Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Explain how you would verify the following:
a) Investment income. (5 marks)
b) Bank balances. (5 marks)
c) Contingent liabilities. (5 marks)
d) Petty cash balances.
a) Bank balances

i) The auditor should obtain the bank reconciliation statement as at the end of the period and perform the following procedures:

Verify that the reconciliation is accurately prepared;
 Ensure that the correct balances as per the bank statement and the cash book have been picked in the reconciliation;

Verify that the reconciling items have subsequently cleared;
 Ensure that there are no unexplained variances;

 Verify that all un-presented cheques had been dispatched to the payees and that all un- credited deposits have cleared.
This will assist the auditor in testing for window dressing. Window dressing in this context refers to attempts to overstate the liquidity of the company keeping the cash book open such that money received after year end is credited to the cash book increasing the cash balance and reducing debtors. It could also take place debiting cheques paid in the period under review but are not dispatched until after year- end.
This procedure of inspecting the bank reconciliation statement assists in verifying the completeness and accuracy of the bank balance.
ii) The auditor should obtain a direct confirmation from the bank of the amount holding on behalf of the client. The auditor should obtain the clients consent to communicate directly with the bank. Where consent is granted a standard letter of request should be sent to the bank.
The reply to this request is a good source of corroborative audit evidence to confirm the existence of the bank balance and other information such as the interest earned, any loans granted to the company or any restrictions placed on the operation of the account.

b) A contingency may be defined as a condition which exists at the balance sheet date where the ultimate outcome (gain or loss) will only be confirmed the occurrence or non-occurrence of one or more uncertain future events.

Probable losses should be accrued, possible losses should be disclosed and probable gains should be disclosed.

1. In relation to pending legal matters, I would:

a. Review the clients system of recording claims including the procedure for bringing them to the attention of management.
b. Discuss with the legal department or company secretary the procedures for instructing solicitors.
c. Examine board or management minutes for indications of possible claims
d. Examine correspondence with solicitors, including bills rendered
e. Obtain a list of matters referred to solicitors with the company‘s estimates of possible liabilities.
f. Obtain a letter of representation from the relevant directors that he is not aware of any other matters referred to solicitors

2. Letter of representation: –

The knowledge of contingent liabilities may be confined to management and is therefore a suitable matter for inclusion in such a letter.

3. In relation to guarantees: –

Examine the memorandum and articles of association of the company to ascertain whether the company‘s directors have: –
i) Powers to give this guarantee to other parties.
ii) The maximum amount they can guarantee
iii) The parties they are allowed to guarantee.

a) Read through minutes of directors and ascertain whether a resolution was passed providing for this guarantee
b) Examine correspondence between the lender and client to ascertain:-

Amount of loan guaranteed
 Interest on this loan
 Date when due
 Any special terms

c) Write to the party guaranteed and request his confirmation regarding the discharge of this liability. In case this is doubtful request client to provide for this liability

c) Petty cash

1) Examine the strength of the Internal Control System regarding petty cash payment.
2) Ensure that petty cash is maintained on an imprest system.
3) For all petty cash payments, a petty cash voucher should be raised and signed the person using this amount and the authorization a responsible officer and for this reason the auditor should take a sample of this vouchers and ensure that they are genuine.
4) The auditor should count petty cash at hand using surprise visits and should add back the amount spent to ensure that both items agree with the float.
5) For any deficit, the auditor should obtain a certificate of shortage from the petty cashier.
6) The auditor should not accept IOU‘s except if these were authorized a responsible officer

Note: The key audit procedure is to carry out a cash count and to ensure the physical balance is reconciled to the ledger (testing for completeness, accuracy and existence).

d) Investment Income

This is received mainly from two sources i.e. fixed interest deposits and shares in listed companies.

(i) For fixed interest deposits, verify the overall income in the accounts analytical review. In overall terms as the income is fixed, the expected income can be calculated. It is necessary to consider withholding tax deducted on the income.
(ii) For fixed interest deposits, test individual receipts to the cashbooks to ensure that the expected interest was received and check the calculations.
(iii) For shares in listed companies select a sample of investments and obtain from the company details of dividend payments made during the year or the dividend warrants.
(iv) Trace receipt of these dividends to the cashbook via dividend warrants.
(v) For shares in listed companies reconcile total income in accounts to total income in cashbook.
(vi) For shares disposed or purchased in the year check to clients broker note that all dividends to which the client was entitled have been received in the year.

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