Skip to content
MarkSchemeMarkScheme
Sign up — no card

9706 · 3.2.3

Auditing and Stewardship of Limited Companies — practice questions

Practice and worked examples for 9706 Auditing and Stewardship of Limited Companies. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

The directors of Z plc review the Statement of Cash Flows for the year. Net cash from operating activities was $420,000; investing outflows $180,000; dividends paid $95,000.

Explain why the Statement of Cash Flows is essential for assessing liquidity.

Show solution outline

Profit per the SoPL can include non-cash items (depreciation, accruals). The SoCF shows actual cash generated ($420,000 from operations), whether the firm can fund investments ($180,000) and dividends ($95,000) without external borrowing, and highlights liquidity risk even when reported profit is higher.

Worked example 2

An auditor for Delta Ltd is finalising the audit. The draft profit before tax is $5,000,000 and total assets are $80,000,000. The auditor's materiality threshold is 5% of profit before tax or 1% of total assets. An uncorrected error is found: a sales invoice of $40,000 was incorrectly omitted from the year's revenue.

Determine if this misstatement is material and explain the implication for the audit report.

Show solution outline

Step 1: Calculate materiality thresholds.

  • Profit-based threshold: 5% of $5,000,000 = $250,000
  • Asset-based threshold: 1% of $80,000,000 = $800,000

Step 2: Compare the misstatement to the thresholds. The misstatement is $40,000. This amount affects both profit (understated revenue) and assets (understated trade receivables).

  • $40,000 is less than the profit threshold of $250,000.
  • $40,000 is less than the asset threshold of $800,000.

Step 3: Conclude on materiality. Quantitatively, the misstatement of $40,000 is not material as it falls below both of the auditor's established thresholds.

Step 4: Explain the implication. Because the misstatement is not material, the auditor will communicate it to management but will not need to issue a qualified audit report if the directors refuse to correct it. The financial statements can still be considered to present a 'true and fair view'. The auditor would issue an unqualified audit report. However, the auditor would also consider if there are many similar small errors that could be material in aggregate.

Mark a 9706 question on this topicFull lessonOpen in course studio