Auditing Hand Out

MORE REVISION SERIES-PAST QUESTIONS AND ANSWERS ON AUDITING & TAXATION- ICM- UK (ACCOUNTING & FINANCE)

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JUNE 2005 AUDITING & TAXATION

QUESTIONS

PART A

1. Post balance sheet events can be ignored. Discuss. [10]

PART B

2. a) Explain the rights of an auditor. [10] b) Explain the principal contents of an auditor‟s report. [10]

3. Explain briefly how you would verify the following items: a) Freehold land and buildings

b) Investments c) Stocks and work in progress d) Trade creditors [5 each]

4. a) Explain the role of the internal audit department. [10]

b) Outline the stages of an audit. [10] 5. Explain the following terms:

a) Letter of engagement b) ICQ

c) Internal controls d) The dismissal of an auditor [5 each]

PART C

The following information applies to any personal tax calculations: TAX RATES

10% on the first $3,000 of taxable income 20% on the next $27,000 of taxable income

40% on any further taxable income PERSONAL ALLOWANCES Single person $8,000

Additional allowance of $3,000 can be claimed by one of the partners in a marriage PENSION CONTRIBUTIONS

Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a qualifying pension fund.

From age 50 a maximum of 20% can be paid in.


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6. Corin, aged 56, is a single person who earns $48,000 per year. He has paid 5% of his

gross pay into a qualifying pension fund. Corin has also paid $600 in respect of professional subscriptions.

Brian, aged 39, is married (and claims the additional allowance) and earns $46,000. He

has paid 6% of his gross pay into a qualifying pension. Brian has also paid $500 in respect of expenses that are allowable against tax.

TASKS Calculate the taxable pay and the total tax payable for EACH of the following: a) Corin [7]

b) Brian [8]

7. The following is the summarized internal Profit & Loss account of KRE Ltd after its first year of trading:

£

Sales 2,600,000 Cost of sales (1,300,000)

Distribution costs (450,000) Administration expenses (290,000) Depreciation of equipment (80,000)

Depreciation of IT equipment (30,000) Other information:

Original cost of equipment 600,000 Original cost of IT equipment 150,000 Corporation tax (i.e. company taxation) is charged at 20% of the taxable profit.

Initial writing down allowances are: 25% as regards equipment

50% as regards IT equipment Included in the distribution costs is £6,000, which is deemed non-allowable. TASK

Calculate KRE Ltd‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) The tax benefits of contributing to a pension plan b) PAYE

c) The collector of taxes d) Capital gains tax (CGT)

[5 each]


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SUGGESTED ANSWERS: JUNE 2005

Q1.

Post Balance Sheet Events

These are events, both favourable and unfavourable that occurs between the balance sheet date

and the date on which the financial statements are approved by the Board of Directors”. Post balance sheet events fall into two categories, namely

1. Adjusting events 2. Non-adjusting events

Adjusting events are events that provide additional information or conditions existing at the balance sheet date. Example is the discovery of error or fraud that shows that the accounts

were not correct after the balance sheet date. Another example is proposed dividends. Non-adjusting events are events that arise after the balance sheet date and concern conditions

that do not exist at the balance sheet date. Such events will not have any effect on the balances in the Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers and

acquisitions, strikes and labour disputes, changes in the exchange rate etc IAS 10 /FRS 21 (Events after the Balance Sheet date) requires that the auditor should design

his audit procedures to ascertain whether such events exis t. He should perform post balance sheet review before signing his report. He should be able to distinguish between adjustable

events, non-adjustable events, and their effect on the financial statement. Material post balance sheet events require changes in the amounts to be included in the financial statement where:

a) It is an adjusting event or

b) It indicates that application of the going-concern concept is not appropriate. A material post balance sheet event should be disclosed where it is a non-adjusting events

From the above, it can be concluded that post balance sheet events cannot be ignored and the auditor has a duty to perform post balance sheet review to determine their effects on the financial statement before signing his report.

Post-balance sheet events will be disclosed in the notes to the financial statements, in addition to disclosure in the members‟ report. The financial impact of post-balance sheet events will

also be disclosed where it is known or can be estimated. Q2a.

The rights of an auditor include the following:

a) Right of access at all times, to the books and accounts and vouchers of the company

b) The right to require from the officers including the directors of the company such information and explanations necessary for the performance of his duties as an auditor.

c) The right to attend any general meeting of the company and to receive notices to any

meeting and to be heard on any part of the meeting which concerns him as an auditor d) The right to be notified in writing, any intended resolution to remove him from office

as auditor of the company.


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e) The right before accepting appointment as an auditor of the company, to communicate with the outgoing auditor (if any) and invite him to make any representations and

supply any information about the company (which he may or may not supply). f) The right to contract with the company, in addition to the statutory duties, to undertake

or provide accounting, taxation and other services to the company.

Q2b. The principal content of an auditor’s report

The auditor‟s report should include the following basic elements a. Title: An appropriate title such as “Auditor‟s Report” should be used to enable the

reader distinguish it from reports from others such as Management report b. Addressee: The auditor‟s report should appropriately be addressed. The report is

normally addressed to the shareholders or the Board of Directors. c. Identification of financial statements: The report should identify the financial

statements audited. It should show the name of the company, the accounts audited (e.g.

P&L and balance sheet) and the financial year d. Reference to Auditing Standards or practices: The report should also indicate the

Auditing Standards followed e.g. International Standards on Auditing (ISA) e. Opinion of the financial statement: The report should clearly state the auditors opinion

on the financial statement as to whether it shows a true and fair view of the entity‟s

financial position and the results of its operations (P & L accounts) or not. f. Signature: The report should be signed in the name of the audit firm, the personal

name of the auditor or both the personal name and the name of the audit firm. g. Auditor’s Address: The report indicate the address and location of the auditor‟s main

office

h. Date of Report: The report should be dated.

Q3a. Freehold land and Buildings

The following procedures will be followed in the verification of freehold land and buildings a) Obtain a schedule of fixed assets

b) Examine a sample of title deeds and land registry certificate and conveyance documents from solicitors and leases. Pay particular attention to mortgages and securities over assets

c) Inspect the minutes of Board of Directors to ensure that, all title deeds, conveyances, tenancy agreements and leases are properly authorised.

d) Check entries in the fixed assets register and trace back to source documents to ensure it is properly stated at cost

e) Review the companies policy for depreciation and ensure that land is not depreciated

f) Check the calculations of the depreciation and ensure they are accurate g) Where freehold or leasehold assets are let to third parties, inspect tenancy agreement

and check the rental income


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h) Physically inspect assets to ensure their existence i) Check the classification and presentation of fixed assets in the balance sheet.

j) Ensure that, the amount stated in the financial information is in agreement with the accounting records.

Q 3b Investment:

The following procedures can be followed to verify investment

a. Request for a list of all investment currently held by the client and distinguish between quoted and unquoted. A reconciliation of the current book value and that of the previous year should be made. Ask that the market value of all investment at

the end of the year should be shown i.e. the quoted investment. b. Verify purchase or sale of investment during the year with documentary evidence

e.g. Contract notes or agreements c. Scrutinize the directors Minutes book for proper authorization of purchase and sale

of investment.

d. If the investment is quoted, check the market value shown in the list with that of the stock exchange values. In the case of unquoted ones inspection should be made of

the company‟s accounts and though there is no market value disclosed for unquoted investment consideration should be given as to whether the net realizable value is below cost for current assets and for fixed assets, whether a permanent fall in value

has occurred. e. Physically inspect certificates and bonds, whether they are free from any charge.

f. To verify purchases examine contract notes and paid cheque counterfoils and for disposals, vouch the income received.

g. Verify that all incomes have been received and properly treated in the financial

statement. h. Compare investment income with previous year‟s and ensure that the basis of

recognizing income is consistent with previous years. Investigate any significant fluctuations.

i. Ensure proper disclosure in the accounts.

Q3.c Stocks & work-in progress:

In verifying stocks and work in progress, perform the following audit procedures: 1. Review the system of internal control over stocks 2. Perform compliance tests on key controls relating to purchases, sales, creditors and

debtors 3. Physically check samples by counting selected items of stock

4. Observe stock taking (i.e. Attend stock taking ) 5. Check on slow moving, obsolete stocks 6. Compare the current years stock with previous years stocks and note any

significant changes 7. Confirm that the stock valuation is in line with SSAP 9

8. Verify each work- in-progress item with a job card.


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Q3d Trade creditors

Follow the following audit procedure in the verification of trade creditors

1. Evaluate the system of internal control over purchase

2. Obtain a copy of the schedule of balances of creditors and confirm the balances with the creditors control account

3. Examine a sample from the creditors ledger with aged lists 4. Enquire into any material debit balances on any of the creditors account 5. Check trade creditors to purchases and note down the credit period. If it is increasing, it may

suggest lack of funds 6. Circularise sample of creditors

7. Enquire into any exceptions received from the creditors‟ circularization 8. Check that all creditors are properly disclosed in the financial statement

Q4a.

The role played by internal Audit department includes the following:

i. It helps reduce the amount of detailed work to be carried out by the external auditors if it is found to be reliable

ii. They review the system of accounting, financial and other operational controls of the

business and notify management and advice them on the best practice. iii. They review and test compliances and accuracy of the companies policies

iv. They exist to review and improve the system of internal checks. v. They also prevent fraud and helps in early detection of fraud and irregularities vi. They undertake special investigation at the request of management.

Q4b.

The stages in an audit can be summarized as follows: i. Background Research : - This involves a research into the history of the company, its

product, its present condition and future prospect, the location of all branches, any

problem in accounting system and changes in law or accounting practice which affect the company.

ii. Preparation of the audit plan:- This involves preparing an overall audit plan which shows how the audit work will be done, the staff who will do the work, the budgeted time and cost

iii. Accounting system review: - This will involve the review of the adequacy of the accounting system and documentations of transactions.

iv. Internal control system review: - It is a review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the final account.

v. Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to the

completeness, accuracy and validity of the information contained in the accounting


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records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinary transaction.

vi. Analytical Review: - This is the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past experiences and other non- financial information available.

vii. Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items.

viii. Preparation and signing of report:-This is where the auditor expresses his opinion in a

report as to whether the financial statement shows a true and fair view or not. The report shows the person to whom the report is addressed, the financial statement

audited, the responsibilities of management and the auditor, the signature of the auditor and the date of the report.

Q5a. Letter of Engagement (or Engagement letter)

This is a letter sent by the auditor to his client at the beginning of any new audit or

accountancy work. It sets out the terms of the engagement and forms the basis of the contract. The engagement letter defines clearly, the extent of the auditors‟ responsibilities and the responsibilities of the directors. It also provides a written confirmation of the auditor‟s

acceptance of the appointment. The client is required to acknowledge receipt of the letter and state if it is in accordance with his understanding of the agreement.

Q5b. Internal Control Questionnaire- ICQ

It consists of a series of questions designed to establish which control exist in the accounting

system and any possible weaknesses. Internal control Questionnaire (ICQ) is a comprehensive, all inclusive method of ascertaining, recording and evaluating a system of internal controls. It

is a pre-printed document designed by the auditor to be used in assessing the adequacy of the clients accounting system. Internal Control Questionnaire helps audit staff familiarize themselves with the client‟s accounting system quickly and more comprehensively

Q5c. Internal control: It is defined as the whole system of control, financial and otherwise

established by the management in other to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets and secure as far as possible, the completeness and accuracy of the records. The individual

components of an internal control system are known as control or internal controls.

The main types of internal controls are i. organization

ii. segregation of duties

iii. physical iv. authorization and approval

v. arithmetical and accounting


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vi. personnel vii. supervision

viii. management

Q5d. Dismissal of an auditor: - There are a number of procedures and rules to be followed before

an auditor of a company can be dismissed or removed. The companies Act 1985 (section 391) has the following provisions/rules regarding the dismissal of an auditor

a. Auditors of a company can be removed by an ordinary resolution (i.e. a simple majority) at an Annual General Meeting (AGM)

b. Written notices shall have been given to the company of the intention to move a resolution

to remove an auditor not less than 28 days. c. On receipt of such intended resolution, the company shall forthwith send a copy to the

auditors concerned d. The auditor shall have the right to make a written representation to the company and

request their notification to members. (Thus, if he does not want to be removed, he will

state his case and request the directors to send it to the members of the company.) e. The auditor shall have the right to speak at the meeting on the subject of his intended

removal and if the representation have not been sent to members, he has the right to read it out at the meeting

Q6. a) CORIN

COMPUTATION OF TAXABLE PAY AND TAX PAYABLE

$ $

Basic Salary 48,000 Less:

Contribution to pension Fund (5%) 2,400 Professional subscription 600 (3,000)

Less Personal allowance (single) (8,000) TAXABLE PAY 37,000 TAX

PAYABLE INCOME RATE TAX PAYABLE

First 3,000 10% 300 Next 27,000 20% 5,400

Excess 7,000 40% 2,800 Tax payable 8,500

NOTE: The total taxable income is 37,000 so first 3,000 attract 10% next 2,700 attracts 20%. Total up, so this part is 3,000 + 27,000 =30,000

Remaining (37,000-30,000) = 7,000, so excess of 7,000 will attract 40%.


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Note how this is calculated throughout this handout.

Q6 b) BRIAN

CALCULATION OF TAXABLE PAY AND TAX PAYABLE $ $


Contribution to pension Fund (6%) 2,760 Allowable expenses 500 (3,260)

Less Personal allowance (single) (8,000) Marriage allowance (3,000) (11,000)

TAXABLE PAY 31,740

TAX PAYABLE

INCOME RATE TAX PAYABLE

First 3,000 10% 300 Next 27,000 20% 5,400 Excess 1,740 40% 696

Tax payable 6,396

Q7. KRE LTD

CALCULATION OF TAXABLE PROFIT AND TAX PAYABLE

Net Profit before tax 450,000 Add: Depreciation of IT equipments 30,000 Depreciation of Equipments 80,000

Non-allowable Distribution cost 6,000 116,000 Adjusted Net Profit 566,000

Less Capital Allowance: IT Equipments (50%X150,000) 75,000

Equipments (25% X 600,000) 150,000 (225,000) Taxable profit 341,000

Tax thereon @20% (341,000 X 20%) 68,200

WORKINGS: PROFIT AND LOSS ACCOUNT


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Sales 2,600,000 Cost of sales (1,300,000) Gross profit 1,300,000

Distribution cost 450,000 Administrative expenses 290,000

Depreciation of equipments 80,000 Depreciation of IT equipments 30,000 (850,000) Net profit before tax 450,000

Q8a) The tax benefits of contributing to a pension plan:

Contributing to a retirement plan (i.e. pension) makes sense for practically all taxpayers. It is one of the easiest and most powerful ways to reduce your overall tax burden. In fact if these accounts were more accurately referred to as tax-reducing accounts people would likely take

greater notice of them. Tax avoidance is the primary objective that sparks taxpayer interest in retirement accounts. The contribution you make to a retirement account is not applied towards

your adjusted gross income (AGI), therefore it will keep you in a lower tax bracket so you‟ll end up paying less in taxes. The next benefit comes from having this money invested in a tax deferred account so you can enjoy the substantial benefits of tax deferred compounding with the growth

which occurs in the account not being taxable until you retire and begin withdrawing funds. Presumably at retirement you will be in a lower marginal tax bracket however even if you are not,

you will still come out ahead because the act of deferring taxes and the benefit of compounding over many years will likely leave you with more funds accumulated in a retirement account even if your tax rate is indeed higher in retirement.

b) PAYE: PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the

government from employees. The tax collected during the year may be enough to discharge the

taxpayer's liability for tax. This is, in effect, a provisional payment of tax on the

employee's income. The amount withheld is determined partly by the employee's expected tax

allowances, exemptions and reliefs, and partly by tax tables that determine the amount of tax to be

deducted for the salary or wage paid to the employee.

PAYE is, in effect, a withholding tax administered separately by the tax authority. .

c) The collector of taxes: The Collector of taxes collects taxes and excises due to the town. The

tax collector deposits all moneys received, and must turn over to the treasurer all receipts at least

once a week. Tax Collectors also pursue delinquent accounts.

Non-payment of taxes may cause you to pay interest and additional collection charges.

http://www.erate.com/money-needed-to-retire.htm

http://en.wikipedia.org/wiki/Employer

http://en.wikipedia.org/wiki/Income_tax

http://en.wikipedia.org/wiki/Income

http://en.wikipedia.org/wiki/Withholding_tax


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Additionally, non-payment of taxes may result in the loss of property. The Collector of Taxes is

an elected position with a three year term.

d) Capital Gains Tax (CGT): Capital Gains Tax is a tax charged on capital gains, a profit that

results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds

the purchase price. Thus the profit realized on the sale of asset that was purchased at a lower

price. The most common capital gains are realized from the sale of stocks, bonds, precious metals

and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of assets by individuals and trustees. Capital gains made by companies are subject to corporation tax. The total capital gain is defined as the value of the asset when it is sold (or given away etc.) minus its

value when originally bought (or inherited etc.). As with income tax, there is a threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt amount‟ is £8,800 for

individuals and £4,400 for trusts. This is subtracted from total capital gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income. Capital gains are taxed at 10% below the starting-rate limit, 20% between the starting- and basic-

rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.

SEPTEMBER 2005

AUDITING & TAXATION

QUESTIONS

PART A

1. Explain the term true and fair. [10]

PART B

2. a) Explain the role of internal questionnaires. [10]

b) Explain briefly the principal contents of a company‟s annual report and accounts. [10]

3. Explain briefly how you would verify the following items:

a) Trade debtors b) Investments

c) Share capital d) Stock and work in progress [5 each]

4. Explain the following terms: a) Letter of weakness

b) Interim audit c) The audit programme d) Post balance sheet events [5 each]

http://en.wikipedia.org/wiki/Tax

http://en.wikipedia.org/wiki/Capital_gain

http://en.wikipedia.org/wiki/Profit

http://en.wikipedia.org/wiki/Capital_asset

http://en.wikipedia.org/wiki/Asset


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5. a) Explain the major data verification checks associated with entering financial data into a computerized accounting system. [10]

b) The auditors work for the directors of a company. Discuss. [10]

PART C

The following information applies to any personal tax calculations: TAX RATES 10% on the first $3,000 of taxable income

20% on the next $27,000 of taxable income 40% on any further taxable income

PERSONAL ALLOWANCES Single person $8,000 Additional allowance of $3,000 can be claimed by one of the partners in a marriage

PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a qualifying

pension fund. From age 50 a maximum of 20% can be paid in.

6. Yousef, aged 49, is a single person who earns $57,000 per year. He has paid 5% of his gross pay into a qualifying pension fund. Yousef has also paid $500 in respect of

professional subscriptions. Ocean, aged 36, is married (and claims the additional allowance) and earns $53,000. He

has paid 6% of his gross pay into a qualifying pension. Ocean has also paid $800 in

respect of expenses that are allowable against tax. TASKS

Calculate the taxable pay and the total tax payable for EACH of the following: a) Yousef [7] b) Ocean [8]

7. The following is the summarized internal Profit & Loss account of Rove Ltd. after its first

year of trading: £ Sales 2,600,000

Cost of sales (1,300,000) Distribution costs (440,000)

Administration expenses (270,000) Depreciation of equipment (70,000) Depreciation of IT equipment (40,000)

Other information: Original cost of equipment 500,000

Original cost of IT equipment 200,000 Corporation tax (i.e. company taxation) is charged at 22% of the taxable profit. Initial writing down allowances are:

25% as regards equipment


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50% as regards IT equipment Included in the distribution costs are £10,000 which are deemed non-allowable. TASKS

Calculate Rove Ltd.‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) Personal allowances b) Schedule E

c) Tax avoidance d) Tax codes [5 each]

SUGGESTED ANSWERS: SEPTEMBER 2005

Q1. True and Fair Both the Companies Acts and Accounting standards require the financial statement of a company to give a true and fair view. However, there is no legal definition of the term true and fair. The

meaning of true and fair can be broken down into two:

True: This means in accordance with facts Fair: This means in accordance with expectations, relevance and objectivity free from bias etc. The following quotations represent some authoritative views on the meaning of the term true and

fair a) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia) b) True and fair view implies that all statutory and other information is not only available

but is presented in a form which it can be properly and readily accepted (Sir Russell

Kettle)

In summary, there is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view, the accounts must be prepared in accordance with generally Accepted accounting principles and must conform to relevant statutory and regulatory

requirement and the accounts must not me misleading and should be free from bias.

Q2a. Internal control questionnaire (ICQ) plays the following roles in an audit: i. It enables the auditor identify specific areas of weakness in the client accounting system

ii. It enable the auditor design a series of test in his audit program

iii. It helps audit staff familiarize themselves with the clients system quickly iv. It is a major tool in ascertaining the clients accounting system

v. ICQ enables the auditor review and assess the adequacy of the clients system


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Q2b. The main sections or content of an annual report include the following

a. Introductory material: Many annual reports begin with a brief or summary of the history

of the company and its objectives. b. Operational reports and reviews: This section contains a report from the chairman as well

as individual reports from senior officers of the company. This section is usually supported by a series of charts, and graphs statistical tables which compare the current years achievement with the previous years

c. The Accounts: This is the main section of the annual report. It contains the statutory and professional requirements of accounts. The accounts will show the main financial

statement (the profit and loss, the balance sheet, the cash flow statement), the auditor‟s report, accounting policies, notes to the accounts, the directors report etc.

d. Shareholders information: This is shown at the end of the annual report and it is

presented as additional data. Shareholders information may include details about the financial results over the past four or five years, names and addresses of major

shareholders, notices of Annual General Meetings and information about the companies share prices

Q3a. Trade Debtors:-

The following procedure will be followed to verify debtors.

a. Obtain a list of all the balances of debtors. b. Cast the list and agree the total to the general ledger control account balance c. Select a sample of individual debtors account and test as follows.

- Trace debit entries to entries in the sales day book - Check that dispatch notes have corresponding sales invoices

- Trace credit entries to the cash book d. Circularize the sample selected e. Examine all confirmations replied and investigate any exceptions

f. Consider the adequacy of bad debt provisions, sales returns and cash discounts g. Consider the value stated in the balance sheet.

Q3b: Investment : verification of investment include the following audit procedure

1) Request for a list of all investment currently held by the client and distinguish between

quoted and unquoted. 2) Verify purchase or sale of investment during the year with documentary evidence.

3) Examine the Directors Minutes book for proper authorization of purchase and sale of investment.

4) If the investment is quoted, check the market value shown in the list with that of the

stock exchange values. 5) Physically inspect certificates and bonds. If they have been deposited with a bank a

certificate stating in whose name they are registered and whether they are free from any charge should be shown and this should be compared with the standard bank letter.

6) To verify purchases examine contract notes and paid cheque counterfoils and for

disposals, sold contracts.


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7) Vouch the income received. 8) Verify that all incomes have been received and properly treated in the financial

statement.

9) Ensure proper disclosure in the accounts.

Q3c. Share Capital: The verification of share capital:

a. Ensure that the number of shares and type of shares issued is within the limit authorized by the companies Memorandum and Article

b. Ensure that the issue was properly authorized by inspecting the minutes of Directors c. Ascertain and evaluate the system for the control of the issue of shares. d. Agree total shares issued per draft accounts to shareholders register

e. Test the additions of shareholders register f. Ensure that all monies received on application were contained in a specia l bank account

until allotment g. Vouch the payment of underwriting and other fees h. Where shares are issued not for cash, but for other consideration, vouch the agreement and

ensure that all entries are properly made i. Check the value of share capital in the balance sheet and ensure that it is correctly stated.

Q3d: Stocks & work-in progress: In verifying stocks and work in progress, the following

procedures can be followed: i. Review the system of internal control over stocks

ii. Perform compliance tests on key controls relating to purchases, sales, creditors and

debtors iii. Physically check samples by counting selected items of stock

iv. Observe stock taking (i.e. attend stock taking ) v. Check on slow moving, obsolete stocks vi. Compare the current years stock with previous years stocks and note any significant

changes vii. Confirm that the stock valuation is in line with SSAP 9

viii. Verify each work- in-progress item with a job card. Q4a. Letter of Weakness: It is a letter sent by the auditor to his client, bringing to his attention the

weakness found in the internal control system during the audit. This letter is also known as management letter, letter of comment, letter of recommendation, post audit letter, internal control

letter The letter points out the weaknesses found in the internal control system and gives recommendations to improve them. It is usually presented to the client in a meeting with the auditor.

Q4b. Interim Audit: Is an audit that is conducted to cover a certain time or up to a certain date

within the financial period. It may be done to cover a month, a quarter or half year on the request of a client. Some audit work such as verification of assets and liabilities may not be carried out


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during interim audit. These may be deferred to the final audit. The work done may include ascertaining the system of accounting and internal controls, evaluation of the system for adequacy and any possible weaknesses, design and performing compliance tests etc.

Q4c. Audit Program –The audit program essentially consists of a very detailed list of things to be

done in an audit engagement. It is a statement of decision to an audit engagement for the purpose of indicating what to do, how to do it and when do it. The audit program develops and documents the nature, timing and extent of planned audit procedures required to implement the overall audit

plan. The purpose is to assist the auditor to ascertain / determine the reliability of the accounting records used in preparing the final account. It is normally on a printed form or booklet.

It ensures that no aspect of the audit work is over- looked and therefore gives a clear perspective of work to be done by the auditor.

Q4d. Post Balance Sheet Events: Post Balance sheet events are those events both favourable and unfavourable which occur between the balance sheet date and the date on which the financial

statements are approved by the Board of Directors”. Post balance sheet events fall into two categories;

1. Adjusting events

2. Non-adjusting events Adjusting events are events that provide additional information or conditions existing at the

balance sheet date. Example is the discovery of error or fraud that shows that the accounts were not correct after the balance sheet date. Another example is proposed dividends. Non-adjusting events are events that arise after the balance sheet date and concern conditions that

do not exist at the balance sheet date. Such events will not have any effect on the balances in the Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers a nd

acquisitions, strikes and labour disputes, changes in the exchange rate etc Q5a. Data verification checks are controls designed to ensure that, data received for processing

are processed correctly. The following are some controls a. Check digit: This is a detective control to establish the validity of numerical data such as

accounts numbers. One digits with a “block” of digits is produced by the mathematical function of the other digits

b. Format checks: This checks any omission of details of items. Missing and duplicate

numbers are revealed for investigation c. Existence check: These are checks on record fields to ensure that the data is valid for that

field. It checks correct codes wrongly used against a correct digits d. Logical checks: these are used to ensure that, codes on the documents are acceptable in

the accounting system

e. Range checks: These are checks designed to ensure that the data in a certain lies within predetermined limits or range. Outside range data are then rejected.

Q5b. Auditors do not work for the directors of the company. Rather the auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts

prepared by the directors to be sent to the members of the enterprise gives a true and fair view and


- - 17 - -

have been prepared in accordance with the companies Acts (sec. 235). The auditor therefore works for the members of the company who appoint him as auditors at an Annual General Meeting (AGM). The work done by the auditor will be to report to the members as to:

a. whether proper accounting records have been kept b. whether all returns have been received from branches

c. whether or not the accounts prepared are in agreement with the records d. Whether the information and explanations given in the directors report is consistent with

the accounts and finally,

e. Whether in his opinion, the financial statement presents a true and fair of the company‟s affairs at the balance sheet date and of its profit and loss for the period under review.

Q6. a) YOUSELF

CALCULATION OF TAXABLE PAY AND TAX PAYABLE

$



Less Personal allowance (single) (8,000) TAXABLE PAY 45,650

TAX PAYABLE

INCOME RATE TAX PAYABLE First 3,000 10% 300

Next 27,000 20% 5,400 Excess 15,650 40% 6,260 Tax payable 11,960

Q6 b.) OCEAN


$ Basic Salary 53,000

Less: Contribution to pension Fund (6%) 3,180 Allowable expenses 800 (3,980)


- - 18 - -

Less Personal allowance (single) (8,000) Marriage allowance (3,000) (11,000) TAXABLE PAY 38,020

TAX PAYABLE


Next 27,000 20% 5,400 Excess 8,020 40% 3,208

Tax payable 8,908

Q7. ROVE LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE $ Net Profit before tax 480,000

Add: Depreciation of IT equipments 40,000 Depreciation of Equipments 70,000

Non-allowable Distribution cost 10,000 120,000 Adjusted Net Profit 600,000

Less Capital Allowance:

IT Equipments (50%X200, 000) 100,000 Equipments (25% X 500,000) 125,000 (225,000) Taxable profit before tax 375,000

Tax thereon @22% (375,000 X 22%) 82,500



Gross profit 1,300,000 Distribution cost 440,000 Administrative expenses 270,000

Depreciation of equipments 70,000 Depreciation of IT equipments 40,000 (820,000)

Net profit 480,000


- - 19 - -

Q8 a) Personal allowances: Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance. This is the

amount of income you can receive each year without having to pay tax on it. Depending on your circumstances, you may also be able to claim certain other allowances

c) Schedule E:

Schedule E is used to report income or loss from rental real estate, royalties, partnerships, estates

and trusts. Schedule E is also used when reporting income/loss from S Corporations.

c) Tax avoidance:

Tax avoidance is legal. It involves individuals (or firms) managing their affairs in such a way that they reduce their tax bills below what they otherwise might have been by lawful means, sometimes by using loopholes in the tax law. Other terms are tax planning and tax mitigation.

Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce

the amount of tax that is payable by means that are within the law. The use of legal methods to modify an individual's financial situation in order to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits. This

practice differs from tax evasion, which is illegal. Most taxpayers use some forms of tax avoidance. For example, individuals who contribute to employer-sponsored retirement plans with

pre-tax funds are engaging in tax avoidance because the amount of taxes paid on the funds when they are withdrawn is usually less than the amount that the individua l would owe today. Furthermore, retirement plans allow taxpayers to defer paying taxes until a much later date, which

allows their savings to grow at a faster rate.

d) Tax codes:

A tax code is used by your employer or pension payer to calculate the amount of tax to deduct from your pay or pension. A tax code is usually made up of several numbers and a letter, for

example: 117L or K497.

An employee's tax code is used by employers to calculate the amount of income tax that must be withheld, or deducted, from the employee's wage or salary.

The tax code is the mechanism by which "pay as you earn" (PAYE) is operated in the UK, making it possible for most employees to have paid exactly the right amount of income tax by the

end of each tax year. As a result, most employees in the UK do not have to complete an income tax return.

In the UK, every person paid under the PAYE scheme is allocated a tax code. This code describes to employers how much tax to deduct from an employee. Tax codes are usually adjusted

once a year to take into account any changes made in the National Budget, but can be altered more often if someone has paid to much or too little tax the previous tax year.


http://en.wikipedia.org/wiki/United_Kingdom

http://en.wikipedia.org/wiki/PAYE


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DECEMBER 2005

AUDITING & TAXATION

QUESTIONS

PART A

1. Distinguish between internal check and internal control. [10] PART B

2. a) Discuss the different forms of control expected to be found in a computerized

accounting system. [10] b) Explain the principal factors involved in planning an audit. [10]

3. Explain briefly how you would verify the following items: a) Debentures b) Trade debtors

c) Freehold land and buildings d) Loans made to other businesses [5 each]

4. Explain the following: a) Walk-through tests b) Compliance tests

c) Test-checks d) Substantive tests [5 each]

5. a) Explain the legal duties of an auditor. [10] b) Explain the principal contents that an auditor should refer to in a letter of engagement.

[10] PART C

6. The following information applies to any personal tax calculations: TAX RATES 10% on the first $3,000 of taxable income.

20% on the next $27,000 of taxable income. 40% on any further taxable income.

PERSONAL ALLOWANCES Single person $8,000. Additional allowance of $3,000 can be claimed by one of the partners in a marriage.


pension fund. From age 50 a maximum of 20% can be paid in. Leto, aged 39, is a single person who earns $49,000 per year. She has paid 5% of her gross

pay into a qualifying pension fund. Leto has also paid $700 in respect of professional subscriptions.

Buster, aged 42, is married (and claims the additional allowance) and earns $63,000. He has paid 6% of his gross pay into a qualifying pension. Buster has also paid $500 in respect of expenses, which are allowable against tax.


- - 21 - -

TASKS Calculate the taxable pay and the total tax payable for EACH of the following: a) Leto [7]

b) Buster[8]

7. The following is the summarised internal Profit & Loss account of WIGANA Ltd. after its

first year of trading:

£ Sales 2,900,000

Cost of sales (1,600,000) Distribution costs (510,000) Administration expenses (260,000)

Depreciation of equipment (50,000) Depreciation of IT equipment (40,000)

Other information: Original cost of equipment 600,000 Original cost of IT equipment 400,000

Corporation tax (i.e. company taxation) is charged at 22% of the taxable profit. Initial writing down allowances are:

25% as regards equipment 50% as regards IT equipment Included in the distribution costs is £9,000 which is deemed non-allowable.

TASK Calculate WIGANA Ltd‟s total taxab le profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) Tax evasion

b) The collector of taxes c) PAYE

d) Capital gains tax (CGT) [5 each]

SUGGESTED ANSWERS- DECEMBER 2005

Q1. Internal Checks: This is the area of internal control, which is exclusively concerned with the prevention and early detection of fraud and errors. It invo lves arrangement of accounting and other duties to ensure that, no single individual handles one transaction from

the beginning to the end and that the work of each individual is subject to independent checks.

Internal control however, is the whole system of control(including internal checks), financial and otherwise established by management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard assets and secure as far as possible, the completeness and accuracy of the


- - 22 - -

records.

Q2a. Controls in a computerized system can be group into two forms:

(a) General Controls and

(b) Application Controls.

General Controls: These include

i. System development controls

ii. Documentation and record testing

iii. Access controls such as physical barriers

iv. Backup and reconstruction facilit ies

Application Controls: These include:

i. Check digit verification

ii. Format checks

iii. Sequence checks

iv. Range checks

v. Programmed controls

vi. Batch registers

vii. Input validity checks etc.

Q2b. The Auditor must plan the audit work if the work is to be done to a high standard of skill and care. The following are some factors that are involved in planning the audit:

An outline of the audit work to be done on each area of the clients‟ systems and the financial statement

A review of last year‟s working papers

Changes in legislation (Accounting standards, audit ing standards and other relevant

regulations)

Analytical review of management accounts

Changes in accounting system

The staff who will be needed to do the work

The timing of the work to be done

Degree of reliance on internal controls

The time budget and cost of the audit.

Q3a. Debentures: These are long-term liabilities and the verification procedures are as follows:

a) Obtain a schedule of all debentures detailing the sums due at the beginning of the year, additions and redemptions.

b) Obtain a copy of the debenture deed and note the terms and conditions of the debentures. A copy must be made for the permanent file


- - 23 - -

c) Agree opening balance with last years working papers.

d) Check that the entries relating to issues of debentures and redemptions are correctly recorded in the books

e) Verify the issue of new debentures with Board minutes and ensure that proper

approval was given

f) Vouch payments of interest and repayment of the debenture with the cashbook to see if the amount paid as interest and repayment is correct.

g) Agree the total amount of debentures outstanding with the register of debenture holders

h) If the debenture is secured, verify if the charge is registered at the company house.

i) Consider whether it is correctly disclosed in the balance sheet.

Q 3 b.Trade debtors

The following procedure will be followed to verity debtors.

i. Request for a list of all the balances of debtors. ii. Total/Cast the list and agree the total to the general ledger control account balance iii. Select a sample of individual debtors account and test as follows.

- Trace debt entries to entries in the sales day book - Check that dispatch notes have corresponding sales invoices

- Trace credit entries to the cash book iv. Circularize the sample selected v. Examine all confirmations replied and investigate any exceptions

vi. Consider the adequacy of bad debt provisions, sales returns and cash discounts

Q3c: Freehold land and Buildings

The following procedures will be used in the verification of freehold land and buildings

1. Obtain a schedule of fixed assets held by the company. 2. Examine a sample of title deeds and land registry certificate, conveyance documents from

solicitors and leases. Pay attention to mortgages and securities over assets 3. Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised.

4. Check entries in the fixed assets register and trace back to source documents to ensure it is properly stated at cost

5. Review the companies policy for depreciation and ensure that land is not depreciated 6. Check the calculations of the depreciation and ensure they are accurate 7. Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and

check the rental income 8. Inspect assets to ensure their existence

9. Check the classification and presentation of fixed assets 10. Ensure that, the amount stated in the financial information is in agreement with the

accounting records.


- - 24 - -

Q3d: Loans made to other Business: the following procedures will be used in the verification a. Review authorization for granting of loan and advances if made during the year

b. The application for the loan and the receipts for the amounts must be inspected c. Obtain a certificate from the borrower confirming the amount outstanding as at the balance

sheet date d. Study the written agreement covering the loan (that is the terms as to interest and

repayment)

e. Review the possibility of non-payment. E.g. the type of collateral security f. Check the receipts of all interest received on loan

g. Check that the loan is properly disclosed in the balance sheet.

Q4a Walk-through tests: Walk- through is the process of tracing one or more transactions

through the accounting system and observing the application of relevant aspect of the internal control system.

Q4b Compliance Test: These are tests designed to obtain reasonable assurance that those internal controls in the clients system were functioning properly and throughout the period. In compliance tests, the auditor tests the controls and not transactions invo lved. It is sometimes called test of controls. If the internal control is found to be

weak, then the auditor will perform more substantive tests. Thus, the results of compliance test will determine the extent of substantive tests.

Q4c Tests-checks: This is an audit technique or procedure where a sample of population is checked in detail and the result applied to the whole population. There are two methods used in test checking: (a) Judgement sampling-where the selection of the items to be tested are determined by the auditor‟s judgement and (b) Statistical

Sampling– where the selection of the items to be tested are by statistical or mathematical principles.

Q4d Substantive tests: - This is defined as those tests of transactions and balances and other procedures such as analytical review, which seek to provide audit evidence as to the completeness, accuracy and validity of information contained in the accounting

records or financial statement. Substantive test are usually applied to transactions when the internal control is found to be weak and therefore the auditor cannot rely on it. It is also applied to extraordinary items and all assets and liabilities in the balance

sheet. When it is directed to the profit, the auditor will ensure that, all items (income and expenses) recorded in the profit and loss have been earned or incurred and have

actually been included in the calculation of the profit or loss. The auditor will conduct substantive test on the balance sheet to ensure the existence of assets and liabilities, ownership of assets and responsibility of all liabilit ies, the correctness of their values,

how the items are presented etc. Some of the tools or methods used in substantive testing include Inspection, Observation, Enquiry, Analytical review, Recalculation,

Vouching.


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Q5a. The duties of an auditor

The statutory duty of an auditor is to report to the members of the company as to whether or not

the accounts prepared gives a true and fair view and have been properly prepared in accordance with the companies Act 1985. To fulfill this, the auditor is required:

a.To make a report as to whether proper accounting records have been kept. b. To report whether all returns have been received from branches c.To report whether or not the accounts prepared are in agreement with the records

d. Whether the information and explanations given in the directors report is consistent with the accounts

e.State whether the accounts and statements comply with the Companies Act and finally, f. Whether in his opinion, the financial statement presents a true and fair of the company‟s

affairs at the balance sheet date and of its profit and loss for the period under review.

Q5b.

The form and content of audit engagement letters may vary for each client, but they would generally include the following:

1. The objective of the audit of the financial statement

2. Management‟s responsibilities regarding proper accounting records and the financial statement by establishing and maintain effective internal controls.

3. The auditors responsibilities to express his opinion on the financial statement 4. The scope of the audit work, including reference to applicable legislation such as the

companies Act and pronouncements of professional bodies such as the auditing standards,

accounting standards 5. The basis on which fees will be computed

6. The need to send letter of weakness to management 7. Any arrangement for the auditor to provide accounting and taxations services 8. Unrestricted access to whatever records, documentation and other information requested in

connection with the audit.

Q6. a) LETO


$ Basic Salary 49,000 Less




- - 26 - -

TAX PAYABLE INCOME RATE TAX PAYABLE

First 3,000 10% 300 Next 27,000 20% 5,400


Q6 b.) BUSTER



Less Contribution to pension Fund (6%) 3,780 Allowable expenses 500 (4,280)

Less Personal allowance (single) (8,000)

Marriage allowance (3,000) (11,000) TAXABLE PAY 47,720

TAX PAYABLE

INCOME RATE TAX PAYABLE First 3,000 10% 300 Next 27,000 20% 5,400


Q7. WIGANA LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE

£ £ Net Profit 440,000 Add: Depreciation of IT equipments 40,000

Depreciation of Equipments 50,000 Non-allowable Distribution cost 9,000 99,000

Adjusted Net Profit 539,000 Less Capital Allowance:

IT Equipments (50%X400, 000) 200,000


- - 27 - -


Tax thereon@ 22% (164,000 X 22%) 36,080





Net profit 440,000

Q8.

a) Tax evasion: Tax evasion is the general term for efforts by individuals, firms, trusts and other

entities to evade taxes by illegal means.

Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of

their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest

tax reporting (such as declaring less income, profits or gains than actually earned; or overstating

deductions or expenses)

b) The collector of taxes: The Collector of taxes collects taxes and excises due and deposits all

moneys received, and must turn over to the treasurer all receipts at least once a week. Tax

Collectors also pursue delinquent accounts. Non-payment of taxes may cause you to pay interest

and additional collection charges. Additionally, non-payment of taxes may result in the loss of

property. The Collector of Taxes is an elected position with a three year term.

c) PAYE: PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the




allowances, exemptions and reliefs, and partly by tax tables that determine the amount of tax to be

deducted for the salary or wage paid to the employee.

The UK introduced PAYE in 1944.

http://en.wikipedia.org/wiki/Corporation

http://en.wikipedia.org/wiki/Trust_(property)






- - 28 - -

d) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital

gains, the profit realized on the sale of a non- inventory asset that was purchased at a lower price.

The most common capital gains are realized from the sale of stocks, bonds, precious metals and

property.



individuals and £4,400 for trusts. This is subtracted from total capital gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income: treated as the top slice of income, capital gains are taxed at 10% below the starting-rate limit, 20%

between the starting- and basic-rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.

Note: A capital gain is a profit that results from investments into a capital asset, such

as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a

higher selling price and a lower purchase price, resulting in a financial gain for the

seller. Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less

than the purchase price.

MARCH 2006

AUDITING & TAXATION

QUESTIONS

PART A

1. Explain the rights of an auditor of a limited company. [10]

PART B

2. Explain briefly the following types of audit: a) Statutory

b) Non-statutory c) Interim

d) Continuous e) Management [4 each] 3. Explain briefly how you would verify the following items:

a) Trade creditors b) The bank balance

c) Vehicles






http://en.wikipedia.org/wiki/Profit

http://en.wikipedia.org/wiki/Capital_asset


- - 29 - -

d) Stock and work in progress [5 each] 4. a) Explain the role of an internal audit department. [10]

b) Explain what internal controls can be „built‟ into the typical financial accounting system i.e. from the recording of each financial transaction to the production of the first

draft final accounts. [10] 5. Explain the stages of an audit. [20]

PART C

6. The following information applies to any personal tax calculations: TAX RATES

10% on the first $3,000 of taxable income 20% on the next $27,000 of taxable income 40% on any further taxable income

PERSONAL ALLOWANCES Single person $8,000

Additional allowance of $3,000 can be claimed by one of the partners in a marriage. PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a qualifying


Mitzie, aged 38, is a single person who earns $55,000 per year. She has paid 6% of her gross pay into a qualifying pension fund. Mitzie has also paid $600 in respect of professional subscriptions.

Frank, aged 46, is married (and claims the additional allowance) and earns $67,000. He has paid 5% of his gross pay into a qualifying pension fund. Frank has also paid $700 in

respect of expenses, which are allowable against tax. TASKS Calculate the taxable pay and the total tax payable for EACH of the following:

a) Mitzie [7] b) Frank [8]

7. The following data relates to REM Ltd.:

£ Internal profit before tax 495,000

Original cost of machinery 400,000 Original cost of computers 300,000 Expenses deemed to be non-allowable 8,000

Internal rates of depreciation charged in the Profit & Loss account:

Machinery 20% on cost Computers 25% on cost


- - 30 - -

The relevant capital allowances allowed by the Inland Revenue are: Machinery 25% on cost Computers 40% on cost

TASK Calculate REM Ltd.‟s taxable profit AND the total tax charge for the year.

Note: corporation (or company) tax is levied at the rate of 25%. [15] 8. Write short notes on THREE of the following:

a) Personal allowances b) Capital gains tax (CGT)

c) Tax evasion d) Tax codes [5 each]

SUGGESTED ANSWERS- MARCH 2006

Q1 An auditor‟s includes the following a) He has the right of access at all times, to the books and accounts and vouchers of the

company b) He has the right to require from the officers including the directors of the company, such

information and explanations necessary for the performance of his duties as an auditor. c) The right to attend any general meeting of the company and to receive notices to any

meeting and to be heard on any part of the meeting which concerns them as an auditor

d) The right to be notified in writing, any intended resolution to remove them from office as auditors of the company

e) The right, before accepting appointment as auditors of the company, to communicate with

the outgoing auditor (if any) and invite him to make any representations and supply any information about the company which he may or may not supply.

f) He also has the right to contract with the company, in addition to the statutory duties, undertake or provide accounting, taxation and other services to the company.

Q2a. Statutory Audit: It is an audit carried out to meet statutory requirements. For example, the

company Act 1985 requires that, every company must have its accounts audited annual by an independent auditor. The scope of the auditors work is determined by law/ statute.

Q2b. Non-Statutory Audit (or Private Audit): This type of audit is carried out at the request of the owner of an enterprise. It is not required by statute. It is carried out in enterprises such as

partnerships, sole proprietorships, etc. The scope of audit work is determined by the client (owner).

Q2c. Interim Audit: An Interim Audit is the audit which is carried out or conducted to cover a certain time or up to a certain date within a financial period. Normally interim audit will be about

two-thirds of the way through the year e.g. September or October for December year end. It may also be done to cover a month, a quarter or half year on the request of a client. Some audit work


- - 31 - -

such as verification of assets and liabilities may not be carried out during interim audit. These may be deferred to the final audit. The work done may include ascertaining the system of accounting and internal controls, evaluation of the system for adequacy and any possible

weaknesses, design and performing compliance tests etc.

Q2d. Continuous Audit:

Continuous audit is an audit that is carried out continuously during the financial year of the client.

Such an approach applied to enterprises where the volume of transaction is very large. The work is so great that, the audit staffs are on the premises of the client almost the whole year round,

making several visits.

Q2e Management Audit: This is concerned with the examination of procedures laid down by

management and of its efficiency. The objective here is to arrive at an opinion on the efficiency of management rather than on the financial statements. Areas covered by management audit includes

a) Relationships between management and shareholders b) Current standing of the organization in relation to its industry and the general public. c) Relationship between management and staff et

Q3a. Trade Creditors

Creditors can be verified by the following procedures 1. Evaluate the system of internal control over purchase

2. Obtain a copy of the schedule of balance of creditors and confirm the balances with the creditors control account

3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on the creditors account 5. Check trade creditors to purchases and note down the credit period.

6. Circularise sample of creditors 7. Examine all responses received from the circularization and investigate any exceptions

7. Check that all creditors are properly disclosed in the financial statement

Q3b. Bank balance perform the following procedures apply

i. Appraise the system of internal control over bank ii. Examine the bank reconciliation statement and note the following

a) that all uncleared cheques are cleared b) that all payments or lodgments not credited at the balance sheet date have

been credited

c) Investigate any exceptions in the bank statement iii. Check the arithmetical accuracy of the bank reconciliation statement(i.e. calculations)

iv. Trace cash payments and cash receipts to the various documents taking notes of cheque numbers

v. Trace all contra entries, dishourned cheques, cancelled cheques

vi. Vouch any transfers to the petty cash book and other bank accounts


- - 32 - -

vii. Cast the bank column of the cash book viii. Send the standard bank letter and check the information received with the bank statement

ix. Consider the value of bank balance in the balance sheet

Q3c. Vehicles:

The verification of vehicles will involve the following procedures 1. Obtain a schedule of list of motor vehicles (where a number of vehicles are held by the

client) and agree the total cost with the motor vehicle accounts in the ledger

2. Inspect the registration documents and ensure that they are registered in the name of the company

3. Where the company registers the vehicle in the name of an employee or a third party, the party concerned should sign the certificate acknowledging the companies ownership

4. Examine the insurance policy and note that insurance premium are paid on due dates

5. Review the depreciation policy and reasonableness of deprecation rates over vehicles. 6. Examine all purchase and disposals of vehicles during the year and ensure that proper

authority was given and properly accounted for in the accounts 7. Ensure that no collusion existed with outside agents on cheap sale prices 8. Inspect invoices of all purchases and cheques paid counterfoils

9. Physically inspect vehicles and compare repairs and fuel bills with car numbers. 10. Check the presentation and valuation of vehicles in the financial statement.

Q3d: Stocks & work-in progress: In verifying stocks and work in progress, the procedures are

a. Review the system of internal control over stocks

b. Perform compliance tests on key controls relating to purchases, sales, creditors and debtors

c. Physically check samples by counting selected items of stock d. Observe stock taking (i.e. Attend stock taking ) e. Check on slow moving, obsolete stocks

f. Compare the current years stock with previous years stocks and note any significant changes

g. Confirm that the stock valuation is in line with SSAP 9 h. Verify each work- in-progress item with a job card.

Q4a. Role of Internal Audit department:

The role played by internal audit department includes the following

a. It helps reduce the amount of detailed work to be carried out by the external auditors. b. The department reviews the system of accounting, financial and other operations controls

of the business and notify management and advice them.

c. They review and test compliances and accuracy of the companies policies d. To review and improve the system of internal checks.

e. To prevent and early detection of fraud and irregularities f. To undertake special investigation at the request of management.


- - 33 - -

Q4b. Internal control is the whole system of control financial and otherwise established by management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard assets and secure as far as

possible, the completeness and accuracy of the records.

The following are the internal controls that can be “built” into a typical financial accounting system

i. Segregation of duties: the functions of authorizing transactions; recording the transactions; and custody of the associated assets should be undertaken by separate staff.

ii. Organization: there should be a clear organization chart and all staff should have up to date job descriptions that clearly indicate their responsibilities.

iii. Authorization and approval: all transactions and decisions should be formally

authorized by nominated staff. iv. Physical: there should be suitable controls over access to offices, assets, controlled

stationery and computer systems. v. Management: production of suitable financial and operational management

information; use of exception reports; critical review and enquiry by management.

vi. Arithmetical and accounting : checking / re-performing tasks carried out by others; costing (adding up) orders, invoices, payroll etc; reconciliation between the bank and

accounting records; control accounts. vii. Personnel: appointment of staff should be adequately controlled; all staff should be

suitably trained for their post and appraised regularly.

viii. Supervision: all staff and activities should be adequately supervised by someone who understands the process and will detect deviations from accepted practice.

Q5. The stages in an audit can be summarized as follows

i. Background Research : - This will include a brief research into the history of the company, its product, its present condition and future prospect, the location of all branches, any problem in accounting system and changes in law or accounting practice

which affect the client. ii. Preparation of the audit plan:- This involves preparing an overall audit plan showing how

the audit work will be done, the staff who will do the work, the budget time and cost iii. Accounting system review: - This will involve the review of the adequacy of the

accounting and documentations of transactions.

iv. Internal control system review: - A review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of

accounts can be relied on for the preparation of the finals account. v. Substantive Testing: - This involves the tests of transactions and balances and other

procedures such as analytical review which seek to provide audit evidence as to the

completeness, accuracy and validity of the information contained in the accounting records.


- - 34 - -

vi. Analytical Review: - This involves the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past experiences and also other financial and non- financial information available.

vii. Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies are

acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items which needs to be disclosed.

viii. Preparation and signing of report:-This is where the auditor expresses his opinion in a report as to whether the financial statement shows a true and fair view or not. The report

shows the person to whom the report is addressed, the financial statement audited, the responsibilities of management and the auditor, the signature of the auditor and the date of the report.

Q6. a) MITZIE



Less: Contribution to pension Fund (6%) 3,300 Professional subscription 600 (3,900)


TAXABLE PAY 43,100 TAX PAYABLE


First 3,000 10% 300 Next 27,000 20% 5,400 Excess 13,100 40% 5,240

Tax payable 10,940


- - 35 - -

Q6 b.) FRANK


$

Basic Salary 67,000 Less Relief: Contribution to pension Fund (5%) 3,350

Allowable expenses 700 (4,050)

Less Personal allowance (single) (8,000) Marriage allowance (3,000) (11,000) TAXABLE PAY 51,950

TAX PAYABLE


Next 27,000 20% 5,400 Excess 21,950 40% 8,780

Tax payable 14,480 Q7. REM LTD


$ $ Net Profit before tax 495,000 Add: Non-allowable Expenses 8,000

Depreciation: Computers (25% x 300,000) 75,000

Machinery (20% x 400,000) 80,000 163,000 Adjusted Net Profit 658,000

Less Capital Allowance: Computers Equipments (40%X300, 000) 120,000

Machinery (25% X 400,000) 100,000 (220,000) Taxable profit 438,000

Tax thereon @25% (433,000 X 25%) 109,500


- - 36 - -

Q8 a) Personal allowances: This is the amount of income you can receive each year without having to pay tax on it.

Depending on your circumstances, you may also be able to claim certain other allowances

Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance.

b) A capital gains tax (abbreviated: CGT) is a tax charged on capital gains, the profit realized on

the sale of a non- inventory asset that was purchased at a lower price. The most common capital

gains are realized from the sale of stocks, bonds, precious metals and property.



individuals and £4,400 for trusts. This is subtracted from total capital gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income: treated as the top slice of income, capital gains are taxed at 10% below the starting-rate limit, 20%

between the starting- and basic-rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.

c) Tax Evasion: Exists when an individual, or group of individuals (such as a firm), conceal or understate their incomes in order to avoid paying taxes. This may involve lying about one's income, claiming deductions you are not entitled to, or not declaring income received in cash. The latter - sometimes seen as part of the informal economy - can also lead to concealing sales and

thus evading indirect taxes, primarily VAT.

Tax evasion is illegal and may result in fines or imprisonment or both.

d) Tax codes

A tax code is used by employers or pension payer to calculate the amount of tax to deduct from

your pay or pension. A tax code is usually made up of several numbers and a letter, for example: 117L or K497.

An employee's tax code is used by employers to calculate the amount of income tax that must be withheld, or deducted, from the employee's wage or salary. The tax code is the mechanism by

which "pay as you earn" (PAYE) is operated in the UK, making it possible for most employees to have paid exactly the right amount of income tax by the end of each tax year. As a result, most

employees in the UK do not have to complete an income tax return.





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JUNE 2006

AUDITING & TAXATION

PART A


PART B

2. a) Explain the process of approving an invoice for payment. You are advised to refer to the relevant source documents to be examined in this process. [10]

b) Draft the body of a „clean‟ audit report. [5] c) Explain the principal purpose of an audit trail. [5]

3. Explain briefly how you would verify the following items: a) Trade debtors

b) Plant and equipment c) Trade creditors

d) Bank balances [5 each] 4. Explain the following terms:

a) Letter of weakness b) Interim audit

c) The audit Programme d) Post balance sheet events [5 each] 5. a) Explain the major data verification checks associated with entering financial data into

a computerized accounting system. [10] b) Outline the stages of an audit. [10]

PART C

6. The following information applies to any personal tax calculations:

TAX RATES 10% on the first $3,000 of taxable income

20% on the next $27,000 of taxable income 40% on any further taxable income PERSONAL ALLOWANCES

Single person $8,000 Additional allowance of $3,000 can also be claimed by one of the partners in a marriage.


pension fund.


Louisa, aged 38, is a single person who earns $49,000 per year. She has paid 5% of her gross pay into a qualifying pension fund. Louisa has also paid $400 in respect of professional subscriptions.


- - 38 - -

Carlos, aged 41, is married (and claims the additional allowance) and earns $59,000 per year. He has paid 6% of his gross pay into a qualifying pension. Carlos has also paid $700 in respect of expenses which are allowable against tax.

TASKS

Calculate the taxable pay, and the total tax payable for EACH of the following: a) Louisa [7] b) Carlos [8]

7. The following is the summarized internal profit and loss account of Zanue Ltd. after its

first year of trading: £ Sales 2,900,000



Other information:



50% as regards IT equipment Included in the distribution costs are £8,000 which are deemed non-allowable. TASKS

Calculate Zanue Ltd‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) Personal allowances b) Schedule D

c) PAYE d) The basic principles of taxation [5 each]


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SUGGESTED ANSWERS- JUNE 2006

Q1 True and Fair:

No precise definition exists for the term true and fair. However, the term true and fair can be broken down into two:

True: this means in accordance with facts

Fair: this means in accordance with expectations, relevance, and objectivity, free from bias.

The following quotations represent some authoritative views on the meaning of the term true and fair

a) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia) b) True and fair view implies that all statutory and other information is not only available but

is presented in a form which it can be properly and readily accepted (Sir Russell Kettle) In summary, there is no statutory or professional definition of true and fair view. However, to say

financial statement shows a true and fair view, the accounts must be prepared in accordance with generally Accepted accounting principles and must conform to relevant statutory and regulatory

and the accounts must not me misleading and should be free from bias. Q2a. The following procedures are involved in approving payment of invoice

1. There must be procedures for issuing requisition notes and responsible persons for such requisition

2. purchase order must be prepared and authorized 3. Goods received must be examined in terms of quantity, quality and conditions of the

items.

4. Check calculations of the supplier‟s invoice amount and ensure that they are correctly priced.

5. ensure payment voucher accompanies the invoice 6. Ensure that expenditure is properly invoiced as shown by the purchase order.

Q2b. A “clean” audit report/unqualified audit report is normally given when the auditor is

satisfied in all material respect that the financial statements give a true and fair view. The body of a clean report is as follows “We have audited the financial statements on pages x-y in accordance auditing standards. In

our opinion, the financial statements give a true and fair view of the state of affairs as at 31st

December 200x and of its profit and loss for the year then ended and have been properly

prepared in accordance with the companies Act 1985”


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Q2c. An audit trail: An audit trail, in relation to accounting, is a record left by the accounting information system of movements in individual transaction data. This record, in the form of references to the processing of the data, provides a trail of the processing of transactions and other

events entered into by the entity. The principal purpose of audit trail is that it enables the auditor to quickly understand how data flows through the accounting information system.

An auditor may follow the audit trail of a transaction as part of a systems "walk-through" to

either obtain or verify their understanding of the accounting information system.

Q3a. Trade Debtors:

The following procedure will be followed to verity debtors. a) Examine the system of internal control over sales and debtors and test the effectiveness of

the system

b) Obtain a list of all the balances of debtors. c) Cast or total the list and agree the total to the general ledger control account balance

d) Enquire into debtors with credit balances on a debtors account (as this is unusual) e) Select a sample of individual debtors account and test as follows.

i. Trace debt entries to entries in the sales day book

ii. Check that dispatch notes have corresponding sales invoices iii. Trace credit entries to the cash book

f) Circularize the sample selected g) Examine all confirmations replied and investigate and exceptions h) Consider the adequacy of bad debt provisions, sales returns and cash discounts.

i) Consider the valuation of debtors in the balance sheet.

Q3 b. Plant and Machinery:

The verification procedure will include the following

a) Examine the title document to establish that the plant& machinery is owned by the company by inspecting the purchase invoice.

b) Ascertain that there is proper authorization and approval for the purchase by examining

directors‟ minutes. c) Vouch the original invoices from the supplier and check the cost price and installation

d) Where installation is done by the company‟s staff, examine the wages and allowances paid to the staff

e) Physically inspect the plant & machinery and examine the asset register

f) Vouch all disposals and verify that all cost and depreciation balances have been accounted for.

g) Review the depreciation policy over plant and machinery and ensure that they are consistently applied.

h) Check the calculation of depreciation and ensure that depreciation is accurate.

i) Consider the valuation in the balance sheet

http://www.abrema.net/abrema/walk_thru_g.html


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Q3c. Trade Creditors:

Audit procedures include the following: Evaluate the system of internal control over purchases

Obtain a copy of the schedule of balance of creditors and confirm the balances with the creditors control account

Enquire into any material debit balances on the creditors account Check trade creditors to purchases and note down the credit period. Circularise sample of creditors

Check that all creditors are properly disclosed in the financial statement

Q3d. Bank balance: General verification procedures are: Appraise the system of internal control over bank Examine the bank reconciliation statement and note the following

i. That all uncleared cheques are cleared ii. That all payments or lodgments not credited at the balance sheet date have been

credited iii. Investigate any exceptions

Check the arithmetical accuracy of the bank reconciliation statement

Trace cash payments and cash receipts to the various documents taking notes of cheque numbers

Trace all contra entries, dishourned cheques, cancelled cheques Vouch any transfers to the petty cash book and other bank accounts Cast the bank column of the cash book

Send the standard bank letter and check the information received with the bank statement Consider the value of bank balance in the balance sheet

Q4a. Letter of Weakness: It is a letter sent by the auditor to his client, bringing to his attention the

weakness found in the internal control system during the audit. This is letter also known as management letter, letter of comment, letter of recommendation, post audit letter, internal control

letter The letter points out the weaknesses found in the internal control system and gives recommendations to improve them. It is usually presented to the client in a meeting with the auditor.

Q4b. Interim Audit is an audit that is conducted to cover a certain time or up to a certain date within the financial period. It may be done to cover a month, a quarter or half year on the request of a client. Some audit work such as verification of assets and liabilities may not be carried out

during interim audit. These may be deferred to the final audit. The work done may include ascertaining the system of accounting and internal controls, evaluation of the system for adequacy

and any possible weaknesses, design and performing compliance tests etc.


- - 42 - -

Q4c. Audit Program –The audit program essentially consists of a very detailed list of things to be done in an audit engagement. It is a statement of decision to an audit engagement for the purpose of indicating what to do, how to do it and when do it. The audit program develops and

documents the nature, timing and extent of planned audit procedures required to implement the overall audit plan. The purpose is to assist the auditor to ascertain / determine the reliability of the

accounting records used in preparing the final account. It is normally on a printed form or booklet. It ensures that no aspect of the audit work is over- looked and therefore gives a clear perspective of work to be done by the auditor.

Q4d. Post Balance Sheet Events: Post Balance sheet events are those events both favourable and

unfavourable which occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors”. Post balance sheet events fall into two categories, namely


Adjusting events are events that provide additional information or conditions existing at the balance sheet date. Example is the discovery of error or fraud that shows that the accounts were not correct after the balance sheet date. Another example is proposed dividends.

Non-adjusting events are events that arise after the balance sheet date and concern conditions that do not exist at the balance sheet date. Such events will not have any effect on the balances in the

Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers and acquisitions, strikes and labour disputes, changes in the exchange rate etc










a) Check digit verification

b) Format checks

c) Sequence checks

d) Range checks

e) Programmed controls

f) Batch registers

g) Input validity checks etc.


- - 43 - -

Q5b.The stages in an audit can be summarized as follows: a. Background Research : - This involves a research into the history of the company,

its product, its present condition and future prospect, the location of all branches,

any problem in accounting system and changes in law or accounting practice which affect the client.

b. Preparation of the audit plan:- This involves preparing an overall audit plan which shows how the audit work will be done, the staff who will do the work, the budgeted time and cost

c. Accounting system review: - This will involve the review of the adequacy of the accounting system and documentations of transactions.

d. Internal control system review: - It is a review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the final

account. e. Substantive Testing: - This involves the tests of transactions and balances and

other procedures such as analytical review which seek to provide audit evidence as to the completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary

where there is weak internal control or the item is extraordinary transaction.

f. Analytical Review: - This is the study of relationships between elements of the

financial information expected to confirm a predictable pattern based on the organization‟s past experiences and other non- financial information available.

g. Analytical Review of financial statement:- This is where the auditor performs

overall analytical review of the financial statement to determine whether accounting policies are acceptable and are used consistently , all items in the

financial statement are compatible to the best of his knowledge and also adequate disclosure of items which

h. Preparation and signing of report:-This is where the auditor expresses his

opinion in a report as to whether the financial statement shows a true and fair view or not. The report shows the person to whom the report is addressed, the financial

statement audited, the responsibilities of management and the auditor, the signature of the auditor and the date of the report.


- - 44 - -

Q6. a) LOUISA








Q6b.) CARLOS


$

Basic Salary 59,000 Less: Contribution to pension Fund (6%) 3,540


Less Personal allowance (single) 8,000 Marriage Allowance 3,000 (11,000) TAXABLE PAY 43,760

TAX PAYABLE


Next 27,000 20% 5,400 Excess 13,760 40% 5,504

Tax payable 11,204


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Q7. ZANUE LTD


£ Net Profit 640,000

Add: Depreciation of IT equipments 30,000 Depreciation of Equipments 80,000 Non-allowable Distribution cost 8,000 118,000

Adjusted Net Profit 758,000

Less Capital Allowance: IT Equipments (50%X240, 000) 120,000


Tax thereon@ 22% (488,000 X 22%) 107,360

WORKINGS: PROFIT AND LOSS ACCOUNT Sales 2,900,000

Cost of sales (1,400,000) Gross profit 1,500,000 Distribution cost 460,000

Administrative expenses 290,000 Depreciation of equipments 80,000

Depreciation of IT equipments 30,000 (860,000) Net profit 640,000

Q8 a) Personal allowances:

Almost everyone who lives in the UK is entitled to an Income Tax Personal Allowance. This is the amount of income you can receive each year without having to pay tax on it. Depending on your circumstances, you may also be able to claim certain other allowances

b) Schedule D

An income tax form used by taxpayers to report their realized capital gains or losses. Investors are required to report their capital gains (and losses) from the sales of assets, which result in

different cash values being received for them than what was or iginally paid, in order to calculate some amount of taxation to the income and wealth that is generated through investment activities.

c) PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the government

from employees. The tax collected during the year may be enough to discharge the taxpayer's



- - 46 - -

liability for tax. This is, in effect, a provisional payment of tax on the employee's income. The

amount withheld is determined partly by the employee's expected tax allowances, exemptions and

reliefs, and partly by tax tables that determine the amount of tax to be deducted for the salary or

wage paid to the employee.

d) The basic principles of taxation:

The basic principles of taxation refer to the general principles that every good tax system should

have. In 1776, Adams Smith in his book “the Wealth of Nations” laid down four basic principles that should be seen in every good tax system. These are

1. The principle of Equity: Taxes should be fair to different individuals and should reflect a person‟s ability to pay. The ability-to-pay principle holds that people‟s taxes should be based upon their ability to pay, usually as measured by income or wealth.

2. certainty: It should be certain, not arbitrary 3. Convenience : it should be convenient in terms of timing and payment.

4. efficiency: it should be administratively efficient with a relatively small cost of collection as a proportion of the revenue raised.

SEPTEMBER 2006

AUDITING & TAXATION

PART A

1. Explain the principal contents of FRS 21 (events after the balance sheet date). [10]

PART B

2. Explain the stages of an audit. [20]

3. Explain briefly how you would verify the following items: a) Trade debtors b) Freehold property

c) Trade creditors d) bank balances [5 each]

4. a) Explain the legal duties of an auditor. [10] b) Explain the importance of a letter of engagement. [10] 5. Explain the following terms:

a) ICQ b) Internal controls

c) Audit trail d) True and fair [5 each]

PART C

The following information applies to any personal tax calculations:

TAX RATES 10% on the first $3,000 of taxable income 20% on the next $27,000 of taxable income

40% on any further taxable income




- - 47 - -

PERSONAL ALLOWANCES Single person $8,000 Additional allowance of $3,000 can also be claimed by one of the partners in a marriage.



6. Chorley, aged 43, is a single person who earns $57,000 per year. He has paid 5% of his salary into a qualifying pension fund. Chorley has also paid $800 in respect of professional

subscriptions. Sunita, aged 32, is married (and claims the additional allowance) and earns $64,000. She

has paid 5% of her gross pay into a qualifying pension fund. Sunita has also paid $400 in

respect of expenses that are allowable against tax. TASKS

Calculate the taxable pay and the total tax payable for EACH of the following: a) Chorley [7] b) Sunita [8]

7. The following is the summarised internal profit and loss account of Huish Ltd. after its

first year of trading: £ Sales 2,400,000





25% as regards equipment 50% as regards IT equipment

Included in the administration expenses is £7,000 which is deemed non-allowable. TASKS Calculate Huish Ltd.‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following:

a) PAYE b) Schedule D c) Capital gains tax (CGT)

d) The basic principles of taxation [5 each]


- - 48 - -

SUGGESTED ANSWERS- SEPTEMBER 2006

Q1. FRS 21 (Events after the Balance Sheet Date): It is defined as “Those events both

favourable and unfavourable which occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors

FRS 21 sets out the recognition and measurement requirements for two types of event after the balance sheet date:

Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at the end of the reporting period, including an event that indicates that

the going concern assumption in relation to the whole or part of the enterprise is not appropriate. For example, the settlement of a court case that confirms the entity had a present obligation at the balance sheet date.

Non-adjusting event: An event after the reporting period that is indicative of a condition that

arose after the end of the reporting period. For example, a decline in market value of investments between the balance sheet date and the date when the financial statements are

authorized for issue.

Accounting Treatment

Adjust financial statements for adjusting events Do not adjust for non-adjusting events

If an entity declares dividends after the reporting period, the entity shall not recognize those dividends as a liability at the end of the reporting period. That is a non-adjusting event.

Disclosure : Non-adjusting events should be disclosed if they are of such importance that non-

disclosure would affect the ability of users to make proper evaluations and decis ions. The required disclosure is (a) the nature of the event and (b) an estimate of its financial effect or a statement

that a reasonable estimate of the effect cannot be made.

If non-adjusting events after the balance sheet date are material and non-disclosure could influence the economic decisions of users the entity should disclose the nature of the event and an estimate of its financial effect or a statement that such an estimate cannot be made. FRS 21

supersedes the existing UK accounting requirements in this area which were set out in SSAP 17 „Accounting for post balance sheet events'.

Q2.The stages in an audit can be summarized as follows:

i. Background Research: - This involves a research into the history of the company, its



- - 49 - -

problem in accounting system and changes in law or accounting practice which affect the client.

ii. Preparation of the audit plan:- This involves preparing an overall audit plan which shows

how the audit work will be done, the staff who will do the work, the budgeted time and cost


iv. Internal control system review: - It is a review of the internal control system to know

whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the final account.

v. Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to the completeness, accuracy and validity of the information contained in the accounting

records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinary transaction.

vi. Analytical Review: - This is the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past experiences and other non- financial information available.

vii. Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items which

viii. Preparation and signing of report:-This is where the auditor expresses his opinion in a



Q3 a) Trade debtors:


a) Determine the system of internal control over sales and debtors and test the effectiveness of the system

b) Obtain a list of all the balances of debtors.

c) cast the list and agree the total to the general ledger control account balance d) Enquire into debtors with credit balances

e) Select a sample of individual debtors account and test as follows. i. Trace debt entries to entries in the sales day book

ii. Check that dispatch notes have corresponding sales invoices

iii. Trace credit entries to the cash book f) Circularize the sample selected

g) Examine all confirmations replied and investigate and exceptions h) Consider the adequacy of bad debt provisions, sales returns and cash discounts. i) Consider the valuation of debtors in the balance sheet


- - 50 - -

Q3b. Freehold property

The following procedures will be employed in the verification. 1. Obtain a schedule of fixed assets

2. Examine a sample of title deeds and land registry certificate, conveyance documents from solicitors and leases. Pay particular attention to mortgages and securities over assets

3. Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy agreements and leases are properly authorised.

4. Check entries in the fixed assets register and trace back to source documents to ensure it is

properly stated at cost 5. Review the companies policy for depreciation and ensure that land is not depreciated

6. Check the calculations of the depreciation and ensure they are accurate 7. Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and

check the rental income

8. Physically inspect assets to ensure their existence 9. Check the classification and presentation of fixed assets

10. Ensure that, the amount stated in the financial information is in agreement with the accounting records.

Q3c. Trade Creditors

Creditors can be verified using the following procedures

1. Evaluate the system of internal control over purchase 2. Obtain a copy of the schedule of balance of creditors and confirm the balances with the

creditors control account

3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on the creditors account

5. Check trade creditors to purchases and note down the credit period. 6. Circularise sample of creditors 7. Examine all responses received from the circularization and investigate any exceptions


Q3d. Bank balance

In the verification of bank balance, I will perform the following procedures i. Appraise the system of internal control over bank

ii. Examine the bank reconciliation statement and note the following a. That all uncleared cheques are cleared

b. That all payments or lodgments not credited at the balance sheet date have been credited

c. Investigate any exceptions

iii. Check the arithmetical accuracy of the bank reconciliation statement

iv. Trace cash payments and cash receipts to the various documents taking notes of cheque numbers

v. Trace all contra entries, dishourned cheques, cancelled cheques

vi. Vouch any transfers to the petty cash book and other bank accounts


- - 51 - -

vii. Cast the bank column of the cash book viii. Send the standard bank letter and check the information received with the bank statement

ix. Consider the value of bank balance in the balance sheet

Q4a. The duties of an auditor

The statutory duty of an auditor is to report to the members of the company as to whether or not the accounts prepared gives a true and fair view and have been properly prepared in accordance with the companies Act 1985. To fulfill this, the auditor is required:

1. To make a report as to whether proper accounting records have been kept. 2. To report whether all returns have been received from branches

3. To report whether or not the accounts prepared are in agreement with the records 4. Whether the information and explanations given in the directors report is consistent with

the accounts

5. State whether the accounts and statements comply with the Companies Act and finally, 6. Whether in his opinion, the financial statement presents a true and fair of the company‟s

affairs at the balance sheet date and of its profit and loss for the period under review.

Q4b.

The engagement letter has the following importance a. It defines clearly the extent of the auditors work to be done under the contract.

b. It minimizes any misunderstanding between the auditor and the management c. It serves as a confirmation of the verbal agreement reach between auditor and his

client earlier.

d. The letter assist in drawing distinction between the work of the auditor and other work such as management consultancy, taxation and accountancy

e. The letter indicates the basis on which fees are to be charged f. It educates the client by explaining how in general terms the audit will be conducted.

Q5a. Internal Control Questionnaire- ICQ

Internal control Questionnaire (ICQ) is a comprehensive, all inclusive method of ascertaining,

recording and evaluating a system of internal controls. It is a pre-printed document designed by the auditor to be used in assessing the adequacy of the client‟s accounting system. It consists of a series of questions designed to establish which control exist in the accounting system and any

possible weaknesses. Internal Control Questionnaire helps audit staff familiar ize themselves with the client‟s accounting system quickly and more comprehensively.

Q5b. Internal control: It is defined as the whole system of control, financial and otherwise established by the management in other to carry on the business of the enterprise in an orderly and

efficient manner, ensure adherence to management policies, safeguard the assets and secure as far as possible, the completeness and accuracy of the records. The individual components of an

internal control system are known as control or internal controls.


- - 52 - -

The main types of internal controls are i. organization

ii. segregation of duties

iii. physical iv. authorization and

approval

v. arithmetical and accounting

vi. personnel vii. supervision

viii. management

Q5c. Audit Trail:

An audit trail, in relation to accounting, is a record left by the accounting information system of movements in individual transaction data. This record, in the form of references to the

processing of the data, provides a trail of the processing of transactions and other events entered into by the entity. While some accounting information systems provide a visible and

complete audit trails, others may provide an invisible and/or incomplete trail. A visible audit trail may be in the form of documentation (a paper trail) or an electronic tra il. Accounting information systems have a number of audit trails: for example, trails of different transaction

cycles and/or of different computer applications.

Depending on the accounting information system, the trail may start from the moment data about the event is first captured within the system to the time of its ultimate disposition in the

financial statements. Auditors look for a complete and visible audit trails as such a trail allows the auditor to quickly understand how data flows through the accounting information system.

An auditor may follow the audit trail of a transaction as part of a systems "walk-through" to

either obtain or verify their understanding of the accounting information system.

Q5d. True and Fair: Auditors of the published accounts of companies are required to form an opinion as to whether the accounts they audit show a „true and fair view‟ of the organization's affairs. This is an

important concept in the UK. The meaning of true and fair can be broken down into two:

True: this means in accordance with facts Fair: this means in accordance with expectations, relevance, and objectivity, free from bias.


a) A true and fair view means appropriate classification and grouping of items... and consistent application of generally accepted principles (ICA-Australia)

b) True and fair view implies that all statutory and other information is not only available

but is presented in a form which it can be properly and readily accepted (Sir Russel Kettle)

There is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view, the accounts must be prepared in accordance with generally Accepted accounting principles and must conform to relevant statutory and

regulatory and the accounts must not me misleading and should be free from bias.

http://www.abrema.net/abrema/walk_thru_g.html


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Q6. a) CHORLEY


$

Basic Salary 57,000 Less

Contribution to pension Fund (5%) 2,850 Professional subscription 800 (3,650) Less Personal allowance (single) (8,000)

TAXABLE PAY 45,350


First 3,000 10% 300 Next 27,000 20% 5,400


Q6 b.) SUNITA

COMPUTATION OF TAXABLE PAY AND TAX PAYABLE $ Basic Salary 64,000

Less Contribution to pension Fund (5%) 3,200

Allowable expenses 400 (3,600) Less Personal allowance (single) (8,000)

Marriage allowance (3,000) (11,000) TAXABLE PAY 49,400

TAX PAYABLE



Tax payable 13,460


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Q7. HUISH LTD

CALCULATION OF TAXABLE PROFIT AND TAX PAYABLE Net Profit 590,000


Non-allowable administration expenses 7,000 137,000 Adjusted Net Profit 727,000


IT Equipments (50%X200, 000) 100,000 Equipments (25% X 500,000) 125,000 (225,000) Taxable profit 502,000

Tax thereon@22% (502,000 X 22%) 110,440





Net profit 590,000

Q8.

a) PAYE: PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the




allowances, exemptions and reliefs, and partly by tax tables that determine the amount of tax to

be deducted for the salary or wage paid to the employee.

PAYE is, in effect, a withholding tax administered separately by the tax authority.






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b) Schedule D

It is an income tax form used by taxpayers to report their realized capital gains or losses. Investors are required to report their capital gains (and losses) from the sales of assets, which result in different cash values being received for them than what was originally paid, in order

to affix some amount of taxation to the income and wealth that is generated through investment activities.

c) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital

gains, the profit realized on the sale of a non- inventory asset that was purchased at a lower

price. The most common capital gains are realized from the sale of stocks, bonds, precious

metals and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of

assets by individuals and trustees. Capital gains made by companies are subject to corporation tax. The total capital gain is defined as the value of the asset when it is sold (or given away

etc.) minus its value when originally bought (or inherited etc.). As with income tax, there is a threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt amount‟ is £8,800 for individuals and £4,400 for trusts. This is subtracted from total capital

gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income: treated as the top slice of income, capital gains are taxed at 10%

below the starting-rate limit, 20% between the starting- and basic-rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.


The basic principles of taxation refer to the general principles that every good tax system

should have. In 1776, Adams Smith in his book “the Wealth of Nations” laid down four basic principles that should be seen in every good tax system. These are

1. The principle of Equity: Taxes should be fair to different individuals and should

reflect a person‟s ability to pay. The ability-to-pay principle holds that people‟s taxes should be based upon their ability to pay, usually as measured by income or wealth.

2. certainty: It should be certain, not arbitrary 3. Convenience : it should be convenient in terms of timing and payment. 4. efficiency: it should be administratively efficient with a relatively small cost of

collection as a proportion of the revenue raised.







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DECEMBER 2006 AUDITING & TAXATION

PART A

1. Explain the rights of an auditor of a limited company. [10] PART B

2. Explain the following: a) Compliance tests

b) test-checks c) Substantive tests d) Walk-through tests [5 each]

3. Explain briefly how you would verify the following items: a) Freehold land and buildings

b) The bank balance c) Investments d) Stock and work in progress [5 each]

4 a) Explain the role of an internal audit department. [10]

b) Explain what internal controls can be „built‟ into the typical financial accounting system i.e. from the recording of each financial transaction to the production of the first draft final accounts. [10]

5. Explain the stages of an audit. [20]

PART C




Additional allowance of $3,000 can be claimed by one of the partners in a marriage. PENSION CONTRIBUTIONS



6. Darius, aged 45, is a single person who earns $59,000 per year. He has paid 5% of his

gross pay into a qualifying pension fund. Darius has also paid $800 in respect of professional subscriptions.

Boris, aged 41, is married (and claims the additional allowance) and earns $63,000. He

has paid 5% of his gross pay into a qualifying pension fund. Boris has also paid $500 in respect of expenses, which are allowable against tax.


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TASKS Calculate the taxable pay and the total tax payable for EACH of the following:

a) Darius [7] b) Boris [8]

7. The following data relates to SUS Ltd.: £

Internal profit before tax 580,000 Original cost of machinery 500,000 Original cost of computers 200,000

Expenses deemed to be non-allowable 6,000

Internal rates of depreciation charged in the profit and loss account: Machinery 20% on cost Computers 25% on cost

The relevant capital allowances allowed by the Inland Revenue are:

Machinery 25% on cost Computers 50% on cost Corporation tax (company tax) is charged at 24% of taxable profit. [15]

TASK Calculate SUS Ltd.‟s taxable profit AND the total tax charge for the year.

8. Write short notes on THREE of the following: a) Personal allowances

b) Capital gains tax (CGT) c) PAYE

d) Tax codes [5 each}

SUGGESTED ANSWERS- DECEMBER 2006

Q1 The rights of an auditor includes the following a) The right of access at all times, to the books and accounts and vouchers of the company b) He has the right to require from the officers including the directors of the company,

such information and explanations necessary for the performance of his duties as an auditor.

c) The right to attend any general meeting of the company and to receive notices to any meeting and to be heard on any part of the meeting which concerns them as an auditor

d) The right to be notified in writing, any intended resolution to remove the from office as

auditors of the company


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e) The right, before accepting appointment as auditors of the company, to communicate with the outgoing auditor (if any) and invite him to make any representations and

supply any information about the company which he may or may not supply. f) He also has the right to contract with the company, in addition to the statutory duties,

undertake or provide accounting, taxation and other services to the company.

Q2a. Compliance Test:

These are tests designed to obtain reasonable assurance that those internal controls in the clients system were functioning properly and throughout the period. In compliance tests, the auditor tests the controls and not transactions invo lved. It is

sometimes called test of controls. If the internal control is found to be weak, then the auditor will perform more substantive tests. Tests of control include observation

of an internal control procedure being performed, inspection of evidence that the control procedure was performed (and performed at the appropriate time), and inquiry about how and when the procedure was performed.

Q2b Tests-checks : This is an audit technique or procedure whereby a sample of population is checked in detail and the result applied to the whole population. There are two methods used in test checking: (a) Judgement sampling-where the

selection of the items to be tested are determined by the auditor‟s judgement and (b) Statistical Sampling– where the selection of the items to be tested are by

statistical or mathematical princ iples.

Q2c Substantive tests : - This is defined as those tests of transactions and balances and other procedures such as analyt ical review, which seek to provide audit evidence as to the completeness, accuracy and validity of information contained in the accounting records or

financial statement. Thus Substantive procedures (or substantive tests) are those activities performed by the auditor that gather evidence as to the completeness, validity and/or accuracy

of account balances and underlying classes of transactions.

Substantive test are usually applied to transactions when the internal control is found weak and therefore the auditor cannot rely on it. It is also applied to extraordinary items and all assets and liabilities in the balance sheet. When it is directed to the profit, the

auditor will ensure that, all items (income and expenses) recorded in the profit and loss have been earned or incurred and have actually been inc luded in the calculation of the

profit or loss. The auditor will conduct substantive test on the balance sheet to ensure the existence of assets and liabilities, ownership of assets and responsibility of all liabilities, the correctness of their values, how the items are presented etc. Some of the tools or

methods used in substantive testing include

1. Inspection

2. Observation

3. Enquiry

http://www.abrema.net/abrema/observation_g.html

http://www.abrema.net/abrema/inspection_g.html

http://www.abrema.net/abrema/inquiry_g.html


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4. Analytical review

5. Recalculation

6. Vouchin


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Q2d Walk-through tests: A walk-through refers to the auditor selecting a small sample of representative transactions or economic events and tracing (or "walking") them through the accounting information system. The walk-through may be (a) through just part of the system or

(b) from the time the transactions or events were first captured and input as data to their final disposition in the financial statements. This is similar to following a transaction along the transaction cycle's audit trail.

The purpose of the walk-through may be either for the auditor to identify specific control procedures in an accounting information system or to confirm the system the auditor has previously documented in the working papers is the system that is operating at the time of the

audit. In some instances, it may be more economical for the auditor to obtain/confirm this information by other means, such as through discussions with client personnel. Thus, Walk-

through test involves as tracing one or more transactions through the accounting system and observing the application of relevant aspect of the internal control system.


The following procedures will be employed in the verification of freehold land and buildings

i. Obtain a schedule of fixed assets ii. Examine a sample of title deeds and land registry certificate, conveyance documents

from solicitors and leases. Pay particular attention to mortgages and securities over assets

iii. Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised. iv. Check entries in the fixed assets register and trace back to source documents to ensure

it is properly stated at cost v. Review the companies policy for depreciation and ensure that land is not depreciated vi. Check the calculations of the depreciation and ensure they are accurate

vii. Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and check the rental income

viii. Physically inspect assets to ensure their existence ix. Check the classification and presentation of fixed assets x. Ensure that, the amount stated in the financial information is in agreement with the

accounting records.

Q3b Bank balance

Bank balance can be verified using the following audit procedures: a. Appraise the system of internal control over bank

b. Examine the bank reconciliation statement and note the following i. That all uncleared cheques are cleared

ii. That all payments or lodgments not credited at the balance sheet date have been credited

iii. Investigate any exceptions

http://www.abrema.net/abrema/audit_trail_g.html


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c. Check the arithmetical accuracy of the bank reconciliation statement d. Trace cash payments and cash receipts to the various documents taking notes of cheque

numbers e. Trace all contra entries, dishourned cheques, cancelled cheques f. Vouch any transfers to the petty cash book and other bank accounts

g. Cast the bank column of the cash book h. Send the standard bank letter and check the information received with the bank

statement i. Consider the value of bank balance in the balance sheet

Q3c: Investment : The following procedures can be followed in the verification of investment 1) Request for a list of all investment currently held by the client and distinguish

between quoted and unquoted. A reconciliation of the current book value and that of the previous year should be made. Ask that the market value of all investment at the end of the year should be shown i.e. the quoted.

2) Verify purchase or sale of investment during the year with documentary evidence. E.g. Contract notes or agreements



stock exchange values. In the case of unquoted ones inspection should be made of the company‟s accounts and though there is no market value disclosed for unquoted

investment consideration should be given as to whether the net realizable value is below cost for current assets and for fixed assets, whether a permanent fall in value has occurred.

5) Physically inspect certificates and bonds. If they have been deposited with a bank a certificate stating in whose name they are registered and whether they are free from

any charge should be shown and this should be compared with the standard bank letter.


disposals, sold contracts. 7) Vouch the income received.

8) Verify that all incomes have been received and properly treated in the financial statement.

9) Ensure proper disclosure in the accounts

Q3.d Stocks & work-in progress:

In verifying stocks and work in progress, the following procedures will apply a) review the system of internal control over stocks b) perform compliance tests on key controls relating to purchases, sales, creditors and

debtors c) physically check samples by counting selected items of stock

d) observe stock taking (i.e. attend stock taking )


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e) check on slow moving, obsolete stocks f) compare the current years stock with previous years stocks and note any significant

changes g) confirm that the stock valuation is in line with SSAP 9 h) Verify each work- in-progress item with a job card.

Q4a. The role of the internal audit department:

The role played by internal department includes the following: i. It helps reduce the amount of detailed work to be carried out by the external

auditors if it is found to be reliable

ii. They review the system of accounting, financial and other operations of the business and notify management and advice them on the best practice.

iii. They Review and test compliances and accuracy of the companies policies iv. They exist to review and improve the system of internal checks. v. They also prevent fraud and helps in early detection of fraud and irregularities

vi. They undertake special investigation at the request of management.

Q4b. Internal control is the whole system of control financial and otherwise established by management in order to carry on the business of the enterprise in an orderly and

efficient manner, ensure adherence to management policies, safeguard assets and secure as far as possible, the completeness and accuracy of the records.

The following are the internal controls that can be “built” into a typical financial accounting system


ii. Organization: there should be a clear organization chart and all staff should have up to date job descriptions that clearly indicate their responsibilities.

iii. Authorization and approval: all transactions and decisions should be formally authorized by nominated staff.

iv. Physical: there should be suitable controls over access to offices, assets,

controlled stationery and computer systems. v. Management: production of suitable financial and operational management

information; use of exception reports; critical review and enquiry by management.

vi. Arithmetical and accounting : checking / re-performing tasks carried out by

others; costing (adding up) orders, invoices, payroll etc; reconciliation between the bank and accounting records; control accounts.

vii. Personnel: appointment of staff should be adequately controlled; all staff should be suitably trained for their post and appraised regularly.


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viii. Supervision: all staff and activities should be adequately supervised by someone who understands the process and will detect deviations from accepted

practice.

Q5. The stages in an audit can be summarized as follows: i. Background Research: - This involves a research into the history of the company, its


problem in accounting system and changes in law or accounting practice which affect the client.

ii. Preparation of the audit plan:- This involves preparing an overall audit plan which shows how the audit work will be done, the staff who will do the work, the budgeted time and cost


iv. Internal control system review: - It is a review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the final account.

v. Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to the

completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinary transaction.

vi. Analytical Review: - This is the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past

experiences and other non- financial information available. vii. Analytical Review of financial statement:- This is where the auditor performs overall

analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items.

viii. Preparation and signing of report:-This is where the auditor expresses his opinion in a report as to whether the financial statement shows a true and fair view or not. The report shows the person to whom the report is addressed, the financial statement



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Q6. a) DARIUS




Professional subscription 800 (3,750) Less Personal allowance (single) (8,000) TAXABLE PAY 47,250

TAX PAYABLE


Next 27,000 20% 5,400 Excess 17,250 40% 6,900

Tax payable 12,600

Q6 b.) BORIS




Allowable expenses 500 (3,650) Less Personal allowance (single) (8,000)

Marriage allowance (3,000) TAXABLE PAY 48,350

TAX PAYABLE




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Q7. SUS LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE Net Profit before Tax 580,000

Add: Non-allowable Expenses 6,000 Depreciation: Machinery (500,000 x 20%) 100,000

Computers (200,000 x 25%) 50,000 156,000 Adjusted Net Profit 736,000

Less Capital Allowance: Computers Equipments (50%X200, 000) 100,000

Machinery (25% X 500,000) 125,000 (225,000) Taxable profit 511,000

Tax thereon@ 24% (511,000 X 24%) 122,640

Q8 a) Personal allowances: This is the amount of income you can receive each year without having to pay tax on it. Nearly

everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on your circumstances, you may also be able to claim certain other allowances

b) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital

gains, the profit realized on the sale of a non- inventory asset that was purchased at a lower

price. The most common capital gains are realized from the sale of stocks, bonds, precious

metals and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of

assets by individuals and trustees. Capital gains made by companies are subject to corporation tax. The total capital gain is defined as the value of the asset when it is sold (or given away

etc.) minus its value when originally bought (or inherited etc.). As with income tax, there is a threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt amount‟ is £8,800 for individuals and £4,400 for trusts. This is subtracted from total capital

gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income: treated as the top slice of income, capital gains are taxed at 10%

below the starting-rate limit, 20% between the starting- and basic-rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.












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d) Tax codes: Tax code (PAYE)

A tax code is used by your employer or pension payer to calculate the amount of tax to deduct from your pay or pension. If you have the wrong tax code you could end up paying too much

or too little tax. A tax code is usually made up of several numbers and a letter, for example: 117L or K497.

An employee's tax code is used by employers to calculate the amount of income tax that must be withheld, or deducted, from the employee's wage or salary.

The tax code is the mechanism by which "pay as you earn" (PAYE) is operated in the UK,

making it possible for most employees to have paid exactly the right amount of income tax by the end of each tax year. As a result, most employees in the UK do not have to complete an income tax return.

In the UK, every person paid under the PAYE scheme is allocated a tax code by HM

Revenue & Customs. This is in the form of a number followed by a letter or letters, or a letter

followed by numbers. This code describes to employers how much tax to deduct from an

employee. Tax codes are usually adjusted once a year to take into account any changes made in

the National Budget.

MARCH 2007

AUDITING & TAXATION

PART A


PART B

2. a) Explain the rights of an auditor. [10] b) Explain the principal contents of an auditor‟s report. [10]


b) Vehicles c) Stock and work in progress d) Bank balances [5 each]



http://en.wikipedia.org/wiki/United_Kingdom

http://en.wikipedia.org/wiki/PAYE

http://en.wikipedia.org/wiki/HM_Revenue_%26_Customs




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4. Explain the following terms: a) Letter of engagement

b) Internal control c) Verification checks d) ICQ [5 each]

5. a) The auditor works for the shareholders. Discuss. [10]

b) Outline the stages of an audit. [10]

PART C




Additional allowance of $3,000 can also be claimed by one of the partners in a marriage.

PENSION CONTRIBUTIONS


From age 50 a maximum of 20% can be paid in. 6. Rebecca, aged 42, is a single person who earns $67,000 per year. She has paid 5% of

her gross pay into a qualifying pension fund. Rebecca has also paid $600 in respect of professional subscriptions.

Etienne, aged 49, is married (and claims the additional allowance) and earns $74,000 per year. He has paid 6% of his gross pay into a qualifying pension. Etienne has also paid $500 in respect of expenses which are allowable against tax.


a) Rebecca [7] b) Etienne [8]

7. The following is the summarized internal profit and loss account of Stevmar Ltd after its first year of trading:

£ Sales 3,300,000 Cost of sales (1,600,000)

Distribution costs (510,000) Administration expenses (320,000)

Depreciation of equipment (90,000)


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Depreciation of IT equipment (40,000)



25% as regards equipment 50% as regards IT equipment Included in the distribution costs are £10,000 which are deemed non-allowable.

TASK Calculate Stevmar Ltd‟s total taxable profit AND the total tax charge for the year. [15]


b) Capital gains tax (CGT) c) PAYE

d) The basic principles of taxation [5 each]


Q1 True and Fair: Both Companies acts and accounting standards require the financial statement of a company to

give a true and fair view. However, there is no legal definition of the term true and fair. The meaning of true and fair can be broken down into two:

True: this means in accordance with facts

Fair: this means in accordance with expectations, relevance, and objectivity, free from bias. The following quotations represent some authoritative views on the meaning of the term true

and fair a) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia)

b) True and fair view implies that all statutory and other information is not only available but is presented in a form which it can be properly and readily accepted (Sir Russel

Kettle) In summary, there is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view,, the accounts must be prepared in

accordance with generally Accepted accounting principles and must conform to relevant statutory and regulatory and the accounts must not me misleading and should be free from

bias.


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Q2a: The rights of an auditor includes the following

a) Right of access at all times, to the books and accounts and vouchers of the company b) Right to require from the officers including the directors of the company, such

information and explanations necessary for the performance of his duties as an auditor.

c) The right to attend any general meeting of the company and to receive notices to any meeting and to be heard on any part of the meeting which concerns them as an auditor

d) The right to be notified in writing, any intended resolution to remove them from office as auditors of the company

e) The right, before accepting appointment as auditors of the company, to communicate

with the outgoing auditor (if any) and invite him to make any representations and supply any information about the company which he may or may not supply.

f) The right to contract with the company, in addition to the statutory duties, undertake or provide accounting, taxation and other services to the company.

Q2b. The principal content of an auditor’s report The auditor‟s report should include the following basic elements

a. Title: an appropriate title such as „Auditor‟s Report‟ should be used to enable the reader to distinguish it from reports from others, e.g. Management report

b. Addressee: The auditor‟s report should appropriately be addressed and this is usually

addressed to the shareholders or the board of directors. c. Identification of financial statements: The report should identify the financial

statements audited by the auditor. It includes the name of the company, the accounts audited (e.g. P&L and balance sheet and the financial year

d. Reference to Auditing Standards or practices: The report should also indicate the

auditing standards followed. Example International Standards on Auditing (ISA) e. Opinion of the financial statement: The report should clearly state the auditors opinion

on the financial statement as to whether it shows a true and fair view of the entity‟s financial position and the results of its operations (P & L accounts) or not.

f. Signature: the report should be signed in the name of the audit firm, the personal name

of the auditor or both the personal name and the name of the audit firm. g. Auditor’s Address: The report should indicate the address and location of the auditor‟s

main office h. Date of Report: the report should be dated.



a) Determine the system of internal control over sales and debtors and test the effectiveness of the system

b) Obtain a list of all the balances of debtors.


e) Select a sample of individual debtors account and test as follows.


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i. Trace debt entries to entries in the sales day book ii. Check that dispatch notes have corresponding sales invoices

iii. Trace credit entries to the cash book f) Circularize the sample selected g) Examine all confirmations replied and investigate and exceptions

h) Consider the adequacy of bad debt provisions, sales returns and cash discounts. i) Consider the valuation of debtors in the balance sheet.

Q3b. Vehicles:

The verification of vehicles will involve the following procedures

a. Obtain a schedule of list of motor vehicles (where a number of vehicles are held by the client) and agree the total cost with the motor vehicle accounts in the ledger

b. Inspect the registration documents and ensure that they are registered in the name of the company

c. Where the company registers the vehicle in the name of an employee or a third party,

the party concerned should sign the certificate acknowledging the company‟s ownership

d. Examine the insurance policy and note that insurance premium are paid on due dates e. Review the depreciation policy and reasonableness of deprecation rates over vehicles. f. Examine all purchase and disposals of vehicles during the year and ensure that proper

authority was given and properly accounted for in the accounts g. Ensure that no collusion existed with outside agents on cheap sale prices

h. Inspect invoices of all purchases and cheques paid counterfoils i. Physically inspect vehicles and compare repairs and fuel bills with car numbers. j. Check the presentation and valuation of vehicles in the financial statement.

Q3d: Stocks & work-in progress: In verifying stocks and work in progress, the following

procedures applies i. Review the system of internal control over stocks

ii. Perform compliance tests on key controls relating to purchases, sales, creditors

and debtors iii. Physically check samples by counting selected items of stock

iv. Observe stock taking (i.e. attend stock taking ) v. Check on slow moving, obsolete stocks vi. Compare the current years stock with previous years stocks and note any

significant changes vii. Confirm that the stock valuation is in line with SSAP 9

viii. Verify each work- in-progress item with a job card. Q3d Bank Balance: This will be verified using the following procedures

a. Appraise the system of internal control over bank b. Examine the bank reconciliation statement and note the following

i. That all uncleared cheques are cleared


- - 71 - -


iii. Investigate any exceptions c. Check the arithmetical accuracy of the bank reconciliation statement d. Trace cash payments and cash receipts to the various documents taking notes of cheque

numbers e. Trace all contra entries, dishourned cheques, cancelled cheques

f. Vouch any transfers to the petty cash book and other bank accounts g. Cast the bank column of the cash book h. Send the standard bank letter and check the information received with the bank

statement i. Consider the value of bank balance in the balance sheet



accountancy work. It sets out the terms of the engagement and forms the bas is of the contract. The engagement letter defines clearly, the extent of the auditors‟ responsibilities and the

responsibilities of the directors. It also provides a written confirmation of the auditor‟s acceptance of the appointment. The client is required to acknowledge receipt of the letter and state if it is in accordance with his understanding of the agreement.

Q4b. Internal control: it is defined as the whole system of control, financial and otherwise

established by the management in other to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets and secure as far as possible, the completeness and accuracy of the records. The individual

components of an internal control system are known as control or internal controls. The main types of internal controls are

i. organization ii. segregation of duties iii. physical

iv. authorization and approval v. arithmetical and accounting

vi. personnel vii. supervision viii. management

Q4c: Verification checks:

It is an audit technique which seeks to substantiate the existence, ownership, valuation of assets and liabilities and the manner in which they are recorded in the books of accounts.

Q4d. Internal Control Questionnaire- ICQ

Internal control Questionnaire (ICQ) is a comprehensive, all inclusive method of ascertaining,

recording and evaluating a system of internal controls. It is a pre-printed document designed by


- - 72 - -

the auditor to be used in assessing the adequacy of the clients accounting system. It consists of a series of questions designed to establish which control exist in the accounting system and any

possible weaknesses. Internal Control Questionnaire helps audit staff familiarize themselves with the client‟s accounting system quickly and more comprehensively

Q5a. The auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts prepared by the directors to be sent to the members of the

enterprise gives a true and fair view and have been prepared in accordance with the companies Acts (sec. 235). The auditor therefore works for the members of the company who appoint him as auditors at an Annual General Meeting (AGM). The work done by the auditor will be to

report to the members as to: a. whether proper accounting records have been kept

b. whether all returns have been received from branches c. whether or not the accounts prepared are in agreement with the records d. Whether the information and explanations given in the directors report is consistent

with the accounts and finally, e. Whether in his opinion, the financial statement presents a true and fair of the

company‟s affairs at the balance sheet date and of its profit and loss for the period under review. From the above discursion, it can be concluded that Auditors do not work for the directors of the company but rather work and repost to the members of the

company.

Q5b. The stages in an audit can be summarized as:

i. Background Research : - this will include investigation into the history of the company, its product, its present condition and future prospect, the location of all branches,

any problem in accounting system and changes in law or accounting practice which affect the client.

ii. Preparation of the audit plan:- This involves preparing an overall audit plan showing how the audit work will be done, the staff who will do the work, the budget o time and cost

iii. Accounting system review: - This will involve the review of the adequacy of the accounting and documentations of transactions.

iv. Internal control system review: - A review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the finals account.

v. Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to

the completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinarily transaction. It is

also applied to all assets and liabilities at the balance sheet date. vi. Analytical Review: - This is the study of relationships between elements of the financial

information expected to confirm a predictable pattern based on the organization‟s


- - 73 - -

past experiences and also other financial and non- financial information available. Analytical review is an economic way of obtaining audit evidence.

vii. Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies are acceptable and are used consistently , all items in the financial

statement are compatible to the best of his knowledge and also adequate disclosure of items which needs to be disclosed.

viii. Preparation and signing of report:-This is where the auditor expresses his opinion in a report as to whether the financial statement shows a true and fair view or not. The report shows the person to whom the report is addressed, the financial statement


Q6. a) REBECCA


$ Basic Salary 67,000 Less



TAX PAYABLE




- - 74 - -

Q6 b.) ETIENNE

COMPUTATION OF TAXABLE PAY AND TAX PAYABLE $

Basic Salary 74,000 Less


Less Personal allowance (single) (8,000) Marriage allowance (3,000)

TAXABLE PAY 58,060

TAX PAYABLE



Tax payable 16,924

Q7. STEVMAR LTD


Net Profit 740,000

Add: Depreciation of IT equipments 40,000 Depreciation of Equipments 90,000 Non-allowable administration expenses 10,000 140,000


Less Capital Allowance: IT Equipments (50%X400, 000) 200,000


Tax thereon @23% (480,000 X 23%) 110,400


- - 75 - -




Depreciation of equipments 90,000 Depreciation of IT equipments 40,000 (890,000) Net profit 740,000

Q8.

a) Personal allowances: This is the amount of income you can receive each year without having to pay tax on it. Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on

your circumstances, you may also be able to claim certain other allowances

b) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds,

precious metals and property. Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of

assets by individuals and trustees. Capital gains made by companies are subject to corporation tax. The total capital gain is defined as the value of the asset when it is sold (or given away etc.) minus its value when originally bought (or inherited etc.). As with income tax, there is a

threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt amount‟ is £8,800 for individuals and £4,400 for trusts. This is subtracted from total capital

gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as if they were savings income: treated as the top slice of income, capital gains are taxed at 10% below the starting-rate limit, 20% between the starting- and basic-rate limits, and 40% above

the basic-rate limit. In practice, most capital gains are subject to 40% tax.
















- - 76 - -

As with many of the United Kingdom‟s institutional arrangements, the way in which the state

collects income tax through PAYE owes much of its form and structure to the peculiarities of

the era in which it was devised.




1. The principle of Equity: Taxes should be fair to different individuals and should

reflect a person‟s ability to pay. The ability-to-pay principle holds that people‟s taxes should be based upon their ability to pay, usually as measured by income or wealth.

2. certainty: It should be certain, not arbitrary 3. Convenience : it should be convenient in terms of timing and payment. 4. efficiency: it should be administratively efficient with a relatively small cost of

collection as a proportion of the revenue raised/

JUNE 2007

AUDITING & TAXATION

PART A

1. Explain the term true and fair. [10] PART B

2. a) Explain the major data verification checks associated with entering financial data into a computerized accounting system. [10]

b) The external auditors work for the directors of a company. Discuss. [10]


b) Investments c) Trade creditors d) Stock and work in progress [5 each]

4. a) Explain the role of internal questionnaires. [10] b) Explain the importance of a letter of engagement. [10]

5. Explain the following terms: a) Post balance sheet events

b) Going concern c) Audit trail

d) Accounting standards [5 each]


- - 77 - -

PART C



PERSONAL ALLOWANCES Single person $8,000 Additional allowance of $3,000 can also be claimed by one of the partners in a

marriage. PENSION CONTRIBUTIONS



6. Gavin, aged 49, is a single person who earns $54,000 per year. He has paid 5% of his

salary into a qualifying pension fund. Gavin has also paid $600 in respect of professional subscriptions.

Surinda, aged 34, is married (and claims the additional allowance) and earns $69,000.

She has paid 5% of her gross pay into a qualifying pension fund. Surinda has also paid $700 in respect of expenses that are allowable against tax.

TASKS Calculate the taxable pay and the total tax payable for EACH of the following: a) Gavin [7]

b) Surinda [8]

7. The following is the summarized internal profit and loss account of Lewis Ltd after its first year of trading:

£


Distribution costs (440,000) Administration expenses (250,000) Depreciation of equipment (110,000)

Depreciation of IT equipment (50,000)





- - 78 - -

50% as regards IT equipment Included in the administration expenses is £8,000 which is deemed non-allowable.

TASKS Calculate Lewis Ltd‟s total taxable profit AND the total tax charge for the year. [15]


b) Tax avoidance c) Capital gains tax (CGT) d) The basic principles of taxation [5 each]

SUGGESTED ANSWERS-JUNE 2007

Q1 True and Fair:

The meaning of true and fair can be broken down into two: True: this means in accordance with facts

Fair: this means in accordance with expectations, relevance, and objectivity, free from bias. The following quotations represent some authoritative views on the meaning of the term true and fair


b) True and fair view implies that all statutory and other information is not only available but is presented in a form which it can be properly and readily accepted (S ir Russell Kettle)

In summary, there is no statutory or professional definition of true and fair view. However, to

say financial statement shows a true and fair view,, the accounts must be prepared in accordance with generally Accepted accounting princip les and must conform to relevant statutory and regulatory and the accounts must not me misleading and should be free from

bias.











- - 79 - -

i. Check digit verification

ii. Format checks

iii. Sequence checks

iv. Range checks

v. Programmed controls

vi. Batch registers

vii. Input validity checks etc. Q2b. The auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts prepared by the directors to be sent to the members of the

enterprise gives a true and fair view and have been prepared in accordance with the companies Acts (sec. 235). The auditor therefore works for the members of the company who appoint him

as auditors at an Annual General Meeting (AGM). The work done by the auditor will be to report to the members as to:

a. whether proper accounting records have been kept

b. whether all returns have been received from branches c. whether or not the accounts prepared are in agreement with the records

d. Whether the information and explanations given in the directors report is consistent with the accounts and finally,

e. Whether in his opinion, the financial statement presents a true and fair of the

company‟s affairs at the balance sheet date and of its profit and loss for the period under review.

From the above discursion, it can be concluded that Auditors do not work for the directors of the company but rather work and repost to the members of the company.



a) examine the system of internal control over sales and debtors and test the effectiveness of the system

b) Then obtain a list of all the balances of debtors.


e) Select a sample of individual debtors account and test as follows. i. Trace debt entries to entries in the sales day book

ii. Check that dispatch notes have corresponding sales invoices

iii. Trace credit entries to the cash book f) circularize the sample selected

g) examine all confirmations replied and investigate and exceptions h) Consider the adequacy of bad debt provisions, sales returns and cash discounts. i) Consider the valuation of debtors in the balance sheet.


- - 80 - -

Q3b: Investment : 1) Request for a list of all investment currently held by the client and distinguish between

quoted and unquoted. A reconciliation of the current book value and that of the previous year should be made. Ask that the market value of all investment at the end of the year should be shown i.e. the quoted.












Q3c: Trade Creditors:



3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on the creditors account 5. Check trade creditors to purchases and note down the credit period. If it is increasing, it may

suggest lack of funds 6. Circularise sample of creditors

7. Check that all creditors are properly disclosed in the financial statement Q3d. Stocks & work-in progress: in verifying stocks and work in progress, the following

audit procedures will apply a. Review the system of internal control over stocks

b. Perform compliance tests on key controls relating to purchases, sales, creditors and debtors

c. Physically check samples by counting selected items of stock

d. Observe stock taking (i.e. attend stock taking )


- - 81 - -

e. Check on slow moving, obsolete stocks f. Compare the current years stock with previous years stocks and note any significant

changes g. Confirm that the stock valuation is in line with SSAP 9 h. Verify each work- in-progress item with a job card.

Q4a. Internal control questionnaire (ICQ) plays the following roles in an audit :

i. It enables the auditor identify specific areas of weakness in the client accounting system

ii. It enable the auditor design a series of test in his audit program

iii. It helps audit staff familiarize themselves with the clients system quickly iv. It is a major tool in ascertaining the clients accounting system

v. ICQ enables the auditor review and assess the adequacy of the clients system

Q4b. The engagement letter has the following importance

a. It defines clearly the extent of the auditors work to be done under the contract.

b. It minimizes any misunderstanding between the auditor and the management

c. It serves as a confirmation of the verbal agreement reach between auditor and his client earlier.

d. The letter assist in drawing distinction between the work of the auditor and other

work such as management consultancy, taxation and accountancy e. The letter indicates the basis on which fees are to be charged

f. It educates the client by explaining how in general terms the audit will be conducted.

Q5a. Post Balance Sheet Events It is defined as “Those events both favourable and unfavourable which occur between the

balance sheet date and the date on which the financial statements are approved by the Board of Directors”. Post balance sheet events fall into two categories, namely

1. Adjusting events

2. Non-adjusting events

Adjusting events are events that provide additional information or conditions existing at the balance sheet date. Example is the discovery of error or fraud that shows that the accounts were not correct after the balance sheet date. Another example is proposed dividends.

Non-adjusting events are events that arise after the balance sheet date and concern conditions

that do not exist at the balance sheet date. Such events will not have any effect on the balances in the Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers and acquisitions, strikes and labour disputes, changes in the exchange rate etc


- - 82 - -

Q5b: Going Concern:

The going concern concept assumes that a business or enterprise will continue in operational ex istence for the foreseeable future. This means that the financial statements

being audited are drawn up or prepared on the assumption that there is no intention or necessity liquidate or curtail significantly the scale of operation.

Q5c. Audit Trail:

An audit trail, in relation to accounting, is a record left by the accounting information system of movements in individual transaction data. This record, in the form of references to the processing of the data, provides a trail of the processing of transactions and other events

entered into by the entity. While some accounting information systems provide a visible and complete audit trails, others may provide an invisible and/or incomplete trail. A visible audit

trail may be in the form of documentation (a paper trail) or an electronic trail. Accounting information systems have a number of audit trails: for example, trails of different transaction cycles and/or of different computer applications.

Depending on the accounting information system, the trail may start from the moment data

about the event is first captured within the system to the time of its ultimate disposition in the financial statements. Auditors look for a complete and visible audit trails as such a trail allows

the auditor to quickly understand how data flows through the accounting information system.

Q5d. Accounting Standards: These are rules and regulations postulated by the accountancy profession that underlie the preparation of accounts. They are Specific accounting policies concerning particular topics or industries, providing descriptions of

acceptable methods of treating elements of accounting. These standards are prepared for standardizing the preparation of financial statement and all accountants are required to

conform to these standards. Accounting standards include SSAPs, IAS, GAAP, FRS, IFRS etc.

Q6. a) GAVIN





http://www.anz.com/edna/dictionary.asp?action=content&content=accounting


- - 83 - -



Tax payable 10,780

Q6b.) SURINDA


$

Basic Salary 69,000 Less: Contribution to pension Fund (5%) 3,450


Less Personal allowance (single) (8,000) Marriage allowance (3,000) TAXABLE PAY 53,850

TAX PAYABLE


Next 27,000 20% 5,400 Excess 23,850 40% 9,540

Tax payable 15,240

Q7. LEWIS LTD


£ Net Profit 650,000




- - 84 - -



Tax thereon @20% (568,000 X 20%) 113,600


$ Sales 2,700,000

Cost of sales (1,200,000) Gross profit 1,500,000 Distribution cost 440,000

Administrative expenses 250,000 Depreciation of equipments 110,000


Q8. REFER TO PREVIOUS NOTES FOR THIS QUESTION)

SEPTEMBER 2007 AUDITING & TAXATION

PART A

1. Distinguish between internal control and internal check. [10] PART B

2. a) Explain the rights of an auditor. [10] b) Explain the importance of the true and fair view. [10]

3. Explain briefly how you would verify the following items: a) Loans made to other businesses b) Share capital

c) Stocks and work in progress d) Freehold land and buildings [5 each]

4. a) Explain the process involved in approving the payment of an invoice. [10]

b) Explain the principal functions of an ICQ. [10]

5. a) List and explain the principal data verification checks associated with computer data entry. [10]

b) Explain the importance and usual contents of a letter of engagement. [10]


- - 85 - -

PART C



PERSONAL ALLOWANCES Single person $8,000 Additional allowance of $3,000 can be claimed by one of the partners in a marriage.



6. Carlos, aged 47, is a single person who earns $47,000 per year. He has paid 6% of his gross pay into a qualifying pension fund. Carlos has also paid $600 in respect of

professional subscriptions. Kathy, aged 39, who earns $54,000, is married (and claims the additional allowance). She has paid 5% of her gross pay into a qualifying pension fund. Kathy has also paid $500 in respect of expenses which are allowable against tax.

TASKS Calculate the taxable pay, and the total tax payable for EACH of the following:

a) Carlos [7] b) Kathy [8]

7. The following is the summarized internal profit and loss account of Creekit Ltd after its first year of trading:


Distribution costs (excluding depn.) (450,000) Administration expenses (excluding depn.) (290,000)





Included in the distribution costs are £5,000 which are deemed non-allowable.


- - 86 - -

TASK Calculate Creekit Ltd‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) PAYE

b) Personal allowances c) The difference between tax avoidance and tax evasion.


SUGGESTED ANSWERS-SEPTEMBER 2007

Q1 Internal Checks: This is the area of internal control which is exclusively concerned with the prevention and early detection fraud and errors. It involves arrangement of accounting and other duties to ensure that, no single ind ividual handles one transaction from the beginning to the end and that the work of each individual is subject to

independent checks.

Internal control on however the whole system of control(including internal checks), financial and otherwise established by management in order to carry on the business of

the enterprise in an orderly and effic ient manner, ensure adherence to management policies, safeguard assets and secure as far as possible, the completeness and accuracy

of the records. Q2a. The rights of an auditor includes the following

1. Right of access at all times, to the books and accounts and vouchers of the company 2. Right to require from the officers including the directors of the company, such

information and explanations necessary for the performance of his duties as an auditor. 3. The right to attend any general meeting of the company and to receive notices to any

meeting and to be heard on any part of the meeting which concerns them as an auditor

4. The right to be notified in writing, any intended resolution to remove the from office as auditors of the company

5. The right, before accepting appointment as auditors of the company, to communicate with the outgoing auditor (if any) and invite him to make any representations and supply any information about the company which he may or may not supply.

6. The right to contract with the company, in addition to the statutory duties, undertake or provide accounting, taxation and other services to the company.

Q2b: The importance of True and fair View

True and fair view is important because accounts cannot give a view in an abstract way. The

view given by the accounts and financial information cannot be divorced from the perceptions of the users of accounting information. The auditor in his opinion states whether the financial


- - 87 - -

statement shows a true and fair view so that the reader can have belief in them. The true and fairness of an account gives credibility to the information contained in the financial statement.

Q3a. Loans Made to other Business

The following audit procedures will be employed in the verification:

a. Review authorization for granting of loan and advances if made during the year b. The application for the loan and the receipts for the amounts must be inspected

c. Obtain a certificate from the borrower confirming the amount outstanding as at the balance sheet date

d. Study the written agreement covering the loan (that is the terms as to interest and

repayment) e. Review the possibility of non-payment. E.g. the type of collateral security

f. Check the receipts of all interest received on loan g. Check that the loan is properly disclosed in the balance sheet.

Q3b. Share Capital

The following procedures will be followed in the verification of share capital a. Ensure that the number of shares and type of shares issued is within the limit authorized

by the companies Memorandum and Article

b. Ensure that the issue was properly authorized by inspecting the minutes of Board of Directors

c. Ascertain and evaluate the system for the control of the issue of shares. d. Agree total shares issued per draft accounts to shareholders register e. Test the additions of shareholders register

f. Ensure that all monies received on application were contained in a special bank account until allotment

g. Vouch the payment of underwriting and other fees h. Where shares are issued not for cash, but other consideration, vouch the agreement and

ensure that all entries are properly made

i. Check the value of share capital in the balance sheet and ensure that it is correctly stated.

Q3c. Stocks & work-in progress: In verifying stocks and work in progress, the following procedures will be followed:

a) review the system of internal control over stocks b) perform compliance tests on key controls relating to purchases, sales, creditors

and debtors c) physically check samples by counting selected items of stock d) observe stock taking (i.e. attend stock taking )

e) check on slow moving, obsolete stocks f) compare the current years stock with previous years stocks and note any

significant changes


- - 88 - -

g) confirm that the stock valuation is in line with SSAP 9 h) Verify each work- in-progress item with a job card

Q3d. Freehold land and Buildings


1. Obtain a schedule of fixed assets 2. Examine a sample of title deeds and land registry certificate, conveyance

documents from solicitors and leases. Pay particular attention to mortgages and securities over assets

3. Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised. 4. Check entries in the fixed assets register and trace back to source documents to

ensure it is properly stated at cost 5. Review the companies policy for depreciation and ensure that land is not

depreciated

6. Check the calculations of the depreciation and ensure they are accurate 7. Where freehold or leasehold assets are let to third parties, inspect tenancy

agreement and check the rental income 8. Physically inspect assets to ensure their existence 9. Check the classification and presentation of fixed assets

10. Ensure that, the amount stated in the financial information is in agreement with the accounting records.

Q4a. The following procedures are involved in approving payment of invoice

1. There must be procedures for issuing requisition and responsible persons for such

requisition 2. purchase order must be prepared and authorized

3. Goods received must be examined in terms of quantity, quality and conditions of the items.

4. Check calculations of the supplier‟s invoice amount and ensure that they are

correctly priced. 5. ensure payment voucher accompanies the invoice

6. Ensure that expenditure is properly invoiced as shown by the purchase order.

Q4b. Functions of Internal Control Questionnaires

These documents can have several functions which includes the following: a. A method of ascertainment of the system

b. Enabling the auditor to review and assess the adequacy of the system c. Enabling the auditor to identify areas of weakness d. Enabling the to design a series of tests (audit program) in the audit process

e. Enabling the audit staff to familiarize themselves with the system quickly and comprehensively.


- - 89 - -

Q5a. Data verification checks are controls designed to ensure that, data received for processing are processed correctly. The following are some controls

a. Check digit: this is a detective control to establish the validity of numerical data such as accounts numbers. One digits with a “block” of digits is produced by the mathematical function of the other digits

b. Format checks: This checks any omission of details of items. Missing and duplicate numbers are revealed for investigation

c. Existence check: These are checks on record fields to ensure that the data is valid for that field. It checks correct codes wrongly used against a correct digits

d. Logical checks: these are used to ensure that, codes on the documents are acceptable in

the accounting system e. Range checks: These are checks designed to ensure that the data in a certain lies within

predetermined limits or range. Outside range data are then rejected.

Q5b.The form and content of audit engagement letters may vary for each client, but they would

generally include the following: 1. The objective of the audit of the financial statement

2. Management‟s responsibilities regarding proper accounting records and the financial statement by establishing and maintain effective internal controls.

3. The auditors responsibilities to express his opinion of the financial statement

4. The scope of the audit work, including reference to applicable legislation such as the companies Act and pronouncements of professional bodies such as the auditing

standards, accounting standards 5. The basis on which fees will be computed 6. The need to send letter of weakness to management

7. Any arrangement for the auditor to provide accounting and taxations services 8. Unrestricted access to whatever records, documentation and other information

requested in connection with the audit. The engagement letter has the following importance


b. It minimizes any misunderstanding between the auditor and the management

c. It serves as a confirmation of the verbal agreement reach between auditor and his client earlier.

d. The letter assist in drawing distinction between the work of the auditor and other




- - 90 - -

Q6. a) CARLOS


$

Basic Salary 47,000 Less Relief:


TAXABLE PAY 35,580

TAX PAYABLE



Q6 b.) KATHY



Less Relief: Contribution to pension Fund (5%) 2,700 Allowable expenses 500 (3,200)



TAX PAYABLE




- - 91 - -

Q7. CREEKIT LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE £ Net Profit 320,000





Tax thereon @25% (250,000 X 25%) 62,500





Net profit 320,000

Q8.

a) PAYE: PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the













- - 92 - -

b) Personal allowances: This is the amount of income you can receive each year without having to pay tax on it. Nearly

everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on your circumstances, you may also be able to claim certain other allowances

c) Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. By contrast tax

evasion is the general term for efforts to not pay taxes by illegal means. The term tax

mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax avoidance

d) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital

gains, the profit realized on the sale of a non- inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of assets by individuals and trustees. Capital gains made by companies are subject to corporation

tax. The total capital gain is defined as the value of the asset when it is sold (or given away etc.) minus its value when originally bought (or inherited etc.). As with income tax, there is a threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt

amount‟ is £8,800 for individuals and £4,400 for trusts. This is subtracted from total capital gains to give taxable capital gains. Taxable capital gains are in effect subject to income tax as

if they were savings income: treated as the top slice of income, capital gains are taxed at 10% below the starting-rate limit, 20% between the starting- and basic-rate limits, and 40% above the basic-rate limit. In practice, most capital gains are subject to 40% tax.

DECEMBER 2007

AUDITING & TAXATION

PART A


PART B

2. a) Discuss the different forms of control expected to be found in a computerized accounting

system. [10] b) Explain the principal factors involved in planning an audit. [10]

3. Explain briefly how you would verify the following items: a) Investments

b) Trade creditors c) Freehold land and buildings

d) Loans made to other businesses [5 each]








- - 93 - -

4. a) Outline the stages of an audit. [10] b) Explain the role of an internal audit department. [10]

5 Explain the following terms: a) ICQ b) Letter of engagement

c) The dismissal of an auditor d) Test checking [5 each]

PART C




Single person $8,000 Additional allowance of $3,000 can be claimed by one of the partners in a marriage.

PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a

qualifying pension fund.


6. James, aged 45, is a single person who earns $56,000 per year. He has paid 6% of his gross pay into a qualifying pension fund. James has also paid $800 in respect of professional subscriptions.

Martin, aged 58, is married (and claims the additional allowance) and earns $78,000. He has paid 20% of his gross pay into a qualifying pension. Martin has also paid $700

in respect of expenses which are allowable against tax. TASKS Calculate the taxable pay and the total tax payable for EACH of the following:

a) James [7] b) Martin [8]

7. The following is the summarised internal profit and loss account of ROWIG Ltd after

its first year of trading:

£ Sales 2,800,000




- - 94 - -




Included in the distribution costs are £7,000 which are deemed non-allowable. TASK Calculate ROWIG Ltd‟s total taxable profit AND the total tax charge for the year. [15]


a) Tax evasion b) The basic principles of taxation c) PAYE


SUGGESTED ANSWERS-DECEMBER 2007

Q1. The rights of an auditor includes the following 1. Right of access at all times, to the books and accounts and vouchers of the company

2. Right to require from the officers including the directors of the company, such information and explanations necessary for the performance of his duties as an auditor.

3. The right to attend any general meeting of the company and to receive notices to any

meeting and to be heard on any part of the meeting which concerns them as an auditor 4. The right to be notified in writing, any intended resolution to remove them from office

as auditors of the company 5. The right, before accepting appointment as auditors of the company, to communicate

with the outgoing auditor (if any) and invite him to make any representations and

supply any information about the company which he may or may not supply. 6. The right to contract with the company, in addition to the statutory duties, undertake or

provide accounting, taxation and other services to the company.





a) System development controls

b) Documentation and record testing

c) Access controls such as physical barriers


- - 95 - -

d) Backup and reconstruction facilit ies

Application Controls : These include:

1. Check digit verification

2. Format checks

3. Sequence checks

4. Range checks

5. Programmed controls

6. Batch registers

7. Input validity checks etc.

Q2b. The Auditor must plan the audit work if the work is to be done to a high standard of skill and care. The following are some factors that are involved in planning the audit:

a. An outline of the audit work to be done on each area of the clients‟ systems and the financial statement

b. A review of last year‟s working papers

c. Changes in legis lation (Accounting standards, auditing standards and other relevant regulations)

d. Analytical review of management accounts

e. Changes in accounting system

f. The staff who will be needed to do the work

g. The timing of the work to be done

h. Degree of reliance on internal controls\

i. The time budget and cost of the audit.

Q3a: Investment : The following procedures can be followed in the verification of investment 1) Request for a list of all investment currently held by the client and distinguish between

quoted and unquoted. A reconciliation of the current book value and that of the

previous year should be made. Ask that the market value of all investment at the end of the year should be shown i.e. the quoted.


3) Examine the Directors Minutes book for proper authorization of purchase and sale of

investment. 4) If the investment is quoted, check the market value shown in the list with that of the

stock exchange values. In the case of unquoted ones inspection should be made of the company‟s accounts and though there is no market value disclosed for unquoted investment consideration should be given as to whether the net realizable value is

below cost for current assets and for fixed assets, whether a permanent fall in value has occurred.


- - 96 - -







Q3b: Trade Creditors: Audit procedures


creditors control account 3. Examine a sample from the creditor‟s ledger with aged lists

4. Enquire into any material debit balances on the creditors account 5. Check trade creditors to purchases and note down the credit period. If it is increasing, it may

suggest lack of funds

6. Circularise sample of creditors 7. Check that all creditors are properly disclosed

Q3.c Freehold land and Buildings


1. Obtain a schedule of fixed assets 2. Examine a sample of title deeds and land registry certificate, conveyance documents

from solicitors and leases. Pay particular attention to mortgages and secur ities over

assets 3. Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised. 4. Check entries in the fixed assets register and trace back to source documents to ensure

it is properly stated at cost

5. Review the companies policy for depreciation and ensure that land is not depreciated 6. Check the calculations of the depreciation and ensure they are accurate

7. Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and check the rental income

8. Physically inspect assets to ensure their existence

9. Check the classification and presentation of fixed assets 10. Ensure that, the amount stated in the financial information is in agreement with the

accounting records.


- - 97 - -

Q3d Loans Made to other Business:

a. Review authorization for granting of loan and advances if made during the year

b. The application for the loan and the receipts for the amounts must be inspected c. Obtain a certificate from the borrower confirming the amount outstanding as at the

balance sheet date

d. Study the written agreement covering the loan (that is the terms as to interest and repayment)

e. Review the possibility of non-payment. E.g. the type of collateral security f. Check the receipts of all interest received on loan g. Check that the loan is properly disclosed in the balance sheet.

Q4.a The stages in the modern audit can be summarized as:

a. Background Research : - This will include a brief research of the history of the company, its product, its present condition and future prospect, the location of all

branches, any problem in accounting system and changes in law or accounting practice which affect the client.

b. Preparation of the audit plan:- This involves preparing an overall audit plan showing how the audit work will be done, the staff who will do the work, the budget o time and cost

c. Accounting system review: - This will involve the review of the adequacy of the accounting and documentations of transactions.

d. Internal control system review: - A review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the finals account.

e. Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to the

completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinarily transaction. It is also applied to all assets

and liabilities at the balance sheet date. f. Analytical Review: - This is the study of relationships between elements of the

financial information expected to confirm a predictable pattern based on the organization‟s past experiences and also other financial and non- financial information available. Analytical review is an economic way of obtaining audit evidence.

g. Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items which needs to be disclosed.

h. Preparation and signing of report:-This is where the auditor expresses his opinion in a report as to whether the financial statement shows a true and fair view or not. The

report shows the person to whom the report is addressed, the financial statement


- - 98 - -

audited, the responsibilities of management and the auditor, the signature of the auditor and the date

Q4b.The role played by internal department includes the following: 1. It helps reduce the amount of detailed work to be carried out by the external auditors if

it is found to be reliable 2. They review the system of accounting, financial and other operations of the business

and notify management and advice them on the best practice. 3. They Review and test compliances and accuracy of the companies policies 4. They exist to review and improve the system of internal checks.

5. They also prevent fraud and helps in early detection of fraud and irregularities 6. They undertake special investigation at the request of management.

Q5a Internal Control Questionnaire- ICQ




Q5b. Letter of Engagement (or Engagement letter) This is a letter sent by the auditor to his client at the beginning of any new audit or



Q5c. Dismissal of an auditor: - There are a number of procedures and rules to be followed before an auditor of a company can be dismissed or removed. The companies Act 1985

(section 391) has the following provisions/rules regarding the dismissal of an auditor a. Auditors of a company can be removed by an ordinary resolution (i.e. a simple

majority) at an Annual General Meeting (AGM) b. Written notices shall have been given to the company of the intention to move a

resolution to remove an auditor not less than 28days.

c. On receipt of such intended resolution, the company shall forthwith send a copy to the auditors concerned

d. The auditor shall have the right to make a written representation to the company and request their notification to members. (Thus, if he does not want to be removed, he will state his case and request the directors to send it to the members of the company.)

e. The auditor shall have the right to speak at the meeting on the subject of his intended removal and if the representation have not been sent to members, he has the right to

read it out at the meeting


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Q5d. Tests-checks: This is an audit technique or procedure where a sample of population is checked in detail and the result applied to the whole population. There are two methods

used in test checking: (a) Judgement sampling-where the selection of the items to be tested are determined by the auditor‟s judgement and (b) Statistical Sampling– where the selection of the items to be tested are by statistical or mathematical principles.

Q6. a) JAMES


$


Professional subscription 800 (4,160) Less Personal allowance (single) (8,000)




Tax payable 11,236

Q6 b.) MARTIN


$



Less Personal allowance (single) (8,000) Marriage allowance (3,000) TAXABLE PAY 50,700


- - 100 - -

TAX PAYABLE



Q7. ROWIG LTD


£ Net Profit 430,000 Add: Depreciation of IT equipments 30,000

Depreciation of Equipments 40,000 Non-allowable Distribution expenses 7,000 77,000

Adjusted Net Profit 507,000 Less Capital Allowance:

IT Equipments (50%X500, 000) 250,000


Tax thereon @20% (132,000 X 20%) 26,400

WORKINGS: PROFIT AND LOSS ACCOUNT Sales 2,800,000

Cost of sales (1,500,000) Gross profit 1,300,000

Distribution cost 560,000 Administrative expenses 240,000 Depreciation of equipments 40,000


Q8. REFER TO PREVIOUS NOTES


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MARCH 2008 AUDITING & TAXATION

PART A

1. Explain the true and fair view. [10] PART B

2. Explain the following types of audit: a) Statutory

b) Non-statutory c) Continuous d) Interim

e) Management [4 each] 3. Explain briefly how you would verify the following items:

a) Freehold land and buildings b) The bank balance c) Investments

d) Stock and work in progress [5 each] 4. a) Explain the role of an internal audit department. [10]

b) Explain what internal controls can be „built‟ in to the typical financial accounting system i.e. from the recording of each financial transaction to the production of the first draft final accounts. [10]

5. Fully explain the stages of an audit. [20]

PART C




Additional allowance of $3,000 can be claimed by one of the partners in a marriage. PENSION CONTRIBUTIONS



6. Grace, aged 43, is a single person who earns $47,000 per year. She has paid 5% of her

gross pay into a qualifying pension fund. Grace has also paid $700 in respect of professional subscriptions.

Vincent, aged 39, is married (and claims the additional allowance) and earns $61,000.

He has paid 5% of his gross pay into a qualifying pension fund. Vincent has also paid $800 in respect of expenses, which are allowable against tax.


- - 102 - -


a) Grace [7] b) Vincent [8]

7. The following data relates to LBW Ltd: £

Internal profit before tax 640,000 Original cost of machinery 500,000 Original cost of computers 250,000

Expenses deemed to be non-allowable 8,000

Internal rates of depreciation charged in the profit and loss account: Machinery 20% on cost Computers 25% on cost

The relevant capital allowances allowed by the Inland Revenue are:

Machinery 25% on cost Computers 50% on cost

Corporation tax (company tax) is charged at 20% of taxable profit. TASK

Calculate LBW Ltd‟s taxable profit AND the total tax charge for the year. [15] . 8. Write short notes on THREE of the following:

a) Personal allowances b) Capital gains tax (CGT)

c) PAYE d) Tax codes [5 each}

SUGGESTED ANSWERS-MARCH 2008

Q1. True and Fair: The Companies Acts and Accounting Standards require the financial statement of a company to give a true and fair view. However, there is no legal definition of

the term true and fair. The meaning of true and fair can be broken down into two: True: this means in accordance with facts Fair: this means in accordance with expectations, relevance, and objectivity, free from bias.




- - 103 - -

b) True and fair view implies that all statutory and other information is not only available but is presented in a form which it can be properly and readily accepted (Sir Russel

Kettle) In summary, there is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view,, the accounts must be prepared in

accordance with generally Accepted accounting principles and must conform to relevant statutory and regulatory and the accounts must not me misleading and should be free from

bias.

Q2.a Statutory Audit: These are audit carried out to meet statutory requirements. For example,

the company Act 1985 requires that, every company must have its accounts audited annual by an independent auditor. The scope of the auditors work is determined by law/ statute.

Q2b. Non-Statutory Audit (or Private Audit): This type of audit is carried out at the request of

the owner of an enterprise. It is not required by statute. It is carried out in enterprises such as partnerships, sole proprietorships, etc. The scope of audit work is determined by the client

(owner).

Q2c Continuous Audit:

Continuous audit is one that is carried out continuously during the financial year of the client. Such an approach applied to enterprises where the volume of transaction is very large. The

work is so great that, the audit staffs are on the premises of the client almost the whole year round, making several visits.

Q2d Interim Audit: Interim Audit is the one that is carried out or conducted to cover a certain time or up to a certain date within a financial period. Normally interim audit will be about two-

thirds of the way through the year. E.g. September or October for December year end. It may also be done to cover a month, a quarter or half year on the request of a client. Some audit work such as verification of assets and liabilities may not be carried out during interim audit.

These may be deferred to the final audit. The work done may include ascertaining the system of accounting and internal controls, evaluation of the system for adequacy and any possible

weaknesses, design and performing compliance tests etc.

Q2e Management Audit: This is concerned with the examination of procedures laid down by

management and of its efficiency. The objective here is to arrive at an opinion on the efficiency of management rather than on the financial statements. Areas covered by

management audit includes a) Relationships between management and shareholders b) Current standing of the organization in relation to its industry and the general public.

c) Relationship between management and staff etc


- - 104 - -



a) Obtain a schedule of fixed assets b) Examine a sample of title deeds and land registry certificate, conveyance documents

from solicitors and leases. Pay particular attention to mortgages and securities over

assets c) Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised. d) Check entries in the fixed assets register and trace back to source documents to ensure

it is properly stated at cost

e) Review the companies policy for depreciation and ensure that land is not depreciated f) Check the calculations of the depreciation and ensure they are accurate

g) Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and check the rental income

h) Physically inspect assets to ensure their existence

i) Check the classification and presentation of fixed assets j) Ensure that, the amount stated in the financial information is in agreement with the

accounting records.

Q3b. Bank balance

In the verification of bank balance, I will perform the following procedures 1. Appraise the system of internal control over bank

2. Examine the bank reconciliation statement and note the following i. That all uncleared cheques are cleared

ii. That all payments or lodgments not credited at the balance sheet date have been

credited iii. Investigate any exceptions

3. Check the arithmetical accuracy of the bank reconciliation statement 4. Trace cash payments and cash receipts to the various documents taking notes of cheque

numbers

5. Trace all contra entries, dishourned cheques, cancelled cheques 6. Vouch any transfers to the petty cash book and other bank accounts

7. Cast the bank column of the cash book 8. Send the standard bank letter and check the information received with the bank

statement

9. Consider the value of bank balance in the balance sheet

Q3c: Investment : The following procedures can be followed in the verification of investment 1) Request for a list of all investment currently held by the client and distinguish between

quoted and unquoted. A reconciliation of the current book value and that of the

previous year should be made. Ask that the market value of all investment at the end of the year should be shown i.e. the quoted.


- - 105 - -












Q3d. Stocks & work-in progress: in verifying stocks and work in progress, the following audit

procedures will apply a. Review the system of internal control over stocks b. Perform compliance tests on key controls relating to purchases, sales, creditors and

debtors c. Physically check samples by counting selected items of stock

d. Observe stock taking (i.e. attend stock taking ) e. Check on slow moving, obsolete stocks f. Compare the current years stock with previous years stocks and note any significant

changes g. Confirm that the stock valuation is in line with SSAP 9

h. Verify each work- in-progress item with a job card Q4a. The role played by internal department includes the following

a. to reduce the amount of detailed work to be carried out by the external auditors if it is found to be reliable

b. To review the system of accounting, financial and other operations of the business and notify management and advice them.

c. Review and test compliances and accuracy of the companies policies

d. To review and improve the system of internal checks. e. To prevent and early detection of fraud and irregularities

f. To undertake special investigation at the request of management


- - 106 - -

Q4b. The following are the internal controls that can be “built” into a typical financial accounting system


ii. Organization: there should be a clear organization chart and all staff should

have up to date job descriptions that clearly indicate their responsibilities. iii. Authorization and approval: all transactions and decisions should be formally

authorized by nominated staff. iv. Physical: there should be suitable controls over access to offices, assets,

controlled stationery and computer systems.

v. Management: production of suitable financial and operational management information; use of exception reports; critical review and enquiry by

management. vi. Arithmetical and accounting : checking / re-performing tasks carried out by

others; costing (adding up) orders, invoices, payroll etc; reconciliation between

the bank and accounting records; control accounts. vii. Personnel: appointment of staff should be adequately controlled; all staff

should be suitably trained for their post and appraised regularly. viii. Supervision: all staff and activities should be adequately supervised by

someone who understands the process and will detect deviations from accepted

practice.

Q5. The stages in an audit can be summarized as:

1) Background Research : - This will involve a review of the history of the company, its

product, its present condition and future prospect, the location of all branches, any problem in accounting system and changes in law or accounting practice which affect the client.

2) Preparation of the audit plan:- This involves preparing an overall audit plan showing how the audit work will be done, the staff who will do the work, the budget o time and

cost 3) Accounting system review: - This will involve the review of the adequacy of the


4) Internal control system review: - A review of the internal control system to know whether the client maintains proper or adequate books of accounts and whether the

books of accounts can be relied on for the preparation of the finals account. 5) Substantive Testing: - This involves the tests of transactions and balances and other


completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak

internal control or the item is extraordinarily transaction. It is also applied to all assets and liabilities at the balance sheet date.


- - 107 - -

6) Analytical Review: - This is the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past

experiences and also other financial and non- financial information available. Analytical review is an economic way of obtaining audit evidence.

7) Analytical Review of financial statement:- This is where the auditor performs overall

analytical review of the financial statement to determine whether accounting po licies are acceptable and are used consistently , all items in the financial statement are

compatible to the best of his knowledge and also adequate disclosure of items which needs to be disclosed.

8) Preparation and signing of report:-This is where the auditor expresses his opinion in a



Q6. a) GRACE



Less Relief: Contribution to pension Fund (5%) 2,350


TAX PAYABLE


Next 27,000 20% 5,400 Excess 5,950 40% 2,380

Tax payable 11,236


- - 108 - -

Q6 b.) VINCENT





TAXABLE PAY 46,150

TAX PAYABLE



Tax payable 16,150 12,160

Q7. LBW LTD


Net Profit 640,000

Add: Depreciation of computers 62,500 Depreciation of machines 100,000 Non-allowable expenses 8,000 170,500


Less Capital Allowance: Computers (50%X250, 000) 125,000

Machines (25% X 500,000) 125,000 (250,000) Taxable profit 560,500

Tax thereon @20% (560,500 X 20%) 112,100


- - 109 - -

WORKINGS

Depreciation of Machinery (500,000 x 20%) 100,000 Depreciation of -computers (250,000 x 25%) 62,500

Q8. REFER TO PREVIOUS NOTES

JUNE 2008

AUDITING & TAXATION PART A

1. Distinguish between internal control and internal check. [10] PART B

2. a) Explain the rights of an auditor. [10]

b) Explain the principal contents of an auditor‟s report. [10] 3. Explain briefly how you would verify the following items:

a) Trade creditors b) Provision for doubtful debts c) Stock and work in progress

d) Bank balances [5 each] 4. Explain the following terms:

a) Letter of engagement b) Non-statutory audit c) Management audit

d) ICQ [5 each] 5. a) The auditor works for the shareholders. Discuss. [10]

b) Outline the stages of an audit. [10] ART C




Single person $8,000 Additional allowance of $3,000 can also be claimed by one of the partners in a

marriage. PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a

qualifying pension fund. From age 50 a maximum of 20% can be paid in.


- - 110 - -

6. Isaac, aged 51, is a single person who earns $59,000 per year. He has paid 6% of his gross pay into a qualifying pension fund. Isaac has also paid $500 in respect of

professional subscriptions. Sophie, aged 42, is married (and claims the additional allowance) and earns $68,000

per year. She has paid 5% of her gross pay into a qualifying pension. Sophie has also

paid $700 in respect of expenses which are allowable against tax. TASKS

Calculate the taxable pay and the total tax payable for EACH of the following: a) Isaac [7] b) Sophie [8]

7. The following is the summarized internal profit and loss account of Adu-Tutu Ltd after its first year of trading:


Distribution costs (not including the depreciation charge) (520,000) Administration expenses (not including the depreciation charge) (340,000)





Included in the distribution costs are £8,000 which are deemed non-allowable. TASK Calculate Adu-Tutu‟s Ltd‟s total taxable profit AND the total tax charge for the year.

[15]

8. Write short notes on THREE of the following: a) Personal allowances b) Capital gains tax (CGT)

c) PAYE d) Tax codes [5 each]


- - 111 - -


Q1 Internal Checks: This is the area of internal control which is exclusively concerned with the prevention and early detection fraud and errors. It involves arrangement of

accounting and other duties to ensure that, no single ind ividual handles one transaction from the beginning to the end and that the work of each individual is subject to independent checks.

Internal control on however the whole system of control(including internal checks), financial and otherwise established by management in order to carry on the business of the enterprise in an orderly and effic ient manner, ensure adherence to management

policies, safeguard assets and secure as far as possible, the completeness and accuracy of the records.

Q2a. The rights of an auditor includes the following

1. Right of access at all times, to the books and accounts and vouchers of the company

2. Right to require from the officers including the directors of the company, such information and explanations necessary for the performance o f his duties as an auditor.

3. The right to attend any general meeting of the company and to receive notices to any meeting and to be heard on any part of the meeting which concerns them as an auditor

4. The right to be notified in writing, any intended resolution to remove them from office


with the outgoing auditor (if any) and invite him to make any representations and supply any information about the company which he may or may not supply.

6. The right to contract with the company, in addition to the statutory duties, undertake or

provide accounting, taxation and other services to the company. Q2b. The principal content of an auditor’s report

The auditor‟s report should include the following basic elements 1. Title: an appropriate title such as „Auditor‟s Report‟ should be used to enable the reader

to distinguish it from reports from others, e.g. Management report 2. Addressee: The auditor‟s report should appropriately be addressed and this is usually

addressed to the shareholders or the board of directors.

3. Identification of financial statements: The report should identify the financial statements audited by the auditor. It includes the name of the company, the accounts

audited (e.g. P&L and balance sheet and the financial year 4. Reference to Auditing Standards or practices: The report should also indicate the

auditing standards followed. Example International Standards on Auditing (ISA)

5. Opinion of the financial statement: The report should clearly state the auditors opinion on the financial statement as to whether it shows a true and fair view of the entity‟s

financial position and the results of its operations (P & L accounts) or not. 6. Signature: the report should be signed in the name of the audit firm, the personal name

of the auditor or both the personal name and the name of the audit firm.


- - 112 - -

7. Auditor’s Address: The report should indicate the address and location of the auditor‟s main office

8. Date of Report: the report should be dated. Q3a. Trade Creditors

Trade creditors can be verified by the audit procedure below.



3. Examine a sample from the creditor‟s ledger with aged lists

4. Enquire into any material debit balances on the creditors account 5. Check trade creditors to purchases and note down the credit period.

6. Circularise sample of creditors 7. Examine all responses received from the circularization and investigate any exceptions 7. Check that all creditors are properly disclosed in the financial statement

Q3b. Provision for bad debts:

The following audit procedures will apply: 1. Examine debts against which specific provisions have been made in line

with information from debt collection agencies or solic itors.

2. Where provision is based on aged analysis, check whether proper analys is has been prepared and consider the reasonableness and consistency of the

formulas. 3. Check the make-up of the debtors balance 4. Consider whether cheques issued by debtors have been dishonoured for lack

of funds 5. Considers reports from solicitors to see if customers have been declared

bankrupt 6. Compare the current provision with the previous year and investigate any

material difference

Q3c. Stocks & work-in progress: Audit procedure for verifying stocks and work in progress

a) Review the system of internal control over stocks b) Perform compliance tests on key controls relating to purchases, sales, creditors and

debtors

c) Physically check samples by counting selected items of stock d) Observe stock taking (i.e. attend stock taking )

e) Check on slow moving, obsolete stocks f) Compare the current years stock with previous years stocks and note any

significant changes

g) Confirm that the stock valuation is in line with SSAP 9 h) Verify each work- in-progress item with a job card.


- - 113 - -

Q3d. Bank balance: Audit procedures for bank balance

a. Appraise the system of internal control over bank


ii. That all payments or lodgments not credited at the balance sheet date have

been credited iii. Investigate any exceptions


numbers

e. Trace all contra entries, dishourned cheques, cancelled cheques f. Vouch any transfers to the petty cash book and other bank accounts


statement

i. Consider the value of bank balance in the balance sheet

Q4a. Letter of Weakness: - (other names for this letter are management letter, letter of comment, letter of recommendation, post audit letter, internal control letter). It is a letter sent by the auditor to his client bringing to his attention the weakness found in the internal control

system during the audit. The letter points out the weaknesses in the internal control system and gives recommendations to improve them. It is usually presented to the client in a meeting with

the auditor.







Q4c. Management Audit: This is concerned with the examination of procedures laid down by management and of its efficiency. The objective here is to arrive at an opinion on the

efficiency of management rather than on the financial statements. Areas covered by management audit includes

a) Relationships between management and shareholders


- - 114 - -

b) Current standing of the organization in relation to its industry and the general public. c) Relationship between management and staff etc





Q5a. Q5a. The auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts prepared by the directors to be sent to the members of the


report to the members as to: a. whether proper accounting records have been kept




From the above discursion, it can be concluded that Auditors works for the members

(shareholders) of the company but not the directors of the company

Q5b. The stages in an audit include the following:

Background Research : - This will involve a review of the history of the company, its


Preparation of the audit plan:- This involves preparing an overall audit plan showing how the audit work will be done, the staff who will do the work, the budget o time and

cost

Accounting system review: - This will involve the review of the adequacy of the


Internal control system review: - A review of the internal control system to know

whether the client maintains proper or adequate books of accounts and whether the books of accounts can be relied on for the preparation of the finals account.

Substantive Testing: - This involves the tests of transactions and balances and other



- - 115 - -

completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak

internal control or the item is extraordinarily transaction. It is also applied to all assets and liabilities at the balance sheet date.

Analytical Review: - This is the study of relationships between elements of the financial

information expected to confirm a predictable pattern based on the organization‟s past experiences and also other financial and non- financial information available.

Analytical review is an economic way of obtaining audit evidence.

Analytical Review of financial statement:- This is where the auditor performs overall

analytical review of the financial statement to determine whether accounting policies are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items which

needs to be disclosed.

Preparation and signing of report:-This is where the auditor expresses his opinion in a



Q6. a) ISAAC


$



TAXABLE PAY 46,960

TAX PAYABLE INCOME RATE TAX PAYABLE First 3,000 10% 300

Next 27,000 20% 5,400 Excess 16,960 40% 6,784

Tax payable 11,236


- - 116 - -

Q6 b.) SOPHIE





TAXABLE PAY 52,900

TAX PAYABLE



Tax payable 14,860

Q7. ADU-TUTU LTD


Net Profit 890,000 Add: Depreciation of IT equipments 50,000 Depreciation of Equipments 100,000

Non-allowable Distribution expenses 8,000 158,000 Adjusted Net Profit 1,048,000


IT Equipments (50%X500, 000) 250,000 Equipments (25% X 900,000) 225,000 (475,000)

Taxable profit 573,000 Tax thereon @22% (573,000 X 22%) 126,060


- - 117 - -




Depreciation of equipments 100,000 Depreciation of IT equipments 50,000 (1,010,000) Net profit 890,000

Q8.REFER TO PREVIOUS NOTES

SEPTEMBER 2008

AUDITING & TAXATION

PART A


PART B

2.a) Explain the major data verification checks associated with entering financial data into

computerized accounting system. [10] b) Outline the concept of INDEPENDENCE as regards an auditor. [5]

c) Explain the importance of SEGREGATION of duties. [5] 3. Explain briefly how you would verify the following items:

a) Investments b) Bank balances

c) Trade creditors d) Stock and work in progress [5 each]

4. a) Explain the role of an internal auditor. [10] b) Explain the importance of a letter of engagement. [10]

5. Explain the following terms: a) Post balance sheet events

b) The auditor‟s opinion c) Audit trail

d) Accounting standards [5 each] PART C


- - 118 - -




Additional allowance of $3,000 can also be claimed by one of the partners in a marriage.



From age 50 a maximum of 20% can be paid in. 6. Sarjo, aged 42, is a single person who earns $59,000 per year. He has paid 6% of his

salary into a qualifying pension fund. Sarjo has also paid $700 in respect of professional subscriptions.

Abdula, aged 39, is married (and claims the additional allowance) and earns $71,000. He has paid 5% of his gross pay into a qualifying pension fund. Abdula has also paid $500 in respect of expenses that are allowable against tax.


a) Sarjo [7] b) Abdula [8]

7. The following is the summarized internal profit and loss account of Lucio Ltd after its first year of trading:


Distribution costs (510,000) Administration expenses (320,000)






- - 119 - -

Included in the distribution costs is £5,000 of entertaining expenses which have been deemed non-allowable as regards tax.

TASKS Calculate Lucio Ltd‟s total taxable profit AND the total tax charge for the year. [15]


b) Tax avoidance c) PAYE d) The basic principles of taxation [5 each

SEPTEMBER 2008: SUGGESTED ANSWERS

Q1. The rights of an auditor includes the following 1. Right of access at all times, to the books and accounts and vouchers of the company


3. The right to attend any general meeting of the company and to receive notices to any

meeting and to be heard on any part of the meeting which concerns them as an auditor 4. The right to be notified in writing, any intended resolution to remove them from office


with the outgoing auditor (if any) and invite him to make any representations and

supply any information about the company which he may or may not supply.

6. The right to contract with the company, in addition to the statutory duties, undertake or provide accounting, taxation and other services to the company.

Q2 a)

A verification check ensures that data is correctly transferred into a computer from the medium that it was originally stored on. Verification checks are usually used to check that information written on a data collection form has been correctly typed into a computer by a data entry

worker.

Data verification checks are controls designed to ensure that, data received for processing are processed correctly. The following are some controls

a. Check digit: this is a detective control to establish the validity of numerical data such as

accounts numbers. One digits with a “block” of digits is produced by the mathematical function of the other digits

../../../Documents%20and%20Settings/Debs/Local%20Settings/Temp/backupwwwrootsubjectsitgcseCOMPANIOGCSEdatacol.htm


- - 120 - -

b. On-Screen Prompts : After a user has entered some data it is redisplayed on the screen. The user is prompted to read the data and confirm that it has been entered correctly. If

the user has entered any data incorrectly he should respond that the data is inaccurate and retype the incorrect parts.

c. Dual Input: This method is used when data is entered at the keyboard. The data to be

entered is typed in twice by two different operators. The two copies of the data are then compared. Any differences are detected. The operators will be prompted to retype the

sections that differ until both copies agree. When the two copies agree it is assumed by the computer that the data has been entered correctly.

d. Format checks: This checks any omission of details of items. Missing and duplicate

numbers are revealed for investigation e. Existence check: These are checks on record fields to ensure that the data is valid for

that field. It checks correct codes wrongly used against a correct digits f. Logical checks: these are used to ensure that, codes on the documents are acceptable in

the accounting system

g. Range checks: These are checks designed to ensure that the data in a certain lies within predetermined limits or range. Outside range data are then rejected.

Q2b. Auditor independence refers to the independence of the auditor from parties, that have

an interest in the financial statements of an entity. It is essentially an attitude of mind

characterized by integrity and an objective approach to the audit process. The concept

requires the auditor to carry out his work freely and in an objective manner.

The purpose of an audit is to enhance the credibility of financial statements by providing

written reasonable assurance from an independent source that they present a true and fair view

in accordance with an accounting standard. This objective will not be met if users of the audit

report believe that the auditor may have been influenced by other parties, more specifically

company directors or by conflicting interests (e.g. if the auditor owns shares in the company to

be audited). In addition to technical competence, auditor independence is the most important

factor in establishing the credibility of the audit opinion.

Q2c)

Segregation of duties is one of the key concepts of internal control and is the most difficult and

sometimes the most costly one to achieve. In essence, SoD implements an appropriate level of

checks and balances upon the activities of individuals.

Separation of duty, as a security principle, has as its primary objective the prevention of fraud

and errors. This objective is achieved by disseminating the tasks and associated privileges for a

specific business process among multiple users. This principle is demonstrated in the

http://en.wikipedia.org/wiki/Independence

http://en.wikipedia.org/wiki/Auditor

http://en.wikipedia.org/wiki/Financial_statements

http://en.wikipedia.org/wiki/Objective_approach

http://en.wikipedia.org/wiki/Financial_statements


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traditional example of separation of duty found in the requirement of two signatures on a

check.

Segregation of duties is critical to effective internal control because it reduces the risk of mistakes and inappropriate actions. It helps fight fraud by discouraging collusion.

In general, the following functions should be separated among employees:

Approval Accounting/reconciling Asset custody

No one person should:

Initiate a transaction Approve a transaction Record a transaction

Reconcile balances Handle assets

Review reports

Q3.a Investment:

The following procedures can be employed to verify investment a. Request for a list of all investment currently held by the client and distinguish

between quoted and unquoted. A reconciliation of the current book value and that of the previous year should to be made. Ask t hat the market value of all

investment at the end of the year should be shown i.e. the quoted. b. Verify purchase or sale of investment during the year with documentary

evidence. E.g. Contract notes or agreements

c. Scrutinize the directors Minutes book for proper authorization of purchase and sale of investment.

d. If the investment is quoted, check the market value shown in the list with that of the stock exchange values. In the case of unquoted ones inspection should be made of the company‟s accounts and though there is no market value disclosed

for unquoted investment consideration should be given as to whether the net realizable value is below cost for current assets and for fixed assets, whether a

permanent fall in value has occurred. e. Physically inspect certificates and bonds. If they have been deposited with a

bank a certificate stating in whose name they are registered and whether they

are free from any charge should be shown and this should be compared with the standard bank letter.

f. To verify purchases examine contract notes and paid cheque counterfoils and for disposals, vouch the income received.


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g. Verify that all incomes have been received and properly treated in the financial statement.

h. Compare investment income with previous year‟s and ensure that the basis of recognizing income is consistent with previous years. Investigate any significant fluctuations.

i. Ensure proper disclosure in the accounts.

Q3b. Bank balance

In the verification of bank balance, I will perform the following procedures a) Appraise the system of internal control over bank

b) Examine the bank reconciliation statement and note the following i. That all uncleared cheques are cleared



c) Check the arithmetical accuracy of the bank reconciliation statement d) Trace cash payments and cash receipts to the various documents taking notes of cheque

numbers e) Trace all contra entries, dishourned cheques, cancelled cheques f) Vouch any transfers to the petty cash book and other bank accounts

g) Cast the bank column of the cash book h) Send the standard bank letter and check the information received with the bank

statement i) Consider the value of bank balance in the balance sheet

Q3c Trade creditors

Follow the following audit procedure in the verification of trade creditors

1. Evaluate the system of internal control over purchase 2. Obtain a copy of the schedule of balances of creditors and confirm the balances with the

creditors control account 3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on any of the creditors account

5. Check trade creditors to purchases and note down the credit period. If it is increasing, it may suggest lack of funds

6. Circularise sample of creditors 7. Enquire into any exceptions received from the creditors‟ circularization 8. Check that all creditors are properly disclosed in the financial statement

Q3d. Stocks & work-in progress: In verifying stocks and work in progress, I will perform the following audit procedures:

1. review the system of internal control over stocks


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2. perform compliance tests on key controls relating to purchases, sales, creditors and debtors

3. physically check samples by counting selected items of stock 4. observe stock taking (i.e. attend stock taking ) 5. check on slow moving, obsolete stocks

6. compare the current years stock with previous years stocks and note any significant changes

7. confirm that the stock valuation is in line with SSAP 9 8. Verify each work- in-progress item with a job card.

Q4 a : The duties of the internal auditor includes the following

Manage the Internal Audit function.

Keep current on trends in accounting and auditing.

Develop more detailed audit techniques and procedures for specific areas assigned if necessary.

Safeguard work papers and do not disclose matters of a confidential nature.

Perform financial statement review.

Review the internal audit plan, ensure compliance and effectiveness and meet with the chief audit executive regularly.

Review the external audit plan, ensure the performance of the external auditors and

meet separately with them.

Review plan to comply with laws and regulations, and communicate required code

of conduct to company personnel.

Report to board of directors and shareholders and keep avenue of communication open between internal audit, external auditors and the board.

Q4 b.

The engagement letter has the following importance



client earlier. d. The letter assist in drawing distinction between the work of the auditor and other



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Q5a. Post Balance Sheet Events

It is defined as “Those events both favourable and unfavourable which occur between the balance sheet date and the date on which the financial statements are approved by the Board of

Directors”. Post balance sheet events fall into two categories, namely 1. Adjusting events 2. Non-adjusting events


were not correct after the balance sheet date. Another example is proposed dividends. Non-adjusting events are events that arise after the balance sheet date and concern conditions that do not exist at the balance sheet date. Such events will not have any effect on the balances

in the Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers and acquisitions, strikes and labour disputes, changes in the exchange rate etc

Q5b: auditor’s opinion

The audit opinion is that part of the auditor's report to the members of an entity in which the auditor expresses an opinion on the extent to which the financial statements are materially misstated. The fact that it is an opinion, and not a certification, is meant to indicate to financial

statement users that the auditor is providing reasonable assurance, and not complete assurance, as to whether or not the financial statements are materially misstated.

Where the auditor is satisfied that the financial statements fairly present the financial position and results of the entity, the auditor issues what is referred to as an unqualified audit opinion.

An unqualified audit opinion, or a "clean" opinion, is one without any restricting or limiting circumstance . Thus, an unqualified audit opinion begins with the words:

"In my opinion, the financial statements present fairly the financial position of [name of

entity] as at June 30, 200X and the results of its operations and its cash flows for the year then ended."

Where the auditor is not satisfied that the financial statements fairly present the financial

position and results of the entity, or that they are not consistent with the auditor's knowledge of the business, in other words, where the auditor believes that the financial statements contain a material misstatement, the auditor issues either a qualified audit opinion or an adverse

opinion.


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Where the auditor believes that the financial position is true and fair "except for" a particular matter, the auditor issues a qualified audit opinion that identifies a restriction or limitation to

the auditor's opinion. For example:

"In my opinion, except for the effects on the financial report of the matters referred to in my report above, the financial statements present fairly the financial position of [name of entity] as at June 30, 200X and the results of its operations and its cash flows

for the year then ended."

If the nature and materiality of the misstatement(s) is such that the auditor believes the financial statements cannot provide a true and fair view, even with a qualification, the auditor

issues an adverse opinion. In this case, the audit opinion states that ".. the financial statements do not present fairly the financial position ...".

However, if the auditor is unable to gather sufficient appropriate evidence to form an opinion,

the auditor provides what is referred to as an inability opinion. In this instance, the audit report states that "I am unable to and do not express an opinion as to whether the financial statements present fairly the financial position ..."

Q5c. Audit Trail:

An audit trail, in relation to accounting, is a record left by the accounting informatio n system of movements in individual transaction data. This record, in the form of references to the processing of the data, provides a trail of the processing of transactions and other events

entered into by the entity. While some accounting information systems provide a visible and complete audit trails, others may provide an invisible and/or incomplete trail. A visible audit

trail may be in the form of documentation (a paper trail) or an electronic trail. Accounting information systems have a number of audit trails: for example, trails of different transaction cycles and/or of different computer applications.

Depending on the accounting information system, the trail may start from the moment data

about the event is first captured within the system to the time of its ultimate disposition in the financial statements. Auditors look for a complete and visible audit trails as such a trail allows

the auditor to quickly understand how data flows through the accounting information system.

Q5d. Accounting Standards: These are rules and regulations postulated by the accountancy profession that underlie the preparation of accounts. They are Specific accounting policies concerning particular topics or industries, providing descriptions of

acceptable methods of treating elements of accounting. These standards are prepared for standardizing the preparation of financial statement and all accountants are required to

conform to these standards. Accounting standards include SSAPs, IAS, GAAP, FRS, IFRS etc.

http://www.anz.com/edna/dictionary.asp?action=content&content=accounting


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Q6. a) SARJO


$



TAXABLE PAY 46,760


First 3,000 10% 300 Next 27,000 20% 5,400


Q6 b.) ABDULA



Contribution to pension Fund (5%) 3,550 Allowable expenses 500 (4,050) Less Personal allowance (single) (8,000)



First 3,000 10% 300 Next 27,000 20% 5,400



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Q7. ADU-TUTU LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE Net Profit 530,000


Non-allowable Distribution expenses 5,000 195,000 Adjusted Net Profit 725,000



Tax thereon @21% (412,500 X 21%) 86,625




Depreciation of equipments 130,000 Depreciation of IT equipments 60,000 (1,020,000)

Net profit 530,000

Q8. a) Personal allowances:

This is the amount of income you can receive each year without having to pay tax on it. Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on your circumstances, you may also be able to claim certain other allowances

b) PAYE: PAYE (Pay As You-Earn) is an amount collected by employers on behalf of the








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c) Tax avoidance is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law. By contrast tax

evasion is the general term for efforts to not pay taxes by illegal means. The term tax

mitigation is a synonym for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax avoidance





6. certainty: It should be certain, not arbitrary 7. Convenience : it should be convenient in terms of timing and payment.

8. efficiency: it should be administratively efficient with a relatively small cost of collection as a proportion of the revenue raised/

DECEMBER 2008

AUDITING & TAXATION

PART A

1. Explain what post balance sheet events are (SSAP 17 or IAS 10 is the relevant standard). [10]

PART B

2. a) Explain the role of internal questionnaires (ICQs). [10]

b) Explain the importance of a letter of engagement. [10] 3. Explain briefly how you would verify the following items:

a) Trade debtors b) Fixed assets

c) Loans d) Bank balances [5 each]




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4. Explain the following terms: a) Internal control

b) The true and fair view c) Techniques of audit testing d) An audit plan [5 each]

5. a) The auditor works for the shareholders. Discuss. [10]

b) Explain the various data verification checks associated with computerized accounting system. [10]

PART C


TAX RATES 10% on the first $3,000 of taxable income 20% on the next $27,000 of taxable income

40% on any further taxable income PERSONAL ALLOWANCES

Single person $8,000 Additional allowance of $3,000 can also be claimed by one of the partners in a

marriage.

PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a

qualifying pension fund. From age 50 a maximum of 20% can be paid in. 6. Sophie, aged 58, is a single person who earns $88,000 per year. She has paid 20% of

her gross pay into a qualifying pension fund. Sophie has also paid $700 in respect of professional subscriptions.

Lucas, aged 34, is a married person (and claims the additional allowance) and earns $46,500 per year. He has paid 5% of his gross earnings into a qualifying pension plan. Lucas has also paid $500 in respect of expenses which are allowable against tax.


a) Sophie [7] b) Lucas [8]

7. The following is the summarized internal profit and loss account of Marnat Ltd after its first year of trading:


Distribution costs (580,000) Administration expenses (370,000

Depreciation of equipment (110,000


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Depreciation of IT equipment (50,000) Other information:



50% as regards IT equipment Included in the distribution costs are £8,000 which are deemed non-allowable. TASK

Calculate Marnat Ltd‟s total taxable profit AND the total tax charge for the year. [15]

8. Write short notes on THREE of the following: a) Personal allowances b) Capital gains tax (CGT)

c) PAYE d) The basic principles of taxation [5 each]

DECEMBER 2008: SUGGESTED ANSWERS

Q1: Post Balance Sheet Events

These are events both favourable and unfavourable occurring between the balance sheet date

and the date on which the financial statements are approved by the Board of Directors”. Post balance sheet events fall into two categories, namely



were not correct after the balance sheet date. Another example is proposed dividends. Non-adjusting events are events that arise after the balance sheet date and concern conditions

that do not exist at the balance sheet date. Such events will not have any effect on the balances in the Profit and Loss Account or the Balance Sheet. Examples are issue of shares, mergers and

acquisitions, strikes and labour disputes, changes in the exchange rate etc

AS 10, Events after the Balance Sheet Date

IAS 10 and SSAP 17 both distinguish 'adjusting events' from 'non-adjusting events'. Adjusting events provide evidence of conditions that existed at the balance sheet date. Non-adjusting


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events are indicative of conditions arising after the balance sheet date. However, IAS 10 applies the distinction more robustly. Among the effects are:

Dividends to holders of equity instruments declared after the balance sheet date are not

recognized as liabilities.

Dividends declared by subsidiaries after the balance sheet date are not recognized by the parent as income of the previous period.

Accounting treatment

Adjust financial statements for adjusting events – events after the balance sheet date that

provide further evidence of conditions that existed at the end of the reporting period, including

events that indicate that the going concern assumption in relation to the whole or part of the

enterprise is not appropriate.

Do not adjust for non-adjusting events – events or conditions that arose after the end of the

reporting period.

If an entity declares dividends after the reporting period, the entity shall not recognize those

dividends as a liability at the end of the reporting period. That is a non-adjusting event.

Q2a. Internal control questionnaire (ICQ) plays the following roles in an audit: i. It enables the auditor identify specific areas of weakness in the client accounting

system ii. It enable the auditor design a series of test in his audit program iii. It helps audit staff familiarize themselves with the clients system quickly

iv. It is a major tool in ascertaining the clients accounting system v. ICQ enables the auditor review and assess the adequacy of the clients system

Q2 b.

The engagement letter has the following importance



client earlier. d. The letter assist in drawing distinction between the work of the auditor and other



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Q3 a. Trade debtors

The following procedure will be followed to verity debtors. a. Obtain a list of all the balances of debtors.

b. Cast the list and agree the total to the general ledger control account balance c. Select a sample of individual debtors account and test as follows.

- Trace debt entries to entries in the sales day book - Check that dispatch notes have corresponding sales invoices - Trace credit entries to the cash book

d. Circularize the sample selected e. Examine all confirmations replied and investigate any exceptions

f. Consider the adequacy of bad debt provisions, sales returns and cash discounts

Q3b: Loans: The following procedure will be followed in the verification of loans.

1. Review authorization for granting of loan and advances if made during the year

2. The application for the loan and the receipts for the amounts must be inspected 3. Obtain a certificate from the borrower confirming the amount outstanding as at the

balance sheet date

4. Study the written agreement covering the loan (that is the terms as to interest and repayment)

5. Review the possibility of non-payment. E.g. the type of collateral security Q3c. Fixed Assets

The audit procedure associated with fixed assets can be summarised as follows a) Ownership: Check to see that, the title to the asset is clearly vested in the company(i.e.

if the asset belongs to the company and in the company’s name) b) Existence: Check that, the asset exist at the date of the balance sheet and reliable

evidence is available to attest to the existence

c) Valuation: That the assets are stated at a value which is consistent with the accounting principles and assumptions

d) Presentation: That the assts are presented in accordance with best practice and with the due regards for the legal requirements in force at the time.

Q3d. Bank balance

In the verification of bank balance, I will perform the following procedures

1. Appraise the system of internal control over bank 2. Examine the bank reconciliation statement and note the following

i. That all un-cleared cheques are cleared



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iii. Investigate any exceptions 3. Check the arithmetical accuracy of the bank reconciliation statement

4. Trace cash payments and cash receipts to the various documents taking notes of cheque numbers

5. Trace all contra entries, dishourned cheques, cancelled cheques

6. Vouch any transfers to the petty cash book and other bank accounts 7. Cast the bank column of the cash book

8. Send the standard bank letter and check the information received with the bank statement

9. Consider the value of bank balance in the balance sheet

Q4a. REFER TO PREVIOUS NOTES

MORE REVISION SERIES-PAST QUESTIONS AND ANSWERS ON AUDITING-ICM (ACCOUNTING & FINANCE)

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Q4b. True and Fair: The meaning of true and fair can be broken down into two:



a) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia) b) True and fair view implies that all statutory and other information is not only available


There is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view, the accounts must be prepared in accordance with

generally Accepted accounting principles and must conform to relevant statutory and regulatory and the accounts must not me misleading and should be free from bias.

Q4.c: These are techniques for collecting audit evidence and may include the following

Physical examination and count

Confirmation (usually by external source and should be in writing)

Vouching/ Examination of original documents ( i.e. comparing original documents

with entries in the books

Re-computation: Additions, calculations etc

Enquiry ( i.e. asking questions)

Observation ( especially the internal control system)

Re-tracing bookkeeping entries

Q4d Audit plan

The audit plan is a description of the expected scope and conduct of the audit. Auditors initially prepare the audit plan during the audit planning stage, but may revise the plan throughout the audit. As the audit plan is important evidence that the audit will be carried out

in accordance with auditing standards and practice statements, auditors document the audit plan in the audit working papers. The audit plan includes the documentation of:

The audit approach for each material account balance assertion and the basis for its

determination. Where an in-depth approach for any account balance assertion has been selected, the audit approach in respect of each related class of transaction is also documented.

http://www.abrema.net/abrema/audit_approach_g.html


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The time and activity budget, indicating the evidence which each audit staff member is to gather and evaluate, when it is to be gathered and the expected time to be spent on

such activity. The staff planning schedule, indicating when and for how long audit staff members

have been scheduled to work on the engagement and what work they have been

scheduled to do. It may be expressed in hours or other units of time and then costed at the audit firm's standard rate for each staff member, to provide a budgeted standard cost

for the entire audit engagement. (optionally) an audit stage planning schedule, setting out the weeks (or months) during

which the audit team will perform work in each audit stage and the estimated time the

audit team will spend on each activity in each audit stage.

Q5a. Auditors do not work for the directors of the company. Rather the auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts

prepared by the directors to be sent to the members of the enterprise gives a true and fair view and have been prepared in accordance with the companies Acts (sec. 235). The auditor therefore works for the members of the company who appoint him as auditors at an Annual

General Meeting (AGM). The work done by the auditor will be to report to the members as to: a. whether proper accounting records have been kept




Q5 b

A verification check ensures that data is correctly transferred into a computer from the

medium that it was originally stored on. Verification checks are usually used to check that information written on a data collection form has been correctly typed into a computer by a data entry worker.

Data verification checks are controls designed to ensure that, data received for processing are

processed correctly. The following are some controls a. Check digit: this is a detective control to establish the validity of numerical data such as

accounts numbers. One digits with a “block” of digits is produced by the mathematical

function of the other digits b. On-Screen Prompts : After a user has entered some data it is redisplayed on the screen.

The user is prompted to read the data and confirm that it has been entered correctly. If the user has entered any data incorrectly he should respond that the data is inaccurate and retype the incorrect parts.

../../../Documents%20and%20Settings/Debs/Local%20Settings/Temp/backupwwwrootsubjectsitgcseCOMPANIOGCSEdatacol.htm


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c. Dual Input: This method is used when data is entered at the keyboard. The data to be entered is typed in twice by two different operators. The two copies of the data are then

compared. Any differences are detected. The operators will be prompted to retype the sections that differ until both copies agree. When the two copies agree it is assumed by the computer that the data has been entered correctly.

d. Format checks: This checks any omission of details of items. Missing and duplicate numbers are revealed for investigation

e. Existence check: These are checks on record fields to ensure that the data is valid for that field. It checks correct codes wrongly used against a correct digits

f. Logical checks: these are used to ensure that, codes on the documents are acceptable in

the accounting system g. Range checks: These are checks designed to ensure that the data in a certain lies within

predetermined limits or range. Outside range data are then rejected.

Q6. a) SOPHIE






Next 27,000 20% 5,400 Excess 31,700 40% 12,680

Tax payable 18,380


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Q6 b.) LUCAS

COMPUTATION OF TAXABLE PAY AND TAX PAYABLE $ Basic Salary 46,500


Allowable expenses 500 (2,825) Less Personal allowance (single) (8,000) Marriage allowance (3,000)

TAXABLE PAY 32,675


Next 27,000 20% 5,400 Excess 2,675 40% 1,070

Tax payable 6,770

Q7. MARNAT LTD


Net Profit 790,000 Add: Depreciation of IT equipments 50,000

Depreciation of Equipments 110,000 Non-allowable Distribution expenses 8,000 168,000

Adjusted Net Profit 958,000 Less Capital Allowance: IT Equipments (50%X500, 000) 250,000


Tax thereon @22% (483,000 X 22%) 106,260

WORKINGS: PROFIT AND LOSS ACCOUNT Sales 3,800,000 Cost of sales (1,900,000) Gross profit 1,900,000 Distribution cost 580,000 Administrative expenses 370,000 Depreciation of equipments 110,000 Depreciation of IT equipments 50,000 (1,110,000) Net profit 790,000


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Q8 a) Personal allowances:

This is the amount of income you can receive each year without having to pay tax on it. Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on your circumstances, you may also be able to claim certain other allowances

b) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged

on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of assets by individuals and trustees. Capital gains made by companies are subject to corporation

tax. The total capital gain is defined as the value of the asset when it is sold (or given away etc.) minus its value when originally bought (or inherited etc.). As with income tax, there is a threshold below which capital gains tax does not have to be paid. In 2006–07, this „exempt

amount‟ is £8,800 for individuals and £4,400 for trusts. This is subtracted from total capital gains to give taxable capital gains.




employee's income. The amount withheld is determined partly by the employee's expec ted tax







2. Certainty: It should be certain, not arbitrary 3. Convenience : it should be convenient in terms of timing and payment.

4. Efficiency: it should be administratively efficient with a relatively small cost of collection as a proportion of the revenue raised.








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MARCH 2009

AUDITING & TAXATION PART A

1. Distinguish between Internal Check and Internal Control. [10]

PART B

2. a) Explain the process of approving an invoice for payment. You are advised to refer

to the relevant source documents involved in this process. [10] b) Explain the term audit sampling. [10]

3. Explain briefly how you would verify the following items: a) Trade creditors

b) Bank balances c) Freehold land and buildings

d) Loans made to other businesses [5 each] 4. a) Outline the stages of an audit. [10]

b) Explain the role of an internal audit department. [10]

5 Explain the following terms: a) Letter of engagement. b) The true and fair view

c) The dismissal of an auditor d) An audit plan [5 each]

PART C




Additional allowance of $3,000 can be claimed by one of the partners in a marriage. PENSION CONTRIBUTIONS Up to the age of 49 a maximum of 15% of gross pay can be paid tax free into a

qualifying pension fund. From age 50 a maximum of 20% can be paid in.


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6. Martha, aged 49, is a single person who earns $62,000 per year. Martha has paid 6% of

her gross pay Into a qualifying pension fund. Martha has also paid $300 in respect of professional

subscriptions.

Norris, aged 52, is married (and claims the additional allowance) and earns $79,000. Norris has paid 10% of his gross pay into a qualifying pension. Norris has also paid

$600 in respect of expenses which are allowable against tax. TASKS Calculate the taxable pay and the total tax payable for EACH of the following:

a) Martha [7] b) Norris [8]

7. The following is the summarised internal profit and loss account of Marchon Ltd after

its first year of trading:

£ Sales 2,600,000


Depreciation of equipment (45,000)* Depreciation of IT equipment (25,000)*

* Not included in either distribution costs or administration expenses. Other information: Original cost of equipment 600,000

Original cost of IT equipment 400,000 Corporation tax (i.e. company taxation) is charged at 21% of the taxable profit.

Initial writing down allowances are: 25% as regards equipment 50% as regards IT equipment

Included in the distribution costs are £8,000 which are deemed non-allowable. TASKS

Calculate Marchon Ltd‟s total taxable profit AND the total tax charge for the year. [15] 8. Write short notes on THREE of the following:

a) Tax evasion b) The basic principles of taxation

c) Personal allowances d) Capital gains tax (CGT) [5 each]


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Q1 Internal Checks: This is the area of internal control which is exclusively concerned with the prevention and early detection fraud and errors. It involves arrangement of accounting and other duties to ensure that, no single ind ividual handles one transaction from the beginning to the end and that the work of each individual is subject to

independent checks.

Internal control on however the whole system of control(including internal checks), financial and otherwise established by management in order to carry on the business of

the enterprise in an orderly and effic ient manner, ensure adherence to management policies, safeguard assets and secure as far as possible, the completeness and accuracy

of the records.

Q2a. The following procedures are involved in approving payment of invoice There must be procedures for issuing requisition notes and responsible persons for such

requisition purchase order must be prepared and authorized Goods received must be examined in terms of quantity, quality and conditions of the

items. Check calculations of the supplier‟s invoice amount and ensure that they are correctly

priced. ensure payment voucher accompanies the invoice Ensure that expenditure is properly invoiced as shown by the purchase order.

Q2b. AUDIT SAMPLING

Sampling is the application of an audit procedure to less than 100% of the items within an

account balance or class of transactions for the purpose of evaluating some characteristic of all the items within the balance or class of transactions.

Audit sampling refers to the examination of less than 100% of the units comprising a population where (i) each unit has a chance of being selected, and (ii) the objective is to draw a

conclusion about the characteristics of the population. Audit sampling may be performed using either statistical or non-statistical techniques. Statistical techniques, which are not dealt with in these pages, additionally require (i) the units in the population to have the same chance of

being selected (ii) the items for examination to be selected randomly and (iii) the conclusion to be drawn using tables or formulas based on probability theory

Sampling is performed because it is more efficient than testing 100% of a population. By definition, any procedure that does not examine 100% of the items in question is a sampling

procedure.


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creditors control account

3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on the creditors account

5. Check trade creditors to purchases and note down the credit period. 6. Circularise sample of creditors 7. Examine all responses received from the circularization and investigate any exceptions


Q3b. Bank balance: Audit procedures for bank balance

a. Appraise the system of internal control over bank





numbers e. Trace all contra entries, dishourned cheques, cancelled cheques f. Vouch any transfers to the petty cash book and other bank accounts


statement

i. Consider the value of bank balance in the balance sheet

Q3c: Freehold land and Buildings

The following procedures will be used in the verification of freehold land and buildings

Obtain a schedule of fixed assets held by the company. Examine a sample of title deeds and land registry certificate, conveyance documents

from solicitors and leases. Pay attention to mortgages and securities over assets Inspect the minutes of directors to ensure that, all title deeds, conveyances, tenancy

agreements and leases are properly authorised.

Check entries in the fixed assets register and trace back to source documents to ensure it is properly stated at cost

Review the companies policy for depreciation and ensure that land is not depreciated Check the calculations of the depreciation and ensure they are accurate Where freehold or leasehold assets are let to third parties, inspect tenancy agreement and

check the rental income


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Inspect assets to ensure their existence Check the classification and presentation of fixed assets

Ensure that, the amount stated in the financial information is in agreement with the accounting records.

Q3d: Loans made to other Business: the following procedures will be used in the verification a. Review authorization for granting of loan and advances if made during the year

b. The application for the loan and the receipts for the amounts must be inspected c. Obtain a certificate from the borrower confirming the amount outstanding as at the

balance sheet date

d. Study the written agreement covering the loan (that is the terms as to interest and repayment)

e. Review the possibility of non-payment. E.g. the type of collateral security f. Check the receipts of all interest received on loan g. Check that the loan is properly disclosed in the balance sheet.

Q4a. . The stages in an audit include the following:




cost





Substantive Testing: - This involves the tests of transactions and balances and other

procedures such as analytical review which seek to provide audit evidence as to the completeness, accuracy and validity of the information contained in the accounting

records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinarily transaction. It is also applied to all assets and liabilities at the balance sheet date.

Analytical Review: - This is the study of relationships between elements of the financial information expected to confirm a predictable pattern based on the organization‟s past

experiences and also other financial and non- financial information available. Analytical review is an economic way of obtaining audit evidence.

Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are


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compatible to the best of his knowledge and also adequate disclosure of items which needs to be disclosed.

Preparation and signing of report:-This is where the auditor expresses his opinion in a report as to whether the financial statement shows a true and fair view or not. The

report shows the person to whom the report is addressed, the financial statement audited, the responsibilities of management and the auditor, the signature of the auditor and the date

Q4b. The role of the internal audit department:

The role played by internal department includes the following: i. It helps reduce the amount of detailed work to be carried out by the external

auditors if it is found to be reliable

ii. They review the system of accounting, financial and other operations of the business and notify management and advice them on the best practice.

iii. They Review and test compliances and accuracy of the companies policies iv. They exist to review and improve the system of internal checks. v. They also prevent fraud and helps in early detection of fraud and irregularities

vi. They undertake special investigation at the request of management.


This is a letter sent by the auditor to his client at the beginning of any new audit or accountancy work. It sets out the terms of the engagement and forms the basis of the contract.

The engagement letter defines clearly, the extent of the auditors‟ responsibilities and the responsibilities of the directors. It also provides a written confirmation of the auditor‟s


Q5b. True and Fair: The meaning of true and fair can be broken down into two:



c) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia) d) True and fair view implies that all statutory and other information is not only available


There is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view, the accounts must be prepared in accordance with


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generally Accepted accounting principles and must conform to relevant statutory and regulatory and the accounts must not me misleading and should be free from bias.

Q5c. Dismissal of an auditor: - There are a number of procedures and rules to be followed

before an auditor of a company can be dismissed or removed. The companies Act 1985 (section 391) has the following provisions/rules regarding the dismissal of an auditor

f. Auditors of a company can be removed by an ordinary resolution (i.e. a simple majority) at an Annual General Meeting (AGM)

g. Written notices shall have been given to the company of the intention to move a

resolution to remove an auditor not less than 28 days. h. On receipt of such intended resolution, the company shall forthwith send a copy to the

auditors concerned i. The auditor shall have the right to make a written representation to the company and

request their notification to members. (Thus, if he does not want to be removed, he will

state his case and request the directors to send it to the members of the company.) j. The auditor shall have the right to speak at the meeting on the subject of his intended

removal and if the representation have not been sent to members, he has the right to read it out at the meeting

Q5d Audit plan

The audit plan is a description of the expected scope and conduct of the audit. Auditors initially prepare the audit plan during the audit planning stage, but may revise the plan throughout the audit. As the audit plan is important evidence that the audit will be carried out

in accordance with auditing standards and practice statements, auditors document the audit plan in the audit working papers . The audit plan includes the documentation of:

The audit approach for each material account balance assertion and the basis for its determination. Where an in-depth approach for any account balance assertion has been

selected, the audit approach in respect of each related class of transaction is also documented.

The time and activity budget, indicating the evidence which each audit staff member is to gather and evaluate, when it is to be gathered and the expected time to be spent on such activity.

The staff planning schedule, indicating when and for how long audit staff members have been scheduled to work on the engagement and what work they have been

scheduled to do. It may be expressed in hours or other units of time and then costed at the audit firm's standard rate for each staff member, to provide a budgeted standard cost for the entire audit engagement.

http://www.abrema.net/abrema/audit_approach_g.html


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(optionally) an audit stage planning schedule, setting out the weeks (or months) during which the audit team will perform work in each audit stage and the estimated time the

audit team will spend on each activity in each audit stage.

Q6. a) MARTHA


$


Professional subscription 300 (4,020) Less Personal allowance (single) (8,000)




Q6 b.) NORRIS



Contribution to pension Fund (10%) 7,900 Allowable expenses 600 (8,500) Less Personal allowance (single) (8,000)



First 3,000 10% 300 Next 27,000 20% 5,400



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Q7. MARNAT LTD

COMPUTATION OF TAXABLE PROFIT AND TAX PAYABLE Net Profit 320,000


Non-allowable Distribution expenses 8,000 78,000 Adjusted Net Profit 398,000 Less Capital Allowance:

IT Equipments (50%X400, 000) 200,000 Equipments (25% X 600,000) 150,000 (350,000)

Taxable profit 48,000 Tax thereon @21% (48,000 X 21%) 10,080

WORKINGS: PROFIT AND LOSS ACCOUNT Sales 2,600000 Cost of sales (1,400,000) Gross profit 1,200,000 Distribution cost 550,000 Administrative expenses 260,000 Depreciation of equipments 45,000 Depreciation of IT equipments 25,000 (880,,000) Net profit 320,000

Q8

a) Tax evasion: Tax evasion is the general term for efforts by individuals, firms, trusts and

other entities to evade taxes by illegal means.

Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state

of their affairs to the tax authorities to reduce their tax liability, and includes, in particular,

dishonest tax reporting (such as declaring less income, profits or gains than actually earned; or

overstating deductions or expenses)

b) The basic principles of taxation:

The basic principles of taxation refer to the general principles that every good tax system should have. In 1776, Adams Smith in his book “the Wealth of Nations” laid down four basic principles that should be seen in every good tax system. These are

1. The principle of Equity: Taxes should be fair to different individuals and should reflect a person‟s ability to pay. The ability-to-pay principle holds that people‟s taxes

should be based upon their ability to pay, usually as measured by income or wealth. 2. Certainty: It should be certain, not arbitrary

http://en.wikipedia.org/wiki/Corporation

http://en.wikipedia.org/wiki/Trust_(property)



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3. Convenience : it should be convenient in terms of timing and payment. 4. Efficiency: it should be administratively efficient with a relatively small cost of

collection as a proportion of the revenue raised.

c) Personal allowances: This is the amount of income you can receive each year without having to pay tax on it.

Nearly everyone who lives in the UK is entitled to an Income Tax Personal Allowance. Depending on your circumstances, you may also be able to claim certain other allowances

d) Capital gains tax (CGT): A capital gains tax (abbreviated: CGT) is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at

a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property.

Capital gains tax was introduced in 1965 and is levied on gains arising from the disposal of assets by individuals and trustees. Capital gains made by companies are subject to corporation tax. The total capital gain is defined as the value of the asset when it is sold (or given away

etc.) minus its value when originally bought (or inherited etc.).

JUNE 2009

AUDITING & TAXATION

PART A

1. Explain the true and fair view. [10]

PART B

2. a) Discuss the different forms of control expected to be found in a computerized accounting

system. [10]

b) Explain the principal factors involved in planning an audit. [10]

3. Explain briefly how you would verify the fo llowing items:

a) Debentures

b) Trade debtors

c) Freehold land and build ings

d) bank balances [5 each]

4. Explain the following terms:

a) A non-statutory audit





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b) Compliance tests

c) Test-checks

d) ICQ [5 each]

5 a) Explain the legal duties of an auditor. [10]

b) Explain the principal contents that an auditor should refer to in a letter of engagement. [10]

PART C


TAX RATES

10% on the first $3,000 of taxable income

20% on the next $27,000 of taxable income

40% on any further taxable income

PERSONAL ALLOWANCES

Single person $8,000

Additional allowance of $3,000 can be claimed by one of the partners in a marriage.




6. Jerome, aged 43, is a single person who earns $56,000 per year. Jerome has paid 6% of his gross pay

Into a qualify ing pension fund. Jerome has also paid $600 in respect of professional subscriptions.

Nizam, aged 48, is married (and claims the additional allowance) and earns $69,000. Nizam has p aid 8%

of his gross pay into a qualifying pension. Nizam has also paid $800 in respect of expenses which are

allowable against tax.

TASKS

Calculate the taxable pay, and the total tax payable for EACH of the following:

a) Jerome [7]

b) Nizam [8]

7. The following is the summarised internal profit and loss account of Forrover Ltd after its first year of

trading:

£

Sales 2,600,000

Cost of sales (1,300,000)

Distribution costs (480,000)

Admin istration expenses (240,000)

Depreciat ion of equipment (40,000)

Depreciat ion of IT equipment (50,000)

Other in formation:

Original cost of equipment 500,000

Original cost of IT equipment 400,000

Corporation tax (i.e. company taxation) is charged at 20% of the taxab le profit.

Initial writing down allowances are:


50% as regards IT equipment

Included in the distribution costs are £8,000 which are deemed non-allowable.

TASKS

Calculate Forrover Ltd‟s total taxable profit AND the total tax charge for the year. [15]


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a) Tax avoidance

b) The collector of taxes

c) PAYE



Q1 The meaning of true and fair can be broken down into two:



e) A true and fair view means appropriate classification and grouping of items... and

consistent application of generally accepted principles (ICA-Australia) f) True and fair view implies that all statutory and other information is not only available


There is no statutory or professional definition of true and fair view. However, to say financial statement shows a true and fair view, the accounts must be prepared in accordance with generally Accepted accounting principles and must conform to relevant statutory and

regulatory and the accounts must not me misleading and should be free from bias.

Q2a. The rights of an auditor includes the following

7. Right of access at all times, to the books and accounts and vouchers of the company


9. The right to attend any general meeting of the company and to receive notices to any meeting and to be heard on any part of the meeting which concerns them as an auditor

10. The right to be notified in writing, any intended resolution to remove them from office


with the outgoing auditor (if any) and invite him to make any representations and supply any information about the company which he may or may not supp ly.

12. The right to contract with the company, in addition to the statutory duties, undertake or

provide accounting, taxation and other services to the company.

Q2b. The principal content of an auditor’s report The auditor‟s report should include the following basic elements


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9. Title: an appropriate title such as „Auditor‟s Report‟ should be used to enable the reader to distinguish it from reports from others, e.g. Management report

10. Addressee: The auditor‟s report should appropriately be addressed and this is usually addressed to the shareholders or the board of directors.

11. Identification of financial statements: The report should identify the financial

statements audited by the auditor. It includes the name of the company, the accounts audited (e.g. P&L and balance sheet and the financial year

12. Reference to Auditing Standards or practices: The report should also indicate the auditing standards followed. Example International Standards on Auditing (ISA)

13. Opinion of the financial statement: The report should clearly state the auditors opinion

on the financial statement as to whether it shows a true and fair view of the entity‟s financial position and the results of its operations (P & L accounts) or not.

14. Signature: the report should be signed in the name of the audit firm, the personal name of the auditor or both the personal name and the name of the audit firm.

15. Auditor’s Address: The report should indicate the address and location of the auditor‟s

main office 16. Date of Report: the report should be dated.




creditors control account 3. Examine a sample from the creditor‟s ledger with aged lists 4. Enquire into any material debit balances on the creditors account

5. Check trade creditors to purchases and note down the credit period. 6. Circularise sample of creditors

7. Examine all responses received from the circularization and investigate any exceptions 7. Check that all creditors are properly disclosed in the financial statement

Q3b. Provision for bad debts:

The following audit procedures will apply:

7. Examine debts against which specific provisions have been made in line with information from debt collection agencies or solic itors.

8. Where provision is based on aged analysis, check whether proper analys is

has been prepared and consider the reasonableness and consistency of the formulas.

9. Check the make-up of the debtors balance 10. Consider whether cheques issued by debtors have been dishonoured for lack

of funds

11. Considers reports from solicitors to see if customers have been declared bankrupt


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12. Compare the current provision with the previous year and investigate any material difference

Q3c. Stocks & work-in progress: Audit procedure for verifying stocks and work in progress

i) Review the system of internal control over stocks

j) Perform compliance tests on key controls relating to purchases, sales, creditors and debtors

k) Physically check samples by counting selected items of stock l) Observe stock taking (i.e. attend stock taking ) m) Check on slow moving, obsolete stocks

n) Compare the current years stock with previous years stocks and note any significant changes

o) Confirm that the stock valuation is in line with SSAP 9 p) Verify each work- in-progress item with a job card.

Q3d. Bank balance: Audit procedures for bank balance

j. Appraise the system of internal control over bank

k. Examine the bank reconciliation statement and note the following iv. That all uncleared cheques are cleared v. That all payments or lodgments not credited at the balance sheet date have

been credited vi. Investigate any exceptions

l. Check the arithmetical accuracy of the bank reconciliation statement m. Trace cash payments and cash receipts to the various documents taking notes of cheque

numbers

n. Trace all contra entries, dishourned cheques, cancelled cheques o. Vouch any transfers to the petty cash book and other bank accounts

p. Cast the bank column of the cash book q. Send the standard bank letter and check the information received with the bank

statement

r. Consider the value of bank balance in the balance sheet

Q4a. Letter of Weakness: - (other names for this letter are management letter, letter of comment, letter of recommendation, post audit letter, internal control letter). It is a letter sent by the auditor to his client bringing to his attention the weakness found in the internal control

system during the audit. The letter points out the weaknesses in the internal control system and gives recommendations to improve them. It is usually presented to the client in a meeting with

the auditor.


This is a letter sent by the auditor to his client at the beginning of any new aud it or

accountancy work. It sets out the terms of the engagement and forms the basis of the contract.


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The engagement letter defines clearly, the extent of the auditors‟ responsibilities and the responsibilities of the directors. It also provides a written confirmation of the auditor‟s




Q4c. Management Audit: This is concerned with the examination of procedures laid down by management and of its efficiency. The objective here is to arrive at an opinion on the

efficiency of management rather than on the financial statements. Areas covered by management audit includes

d) Relationships between management and shareholders

e) Current standing of the organization in relation to its industry and the general public. f) Relationship between management and staff etc





Q5a. Q5a. The auditor is under a statutory duty to report to the members of an enterprise as to whether or not, the accounts prepared by the directors to be sent to the members of the


report to the members as to: f. whether proper accounting records have been kept

g. whether all returns have been received from branches h. whether or not the accounts prepared are in agreement with the records i. Whether the information and explanations given in the directors report is consistent

with the accounts and finally, j. Whether in his opinion, the financial statement presents a true and fair of the


From the above discursion, it can be concluded that Auditors works for the members

(shareholders) of the company but not the directors of the company


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Q5b. The stages in an audit include the following:


product, its present condition and future prospect, the location of all branches, any problem in accounting system and changes in law or accounting practice which affect

the client.


cost





Substantive Testing: - This involves the tests of transactions and balances and other procedures such as analytical review which seek to provide audit evidence as to the

completeness, accuracy and validity of the information contained in the accounting records or the financial statement. Substantive testing is necessary where there is weak internal control or the item is extraordinarily transaction. It is also applied to all assets

and liabilities at the balance sheet date.

Analytical Review: - This is the study of relationships between elements of the financial

information expected to confirm a predictable pattern based on the organization‟s past experiences and also other financial and non- financial information available. Analytical review is an economic way of obtaining audit evidence.

Analytical Review of financial statement:- This is where the auditor performs overall analytical review of the financial statement to determine whether accounting policies

are acceptable and are used consistently , all items in the financial statement are compatible to the best of his knowledge and also adequate disclosure of items which

needs to be disclosed.

Preparation and signing of report:-This is where the auditor expresses his opinion in a

report as to whether the financial statement shows a true and fair view or not. The report shows the person to whom the report is addressed, the financial statement audited, the responsibilities of management and the auditor, the signature of the auditor

and the date

Q6. a) ISAAC


$


Professional subscription 500 (4,040)


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First 3,000 10% 300 Next 27,000 20% 5,400


Q6 b.) SOPHIE





TAXABLE PAY 52,900

TAX PAYABLE



Tax payable 14,860

Q7. ADU-TUTU LTD


Net Profit 890,000


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Non-allowable Distribution expenses 8,000 158,000 Adjusted Net Profit 1,048,000



Tax thereon @22% (573,000 X 22%) 126,060




Depreciation of equipments 100,000 Depreciation of IT equipments 50,000 (1,010,000) Net profit 890,000

Q8.REFER TO PREVIOUS NOTES


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Auditing Hand Out

Documents

Transcript of Auditing Hand Out