Part A (20 marks)
You are an audit partner with R David & Associates, a large and experienced audit firm.
You have been approached to accept the audit of Darwin Pharmaceuticals Pty Ltd (DPPL), a medium- sized chemical manufacturer. The manufacture of the chemicals results in highly toxic waste and DPPL is currently under investigation by the Environmental Protection Agency for a significant spill of toxic chemicals into a nearby river. The media have reported that senior employees were allegedly involved in trying to cover up the spill.
Identify and explain the key ethical matter regarding DPPL and its management that you should consider before making the decision to accept the engagement. (2 Marks)
Darwin Pharmaceuticals Pty Ltd (DPPL) imports a number of pharmaceutical products. In order to hedge its foreign currency transactions, DPPL entered into a number of forward rate agreements this year. Prior to this time DPPL had had little exposure to derivative instruments, but a series of bad experiences resulting from fluctuating exchange rates convinced the company that a hedging strategy was necessary. During planning for the audit of DPPL, the company’s hedging arrangements were identified as inherently risky and increased testing was carried out in this area. A number of small errors were noted in accounting for hedge transactions, but there did not appear to be any material errors and as such no adjustments were made. A review of the audit file suggests that the errors noted were a result of inexperience and poor controls in the area. While all of the errors were brought to the attention of the treasurer, who is responsible for the company’s hedging strategy, no further action has been taken to date.
Outline what further action the auditor should take in response to the errors and control weaknesses identified. Justify your response. (2 Marks)
R David & Associates has agreed to take on a new audit client, Reaction Pty Ltd, a small garage door manufacturer that has never previously been audited. R David & Associates has issued an engagement letter prior to commencing work for the current year. While conducting the audit, the audit team is unable to gain sufficient appropriate audit evidence around accounts receivable due to a lack of documentation. You have informed client management that you need to issue a modified auditor’s report due to the scope limitation. In response, management has requested that the engagement become a review engagement with the associated lower level of assurance, as they are not required to have an audit.
Outline the appropriate response to this situation. Provide reasons to support your response. (4 Marks)
Consider the following independent situations:
1. You are the auditor of Hail Pty Ltd a medium sized furniture manufacturer. Your audit firm has finalised the financial statements after the client has substantially prepared the accounting records. However, the client admits to having limited knowledge of identifying and calculating impairment and has asked for your assistance. You have proposed a number of adjustments to account for the impairment of assets.
2. You are the auditor of Travel Time Ltd, a large travel agent that also handles all your audit firms travel arrangements on normal commercial rates and provides excellent service. The managing director of Travel Time has indicated that the company is having a tough time of it due to the lack of consumer confidence in the economy at the moment and has asked if you could help by recommending their services to your other audit clients. He has said that he will understand if you are not able to do so. You happily agree to provide the recommendation, as you have always been satisfied with their service.
3. Your audit firm has been approached by a new client, Civil Constructions Ltd, to conduct the audit for the coming year. As part of your client acceptance procedures, you identify that the wife of one of the audit firm’s partners has a substantial shareholding in Civil Constructions Ltd.
4. Your audit client, Pleasure Cruises Ltd, is having cash flow problems and has not paid any of the current year’s fee by the time the auditor’s report is due to be issued. They expect business to pick up in the coming year and have requested an additional time to pay the bill.
For each of the independent situations above:
a) Identify the type of potential threat to independence. Justify your answer. (8 marks)
b) Describe a safeguard, if any, which could be implemented to reduce each of the independence threats. (4 marks)
Part B (40 marks)
In February 2012, the Australian Accounting Standards Boards decided at its meeting to propose the withdrawal of AASB 1031 Materiality. There were several reasons for this proposal which includes: there is no International Reporting Standard equivalent and it does not look like there will be, since 2005 there has been the gradual withdrawal of additional Australian guidance from a number of Australian Accounting Standards, and there is now an updated guidance on materiality in the IASB Conceptual Framework.
The major impact of the withdrawal of AASB 1031 is the removal of the specific quantitative guidance for materiality. The withdrawal of AASB 1031 became effective to annual reporting beginning on or after 1 July 2015.
1. Summarize the significant changes with AASB 1031 Materiality (issued by the Australian Accounting Standards Boards - AASB) from 1995 to 2015. (10 Marks)
2. Prior to the withdrawal of AASB 1031 and with reference to the AASB 1031 Materiality (issued by the Australian Accounting Standards Boards - AASB) and the ASA 320 Materiality in Planning and Performing an Audit and ASA 450 Evaluation of Misstatements Identified during an Audit (issued by the Auditing and Assurance Standards Board – AUASB), (15 Marks):
a. Define materiality.
b. Outline the qualitative and quantitative guidelines of materiality.
c. How the concepts and constructs of “materiality” influence the auditors’ professional judgment on misstatements.
3. Post withdrawal of AASB 1031, would this harmonise/bring uniformity to auditors’ assessment of materiality misstatements or would this bring disparity to auditors’ assessment of misstatements? What other influence this would bring to the auditors’ judgment on misstatements? Discuss your answer and rationale. (Support your answers with the relevant Australian Accounting Standards and Australian Auditing Standards as well as published Peer-reviewed Academic Journals and Articles.) (15 Marks)
NOTE: In answering question Part B, use Harvard referencing style and support your answers with relevant accounting and auditing standards as well as published peer-reviewed academic journals. (Hint: this is a great opportunity to utilise the University’s Library Services online such as Library Search, Advance Search, eJournals and Databases such as EBSCOhost, etc.)
Part C (20 marks)
Gifts Ltd (Gifts) operates 30 specialty gift stores. The company’s year-end is 30 June 2018. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. You are the audit senior, and this is your first year on this audit.
The audit manager has asked you to undertake some research to gain an understanding of Gifts, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks.
Gifts spent $2.1 million in refurbishing all of its stores and extending their central warehouse. In order to finance this refurbishment, Gifts borrowed $2 million from the bank. This is due to be repaid over five years.
The company will be performing a year-end inventory count at the central warehouse, as well as at all 30 stores, on 30 June 2018. Inventory is valued at selling price less an average profit margin, as the finance director believes that this is a close approximation of cost.
Prior to the 2018 financial year, each store maintained its own financial records and submitted returns monthly to head office. During the 2018 financial year all accounting records were centralised within head office. Therefore, at the beginning of the 2018 financial year, each store’s opening balances were transferred into head office’s accounting records. The increased workload at head office has led to some changes in the finance department and in May 2018 the financial controller left. Her replacement will start in late June 2018.
a) List two (2) sources of information that would be of use in gaining an understanding of Gifts, and for each source describe what information you would expect to obtain. (4 Marks)
b) Using the background information provided above, identify six (6) audit risks and explain the auditor’s response to each risk in planning the audit of Gifts. (12 Marks)
The finance director of Gifts is considering establishing an internal audit department and is unsure what factors he should consider when making his decision.
Bearing in mind the differences and similarities between the roles of an internal auditor compared to an external auditor, outline four (4) factors the finance director should consider before establishing an internal audit department. (4 Marks)
*** End of Assignment***