Auditing Assignment: Understanding The Audit Planning Procedures

Question

Task: The questions to be answered in this auditing assignment are:
Week 1

You are the audit manager of Overseas Explorer Ltd (OEL), which acquired the small proprietary company Local Pty Ltd (Local) on 30 June 2018. The price of the acquisition was agreed at $5 million, on the condition that OEL is satisfied with the financial records of Local. As Local is a small proprietary company, it has not prepared statutory financial reports or undergone an audit since its incorporation in 2016. However, Local has agreed to allow your firm, which is the auditor of OEL, to access its books and records. The CEO of OEL, Wendy Champion, has requested that your firm provide assurance on the following three items:
• The management accounts for the year ended 30 June 2017 • All transactions occurring from the date negotiations commenced until the settlement date, to ensure that all transactions were within the normal course of operations • The financial report prepared at the acquisition date of 30 June 2018.
In order to clarify your responsibilities, you requested that OEL indicate the level of assurance that they require for each item. Wendy replied that the financial report as at acquisition date is very important, as are the transactions since negotiations commenced, but that she is willing to have less work done on the previous year’s management accounts. Required: Indicate the type of engagement that will most likely be undertaken for each of the three tasks and the level of assurance to be provided. Explain your selections.

Week 2
You have been the auditor of Data Ltd for two years. Your auditor’s report for Data for the year ended 30 June 2018 was unmodified, indicating that in your opinion the financial report gave a true and fair view. In August 2018, Data obtained a large loan from Better Bank Ltd, to provide additional working capital. Subsequently Data suffered severe trading difficulties and was placed into liquidation in late December 2018, with insufficient funds to repay the loan to Better Bank.

Required: Outline a defense for your audit firm to any legal action taken by Better Bank to recover its loss.

Week 3
You are an audit manager at Hall & Associates, who have been approached to conduct the audit of Computer Games Ltd (CGL), a manufacturer of interactive computer games, for the year ended 30 June 2013. Hall & Associates has not previously audited CGL’s financial report, although it has undertaken other types of engagements for CGL. Last year CGL hired Hall & Associates to assist in the redesign of CGL’s accounting software to ensure that internal controls over internet sales were adequate to ensure the confidentiality of customer data and accuracy of recording. The new software was implemented at the beginning of the current year and appears to be working satisfactorily. As part of this year’s audit, you expect to review the internal controls at CGL, including the controls within the IT systems.

As part of CGL’s financing arrangements with its bank, Easymoney Ltd, it has a loan covenant that stipulates that the quick asset ratio cannot be less than 1:1 or Easymoney Ltd has the right to withdraw all funding. The board has advised you that CGL’s quick asset ratio is currently at 0.9:1 due to industrial action holding up the sale of goods imported from overseas. The board has asked you to ignore this temporary breach of the loan covenant, explaining that CGL is a stable and financially sound company, and that the ratio will return to a positive level on resolution of the industrial dispute. The board has indicated that unnecessarily disclosing this within the audit report would force it to reconsider its plans to use your audit firm for other engagements. As a result of CGL’s current cash flow difficulties, the board has requested that Hall & Associate’s audit fee for 2013 be paid in CGL shares. The board has indicated that the market value of the shares will equate to the value of the audit fee charged by Hall & Associates.

The management of CGL is currently reviewing the structure of its audit committee to ensure that it complies with the requirements of the ASX Corporate Governance Principles and Recommendations. However, the board is confused by the reference in the ASX Corporate Governance Principles and Recommendations to both independent directors and nonexecutive directors, as they thought that they were the same thing. As a result, they have sought your advice concerning the structure of their audit committee.

Required: a) Identify and explain three separate key threats to Hall & Associates’ independence that may arise under APES 110. (3 marks) b) For each independence threat identified in a) above, describe the course of action Hall & Associates needs to take to ensure compliance with APES 110. (7 marks)

Week 4
You are the audit senior responsible for the audit of Sampson Limited. You are currently planning the audit for the year ended 31 December 20X7. 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) Sampson has planned to close an inefficient factory in country New South Wales before the end of 20X7. 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, Sampson 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.

Required: For each of the scenarios above, explain how the components of audit risk (inherent, control or detection risk) are affected.
Week 5
The following financial ratios have been calculated for Nova Ltd for the year ended 30 June 2008:

Actual Budgeted Previous year Industry average results results Current ratio 1.97 1.92 1.87 1.92 Quick asset ratio 1.06 1.06 1.06 1.11 Inventory turnover 4.21 4.91 4.86 4.76 Net profit ratio 0.05 0.03 0.03 0.03 Gross margin 0.65 0.59 0.61 0.61 Required: Provide possible explanations for the results for the various ratios for Nova Ltd and outline their implications for the audit.

Answer

Auditing Assignment Week 1
a. Local Proprietary Limited operated as a small-scale proprietary firm. This small-scale proprietary company didn't need to prepare its financial reports for every accounting period. Therefore, the company had a casual approach towards the preparation of its financial statements. Local Proprietary Limited provided management accounts for the accounting year ending at 30 June, 2017 and the most suitable assurance engagement that can be applied in such a scenario is Limited Assurance. It was also observed that Local Proprietary Ltd did not audit its financial statements ever since 2016, the same year the company received its certificate of incorporation. This makes it even more difficult for the Practitioner to conduct a detailed analysis of the unaudited financial statements provided by the acquired company as it is almost impossible to acquire sufficient evidence.

b. OEL is in-charge of providing documentation and relevant information from the date at which the negotiation of the deal has begun right until the date at which the settlement of the same has taken place. The most suitable assurance engagement that can be applied in this case is reasonable engagement. The Assurance Practitioner will be required to perform a detailed testing along with various other procedures on the documents and information that is provided by the acquiring company. The Practitioner can derive the reliability and genuineness of accounts with utmost precision and thereby conclude its completeness. The Assurance Practitioner will also need to apply multiple accounting standards to evaluate the credibility of the information that is provided by OEL.

c. The accounts of the acquired company remain unaudited since 2016, the year in which the same got incorporated. The acquiring company neither audited its accounts nor fulfilled statutory reporting requirements. This will disallow the assurance practitioner in performing relevant audit procedures and hence, he might issue limited assurance. The financial statements prepared by OEL on the date at which the acquisition took place will require the professional to provide limited assurance. Their lies a strong probability for the presence of errors and frauds in the financial statements of the Local Pty Limited and such a scenario, the professional must refrain from taking any sort of risk and he must provide limited assurance instead of providing reasonable assurance. From the above discussion, it can be learnt that a reasonable assurance must only be issued when the assurance practitioner is fully sure of the accuracy, completeness, correctness, and reliability of the financial statements of an organization. If he is not sure than he should issue limited assurance.

Week 2
The financial statements of an organization must remain free from frauds and errors. This is certainly because the financial statements of an organization reflect its actual financial wellbeing and these are certainly of great use to investors who develop significant investment related decisions based on them. The management of an organization must ensure that the financial statements are duly prepared and these have the least possible errors and frauds to safeguard the interests of the investor. The management is responsible for ensuring that the financial statements of an organization remain free from errors while the auditors are vested with the responsibility of conducting audit function to detect and eliminate the presence of frauds and errors in the financial statements and construct audit reports for the organization.

In the given case study, it can be learnt that there was no substantial audit evidence that can confirm the presence of fraud done by the employees or the management of the company and hence, there was hardly any requirement for reporting the same. The company was experiencing financial crisis owing to the poor performance of the market and lack of liquidity. The daily business operations were regular and the organization was even planning for expansion by entering into new markets. The company was even conducting necessary research work for being able to successfully enter into new markets and for this reason, the company was incurring certain expenditures every year but the final decision was yet not taken.

The auditors were unable to identify exact reasons that led to the company’s failure as the sanction of the fund for its expansion plan and its use started right after the audit period was over. The banking institutions have lent loans based on the financial statements that were recently audited and also based on the estimated and expected financial statements. The banks cannot hold the auditors liable in such a scenario as the latter was hardly associated with the approval of the projections of the financial reports. The difficulties faced in trading that lead to the company’s liquidation can be learnt by conducting the audit in the ongoing year and reporting the lacking of the same. The auditors detected fewer problems in the company’s internal control system and policies and the same is also mentioned in the audit report along with suitable suggestions.

Week 3
The auditors must follow the basic principles of auditing to ensure that the respect and dignity of the profession remain protected and lifted. The basic principles of auditing as stated by APES 110 are objectivity, integrity, professional behavior, professional competence, and confidentiality. (APES 110 2020) Integrity is one of the most important principles of the auditing profession. Integrity requires the auditors to remain true to their profession and he or she must refrain from performing any sort of fraudulent activity by intentionally acknowledging false and misleading information. An auditor must conduct himself professionally and be diligent, honest, truthful, and straight forward in his or her approach. The auditors must not perform activities that harm the integrity of the profession (CPA 2020). There are five threats that can impact the auditing function of an auditor. These threats are advocacy, self-review, self-interest, intimidation, and familiarity threats.

The three material threats faced by Hall & Associates are enumerated below.

i. Self Review threat: The company has designed its internal controls accounting system for reviewing its own work. This imposes self review threat on the auditing company and the integrity of the profession tends to get impacted (Livne 2015).

ii. Intimidation Threats: The auditing firm deals with intimidation threats as it is asked by the client for not disclosing the drop in the latter’s current ratio. Failure to agreeing to the demands of the client would compel the same to reconsider assigning future assignments to the auditing firm (Livne 2015). The audit firm should be sincere in its approach and must refrain from not disclosing the actual information in its audit reports.

iii. Self Interest Threat: The audit firm should refuse to accept the participation in the share capital of the audited firm and must ask the client to pay its audit fees in generally acceptable monetary methods.
(b)
i. The auditors are required to report the actual data and must refrain from approving the fabrication of information in the financial statements. The quick ratio desired by the banking institution is 1:1 whereas the current ratio of the company stands at 0.9:1. This information must be necessarily reported by the auditing firm as this is a very important financial data for the banking institution. The auditors might be held responsible if there is a failure to disclose this information (Murphy 2015). The client believes that this drop in its current ratio is a temporary phenomenon but the auditors must focus on the present numbers and report the information as it is in their audit reports.

ii. The company is facing cash flow crunch and this has lead to liquidity issues and therefore, the audit firm must review its going concern assumptions and make necessary disclosures as and wherever required. The company is offering to pay the audit fees to the auditors in the form of shares. The audit firm must refrain from accepting this offer and must take their audit fees through standard methods. According to APES 110, acceptance of any audit fees outside the standard monetary term imposes a huge threat upon the integrity of the auditors and might impact their independent judgment.

iii. There must be a minimum of three non-executive directors in an audit committee. The majority of the audit committee should comprise of independent directors. Both non-executive directors and independent directors are executives (AUASB 2019). An independent director is only entitled to receive remuneration and is not allowed to hold shares in the organization. A non-executive director is just like a regular director who does not have control in the daily business operations of the organization. The constitution and formation of the audit committee must be as per the ASX laws.

Week 4
a. The company hired a treasurer for taking care of the accountancy function. The treasurer might not be efficient and skilled enough to take care of the accounting responsibilities and he might end up committing unintentional errors which might aggravate the overall problem. The management is in charge of installing internal control systems and appointing skilled employees for every function. The failure of the management in hiring an accountant for performing the accountancy function can impose several risks and it might become impossible for the audit team to successfully detect the presence of frauds and errors in the financials of the company (Traistaru 2016).

b. Every organization faces audit risks. The presence of audit risks can come in the way of evaluating provisions related to closures. The probability of uncertainty is always there while determining the disposal of an asset. It becomes highly difficult for the audit firm to perform an audit when there are control risks in an internal controls system.

c. The company has come up with a scheme for boosting its sales numbers. The scheme proposed by the company offers bonuses and incentives to employees that ring in more sales for the company. There are higher chances for this scheme to backfire as the employees might adopt fraudulent activities for falsely increasing the monthly sales figures to earn a higher incentive. The company must ensure to modify this newly proposed scheme to avoid such incidents from taking place.

d. Another major problem faced by the audit firm is concerned with the shifting of data from the old system to the new system. The loss of data during such migration can become even more problematic if the same is impossible to retrieve. The audit function will get thoroughly impacted if there is a loss of data in the company.
e. The company hired an accountant for performing IT-related tasks such as system maintenance, data backups, and modifications. These tasks can be efficiently performed by IT professionals and the company must make sure it is hiring IT guys for this very purpose.

Week 5
a. Current ratios or CR are used for learning about the ability of firms in honoring their short term debt obligations (Cernusca & Balaciu 2015). In the given case, the CR of the company for the present year has marginally elevated as compared to the last year. The CR is very much the same in comparison to the industry average and therefore, its liquidity seems to be totally in sync with the industry standard. There is no need for audit in this segment as there is hardly any sort of adverse movement.
b. QR or Quick ratios are stronger indicators of a company’s ability to take care of its short term debt obligations. The QR, in this case, is very much the same as what was expected but still a bit lower in comparison to the industry standard. This signifies that the overall performance of the company is lower when compared with the overall industry. An audit must be necessarily conducted for understanding the reasons behind the deficit in the QR.
c. The inventory turnover ratio is lower in comparison to the standard result and this signifies the company’s inability in managing its stock movement. There is a strong need for the audit to be conducted in this scenario for understanding the stock movement as well as strengthening the inventory turnover ratio in the years to come.
d. The company has a strong profit earning ability and this can be confirmed by its gross profit ratio and net profit ratio. Both net profit and gross profit ratio have outperformed and surpassed the budgeted as well as the industry average. The reason for this enhancement in these ratios could be because of profound sales strategies, higher sales, identification, and elimination of unnecessary costs. There is no need to conduct an audit in this segment as the ratios do not show any adverse movement.

References
APES 110 2020, APES code of ethics, viewed 15 May 2020, https://www.apesb.org.au/uploads/standards/apesb_standards/23072019055710_APES_110_Code_of_Ethics_ for_Professional_Accountants_December_2010_-_Final.pdf AUASB 2019, Australian Auditing Standards, viewed 15 May 2020,
https://www.auasb.gov.au/Pronouncements/Australian-Auditing-Standards.aspx Cernusca, L and Balaciu, D.E 2015, The Perception of the Accounting Students on the Image of the Accountant and the Accounting Profession. Auditing assignment Journal of Economics and Business Research, vol. 21, no. 1, pp. 7-24.

CPA 2020, Apes 110 code of ethics for professional accountants, viewed 15 May 2020, https://www.cpaaustralia.com.au/professional-resources/accounting-professional-and-ethical-standards/apes-110-code-of-ethics-for-professional-accountants

Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 15 May 2020, http://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remediesfull

Murphy, G., 2015, A vision for the future: by using the most current technology and keeping their skills up to date, management accountants can enhance their careers and their organizations. Strategic Finance, vol. 97, no. 4, pp.62-64.

Traistaru, D.A., 2016. Perceptions concerning professional judgement and ethics in the evolution of the accounting profession. European Journal of Business and Social Sciences, vol. 4, no. 10, pp.126-135.