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Acct 3005 Auditing Theory And Assessment Answers

1. You are an audit manager with Clarke & Johnson (CJI). For the past years CJ has been the auditor of luxury Travel Holidays LTD (LTH), a travel company. Geoff, the audit partner, has asked you the to contact Chris, LTH’s CEO, with a view to CJ being re-engaged as the auditor for the upcoming audit of the 30 June 2015 financial report.

Geoff has also indicated that intends to allocate Michael, a first-year accountant, and Annette, an accountant in CJ’s tax advisory department, to the LTH audit for the first time. Geoff suggested that you discuss the audit with each of these staff, with a view to identifying any independence issues. You held talks with Chris, Michael and Annette of these conversations were as follows:

Conversation with Chris, situation 1

Chris stated: ‘The board of directors were impressed with last year’s audit and would like to propose reappointing CJ as the auditor of the 30 June 2015 financial report audit. The board would also like to invite Geoff to give a speech about LTH at the next travel agency seminar, to assist in promoting LTH’s business to attract more investors. I understand that this is outside CJ’s normal practice; however, the board expressed the view that it will be very difficult for LTH to continue any business engagements with CJ should Geoff refuse to provide such assistance’.

Conversation with Chris, situation 2

Chris stated: ‘ To express our sincerity towards CJ and Geoff, and to maintain the good relationship in anticipation of another smooth audit for 2015, LTH would like to present a complimentary 14-day holiday package voucher for four people to the Greek isles for both Geoff’s and your family. All expenses, including accommodation and travelling cost, will be paid by LTH’.

Conversation with Michael

 Michael stated: ‘I am very excited to be part of the audit team. I believe that I will be a valuable asset to the team, as my dad is LTH’s financial controller. He is responsible for the preparation of LTH’s financial report.’

Conversation with Annette

Annette stated: ‘I am glad that I have been allocated to this year’s LTH’s audit team. It’s going to be a very efficient audit this year! I was on a temporary assignment at LTH’s just a month ago, helping LTH with its tax calculations and preparing accounting entries that will be reflected in the 30 June 2015 financial report, so I don’t think there will be much audit work required around the tax accounts. It will be great to catch up with everybody at LTH again, as they are so easy to work with.’

Required:

(a) For each situation, identify and evaluate any threats in relation to auditor independence ( 5 Marks).

(b) Identify any safeguards to those threats identified above( 5 Marks).

2. You are an audit senior with Crampton and Hasaad and you are planning the audit of Mining supplies LTD (MSL) for the year ended 30 June 2015. MSL sells mining equipment and spare parts to mining companies across Australia. MSL has operational centres in Perth, Newcastle, and Mt. Isa. Each operational centre warehouses the equipment and spare parts and provides sales and maintenance services. MSL’s head office is located in Melbourne where finance, IT and other corporate services are provided.

MSL has equipment purchase order contracts with a number of manufacturing suppliers based in Europe, Us and China. These manufactures build the specialised, made- to-order equipment and spare parts and ship them to MSL’s operational centres.

Each item of equipment purchased by a customer comes with a two-year spare parts and labour warranty from MSL. The warranty entitles the customer to a maximum of one free maintenance service per year during the warranty period.

Depending on the type of equipment and customer’s location, a maintenance service can take between one day and one week. MSL uses contracted mobile mechanics who travel to the customer’s location to carry out all maintenance services. Some services require the mechanic to travel long distances, due to the remote locations. Any maintenance services that are inside that are outside the warranty conditions are billed to the customer. The billing covers a daily labour rate for the mechanic’s time, any parts replaced and reimbursement for travel, accommodation and living expenses incurred by the mechanic.

Required:

(a) In relation to the purchasing of equipment and spare parts, describe two business risks to MSL that Crampton and Hasaad will consider in planning the 2015 audit.

(b) For each business risk identified in (a) describe a specific audit risk that could arise. Each responses should include the identification of account balances that are impacted directly by the audit risk.

Answers

1. i) The luxury Travel Holidays LTD (LTH) will re-engage Clarke & Johnson (CJ) as the auditor for the upcoming audit for the 30th June 2015 financial report on one condition i.e. the audit partner Geoff would have to give a speech about LTH for their business promotion and attracting investors. Here independence of appearance has been affected where the auditor, having knowledge of all facts of the company, has been forced to address the third party for the interest of the business. Here conflict of interest arises in the case of providing non-audit services. It should be kept in mind that quality and integrity of financial information is very vital.
ii) The lucrative offerings from the party being audited are a threat to auditor independence. In an audit, the auditor should have an approach of objectivity towards the process of audit and that should be with integrity. There should be the independence of mind. The state of mind should not be influenced in such a way that auditors compromise professional judgement (Elder et. al, 2010).
iii) In this case, the auditor must be aware of the relationship of members of the audit team with the audited party. In this case, the accountant and one of the members of the audit team have the direct (father-son) relationship with the financial controller and preparer of the financial report of the company, being audited. The conflict of interest may arise for the specific relationship. There may be the case of compromising professional judgement in favour of relationship.
iv) The employment relationships of team members of audit team with the party being audited may affect the independence. The audit team should have all the necessary information related to the audit and proper explanation to cases and assistance should be available from the auditor whenever it is required. But, it should be checked that there is no conflict of interests (Guan et. al, 2008).

(b) Safeguards

When there are threats to auditor independence, the auditor should identify and evaluate the same to apply proper safeguards. The safeguards are used to reduce the independence risks from the threats identified (Livne, 2015).

i. For any non-audit services depending on the case, the permission must be granted by the chairman of the board or committee or all the board or committee members. The approval of non-audit services by the external auditor should be reviewed thoroughly related to the independence factor and the objectivity. In this case, ethics and legislation should be followed (Hoffelder, 2012). But, at the time of applying guidance, auditors sometimes face challenges. Still, the auditors should not perform the functions in the purview of management, advocacy etc.
ii. In the audit, there should not be any compromise of professional judgement due to economic, commercial or relational interests. But in a society, it is not fully possible. In that case, the factors that may influence judgement are evaluated to a reasonable level and the third party should be informed where it is unacceptable (Elder et. al, 2010).
iii. Where the conflict of interest persists in more than seven days due to a specific relationship, the auditors should inform about the existing conflict of interest in writing to the respective authority or audit committee (Gilbert et. al, 2005).
iv. The hiring of personnel should be considered keeping in mind that it might affect the auditor independence. The audit committee must discuss in detail and investigate properly the independence issues. If required expert guidance should be solicited from legal counsel for appropriate action.

2. Part- a

In relation to the purchasing of equipment and spare parts, the following business risks to MSL will be considered in planning the audit.

i) Here MSL has to depend on the manufacturing suppliers based in Europe, US and China for the specialised, made- to-order equipment and spare parts and delivery of them to MSL’s operational centres. In this case, suppliers reliability should be assessed depending on the business risk factors such as:
a) Additional costs in case suppliers fail to meet the obligations related to quality, delivery, servicing etc.
b) The complexity of order in case of execution of the contract.
c) The greater dependence on the dominant supplier compared to the contract value and suppliers turnover.
ii) MSL has equipment purchase order contracts with suppliers in case of purchasing equipment and spare parts. This is an agreement between the parties and it is legally enforceable. Business risk arises in case contracts do not incorporate specification in detail. The terms and conditions evaluating the entire possible situation related to the purchase and delivery of equipment and spare parts should be mentioned in the contract (Hoffelder, 2012). The terms related to payment should be clearly understood and agreed by the parties, which may generate risks related to block of money or the conditions going in favour of suppliers. The contract is required to be drafted and signed after willingly agreed upon by the parties.

Part -b

i. Auditor mainly focuses on the transactions rather than the account balances. Due to the purchase of capital equipment and spare parts, money gets blocked for a long time. The risk becomes high if this period is extended for long (Lapsley, 2012). This process should be audited correctly. The mistakes are not rectified easily. The audit risk of not gathering proper supplier information is also associated with the business risk related to suppliers. Information of suppliers related to their organisational structure, financial position, production capacity, manufacturing process ensuring quality, experience, no. of employee, training record, and litigation if any etc. is gathered (Fazal, 2013). The financial status is also judged by some key accounting ratios, reducing profits, increasing debts, fall in liquidity position, reducing employees, changing name frequently etc. The financial strength should be sufficient to handle the order.
ii. Audit risk is also found in the case of contractual matters. The auditor should check the contract minutely to reduce risk and thereby helping both the company and signatory. Few things should be noticed. The payment should be done only after receiving delivery and satisfactorily testing the equipment as per the standard laid in the contract (Fazal, 2013). The additional conditions should also be mentioned in the contract regarding packing, date of completion, transport, delivery, acceptance testing, access to audit, maintenance of books, site/work access, post contract support etc. The risk is to be reduced by making conditions of purchase more favourable than the conditions of sale (Hoffelder, 2012). The contract must be signed by the authorised person for the institution, who has delegated the purchase authority

Reference

Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person Education, New Jersey: USA

Fazal, H 2013, What is Intimidation threat in auditing?, viewed 27 April 2017 https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.

Gilbert, W. Joseph J & Terry J. E 2005, The Use of Control Self-Assessment by Independent Auditors, The CPA Journal, vol.3, pp. 66-92

Guan, L, Kaminski, K. A & Wetzel, T. S 2008, ‘Can Investors Detect Fraud Using Financial Statements: An Exploratory Study’, Advances in Public Interest Accounting vol. 13, pp. 17-34.

Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.

Lapsley, I. 2012, Commentary: Financial Accountability & Management, Qualitative Research in Accounting & Management, vol. 9, no. 3, pp. 291-292.

Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 28 April 2017
https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full.

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