15) OURAY CO.

You are a senior manager in the audit department of Ouray& Co. You are reviewing two situations which have arisen in respect of audit clients, which were recently discussed at the monthly audit managers’ meeting:

1. Charlie Co is a significant audit client which develops software packages. Its managing director, Potter Partridge, has contacted one of your firm’s partners regarding a potential business opportunity. The proposal is that Charlie Co and Ouray& Co could jointly develop accounting and tax calculation software, and that revenue from sales of the software would be equally split between the two firms. Potter thinks that Ouray& Co’s audit clients would be a good customer base for the product.
2. Walmart Co is a private hospital which provides elective medical services, such as laser eye surgery to improve eyesight. The audit of its financial statements for the year ended 31 October 20X2 is currently taking place. The audit senior overheard one of the surgeons who performs laser surgery saying to his colleague that he is hoping to finish his medical qualification soon, and that he was glad that Walmart Co did not check his references before employing him. While completing the subsequent events audit procedures, the audit senior found a letter from a patient’s solicitor claiming compensation from Walmart Co in relation to alleged medical negligence resulting in injury to the patient.

Required

Evaluate the ethical, commercial and other professional issues raised, and recommend any actions that should be taken in respect of:

a. Charlie Co

b. Walmart Co

You are also the manager responsible for the audit of another client, Lucy Co, which is a listed company. You are reviewing the working papers of the audit file for the year ended 31 October 20X2, and the audit senior has left a note for your attention:

‘Lucy Co outsources its entire payroll, invoicing and credit control functions to Wong Co. In September 20X2, Wong Co suffered a computer virus attack on its operating system, resulting in the destruction of its accounting records, including those relating to Lucy Co. We have therefore been unable to perform the planned audit procedures on payroll, revenue and receivables, all of which are material to the financial statements. Wong Co has manually reconstructed the relevant figures as far as possible, and has supplied a written statement to confirm that they are as accurate as possible, given the loss of accounting records.’

Required

c.

i) Comment on the actions that should be taken by the auditor, and the implications for the auditor’s report.

ii) Discuss the quality control procedures that should be carried out by the audit firm prior to the auditor’s report being issued.

16) UMBRELLA CO.

a. According to ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements:

‘When identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or assertions give rise to such risks.’

Required:                                    

Discuss why the auditor should presume that there are risks of fraud in revenue recognition and why ISA 240 requires specific auditor responses in relation to the risks identified.

b. You are a manager in Umbrella & Co, a firm of Chartered Certified Accountants. You have just attended a monthly meeting of audit partners and managers at which client related matters were discussed. Information in relation to two clients, which were discussed at the meeting, is given below:

Chico Co

The auditor’s report on the financial statements of Chico Co, a long-standing audit client, for the year ended 31 December 20X2 was issued in April 20X3, and was unmodified. In May 20X3, Chico Co’s audit committee contacted the audit engagement partner to discuss a fraud that had been discovered. The company’s internal auditors estimate that $4.5 million has been stolen in a payroll fraud, which has been operating since May 20X2. The audit engagement partner commented that neither tests of controls nor substantive audit procedures were conducted on payroll in the audit of the latest financial statements as in previous years’ audits there were no deficiencies found in controls over payroll. The total assets recognised in Chico Co’s financial statements at 31 December 20X2 were $80 million. Chico Co is considering suing Umbrella & Co for the total amount of cash stolen from the company, claiming that the audit firm was negligent in conducting the audit.

Required:

Explain the matters that should be considered in determining whether Umbrella & Co is liable to Chico Co in respect of the fraud.

c. Luther Co

Luther Co is a clothing manufacturer, which has recently expanded its operations overseas. To manage exposure to cash flows denominated in foreign currencies, the company has set up a treasury management function, which is responsible for entering into hedge transactions such as forward exchange contracts. These transactions are likely to be material to the financial statements. The audit partner is about to commence planning the audit for the year ending 31 July 20X3.

Required:

Discuss why the audit of financial instruments is particularly challenging, and explain the matters to be considered in planning the audit of Luther Co’s forward exchange contracts.

17) TELFORD CO.

(a) It is 1 July 20X5. You are an audit manager in Telford & Co, a firm of Chartered Certified Accountants. Your role includes performing post-issuance audit quality reviews, and you have been asked to review the audit work performed on Mysticfalls Co for the financial year ended 31 January 20X5. You have gathered the following information from your review of the audit file:

Audit team and fees

Mysticfalls Co is a listed company operating in the construction industry. The company complies with corporate governance regulations and has an audit committee. Mysticfalls Co has been an audit client of Telford & Co for eight years, and Nick Mikealson has been the audit engagement partner during this time. Mysticfalls Co’s auditor’s report was signed by Nick Mikealson and issued last week. The report contained an unmodified opinion.

Telford & Co requires its staff to record each hour they spend working on each client in the firm’s time management system. From reviewing the time records relating to the audit of Mysticfalls Co, you are aware that Nick and the other audit team members recorded the following amount of time on the audit:

Nick Mikealson – audit engagement partner 2 hours

Pat Canley – senior audit manager                 6 hours

Elena Gilbert – audit manager                        35 hours

Six audit assistants                                         130 hours

–––––––––

Total time spent on audit                             173 hours

–––––––––

It is apparent from your review that almost all of the detailed review of the audit working papers was completed by Elena Gilbert, who has evidenced her review by stating ‘final review’ on each page of the audit file. She has recently been promoted to audit manager.

You are also aware that Nick Mikealson booked a total of 40 hours to Mysticfalls Co in respect of non-audit work performed. The only information you can find in the documentation is that the non-audit work related to a ‘special investigation’, and that Nick confirms that it does not create a threat to auditor objectivity. The total fee charged for the audit was $250,000 and the fee for the ‘special investigation’ was $890,000.

Going concern

From reviewing the audit working papers, you are aware that going concern was identified as a significant audit risk at the planning stage of the audit due to low profit margins or losses being made on many of the company’s construction contracts and increasing economic uncertainty. The company typically has 20 contracts ongoing at any time.

Most of the audit work on going concern was performed by Veronica Luna, an audit assistant who has just taken her last professional exam and is not yet qualified. The majority of the audit work performed on going concern focused on a review of five major contracts to determine their profitability. The management of Mysticfalls Co identified the major contracts for review and provided Veronica with forecasts indicating that the contracts would all make a small profit. Veronica confirmed that the assumptions used in the forecasts agreed to assumptions used in previous years and concluded that the contracts which she had reviewed support the going concern status of the company. Having reviewed these major contracts, Veronica completed the conclusion on going concern, stating that there is no significant uncertainty over going concern.

Required:

Comment on the quality of the planning and performance of the audit of Mysticfalls Co, discussing the quality control, ethical and other professional issues raised and recommending appropriate actions to be taken.

(b) You have also been asked to consider the acceptance of a potential new client, the Brightway Group (the Group). Telford & Co has recently been approached by the audit committee of the Group, to become its audit provider.

The parent company of the Group, Brightway Co, is a listed company, and the Group has a total of 14 subsidiaries, 10 of which are foreign subsidiaries. The Group is a food processor, and each of its foreign subsidiaries provides a particular ingredient used in the Group’s main processing plant, which is based in this country. The subsidiaries produce raw ingredients including corn, wheat, vegetables and nuts.

If Telford & Co decides to accept the appointment, it will provide the audit for the Group consolidated financial statements, and for the individual financial statements of some of the subsidiaries.

The Group audit committee has suggested that to keep the audit fee as low as possible, Telford & Co could audit the companies based in this country but the foreign subsidiaries would be audited by local firms. These foreign subsidiaries contribute 60% to the Group’s total assets. The Group has recently become involved with a business in Farland, a remote country, which produces tropical fruit. The business is not incorporated as a company and local regulations in Farland only require financial statements to be prepared or an audit to be performed for companies.

From an internet search regarding the Group, you have also obtained the following information:

Local protestors

One subsidiary, Peru Co, has been accused of environmental damage, due to its operations impacting on the rainforest and causing harm to wildlife. There have been some protests by concerned citizens in the country where Peru Co is located. Digital recordings of these protests have spread world-wide on social media.

Expansion of operations

The Group has recently expanded its operations in a certain country by acquiring a large area of land on which to grow wheat. To receive government approval for the acquisition, a significant ‘incentive payment’ was made to a government minister. This has been reported widely in the media.

Required:

Evaluate the matters which should be considered before Telford & Co accepts the audit of the Brightway Group.

18) BRIDGE CO.

You are a senior manager in Bridge & Co, a global audit firm with offices in more than 30 countries. You are responsible for monitoring audit quality and ethical situations which arise in relation to audit clients. Wonder Co is an audit client whose operations involve haulage and distribution. The auditor’s report for the financial statements of Wonder Co for the year ended 31 December 20X4 was issued last week. You are conducting a review of the quality of that audit, and of any ethical issues which arose in relation to it. Relevant information obtained from a discussion with Mike Motgomery, the audit engagement partner, is given below.

(a) Wonder Co’s audit committee refused to agree to an increase in audit fees despite the company’s operations expanding into new locations. In response to this, the materiality level was increased during the audit, and some review procedures were not carried out. To reduce sample sizes used in tests of detail, the samples were selected based on judgement rather than statistical methods. In addition, only parts of the population being tested were sampled, for example, certain locations were not included in the sample of non-current assets selected for physical verification.

(b) Some of the audit work was performed by an overseas office of Bridge & Co in an ‘off-shoring’ arrangement. This practice is encouraged by Bridge & Co, whose managing partners see it as a way of improving audit efficiency. The overseas office performs the work at a lower cost, and it was largely low-risk, non-judgemental work included in this arrangement for the audit of Wonder Co, for example, numerical checks on documentation. In addition, the overseas office read the minutes of board meetings to identify issues relevant to the audit.

(c) In July 20X4, Elijah Hastings, Wonder Co’s former finance director, joined Bridge & Co as an audit partner, working in the same office as Mike Motgomery. Although Elijah was not a member of the audit team, he did update Mike on some business developments which had taken place at the company during the period before he left. Elijah held a number of equity shares in Wonder Co, which he sold in January 20X5. Since joining Bridge & Co, Elijah has been developing initiatives to increase the firm’s income. One initiative is that audit team members should be encouraged to cross-sell non-audit services and references to targets for the cross-selling of non-audit services to audit clients is now included in partner and employee appraisal documentation.

Required

Comment on the quality control, ethical and professional issues raised in respect of the audit of Wonder Co and the firm-wide policies of Bridge & Co, and recommend any actions to be taken by the audit firm.

Notes

1 The split of the mark allocation is shown against each of the issues above.

2 Assume it is 6 June 20X5.

19) OLIVE CO.

You are a manager in Olive & Co, a firm of Chartered Certified Accountants. You have been temporarily assigned as audit manager to the audit of Kiwi Co, because the engagement manager has been taken ill. The final audit of Kiwi Co for the year ended 28 February 20X5 is nearing completion, and you are now reviewing the audit files and discussing the audit with the junior members of the audit team.

Kiwi Co is a private company which designs and manufactures equipment such as cranes and scaffolding, which is used in the construction industry. The equipment usually follows a standard design, but sometimes Kiwi Co designs specific items for customers according to contractually agreed specifications. The draft financial statements show revenue of $12.5 million, net profit of $400,000, and total assets of $78 million.

The following information has come to your attention during your review of the audit files.

During the year, a new range of manufacturing plant was introduced to the factories operated by Kiwi Co. All factory employees received training from an external training firm on how to safely operate the machinery, at a total cost of $150,000. The training costs have been capitalised into the cost of the new machinery, as the finance director argues that the training is necessary in order for the machinery to generate an economic benefit. After the year end, Carrot Co, a major customer with whom Kiwi Co has several significant contracts, announced its insolvency, and that procedures to shut down the company had commenced. The administrators of Carrot Co have suggested that the company may be able to pay approximately 25% of the amounts owed to its trade payables (creditors). A trade receivable of $120,000 is recognised on Kiwi Co’s statement of financial position in respect of this customer.

In addition, one of the junior members of the audit team voiced concerns over how the audit had been managed. The junior said the following.

‘I have only worked on two audits prior to being assigned to the audit team of Kiwi Co. I was expecting to attend a meeting at the start of the audit, in which the partner and other senior members of the audit team would discuss the audit, but no meeting was held. In addition, the audit manager has been away on holiday for three weeks, and left a senior in charge. However, the senior was busy with other assignments, so was not always available.

‘I was given the task of auditing the goodwill which arose on an acquisition made during the year. I also worked on the audit of inventory, and attended the inventory count, which was quite complicated, as Kiwi Co has a lot of work-in-progress. I tried to be as useful as possible during the count, and helped the client’s staff count some of the raw materials. As I had been to the inventory count, I was asked by the audit senior to challenge the finance director regarding the adequacy of the provision against inventory, which the senior felt was significantly understated.

‘Lastly, we found that we were running out of time to complete our audit procedures. The audit senior advised that we should reduce the sample sizes used in our tests as a way of saving time. He also suggested that if we picked an item as part of our sample for which it would be time consuming to find the relevant evidence, then we should pick a different item which would be quicker to audit.’

Required

In respect of the specific information provided:

(a) Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of:

(i) The training costs that have been capitalised into the cost of the new machinery; and

(ii) The trade receivable recognised in relation to Carrot Co.

(b) Assuming that the financial statements remain unchanged, discuss the effect of these matters on the audit opinion and the auditor’s report.

(c) Evaluate the audit junior’s concerns regarding the management of the audit of Kiwi Co.

20) RICK CO.

You are an audit manager in Rick & Co, a firm of Chartered Certified Accountants. You are reviewing three situations, which were recently discussed at the monthly audit managers’ meeting:

1 Rick & Co has recently been approached by a potential new audit client, Yoshida Co. Your firm is keen to take the appointment. Yoshida Co was recently incorporated by Paxton Yoshida, with its main trade being the retailing of wooden storage boxes. Rick & Co has taken a copy of Paxton Yoshida’s passport, and plans to carry out further client acceptance procedures once engagement terms have been agreed.

2 Rick & Co provides the audit service to CF Co, a national financial services organisation. Due to a number of errors in the recording of cash deposits from new customers that have been discovered by CF Co’s internal audit team, the directors of CF Co have requested that your firm carry out a review of the financial information technology systems. It has come to your attention that while working on the audit planning of CF Co, Jack Saint, one of the juniors on the audit team and who is a recent information technology graduate, spent three hours providing advice to the internal audit team about how to improve the system. As far as you know, this advice has not been used by the internal audit team.

3 KJ Shots Co is a manufacturer of bottled drinks, and has been an audit client of Rick & Co for five years. Two audit juniors attended the annual inventory count last Monday. They reported that Bony Bennet, the new production manager of KJ Shots Co, wanted the inventory count and audit procedures performed as quickly as possible. As an incentive she offered the two juniors ten free bottles of ‘Super Juice’ from the end of the production line. Bony also invited them to join the KJ Shots Co office party, which commenced at the end of the inventory count. The inventory count and audit procedures were completed within two hours (the previous year’s procedures lasted a full day), and the juniors then spent four hours at the office party.

Required

(a) Explain what is meant by ‘money laundering’ and evaluate the matters that should be considered in relation to money laundering before, and on the acceptance of, the audit appointment of Yoshida Co.

(b) With reference to CF Co, explain the ethical and other professional issues raised.

(c) Evaluate the ethical and professional matters raised at the inventory count of KJ Shots Co.

21) GOLDEN CO.

a. Explain what the term ‘lowballing’ means and discuss current guidance in this area.

b. You are an audit manager in Golden & Co (‘Golden’), a firm of Chartered Certified Accountants. Your specific responsibilities include advising the senior audit partner on the acceptance of new assignments. The following matters have arisen in connection with three prospective client companies.

1. Your firm has been nominated to act as external auditor to Pattrik, a private limited company. You have been waiting for a response to your letter of ‘professional enquiry’ to Pattrik’s auditor, Crusty & Co, for several weeks. Your recent attempts to call the current engagement partner, Anton Hunter, in Crusty & Co have been met with the response from Anton’s personal assistant that ‘Mr Hunter is not available’.
2. Golden has been approached by the management of Jalali, a company listed on a recognised stock exchange, to advise on a take-over bid which they propose to make. The target company, Brooke, is an audit client of your firm. However, Jalali is not.
3. A former colleague at Golden, Edwin Stenuit, is now employed by another firm, Sark & Co. Golden and Sark & Co and three other firms have recently tendered for the audit of Thorr, a limited liability company. Thorr is expected to announce the successful firm next week. Yesterday, at a social gathering, Edwin confided to you that Sark & Co ‘lowballed’ on their tender for the audit as they expect to be able to provide Thorr with lucrative other services.

Required

Comment on the professional issues raised by each of the above matters and the steps, if any, that Golden should now take.