Assignment Details - Part A
Part A-1
You are an audit partner with Billings & Associates, a large and experienced audit firm.
You have been approached to accept the audit of Pharmaceuticals Ltd (Pharmaceuticals), a medium-sized chemical manufacturer. The manufacture of the chemicals results in highly toxic waste and Pharmaceuticals 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.
Required:
Identify and explain the key ethical matter regarding Pharmaceuticals and its management that you should consider before making the decision to accept the engagement. (2 Marks)
Part A-2
Pharmaceuticals Ltd (Pharmaceuticals) imports a number of pharmaceutical products. In order to hedge its foreign currency transactions, Pharmaceuticals entered into a number of forward rate agreements this year. Prior to this time Pharmaceuticals 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 Pharmaceuticals, 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.
Required:
Outline what further action the auditor should take in response to the errors and control weaknesses identified. Justify your response.
Part A-3
Billings & Associates has agreed to take on a new audit client, Reaction Pty Ltd, a small garage door manufacturer that has never previously been audited. Billings & 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.
Required:
Outline the appropriate response to this situation. Provide reasons to support your response. (4 Marks)
Part A-4
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.
Required:
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
You are currently planning the audit of Convenience Plus Pty Ltd (CPPL), a large proprietary company that operates a small chain of convenience stores. You are in the process of developing an understanding of its objectives and strategies and the related business risks.
Competition in this sector is intense, with major supermarket chains aggressively purchasing smaller rivals and discounting products below cost in order to increase market share. In order to compete, CPPL has been forced to offer value-added services such as complimentary coffees based on a loyalty scheme. While these strategies have helped to maintain its customer base, its gross margins have dropped by 10%. In an effort to increase profits, CPPL has recently focused on expanding the products available in each store. However, these items have achieved only limited acceptance to date among CPPL's customers and stock obsolescence is high.
All of CPPL's premises are leased. Two of the leases are due to expire prior to the end of the current financial year. In both cases, the land on which the premises are situated has been re-zoned as residential. Due to "prior use" legislation, this does not prevent the premises from being used as a supermarket in the future. However, it does mean the land's value has increased and, on this basis, the lessor is demanding a 50% increase in rent.
CPPL is also experiencing difficulties with two of its major suppliers, who have withdrawn their volume rebates and reduced payment terms from 30 to 14 days. In addition, CPPL has recently initiated legal action against a major supermarket chain for anti-competitive behaviour and predatory pricing.
REQUIRED:
(a) Identify five (5) business risks, as per ISA 315, which may lead to the risk of material misstatement at the financial statement level for CPPL.
(b) For each business risk you identified in (a) above, describe how it may lead to the risk of material misstatement at the financial statement level.
You may wish to present your answer to (a) and (b) using the following table:
Part C
Background
Toy Universe Pty Ltd (TUPL) is a toy manufacturer. TUPL has factories across the country and its customer base includes retailers, as well as individuals, to whom direct sales are made through their website. You are an audit senior at Harley Quinn & Associates and you are currently reviewing documentation of TUPL's internal controls in preparation for the interim audit.
TUPL's website allows individuals to order goods directly and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.
Goods are delivered via local couriers; however, the couriers do not always record customer signatures as proof that the customer has received the goods. Over the past year, there have been customer complaints about the delay between sales orders and receipt of goods. TUPL has investigated these complaints and found that, in each case, the sales order had been entered into the sales system correctly, but was not forwarded to the despatch department for fulfilling.
TUPL's retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. Neither the sales area managers nor the sales director are involved with this process. These customers place their orders through one of the sales team, who decides on sales discount levels.
Raw materials are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to existing supplier details or inclusion of new supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks, as well as supervisors.
In the past six months, TUPL has changed part of its manufacturing process and as a result some new equipment has been purchased. However, there are now considerable levels of plant and equipment that are now surplus to requirement. Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.
REQUIRED:
a) Identify five (5) deficiencies in the internal controls of TUPL. Explain how a business risk arises from each deficiency.
b) Describe a control which TUPL could implement to address each of these deficiencies.
c) Design a test of control Harley Quinn & Associates would perform to assess if each of those controls identified in (b) above is operating effectively.
Part D
Phil, an audit senior at KMC Partners (KMC) is currently reviewing the materiality level for one of his clients, Sali Ltd (Sali).
In March 20X6, Sali decided to move from the SuperD IT system to the SuperB IT system. The expected completion date of the transition was June 20X7. Due diligence was performed on the new system and another auditor (PGD) was engaged to perform data migration work. KMC liaised with PGD on several occasions to obtain access to their workpapers in order to obtain sufficient appropriate audit evidence around the data migration. No major issues were noted.
Ten well-regarded staff members of Sali were made redundant in April 20X7, and as a result, staff morale is very low at Sali. Employees are wondering who will go next, and do not feel that their jobs are safe. Most of them are putting in extra hours, but despite this, the lack of motivation is seriously impacting the quality of their work. Some senior staff members have decided to search the current job market for another suitable positions.
It is now 8 July 20X7 and the audit team is currently finalising its substantive testing and tests of controls. Phil becomes aware of the following events:
REQUIRED:
Determine the impact of each event on the materiality amount (increase, decrease, no impact). Explain your answers.