CPA Auditing and Assurance April 2025 Past Paper Answers

QUESTION ONE

(a) SIX Inherent Limitations of an Audit of Historical Financial Statements (6 marks)

1. Use of Sampling: Audits rely on sampling rather than examining every transaction, which may miss material misstatements.
2. Subjectivity in Estimates: Financial statements include estimates (e.g., provisions, depreciation), which are inherently subjective and prone to error.
3. Reliance on Management Representations: Auditors depend on management’s assertions, which may be incomplete or misleading.
4. Time Constraints: Audits are conducted within a limited timeframe, potentially overlooking issues requiring deeper investigation.
5. Inherent Limitations of Internal Controls: Even robust internal controls cannot eliminate all risks of fraud or error.
6. Historical Focus: Audits focus on past data, not future viability or events post-reporting period.

(b) SIX Challenges Faced by the Office of the Auditor General (6 marks)

1. Resource Constraints: Limited funding and staffing hinder comprehensive audits of public entities.
2. Political Interference: Pressure from government or political entities may compromise audit independence.
3. Access to Information: Delays or restrictions in obtaining records from auditees impede timely audits.
4. Complexity of Public Sector: Diverse and complex operations of government entities require specialized expertise.
5. Resistance to Recommendations: Auditees may ignore or fail to implement audit findings and recommendations.
6. Fraud and Corruption: Detecting sophisticated fraud in public entities is challenging due to systemic issues.

(c) FOUR Factors an External Auditor Considers Before Relying on Internal Auditor’s Work (8 marks)

1. Objectivity: The external auditor assesses whether the internal auditor operates independently from management influence (e.g., reporting to the audit committee). Lack of objectivity reduces reliance.
2. Competence: The qualifications, experience, and training of the internal audit team are evaluated to ensure they can perform reliable work.
3. Scope and Quality of Work: The external auditor reviews the internal auditor’s procedures, documentation, and testing to confirm alignment with audit objectives and standards.
4. Organizational Status: The internal auditor’s position within the entity (e.g., authority and access to records) is considered to ensure they can perform effectively without restrictions.

QUESTION TWO

(a) TWO Safeguards to Manage Conflict of Interest for Auditing MF and RFL (2 marks)

1. Separate Audit Teams: Assign different engagement teams to MF and RFL to prevent sharing of confidential information.
2. Confidentiality Protocols: Implement strict confidentiality agreements and access controls to ensure client data is segregated.

(b) FOUR Potential Risks to Independence in MF Audit and Types of Threats (8 marks)

1. Audit Partner Tenure (Ann Muli, 8 years):
   • Threat: Familiarity threat. Long tenure may lead to over-familiarity, reducing professional skepticism.
2. Rachel Njoki’s Employment at MF:
   • Threat: Self-interest threat. Ann Muli’s daughter receiving shares as a bonus creates a financial interest in MF, potentially biasing the audit.
3. Bonus for Early Audit Completion:
   • Threat: Self-interest threat. The 5% bonus incentivizes rushing the audit, compromising quality and objectivity.
4. Potential Information Sharing with RFL:
   • Threat: Confidentiality threat. Auditing both competitors risks unintentional disclosure of sensitive information.

(c) FIVE Procedures for Auditing Wages Department at Deni Ltd. Due to Fraud Risk (10 marks)

1. Reconcile Payroll Records: Compare payroll registers with employee contracts and HR records to identify fictitious employees.
2. Verify Bank Payments: Trace wage payments to bank statements to confirm they match legitimate employee accounts.
3. Perform Physical Verification: Conduct headcounts or employee ID checks to confirm the existence of listed employees.
4. Test Internal Controls: Evaluate the effectiveness of controls over payroll setup, approval, and disbursements to identify weaknesses.
5. Analytical Procedures: Analyze wage trends (e.g., unusual spikes or patterns) to detect anomalies suggestive of fraud.

QUESTION THREE

(a)(i) Rights and Custody of Audit Working Papers (4 marks)

• Right to Working Papers: The auditor has the right to the working papers, as they are created by the audit firm to document their work.
• Custody of Working Papers: The auditor retains custody of the working papers, maintaining them as evidence of the audit process.

(a)(ii) Expected Retention Time of Working Papers (2 marks)

• Audit working papers should be retained for at least 7 years, per international auditing standards (e.g., ISA 230).

(b)(i) Narrative Notes – Advantages and Disadvantages (4 marks)

• Advantages:
  1. Detailed Description: Provide a comprehensive narrative of the internal control system, capturing nuances.
  2. Flexibility: Allow auditors to tailor documentation to the client’s specific processes.
• Disadvantages:
  1. Time-Consuming: Writing detailed notes is labor-intensive and may delay audit progress.
  2. Subjectivity: Lack of standardization can lead to inconsistent documentation across audits.

(b)(ii) Internal Control Questionnaire – Advantages and Disadvantages (4 marks)

• Advantages:
  1. Standardized Format: Ensures consistent evaluation of controls across clients.
  2. Efficiency: Quick to complete, saving time during the audit process.
• Disadvantages:
  1. Limited Depth: May not capture complex or unique control processes adequately.
  2. Risk of Bias: Pre-set questions may lead to overlooking unlisted control weaknesses.

(c) THREE Differences Between a Review Engagement and an External Audit (6 marks)

1. Objective: A review provides limited assurance (negative assurance) that no material misstatements exist, while an audit provides reasonable assurance (positive assurance) on the fairness of financial statements.
2. Procedures: Reviews rely on inquiries and analytical procedures, whereas audits involve extensive testing, including substantive procedures and control evaluations.
3. Reporting: Review reports state no material modifications are needed (limited assurance), while audit reports express an opinion on whether financial statements are free of material misstatement.

QUESTION FOUR

(a)(i) Definition of Significant Risks (2 marks)

• Significant Risks: Risks of material misstatement that require special audit consideration due to their complexity, magnitude, or likelihood of occurrence, often involving fraud, estimates, or non-routine transactions.

(a)(ii) SIX Factors to Determine Significant vs. Non-Significant Risks (6 marks)

1. Likelihood of Misstatement: Higher probability of material misstatement increases risk significance.
2. Magnitude of Impact: Risks with potential for large financial statement errors are more significant.
3. Complexity of Transactions: Complex or non-routine transactions (e.g., derivatives) are more likely significant.
4. Fraud Risk: Risks involving potential fraud are typically significant due to intentional misstatement.
5. Subjectivity in Estimates: Risks tied to subjective judgments (e.g., provisions) are often significant.
6. Control Weaknesses: Risks in areas with weak internal controls are more likely to be significant.

(b) Audit Opinions for Bora Ltd. Matters (12 marks)

1. Lawsuit for Breach of Warranty (Sh.40,000,000):
   • Issue: Management has not recognized a provision despite a probable loss, per IAS 37.
   • Opinion: If material and not adjusted, issue a qualified opinion due to non-compliance with IFRS. If pervasive, an adverse opinion may be appropriate.
2. Loss of Non-Current Asset Records:
   • Issue: Lack of supporting documents prevents verification of asset existence and valuation, limiting audit evidence.
   • Opinion: If material, issue a qualified opinion due to scope limitation. If pervasive, a disclaimer of opinion may be necessary.
3. Goodwill Not Tested for Impairment:
   • Issue: IAS 36 requires annual impairment testing. Material impairment not recognized affects financial statement accuracy.
   • Opinion: If material and not corrected, issue a qualified opinion. If pervasive, an adverse opinion may apply.
4. Internal Control Loophole in Wages:
   • Issue: Suspected ghost workers indicate control weaknesses, but no misstatements were identified.
   • Opinion: If no material misstatements are found, issue an unmodified opinion but include an emphasis of matter to highlight the control issue.

QUESTION FIVE

(a) FIVE Factors Determining Auditor Responsibility for Non-Detection of Errors and Frauds (5 marks)

1. Nature of Error/Fraud: Auditors are responsible for detecting material misstatements, not immaterial or well-concealed frauds.
2. Audit Scope and Procedures: Responsibility depends on whether appropriate procedures (per ISAs) were applied to detect material issues.
3. Professional Skepticism: Failure to exercise adequate skepticism may result in auditor liability.
4. Management Collusion: Sophisticated fraud involving management collusion reduces auditor responsibility, as it’s harder to detect.
5. Reasonable Assurance: Auditors provide reasonable, not absolute, assurance, limiting responsibility for undetected issues within this scope.

(b) Steps for Kemikali Ltd.’s Refusal to Amend WIP Valuation Error (5 marks)

1. Discuss with Management: Engage management to explain the error’s impact and IFRS requirements, urging correction.
2. Escalate to Audit Committee: If management refuses, escalate to those charged with governance (e.g., audit committee) for resolution.
3. Assess Materiality: Evaluate whether the error is material or pervasive to the financial statements.
4. Propose Audit Adjustments: Document proposed adjustments in the management letter, noting management’s refusal.
5. Issue Modified Opinion: If material and uncorrected, issue a qualified opinion (material) or adverse opinion (pervasive), explaining the misstatement.

(c) FIVE Factors Influencing Auditor’s Judgment on Sufficiency of Audit Evidence (10 marks)

1. Risk of Material Misstatement: Higher risks (e.g., fraud or complex transactions) require more extensive evidence.
2. Quality of Evidence: Reliable sources (e.g., third-party confirmations) reduce the quantity of evidence needed.
3. Internal Control Effectiveness: Strong controls allow auditors to rely on less substantive testing, reducing evidence needs.
4. Materiality Levels: Lower materiality thresholds necessitate more evidence to ensure accuracy.
5. Nature of Account or Transaction: Complex or subjective areas (e.g., estimates) require more robust evidence to support conclusions.