Wind Power Ltd, Mechanical Pty Ltd, Iron & Steel Ltd Auditing - Assignment Example

Auditing Assignment Name: Institution: Auditing Assignment Questions: QUESTION 1 Mr Paul Smith joined as the Senior Partner of Fair & Co (Fair), Chartered Accountants. Mr Smith reviewed Fair’s audit clients to ensure that the independence requirements of APES 110 are being complied with. His review has identified the following FOUR INDEPENDENT situations: Situation 1 Wind Power Ltd (Wind) is a listed company for which Fair has been an auditor for the last 5 years. Mrs Liz Taylor, the wife of Wind’s Auditor-in-charge, Mr Greg Taylor purchased substantial amount of shares in Wind on the advice of her financial advisor in the previous week. a) Familiarity threat: Mrs Liz who is the wife of Auditor in charge of the client has introduced a familiarity threat by purchasing a substantial proportion of the clients’ shares. This is particularly dangerous because the family relationship can make Mr Greg to become too sympathetic towards the clients interests perhaps because he would like to protect the interests of his wife. b) Safeguard: i) Applying standards processes to the audit of the entity. ii) Engaging a professional accountant from outside to review the work done and give his recommendations. c) The familiarity threat is not likely to be overcome by the safeguards and hence independence cannot be achieved. Mr Greg must therefore refuse to carry out the engagement with this particular client so long as his wife has financial interests with it (ICAA/NIA, 2008, p. 12). Situation 2 Mechanical Pty Ltd (Mechanical) is a company repairing automobiles, for which Fair has been an auditor for many years. Recently, both Mechanical and Fair have decided to combine their car industry expertise by forming a private company called “Auto Fast Pty Ltd” (Auto) for providing professional service to car dealers. a) Familiarity threat: A familiarity threat was introduced when both Mechanical and fair decided to form a company together. As such, Fair may not longer be in a position to objectively audit Mechanical. This is especially dangerous because the common business can make Fair to become too sympathetic towards the Mechanical interests perhaps because they would like to protect their interests. b) Safeguard: i) Applying standards processes to the audit of the entity. ii) Engaging a professional accountant from outside to review the work done and give his recommendations. c). The familiarity threat is not likely to be overcome by the safeguards and hence independence cannot be achieved. Fair must therefore refuse to audit Mechanical so long as they are doing business together (ICAA/NIA, 2008, p.12). Situation 3 One of the partners of Fair, Mr John Mansfield has been operating a hardware business with his family called Cheap-hardware Pty Ltd (Cheap). For the last two years, Fair has been auditor of Cheap and Mr Mansfield has been preparing the financial statements of Cheap. Mr Mansfield has not been the audit partner for Cheap in the past and is not the audit partner for the present engagement. a) Self-review threat : Mr Mansfield has been preparing the financial statements of Cheap and entrust it to be audited with another partner which leads to exposure to self-review threat. This is because one auditor is responsible for the worker of the preparer who is also a partner in the same firm. b) Safeguard: i) Applying standards processes to the audit of the entity. ii) Engaging a professional accountant from outside to review the work done and give his recommendations. c) Self review threat is not likely to be overcome by the safeguards and hence independence cannot be achieved. The auditor must therefore refuse to audit Cheap so long as it is owned by a partner within the firm (ICAA/NIA, 2008, p. 16). Situation 4 Iron & Steel Ltd (Iron) is a publicly listed company, which exports iron ore from Queensland. Mr Nick Travers, Fair’s Auditor-in-charge of Iron has recently purchased significant amount of shares of Ferries Australia Ltd (Ferries). The prospectus of Ferries disclosed that Iron is one of the two major shareholders. a) Self-interest threat By acquiring significant shares of the client, the partner has compromised his independence in auditing of that particular client since he wields a direct control over the company. This is because the auditor may no longer be in a position to objectively audit the client since he will tend to favour it because of the financial interest he has with it. b) Safeguard i) Applying standards processes to the audit of the entity. ii) Engaging a professional accountant from outside to review the work done and give his recommendations. c) Self interest threat is not likely to be overcome by the safeguards and hence independence cannot be achieved. The auditor must therefore refuse to audit Iron so long as it possess significant share with it (ICAA/NIA, 2008, p. 17). QUESTION 2 You are Audit Manager on the audit of Black Pearls Limited (Black), a pearling company based in Monkey Mia for the year ended 30 June 2010. The directors’ declaration and audit report were signed on 28 July 2010. The financial report and audit report were mailed to shareholders on 4 August 2010. You are reviewing the final report drafted by the Audit Supervisor and were made aware of FOUR INDEPENDENT situations given below: 1. On 10 June 2010, Pearl’s management had written down an investment in a pearl cultivation farm thinking that the Pearling Regulatory Authority (PRA) will not allow its commercialisation. To their surprise, on 27 July 2010, PRA gave Black the approval to commercialise the pearl farm. The changes should lead to adjustments at the financial statements since it provides additional evidence of conditions that existed at the date of the balance sheet and if not included in the statements, it can lead to material misrepresentation. This is an event that occurred subsequent to the balance sheet date and hence do not lead to adjustment of the financial statement. However, its disclosure is important so that the financial statement is not misleading. Additional procedures: make inquiries from the clients’ legal litigations, claims and assessments from the client’s legal counsel. Obtain a letter of representation concerning the matter from a senior official. 2. On 20 June 2010, Pearl entered into a contract to purchase “Black pearls” from High-Fashions Pty Ltd in Andaman Islands. The first batch of pearls were shipped FOB, the title passed to Pearl on 21 June 2010. At the time of entering into the contract, the content of “black pearls” was estimated as 70% and liability for the purchase calculated accordingly at year end. However, when the shipment was received by Pearl on 13 July 2010, the “Black pearl” content was found to be 90%, resulting in the liability being understated. The titled passed after the balance sheet date and hence should not lead to adjustments of the financial statements. The event is however material and hence should be disclosed as notes in the financial statements, to prevent the financial statements from misleading the readers. Additional procedures: the materiality of the liability as a result of adjustments should be established. The decision above will only hold if the possible liability is material. 3. On 22 July 2010, Pearl received notice that one of its customers was taking legal action in relation to a disputed warranty claim. The customer purchased “Pink pearls” in May 2010, and first informed Pearl of problems with the Pink pearls on 28 June 2010. The occurrence of the event is not probable, and even if it occurs, it is not material and hence no action should be taken for the year ended 30 June 2010. Additional procedures: procedures should be carried out to establish the possibility of the event occurring together with the materiality of such occurrence. 4. On 30 September 2010, Shell settled a lawsuit for about twice the amount accrued in the financial report for the accident which took place on 20 August 2010. The event has occurred after the financial statements have already been issued to the shareholders and hence not action can be taken for the current financial year. No additional procedures since the event has happened after the statements have already been issued to the shareholders (Gay and Simnett, 2010, p. 65). QUESTION 3 Blue-fin Tuna Seafood Ltd (Blue-fin) is an Australian company based in Port Lincoln and an on-going client of your audit firm for the last five years. In the past you have been issuing unqualified audit reports. Before commencing this financial year’s audit, you discussed the following independent situations with its Finance Director.  The Korean market has grown rapidly over the last three years and has become the company’s most significant customer base, being 70% of Blue-fin’s total sales amount and volume. The sale contracts are in US dollars. Valuation The inventory is valued at the lower of cost and market value. If the market value is less than the cost, the assertion will be at a risk of overstating or understating the real value due to fluctuations of exchange rate. Tests Trace the records of costs to the vendor in regard to the purchased inventory. Review the cost accumulation and overhead allocation procedures in regard to the manufactured inventory. Examine the inventory items for sign so of excessive age and damage. Determine the current net realisable value and ensure that all the inventory has been recorded at realizable value is less than cost.  Due to language differences between Blue-fin and the Korean customers, it is unlikely that the Korean customers will respond to requests of Blue-fin to confirm their outstanding balances at year end. Presentation and disclosure Some of the account receivable may fail to get settled as a result of the language barrier which put the business at the risk of not describing and disclosing the doubtful debts or setting aside enough provision for doubtful debts. Tests Read through the financial statement to make sure that the appropriate disclosure such as doubtful debt and provision for doubtful debts has been made.  the global financial crisis over the last year has caused the volume of sales orders from Korean customers to fall by 30%, and its three major Korean customers have requested for extended payment terms. Presentation and disclosures Some of the account receivable may fail to get settled as a result of the language barrier which put the business at the risk of not describing and disclosing the doubtful debts or setting aside enough provision for doubtful debts. Tests Read through the financial statement to make sure that the appropriate disclosure such as doubtful debt and provision for doubtful debts has been made.  Blue-fin is under severe pressure from Indonesian competitors who have reduced their export tuna prices by nearly 15% of Blue-fin’s export prices. Valuation The inventory is valued at the lower of cost and market value. If the market value is less than the cost, the assertion will be at a risk of overstating or understating the real value due to competition from Indonesian firms who have reduced the prices of their goods. Tests Trace the records of costs to the vendor in regard to the purchased inventory. Review the cost accumulation and overhead allocation procedures in regard to the manufactured inventory. Examine the inventory items for sign so of excessive age and damage. Determine the current net realisable value and ensure that all the inventory has been recorded at realizable value is less than cost (Gay and Simnett, 2010, p. 65). QUESTION 4 You are the Audit Manager for your client Build Roads Ltd (Build), a large road building company. You are making an annual examination to express an opinion on the annual financial report to the shareholders of Build. Required Using the relevant auditing standard state the specific sections and comment on at least three (3) issues for each of the following matters: a. What are the auditor’s responsibilities in relation to going concern of a client at the planning stage? ISA 570.11 requires the auditor to obtain an understanding of the entity through consideration of any events or conditions and the resultant business risks which may significantly casts suspicion on the ability of the entity to continue as a going concern. This consideration is essential when reviewing the threat of material misstatements, which may affect the timing, nature and the scope of procedures which the auditor undertakes in regard to those risks. The auditor is also required to review the preliminary assessment in regard to appropriateness of the going concern assumption which has been undertaken by the management. Alternatively, the auditor can hold discussion with the management to identify any issue which may cast doubt. The auditor will then use the information he has acquired to plan for further investigations. b. Why should the auditor be alert to related parties transactions and what audit procedures should be used to identify related parties? SFAS 57 emphasizes the disclosure of related parties because GAAP require its disclosure together with the control relationships. Also, lack of adequate disclosure can lead to potential distortion or misleading financial statements. Another reason for the emphasis is because undisclosed related parties could be harbouring instances of fraudulent financial reporting and misappropriation of assets. Audit procedures to identify the related parties can involve inquiry and review of relevant information which can help in identifying the related parties, while placing emphasis on identification of material related-party transactions. Indications of previous instances of undisclosed material transitions should be closely examined. Inquiry from management can help discover the names of all related parties and whether there were any transactions with such parties during the current period. The auditor should obtain names of all trusts such as pensions which have been established together with the names of the officers of those trusts. Principal stockholders of closely held entities can be identified through review of the available listings. The audit staff should then be provided with the names of the known parties so they can identify their transactions in connection with the entity. To further identify undisclosed relationships, the auditor can review the extent and nature of the business transacted with major suppliers, customers, borrowers or lenders. Finally, the auditor can consider whether the transactions which are occurring are given accounting recognition. (c). Outline the considerations that affect the nature, timing and extent of tests of control. Timing of testing Testing can be scheduled throughout the year or quarterly depending on how the control coincides with preparation of financial statements. If the financial statements are prepared only at the end of the year, then there is only one opportunity of timing the test of controls-at the end of the year. Extent of testing The extent of testing depends on the risk of error and materiality. It also depends on the risk of failure of the control which is also referred to as risk of misstatement as a result of a control failing. The extent of tests is expanded where high risk of failure is expected. Nature of test The connection of the risk exposure to the internal control system determines the nature of the tests. It also depends with the complexity and the size of the entity. The nature of assessments in entities operating under stable environments is usually limited. (d). Why is assessment of what is material a matter of judgment for both qualitative and quantitative materiality assessments? Information is considered to be material if its misstatement or omission can influence the economic decisions of the users after relying on the financial statements. As such, materiality depends on the error or size of the item being judged within particular circumstances of its misstatement or omission. Thus, materiality provides a cut-off or threshold point rather than being a basic qualitative or quantitative characteristic upon which information must have if it is to be useful (Gay and Simnett, 2010, p. 85). QUESTION 5 The following are FOUR INDEPENDENT situations which you have discovered during your audits for the year ended 30 June 2011. Assume that all amounts involved are material: 1. Mobile innovations Ltd (Mobile) produced a new mobile phone and applied for worldwide patent. As it was considered very valuable, Mobile debited the asset account with the fair value of its patents. This was significantly more than the amount that was spent on “research and development” (R&D) of the machine. Despite your drawing their attention to its non-compliance with AASB138, the directors of Mobile showed R&D asset at fair value. Qualified Reasons: None compliance to AASB138 and GAAP for the valuation of patents does not affect the rest of the financial statement but its materiality warrants qualification of the report. 2. Chamber & Choir Pty Ltd (Chamber) organises famous artists to perform in Australia. A well known soprano had been booked by Chamber to perform in Perth and the payment to them was to be made in British Pounds. With the fall in Australian dollar, Chamber was not able to pay the soprano and the event was cancelled. It is expected that the soprano will sue Chamber for damages. Chamber does not have any other income, cash or assets to pay them. Disclaimer of opinion: Reasons: There is a substantial doubt about Chambers’ ability to continue as a going (SAS No. 59). This is because Chamber does not have any other income. 3. High-rise Apartments & Co Ltd (High-rise) purchases large vacant blocks of land and constructs apartment buildings on it. The manner in which High-rise has allocated costs to these blocks of land is in question. Your investigation shows that the apportionment of costs to apartments sold has been kept low in order to boost profits. In your opinion, this has resulted in the overvaluation of the unsold blocks of land. The directors of the company do not agree with you. Adverse Reasons: I cannot give an opinion because there are significant uncertainties within the client since the management has resulted into substantial overvaluation of key assets and yet they are not ready to cooperate with me-my independence is at stake (SAS No. 26; SAS No. 7). 4. Medical Help Pty Ltd (Medical) is company providing medical support to poor people. It has not kept proper donation receipts and payment vouchers for most of the transactions. Medical has been paying amounts of “honoraria” to doctors, without deducting income tax (Pay As You Go Withholding). You have taken expert advice that income tax needs to be deducted from the “honoraria”, but the directors believe that Medical does not have to make any tax deduction. Qualified Reasons: None compliance to GAAP for failure to deduct tax from the honoraria does not affect the rest of the financial statement but its materiality warrants qualification of the report (Gay and Simnett, 2010, p. 45). References Gay, G., & Simnett, R. (2010). Auditing and assurance services in Australia (4th ed). Melbourne: McGraw-Hill. The Institute of Chartered Accountants in Australia (ICAA), & the National Institute of Accountants (NIA). (2008). Independence guide: interpretations in a co-regulatory environment. The Joint Accounting Bodies, 3, 12-18. Read More