Question 1 - The annual report and independence)
Find the latest annual report of your company1 in https://www.asx.com.au/prices/company-information.htm:
(a) What is the name of the company and the company's financial year end?
Information regarding audit committee and independence:
(b) What is the size of the audit and risk committee?
(c) Is the audit and risk committee independent?
(d) Why does the ASX recommend audit committees be independent?
(e) Does the non-audit service fee exceed 10% of the annual external audit engagement fee?
(f) Does the audit committee discuss the auditor's provision of non-audit service? If yes, provide details of their discussion.
(g) Explain the problems that are perceived to arise when non-audit service fees are high relative to audit engagement fees.
Information regarding external auditor:
(h) Which firm provided the external audit service?
(i) Who signed the Auditor's Independence Declaration and Auditor's Report?
(j) What date were the Auditor's Independence Declaration and Auditor's Report signed?
(k) Which standards and regulations does the external auditor refer to in the Auditor's Report?
See appendix below to find out which is your company.
Question 2 - Ethics and audit expectation-performance gap
The Barings Bank was one of the world's oldest merchant bank and had problems with rogue trading in the middle of the 1990s. Nick Leeson was floor manager for trades in Singapore as well as head of settlement operations, thus he was able to settle his own trades, bypassing the bank's own internal controls.
Whilst trading, Nick Leeson supposedly made $10 million profit in one week for the bank. This humongous profit caught the attention of other staff members in the bank. For instance, Mike Killian, who was the head of Global Futures and Options Sales, knew that the whole of Barings bank was making about GBP 200 million a year. If Nick Leeson carried on making such profit throughout the year it would be half a billion dollars a year profit! Accordingly to some sources Mike said that if Nick is doing that amount of business for that amount of profit, then they should shut down the rest of the bank because they were just overheads.
Due to Nick's rogue trading the bank went bankrupt in 1995.
(a) Mike Killian was cynical that one person alone was making more money than all the rest of Barings Bank staff. Questioning the reliability of information and being alert to conditions that may indicate possible fraud is an attitude expected from auditors. What is the name of this professional attitude and what is its use of it in the role of auditors?
(b) Nick Leeson was floor manager for trades as well as head of settlement operations. This means that he was able to settle his own trades, bypassing the bank's own internal controls. Considering the Code of Ethics for Professional Accountants, which kind of threat to independence does this relate to? Describe this threat and suggest a safeguard to eliminate or reduce this threat.
(c) Before going bankrupt in 1995 Barings bank had an unqualified audit report. What does that mean regarding audit expectation-performance gap? How does an unqualified audit report relate to the bank going bankrupt?
Question 3 - Analytical procedures
You are audit partner of a retailer which has a financial year end of 30 June 2015. The audit senior has completed the calculation of a number of ratios as the first stage of the analytical procedures. You have managed to secure some industry benchmarking data for comparative purposes:
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Solvency
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Year 2014
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Var
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Year 2015
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Benchmark 2015
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|
Quick ratio
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5.02
|
132%
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11.66
|
10.00
|
|
Current ratio
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18.66
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0%
|
18.64
|
15.00
|
|
Debt to equity
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0.11
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173%
|
0.30
|
0.20
|
|
Times interest earned
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18.50
|
-49%
|
9.44
|
20.00
|
|
Efficiency
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Year 2014
|
Var
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Year 2015
|
Benchmark 2015
|
|
Accounts receivable turnover
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11.50
|
-79%
|
2.40
|
10.00
|
|
Inventory turnover
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2.00
|
34%
|
2.67
|
2.00
|
|
Asset turnover
|
0.21
|
-14%
|
0.18
|
0.20
|
|
Profitability
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Year 2014
|
Var
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Year 2015
|
Benchmark 2015
|
|
Return on sales
|
48.0%
|
48%
|
71.0%
|
50.0%
|
|
Return on assets
|
10.0%
|
30%
|
13.0%
|
12.0%
|
|
Return on shareholder's equity
|
8.0%
|
50%
|
12.0%
|
9.0%
|
Discuss the impact of the analytical procedures calculated above on your audit plan for June 2015:
Solvency-
(a) Provide a brief analysis of the client's solvency.
(b) Based on your findings, name three accounts which should be investigated throughout the audit and provide justification for your choices.
(c) Which further information would you request from your client in order to improve your understanding of your client's solvency?
Efficiency-
(d) Provide a brief analysis of the client's efficiency.
(e) Based on your findings, name three accounts which should be investigated throughout the audit and provide justification for your choices.
(f) Which further information would you request from your client in order to improve your understanding of your client's efficiency?
Profitability-
(g) Provide a brief analysis of the client's profitability.
(h) Based on your findings, name three accounts which should be investigated throughout the audit and provide justification for your choices.
(i) Which further information would you request from your client in order to improve your understanding of your client's profitability?
Question 4 - Auditor's independence and liability
Eraser Limited (Eraser) traded from 1995 until it was taken over in early 2015 by Pencil Limited (Pencil), a local bank, which paid a price equivalent to the net asset backing of Eraser as disclosed in the 2014 financial report. A large portion of Eraser's business was issuing loans for investment properties in prime locations. While the 2014 financial report of Eraser was being prepared, Pencil sent a privity letter request to Eraser's auditors, notifying them of their reliance on the 2014 audited financial report, and the reason of their reliance. They received a response from Eraser's auditors that 'no duty of care' was owed by the auditors to Pencil.
During 2015, a segment of the investment property market in prime locations collapsed, causing substantial losses to be realised on the investment property portfolio. It was recognised that insufficient security in relation to these properties had been taken out. On additional investigations it was found that Eraser's accountants provided internal and external auditing services to the company. The auditors, as part of their internal audit duties, reviewed the internal control system regarding property investment and had determined in their report that the system was working in accordance with the company's guidelines. It was also concluded that these guidelines might need to be reassessed as they were very lenient and exposed the company to substantial and unnecessary financial risks in comparison to other lending institutions.
The internal audit report was dated after year end 2014, but before the external audit report was signed. It had also been considered and minuted at a meeting of the audit committee, which was held before the external audit report was signed. However, any decision was deferred to the next meeting of the audit committee. This next meeting was held after the external audit report had been signed. The external audit partner denied any knowledge of this internal audit report.
The losses on investment property have caused significant financial distress to Pencil, which has approached you to act as their legal counsel for advice.
You have talked to the firm which audited Eraser prior to 2015 and established the following facts:
- The auditor received many privity letter requests prior to 2015 and had a standard company policy of refusing to acknowledge a duty of care in all instances.
- The audit firm's audit manual acknowledged responsibilities to interested parties who '...read and rely upon our reports, and this extends beyond the persons who employ us in the first instance or those to whom the report is addressed initially".
Your tasks are:
a) Outline issues to consider whether a public accounting firm should or should not provide both internal and external auditing services.
b) What issues need to be considered in order to determine whether or not a case for negligence against Eraser's auditors would proceed?
c) Assume Eraser's auditors were negligent. To be successful in this case against the auditors which issues need to be established?
You should include reference to ethical standards, case law, and auditing standards where appropriate.
Question 5 - Audit planning and assertions
You are the audit senior on Tables Limited (Tables) audit and have started planning for the 2016 audit. You have been able to get the following information about various sectors of the business.
1 - Property, plant and equipment (PPE)
There are generally few fixed asset transactions. Asset registers are maintained, and staffs are generally competent. The transactions are often not complex but an element of risk can be introduced when management has to make decisions concerning whether to capitalise or expense items. PPE, being less liquid than other assets, are generally not subject to theft. In recent years a number of PPE items have been manufactured in-house. You have noticed as a result of your analytical procedures that repairs and maintenance expense has dropped considerably in the last two years.
2 - Inventory balances and purchase transactions
Although fairly voluminous, purchases transactions at Tables are not complex. Inventories are tightly controlled so that overstocking and obsolescence are normally not a problem. Inventory, although not as liquid as cash, is subject to theft. At Tables, finished package products are shipped immediately to customer, although large quantities of purchased merchandise are maintained on hand. The personnel handling purchases and inventory transactions are, in general, competent. Access to the warehouse is unrestricted.
3 - Trades payables transactions and balances
Although not complex, the amount of trade payables transactions is quite high. A significant risk with trade payables is that employees may fail to record them in books. The reason is because the company has applied to the bank for an increase in its overdraft and wants to impress the bank with a strong current ratio. At Tables a request form is first prepared for all items that are to be paid through the cash disbursements system. The previous trade payables clerk, who had been with the company for eight years, left in December 2015. A new clerk was hired but is not yet thoroughly familiar with the procedure.
4 - Trade receivables and credit sales system
Transactions of trade receivables and credit sales are not particularly complex at Tables, nor is there any degree of estimation involved (except for the allowance of doubtful debts account). The persons processing revenue and trade receivables transactions are thoroughly familiar with the procedures and are generally competent. Sales transactions processing does, however, entail the completion of many transactions. Competition from overseas is becoming an issue, and because of the poor general economic conditions some customers have requested extensions of time to pay.
For each of the above account balances and classes of transactions:
a) Determine any significant audit risks with reference to each relevant facts;
b) Identify the key assertion at risk (as per ASA 315) to each significant audit risk; and
c) Outline the internal controls relevant to the audit. Provide justifications in each case.
Appendix-
Your company (Question 1)
You are assigned to the company accordingly to the last number of your student identification number:
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#
|
CODE
|
COMPANY
|
|
1
|
BHP
|
BHP Billiton Limited
|
|
2
|
BXB
|
Brambles Limited
|
|
3
|
CBA
|
Commonwealth Bank of Australia
|
|
4
|
NAB
|
National Australia Bank Limited
|
|
5
|
SCG
|
Scentre Group
|
|
6
|
TCL
|
Transurban Group
|
|
7
|
WBC
|
Westpac Banking Corporation
|
|
8
|
WES
|
Wesfarmers Limited
|
|
9
|
WOW
|
Woolworths Limited
|
|
0
|
WPL
|
Woodside Petroleum Limited
|
For example, if you student identification number is 215049776 your company is TCL - Transurban Group Stapled. Do not confuse the Australian annual report you need to check with the US Form 20-F.