PAA 1 – 2

56. Trumpet Enterprises Co (Trumpet) has been trading for 15 years selling insurance and has recently become a listed company. Trumpet is required to comply with corporate governance principles in order to maintain its listed status and the finance director has undertaken a review of whether or not the company complies.

Wilson Galloon is the chair of Trumpet, until last year he was the chief executive. Wilson is unsure if Trumpet needs more non‐executive directors as there are currently three non‐executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non‐executive director.

The finance director, Emily Wei, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form of an annual bonus based on profits. Emily is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant.

There are a large number of shareholders and therefore the directors believe that it is impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email.

Required:

Describe TWO corporate governance weaknesses faced by Trumpet Enterprises Co and provide a recommendation to address each weakness to ensure compliance with corporate governance principles.

Note: Prepare your answer using two columns headed Weakness and Recommendation respectively.

57. You are the audit manager of Cloud & Co and you are planning the audit of Connect Financials Co (Connect), who specialize in the provision of loans and financial advice to individuals and companies. Cloud & Co has audited Connect for many years.

The directors are planning to list Connect on a stock exchange within the next few months and have asked if the engagement partner can attend the meetings with potential investors. In addition, as the finance director of Connect is likely to be quite busy with the listing, he has asked if Cloud & Co can produce the financial statements for the current year.

During the year, the assistant finance director of Connect left and joined Cloud & Co as a partner. It has been suggested that due to his familiarity with Connect, he should be appointed to provide an independent partner review for the audit.

Once Connect obtains its stock exchange listing it will require several assignments to be undertaken, for example, obtaining advice about corporate governance best practice. Cloud & Co is very keen to be appointed to these engagements, however, Connect has implied that in order to gain this work Cloud & Co needs to complete the external audit quickly and with minimal questions/issues.

The finance director has informed you that once the stock exchange listing has been completed, he would like the engagement team to attend a weekend away at a luxury hotel with his team, as a thank you for all their hard work. In addition, he has offered a senior member of the engagement team a short‐term loan at a significantly reduced interest rate.

Required:

1. Identify and explain FIVE ethical threats which may affect the independence of Cloud & Co’s audit of Connect Financials Co, and
2. For each threat, suggest a safeguard to reduce the risk to an acceptable level.

 Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

58. You are an audit supervisor of Craving & Co and you are planning the audit of Hunting Co, a listed company, for the year ending 31 March 20X8. The company manufactures computer components and forecast profit before tax is $25.6 million and total assets are $57.3 million.

Hunting Co’s finance director has informed the audit engagement partner that one of the company’s non‐executive directors (NEDs) has just resigned, and he has enquired if the partners at Craving & Co can help Hunting Co in recruiting a new NED. Specifically he has requested the engagement quality control reviewer, who was until last year the audit engagement partner on Hunting Co, assist the company in this recruitment. Craving & Co also provides taxation services for Hunting Co in the form of tax return preparation along with some tax planning advice. The finance director has recommended to the audit committee of Hunting Co that this year’s audit fee should be based on the company’s profit before tax. At today’s date, 20% of last year’s audit fee is still outstanding and was due to be paid three months ago.

Required:

1. Identify and explain FIVE ethical threats which may affect the independence of Craving & Co’s audit of Hunting Co, and
2. For each threat, suggest a safeguard to reduce the risk to an acceptable level.

Note: The total marks will be split equally between each part. Prepare your answer using two columns headed Ethical threat and Possible Safeguard respectively.

59. The listing rules of the stock exchange require compliance with corporate governance principles and the directors of Fresco Co are confident that they are following best practice in relation to this. However, the chair recently received correspondence from a shareholder, who is concerned that the company is not fully compliant. The company’s finance director has therefore requested a review of the company’s compliance with corporate governance principles.

Fresco Co has been listed for over eight years and its board comprises four executive and four independent non‐executive directors (NEDs), excluding the chair. An audit committee comprised of the NEDs and the finance director meets each quarter to review the company’s internal controls.

The directors’ remuneration is set by the finance director. NEDs are paid a fixed fee for their services and executive directors are paid an annual salary as well as a significant annual bonus based on Fresco Co’s profits. The company’s chair does not have an executive role and so she has sole responsibility for liaising with the shareholders and answering any of their questions.

Required:

Describe TWO corporate governance weaknesses faced by Fresco Co and provide a recommendation to address each weakness to ensure compliance with corporate governance principles.

Note: Prepare your answer using two columns headed Weakness and Recommendation respectively.

60. You are an audit manager of Saturn & Co and have been assigned to the audit of Tangle Tech Co (Tangle), a company which is planning to list on a stock exchange within six months. The listing rules of the stock exchange require compliance with corporate governance principles, and the directors are unsure whether they are following best practice in relation to this. They have asked the audit engagement partner for their view on this matter. Tangle’s board is comprised of six executive directors, a non-executive chairman and three other non-executive directors (NEDs). The chairman and one of the NEDs are former executive directors of Tangle and on reaching retirement age were asked to take on non-executive roles. The company has established an audit committee, and all NEDs are members including the chairman who chairs the committee. All four members of the audit committee were previously involved in sales or production related roles.

All of the directors have been members of the board for at least four years. As the chairman does not have an executive role, he has sole responsibility for liaising with the shareholders and answering any of their questions. The company has not established an internal audit function to monitor internal controls.

Required:

(a)Using the information above:

Describe FIVE corporate governance weaknesses faced by Tangle Tech Co and provide a recommendation to address each weakness to ensure compliance with corporate governance principles.

61. Shape Enterprises Co (Shape) has been trading for 15 years selling insurance and has recently become a listed company. In accordance with corporate governance principles Shape maintains a small internal audit department. The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, Yellow & Co. Shape is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of whether or not the company complies. Will Wade is the chairman of Shape, until last year he was the chief executive. Will is unsure if Shape needs more non-executive directors as there are currently three non-executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director.

The finance director, Emily Wong, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form of an annual bonus based on profits. Emily is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant.

There are a large number of shareholders and therefore the directors believe that it is impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email.

(a) In respect of the corporate governance of Shape Enterprises Co:

(i) Identify and explain FIVE corporate governance weaknesses; and

(ii) Provide a recommendation to address each weakness.

Note: The total marks will be split equally between each part.

62. Green Apple Enterprises Co (Green Apple) is a retail company planning to list on a stock exchange within the next six months, and management has been advised by the company’s auditors about the need for compliance with corporate governance provisions. In particular, the finance director is looking to recruit non-executive directors as he understands that Green Apple will need to establish an audit committee. The finance director has two potential nonexecutive directors whom he is considering approaching to join the board of Green Apple. Johnson Glyph is currently an executive sales director of a listed multi-national banking company; he sits on an audit committee of another company as a non-executive director and is agreeable to being paid a fixed fee which is not related to profits. Honey Clam is currently a finance director of a small retail company, which does not compete with Green Apple; he has expressed an interest in a fixed seven year contract and he is the brother of Green Apple’s chief executive.

Required:

(a) Explain the benefits to Green Apple Enterprises Co of establishing an audit committee.

(b) Discuss the advantages and disadvantages of appointing:

(i) Johnson Glyph; and

(ii) Honey Clam

as non-executive directors of Green Apple Enterprises Co.

Note: The total marks will be split equally between each part.

63. You are an audit manager of Dark Partners & Co (Dark) and are planning the audit of Silver Finance Co (Silver), a banking institution which provides a range of financial services including loans. Your firm has audited Silver for four years and the company’s year-end is 30 September 2017. At the end of August, Silver’s financial controller left and the new replacement is not due to start until approximately two months after the year end. The finance director, who is the sister-in-law of the audit engagement partner, has asked if a member of the audit team can be seconded to Silver for three months to act as the temporary financial controller. You are aware that a number of the audit team members currently bank with Silver and two team members have significant loans owing to the company. Dark’s taxation department also provides services to Silver. They have been approached by Silver to represent them in negotiations to resolve some outstanding issues with the taxation authorities, for which the fees quoted are substantial. The finance director has informed the audit engagement partner that when the audit is complete, she would like the whole team to attend an evening watching the national football team play a match followed by a luxury meal.

Required:

(a)Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the independence of Dark Partners & Co’s audit of Silver Finance Co; and

(ii) For each threat, explain how it might be reduced to an acceptable level.

Note: The total marks will be split equally between each part.

64. Leaf & Flower & Co (‘Leaf & Flower’) is a firm of Chartered Certified Accountants which has seen its revenue decline steadily over the past few years. The firm is looking to increase its revenue and client base and so has developed a new advertising strategy where it has guaranteed that its audits will minimize disruption to companies as they will not last longer than two weeks. In addition, Leaf & Flower has offered all new audit clients a free account preparation service for the first year of the engagement, as it is believed that time spent on the audit will be reduced if the firm has produced the financial statements. The firm is seeking to reduce audit costs and has therefore decided not to update the engagement letters of existing clients, on the basis that these letters do not tend to change much on a yearly basis. One of Leaf & Flower’s existing clients has proposed that this year’s audit fee should be based on a percentage of their final pre-tax profit. The partners are excited about this option as they believe it will increase the overall audit fee. Leaf & Flower has recently obtained a new audit client, Thunder Brothers Co (Thunder), whose yearend is 31 December. Thunder requires their audit to be completed by the end of February; however, this is a very busy time for Leaf & Flower and so it is intended to use more junior staff as they are available. Additionally, in order to save time and cost, Leaf & Flower have not contacted Thunder’s previous auditors.

(a) Required:

(i) Identify and explain FIVE ethical risks which arise from the above actions of Leaf & Flower & Co; and

(ii) For each ethical risk explain the steps which Leaf & Flower & Co should adopt to reduce the risks arising.

Note: The total marks will be split equally between each part.

65. You are an audit senior of Sand & Co and have been allocated to the audit of Pillow Shells Co (Pillow), a listed company which has been an audit client for eight years and specializes in manufacturing musical instruments. Barak Olav was the audit engagement partner for Pillow and as she had completed seven years as the audit engagement partner, she has recently been rotated off the audit engagement. The current audit partner, Steve Smith, has suggested that in order to maintain a close relationship with Pillow, Barak should undertake the role of independent review partners this year. In addition, Pillow has requested that Barak assist them by attending their audit committee meetings, as a non-executive director has recently left the company. Pillow has also asked Steve and the other partners at Sand & Co to help them in recruiting a new non-executive director. The total fees received by Sand & Co for last year equated to 16% of the firm’s total fee income. The current year’s audit fee has not yet been confirmed, but along with taxation and other possible non-audit fees the total income from Pillow this year could be greater than for last year. Last year’s audit fee was being paid monthly by Pillow but no payments have been made for the last three months. The audit manager for Pillow has just announced that he is leaving Sand & Co to join Pillow as the financial controller.

Required:

Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the independence of Sand & Co’s audit of Pillow Shells Co; and

(ii) For each threat explain how it might be reduced to an acceptable level.

Note: The total marks will be split equally between each part.

66. Hall & Co has recently accepted the audit engagement of a new client, Almond Co, who is the main competitor of Cement Publishing Co. The finance director of Cement Publishing Co has enquired how Hall & Co will keep information obtained during the audit confidential.

Required:

Explain the safeguards which Hall & Co should implement to ensure that the identified conflict of interest is properly managed.

67. The finance director of Precede informed the audit partner that the reason for appointing Guitar & Co as auditors was because they audit other mobile phone companies, including Precede’s main competitor. The finance director has asked how Guitar & Co keeps information obtained during the audit confidential.

Required:

(a) Explain the safeguards which your firm should implement to ensure that this conflict of interest is properly managed.