Question 1 (15 marks)
The audit partner has just advised you that he has been approached to accept the appointment of auditor to Games Limited. Games Limited is a manufacturer of gaming machines and has been named in a recent anti-corruption enquiry as having offered incentives to state government members to support a proposed bill which would allow an increased number of gaming machines in licensed premises. No charges have yet been laid against Gaming
Limited’s or any of its employees. The audit partner explains to you that Games Limited’s auditors were re-appointed for the current financial year at the Annual General Meeting held two months ago. However, Games Limited managing director is unhappy with the existing auditing firm as the audit partner assigned to Games Limited has been changed.
The audit partner is unsure whether he should accept the appointment and has asked you to outline any ethical, legal and other factors to be considered in his decision about whether to accept the appointment for the current year, and to indicate the steps that need to be taken prior to the appointment. (5 marks)
Mitchell is part of an audit team who has been sent to Mexico to conduct an audit of one of their client’s subsidiary companies. During the audit Mitchell uncovers a series of bribes that the company has paid to local authorities. Bribes are considered a normal part of business in this particular city so the subsidiary company feels as though they have done nothing wrong. Mitchell thinks of herself as an honest person and is trying to decide what is ethically appropriate.
Determine what decision Mitchell will make regarding whether or not she will report the bribes by applying ethical theories of teleology and deontology. (5 marks)
China and Chong, accountants, were employed for several years by Bulls Co. Ltd to make annual audits. As a result of a change in control, in company discontinued the engagement of Chin and Chong and retained another firm of accountants. Bulls Co. thereupon demanded that Chin and Chong surrender all working papers they had prepared in undertaking audits for the company.
Chin and Chong refused on the grounds that the working papers were their property. The company brought legal action to recover the working papers. Should it succeed? State briefly what the law is, in general, as to ownership of auditors’ working papers. (5 marks)
Question 2 – (20 marks)
Delta audit firm was planning the audit for its existing client, Apple and Banana Corp. Which is a small retailing company that does not have any warehousing facilities as all stock is kept on the premises and they only have a small team of staff, which makes the separation of duties principle difficult. The preliminary tests of controls found that the internal control procedures are well designed, but not always observed due to the small number of staff. Previous experience with this client also showed that controls were not always observed.
Despite this, Delta has never discovered a material misstatement in the accounts.
Determine and justify what audit strategy should be used? (5marks)
FUN Limited is a large public company whose year-end is 30 June 20X0. FUN operates 3 divisions: entertainment, hospitality, and tourism & leisure. Each division is run as a separate business, with its own accounting system and management team. While planning the audit of FUN, you become aware of the following independent and material situations.
i. The entertainment division owns the largest chain of cinemas in Fiji. Owing to changes in technology in the USA, movie distributors will shortly begin releasing films using a recording that is incompatible with the movie projectors used by FUN. Approximately 70% of the movies the entertainment division screens are sourced from the USA. The movie projectors currently have an estimated useful life of 4 years. FUN has sufficient financial resources to purchase and install new movie projectors without interpreting cinema operations.
ii. In March 20X0 the entertainment division introduced a new general ledger system. Apart from a few teething problems the systems seems to be functioning well and now produces a range of management reports that were not previously available. Owing to an oversight by your firm’s computer audit division, no audit staff were present during the conversion process.
iii. The Hospitality division is involved in a luxury hotel development on an island in Indonesia. The project is currently around 60% complete, and FUN is carrying around $70m of work-in- progress related to the project in its balance sheet. The Asian economic crisis has cast doubts on the future of the project, with estimates of hotel patronage and revenue falling on a weekly basis. iv. Under the terms of its bank loan the hospitality division must maintain 3 key financial ratios at set levels or risk the loan being immediately recalled. Owing to the downturn in the hospitality industry, the division is currently in breach of 2 of these ratios. The directors are currently negotiating the loan terms with the bank, arguing that although the hospitality division is in breach, overall
FUN’s ratios are within set limits.
Tourism & Leisure division
v. The tourism & leisure division manages 3 ski lodges in Nadi on behalf of the private investor. In March 20X0 unusually heavy rains caused land slippage, which badly affected the foundations of these lodges. Preliminary reports suggest that the lodges will have to be demolished and rebuilt. The private investor is taking legal action against FUN, claiming that a lack of proper maintenance work caused the slippage.
vi. Approximately 30% of the division’s revenue comes from organizing and selling tour packages to travel agents. The tour packages are tailored to the needs of tourists from Korea, Japan and Thailand. Selected travel agents are given a certain number of packages, which they allocate to customers once a deposit is paid. On account of the economic downturn in Asia, travel agencies are experiencing late cancellation rates of around 50%. Although the customers are liable for the full cost of the tour for cancelling on short notice, FUN has found it is unable to collect most of the money owing as the customers simply lack the capacity to pay.
For each of the situations (i ) to (vi):
a) How will the situation affect your audit plan? (5 marks)
b) What further information would you seek prior to finalising your audit program?
c) According to ISA 315, an auditor needs to take certain steps to understand the entity and its environment. Outline these key steps. ( 5 marks)
Question 3 – (15 marks)
Briefly discuss recent developments of the common law regarding the liability of auditors to third parties, with reference to the major cases since 1963. (5 marks)
Part B (10 marks)
Jacobs Jack, the owner of a small company, asked Janet Jones, a public accountant, to conduct an audit of the company’s records. Jack told Jones that an audit was to be completed in time to submit an audited financial report to a bank as part of a loan application. Jones immediately accepted the engagement and agreed to provide an auditor’s report within 3 weeks. Jack agreed to pay Jones a fixed fee plus a bonus if the loan was granted.
Jones hired 2 accounting students to conduct the audit and spent several hours telling them exactly what to do. Jones told the students not to spent time reviewing the controls but instead to concentrate on proving the mathematical accuracy of the ledger accounts and summarizing the data in the accounting records that supported Jack’s financial report. The students followed Jones instructions and after 2 weeks gave Jones the financial report, which did not include footnotes. Jones reviewed the financial report and prepared an unqualified auditor’s report. The working papers, however, did not refer to the use of acceptable accounting policies or compliance with relevant regulations and statutory requirements.
Jack received the loan from the bank. Unfortunately, 6 months later Jack was forced into liquidation due to financial difficulties. As a result, the bank was unable to recover the amount of the loan. The bank is now attempting to recover its money from Jones on the grounds that Jone’s audit was report was negligently prepared.
Required: (Provide specific case references to support your answer)
a) Do you believe Jones has used reasonable skill and care in conducting the audit?
b) Do you believe Jones owes the bank a duty of care?
1. The course textbook is:
Leung, P., Coram, P., Cooper, B., Richardson, P., 2011, Modern Auditing & Assurance Services, 5th Edition, John Wiley & Sons Limited, Australia.