csuACC331 - Auditing and Assurance Services

ACC331 - Auditing and Assurance Services

Session 1 2013

Faculty of Business

School of Accounting and Finance

CSU Study Centre Sydney

Task

Question 1 - Ethics (7.5% of total subject assessment)

Question 1

Jimmy Ford, a senior audit manager for Fitzgerald & Milhouse Chartered Accountants, has recently been informed that the firm has plans to promote him to partner within the next year or two so long as he continues to perform at the same high level of performance as he has achieved in the past. Jimmy is particularly good at dealing effectively with people, including the staff of clients, professional staff, partners and potential clients. He has recently built a bigger home for himself which he uses to entertain people, and he has been granted memberships of his local community’s most prestigious country clubs. Jimmy is very confident about his future with Fitzgerald & Milhouse.

Jimmy has recently been assigned to the audit of Engines International Ltd, a large wholesale company that ships goods throughout the world. It is one of Fitzgerald & Milhouse’s most prestigious clients representing a substantial proportion of audit revenues. During the audit, Jimmy determines that Engine International uses a method of revenue recognition called ‘bill and hold’, which involves billing customers for goods that are not shipped until a considerable time later. This method has recently been questioned by the Australian Securities and Investment Commission. After considerable research, Jimmy concludes that the method of revenue recognition is not appropriate for Engine International. When Jimmy discusses the matter with the senior audit partner, she concludes that the accounting method has been used for more than ten years by the company and is appropriate. The partner is certain the firm will lose the client if the revenue recognition method is found inappropriate by the auditors. Jimmy argues that, although the revenue recognition method was appropriate in previous years, the ASIC comments suggest it is inappropriate in the current year. Jimmy recognises the partner’s responsibility to make the final decision, but he feels strongly enough to state that he plans to include a statement in the working papers that he disagrees with the partner’s decision. The

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partner informs Jimmy that she is unwilling to permit such a statement because of the potential legal implications. She is willing, however, to write a letter to Jimmy stating that she takes full responsibility for making the final decision if a legal dispute arises. She concludes by saying, “Jimmy, partners must act like partners, not like loose cannons trying to make like difficult for the other partners. You have some growing up to do before I would feel comfortable with you as a partner”.

Required:

What should Jimmy do? Decide your response using the AAA ethical decision model

Question 2 - Legal liability of auditors (7.5% of total subject assessment)

NFD Ltd is a distributor and warehousing facility for chemicals and fertilizer. It was reported to be carrying a very high level of inventory in its audited balance sheet at the time a successful takeover offer was made by Edge Ltd. Two months after the takeover, it is discovered that those inventories NFD does hold were considerably over valued and that they do not in fact possess the quantity of inventory claimed at the time of the audit. In the court action subsequently filed by Edge against NFD’s auditors, the following matters were established in evidence:

The auditors did not attend all stocktakes at year-end. They were present at those for the Sydney based operations of the company only. 50% of the company’s inventory is purportedly held at the company’s Bathurst facility and it is this inventory that does not exist. The Sydney based inventory is determined to have been overvalued by 35%. Although the auditors correctly verified the quantity of Sydney stock, they accepted managements valuation, which did not take account of considerable obsolescence. It is also raised in evidence that the auditors were subjected to considerable pressure by NFD’s management to complete the audit within one month of the balance date. The auditors had held this audit for the past six years and there was no evidence of any previous misstatements of the value of inventory. Edge asserted that they had relied on the audited financial statements, as supplied to them by NFD in making their takeover offer. There is no evidence that the auditors were aware of this intended use of the accounts.

Required:

a) Prepare the case for Edge in their efforts to sue the auditors for negligence. Refer to relevant case law and precedents.

b) Will Edge be successful in their legal action? Justify your position making reference to the relevant cases and precedents.

c) Would your answer to b) change if Edge had written to the auditors telling them that they intended to buy NFD and were relying on the audited financial statements to assist them in making their decision?

Rationale

Content assessed: Topics 1-2

This assignment has been designed to assess your ability to:

1. Apply the ethical rulings of the accounting bodies using sound ethical decision-making techniques.

2. Explain the concept of reasonable care and skill and define negligence and indicate to what extent a duty of care may be owed to third parties.

3. Discuss influences on the audit processes, including the Corporations Act, Common Law, Australian and International professional standards, professional bodies and public expectations within a global market.

Marking criteria

Marks will be awarded for responses to question 1 based on the extent to which you:

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· Effectively identified and critically analysed the relevant ethical issues

· Adhered to the structure outlined in the AAA decision model

· Reached a decision that logically flows from a use of the AAA ethical decision model

· Communicated your response in an understandable and concise manner

· Provided evidence of some research in the appropriate format

Marks will be awarded for responses to question 2 based on the extent to which you:

· Demonstrated an understanding of the legal principles involved in negligence, particularly ‘duty of care’

· Applied the relevant legal principles and case law to the specific case presented

· Evaluated the application of legal principles to justify a position.

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Assessment item 3

Assignment 2

Value:20%

Due date:15-May-2013

Return date:05-Jun-2013

Length: 2500 to 3000 words

Submission method options

Hand delivery (option applies to Internal only)

Alternative submission method

Task

Question 1- Inherent Risk, Control Risk and Audit planning (6% of total subject assessment)

You are the audit senior responsible for the audit of Delilah Ltd. You are currently planning the audit for the year ended 30 June 2012. During your initial planning meeting held with the financial controller, he told you of the following changes in the company’s operations:

(i) Due to the financial controller’s workload, the company has employed a treasurer. The financial controller is excited about the appointment because in the two months that the treasurer has been with the company he has realised a small profit for the company through foreign-exchange transactions in yen.

(ii) Delilah has planned to close an inefficient factory in country New South Wales before the end of 2012. It is expected that the redeployment and disposal of the factory’s assets will not be completed until the end of the following year. However, the financial controller is confident that he will be able to determine reasonably accurate closure provisions.

(iii) To help achieve the budgeted sales for the year, Delilah is about to introduce bonuses for its sales staff. The bonuses will be an increasing percentage of the gross sales made, by each salesperson, above certain monthly targets.

(iv) The company is using a new general ledger software package. The financial controller is impressed with the new system, because management accounts are easily produced and allow detailed comparisons with budgets and prior-period figures across product lines and geographical areas. The conversion to the new system occurred with a minimum of fuss. As it is a popular computer package, it required only minor modifications.

(v) As part of the conversion, the position of systems administrator was created. This position is responsible for all systems maintenance, including data backups and modifications. These tasks were the responsibility of the accountant.

(vi) The managing director has returned from the USA, where he signed a contract to import a line of clothing that has become the latest fashion fad in the USA. The company has not previously been engaged in the clothing industry.

Required:

For each of the scenarios above, identify which of the components of audit risk (inherent, control or detection risk) are affected. In your answer you will need to justify you choice. Format your answer as follows:

Part	Inherent Risk or CR	Justification
i
ii
iii
iv
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Question 2 - Internal Controls and Substantive Testing (6% of total subject assessment)

You are the auditor of PC Ltd., a company that produces low cost electronic goods to children and young adults. The audit has a year end of 30^th June 2012.

There are four main people involved with the acquisitions of inventory for PC Ltd. Ms Auburn is the purchases officer; Mr Brown is the Accounts Payable Clerk; Mr Crimson is the Financial Controller and Ms Dark is the Payments Officer.

The acquisitions system works as follows:

· Ms Auburn is responsible for purchases within PC ltd. There is a computerised inventory system and whenever the inventory level goes below a certain level, Ms Auburn prepares a purchases requisition to buy new stock from one of three suppliers that PC uses.

· Ms Auburn then prepares a three part prenumbered purchase order. Every Month Mr Crimson reviews a listing of purchase orders issued to ensure all have been accounted for. The original copy of the purchase order is sent to the vendor. The receiving department within PC is sent the second copy, which is then used as a receiving report. The third and final copy is kept on file within the purchases department along with the original purchases requisition.

· When the purchased goods arrive they are immediately sent to the receiving department where the receiving report (which is the second copy of the invoice) is filled out by the store-room employee and authorised by the store-room supervisor. A copy of this document is taken and kept in the store-room. The original is sent to Mr Brown in accounts payable.

· When the supplier invoice is received it is forwarded to Mr Brown. He checks the price on the invoice, compares the quantities to the details on the receiving report and checks the footings and calculations. Once this is done he enters the details of each invoice into the computer system that updates the purchases journal and accounts payable master file.

· The invoice is then sent to Mr Crimson for authorisation. Attached to the invoice is a copy of the materials purchase requisition and the receiving report. After Mr Crimson has approved the invoice for payment the documents are sent to the person responsible for cheque preparation in the accounting department (Ms Dark).

Required:

a) Identify three controls that operate within this system and state the potential errors they are aimed at preventing.

b) Describe two additional controls (or improvements to controls) that you would implement into this system and why.

c) Describe the substantive tests that you would perform on transactions in the acquisitions cycle of this system to gain adequate assurance over the assertions of completeness, cut off and accuracy.

Question 3 - Analytical procedures and Substantive Testing (8% of total subject assessment)

Below are the financial statements and additional information for Tehran Ltd.

Balance Sheet

	30/06/2012	30/06/2011
	$'000	$'000
Current Assets
Cash	58	73
Receivables	4579	3928
Inventories	3624	2047
Total Current Assets	8261	6048
Non Current Assets
Property Plant & Equipment	28763	29417
Receivables	2000	2000
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Total Non Current Assets	30763	31417
Total Assets	39024	37465
Current Liabilities
Bank Loan - Secured	5000	7500
Accounts Payable	2500	2473
Provisions	643	610
Total Current Liabilities	8143	10583
Non Current Liabilities
Bank Loan - Secured	22000	20000
Provisions	547	510
Total Non Current Liabilities	22547	20510
Total Liabilities	30690	31093
Net Assets	8334	6372
Shareholders Equity
Share Capital	5000	5000
Retained Profits	3334	1372
Total Shareholders Equity	8334	6372
Income
Statement
	30/06/2012	30/06/2011
	$'000	$'000
Revenue	20007	19943
COGS	13305	15428
Gross Profit	6702	4515
Operating Expenses	3486	3047
Net Profit Before Tax	3216	1468
Tax	1254	572
Net Profit After Tax	1962	896
Retained Profits: Beginning	1372	476
Retained Profits: End	3334	1372

Tehran Ltd manufactures carpets. Approximately 80% of the company’s sales arise as a result of exports. When Tehran sells abroad the customers are billed in the currency of that country.

The main raw material used by Tehran is wool, which is purchased locally in Australia. You have been informed that the company’s profitability has improved due to a recent slump in wool prices.

With the exception of the managing director, Hank Largow, all of the management of Tehran are from Australia. Hank is on a five year contract which was put in place by Tehrans’ US parent company. Hank has a reputation for delivering results from subsidiaries which have not performed well in the past. Hank does not much like Australia and has every intention of returning to the US when his contract is finished. The US parent company was dissatisfied with the company’s 2011 performance and has paid close attention to the company’s performance in 2012.

The company operates a standard costing system and the finished goods inventory is valued at standard cost. Raw materials are valued at actual invoiced cost. No work in progress exists at year end. During 2012, production has been increased by 10% compared to 2011 levels. His has resulted in favourable absorption variances which have contributed to the improved profitability during 2012.

Tests on the compnay’s inventory and debtors controls in prior years have shown the systems to be reliable. The systems are capable of producing reports on the ageing of inventory and debtors and the sales history of individual profit lines.

Approximately 80% of the company’s receivables are overseas customers and the debt is denominated in foreign currency. Most of these customers are on 60 day credit terms.

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Midway through the year a new financial controller, Mr Pink, was appointed after the previous financial controller resigned. Mr Pink has informed you that a number of customers have complained about the quality of Tehran's products.

The property plant and equipment account is broken down as follows:

Property – factory building	27,000,000
Plant & Equipment (including vehicles)	1,763,000
	28,763,000

Additions and disposals of fixed assets have not been substantial during 2012. The factory itself was acquired 6 years ago and since that time no independent valuation has been carried out. Hank has assured you that the current market value of the company is not less than $27,000,000.

The bank loans are secured by a fixed charge over the company’s buildings. A loan repayment of $5

million due on 30^th November 2012 was reduced to $500,000. Hank has stated that this was done with the agreement of the bank and that the bank is comfortable with the company’s performance. Hank also pointed out that the company has made all of its interest payments on time.

The non-current receivable is an export market development grant from the federal government.

In prior years no serious differences between the auditors and the management have arisen. The audit has always been completed on time with an unqualified opinion issued.

Required:

a) Calculate the following ratios: Gross Margin, Net Profit Ratio, Return on total assets, Current Ratio, Quick Ratio, Inventory Turnover, Accounts Receivable turnover, Debt to Equity Ratio (NB, for inventory turnover and accounts receivable turnover, assume the balances for 2010 are the same as 2011).

b) Making reference to the ratios you calculated in part a) and the additional information provided, describe what you consider to be the risk factors that will impact on the audit of receivables and inventory.

c) What other risk factors (aside from those related to receivables and inventory) do you think will impact on the audit?

d) In respect to the accounts of Inventory, Accounts Receivable and Land and Buildings, outline the substantive procedures you would perform. (In your answer you will need to identify the audit assertion(s) most at risk for each of these accounts).

Rationale

Content assessed: Topics 3 - 7

Th

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