82) PHENIX CO.

a. You are an audit manager in Phenix & Co which offers a range of audit and other assurance services to its clients. One of your audit clients is Nikki Co which operates a commercial haulage company. Nikki Co has been an audit client for the last five years and is currently planning a significant expansion of its operations into a new geographical area and jurisdiction. In order to finance the planned expansion, Nikki Co needs funds to purchase additional heavy goods vehicles, expand its warehousing facilities and recruit more drivers. The company is also planning a major advertising and marketing campaign targeted at potential customers in the new jurisdiction.

Nikki Co’s finance director, Suzanne Naruto, has approached you to ask if your firm will provide a report on the prospective financial information which has been prepared in support of a loan application. The application is for a new long-term loan of $22 million from the company’s current lender which it intends to use exclusively to finance the planned expansion. The company currently has an existing long-term loan of $31 million from the same bank which is redeemable in five years’ time.

Suzanne Naruto has provided you with the following extract from the prospective financial information which will form part of the company’s loan application:

Forecast statements of profit or loss

Note    Year ended      Year ending    Year ending

31 August       31 August       31 August

20X8               20X9               20Y0

Unaudited       Forecast          Forecast

$000                $000                $000

Revenue                                  1          138,861           174,965           225,705

Cost of sales                            2          (104,862)        (124,786)        (157,230)

Administrative expenses         3          (22,936)          (21,984)          (20,743)

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

Operating profit                                  11,063             28,195             47,732

Finance costs                          4          (1,450)            (1,638)            (1,597)

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

Profit before tax                                  9,613               26,557             46,135

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

Notes:

• Revenue represents the amounts derived from the provision of haulage services to commercial customers operating principally in the retail sector. Nikki Co’s board of directors believes that trade in both its existing and new markets will experience significant growth over the next two years.
• Cost of sales comprises the costs of warehousing and distribution including relevant staff costs, maintenance and repair of vehicles and depreciation of property, equipment and vehicles.
• Administrative expenses are mainly the costs of running Nikki Co’s central head office facility.
• Finance costs represent the cost of servicing long-term finance from Nikki Co’s bankers.

Required:

i) Explain the matters which should be considered by Phenix & Co before accepting the engagement to review and report on Nikki Co’s prospective financial information.

ii) Assuming Phenix & Co accepts the engagement, recommend the examination procedures to be performed in respect of Nikki Co’s forecast statements of profit or loss. 

b. One of your colleagues at Phenix & Co, Benjamin Ezra, has been taken ill at short notice and you have been temporarily assigned as audit manager on George Co, an IT consultancy company which is listed on a second tier investment market. The final audit of George Co for the year ended 30 June 20X8 is approaching completion and you are in the process of reviewing the audit working papers. The draft financial statements for the year recognise profit before taxation for the year of $54.2 million and total assets of $23.1 million.

The audit supervisor, who is a part-qualified chartered certified accountant, has sent you an email from which the following extract is taken:

‘It’s great to have you on board as I was beginning to worry that there would be no manager review of our working papers prior to the final audit clearance meeting next week. The audit assistant and myself have done our best to complete all of the audit work but we only saw Benjamin on the first day of the audit about a month ago when I think he was already feeling unwell. We had a short briefing meeting with him at which he told us ‘if in doubt, follow last year’s working papers.’

One issue which I wanted to check with you is that George Co has introduced a cashsettled share-based payment scheme by granting its directors share appreciation rights (SARs) for the first time this year. This was not identified at planning as a high risk area. The SARs were granted on 1 July 20X7 at which date the client obtained a valuation of the rights which was performed by an external firm of valuers. I have filed a copy of the valuation report and I have looked up the valuers online and have found a very professional looking website which confirms that they know what they are doing. The cost of the SARs scheme based on this valuation is being appropriately recognised over the three-year vesting period and a straight line expense of $195,000 has been recognised in the statement of profit or loss on this basis. A corresponding equity reserve has also been correctly recognised on the statement of financial position.

The amount also seems immaterial and I can’t see any need to propose any amendments to the financial statements in relation to either the amounts recognised or the disclosures made in the notes to the financial statements.’

Required:

Comment on the quality of the planning and performance of the audit of George Co discussing the quality control and other professional issues raised.

83) HOPE CO.

You are a manager in Boyle & Co. One of your audit clients is Hope Co which operates commercial real estate properties typically comprising several floors of retail units and leisure facilities such as cinemas and health clubs, which are rented out to provide rental income.

Your firm has just been approached to provide an additional engagement for Hope Co, to review and provide a report on the company’s business plan, including forecast financial statements for the 12-month period to 31 May 20X3. Hope Co is in the process of negotiating a new bank loan of $30 million and the report on the business plan is at the request of the bank. It is anticipated that the loan would be advanced in August 20X2 and would carry an interest rate of 4%. The report would be provided by your firm’s business advisory department and a second partner review will be conducted which will reduce any threat to objectivity to an acceptable level.

Extracts from the forecast financial statements included in the business plan are given below:

Statement of profit or loss (extract)

Note                FORECAST                UNAUDITED

12 months to               12 months to

31 May 20X3              31 May 20X2

$000                            $000

Revenue                                                               25,000                         20,600

Operating expenses                                               (16,550)                      (14,420)

––––––                        ––––––

Operating profit                                                    8,450                           6,180

Profit on disposal of Holt Retail   1                      4,720                           –

Finance costs                                                        (2,650)                        (1,690)

––––––                        ––––––

Profit before tax                                                  10,520                         4,490

––––––                        ––––––

Statement of financial position

Note                FORECAST                UNAUDITED

12 months to               12 months to

31 May 20X3              31 May 20X2

Assets                                                                   $000                            $000

Non-current assets

Property, plant and equipment     2                      330,150                       293,000

Current assets

Inventory                                                              500                              450

Receivables                                                           3,600                           3,300

Cash and cash equivalents                                    2,250                           3,750

–––––––                      –––––––

6,350                           7,500

–––––––                      –––––––

Total assets                                                          336,500                       300,500

–––––––                      –––––––

Equity and liabilities

Equity

Share capital                                                         105,000                       100,000

Retained earnings                                                 93,400                         92,600

–––––––                      –––––––

Total equity                                                           198,400                       192,600

–––––––                      –––––––

Non-current liabilities

Long-term borrowings                  2                      82,500                         52,500

Deferred tax                                                          50,000                         50,000

Current liabilities

Trade payables                                                      5,600                           5,400

–––––––                      –––––––

Total liabilities                                                    138,100                       107,900

–––––––                      –––––––

Total equity and liabilities                                 336,500                       300,500

–––––––                      –––––––

Notes:

1 Holt Retail is a retail park which is underperforming. Its sale is currently being negotiated, and is expected to take place in September 20X2.

2 Hope Co is planning to invest the cash raised from the bank loan in a new retail and leisure park which is being developed jointly with another company, Kestrel Co.

Required:

In respect of the engagement to provide a report on Hope Co’s business plan:

a) Identify and explain the matters that should be considered in agreeing the terms of the engagement.

Note: You are NOT required to consider ethical threats to objectivity.

b) Recommend the procedures that should be performed in order to examine and report on the forecast financial statements of Hope Co for the year to 31 May 20X3.

c) Explain the difference between best estimate assumptions and hypothetical assumptions used in a forecast and discuss the relative level of risk of each.

84) AJO CO.

a. You are a manager in one of the assurance departments of Ajo & Co, a large firm of Chartered Certified Accountants. You are currently assigned to a due diligence engagement for one of your firm’s audit clients, Betty Co, a manufacturer of bespoke furniture. The audit of Betty Co is conducted by a team from a different department; you have never been involved in the audit of this client.

The engagement is to conduct a financial and operational due diligence review of Jug Co, a company which has been identified as a potential acquisition target by Betty Co, due to the synergies offered and the potential to expand the existing production facilities. As part of the due diligence review, you have been asked to provide a valuation of Jug Co’s assets and liabilities and an analysis of the company’s operating profit forecasts. This will assist Betty Co in determining an appropriate purchase price for Jug Co.

During the engagement fieldwork your team identified two matters, which require your further consideration, as follows:

• While reviewing correspondence with customers in relation to outstanding receivables, one of the team found a letter from a large retailer, for which Jug Co produces a number of unique products, providing advanced notice that they are not renewing their purchasing agreement when the current one expires. The customer advised that they are switching to a new entrant to the market who is substantially cheaper than Jug Co. A brief analysis identified that the customer provides, on average, almost 5% of Jug Co’s annual revenues.
• Jug Co owns a piece of land which was given to it as a gift by the local authorities ten years ago. The land surrounds the entrance to the main production premises and is designated as a nature reserve. Restrictions were imposed on the usage of the land which also limit who the owner is able to sell the land to in the future. The land has zero carrying value in the financial statements.

No additional matters have arisen for your consideration. You are also aware that the financial statements for the last ten years have been audited and no modifications have been made to the auditor’s opinion during this period.

Required

In respect of the two matters identified above:

i. Explain why each matter requires further investigation as part of the due diligence review; and 

ii. Recommend the investigation procedures to be performed.

b. The management team of Betty Co has also approached Ajo & Co to ask whether representatives of the firm would be available to attend a meeting with the company’s bankers, who they are hoping will finance the acquisition of Jug Co, to support the management team in conveying the suitability of the acquisition of Jug Co. For the meeting the bank requires the most up-to-date interim accounts of Betty Co with the accompanying auditor’s independent interim review report. Your firm is due to complete the interim review shortly and the management team of Betty Co has requested that the interim review is completed quickly so that it does not hold up negotiations with the bank, stating that if it does, it may affect the outcome of the next audit tender, which is due to take place after the completion of this year’s audit.

Required

Comment on the ethical and professional issues raised, and recommend any actions which should be taken in respect of the request from the management team of Betty Co.

85) ROGERS AND KEVIN CO.

Your audit client, Rogers Co, is intending to purchase a new warehouse at a cost of $500,000. One of the directors of the company, Pik Pamento, has agreed to make the necessary finance available through a director’s loan to the company. This arrangement has been approved by the other directors, and the cash will be provided on 30 March 20X0, one day before the purchase is due to be completed. Pik’s financial advisor has asked to see a cash flow projection of Rogers Co for the next three months. Your firm has been asked to provide an assurance report to Pik’s financial advisor on this prospective financial information.

The cash flow forecast is shown below.

January 20X0              February 20X0            March 20X0

$’000                           $’000                           $’000

Operating cash receipts

Cash sales                         125                              135                              140

Receipts from credit sales 580                             600                              625

Operating cash payments

Purchases of inventory     (410)                           (425)                           (425)

Salaries                             (100)                           (100)                           (100)

Overheads                         (175)                           (175)                           (175)

Other cash flows

Dividend payment                                                (80)

Purchase of new licence   (35)

Fixtures for new warehouse                                                                     (60)

Loan receipt                                                                                              500

Payment for warehouse                                                                            (500)

________                     ________                    ________

Cash flow for the month   (15)                             (45)                             5

Opening cash                    100                              85                                40

Closing cash                     85                                40                                45

The following information is relevant:

1 Rogers Co is a wholesaler of catering equipment and frozen food. Its customers are mostly restaurant chains and fast food outlets.

2 Customers who pay in cash receive a 10% discount. Analysis has been provided showing that for sales made on credit, 20% of customers pay in the month of the sale, 60% pay after 45 days, 10% after 65 days, 5% after 90 days, and the remainder are bad debts.

3 Rogers Co pays for all purchases within 30 days in order to take advantage of a 12% discount from suppliers.

4 Overheads are mainly property rentals, utility bills, insurance premiums and general office expenses.

5 Rogers Co needs to have a health and safety licence as it sells food. Each licence is valid for one year and is issued once an inspection has taken place.

6 A profit forecast has also been prepared for the year ending 31 December 20X0 to help with internal planning and budgeting.

This is the first time that Rogers Co has requested an assurance report, and the directors are unsure about the contents of the report that your firm will issue. They understand that it is similar in format to an auditor’s report, but that the specific contents are not the same.

Required

a) Recommend the procedures that should be performed on the cash flow forecast for the three months ending 31 March 20X0 in order to provide an assurance report as requested by Rogers Co.

b) Explain the main contents of the report that will be issued on the prospective financial information.

Another audit client of yours, Kevin Co, is a manufacturing company with a year ended 30 September 20W9. The audit work has been completed and reviewed and you are due to issue the auditor’s report in three days. The draft audit opinion is unmodified. The financial statements show revenue for the year ended 30 September 20W9 of $15 million, net profit of $3 million, and total assets at the year end are $80 million.

The finance director of Kevin Co telephoned you this morning to tell you about the announcement yesterday, of a significant restructuring of Kevin Co, which will take place over the next six months. The restructuring will involve the closure of a factory, and its relocation to another part of the country. There will be some redundancies and the estimated cost of closure is $250,000. The financial statements have not been amended in respect of this matter.

Required

c) In respect of the announcement of the restructuring:

i) Comment on the financial reporting implications, and advise the further audit procedures to be performed

ii) Recommend the actions to be taken by the auditor if the financial statements are not amended

86) SCARCY CO.

a. You are a manager in Terry & Co, a firm of accountants which has 12 offices and 30 partners, 10 of whom are members of ACCA. 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. Terry & 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.

Still not sure? We guarantee to be cheaper than your existing service provider and for the month of January we are offering free business advice to all new audit clients.

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

Terry & Co, Chartered Certified Accountants.

Required:

Comment on the suitability of the advertisement discussing any ethical and professional issues raised.

b. As a result of advertising, Terry & Co has been appointed by Scarcy Co to perform a due diligence review of a potential acquisition target, Peralta Tyres Co. As part of the due diligence review and to allow for consideration of an appropriate offer price, Scarcy Co has requested that you identify and value all the assets and liabilities of Peralta Tyres Co, including items which may not currently be reported in the statement of financial position.

Scarcy Co is a large, privately owned company operating only in this country, which sells spare parts and accessories for cars, vans and bicycles. Peralta Tyres Co is a national chain of vehicle service centres, specialising in the repair and replacement of tyres, although the company also offers a complete range of engine and bodywork services as well. If the acquisition is successful, the management of Scarcy Co intends to open a Peralta Tyres service centre in each of its stores.

One of the reasons for Peralta Tyres Co’s success is their internally generated customer database, which records all customer service details. Using the information contained on the database software, the company’s operating system automatically informs previous customers when their vehicle is due for its next service via email, mobile phone text or automated letter. It also informs a customer service team to telephone the customer if they fail to book a service within two weeks of receiving the notification. According to the management of Peralta Tyres Co, repeat business makes up over 60% of annual sales and management believes that this is a distinct competitive advantage over other service centres.

Peralta Tyres Co also recently purchased a licence to distribute a new, innovative tyre which was designed and patented in the United States. The tyre is made of 100% recycled materials and, due to a new manufacturing process, is more hardwearing and therefore needs replacing less often. Peralta Tyres Co paid $5 million for the licence in January 20X5 and the company is currently the sole, licenced distributor in this country.

During a brief review of Peralta Tyres Co’s financial statements for the year ended 30 June 20X5, you notice a contingent liability disclosure in the notes relating to compensation claims made after the fitting of faulty engine parts during 20X4. The management of Peralta Tyres Co has stated that the fault lies with the manufacturer of the part and that they have made a claim against the manufacturer for the total amount sought by the affected customers.

Required:

i. Describe the purpose of a due diligence assignment and compare the scope of a due diligence assignment with that of an audit of historical financial statements. (6 marks)

ii. Recommend, with reasons, the principal additional information which should be made available to assist with your valuation of Peralta Tyres Co’s intangible assets. (7 marks)

iii. Explain the specific enquiries you should make of Peralta Tyres Co’s management relevant to the contingent liability disclosed in the financial statements. (5 marks)

87) INDIGO CO.

Indigo Co, an audit client of your firm, is a large privately owned company whose operations involve a repair and maintenance service for domestic customers. The company offers a range of services, such as plumbing and electrical repairs and maintenance, and the repair of domestic appliances such as washing machines and cookers, as well as dealing with emergencies such as damage caused by flooding. All work is covered by a two-year warranty.

The directors of Indigo Co have been seeking to acquire expertise in the repair and maintenance of swimming pools and hot-tubs as this is a service increasingly requested, but not offered by the company. They have recently identified Justin Co as a potential acquisition. Preliminary discussions have been held between the directors of the two companies with a view to the acquisition of Justin Co by Indigo Co. This will be the first acquisition performed by the current management team of Indigo Co. Your firm has been asked to perform a due diligence review on Justin Co prior to further discussions taking place. You have been provided with the following information regarding Justin Co:

Justin Co is owner-managed, with three of the five board members being the original founders of the company, which was incorporated thirty years ago. The head office is located in a prestigious building, which is owned by the founders’ family estate. The company recently acquired a separate piece of land on which a new head office is to be built.

The company has grown rapidly in the last three years as more affluent customers can afford the cost of installing and maintaining swimming pools and hot-tubs. The expansion was funded by a significant bank loan. The company relies on an overdraft facility in the winter months when less operating cash inflows arise from maintenance work.

Justin Co enjoys a good reputation, though this was tarnished last year by a complaint by a famous actor who claimed that, following maintenance of his swimming pool by Justin Co’s employees, the water contained a chemical which damaged his skin. A court case is ongoing and is attracting media attention.

The company’s financial year end is 31 August. Its accounting function is outsourced to Damon Co, a local provider of accounting and tax services.

Required:

a) Explain the potential benefits to Indigo Co of having an externally provided due diligence review.

b) Recommend additional information which should be made available for your firm’s due diligence review, and explain the need for the information.

Indigo Co is tendering for an important contract to provide subcontracting services to Lavender Co. Lavender Co is also an audit client of your firm and Indigo Co’s management has asked your firm to provide advice on the tender it is preparing.

c) Explain the ethical and professional matters your firm should consider in deciding whether to provide advice to Indigo Co on the tender.

88) MESA CO.

You are a manager in the business advisory department of Greg & Co. Your firm has been approached to provide assurance to Mesa Co, a company which is not an audit client of your firm, on a potential acquisition. You have just had a conversation with Elijah Hefley, Mesa Co’s managing director, who made the following comments:

‘Mesa Co is a book publisher specialising in publishing textbooks and academic journals. In the last few years the market has changed significantly, with the majority of customers purchasing books from online sellers. This has led to a reduction in profits, and we recognise that we need to diversify our product range in order to survive. As a result of this, we decided to offer a subscription-based website to customers, which would provide the customer with access to our full range of textbooks and journals online.

On investigating how to set up this website, we found that we lack sufficient knowledge and resources to develop it ourselves and began to look for another company which has the necessary skills, with a view to acquiring the company. We have identified Mondle Co as a potential acquisition, and we have approached the bank for a loan which will be used to finance the acquisition if it goes ahead.

Mesa Co has not previously acquired another company. We would like to engage your firm to provide guidance regarding the acquisition. I understand that a due diligence review would be advisable prior to deciding on whether to go ahead with the acquisition, but the other directors are not sure that this is required, and they don’t understand what the review would involve. They are also unsure about the type of conclusion that would be issued and whether it would be similar to the opinion in an auditor’s report.’

Elijah Hefley has sent you the following information about Mondle Co:

Company background

Mondle Co was established four years ago by two university graduates, Vic Sandhu and Lou Lien, who secured funds from a venture capitalist company, BizGrow, to set up the company. Vic and Lou created a new type of website interface which has proven extremely popular, and which led to the company growing rapidly and building a good reputation. They continue to innovate and have won awards for website design. Vic and Lou have a minority shareholding in Mondle Co.

Mondle Co employs 50 people and operates from premises owned by BizGrow, for which a nominal rent of $1,000 is paid annually. The company uses few assets other than computer equipment and fixtures and fittings. The biggest expense is wages and salaries and due to increased demand for website development, freelance specialists have been used in the last six months. According to the most recent audited financial statements, Mondle Co has a bank balance of $500,000.

The company has three revenue streams:

• Developing and maintaining websites for corporate customers. Mondle Co charges a one-off fee to its customers for the initial development of a website and for maintaining the website for two years. The amount of this fee depends on the size and complexity of the website and averages at $10,000 per website. The customer can then choose to pay another one-off fee, averaging $2,000, for Mondle Co to provide maintenance for a further five years.
• Mondle Co has also developed a subscription-based website on which it provides access to technical material for computer specialists. Customers pay an annual fee of $250 which gives them unlimited access to the website. This accounts for approximately 30% of Mondle Co’s total revenue.
• The company has built up several customer databases which are made available, for a fee, to other companies for marketing purposes. This is the smallest revenue stream, accounting for approximately 20% of Mondle Co’s total revenue.

Extracts from audited financial statements

Statement of profit or loss

Year ended      Year ended      Year ended      Year ended

30 September  30 September 30 September 30 September

20X3               20X2               20X1               20X0

$000                $000                $000                $000

Revenue                        4,268               3,450               2,150               500

Operating expenses     (2,118)            (2,010)            (1,290)            (1,000)

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

Operating profit/(loss) 2,150              1,440               860                  (500)

Finance costs              (250)               (250)               (250)               –

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

Profit/(loss) before tax 1,900              1,190               610                  (500)

Tax expense                (475)               (300)               (140)               –

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

Profit/(loss) for the year 1,425           890                  470                  (500)

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

There were no items of other comprehensive income recognised in any year.

Required:

a. Discuss the benefits to Mesa Co of a due diligence review being performed on Mondle Co.

b. Identify and explain the matters which you would focus on in your due diligence review and recommend the additional information which you will need to perform your work.

c. Describe the type of conclusion which would be issued for a due diligence report and compare this to an auditor’s report.

89) ALAMEDA CO.

a. You are the manager responsible for the audit of Alameda Hospital Co, for the year ended 31 March 20X7, working in the audit department of Vulture & Co. Alameda Hospital Co is a private sector medical facility, where patients undergo minor surgical procedures and receive treatments such as physiotherapy. You have recently visited the audit team, who are currently on site performing the fieldwork, to review the work performed to date and to discuss their progress. During your visit the audit senior informed you of the following matter:

During a review of the valuation of medical inventories, including medicines used in a variety of treatments at the hospital, it was noted that a number of items had passed their recommended use by dates. These were recorded on an inventory spreadsheet maintained by the financial controller and were easy to spot because they were highlighted in red. One of the audit team inspected a sample of the inventories in question and confirmed that their use by dates had expired. When asked about this, the financial controller stated that the audit team must be mistaken. The audit team requested to look at the spreadsheet again but he refused. The next day the finance director confronted the audit team accusing them of extending their investigations ‘beyond their remit’. He also threatened to remove them from the premises if they continued to ask questions which were not relevant to the audit of the hospital’s financial statements. Since then, the audit team has been unable to complete the audit of medical inventories. They have also noted that the room where the inventories were previously kept has been emptied.

Required:

Identify and explain the ethical and professional issues raised and recommend any actions which should be taken in respect of the matter described by the audit senior.

b. Vulture & Co is also engaged to produce an assurance report on the performance information of Alameda Hospital Co which is included in the company’s integrated report. The integrated report will be published on the company’s website later in the year, and is not part of the information published with the financial statements.

Vulture & Co has a specialist team, independent from the audit department, which provides assurance on key performance indicators. Under the terms of the engagement, this team is required to provide assurance with regard to both the accuracy and completeness of the key performance indicators which are used to monitor the hospital’s efficiency and effectiveness. Several of the key performance indicators included in the draft integrated report, all of which the Hospital claims to have met, are shown below:

1 To maintain an average patient to nurse ratio of no more than 6:1.

2 To achieve a minimum 75% annual usage of surgical rooms.

3 To ensure that the rate of admissions within 28 days for previously treated conditions does not exceed 3%.

Required:

i. Discuss the benefits of independent assurance being provided on the key performance indicators included in the integrated report of Alameda Hospital Co to the company’s management and to external users of the report. 

ii. Recommend the examination procedures which should be used in obtaining assurance relating to the key performance indicators of Alameda Hospital Co.

90. TROY CO.

You are a manager in the forensic investigation department of your audit firm. The directors of a local manufacturing company, Troy Co, have contacted your department regarding a suspected fraud, which has recently been discovered operating in the company, and you have been asked to look into the matter further. You have held a preliminary discussion with Gina Linetti, the finance director of Troy Co, the notes of this conversation are shown below.

Notes of discussion with Gina Linetti

Four months ago Troy Co shut down one of its five factories, in response to deteriorating market conditions, with all staff employed at the factory made redundant on the date of closure.

While monitoring the monthly management accounts, Gina performs analytical procedures on salary expenses. She found that the monthly total payroll expense had reduced by 3% in the months following the factory closure – not as much as expected, given that 20% of the total staff of the company had been made redundant. Initial investigations performed last week by Gina revealed that many of the employees who had been made redundant had actually remained on the payroll records, and salary payments in respect of these individuals were still being made every month, with all payments going into the same bank account. As soon as she realised that there may be a fraud being conducted within the company, Gina stopped any further payments in respect of the redundant employees. She contacted our firm as she is unsure how to proceed, and would like our firm’s specialist department to conduct an investigation.

Gina says that the senior accountant, Bryce Wayne, has been absent from work since she conducted her initial investigation last week, and it has been impossible to contact him. Gina believes that he may have been involved with the suspected fraud.

Gina has asked whether your department would be able to provide a forensic investigation, but is unsure what this would involve.

Troy Co is not an audit client of your firm.

Required

a) Identify and explain the matters that should be considered before accepting the engagement to perform a forensic investigation at Troy Co.

b) (i) Describe the objectives of a forensic investigation

(ii) Explain the steps involved in a forensic investigation into the payroll fraud, including examples of procedures that could be used to gather evidence

c) Assess how the fundamental ethical principles of the IESBA’s Code of Ethics for Professional Accountants should be applied to the provision of a forensic investigation service.

91) TYSON CO.

a. You are a manager in the forensic department of your firm, Karen & Co. You have received a request from Tyson Co about an inventory fraud which was brought to the attention of the company’s audit committee by a whistle-blower. Tyson Co is not currently a client of your firm.

Tyson Co manufactures and sells parts used in the automotive industry to both car manufacturers and to garages specialising in the repair and servicing of cars. The audit committee would like Karen & Co to perform a forensic investigation to quantify the loss suffered as a result of the inventory fraud, and to recommend improvements in the company’s internal controls to avoid similar issues in the future. In addition, the audit committee has mentioned that although the quantification of the loss is to form the basis of an insurance claim, the matter has been reported to the police who will be investigating the matter further.

Required:

Evaluate the matters which should be considered before your firm accepts the invitation to perform a forensic investigation for Tyson Co.

b.Having accepted the engagement, the operations director provides you with the following summary of the allegations of the whistle-blower:

‘The warehouse manager has been working with one of the sales representatives to dispatch goods to a fictitious customer which the warehouse manager has created on the dispatch system. The sales orders are input by the sales representative into the dispatch system which is not directly linked to the invoicing and accounting system. After the goods dispatch note is issued by the warehouse manager and the goods leave the warehouse for delivery to the fictitious customer, the sales representative cancels the original order. The warehouse manager reverses the dispatch immediately so that the daily report on inventory movement used to generate invoices in the sales system does not reflect movement of the goods. The sales representative takes delivery of the goods at the address of the fictitious customer and then sells the parts on the internet, splitting the proceeds with the warehouse manager. The warehouse manager supervises and participates in all inventory counts and this way ensures he is able to adjust the records of inventory to disguise the missing items.’

The operations director has informed you that no authorisation is required for either the cancellation of orders or the reversal of dispatch notes.

Required:

i. Recommend the procedures which should be performed in order to quantify the inventory loss; and 

ii. Evaluate the deficiencies in Tyson Co’s internal control system, and explain how they contributed to the fraud, together with recommendations to prevent such a fraud reoccurring.

c. The audit committee members have expressed their dissatisfaction that the company’s auditor did not identify the fraud.

Required:

Explain the difficulties arising for management and for the auditor with respect to discovering fraud.

92) YUMA CO.

a. Raymond & Co, a firm of Chartered Certified Accountants, is the external audit provider for the Yuma Group (the Group), a manufacturer of mobile phones and laptop computers. The Group obtained a stock exchange listing in July 20X2. The audit of the consolidated financial statements for the year ended 28 February 20X3 is nearing completion.

You are a manager in the audit department of Raymond & Co, responsible for conducting engagement quality control reviews on listed audit clients. You have discussed the Group audit with some of the junior members of the audit team, one of whom made the following comments about how it was planned and carried out.

‘The audit has been quite time-pressured. The audit manager told the juniors not to perform some of the planned audit procedures on items such as directors’ emoluments and share capital as they are considered to be low risk. He also instructed us not to use the firm’s statistical sampling methods in selecting trade receivables balances for testing, as it would be quicker to pick the sample based on our own judgment.

‘Two of the juniors were given the tasks of auditing trade payables and going concern. The audit manager asked us to review each other’s work as it would be good training for us, and he didn’t have time to review everything.

‘I was discussing the Group’s tax position with the financial controller, when she said that she was struggling to calculate the deferred tax asset that should be recognised. The deferred tax asset has arisen because several of the Group’s subsidiaries have been loss making this year, creating unutilised tax losses. As I had just studied deferred tax at college I did the calculation of the Group’s deferred tax position for her. The audit manager said this saved time as we now would not have to audit the deferred tax figure.

‘The financial controller also asked for my advice as to how the tax losses could be utilised by the Group in the future. I provided her with some tax planning recommendations, for which she was very grateful.’

Required:

In relation to the audit of the Yuma Group, evaluate the quality control, ethical and other professional matters arising in respect of the planning and performance of the Group audit.

c. The audit committee of the Group has contacted Raymond & Co to discuss an incident that took place on 1 June 20X3. On that date, there was a burglary at the Group’s warehouse where inventory is stored prior to despatch to customers. CCTV filmed the thieves loading a lorry belonging to the Group with boxes containing finished goods. The last inventory count took place on 30 April 20X3.

The Group has insurance cover in place and Raymond & Co’s forensic accounting department has been asked to provide a forensic accounting service to determine the amount to be claimed in respect of the burglary. The insurance covers the cost of assets lost as a result of thefts.

It is thought that the amount of the claim will be immaterial to the Group’s financial statements, and there is no ethical threat in Raymond & Co’s forensic accounting department providing the forensic accounting service.

Required:

i) In respect of the theft and the associated insurance claim:

ii) Evaluate the matters to be considered, and the steps to be taken in planning the forensic accounting service.

iii) Recommend the procedures to be performed in determining the amount of the claim.

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

93) ANOUK CO.

a. You are responsible for the audit of Anouk Co, a listed company, and you are completing the review of its interim financial statements for the six months ended 31 October 20X7. Anouk Co is a car manufacturer, and historically has offered a three year warranty on cars sold. The financial statements for the year ended 30 April 20X7 included a warranty provision of $1.5 million and recognised total assets of $27.5 million. You are aware that on 1 July 20X7, due to cost cutting measures, Anouk Co stopped offering warranties on cars sold. The interim financial statements for the six months ended 31 October 20X7 do not recognise any warranty provision. Total assets are $30 million at 31 October 20X7.

Required:

i. Explain the principal analytical procedures that should be used to gather evidence in a review of interim financial information. 

ii. Assess the matters that should be considered in forming a conclusion on Anouq Co’s interim financial statements, and the implications for the review report.

b. You are also responsible for the audit of Jamie Co, a large, private company which is currently owned by the Lodge family, who own the majority of the company’s shares.

Following the completion of the audit this year, the finance director, Kylie Lodge, contacted you and told you that the family is considering listing the company on the stock exchange. They would like to recruit one of your audit partners for a six-month period to help prepare for the listing. As the board is concerned that the necessary skills and personnel to support the listing are not currently present within the company, Kylie Lodge has also requested that your firm assist them in identifying and recruiting new members to the board.

Currently, most of the executive director roles are performed by family members, except for the directors of operations and human resources, who are both long-serving employees. The board operates no audit committee and there is only one non-executive director, who works elsewhere as an IT consultant. Other than the recruitment of new board members, Jamie Co is not planning on making any changes to its governance structure prior to or subsequent to listing.

Jamie Co has a financial year ending 31 March 20X8, and audit planning is scheduled to take place in January 20X8.

Required:

In relation to the information provided for Jamie Co, comment on:

i. The ethical and professional matters in relation to the recruitment requests made by Jamie Co.

ii. The implications the governance structure and proposed listing may have on the audit process.

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