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Financial Accounting

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Financial Accounting

DIPLOMA IN PUBLIC AUDIT

AUDIT IN CONTEXT PAPER

Level 1 Examination

21 June 2007

MARKING SCHEME

     (Copyright)

    DPA Level 1 Marking Scheme June 2007

    Audit in Context Paper

    Question 1

    (a) Give a definition of internal audit and external audit.

Definition of external audit: ‘an independent examination of, and expression of an

    opinion on, the financial statements of an organisation’.

Definition of internal audit: ‘an independent appraisal function, established by the

    management of an organisation for the review of the internal control system as a

    service to the organisation’.

     1 mark for each of the above or any other reasonable definition up to a maximum of 2

    (b) Outline the similarities and differences between internal and external audit.

Key Differences

Accountability

    ? External audit are appointed by statute

    ? External audit are accountable to the governing body

    (shareholders/Parliament/elected members, etc).

    ? Internal audit are appointed by and are answerable to management

Objectives

    ? External audit provide an independent opinion

    ? External audit’s objectives are set by statute/regulators

    ? Internal audit provide a service to management

    ? Internal audit’s objectives are negotiated with management

     1 mark should be awarded for each valid difference up to a maximum of 3

Key Similarities

Common Interests

    These are to ensure that the organisation has:

    ? Effective internal control systems

    ? Continuous operation of control systems

    ? Flow of financial and management information

    ? Effective non-financial control systems

    ? Compliance with laws and regulations

Common Features

    ? Key personnel features

    1. Independence

    2. Competence

    3. Integrity ? Form independent opinion

    ? Follow professional standards

     1 mark should be awarded for each valid difference up to a maximum of 3

    DPAAIC Page 2 of 8

    DPA Level 1 Marking Scheme June 2007

    Audit in Context Paper

    (c) Give a brief description of the main objectives of internal audit.

The objectives of internal audit are to:

    ? Examine, evaluate and report on the adequacy of systems of internal control,

    at a reasonable cost

    ? Provide a consulting role for management

    ? Input into corporate governance and risk management

    ? Maintain personal objectivity

    ? Display professionalism

    ? Work within the resources provided by developing a comprehensive plan with

    full evaluation and recording of the system of internal controls ? Ensure that there are thorough evidence gathering, reporting and follow-up

    procedures

     1 mark should be awarded for each objective outlined in answers,

     subject to a maximum of 4

    (d) Describe potential areas of overlap in the work of internal and external audit.

There is the potential to overlap when

    ? Examining the same internal control systems

    ? Examining the same sources of information

    ? Verifying assets and liabilities

    ? Visiting auditees at the same time

     1 mark should be awarded for each of the above suggestions outlined above,

     or other similar suggestions, up to a maximum of 4

    (e) Summarise those factors that ISA 610 ‘considering the work of internal audit’

    expects external auditors to take into account when deciding how much reliance

    to place on the work of internal audit.

The factors to be taken into account are:

    ? To consider the activities of internal audit and their effect, if any, on external

    audit procedures

    ? To obtain sufficient understanding of internal audit activities to identify and

    assess the risks of material misstatement of the financial statements and to

    design and perform further audit procedures

    ? To perform an assessment of the internal audit function when internal

    auditing is relevant to the external auditor’s risk assessment

    ? When the external auditor intends to use specific work of internal audit, the

    external auditor should evaluate and perform audit procedures on that work

    to confirm its adequacy for the external auditor’s purposes.

     1 mark for each of the above, or reasonably similar description

     up to a maximum of 4

     (20)

    DPAAIC Page 3 of 8

DPA Level 1 Marking Scheme June 2007

    Audit in Context Paper

Question 2

    (a) What is meant by the term ‘internal control’?

    Definition: ‘The process designed and effected by those in charge with

    governance, management and other personnel to provide reasonable assurance

    about the achievement of the entity’s objectives with regard to reliability of

    financial reporting, effectiveness and efficiency of operations, and compliance with

    applicable laws and regulations’.

    Source: Audit Practices Board’s (APB) Glossary of Terms.

     2 marks for the above or any other reasonable definition

(b) List the eight types of control referred to by the acronym ‘SOAPSPAM’ and give an

    example of the type of risk for which each is appropriate.

    Type of control Risk

    Segregation of duties Risk of one person having complete

    responsibility for all stages of a process

    Organisational Risk of delegating responsibility to an

    inappropriate level

    Authorisation and approval Risk of unauthorised and invalid data

    entering a system

    Physical Risk of loss or damage to the tangible assets

    of an organisation

    Supervision Risk of failure by staff to comply with proper

    procedures

    Personnel Risk of employing or appointing staff without

    the relevant skills or experience to carry out

    their assigned duties

    Arithmetic and accounting Risk of accounting errors such as mis-coding

    or omission

    Management Risk of cumulative errors or unusual

    transactions slipping through other controls

     Risks are indicative only and students should be given credit for other relevant risks

     ? mark awarded for each type of control and ? mark for each risk,

     subject to a maximum of 8

     (10)

DPAAIC Page 4 of 8

DPA Level 1 Marking Scheme June 2007

    Audit in Context Paper

Question 3

(a) Explain what you understand by ‘audit independence’ and say why it is important.

    Definition: Independence is ‘essentially an attribute of mind characterised by

    integrity and an objective approach to professional work’.

     1 mark for the above or similar definition

    Explanation

    ? Lack of independence may lead to a lack of objectivity.

    ? Without independence, auditors’ findings cannot be relied upon.

     1 mark for each of the above up to a maximum of 2

(b) Identify and explain four possible threats to internal audit’s independence in a

    public sector organisation with which you are familiar.

    Threats to internal auditors’ independence:

    ? Personal relationships may reduce objectivity.

    ? Previous involvement in decisions/systems.

    ? Audit acting as part of the control systems may affect its objectivity.

    ? Political pressure may be put on the auditor, for example, not to reveal

    something.

    ? Reporting may be restricted to, for example, the Director of Finance.

    ? Local personal interests.

    ? Lack of training of staff may impact on their understanding of independence.

     1 mark for any of the above, subject to a maximum of 4

(c) What standards are applicable to the work of internal audit in the local

    government sector?

    Relevant Standards include:

    ? APB Guideline 308 ‘Guidance for internal auditors’

    ? CIPFA Statement of Professional Practice

    ? CIPFA Code of Practice for Internal Audit in Local Government in the United

    Kingdom

    ? Relevant IIA standards

     1 mark for any of the above, subject to a maximum of 3

     (10)

DPAAIC Page 5 of 8

    DPA Level 1 Marking Scheme June 2007 Audit in Context Paper

Question 4

(a) What is ‘stewardship’ and why is it particularly important in the public sector?

    Stewardship is defined as being, ‘when one person or group manage the

    productive resources of another person or group’.

     1 mark for the above definition, or similar definition

    Stewardship is particularly important in the public sector because taxpayers’

    money is being spent on behalf of taxpayers.

    Taxpayers do not have a choice about whether or not they invest in public

    services and do not get a choice as to what their money is invested in.

    Therefore, the stewards of public money have a duty to spend wisely and

    maintain good control over public expenditure.

     2 marks for the above points, or similar, well put

(b) List eight stakeholders of a typical public authority.

    Government Parliament

    Politicians MPs /Government Ministers /Councilors’

    Employees

    Trades Unions

    Service users

    General public

    General taxpayers

    Local taxpayers

    Local businesses

    Suppliers

    Local press, and the media generally

     ? mark for any suitable stakeholder, up to a maximum of 4

(c) Explain why having an internal audit service will improve stewardship for

    stakeholders.

    Having an internal audit service will give stakeholders confidence that:

    ? The systems in place to manage services are well managed and

    controlled

    ? Arrangements will be in place to achieve due economy, efficiency and

    effectiveness

    ? Public money will be safeguarded

     3 marks for the above or any other reasonable explanation

     (10)

    DPAAIC Page 6 of 8

    DPA Level 1 Marking Scheme June 2007 Audit in Context Paper

Question 5

(a) Provide a definition of risk.

    Definition: Risk is the ‘possibility of incurring misfortune or loss’.

    Source: Collins’ Concise Dictionary.

     1 mark for the above or any other reasonable definition

    (b) Explain the difference between audit risk and business risk.

    Business risk is the risk that the business faces at all levels within the operation,

    regardless of its size, structure or nature. Business risks can be split into three

    types: financial risks, operational risks and compliance risks.

    Audit risk is the risk that the auditor will give an incorrect or invalid opinion, ie

    the risk to the auditor. Audit risk incorporates inherent risk, control risk and

    detection risk, ie AR=IR x CR x DR

     1 mark should be awarded for each reasonable description of both types of risk

     The components of audit risk should be identified as part of the answer

    (c) What is the public sector attitude towards risk and why is this likely to be

    different to the private sector view of risk?

    The public sector tends to be risk averse. Conversely, the private sector is more

    risk embracing.

    Private sector organisations tend to be driven by exploiting opportunities to make

    a profit. Some projects may fail but often this is seen as a learning experience in

    the private sector.

    The public sector is not driven by the profit motive as it is a provider of essential

    public services. If a project were to fail in the public sector it would have a more

    significant impact such as damage to the reputation of the organisation concerned

    or a public outcry if taxpayers’ money was wasted. For this reason public sector

    organisations are traditionally more risk averse than private sector organisations.

     ? mark for stating what the traditional public sector approach to risk is likely to be

     and ? mark for stating what the private sector approach to risk is likely to be

     2 marks for providing a reasonable explanation of why this is the case DPAAIC Page 7 of 8

DPA Level 1 Marking Scheme June 2007

    Audit in Context Paper

(d) There are four approaches to risks, often referred to as the four ‘T’s, ie treat,

    tolerate, terminate and transfer. Provide an explanation of what is meant by

    each of these four terms.

    Treat: by treating, risk is contained at an acceptable level.

    Tolerate: the ability to do anything about certain types of risk may be limited so

    they have to be lived with. (The cost of treating or transferring the risk is likely

    to outweigh the benefits gained).

    Transfer: transferring the risk to a third party. The most likely way of doing this

    is to pay for insurance.

    Terminate: this option is likely to be of limited use in the public sector as it will

    not always be an option to terminate activities. Terminating risk tends to be

    thought of as ‘a last resort’.

     1 mark to be awarded for each of the above or other similar definitions

     up to an overall of 4

     (10)

    DPAAIC Page 8 of 8

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