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PAA 1 – 2

Question 56-67
Question 56-67

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1 / 12

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.

Weakness Recommendation
Wilson Galloon is now the chair after having been the chief executive until last year.

 

The chair must be an independent non‐executive director and hence cannot have previously been the chief executive of the same company. The roles of chair and chief executive are both very important and carry significant responsibilities. Too much power resides in the hands of one individual.

Wilson Galloon should return to his role as chief executive as this will fill the current vacancy and an independent non‐executive director should be recruited to fill the role of chair. Open advertising and/or an external search consultancy should be used for the appointment of the chair.
The board comprises five executives and only three non‐executive directors.

 

There should be an appropriate balance of executives and non‐executives, to ensure that the board makes the correct objective decisions, which are in the best interest of the stakeholders of the company.

 

The executives can dominate the board’s decision making.

At least half the board, excluding the chair should be independent NEDs. Hence the board of Trumpet should consider recruiting and appointing two additional independent non-executive directors.
Wilson Galloon is considering appointing his close friend as a non‐executive director. The friend has experience of running a manufacturing company.

 

If this director is a close friend of Bill Bassoon, then it is possible that he will not be independent.

 

In addition, other than being a former chief executive, he does not have any relevant experience of the insurance industry and so it is questionable what value he will add to Trumpet.

Only independent non‐executives with relevant experience and skills should be appointed to the board of Trumpet. Appointments should be based on merit and objective criteria and should promote diversity. The close friend of Wilson Galloon is unlikely to meet these criteria, as he has no experience in the insurance industry, and so should not be appointed.

 

Open advertising and/or an external search consultancy should be used for the appointment of the NEDs.

The remuneration for directors is set by Emily Wei, the finance director.

 

However, no director should be involved in setting their own remuneration as this may result in excessive levels of pay being set.

Emily may pay more to directors who are willing to support his agenda in board meetings.

The board should establish formal and transparent procedures for developing the policy for executive directors’ remuneration.

 

The remuneration committee should determine the policy for executive director remuneration, as well as set the remuneration for the chair, executive directors and senior management.

All directors’ remuneration is in the form of an annual bonus.

 

Pay should motivate the directors to focus on the long‐term growth of the business.

 

Annual targets can encourage short‐term strategies rather than maximizing shareholder wealth.

The remuneration of executives should be restructured to include a significant proportion aimed at long‐term, sustainable company performance. Shares awards should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more.
In addition, non‐executive directors’ pay should not be based on meeting company targets as their pay should be independent of how the company performs. NED remuneration should be determined by the board. It should reflect time commitment and responsibilities of the role and should not include share options or other performance related elements.

 

Trumpet does not currently have an audit committee.

 

Audit committees undertake an important role in that they help the directors to satisfy their responsibility of accountability with regards to maintaining an appropriate relationship with the company’s auditor.

 

Without an audit committee there is no oversight of the financial reporting processes of the company.

Trumpet should appoint an audit committee as soon as possible. The committee should comprise at least three independent non-executives, one of whom should have relevant financial experience.
A new sales director was appointed nine months ago, however, he has not undergone any board training.

 

All directors should receive induction training when they first join the board so that they are fully aware of their responsibilities.

 

The new sales director may not be fully effective in the role without the relevant training and induction.

The new sales director should immediately receive relevant training from Wilson Galloon to ensure that he has a full understanding of his role and responsibilities.
Trumpet is not planning to hold an annual general meeting (AGM) as the number of shareholders are such that it would be too costly and impractical.

 

However, the AGM is an important meeting in that it gives the shareholders an opportunity to raise any concerns, receive an answer and vote on important resolutions.

 

The proposal to send the financial statements and resolutions by email is not appropriate as it does not allow shareholders an opportunity to raise relevant questions.

The company should continue to hold the AGM.

 

Sending information by email in advance of the meeting may be practical and save some costs; however, this should not be seen as a replacement for the AGM.

 

Ethical Threat Managing Risk
Connect Financials Co (Connect) has asked the engagement partner of Cloud & Co to attend meetings with potential investors.

 

This represents an advocacy threat.

 

The audit firm may be perceived as promoting investment in Connect and this threatens objectivity.

The engagement partner should politely decline this request from Connect, as it represents too great a threat to independence.
Due to the stock exchange listing, Connect has requested that Cloud & Co produce the financial statements.

 

This represents a self‐review threat.

 

The auditor may not detect errors in the financial statements they were responsible for preparing, or, may not wish to admit to errors that are detected.

As Connect is currently not a listed company then Cloud & Co are permitted to produce the financial statements and also audit them.

 

However, Connect is seeking a listing, therefore, ideally Cloud & Co should not undertake the preparation of the financial statements as this would represent too high a risk.

 

If Cloud & Co chooses to produce the financial statements then separate teams should undertake each assignment and the audit team should not be part of the accounts preparation process. The preparation must be routine and mechanical in nature, therefore the audit firm must not be responsible for selecting accounting policies or determining accounting estimates.

The assistant finance director of Connect has joined Cloud & Co as a partner and has been proposed as the review partner.

 

This represents a self‐review threat.

 

The new review partner will not be independent and may not detect errors, or, may not wish to admit to errors that are detected in the financial statements he was responsible for whilst in the position of FD. He will also lack professional skepticism.

This partner must not be involved in the audit of Connect until a cooling‐off period has been served. An alternative review partner should be appointed.
Connect has several potential assurance assignments available and Cloud & Co wish to be appointed to these. There is a potential self‐interest threat as these assurance fees along with the external audit fee could represent a significant proportion of Cloud & Co’s fee income. The firm may be reluctant to upset their client for fear of losing the work and associated fees. The firm should assess whether these assignments, along with the audit fee, would represent more than 15% of gross practice income for two consecutive years. These assurance assignments will only arise if the company obtains its listing and hence will be a public interest company.

 

If the recurring fees are likely to exceed 15% of annual practice income then additional consideration should be given as to whether these assignments should be sought by the firm.

 

Fees will need to be discussed with the audit committee.

Connect has implied to Cloud & Co that they must complete the audit quickly and with minimal questions/issues if they wish to obtain the assurance assignments.

 

This creates an intimidation threat on the team.

 

They may feel pressure to cut corners and not raise issues, and this could compromise the objectivity of the audit team.

The engagement partner should politely inform the finance director that the team will undertake the audit in accordance with all relevant ISAs and their own quality control procedures. This means that the audit will take as long as is necessary to obtain sufficient, appropriate evidence to form an opinion.

 

If any residual concerns remain or the intimidation threat continues then Cloud & Co may need to consider resigning from the engagement.

The finance director has offered the team free weekend away at a luxury hotel.

 

This represents a self‐interest threat.

 

The audit team may feel indebted to the client and reluctant to raise issues identified during the audit.

Acceptance of goods and services, unless clearly trivial and inconsequential in value, is not permitted. As it is unlikely that a weekend at a luxury hotel for the whole team has an insignificant value, then this offer should be politely declined.

2 / 12

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.

Ethical Threat Possible Safeguard
The finance director is keen to report Hunting Co’s financial results earlier than normal and has asked if the audit can be completed in a shorter time frame.

 

This may create an intimidation threat on the team as they may feel under pressure to cut corners and not raise issues in order to satisfy the deadlines and this could compromise the objectivity of the audit team and quality of audit performed.

The engagement partner should discuss the timing of the audit with the finance director to understand if the audit can commence earlier, so as to ensure adequate time for the team to gather evidence.

 

If this is not possible, the partner should politely inform the finance director that the team will undertake the audit in accordance with all relevant ISAs and quality control procedures. Therefore the audit is unlikely to be completed earlier.

 

If any residual concerns remain or the intimidation threat continues, then Craving & Co may need to consider resigning from the engagement.

A non‐executive director (NED) of Hunting Co has just resigned and the directors have asked whether the partners of Craving & Co can assist them in recruiting to fill this vacancy.

 

This represents a self‐interest threat as the audit firm cannot undertake the recruitment of members of the board of Hunting Co, especially a NED who will have a key role in overseeing the audit process and audit firm.

Craving & Co is able to assist Hunting Co in that they can undertake roles such as reviewing a shortlist of candidates and reviewing qualifications and suitability.

 

However, the firm must ensure that they are not seen to undertake management decisions and so must not seek out candidates for the position or make the final decision on who is appointed.

The engagement quality control reviewer (ECQR) assigned to Hunting Co was until last year the audit engagement partner.

 

This represents a familiarity threat as the partner will have been associated with Hunting Co for a long period of time and so may not retain professional skepticism and objectivity.

As Hunting Co is a listed company, then the previous audit engagement partner should not be involved in the audit for at least a period of five years. An alternative ECQR should be appointed instead.
Craving & Co provides taxation services, the audit engagement and possibly services related to the recruitment of the NED.

 

There is a potential self‐interest or intimidation threat as the total fees could represent a significant proportion of Craving & Co’s income and the firm could become overly reliant on Hunting Co.

This could result in the firm being less challenging or objective due to fear of losing such a significant client.

Craving & Co should assess whether audit, recruitment and taxation fees would represent more than 15% of gross practice income for two consecutive years.

 

If the recurring fees are likely to exceed 15% of annual practice income this year, additional consideration should be given as to whether the recruitment and taxation services should be undertaken by the firm.

 

In addition, if the fees do exceed 15%, then this should be disclosed to those charged with governance at Hunting Co.

 

If the firm retains all work, it should arrange for a pre‐issuance (before the audit opinion is issued) or post issuance (after the opinion has been issued) review to be undertaken by an external accountant or by a regulatory body.

The finance director has suggested that the audit fee is based on the profit before tax of Hunting Co which constitutes a contingent fee. Contingent fees give rise to a self‐interest threat and are prohibited under ACCA’s Code of Ethics and Conduct.

 

If the audit fee is based on profit, the team may be inclined to ignore audit adjustments which could lead to a reduction in profit.

Craving & Co will not be able to accept contingent fees and should communicate to those charged with governance at Hunting Co that the external audit fee needs to be based on the time spent and levels of skill and experience of the required audit team members.
At today’s date, 20% of last year’s audit fee is still outstanding and was due for payment three months ago.

 

A self‐interest threat can arise if the fees remain outstanding, as Craving & Co may feel pressure to agree to certain accounting adjustments in order to have the previous year and this year’s audit fee paid.

 

In addition, outstanding fees could be perceived as a loan to a client which is strictly prohibited.

Craving & Co should discuss with those charged with governance the reasons why the final 20% of last year’s fee has not been paid. They should agree a revised payment schedule which will result in the fees being settled before any more work is performed for the current year audit. The auditor’s report for this year must not be issued until the fees from last year have been paid.

3 / 12

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.

Weakness Recommendation
The finance director is a member of the audit committee.

 

The audit committee should be made up entirely of independent NEDs. The role of the committee is to maintain objectivity with regards to financial reporting; this is difficult if the finance director is a member of the committee as the finance director will be responsible for the preparation of the financial statements.

The audit committee must comprise independent NEDs only, therefore the finance director should resign from the committee.
The remuneration for directors is set by the finance director.

 

However, no director should be involved in setting their own remuneration as this may result in excessive levels of pay being set.

There should be a fair and transparent policy in place for setting remuneration levels. The NEDs should form a remuneration committee to decide on the remuneration of the executives. The board as a whole should decide on the pay of the NEDs.
Executive remuneration includes a significant annual profit related bonus. Remuneration should motivate the directors to focus on the long‐term growth of the business, however, annual targets can encourage short term strategies rather than maximizing shareholder wealth. The remuneration of executives should be restructured to include a significant proportion based on long‐term company performance.

 

For example, executives could be granted share options with a minimum vesting and holding period of five years, as this would encourage focus on the longer term position.

The chair has sole responsibility for liaising with the shareholders and answering any of their questions.

 

This is a role which the board as a whole should undertake.

All members of the board should be involved in ensuring that satisfactory dialogue takes place with shareholders, for example, all should attend meetings with shareholders such as the annual general meeting.

 

The board should state in the annual report the steps they have taken to ensure that the members of the board, and in particular the non‐executive directors, develop an understanding of the views of major shareholders about the company.

4 / 12

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.

Weakness Recommendation
The board is comprised of six executives and only four non-executive directors (NEDs). There should be an appropriate balance of executives and NEDs, to ensure that the board makes the correct objective decisions, which are in the best interest of the stakeholders of the company, and no individual or group of individuals dominates the board’s decision-making.

 

At least half of the board should be comprised of NEDs. Hence the board of Tangle Tech Co (Tangle) should consider recruiting and appointing additional independent NEDs to satisfy this requirement.
One of the NEDs and the chairman are former executive directors of Tangle who were asked to take on their existing roles following retirement. As former executive directors, they were previously employed by the company and so may not bring the required level of independence and objective judgment to the role as is necessary. The independence of the other NEDs cannot be assessed.

 

Only independent non-executives with relevant experience and skills should be appointed to the board of Tangle. A review should be under taken of the independence of all existing NEDs. Any who are not independent should ideally be replaced or supplemented by independent NEDs.
The chairman, who is a NED, sits on the audit committee as the chair. The audit committee is supposed to be made up of independent NEDs. The chairman can, for smaller companies, sit on the committee provided that he is an independent non-executive, which is not the case for Tangle.

 

The chairman should cease to undertake the role of chair of the audit committee. One of the newly appointed independent NEDs should be appointed to this role instead.
All four members of the audit committee were previously involved in sales or production related roles. At least one member of the audit committee should have recent and relevant financial experience. None of the NEDs were former finance directors and so it is unlikely they possess the required financial experience.

 

The company should ensure when they recruit the new independent NEDs that at least one of them has the required recent and relevant financial experience.
All of the directors have been members of the board for at least four years. The shareholders should review on a regular basis that the composition of the board of directors is appropriate, and that there is an appropriate re-election process in place to ensure this can be achieved. The directors should be subject to re -election by the shareholders at regular intervals not exceeding three years.

At the current year’s annual general meeting it should be proposed that a number of the directors are subject to re-election. The remaining directors could then be subject to re-election next year.

 

The chairman has sole responsibility for liaising with the shareholders and answering any of their questions. However, this is a role which the board as a whole should undertake. All members of the board should be involved in ensuring that satisfactory dialogue occurs with shareholders, for example, all should attend meetings with shareholders such as the annual general meeting.

The board should state in the annual report the steps they have taken to ensure that the members of the board, and in particular the non-executive directors, develop an understanding of the views of major shareholders about the company.

Currently Tangle has not established an internal audit function. The audit committee should consider the effectiveness of internal controls and internal audit could support this role. Where there is no internal audit function, the audit committee is required to annually consider the need for one. Further consideration should be given to establishing an internal audit function. Having an internal audit function will help the audit committee to discharge their responsibility for monitoring internal controls. However, the costs of establishing an internal audit function should be considered against the benefits to be gained.

5 / 12

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.

Weakness Recommendation
Will Wade is now the chairman; however, until last year he was the chief executive. The chairman is supposed to be an independent non-executive director and hence cannot have previously been the chief executive.

 

The roles of chairman and chief executive are both very important and carry significant responsibilities; hence this prevents too much power residing in the hands of one individual.

 

Will Wade should return to his role as chief executive as this will fill the current vacancy and an independent non-executive director should be recruited to fill the role of chairman.
The board is comprised of five executives and only three non-executive directors.

 

There should be an appropriate balance of executives and non-executives, to ensure that the board makes the correct objective decisions, which are in the best interest of the stakeholders of the company, and no individual or group of individuals dominates the board’s decision-making.

 

At least half of the board should be comprised of non-executive directors. Hence the board of Shape should consider recruiting and appointing an additional one to two non-executive directors.
Will Wade is considering appointing his close friend as anon-executive director; the friend has experience of running a manufacturing company.

 

Non-executives bring valuable experience to a company, but they must also exercise their independent judgment over the whole board. If this director is a close friend of Will Wade, then it is possible that he will not be independent. In addition, other than being a former chief executive, he does not have any relevant experience of the insurance industry and so it is questionable what value he will add to Shape.

 

Only independent non-executives with relevant experience and skills should be appointed to the board of Shape. The close friend of Will Wade is unlikely to meet these criteria, as he has no experience in the insurance industry, and so should not be appointed.
All directors’ remuneration is in the form of an annual bonus. However, the pay should motivate the directors to focus on the long-term growth of the business. Annual targets can encourage short-term strategies rather than maximizing shareholder wealth.

 

In addition, non-executive directors’ pay should not be based on meeting company targets as their pay should be independent of how the company performs.

 

The remuneration of executives should be restructured to include a significant proportion aimed at long-term company performance. Perhaps they could be granted share options, as this would help to move the focus to the longer term. Non-executives should be paid an annual fee for their services, which is unrelated to how Shape performs.

 

There should be a fair and transparent policy in place for setting remuneration levels. The non-executive directors should decide on the remuneration of the executives. The finance director or chairman should decide on the pay of the non-executives.

 

Shape does not currently have an audit committee.

 

Audit committees undertake an important role in that they help the directors to satisfy their responsibility of accountability with regards to maintaining an appropriate relationship with the company’s auditor.

Shape should appoint an audit committee as soon as possible. The committee should be comprised of at least three independent non-executives, one of whom should have relevant financial experience.

 

The three current non-executives should be appointed to the audit committee, assuming they meet the requirements of independence.

 

A new sales director was appointed nine months ago, however, he has not undergone any board training. All directors should receive induction training when they first join the board so that they are fully aware of their responsibilities.

 

The new sales director should immediately receive relevant training from Will Wade to ensure that he has a full understanding of his role and responsibilities
Shape is not planning to hold an annual general meeting (AGM) as the number of shareholders are such that it would be too costly and impractical.

 

However, the AGM is an important meeting in that it gives the shareholders an opportunity to raise any concerns, receive an answer and vote on important resolutions.

 

The proposal to send the financial statements and resolutions by email is not appropriate as it does not allow shareholders an opportunity to raise relevant questions.

 

The company should continue to hold the AGM.

 

Sending information by email in advance of the meeting may be practical and save some costs; however, this should not be seen as a replacement for the AGM.

6 / 12

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.

7 / 12

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.

Ethical threat Steps to reduce the threat
The finance director is the sister-in-law of the audit engagement partner and hence there is a family relationship.

 

There is a familiarity and self-interest threat as the audit partner and the finance director both hold senior positions and therefore are in a position to influence the outcome of the audit. There is a concern that they may place their family relationship above the needs of the users of the financial statements.

 

Although the family relationship is only established by marriage, as it is a sister-in-law, it would be advisable for the audit engagement partner to be removed and an alternative partner appointed.
Silver Finance Co’s (Silver) finance director has asked if a member of the audit team can be seconded to fill the role of financial controller.

 

A self-review risk arises if the team member prepares records and schedules which support the financial statements and is then part of the audit team responsible for auditing these.

Dark Partners & Co (Dark) should clarify exactly which areas the seconded team member would assist Silver on. Though it is likely that as the financial controller, the team member will be directly involved in dealing with items related to the financial statements.

 

As such, the request from the finance director should be politely declined, or the team member should be removed from the audit of Silver.

 

Two members of the audit team have significant loans owing to the company. Silver is a banking institution and hence the provision of a loan is within the normal course of business.

 

However, if either of the loans has any preferential terms, such as rates or repayment periods, then this would represent a self-interest threat.

 

The terms of the loans should be reviewed to ascertain whether they are in any way preferential. If not, no further action is required.

 

However, if the terms are preferential then either the terms should be amended or these two members should be removed from the audit team.

Silver has requested that Dark’s taxation department represents them in negotiations to resolve some outstanding issues with the taxation authorities.

 

There is a potential advocacy threat where the firm may promote an opinion on behalf of Silver, such that the independence of the firm is compromised.

 

In addition, the outcome of these issues may have a material impact on the financial statements, resulting in a self-review threat.

 

Due to the likelihood of these issues having a material impact on the financial statements and the advocacy threat, it is advisable that the firm politely declines this request.
The taxation fees being quoted to Silver are substantial.

 

There is a potential self-interest threat as the total fees could represent a significant proportion of Dark’s income and the firm could become overly reliant on Silver.

Dark should assess whether audit, non-audit and total taxation fees would represent a significant proportion of recurring fee income.

 

If the recurring fees are likely to be significant, additional consideration should be given as to whether the taxation and/or non-audit assignments should be undertaken by the firm.

The finance director has invited the whole team to attend an evening out watching the national football team play a match followed by a luxury meal.

 

This represents a self-interest and familiarity threat as the acceptance of goods and services, unless insignificant in value, is not permitted.

 

As it is unlikely the football tickets and luxury meal for the whole team has an insignificant value, then this offer should be politely declined.

8 / 12

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.

Ethical threat Steps to reduce the threat
Leaf & Flower guarantees that its audits will not last longer than two weeks.

 

The amount of time required to complete an audit depends upon the nature of each audit client’s business and the level of associated risk. To restrict the duration of all audits to two weeks, regardless of the level of complexity and risks of the business, will result in sufficient and appropriate audit evidence not being obtained. Leaf & Flower would be at risk of giving incorrect audit opinions, leading to possible litigation. The firm would contravene the ACCA Code of Ethics.

 

Leaf & Flower should retract the ‘two-week guarantee’ immediately, and explain to its audit clients that the duration of audits will depend upon the level of complexity and risk associated with each business.

 

The completion date of the audit will be

agreed with each client at the planning stage, but this may need to change if any circumstances cause the auditor to re-evaluate the company’s level of assessed risk.

Leaf & Flower is offering a free accounts preparation service to new audit clients.

 

The preparation of the accounts, which the firm will then audit, gives rise to a self-review threat. In addition, the fact that the accounts preparation service is offered for free may be considered lowballing which is not unacceptable but may result in the quality of the services provided being damaged.

 

Leaf & Flower should ensure that a separate team is allocated to the accounts preparation work.

 

It must not offer the accounts preparation service to listed clients.

It is important that the firm demonstrates that appropriate time and appropriately-qualified staff are assigned to its audit engagements, and that the ISAs are adhered to.

Leaf & Flower has decided not to update the engagement letters of existing clients. This goes against the requirements of ISA 210.

 

Leaf & Flower should review the need for updating engagement letters on an annual basis.
An existing client has suggested that their audit fee should be based on a percentage of their final pretax profit.

 

This constitutes a contingent fee. Contingent fee structures create a self-interest threat which cannot be mitigated. They are therefore prohibited for audit services by the ACCA Code of Ethics.

 

Leaf & Flower should decline the client’s proposal, and explain that audit fees would be based on the level work required to obtain sufficient appropriate audit evidence.
Leaf & Flower plans to rely on more junior staff to carry out the audit of a new client, Thunder, during a busy period for the firm.

The risks associated with the Thunder audit are difficult to assess, as this is the first year that Leaf & Flower is performing the audit. Junior staff is unlikely to have sufficient knowledge and experience to determine the amount of audit work required, thus increasing the risk of giving an incorrect audit opinion.

 

Leaf & Flower needs to re-assess its resourcing plans, and allocate an appropriate number of experienced audit staff to the Thunder audit engagement. If this is not possible, Leaf & Flower should discuss with the client the possibility of changing the timing of the audit to a period when adequate staff resources are available.
Leaf & Flower has not contacted Thunder’s outgoing auditor.

 

It is important for the firm to communicate with the outgoing auditor, as it needs to understand whether there are any actions by the client which would preclude the firm from accepting the engagement on ethical grounds.

 

Leaf & Flower should contact the previous auditors, to confirm the reason behind the change of auditor and to ascertain that there are no ethical issues precluding the firm from acting as Thunder’s auditor.

9 / 12

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.

Ethical threat Steps to reduce the threat
Leaf & Flower guarantees that its audits will not last longer than two weeks.

 

The amount of time required to complete an audit depends upon the nature of each audit client’s business and the level of associated risk. To restrict the duration of all audits to two weeks, regardless of the level of complexity and risks of the business, will result in sufficient and appropriate audit evidence not being obtained. Leaf & Flower would be at risk of giving incorrect audit opinions, leading to possible litigation. The firm would contravene the ACCA Code of Ethics.

 

Leaf & Flower should retract the ‘two-week guarantee’ immediately, and explain to its audit clients that the duration of audits will depend upon the level of complexity and risk associated with each business.

 

The completion date of the audit will be

agreed with each client at the planning stage, but this may need to change if any circumstances cause the auditor to re-evaluate the company’s level of assessed risk.

Leaf & Flower is offering a free accounts preparation service to new audit clients.

 

The preparation of the accounts, which the firm will then audit, gives rise to a self-review threat. In addition, the fact that the accounts preparation service is offered for free may be considered lowballing which is not unacceptable but may result in the quality of the services provided being damaged.

 

Leaf & Flower should ensure that a separate team is allocated to the accounts preparation work.

 

It must not offer the accounts preparation service to listed clients.

It is important that the firm demonstrates that appropriate time and appropriately-qualified staff are assigned to its audit engagements, and that the ISAs are adhered to.

Leaf & Flower has decided not to update the engagement letters of existing clients. This goes against the requirements of ISA 210.

 

Leaf & Flower should review the need for updating engagement letters on an annual basis.
An existing client has suggested that their audit fee should be based on a percentage of their final pretax profit.

 

This constitutes a contingent fee. Contingent fee structures create a self-interest threat which cannot be mitigated. They are therefore prohibited for audit services by the ACCA Code of Ethics.

 

Leaf & Flower should decline the client’s proposal, and explain that audit fees would be based on the level work required to obtain sufficient appropriate audit evidence.
Leaf & Flower plans to rely on more junior staff to carry out the audit of a new client, Thunder, during a busy period for the firm.

The risks associated with the Thunder audit are difficult to assess, as this is the first year that Leaf & Flower is performing the audit. Junior staff is unlikely to have sufficient knowledge and experience to determine the amount of audit work required, thus increasing the risk of giving an incorrect audit opinion.

 

Leaf & Flower needs to re-assess its resourcing plans, and allocate an appropriate number of experienced audit staff to the Thunder audit engagement. If this is not possible, Leaf & Flower should discuss with the client the possibility of changing the timing of the audit to a period when adequate staff resources are available.
Leaf & Flower has not contacted Thunder’s outgoing auditor.

 

It is important for the firm to communicate with the outgoing auditor, as it needs to understand whether there are any actions by the client which would preclude the firm from accepting the engagement on ethical grounds.

 

Leaf & Flower should contact the previous auditors, to confirm the reason behind the change of auditor and to ascertain that there are no ethical issues precluding the firm from acting as Thunder’s auditor.

10 / 12

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.

11 / 12

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.

12 / 12

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.

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