Problem
This is a question about audit quality and auditor liability.
Lee Jones a chartered accountant with Jones & Associates, is the audit partner on the audit of Tanks Limited (TL) for 2019/20, a company listed on the Australian Stock Exchange. Mr. Jones has been the partner on the audit since 2016/17. Tanks Limited is a large retail firm, specialising in the sale of sporting goods. Tanks Limited has posted healthy profits for the last 4 financial years, even though the industry has performed poorly. Tanks Limited also experienced financial problems 5 years ago. Forecasts prepared by the Tanks Limited accounting division indicate they are on course to achieve their most successful year on record ever. As a result of its increased profitability, Tanks Limited has been able to acquire one of its major competitors, Waterworld Limited. Given Lee Jones's intimate knowledge of the company, he has provided consulting advice to the company for a number of years, including advice on the Waterworld Limited takeover. (Limited audit work was necessary in auditing the details of the takeover).
The audit team is composed of Jones, Paul Sands, Kirsty Smart and 6 junior audit assistants (2 straight from finalising their studies at University). Other than the junior assistant, the same audit team has conducted the audit of TL for the last 6 years. In addition, the Managing Director of TL specifically requests that Jones, Sands and Smart remain part of the audit team refusing the request by the audit firm to rotate the audit team.
During the 2019/20 audit, the internal control structure was assessed, revealing poor internal controls. This assessment of internal controls has been carried forward from year to year and it has been confirmed by regular discussions with the Chief Accountant of TL that no changes have been made over the last 4 years. Overall audit risk had been assessed as high and a large amount of audit evidence was collected and tested by the audit team.
TL is one of a number of major clients for Jones and Associates. In the last year Jones and Associates have accepted two major clients to add to their client base and this has resulted in staffing difficulties for the firm. As a result of this, Jones has informed all audit teams that time budgets for audit engagements are to be reduced. Paul Sands devised an audit plan aimed at reducing the time taken to audit Tanks Limited by 10% compared to the previous year.
The interim tests of internal controls for the 2019/20 audit had taken somewhat longer than expected. Tanks limited also had an upgrade in their computerised accounting system for sales and accounts receivable. While the new system had some initial problems, the audit assistants were not concerned because they had decided to examine only manual internal controls and ignore the computer system.
At year-end, Jones assigned responsibility for the audit of accounts receivable to one of the junior auditors, Fred Stark who has never been on the audit before. Stark notes that accounts receivable have increased by 25% compared to 2018/19 and that the accounts receivable turnover have slipped from 58 days (the average for the past three years) to 76 days in 2019/20.
In accordance with Sands's plan to reduce time on the audit, Stark reduced the sample size for the audit of balances. In completing the 2019/20 audit work for Accounts Receivable, Stark found a number of errors, but the total of the errors was considered immaterial. Stark spoke to Jones about some Accounts Receivable confirmations where customers had complained that they had been billed for July 2020 sales on their June 2020 account, and 20% of the positive confirmation requests had been returned with the Post Office notations "Unclaimed - not known at this address". Jones explained that the client would correct the cut-off errors noted on the audit file and to make a note for next year's audit file to follow up the confirmations returned.
No further action was taken. Jones was very happy that the audit team had all testing completed in 30% less time than the preceding year. In fact they knew if they finished the audit in less time than last year they would all receive a small bonus as a result of this. The entire audit was completed on schedule and an unqualified audit report was issued.
Six months later, Jones received a call from Tanks Limited and was informed that the company was in serious financial trouble. Investigations have revealed that accounts receivable was significantly overstated. The main cause of the misstatement is the inclusion of fictitious accounts in accounts receivable. The new financial controller for Tanks Limited had intentionally overstated accounts receivable by creating fictitious sales. Material errors were also found in the valuation of the provision for doubtful debts. Errors occurred because of a programming error in the new computer system used to record credit sales, allowing the credit manager to steal $78,000 by purchasing products and then deleting the sales without any audit trail.
Task
I. List three areas where the auditors failed to apply suitable auditing procedures (that is, you are required to identify and describe specific weaknesses in the conduct of the audit in accordance with auditing standards). (Auditor's liability)
II. Suggest three specific audit procedures that you would introduce to the audit of Tanks Limited to improve the quality of the audit.
III. Discuss whether or not you believe Jones & Associates would be liable