F8 PT2 ANSWERS 3

Lecturer's comments: this is a very popular exam question. It pays to scrutinise every single detail and understand the application. Alan Lewin could easily make this a 12 mark question.

FINANCIAL STATEMENT
• TYPES OF RISKS
- ASSERTION WORKS

Revenue
• BUSINESS
- CLASSIFICATION: Check the accounting policy for revenue recognition particularly in respect of software licences to ensure that it has been applied consistently and in accordance with accounting standards.
• INHERENT
- COMPLETENESS: Obtain a breakdown of sales on a monthly basis and discuss significant fluctuations with management. Any explanations should be corroborated.
• DETECTION
- OCCURRENCE: Perform tests of controls on controls over the processing of sales orders and invoicing. Sample sizes should reflect the increased risk.
• DETECTION
- EXISTENCE: For a sample of sales transactions perform substantive procedures tracing the transaction from the initial order to the posting in the ledgers. The sample size would be affected by the results of the tests of controls.
• CONTROL
- CUT-OFF: Check cut-off at the year end to ensure that revenue has only been recognised in relation to sales genuinely made in the accounting period.

Gross margin
• INHERENT
VALUATION: Check the basis on which costs have been capitalised as development costs. Those which do not meet the conditions of IAS 38 Intangible assets should be expensed.
• INHERENT
UNDERSTANDABILITY: The gross margin of 80% seems high in spite of the nature of the business. Obtain industry information to establish an industry average.
• INHERENT
UNDERSTANDABILITY: Compare the gross profit margin on a quarterly basis and compare with the results of the previous year. Discuss the reasons behind significant variations with management.
• CONTROL
CLASSIFICATION: Obtain a breakdown of costs included in cost of sales and compare with previous year to establish any change in the way that costs have been allocated to the expense categories.
• CONTROL
OCCURRENCE: For a sample of expenses trace the transaction from source documentation to posting in the accounts.
• CONTROL
CUT-OFF: Agree opening inventory to previous years accounts. The position statement audit should provide evidence regarding the quantity and valuation of closing inventory.
• CONTROL
CUT-OFF: In particular cut-off should be confirmed to ensure that it is in line with sales cut‑off.

Operating expenses
• INHERENT
UNDERSTANDABILITY: Compare monthly levels of expenditure with previous year and obtain explanations for any significant changes.
• CONTROL
ACCURACY: Obtain a breakdown of distribution costs, administrative expenses and selling costs. Compare the nature of the expenditure with that included in the previous
year to highlight any misclassification.
• CONTROL
CUT-OFF: Review expenses incurred after the year end to ensure that all expenses relating to the current period have been correctly accrued for.
• CONTROL
VALUATION & ACCURACY : Review the impact of depreciation on the operating expenses figures. Obtain a schedule of non-current assets and recalculate depreciation charged based on the company's policy. Confirm that this is consistent and reasonable in the light of the nature of the asset.
• DETECTION
OCCURRENCE: Perform tests of controls on controls over the processing of expenses from initiation of the transaction to posting in the ledgers.
• DETECTION
OCCURRENCE: For a sample of expenses trace the transaction from its source eg invoice to its recording in the ledgers.

Interest
• CONTROL
ACCURACY: Obtain an analysis of interest payable/receivable casted.
rates applicable to the different categories of investment.
• CONTROL
EXISTENCE: Agree interest payable to bank statements/loan agreements.
• CONTROL
ACCURACY: For interest receivable perform a proof in total calculation based on the interest For a sample of investments agree the interest actually received and accrued for to the terms of the investment.

Tax
• INHERENT
OBLIGATIONS: Obtain and review any correspondence with the tax authorities.
•INHERENT
UNDERSTANDABILITY: Discuss the calculation with management and confirm any explanations.
•DETECTION
EXISTENCE: Obtain a copy of the tax calculation to establish why it has increased so significantly.

Dividends
• INHERENT
UNDERSTANDABILITY: Discuss the rationale behind the dividend payment with management, particularly regarding sustainability.
• DETECTION
EXISTENCE: Confirm that the payment of the dividend is minuted.
• DETECTION
RIGHTS: Check that the payment does not breach legislation regarding distributable profits.

Earnings per share
* INHERENT
VALUATION: Confirm the basis on which the calculation has been performed. If additional shares have been issued confirm that the legal procedures have been complied with and establish the purpose of the share issue.
• CONTROL
ACCURACY: Reperform the EPS calculation.