1. NOVATO CO.

You are an audit manager in Novato & Co, a firm of Chartered Certified Accountants. You have recently been assigned to the audit of Blaze Co for the year ended 31 December 20X8. Blaze Co is an unlisted company and has been an audit client of your firm for a number of years.

Blaze Co is a national distributor of cleaning products. The company buys the cleaning products from wholesalers and employs a team of approximately 800 sales staff around the country who sell the company’s products to both domestic households and small to medium-sized businesses. Around 75% of Blaze Co’s sales transactions are cash-based and each of the company’s sales staff prepares a cash sales report on a monthly basis. According to Blaze Co’s chief executive, Joey Tribbiani, and in order to foster ‘an entrepreneurial spirit’ amongst his staff, each staff member (including the senior management team) is encouraged to make cash sales and is paid on a commission basis to sell the company’s products to friends and family. Mr Tribbiani leads the way with this scheme and recently sold cleaning products with a value of $38,000 to a business associate of his. He has transferred these funds directly into an off-shore bank account in the company’s name on which he is the sole signatory.

Review of audit working papers

Your review of the audit working papers and an initial meeting with Mr Tribbiani have identified the following potential issues:

Following your review of the audit engagement letter and the working papers of the taxation section of the audit file, you have established that Novato & Co performed the taxation computation for Blaze Co and completed the tax returns for both the company and Mr Tribbiani personally. All of the taxation services have been invoiced to Blaze Co as part of the total fee for the audit and professional services. Mr Tribbiani’ personal tax return includes a significant number of transactions involving the purchase and sale of properties in various international locations. The taxation working papers include a detailed review of a number of off-shore bank accounts in Mr Tribbiani’ name which identified the property transactions.

During your initial meeting with Mr Tribbiani, he informed you that Blaze Co is planning to develop a new website in order to offer online sales to its customers. He has asked Novato & Co to provide assistance with the design and implementation of the website and online sales system.

As a result of your audit review visit at the client’s premises, you have learned that the audit team was invited to and subsequently attended Blaze Co’s annual office party. The client provided each member of the audit team with a free voucher worth $30 which could be redeemed at the venue during the party. The audit senior, Ian Metcalfe, who has worked on the audit for the last three years has informed you that the audit team has always been encouraged to attend the party in order to develop good client relations.

Required:

(a) (i) Discuss the policies and procedures which Novato & Co should have in place in relation to an anti-money laundering programme; and

(ii) Evaluate whether there are any indicators of money laundering activities by either Blaze Co or its staff.

(b) Comment on the ethical and professional issues arising from your review of the audit working papers and recommend any actions which should now be taken by Novato & Co.

2) KODAIK CO.

(a) You are a manager in Kodaik & Co, responsible for the audit of Diaz Co, an owner-managed business which operates a chain of bars and restaurants. This is your firm’s first year auditing the client and the audit for the year ended 30 September 20X2 is underway. The audit senior sends a note for your attention:

‘When I was auditing revenue I noticed something strange. Diaz Co’s revenue, which is almost entirely cash-based, is recognised at $5.5 million in the draft financial statements. However, the accounting system shows that till receipts for cash paid by customers amount to only $3.5 million. This seemed odd, so I questioned Ava Carson, the financial controller about this. She said that Jack Diaz, the company’s owner, deals with cash receipts and posts journals dealing with cash and revenue. Ava asked Jack the reason for these journals but he refused to give an explanation.

‘While auditing cash, I noticed a payment of $2 million made by electronic transfer from the company’s bank account to an overseas financial institution. The bank statement showed that the transfer was authorised by Jack Diaz, but no other documentation regarding the transfer was available.

‘Alarmed by the size of this transaction, and the lack of evidence to support it, I questioned Jack Diaz, asking him about the source of cash receipts and the reason for electronic transfer. He would not give any answers and became quite aggressive.’

Required

(i) Discuss the implications of the circumstances described in the audit senior’s note; and

(ii) Explain the nature of any reporting that should take place by the audit senior.

(b) You are also responsible for the audit of Bing Co, and you are currently reviewing the working papers of the audit for the year ended 30 August 20X2. In the working papers dealing with payroll, the audit junior has commented as follows.

‘Several new employees have been added to the company’s payroll during the year, with combined payments of $125,000 being made to them. There does not appear to be any authorisation for these additions. When I questioned the payroll supervisor who made the amendments, she said that no authorisation was needed because the new employees are only working for the company on a temporary basis. However, when discussing staffing levels with management, it was stated that no new employees have been taken on this year. Other than the tests of controls planned, no other audit work has been performed.’

Required

In relation to the audit of Bing Co’s payroll, explain the meaning of the term ‘professional scepticism’, and recommend any further actions that should be taken by the auditor.

(c) You are also the manager responsible for the audit of the Nassau Group, which comprises a parent company and six subsidiaries. The audit of all individual companies’ financial statements is almost complete, and you are currently carrying out the audit of the consolidated financial statements. One of the subsidiaries, Elena Co, is audited by another firm, Josie & Co. Your firm has fulfilled the necessary requirements of ISA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) and is satisfied as to the competence and independence of Josie & Co.

You have received from Josie & Co the draft auditor’s report on Elena Co’s financial statements, an extract from which is shown below:

‘Qualified Opinion (extract) ‘

In our opinion, except for effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view of the financial position of Elena Co as at 30 September 20X2…’

An extract of Note 12 to Elena Co’s financial statements is shown below.

‘Basis of Qualified Opinion (extract)

‘The company is facing financial damages of $2 million in respect of an on-going court case, more fully explained in Note 12 to the financial statements.

Management has not recognised a provision but has disclosed the situation as a contingent liability. Under International Financial Reporting Standards, a provision should be made if there is an obligation as a result of a past event, a probable outflow of economic benefit, and a reliable estimate can be made. Audit evidence concludes that these criteria have been met, and it is our opinion that a provision of $2 million should be recognised. Accordingly, net profit and shareholders’ equity would have been reduced by $2 million if the provision had been recognised.’

An extract of Note 12 to Elena Co’s financial statements is shown below.

‘Note 12 (extract)

The company is the subject of a court case concerning an alleged breach of planning regulations. The plaintiff is claiming compensation of $2 million. The management of Elena Co, after seeking legal advice, believe that there is only a 20% chance of a successful claim being made against the company.’

Figures extracted from the draft financial statements for the year ending 31 March 20X2 are as follows.

Nassau Group                         Elena Co

$m                                           $m

Profit before tax                                  20                                            4

Total assets                                          85                                            20

Required

Identify and explain the matters that should be considered, and actions that should be taken by the group audit engagement team, in forming an opinion on the consolidated financial statements of the Nassau Group.

3) BEVERLY CO.

(a) You are an audit manager in Roots & Co, an audit firm which operates as part of an international network of firms. This morning you received a note from a partner regarding a potential new audit client:

‘I have been approached by the audit committee of the Beverly Group, which operates in the mobile telecommunications sector. Our firm has been invited to tender for the audit of the individual and group financial statements for the year ending 30 September 20X3, and I would like your help in preparing the tender document. This would be a major new client for our firm’s telecoms audit department.

The Beverly Group comprises a parent company and six subsidiaries, one of which is located overseas. The audit committee is looking for a cost effective audit, and hopes that the strength of the Beverly Group’s governance and internal control mean that the audit can be conducted quickly, with a proposed deadline of 31 November 20X3. The Beverly Group has expanded rapidly in the last few years and significant finance was raised in January 20X3 through a stock exchange listing.’

Required

(i) Explain why a firm of auditors may decide NOT to seek re-election as auditor.

(ii) Evaluate the specific matters to be included in the tender document for the audit of the Beverly Group.

(b) Roots & Co is facing competition from other audit firms, and the partners have been considering how the firm’s revenue could be increased. Two suggestions have been made:

1. Audit partners and managers can be encouraged to sell non-audit services to audit clients by including in their remuneration package a bonus for successful sales.
2. All audit managers should suggest to their audit clients that as well as providing the external audit service, Roots & Co can provide the internal audit service as part of an ‘extended audit’ service.

Required

Comment on the ethical and professional issues raised by the suggestions to increase the firm’s revenue.

4) INDIANA CO.

It is 1 August 20X5. You are a manager in the audit department of Indiana & Co, a firm of Chartered Certified Accountants. You are working on the audit of the Don Group (the Group), which has a financial year ending 30 October 20X5. The Group, a listed entity, offers an internet television network, with over 9 million subscription members in eight countries.

You are provided with the following exhibits:

1. An email which you have received from the Group audit engagement partner.
2. Background information and matters relevant to audit planning.
3. Selected financial information from the Group management accounts.
4. An extract from the audit strategy document prepared by Narayan Associates, the component auditor which audits one of the Group’s subsidiaries.
5. Details of the planned acquisition of a new foreign subsidiary, Michelle Co, and a possible joint audit arrangement.

Required:

Respond to the instructions in the email from the audit engagement partner. (46 marks)

Note: The split of the mark allocation is shown in the partner’s email (Exhibit 1).

Professional marks will be awarded for the presentation and logical flow of the briefing notes and the clarity of the explanations provided. (4 marks)

(50 marks)

Exhibit 1 – Email from audit engagement partner

To: Audit manager

From: Daniel Morgan, Audit engagement partner

Subject: Audit planning for the Don Group

Date: 1 August 20X5

Hello

I have provided you with some information in the form of a number of exhibits which you should use to help you with planning the audit of the Don Group (the Group) for the financial year ending 30 October 20X5.

I require you to prepare briefing notes for my own use, in which you:

(a) Using the information in all exhibits, evaluate the audit risks to be considered in planning the Group audit. (24 marks)

(b) Using the information provided in Exhibit 4:

(i) Evaluate the extract from the component auditor’s strategy, commenting on the audit strategy responses and ethical matters relating to the issues identified; and (10 marks)

(ii) Design the principal audit procedures which you will instruct the component auditor to perform on the sale of property to the Group chief executive officer. (6 marks)

(c) Using Exhibit 5, discuss whether it is appropriate for a joint audit to be performed on Michelle Co, commenting on the advantages and disadvantages of a joint audit arrangement. (6 marks)

Thank you

Exhibit 2 – Background information

The Group started to offer an internet streaming service for films and TV programmes ten years ago. The Group’s business model is to acquire licences for films and TV programmes and customers pay a monthly subscription fee to access them and watch online.

The Group has a subsidiary in each country in which it offers its subscription service. Indiana & Co audits all of the subsidiaries with the exception of Keith Co, one of the Group’s foreign subsidiaries, which is audited by a local firm called Narayan Associates. All companies within the Group have the same financial year end, and with the exception of Keith Co, which reports under local accounting standards, the Group companies all use IFRS® Standards as their financial reporting framework.

Matters relevant to audit planning

Following a discussion between the Group audit engagement partner and a representative of the Group audit committee, several matters were noted as being relevant to the audit planning:

Annual incentive scheme

For several years, the Group has operated an annual incentive scheme for staff, under the terms of which employees are eligible to receive an annual incentive payment linked to the achievement of selected targets. The scheme operates across all Group companies, with some employees’ targets linked to profitability, while others are aligned to non‑financial measures including customer satisfaction. Participants in the scheme are entitled to earn a maximum annual incentive payment of 5% of their salary. Approximately 6,590 employees, including the senior executive directors, are entitled to participate in the annual incentive scheme. Last year the average bonus payment was $1,250 per participant.

Legal case

In February 20X5, a legal case was initiated against the Group by Ken Co, a film production company. Ken Co claims that the Group has infringed copyright by streaming a film in specific countries for which a licence has not been acquired. The Group insists that the film is covered by a general licence which was acquired several years ago. The Group finance director is not willing to recognise the legal claim within the financial statements as he is confident that the claim against the Group will not be successful, and he does not want to discuss it further with the audit team, emphasising that there is no relevant documentation available for evaluation at this time.

Keith Co

Narayan Associates provides the audit service to Keith Co, one of the Group’s foreign subsidiaries. Keith Co is one of the Group’s larger subsidiaries, it is a listed company in its home jurisdiction, with total assets of $140 million. Keith Co is the only subsidiary which does not follow IFRS Standards, as in its local jurisdiction companies must follow local accounting rules. It uses the same currency as the rest of the Group.

Keith Co was acquired several years ago, and goodwill of $38 million is recognised in the Group financial statements in respect of the company.

Exhibit 3 – Selected financial information

                                                                       Note                Projected to               Actual to

                                                                                        30 October 20X5       30 October 20X4

                                                                                                 $ million                     $ million

Group revenue                                                1                           980                              780

Operating profit                                                                                78·4                             70·2

Profit before tax                                                                       60·1                             58·7

                                                                                                       –––––                          –––––

Total assets                                                                                 780                              600

                                                                                                     –––––                          –––––

Included in total assets:

Intangible assets – licences                            2          580                              420

Intangible assets – goodwill                           3          135                              135

Number of subscription customers                                     10,500,000                  8,070,000

Notes:

1. The Group’s main source of revenue is from monthly membership fees. Members are billed in advance of the start of their monthly membership and revenue is recognised when the bill is sent to the customer, all of whom pay by credit card. The price of a regular subscription has remained at $8·20 per month throughout 20X4 and 20X5. Occasionally, the Group offers a free trial period to new customers. This year, the Group also introduced a new premium subscription package, which allows customers to add two family members to their subscription for an additional fee of $5 per month.
2. The Group acquires content licences per title in order to stream film and TV content to its subscribers. The content licences are each for a fixed time period, varying between three and five years. The Group capitalises the cost per title as an intangible asset. Group policy is to amortise licences over a five-year period, the finance director justifies this as being ‘the most prudent’ accounting treatment.
3. Goodwill arising on business combinations is tested annually for impairment in accordance with IAS® 36 Impairment of Assets. Due to the strong performance of the Group, no impairment of goodwill has been recognised in recent years.

Exhibit 4 – Extract from component auditor strategy document

The three points below are an extract from the audit strategy prepared by Narayan Associates in relation to their audit of Keith Co. Other sections of the audit strategy, including the audit risk assessment, have been reviewed by the Group audit team and are considered satisfactory so you do not need to consider them.

Issue identified by Narayan Associates      Audit strategy response by Narayan

Associates

Materiality

Internet services in the country have been     Materiality will be based on total assets for the

subject to considerable disruption. As a        first time this year due to the significant

result of this, a significant number of             reduction in revenue and profit.

customers have cancelled their subscriptions           Based on 1% of assets, materiality is determined

and the company is projected to make a loss at $1·4 million.

this year.                                                         In the previous year, materiality based on revenue

was determined to be $1·2 million.

Payroll                                                            Planned audit procedures:

From 1 November 20X4, payroll accounting – Agree the total payroll figure, estimated to be

services are provided to Keith Co by             $6 million, from the statement of profit or

Narayan Associates as an additional             loss to the payroll reports generated by Narayan

non-audit engagement.                                   Associates.

– No further audit procedures are considered necessary.

Sale of property                                              Planned audit procedures:

Keith Co sold a small, unused building          – Confirm $50,000 is included in receivables

located on the coast to the Group’s chief       within current assets.

executive officer (CEO) in March 20X5, for  – No further audit procedures are considered

$50,000. The amount is still outstanding for  necessary because the transaction is not material to

payment.                                                         the financial statements, and local accounting

The Group CEO is planning to use the          rules do not require disclosure of the transaction.

property as a holiday home.

Exhibit 5 – Potential new subsidiary

The Group is planning the acquisition of a new foreign subsidiary, Michelle Co, which is located in Farland. The negotiations are at an advanced stage, and it is likely that the acquisition will take place in November 20X5.

The Group’s audit committee has suggested that if the acquisition goes ahead, due to the distant location of the company and the fact that Indiana & Co has no offices in Farland, a joint audit could be performed with Michelle Co’s current auditors, Lucille Associates, a small local firm of Chartered Certified Accountants

5) DENVER CO.

a. Explain the reasons why a firm of auditors may decide NOT to seek re-election as auditor. 

The Denver Group is a large group of companies operating in the furniture retail trade. The group has expanded rapidly in the last three years, by acquiring several subsidiaries each year. The management of the parent company, Denver Co, a listed company, has decided to put the audit of the group and all subsidiaries out to tender, as the current audit firm is not seeking re-election. The financial year end of the Denver Group is 31 December 20X4.

You are a senior manager in Springs & Co, a global firm of Chartered Certified Accountants, with offices in over 100 countries across the world. Springs & Co has been invited to tender for the Denver Group audit (including the audit of all subsidiaries). You manage a department within the firm which specialises in the audit of retail companies, and you have been assigned the task of drafting the tender document. You recently held a meeting with Derik Jalousie, the group finance director, in which you discussed the current group structure, recent acquisitions, and the group’s plans for future expansion.

Meeting notes – Denver Group

Group structure

The parent company owns 20 subsidiaries, all of which are wholly owned. Half of the subsidiaries are located in the same country as the parent, and half overseas. Most of the foreign subsidiaries report under the same financial reporting framework as Denver Co, but several prepare financial statements using local accounting rules.

Acquisitions during the year

Two companies were purchased in June 20X4, both located in this country:

1. Belmont Co, a company which operates 20 furniture retail outlets. The audit opinion expressed by the incumbent auditors on the financial statements for the year ended 31 December 20X3 was modified due to material misstatement as a result of nondisclosure of a contingent liability. The contingent liability relates to a court case which is still ongoing.
2. Janice Co, a large company, whose operations are distribution and warehousing. This represents a diversification away from retail, and it is hoped that the Denver Group will benefit from significant economies of scale as a result of the acquisition.

Other matters

The acquisitive strategy of the group over the last few years has led to significant growth. Group revenue has increased by 25% in the last three years, and is predicted to increase by a further 35% in the next four years as the acquisition of more subsidiaries is planned. The Denver Group has raised finance for the acquisitions in the past by becoming listed on the stock exchanges of three different countries. A new listing on a foreign stock exchange is planned for April 20X5. For this reason, management would like the group audit completed by 31 March 20X5.

Required:

b. Recommend and describe the principal matters to be included in your firm’s tender document to provide the audit service to the Denver Group.

c. Using the specific information provided, evaluate the matters that should be considered before accepting the audit engagement, in the event of your firm being successful in the tender.

d. Discuss how transnational audits may differ from other audits of historical information and how this may contribute to a higher level of audit risk in relation to the audit of Denver Group.

6) ROSA CO.

A high-quality audit features the exercise of professional judgement by the auditor, and importantly, a mind-set which includes professional scepticism throughout the planning and performance of the audit.

Required:

a. Explain the meaning of the term professional scepticism, and discuss its importance in planning and performing an audit.

You are an audit manager in Saffron & Co, working on the audit of the Rosa Group (the Group), whose financial year ended on 30 April 20X5. This is the first time you have worked on the Group audit. The draft consolidated financial statements recognise profit before tax of $6 million (20X4 – $9 million) and total assets of $90 million (20X4 – $82 million). The Group manufactures equipment used in the oil extraction industry.

Goodwill of $12 million is recognised in the Group statement of financial position, having arisen on several business combinations over the last few years. An impairment review was conducted in April 20X5 by Gunther Dante, the Group finance director, and this year an impairment of $52,000 is to be recognised in respect of the goodwill.

Gunther has prepared a file of documentation to support the results of the impairment review, including notes on the assumptions used, his calculations, and conclusions. When he gave you this file, Gunther made the following comment:

‘I don’t think you should need any evidence other than that contained in my file. The assumptions used are straightforward, so you shouldn’t need to look into them in detail. The assumptions are consistent with how we conducted impairment reviews in previous years and your firm has always agreed with the assumptions used, so you can check that back to last year’s audit file. All of the calculations have been checked by the head of the Group’s internal audit department.’

Gunther has also informed you that two members of the sales team are suspected of paying bribes in order to secure lucrative customer contracts. The internal audit team were alerted to this when they were auditing cash payments, and found significant payments to several new customers being made prior to contracts being signed. Gunther has asked if Saffron & Co would perform a forensic investigation into the alleged bribery payments.

Required:

i) Discuss how professional scepticism should be applied to the statement made by Gunther.

ii) Design the principal audit procedures to be performed on the impairment of goodwill.

c. Design the procedures to be used in performing a forensic investigation on the alleged bribery payments.

7) WALNUT CO.

You are a manager in the audit department of Walnut & Co, a global firm of Chartered Certified Accountants with branches worldwide offering a range of audit and assurance services to its clients. Your responsibilities include reviewing ethical matters which arise with audit clients, and dealing with approaches from prospective audit clients.

a. The management of Andrew Co has invited Walnut & Co to submit an audit proposal (tender document) for their consideration. Andrew Co was established only two years ago, but has grown rapidly, and this will be the first year that an audit is required. In previous years a limited assurance review was performed on its financial statements by an unrelated audit firm. The company specialises in the recruitment of medical personnel and some of its start-up funding was raised from a venture capital company. There are plans for the company to open branches overseas to help recruit personnel from foreign countries.

Andrew Co has one full-time accountant who uses an off-the-shelf accounting package to record transactions and to prepare financial information. The company has a financial year ending 30 April 20X5.

The following comment was made by Subharu Andrew, the company’s founder and owner-manager, in relation to the audit proposal and potential audit fee:

‘I am looking for a firm of auditors who will give me a competitive audit fee. I am hoping that the fee will be quite low, as I am willing to pay more for services that I consider more beneficial to the business, such as strategic advice. I would like the audit fee to be linked to Andrew Co’s success in expanding overseas as a result of the audit firm’s advice. Hopefully the audit will not be too disruptive and I would like it completed within four months of the year end.’

Required:

i) Explain the specific matters to be included in the audit proposal (tender document), other than those relating to the audit fee.

ii) Assuming that Walnut & Co is appointed to provide the audit service to Andrew Co, discuss the issues to be considered by the audit firm in determining a fee for the audit including any ethical matters raised.

b. Jules Co is a long-standing audit client of your firm and is a listed company. Bobby Wellington has acted as audit engagement partner for seven years and understands that a new audit partner needs to be appointed to take his place. Bobby is hoping to stay in contact with the client and act as the engagement quality control reviewer in forthcoming audits of Jules Co.

Required:

Explain the ethical threats raised by the long association of senior audit personnel with an audit client and the relevant safeguards to be applied, and discuss whether Bobby Wellington can act as engagement quality control reviewer in the future audits of Jules Co.

c. Cashew Co is a listed entity, and its audit committee has asked Walnut & Co to perform an actuarial valuation on the company’s defined benefit pension plan. One of the audit partners is a qualified actuary and has the necessary skills and expertise to perform the service. Cashew Co has a year ending 31 March 20X5, and the audit planning is due to commence next week. Its financial statements for the year ended 31 March 20X4, in respect of which the auditor’s report was unmodified, included total assets of $35 million and a pension liability of $105,000.

Required:

Identify and discuss the ethical and other professional issues raised, and recommend any actions that should be taken in respect of Cashew Co.

8) CRIPPLE CO

You are a manager at Cripple & Co, a firm of Chartered Certified Accountants. One of the partners has asked you to investigate and respond to a number of issues which have arisen with two different companies.

a. Drake Co, a potential new client, is a privately owned and rapidly expanding company which currently operates below the audit threshold in the country in which it is based. The company’s management is currently considering having either a full audit or a limited assurance review of their financial statements. The partner would like you to assist the management of Drake Co by writing a response to them in which you:

i. Explain the difference between an audit of historical financial statements and a limited assurance review; and

ii. Discuss the relative advantages and disadvantages to Drake Co of having an audit of their historical financial statements as opposed to a limited assurance review. (12 marks)

Drake Co was incorporated in 20X5, with founder and chief executive Mr Nimesh Krishna as the sole shareholder. After a period of rapid growth, Drake Co took out a ten-year bank loan facility in July 20X7 to finance Mr Krishna’s ambitious expansion plans. This was supported by a further injection of financial capital in 20X4 through a new issue of shares in the company. The shares were sold to Mr Robert Buffay, an ex-business partner of Mr Krishna. The sale gave Mr Buffay a 40% shareholding in Drake Co. He has no involvement in the management of the company.

Until recently Drake Co operated with a small accounting department, comprising one full-time member of staff and one part-time employee. Due to the expansion of the company and Mr Krishna’s plans to expand the customer base internationally, it has been necessary to increase the size of the accounting function to include two new full-time members of staff. Both of the new recruits are part-qualified accountants and Mr Krishna has committed to sponsoring them through their remaining training and ACCA examinations.

Required

Prepare the response to the management of Drake Co as requested by the partner.

b. The audit committee of another client, Blue Co, has asked the partner to consider whether it would be possible for the audit team to perform a review of the company’s internal control system. A number of recent incidents have raised concerns amongst the management team that controls have deteriorated and that this has increased the risk of fraud, as well as inefficient commercial practices. The auditor’s report for the audit of the financial statements of Blue Co for the year ended 30 April 20X6 was signed a few weeks ago. Blue Co is a listed company.

Required

In respect of the request for Cripple & Co to review Blue Co’s internal control systems: Identify and discuss the relevant ethical and professional issues raised, and recommend any actions necessary.

9) JASPER CO.

a. You are an audit manager in Potter & Co, a firm of Chartered Certified Accountants which offers a range of assurance services. You are responsible for the audit of Jasper Co, a company which provides approximately 10% of your firm’s practice income each year. The finance director of Jasper Co has recently contacted you to provide information about another company, Salsa Co, which is looking to appoint a provider of assurance services. An extract from the email which the finance director of Jasper Co has sent to you is shown below:

‘One of my friends, Gordon Ramsey, is the managing director of Salsa Co, a small company which is looking to expand in the next few years. I know that Gordon has approached the company’s bank for finance of $6 million to fund the expansion. To support this loan application, Gordon needs to appoint a firm to provide a limited assurance review on the company’s financial statements. He would also want the appointed firm to provide tax planning advice and to prepare both the company’s and his personal tax computations for submission to the tax authorities. I have asked Gordon to contact you, and I hope that Potter & Co will be able to provide these services to Salsa Co for a low fee. If the fee you suggest is too high, and unacceptable to Gordon, then I will recommend that Gordon approaches Griffon & Co instead, and I would also consider appointing Griffon & Co to provide the audit of Jasper Co.’

Griffon & Co is a firm of Chartered Certified Accountants which has an office in the same town as Potter & Co.

You have done some research on both Salsa Co and Gordon Ramsey and have confirmed that the company is small enough to be exempt from audit. The company is owner managed, with the Ramsey family owning 90% of the share capital. Gordon Ramsey is a director and majority shareholder of three other companies. An article in a newspaper from several years ago about Gordon Ramsey indicated that one of his companies was once fined for breach of employment law and that he had used money from one of the company’s pension plans to set up a business abroad, appointing his son as the managing director of that business.

Required:

In relation to Potter & Co’s potential acceptance of Salsa Co as a client of the firm:

i) Explain the ethical issues and other matters which should be considered; and.

ii) Explain the importance of obtaining customer due diligence and recommend the information which should be obtained.

b. Potter & Co has agreed to perform an assurance engagement for Jasper Co; the engagement will be a review of prospective financial information which is needed to support the company’s overdraft facilities. Jasper Co had a financial year ended 30 September 20X7, and an unmodified opinion was issued on these financial statements last month. Potter & Co’s partner responsible for ethics has agreed that any threats to objectivity will be reduced to an acceptable level through the use of a team separate from the audit team to perform the work.

The operating profit forecast for the two years to 31 March 20Y0 prepared by a member of the accounting team of Jasper Co is shown below, along with some accompanying notes.

Note    Six months      Six months      Six months      Six months

30 September 31 March         30 September 31 March

20X8               20X9               20X9               20Y0

$000                $000                $000                $000

Revenue                      1          12,800             16,900             13,700             18,900

Gross profit %                        34%                 45%                 36%                 46%

Operating costs:

Staff costs                               (2,800)            (2,900)            (2,800)             (2,900)

Design costs                2          (1,200)            (1,200)            (1,250)             (1,250)

Marketing                               (900)               (1,000)            (1,100)             (1,100)

Interest on overdraft   3          (25)                 (10)                 –                      –

Other expenses           4          (3,840)            (5,070)            (4,110)             (5,670)

––––––            ––––––            ––––––            ––––––

Operating profit                      4,035               6,720               4,440               7,980

––––––            ––––––            ––––––            ––––––

Notes:

• Jasper Co is a producer of greetings cards and giftware, the demand for which is seasonal in nature.
• Design costs are mostly payroll costs of the staff working in the company’s design team, and the costs relate to the design and development of new product ranges.
• Jasper Co has agreed with its bank to clear its overdraft by 1 September 20X9, and the management team is confident that after that point the company will not need an overdraft facility.
• The total ‘Other expenses’ is calculated based on 30% of the projected revenue for the six-month period.

Required:

Recommend the examination procedures which should be used in the review of the profit forecast.

10) COSTA CO.

You are a senior manager at Costa & Co, a firm of Chartered Certified Accountants. You are responsible for reviewing quality control and ethical matters which arise with the firm’s portfolio of clients. During recent investigations you identified the following matters:

Dan Co

Dan Co currently qualifies as a small company in the jurisdiction in which it operates, with turnover of $7.5 million (20X6 – $5.3 million), and as such is not required by law to have an audit. Until recently, your firm has provided a range of non-audit services to Dan Co including bookkeeping, payroll and tax computation and advice. The company recently obtained an offer for a significant amount of finance to help the company grow. The management of Dan Co has ambitious plans for growth which they believe will result in revenue doubling within one year and then continuing to grow at a similar rate for at least the next five years. In order to secure the funding, the directors have decided to have the financial statements audited and have asked if Costa & Co will become the company’s auditors, as well as continuing to provide the existing services. This will include auditing the financial statements for the year ended 30 August 20X7 at the request of the new financers.

Bass Co

You have been approached by Bass Co, a retail company, to provide audit and tax services. In response you have written to the outgoing auditor to ask if there are any matters which you should be made aware of which might prevent you from accepting the assignment. Despite a number of follow up phone calls, you have not been able to obtain a response from the outgoing audit firm. On discussing this with the management team of Bass Co, you are made aware that the company is suing the outgoing auditor for damages due to the detrimental effect on their reputation following the auditor issuing a modified opinion, which the directors of Bass Co felt was inappropriate. The reason for the modified opinion was the application of an accounting treatment which the outgoing auditor considered to be inappropriate and a material misstatement.

Chuck Co

Chuck Co is a listed audit client of your firm. The management team of Chuck Co has asked you to perform a valuation of the shares of another audit client, Nate Co, with a view to buying the entire shareholding. Nate Co is a private company whose shares are owned entirely by the original founder, Mr Jim Slow.

Required

Comment on the ethical and other professional issues raised, and recommend any actions which should be taken in respect of:

a. Dan Co

b. Bass Co

c. Chuck Co

11) CRUZ CO.

You are an audit manager in Cruz & Co, a firm of Chartered Certified Accountants. You have recently been made responsible for reviewing invoices raised to clients and for monitoring your firm’s credit control procedures. Several matters came to light during your most recent review of client invoice files:

Scoob Co, a large private company, has not paid an invoice from Cruz & Co dated 5 June 20X7 for work in respect of the financial statement audit for the year ended 28 February 20X7. A file note dated 30 November 20X7 states that Scoob Co is suffering poor cash flows and is unable to pay the balance. This is the only piece of information in the file you are reviewing relating to the invoice. You are aware that the final audit work for the year ended 28 February 20X8, which has not yet been invoiced, is nearly complete and the auditor’s report is due to be issued imminently.

Lodge Co, a private company whose business is the manufacture of industrial machinery, has paid all invoices relating to the recently completed audit planning for the year ended 31 May 20X8. However, in the invoice file you notice an invoice received by your firm from Lodge Co. The invoice is addressed to Valerie Derello, the manager responsible for the audit of Lodge Co. The invoice relates to the rental of an area in Lodge Co’s empty warehouse, with the following comment handwritten on the invoice: ‘rental space being used for storage of Ms Derello’s speedboat for six months – she is our auditor, so only charge a nominal sum of $100’. When asked about the invoice, Valerie Derello said that the invoice should have been sent to her private address. You are aware that Lodge Co sometimes uses the empty warehouse for rental income, though this is not the main trading income of the company.

In the ‘miscellaneous invoices raised’ file, an invoice dated last week has been raised to Software Supply Co, not a client of your firm. The comment box on the invoice contains the note: ‘referral fee for recommending Software Supply Co to several audit clients regarding the supply of bespoke accounting software’.

Required

Identify and discuss the ethical and other professional issues raised by the invoice file review, and recommend what action, if any, Cruz & Co should now take in respect of:

a. Scoob Co

b. Lodge Co

c. Software Supply Co

Another client, Sci-Tech Co, is a pharmaceutical research company. Your firm is engaged to provide an assurance conclusion on some key performance indicators (KPIs) that it discloses in its operating and financial review. Sci-Tech Co receives funding from governmental health departments, as well as several large charitable donations, the amount of which depends whether three KPI targets are met annually. All three of the targets must be met in order to secure the government funding.

Extracts from Sci-Tech Co’s operating and financial review are as follows.

Required

d.

i) Discuss why it may not be possible to provide a high level of assurance over the stated key performance indicators.

ii) Describe the procedures to verify the number of serious accidents in the year ended 30 November 20X7.

12) BONNIE CO.

You are a manager in Bonnie & Co, a firm of accountants which has 12 offices and 30 partners, 10 of whom are members of ACCA. As an expert in ethics and professional conduct, you have been asked to advise the partners on the following issues, which were raised at a recent meeting.

(a) An advertisement has been drafted as part of the firm’s drive to increase the number of clients. It is suggested that it should be placed in a number of quality national as well as local newspapers:

Have you had enough of your accountant charging you too much for poor quality services?

Does your business need a kick-start?

Look no further; Bonnie & Co provides the most comprehensive range of finance and accountancy services in the country as well as having the leading tax team in the country who are just waiting to save you money. We are offering free business advice to all new audit clients.

Drop in and see us at your local office for a free consultation.

Bonnie & Co, Chartered Certified Accountants.

(b) The planning for the audit of Blossom Co’s financial statements for the year ending 31 March 20X6 will commence shortly. In preparation the audit partner telephoned Blossom Co’s finance director, Stefan Salvatore, to set up a planning meeting and to remind him that fees relating to a tax engagement from the previous year were still outstanding. Mr Salvatore raised concerns about the conduct of the previous audit, stating numerous examples of when he and his staff had been interrupted when they were busy. He stated that he wanted guarantees that this year’s audit will be more efficient, less intrusive and cheaper, otherwise he will seek an alternative auditor.

Required

Evaluate each of the issues described above, commenting on the ethical and professional issues raised and recommend any actions necessary in response to the issues identified.

(c) You are also the manager responsible for the audit of Romeo Co, and you are planning the final audit of the financial statements for the year ending 30 June 20X6. Romeo Co is a supplier of components used in the manufacture of vehicle engines. Due to a downturn in the economy, and in the automotive industry particularly, the company has suffered a decline in sales and profitability over the last two years, mainly due to the loss of several key customer contracts. Many of Romeo Co’s non-current assets are impaired in value, and a significant number of receivables balances have been written off in the last six months.

In response to the deteriorating market conditions, the management of Romeo Co decided to restructure the business. The main manufacturing facility will be reduced in size by two-thirds, and investment will be made in new technology to make the remaining operations more efficient, and to enable the manufacture of a wider variety of components for use in different types of engines and machinery. In order to fund this restructuring, the management of Romeo Co approached the company’s bank with a request for a significant loan. You are aware that without the loan, Romeo Co is unlikely to be able to restructure successfully, which will raise significant doubt over its ability to continue as a going concern.

Your firm has been asked to advise on the necessary forecasts and projections that the bank will need to see in order to make a decision regarding the finance requested. Management has also requested that your firm attend a meeting with the bank at which the forecasts will be discussed.

Required

(i) Identify and explain the matters that should be considered, and the principal audit procedures to be performed, in respect of the additional funding being sought. 

(ii) Comment on the ethical and other implications of the request for your firm to provide advice on the forecasts and projections, and to attend the meeting with the bank.