager 05/4/2013. In July 2012, the acquisition of Miranda Co was completed; Miranda Co is wholly owned. Miranda Co is the fifteenth company to be acquired by Carrie Co. All of the subsidiaries are wholly owned; five of the subsidiaries are based in the same country as Carrie Co. Half of the overseas subsidiaries report under a different financial reporting framework to Carrie Co. Goodwill on the acquisition of Miranda Co is recognised in the consolidated statement of financial position at $3,850,000. The calculation provided by the client is shown below: $000 Cost of investment: Cash consideration 30,000 Other 50 Deferred consideration (Note 1) 5,000 Contingent consideration (Note 2) 0 Net assets acquired (31,200) Goodwill on acquisition 3,850 Note 1: The deferred consideration of $5m cash is payable on 31 July 2015. Note 2: The contingent consideration of $15m cash is payable on 31 July 2016 if Miranda Co s revenue grows at least 4% per annum. There is only a 40% chance that Miranda Co will achieve growth in revenue of at least 4% and so the directors have not included the contingent consideration in the goodwill calculation. 6 KAPLAN PUBLISHING

FINAL ASSESSMENT QUESTIONS All of the figures in the schedule are material to the financial statements of Carrie Co and the Carrie Group. We have reviewed the likelihood of achieving the revenue target and believe that the director s assessment of a 40% chance is robust. However, the fair value of the contingent consideration that should be included in the goodwill calculation is $6m. Required: Respond to the email from the audit partner. (18 marks) Note: the split of the mark allocation is shown within the partner s email. (c) (i) Define transnational audit, and explain the relevance of the term to the audit of the Carrie Group; (3 marks) (ii) Discuss TWO features of a transnational audit that may contribute to a high level of audit risk in such an engagement (4 marks) (Total: 25 marks) KAPLAN PUBLISHING 7

PAPER P7 : ADVANCED AUDIT AND ASSURANCE SECTION B TWO questions ONLY to be attempted 3 You are a manager in the audit department of Beaumont & Co, responsible for the audits of Hoy Co, Wiggins Co, and Pendleton Co. All three companies have a financial year end of 31 December 2012, and the audits of all companies are nearing completion. The following issues have arisen: (a) (b) Hoy Co is a large, private company, whose business activity is the manufacture of bespoke bicycle frames and parts. Hoy Co was established 15 years ago by Chris Boardsman and his wife, who still own the majority of the company s shares. The company has grown rapidly and now employs more than 200 staff in 12 offices. Five weeks ago Hoy Co s internal audit function discovered a fraud operating at one of the offices while reviewing the procedures relating to receipts from customers. A number of customers appeared to be settling their accounts late. On further investigation, the internal audit function discovered that one of the cashiers had been teeming and lading receipts from customers. (Teeming and lading is misappropriation of receipts from customers, concealed by recording a later receipt from a different customer against the account from which money was taken. The process is repeated so that it simply appears that customers are paying late, and the misappropriation consequently remains undiscovered). The Cash Manager had been absent from work throughout this period, due to illness, and the usual segregation of duties was not operating. Chris Boardsman is considering taking legal action against Beaumont & Co because their audit procedures did not reveal the fraud. Required: (i) Compare the responsibilities of the external auditor and of management in relation to the prevention and detection of fraud; and (ii) Recommend procedures that could be used by your firm to quantify the financial loss suffered by Hoy Co as a result of the fraud. (8 marks) Wiggins Co manufactures pushchairs, prams and strollers, as well as other equipment for parents. On 29 February 2013, Wiggins Co undertook a product recall of approximately 2,000 jogging strollers when it was identified that the front wheel can come loose and cause the stroller to tip over, posing fall and injury hazards to the children in the stroller and the adults pushing the stroller. The draft audit opinion is unmodified. The financial statements have not been amended in respect of this matter. Required: Comment on the financial reporting implications, and advise the further audit procedures to be performed. (6 marks) 8 KAPLAN PUBLISHING

FINAL ASSESSMENT QUESTIONS (c) Pendleton Co has decided to introduce an internal audit function to evaluate and monitor the adequacy and effectiveness of the company s internal controls. Pendleton Co intends to outsource the function and would like your firm to tender for the contract. Required: Evaluate the professional and ethical matters that should be considered in deciding whether to tender for the contract. (6 marks) (Total: 20 marks) 4 (a) Explain the term prospective financial information ( PFI ). (3 marks) You are an audit manager at Hive & Co, a firm of Chartered Certified Accountants. You have been approached by JTV Co, a commercial television network, for which you have been asked to tender for engagements to provide audit, assurance and business advice services. Due to the recent increase in cable and satellite television channels over the last three years, JTV has been impacted by a significant decline in revenue and profit. The directors want to secure a loan of $1m in order to launch a new channel. The new channel will produce sponsored programmes, available on demand (rather than the traditional scheduled programmes with commercial breaks). The $1m will be used to purchase the license to operate the new channel, and invest in new property, plant and equipment, as well as paying for the services of the personnel required during the first year of operation. The directors have approached Hatton Bank for the loan. The bank requires a detailed business plan to support the loan application which must be supported by an assurance opinion on the prospective financial information contained within the plan. You would be tendering to review the business plan and provide an assurance opinion as requested by the bank, undertake the annual audit, and if the loan is successful, to assist in developing JTV s corporate strategy. KAPLAN PUBLISHING 9

PAPER P7 : ADVANCED AUDIT AND ASSURANCE Prospective financial information from business plan Statement of Financial Position ACTUAL FORECAST As at 30 November As at 30 May As at 30 November 2012 2013 2013 2014 $000 $000 $000 $000 As at 30 November Non-current assets Intangible assets 658 658 1,050 1,050 Property, plant and equipment 138 124 153 165 Current assets Trade and other receivables 385 354 400 455 Programme rights and other 300 285 330 385 inventory Cash and cash equivalents 18 7 125 0 703 646 855 840 Total assets 1,499 1,428 2,058 2,055 Equity Share capital 2 2 2 2 Retained earnings 512 455 512 709 514 457 514 711 Non-current liabilities Term borrowings 224 174 1,024 934 Current liabilities Other payables 633 519 342 282 Provisions 28 28 28 28 Short-term borrowings 100 250 150 100 985 971 1,544 1,344 Total equity and liabilities 1,499 1,428 2,058 2,055 Statement of Comprehensive ACTUAL FORECAST Income Year to 30 November 2012 $000 Six months to 30 May 2013 $000 Year to 30 November 2013 $000 Year to 30 November 2014 $000 Revenue 2,064 960 2,742 3,055 Operating costs (1,950) (994) (2,674) (2,730) Operating profit /(loss) 114 (34) 68 325 Interest expense (20) (23) (45) (44) Earnings before tax 94 (57) 23 281 10 KAPLAN PUBLISHING

Required: (b) (c) FINAL ASSESSMENT QUESTIONS Recommend and describe the principal matters to be included in your firm s tender document to provide the services requested by JTV Co. (8 marks) Describe the examination procedures you should use to verify JTV Co s prospective financial information. (9 marks) (Total: 20 marks) 5 (a) You are the manager responsible for the audit of Énergie Renouvelables Inc (Énergie), a large publicly traded client of your audit firm, operating in the oil and gas industry, for the year ended 31 March 2013. Énergie is based in a country where an Emissions Agreement is in force. Under the agreement, large emitters of carbon dioxide must monitor their CO2 emissions and annually report them. Companies found to have misreported their greenhouse gas emissions are fined $100 for every ton they miss. The largest fine imposed to date is $1.5m. During the audit, you have become aware that Énergie s CO2 emissions monitoring system at its Carra plant was replaced on 15 January 2013, following a fault with the previous system. Énergie did not inform the regulator of the problems with the system, and reported an estimated 125,000 tons of CO2 emissions for the year ended 31 December 2012 (120,000 tons: 2011) based on readings taken using the old system. According to the new system, CO2 emissions at the Carra plant for the three months to 31 March 2013 were 50,000 tons, reflecting the increase in production volume at the plant following a new contract that commenced on 1 May 2012. The directors of Énergie concede that the likely CO2 emissions for the year ended 31 December 2012 was actually in the region of 150,000 tons. However, they have not informed the regulator of the difference as they made the best estimate of emissions given the information available at the time and therefore do not believe they should be subject to a fine. The directors have not disclosed the problems with the monitoring system anywhere in the financial statements as they do not believe that it is relevant, nor provided for any fine as they do not believe it would be material. However, shareholders of companies subject to the Emissions Agreement take breaches of this nature very seriously and it is very important to their decision making. Draft profit is $90m. Total assets are $320m. Required Identify and explain the matters to be considered, and the actions to be taken by the auditor, in respect of the misreporting of greenhouse gas emissions. (10 marks) KAPLAN PUBLISHING 11

PAPER P7 : ADVANCED AUDIT AND ASSURANCE (b) The audit work for the year ended 31 March 2013 is nearly complete, and you are reviewing the draft audit report which has been prepared by the audit senior. The Directors have refused to amend the financial statements in respect of the misreporting of greenhouse gas emissions. Basis of opinion (extract) Management have not accounted for a provision in respect of a fine relating to the misreporting of greenhouse gas emissions, which constitutes a departure from International Financial Reporting Standards. The company reported 125,000 tons of CO2 emissions for the year ended 31 December 2012, when an estimated 150,000 tons were incurred. Profits are overstated as a result of the non-recognition of the provision, but the overstatement is not material and therefore our opinion is not modified. Unmodified opinion as the misstatement is immaterial In our opinion the financial statements present fairly in all material respects, the financial position, of Énergie Renouvelables Inc as at 31 March 2013, and its financial performance and its cash flows for the year then ended, in accordance with International Financial Reporting Standards. Emphasis of Matter We draw attention to the basis of opinion paragraph above, which describes the misreporting of greenhouse gas emissions by Énergie Renouvelables. Our opinion is not modified in respect of this matter. Required: Critically appraise the draft audit report of Énergie Renouvelables for the year ended 31 March 2013, prepared by the audit senior; Note: You are NOT required to re-draft the extracts from the audit report. (10 marks) (Total: 20 marks) 12 KAPLAN PUBLISHING