Practical Illustration: Doing a Numerical and Discursive Question in Class. Adjunct Associate Professor Chee

Practical Illustration: Doing a Numerical and Discursive Question in Class Adjunct Associate Professor Chee

Explaining Concept Some concepts may be abstract for students who do not have working experience, e.g. Audit risk has three components: Inherent risk Control risk Detection risk

Explaining Concept Difficult to understand definition of technical terms, e.g. Inherent risk is the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

Explaining Concept Difficult to understand definition of technical terms, e.g. Control risk is the risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity s internal control.

Explaining Concept Difficult to understand definition of technical terms, e.g. Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Simplify explanation Explaining Concept Inherent risk = The risk that material misstatements occurred Control risk = The risk that material misstatements are: Not prevented; Not detected and corrected by internal controls Inherent risk = The risk that material misstatements are not detected by audit procedures

Management Pressure Inherent Risk Give Examples may manipulate FS Incentive may manipulate FS Expertise lack accounting expertise; junior staff lack guidance

Inherent Risk Give Examples Management Pressure may manipulate FS Incentive may manipulate FS Expertise lack accounting expertise; junior staff lack guidance Business Changes change in accounting system Data transfer error Users lack familiarity Technology Overvalued inventory (obsolete) Economy Cash flow problem Recession Accounting breach IFRS Recognition Recognise revenue too early (cutoff) Recognise research expense as intangible assets Measurement Revaluation of PPE Write down inventory to NRV Disclosure Did not disclose contingent liability

Inherent Risk Summarise Inherent risk is influenced by factors MBA Management PIE Business CTE Accounting RMD Management Pressure Incentive Expertise Business Changes Technology Economy Accounting breach IFRS Recognition Measurement Disclosure

Customise to Examiner s style F8 examiner classified the following risks as control risk, instead of inherent risk: Changes to accounting system Management lack accounting expertise Management Pressure Incentive Expertise Business Changes Technology Economy Accounting breach IFRS Recognition Measurement Disclosure Control risk

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 a) Explain the components of audit risk and, for each component, state an example of a factor which can result in increased audit risk. (6 marks)

Show how MBA can be applied to exam questions F8 Dec 2011 Q3(a) suggested solution

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 (b) Using the information provided, identify and describe FIVE audit risks and explain the auditor s response to each risk in planning the audit of Abrahams Co. (10 marks)

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 (b) The company uses a standard costing method to value inventory; the standard costs are set when a product is first manufactured and are not usually updated. FRS 2 Inventories Standard cost must approximate actual cost Outdated standard costs do not approximate actual cost overstate or understate inventory

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 (b) In September a new accounting package was introduced. This is a bespoke system developed by the information technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too onerous for the accounting team. Two months after the system changeover the IT manager left the company; a new manager has been recruited but is not due to start work until January. Data transfer error Lack support user error

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 (b) In order to fund the development of new products, Abrahams has restructured its finance and raised $1 million through issuing shares at a premium and $2 5 million through a long-term loan. There are bank covenants attached to the loan, the main one relating to a minimum level of total assets. If these covenants are breached then the loan becomes immediately repayable. Pressure to comply with loan covenants Assets may be overstated

Show how MBA can be applied to exam questions F8 Dec 2011 Q3 (b) The company has a policy of revaluing land and buildings, and the finance director has announced that all land and buildings will be revalued as at the year end. Revaluation may not approximate year end fair value Non-compliance with FRS 16

We have: Showing the way Explained concepts in a simple way and with easy to understand/exam relevant examples Summarised concepts into a few key words easy for students to remember MBA PIE; CTE; RMD Illustrated how to apply to exam question Next, students usually ask: What to write in exam answer How much to write in exam answer

Two Types of Discursive Questions Theoretical question without application Application question

Theoretical Discursive Question Different requirements = understand the level of details required by the examiner State/list Explain/describe

Different verbs Requirement State the five fundamental principles in the IFAC Code Answer Integrity Objectivity Professional competence and due care Confidentiality Professional behaviour Requirement Explain the integrity principle in the IFAC Code Answer Professional should be honest and straightforward in professional and business relationship.

Discursive Question Application Using the information in the case, identify and explain the ethical threats affecting the auditor s independence.

Discursive Question Application Using the information in the case, identify and explain the ethical threats affecting the auditor s independence. Identify = a situation or relationship in the case This relationship should be written in the answer Example = the auditor provides accounting service to audit client Explain the ethical threat State the threat created by the relationship Example = this gives rise to self-review threat Elaborate the threat Example = the auditor will be auditing the accounting records produced by himself

Meeting the level of details required by the examiner Bad answer Better answer Good answer The auditor provides accounting service to the audit client. The auditor provides accounting service to the audit client. The auditor provides accounting service to the audit client. This gives rise to a self-review threat. This gives rise to a self-review threat. The auditor will be auditing the financial statements that he produced.

Meeting the level of details required by the examiner Another example from F8 Describe substantive procedures to verify sales revenue

Meeting the level of details required by the examiner Bad answer Select samples sales source documents and agree details to ledgers. Why bad What source documents are not mentioned

Meeting the level of details required by the examiner Bad answer Select samples sales source documents and agree details to ledgers. Better answer Select sample sales orders, agree details to goods despatch notes, sales invoices and to receivable and general ledger.

Meeting the level of details required by the examiner Bad answer Better answer Why still improve Select samples sales source documents and agree details to ledgers. Select sample sales orders, agree details to goods despatch notes, sales invoices and to receivable and general ledger. Objectives of these procedures are not mentioned, i.e. what is the assertion tested

Meeting the level of details required by the examiner Bad answer Better answer Good answer Select samples sales source documents and agree details to ledgers. Select sample sales orders, agree details to goods despatch notes, sales invoices and to receivable and general ledger. Select sample sales orders, agree details to goods despatch notes, sales invoices and to receivable and general ledger to ensure sales transactions are completely and accurately recorded.

Know The Marking Scheme Different examiners have different marking schemes Example F8 from June 2010 onwards Describe = generally 1 mark per point that is adequately explained F8 prior to June 2010 Describe = generally 2 marks per point

Different examiners have different requirements F8 From June 2010 onwards Substantive procedures and test of controls are clearly differentiated in requirements Describe substantive procedures (sales revenue) Describe test of controls (sales system) Prior to June 2010 Describe audit procedures (sales) Include test of controls and substantive procedures

Interpreting multiple requirements Some requirements contain multiple requirements. Example F8 Identify and explain ethical threats affecting auditor s independence and for each threat, describe the auditor s response to the threat. Identify and explain ethical threat Describe auditor s response P1 Explain, with reference to the case, the roles of non-executive directors The four roles of NED Use the information in the case as example of the four roles of NED

Doing a discursive question in class Help the students to interpret the requirements How many detailed requirements How many key points are required (based on the marking scheme) Go through the case to identify relevant points Organise the answers in terms of the level of details required Show bad answers, better answer and good answer

Doing a numerical question in class Go through the marking scheme Using F7 as example, preparing different items in the statement of financial position are given different marks Receivable, payable, bank, etc 1 mark each Goodwill 5 marks

Doing a numerical question in class Prepare work sheet that is modelled after examiner s suggested solution in areas where examiner expects working to be included in the answer, for example Determination of consideration paid/payable to acquire Goodwill determination Determination of unrealised profit in inter-company asset transfers Bond amortisation table Determination of non-controlling interest at year end

Example determining interest come (expense) from bond receivable(payable) A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % %

Example determining interest income (expense) from bond receivable (payable) On 1 July, the company purchase debt securities in cash measured at fair value through profit or loss for $500,000. The principal amount + $460,000 Coupon rate = 5% p.a. Years to maturity = 4 years Interest is paid annually in 30 June Effective interest rate per annum = 2.6786% Required: Prepare the bond amortization table for the US$ debt securities in United States dollars for the period from 1 July 2012 to 30 June 2014.

A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % % 1.7.2012 5% 2.6786% (40,000) 500,000

A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % % 5% 2.6786% (40,000) 500,000 30.6.2013 23,000 13,393 9,607 (30,393) 490,393 460,000 x 5% = 23,000 500,000 x 2.6786% = 13,393

A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % % 5% 2.6786% (40,000) 500,000 30.6.2013 23,000 13,393 9,607 (30,393) 490,393 (40,000) + 9,607 = 30,393

A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % % 5% 2.6786% (40,000) 500,000 30.6.2013 23,000 13,393 9,607 (30,393) 490,393 30.6.2014 23,000 13,136 9,864 (20,529) 480,529

A B C Date Cash Effective Amortisation Unamortised Carrying Interest Interest A-B Amount % % 5% 2.68% (40,000) 500,000 30.6.2013 23,000 13,393 9,607 (30,393) 490,393 30.6.2014 23,000 13,136 9,864 (20,529) 480,529 30.6.2015 23,000 12,871 10,129 (10,400) 470,400

Example determining interest come (expense) from bond receivable(payable)

Doing a numerical question in class Worksheet example Determination of consideration paid/payable to acquire subsidiary Cash consideration Share issues fair value Deferred consideration discounted to present value Contingent consideration expected value discounted to present value

Doing a numerical question in class Worksheet example Determination of goodwill Purchase consideration Non-controlling interest Fair value of assets and liabilities acquired

Worksheet Purchase consideration = Investment in Subsidiary Cash consideration Shares exchange Bond payable Deferred cash consideration Contingent consideration Total Purchase consideration $

Doing a numerical question in class Worksheet example Determination of non-controlling interest Fair value of NCI on acquisition date Post-acquisition profit

Doing a numerical question in class Worksheet Avoid the use of excessive workings which only serve to waste candidate's time No workings at all are likely to get nil marks for unsupported figures.

Doing a numerical question in class Go through opposite cases, for example One case where there is goodwill on consolidation and another case where there is negative goodwill One case where the fair value of assets and liabilities exceed the carrying amount and another case where the fair values are lower than the carrying amount

Thank you