Question bank Flashcards
1.1 The managing director of Airedale Ltd has approached your firm and requested a second opinion on the auditor’s report which its current auditors are proposing to give on the financial statements for the year ended 31 July 20X7. The proposed auditor’s report expresses an adverse opinion due to disagreement over the accounting policies adopted in the financial statements.
Requirement
Identify the ethical issues that may arise for your firm and state, with reasons, how your firm should deal with the request.
1.1 Ethical issues and procedures
* May compromise the opinion of the existing auditor
* Client may be opinion shopping
* May be a threat to professional competence and due care, if not in possession of all the facts
* Audit firm may be tempted to give the opinion the client desires in order to obtain the audit in future
* Obtain client’s permission to contact the existing auditor
* Notify auditor of the work to be undertaken
* So that your firm is in full possession of all the facts
* If client refuses permission, decline to act
1.2 If the regular fees from a client company or group of companies constitute a substantial proportion of the fee income of an audit firm, a self-interest threat is likely to arise so as to impair objectivity.
Requirement
Set out the safeguards a firm should use to recognise this threat and the procedures available to offset it.
1.2 Safeguards re fee
To recognise threat
* Regularly review situation as client profile changes
To offset threat
* Consider whether the firm could be open to criticism and either:
– refuse appointment; or
– introduce safeguards, including independent review and disclosure to ethics partner and those charged with governance.
* Do not accept the assignment if total fees regularly exceed 15% of annual fee income (or 10% for listed company), although it may be possible for another part of the firm to carry out the work.
1.3 You are planning the audit of Sports results-a-minute.com. You have ascertained that the company has overdue fees of £15,000, being the previous year’s audit fee.
Requirement
Explain the threat to your firm’s independence and state the action your firm should take in respect of this matter.
1.3 Overdue fees
* Overdue fees constitute a self-interest threat to independence (ES S4)
* Issue of unmodified report this year may increase chance of collecting overdue fees
* Ideally arrange for settlement of the overdue fees
* Consider resigning from the engagement if not settled and fees are:
– significant
– in dispute
* If do not resign apply appropriate safeguards (eg, second partner review)
* And notify ethics partner
1.4 During the audit of Cairn Ltd, the audit senior discovered that some of the company’s customers had paid invoices twice. The overpayments had not been refunded and had been credited to the statement of profit or loss. The managing director told the audit senior that these customers, which are government bodies, periodically pay the same invoice twice. He also told the audit senior that he has no intention of repaying the money unless the customers ask for it to be repaid.
Requirement
State, with reasons, the action the audit senior should take in respect of this matter.
(3 marks)
1.4 Actions
* Report to Money Laundering Reporting Officer (MLRO) within the firm
* Report to National Crime Agency (NCA)
* Avoid tipping off the client
* So as not to prejudice legal proceedings
* Recommend repayment to customers
* Ensure included as liability not income
Reasons
* Represents proceeds of crime/theft
* Criminal offence if auditor does not report
A fraud has recently been discovered, involving the chief buyer in the purchasing department of Rodney Ltd and a purchase ledger clerk in the accounts department over a period of two years. The managing director of Rodney Ltd has written to the company’s auditors claiming that they had a responsibility to detect frauds during the course of their audits, and requesting an explanation as to how they could have missed it.
Requirement
What points should the auditors make in response to the managing director?
1.5 Points re fraud
* Duty is to report on financial statements
* No responsibility as such to detect fraud
* An audit conducted in accordance with ISA® Standards obtains reasonable assurance that the financial statements are free from material misstatement whether caused by fraud or error
* Auditors may not find material frauds
* Frauds involving collusion harder to detect
* Responsibility set out in engagement letter
* Management is responsible for implementing and monitoring the system of control
1.6 Dimension Ltd is a software company providing e-commerce solutions to business. It was incorporated on 1 April 20X8 and revenue has doubled each year. Rapid expansion is expected to continue for the next few years. This growth requires heavy investment in working capital, particularly work in progress and receivables, and the company will be seeking a substantial increase in the borrowing facility from its bankers when the present facility is due for annual review in September 20X1.
The increase in revenue in the year ended 31 March 20X1 has taken the company over the exemption threshold, and it is obliged to have a statutory audit for the first time.
Requirement
List the benefits that the company may obtain from the statutory audit.
(2 marks)
1.6 Possible benefits
* Independent confirmation of profits earned/net assets
* Assurance of compliance with Companies Act
* Recommendations on systems via management letter
* Added credibility of accounts will help negotiations with bank
* Reliable financial information for business decisions
1.7 You have been invited to tender for the audit of Data plc, a company that owns and operates 35 hotels in the south west of England. You have not previously acted for Data plc, but you are the current auditors of Lodge Ltd, a company that owns and operates hotels in 30 out of the 35 towns in which Data plc operates. The hotels operated by each company offer similar facilities to each other at a similar price.
Requirement
Identify and explain the principal ethical issue that you may need to consider when deciding whether or not to tender for the audit of Data plc, and state the procedures you may need to implement in the event that your tender was successful.
1.7 Principal ethical issue
Confidentiality
* Data and Lodge may perceive threat of disclosure/use of information
* Conflict of interest for audit firm
* Difficult to act in best interest of both clients
Procedures
* Ensure staff are aware of confidentiality issues
* Staff to certify they are aware of procedures
* Obtain informed consent of both clients/inform both clients
* Use different partners and teams
* Independent review of arrangements for ensuring confidentiality maintained
* Information barriers in place
1.8 You are the auditor of Royale Ltd, a manufacturer of fireworks. Following a disappointing last three months of trading, the company has requested an extension to its overdraft facility from its bankers. The bank has in turn asked your firm to provide a report on the company’s working capital, focusing on the recoverability of trade receivables and inventory.
Requirement
Explain the benefits and limitations to both the bank and Royale Limited of obtaining the working capital report.
1.8 Benefits
To the bank
* Reduces uncertainty as to reliability of the information/increases credibility
* Reduces the risk of management bias/independent
* Enables bank to determine risk in advancing more money to Royale
To Royale
Enables them to obtain the overdraft which may not be possible without the report
Limitations
To the bank
* Not all receivable and inventory balances will be looked at by your firm
* Possibility of collusion or misrepresentation
* Evidence likely to be persuasive rather than conclusive/assurance not absolute – reasonable or limited level of assurance depending on scope of work
* Report may not highlight full extent of problem/lack of sufficient information
* Inherent limitations of accounting system/integrity of data
1.9 Mrs Wallace is the audit partner in her firm for Racdale Ltd. She has just been appointed a trustee of the Racdale Family Trust, which owns 20% of the shares in Racdale Ltd. She replaces the family solicitor who has just retired. In addition, Mr Netwater, the audit manager for Racdale Ltd, has given one month’s notice that he will be leaving the firm to become finance director of the company.
Requirement
State the threats to independence that these situations pose, and the safeguards that the firm should employ to maintain objectivity.
1.9 Threats to independence and safeguards
Mrs Wallace
* Self-interest threat
* Trustee interest held by a person in a position to influence the audit is only allowed by ES S2 where:
– Mrs Wallace not a beneficiary of the trust
– the financial interest held by the trust in Racdale Ltd is not material to the trust
– trust is not able to exercise significant influence over Racdale Ltd
– Mrs Wallace does not have significant influence over investment decisions made by the trust
* Therefore transfer audit responsibility to another partner
Mr Netwater
* Familiarity/self-interest/intimidation threat
* Should be removed immediately from audit role
* Review of the audit work performed by Mr Netwater in the current year and, where appropriate, most recent audit
* Firm should reassess composition of audit team
1.10 The following is an extract from an independent accountant’s unmodified report on a profit forecast:’Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast.’
Requirement
Describe the level of assurance provided by this statement and explain how and why it differs from the level of assurance provided by an auditor’s report on annual historical financial statements.
(4 marks)
1.10 Accountant’s report on profit forecast
Comment
* Negative assurance which is limited assurance
How it differs
* Audit provides high level of assurance which is reasonable/not absolute assurance
* Opinion expressed in positive terms
– Give a true and fair view/prepared in accordance with Companies Act/directors’ report
consistent
Why it differs
* Financial statements are based on fact as well as judgement
* Persuasive evidence available
* Often the delay between reporting date and auditor’s report means that even items such as provisions/estimates can be substantiated
* Scope of work on forecasts is limited as forecasts are based on assumptions about the future and as such are subject to uncertainty
1.11 Your firm acts as auditor to Columbus Ltd, a retail car dealer. During the course of your audit for the year ended 30 June 20X5, you discover that the company’s sales manager, helped by the accounts clerk, has deliberately falsified details of the value of vehicles sold in order to increase his monthly bonus payments.
Requirement
Set out your responsibilities in respect of the above matter and contrast these with the responsibilities of the management of Columbus.
(3 marks)
1.11 Responsibilities
Auditor responsibilities
* No responsibility to prevent fraud
* Responsibility to detect material misstatements in the financial statements whether due to fraud or error
* Must design audit procedures to obtain reasonable assurance that financial statements are free from material misstatement whether caused by fraud or error
* Must make report to relevant authority under money laundering regulations
* Must not tip-off sales manager or accounts clerk
Management responsibilities
* Responsible for preventing fraud
* Responsible for detecting fraud
* Must implement system of internal control suitable for the business and monitor such systems
* Responsible for safeguarding the assets of the company
1.12 Your firm’s largest client is Count Ltd (Count), a non-listed company. The statutory audit fee amounts to £468,000 per annum. In addition, your firm provides tax services to Count worth £179,000 per annum. Your firm’s total fee income for the current year is estimated at £6,200,000 including all the fees from Count described above.
Requirement
Outline the ethical issues and state how your firm should address these issues.
(3 marks)
1.12 Ethical issues
* Fee income from Count amounts to 10.44% of firm’s total fee income
* This is above 10% ‘review’ limit in ES S4 for non-listed client
* But under 15% limit
* Self-interest threat – firms objectivity may be impaired if fear losing major client
* Self-review threat for tax work if numbers impact financial statements
How address
* Disclose fee % to ethics partner and those charged with governance at Count
* Internal engagement quality review by partner not connected with audit
* If likely to exceed 10% on regular basis should arrange external quality review
* Separate teams for audit and tax to counter self-review threat
* Consider resignation from tax engagement
1.13 Your firm is the external auditor of Kerry Ltd (Kerry) for the year ended 31 May 20X9. Following a due diligence investigation by your firm, Kerry acquired in January 20X9 the trade and assets of Blue Ltd from the liquidator. These assets are included in Kerry’s statement of financial position at 31 May 20X9.
Requirements
Identify and explain the principal threat to your firm’s objectivity in respect of the audit of the financial statements of Kerry for the year ended 31 May 20X9 and state the safeguards that should be applied.
1.13 Threat
* Self-review
* Audit team may be reluctant to identify impairments
* Audit team may rely too heavily on colleagues’ work
Safeguards
* Members of the audit team should not have been involved in the due diligence investigation
* Independent partner or quality review
1.14 Explain why an external auditor of a company should be objective and independent.
(2 marks)
1.14 Reasons why external auditors should be objective and independent
* Issues arising in the preparation of financial statements involve the use of judgement
* The auditor therefore needs to be unbiased in forming the audit opinion
* Directors may make biased or inappropriate judgements
* The auditor needs to adopt rigorous and robust approach to identify such bias or
inappropriate judgement
* The audit opinion should be based only on the available audit evidence and no other factors
* Independence increases the likelihood that an auditor will be objective
* A lack of independence may reduce public confidence in the auditor’s objective view
* Which would reduce the credibility and reliability of reports and opinions issued by auditors
* Objectivity and independence are required by Ethical Standard S1 and the Companies Act
1.15 Your firm has been the external auditor of Moose Ltd (Moose) for a number of years. Adam Flayman has been the engagement partner for four years. Moose is in the process of becoming a listed company and its directors have requested that Adam Flayman continue as the engagement partner once the company is listed.
Requirements
Discuss the ethical issues arising and any safeguards that your firm should adopt in respect of the directors’ request.
1.15 Ethical issues and safeguards in respect of long association with a client who is in the process
of becoming a listed company
* There is an issue of long association with Moose Ltd
* Which may lead to a familiarity threat
* The audit partner may be too trusting of the client or the client’s representations
* Ethical Standard S3 guideline for rotation of unlisted company engagement partners is 10 years
* For listed companies the engagement partner must not act for more than five years
* Where the entity becomes listed the length of time the partner has already acted must be taken into account
* If the partner has served four years or more, they may continue for no more than two years
once listed
* Adam Flayman has served for four years and therefore may continue for a maximum of two
years
* If Adam continues for two further years after listing safeguards will be required
* Such as independent partner review of the audit work
* Should communicate the maximum number of years to the client
* Document reasons for allowing Adam to continue
* Self-interest threat may arise if fear losing client by failing to meet the directors’ request
* Seek advice from ethics partner
1.16 Describe the role of the ethics partner within an external audit firm.
(3 marks)
1.16 Role of ethics partner within an external audit firm
* Responsible for adequacy of firm’s policies and procedures regarding integrity, objectivity and independence
* Responsible for firm’s compliance with the FRC Ethical Standard
* Responsible for effectiveness of communication on ethical matters to partners and staff
* Provides ethical guidance and advice to individual partners and teams
* Gives consideration to whether policies and procedures are properly covered in training
* Provides guidance where difficult and objective judgement needs to be made or a consistent position reached
* Assesses implications of any breach of the FRC Ethical Standard
* Determines whether any safeguards can be put in place or whether there is a need to resign from engagement
1.17 During the external audit of Kipper Ltd (Kipper), an employee informed the audit senior that the managing director of Kipper had instructed them not to record a transaction in the accounting records. The transaction involved a cash deposit which was paid into the company’s bank account and a week later the same amount was paid by Kipper, via direct transfer, into a bank account of David Hake, a friend of the managing director. The amount is not material in the context of any of the key figures in the financial statements.
Requirements
State, with reasons, how the audit senior should deal with this matter.
(2 marks)
1.17 Actions
* Report to firm’s Money Laundering Reporting Officer (MLRO)
* Without tipping off
* There is suspected money laundering
* Appears to be disguising/transferring proceeds
* No de minimis where money laundering concerned
1.18 Explain the fundamental principle of professional competence and due care and provide two examples of how a firm of chartered accountants can identify whether its partners and staff are complying with this principle.
(4 marks)
1.18 Professional competence and due care
* Maintain professional knowledge and skill at the level required to ensure that clients receive a professional service, based on current developments in practice, legislation and techniques
* Act diligently and in accordance with applicable technical and professional standards when providing professional services
Identify compliance
* On the job supervision of junior staff
* Review of juniors’ and seniors’ work by manager
* Hot/internal quality reviews
* Cold reviews/monitoring
* Staff appraisals
* Staff training
1.19 During the external audit of Milk Ltd (Milk) you discover that the directors have accounted for research costs inappropriately resulting in a material misstatement in Milk’s financial statements. Your firm plans to issue a modified audit opinion if the misstatement is not corrected. During a conversation with your firm’s audit partner, Milk’s managing director, Hazel Blue, indicated that it is the directors’ intention to seek the removal of your firm as external auditors if your firm issues a modified audit opinion in respect of this matter.
Requirement
Explain the actions that your firm should consider taking in response to the conversation between Hazel Blue and your firm’s audit partner.
Actions and explanation
* Discuss the issue with the directors and request that they amend the financial statements as the issue may be avoided if the directors understand the problem of incorrect accounting treatment.
* Reconsider other areas of the audit or undertake an independent internal quality review as the intimidation threat may have impaired objectivity on other aspects of the audit work.
* Seek legal advice or advice from the ethics partner in order to ensure that the firm’s exposure to any risk is limited.
* Consider resignation as the directors’ actions represent an intimidation threat and breakdown of trust as well as raising doubts about management’s integrity.
1.20 Your firm has received notice from Pisces plc (Pisces), a listed company, that it will not be reappointed as an external auditor when its term of office expires as the audit committee of Pisces has recommended the appointment of another firm.
Requirement
Set out the rights and responsibilities of your firm, including those under the Companies Act
2006, relating to the change in appointment.
Rights
Outgoing auditors may:
* make written representations and request directors to circulate to members
* attend and speak at general meeting
Responsible
* Prepare a statement of circumstances:
– specifying reasons for ceasing to hold office
– to be deposited at Pisces’ registered office and copy to be sent to Registrar of Companies
* As Pisces is listed, there is no option to state there are no circumstances
* Obtain permission from client to reply to prospective auditor’s communication
* Return promptly all books and records of the company
* Maintain client confidentiality after ceasing to act
* Maintain anti-money laundering identification records
Your firm has informed its external audit client, Lion Ltd (Lion), that it will not be seeking reappointment at the end of its term of office because of a disagreement with Lion’s directors over the treatment of an accounting item. Charn LLP (Charn), a firm of auditors, has recently written to your firm requesting information that might influence its decision to accept appointment as external auditor of Lion.
Requirement
State your firm’s responsibilities in relation to Charn’s request, as set out in the ICAEW Code of Ethics.
Firm’s responsibilities:
* Obtain authority from the company to discuss Lion’s affairs with the new auditor
* Answer promptly the request for information
* Record in writing any discussions with Charn
* Confirm to Charn that there are matters about which they ought to be aware
* Explaining these matters meaningfully (honestly and unambiguously)
* This should include an explanation of the differences of opinion between the firm and Lion regarding the accounting treatment
* If Lion refuses to grant the firm permission to discuss the client’s affairs, the firm should report that fact to Charn
What ES does giving incentives for non-audit services being sold to audit clients break?
ES S4
What threats are caused by the audit firm helping with the Prep of FS?
Management threat
Self review threat
What must you always consider with money laundering except reporting it?
The effect on FS
