It has been suggested that the most important matter affecting the credibility of the auditor
is that of “independence”.
Required:
Discuss, giving examples, matters other than independence, which might be relevant in relation to the credibility of the auditor and steps that the accounting profession has taken or might take in relation to them. (10marks) (credibility, objectivity, professional competency)
Discuss the following situations in the context of the independence of the auditor, showing clearly the principles involved:
The audit manager in charge of the audit assignment of Andrew Co holds 1,000 £1 ordinary shares in the company (total shares in issue – 100,000). The audit partner holds no shares. (5marks)
The audit fee receivable from Janet Co, a private company is £100,000. The total fee income of the audit firm is £700,000. (5marks)
The audit senior in charge of the audit of Margot Bank Co has a personal loan from the bank of £2,000 on which she is currently paying 13% interest. (5marks)
The audit partner is responsible for two audit assignments, Harry Co and Jean Co. Harry Co has recently tendered for a contract with Jean Co for the supply of material quantities of goods over a number of years. Jean Co has asked the audit partner to advice on the matter. (5Marks)
Explain the concept of objectivity, with reference to
(i) External auditors
(ii) Internal auditors, who are members of ACCA
Outlining any general threats to objectivity that exist (8marks)
(iii) Discuss the threats and the safeguards to objectivity that could be implemented in the two situations given below. (12marks)
Scenario 1
Bakers Co is an audit client of Hinkley Innes, a firm of Chartered Certified Accountants. The firm has had the audit of Bakers for 17 years and the fee represents 7% of firm income. Bakers is considering a major new project and has asked the firm if it would be happy to undertake some one-off consultancy work for the firm. It is possible that the fee income for this contract would represent 10% of that year’s income for Hinkley Innes. The new business services partner, who heads up a new division of the firm, is keen to take on the work, as this would represent his best contract yet.
Scenario 2
Peter works in the purchasing department of Murphy Manufacturing Co. He has been instrumental in setting up control systems in the purchasing department as part of a recent risk management exercise. He has a poor relationship with his immediate supervisor, the Purchasing Director. Murphy Manufacturing has just advertised the post of trainee internal auditor. Peter is interested in the work that internal audit do, having liaised substantially with the department during the recent controls exercise. No formal accountancy qualifications are required for the post, because the successful candidate will be put through accountancy training. Peter has had a chat with the head of internal audit concerning the post and is seriously considering making an application.
Question 2
John and Jane Co (John and Jane) is a computer hardware specialist and has been trading for over five years. The company is funded partly through overdrafts and loans and also by several large shareholders; the year end is 30 April 2014. John and Jane has experienced significant growth in previous years; however, in the current year a new competitor, Drums Design Co (Drums), has entered the market and through competitive pricing has gained considerable market share from John and Jane. One of John and Jane’s larger customers has stopped trading with them and has moved its business to Drums. In addition, a number of John and Jane’s specialist developers have left the company and joined Drums. John and Jane has found it difficult to replace these employees due to the level of their skills and knowledge. John and Jane have just received notification that its main supplier who provides the company with specialist electrical equipment has ceased to trade. John and Jane is looking to develop new products to differentiate itself from the rest of its competitors. It has approached its shareholders to finance this development; however, they declined to invest further in John and Jane. John and Jane’s loan is long term and it has met all repayments on time. The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed.
The directors have produced a cash flow forecast which shows a significantly worsening position over the coming 12 months. They are confident with the new products being developed, and in light of their trading history of significant growth, believe it is unnecessary to make any disclosures in the financial statements regarding going concern. At the year end, John and Jane received notification from one of its customers that the hardware installed by John and Jane for the customers’ online ordering system has not been operating correctly. As a result, the customer has lost significant revenue and has informed John and Jane that they intend to take legal action against them for loss of earnings. John and Jane has investigated the problem post year end and discovered that other work-in-progress is similarly affected, and inventory should be written down. The finance director believes that
as this misstatement was identified after the year end, it can be amended in the 2015 financial statements.
Required:
Describe the procedures the auditors of John and Jane Co should undertake in relation to the uncorrected inventory misstatement identified above. (4 marks)
Explain SIX potential indicators that John and Jane Co is not a going concern. (6 marks)
Describe the audit procedures which you should perform in assessing whether or not John and Jane Co is a going concern. (6 marks)
The auditors have been informed that John and Jane’s bankers will not make a decision on the overdraft facility until after the auditor’s report is completed. The directors have now agreed to include some going concern disclosures. Describe the impact on the auditor’s report of John and Jane Co if the auditor believes the
company is a going concern but that this is subject to a material uncertainty. (4 marks)
Question 3
Peter Cola Co (Peter) manufactures fizzy drinks such as cola and lemonade as well as other
soft drinks and its year end is 30 September 2015. You are an audit manager of Totti & Co and are currently planning the audit of Peter. You attended the planning meeting with the audit engagement partner and finance director last week and the minutes from the meeting are shown below. You are reviewing these as part of the process of preparing the audit strategy document.
Minutes of planning meeting for Peter.
Peter’s trading results have been strong this year and the company is forecasting revenue of
£85 million, which is an increase from the previous year. The company has invested significantly in the cola and fizzy drinks production process at the factory. This resulted in
expenditure of £5 million on updating, repairing and replacing a significant amount of the
machinery used in the production process.
As the level of production has increased, the company has expanded the number of warehouses it uses to store inventory. It now utilises 15 warehouses; some are owned by
Peter and some are rented from third parties. There will be inventory counts taking place at
all 15 of these sites at the year end.
A new accounting general ledger has been introduced at the beginning of the year, with the
old and new systems being run in parallel for a period of two months. In addition, Peter has
incurred expenditure of £4·5 million on developing a new brand of fizzy soft drinks. The
company started this process in July 2014 and is close to launching their new product into the marketplace.
As a result of the increase in revenue, Peter has recently recruited a new credit controller to
chase outstanding receivables. The finance director thinks it is not necessary to continue to
maintain an allowance for receivables and so has released the opening allowance of £1.5
million.
The finance director stated that there was a problem in April in the mixing of raw materials
within the production process which resulted in a large batch of cola products tasting
different. A number of these products were sold; however, due to complaints by customers
about the flavour, no further sales of these goods have been made. No adjustment has been
made to the valuation of the damaged inventory, which will still be held at cost of £1 million
at the year end.
As in previous years, the management of Peter is due to be paid a significant annual bonus
based on the value of year-end total assets.
Required
Explain audit risk and the components of audit risk. (5 marks)
Using the minutes provided, identify and describe SEVEN audit risks, and explain the
auditor’s response to each risk, in planning the audit of Peter Cola Co. (14 marks)
Identify the main areas, other than audit risks, which should be included within the audit strategy document for Peter Cola Co; and for each area provide an example relevant to the audit. (4 marks)
The finance director has requested that the deadline for the 2016 audit be shortened by a
month and has asked the audit engagement partner to consider if this will be possible. The
partner has suggested that in order to meet this new tighter deadline the firm may carry out
both an interim and final audit for the audit of Peter to 30 September 2016
Required
Explain the difference between an interim and a final audit. (3 marks)
Explain the procedures which are likely to be performed during an interim audit of Peter and the impact which it would have on the final audit. (4 marks)
