ACFI 2003 Answers to Additional Questions. Common Questions. With Lengthy and Leveled Explanations.

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ACFI 2003 Answers to Additional Questions and Answers Q1. Explain the four different levels of evidence obtained when performing substantive procedures. Q2. Identify and explain the key audit as... sertions relating to cash. Q3. What are the principal objectives in auditing trade receivables? Q4. Explain examples of substantive tests of inventory that are always performed. Q5. What are the three audit assertions that are important to ensuring that the auditor has gained sufficient and appropriate audit evidence for sales revenue? Q8. Explain the difference between type 1 & type 2 subsequent events and provide examples of each type of event. Deterioration in operation results and financial position after year-end that is so significant that it may indicate the GCA is not appropriate to use in preparation of the FR. Q9. Identify quantitative and qualitative considerations that are taken into account when the auditor evaluates whether misstatements either cause financial reports to be materially misstated or requires additional disclosure. Examples of quantitative and qualitative considerations include: Q10. Explain and provide examples of the various techniques commonly used when testing controls. Q11. What are the factors considered by auditors in determining whether there is a need for additional detailed tests of controls? Q12. Describe the major types of sampling techniques available to auditors. Q13. Identify and explain the factors that influence the sample size for tests of controls. Q14. Explain the key elements of the control environment. Q15. What are control activities and explain the major categories of them? Q16. Explain the three broad categories of corroborating evidence. Answer: There are three broad categories of corroborating evidence. The categories are internally Q17. For the following independent situations, assume you are the audit partner on the engagement: 1 During your examination of Debold batteries, you conclude there is a possibility that inventory is materially overstated. Managements refuses to allow you to expand the scope of your examination sufficiently to verify whether the balance is actually misstated 2 You are auditing woodcolt linen service for the first time; woodcolt has been in business for several years but has never had an audit. After the audit is completed, you conclude that the current –year financial report is presented fairly in accordance with accounting standards. The client didn’t authorize you to do test work for any of the previous years. 3 You were engaged to examine cutter steel company Ltd’s financial statements after the close of the financial year. Because you weren’t engaged until after the financial report date, you weren’t able to physically observe inventory, which is highly material. On the completion of your audit, you are satisfied that cutter’s financial statements are presented fairly, including inventory, about which you were able to satisfy yourself by the use of alternative audit procedures. 4 Four weeks after the year end-date, a major customer of prince construction company Ltd went into Liquidation. Because the customer has confirmed the balance due to prince at the financial report date, management refuses to the charge off the account or otherwise discloses the information. The receivable represents approximately 10%of accounts receivable and 20%of profit from ordinary activities. 5 Auto delivery company Ltd has a fleet of several delivery trucks. In the past, Auto Delivery has followed the policy of purchasing all equipment. In the current year, it decided to lease the trucks. The method of accounting for the trucks is therefore changed to lease capitalization. This change in policy is fully disclosed in footnotes. REQUIRED For each situation, state the type of audit report that should be issued, If your decision depends on additional information, state the alternative reports you are considering and the additional information you need to make the decision. Q18. For the following independent situations, assume that you are the audit partner on the engagement: 1. HardwarefromHome.com.au is an Internet-based start-up company created to sell home hardware supplies online. Although the company had promising start, a downturn in e-commerce retailing has affected the company negatively. The company’s sales and cash position have deteriorated significantly, and you now have reservations about the ability of the company to continue in operation next year. 2. Approximately 20% of the audit of Pine Farms Ltd was performed by a different public accounting firm, selected by you. You have reviewed the accountants’ working papers and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work. 3. The controller of City Hotels Company Ltd won’t allow you to confirm the receivable balance from two of its major customers. The amount of the receivable is material in relation to City’s financial statements. You are unable to satisfy yourself as to the receivable balance by alternative procedures. 4. In the last three months of the current year, Oil Refining Company Ltd decided to change direction and go significantly into the oil-drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significantly potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes. 5. Kieko Co. Ltd has prepared financial statements but has decided to exclude the statement of cash flows. Management explains to you that the users of their financial statements find this statement confusing and prefer not to have it included. 6. Zenos Ltd has prepared its financial statements in accordance with accounting standards. However, the directors have included a note explaining that an alternative treatment of a material issue is preferred and that compliance with accounting standards would mislead users of the statements. You have investigated the issue and agree with management. REQUIRED State the appropriate audit report for each situation from the following choices: a. Unqualified b. Unqualified - emphasis of matter c. Qualified d. Disclaimer e. Adverse. Q19. The following are independent situations for which u will recommend an appropriate audit report: 1 Subsequent to the date of the financial statements as part of his post-financial report audit procedures, a public accountant learned of heavy damage to one of a client’s two plants due to a recent fire; the loss won’t be reimbursed by insurance. The newspapers described the event in detail. The financial statements and appended notes as prepared by management didn’t disclose the loss caused by the fire. 2 A public accountant is engaged in the examination of the financial statements of large manufacturing company with branch offices in many widely separated cities. The public accountant wasn’t able to count the substantial undeposited cash receipts at close of business on the last day of the financial year at all branch offices. As an alternative to this auditing procedures used to verify the accurate cutoff of cash receipts, the public accountant observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on the bank statement on the first business day of the new year. He was satisfied as to the cutoff of cash receipts by the use of the alternative procedures. 3 On 2 January 20X0, Retail auto parts company Ltd received a notice from its primary supplier that, effective immediately, all wholesale prices would be increased by 10%. On the basis of the notice, Retail auto parts revalued its 31 December 20X9 inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; however, the effect of revaluation was material to current assets but not to total assets or profit. The increase in valuation is adequately disclosed in footnotes. 4 e-Lotions.com.au is an online retailer of body lotios and other bath and body supplies. The company records revenue at the time customer orders are placed on the website, rather than when the goods are shipped, which is usually two days after the order is placed. The auditor determines that the amount of orders placed but not shipped as of the financial report date isn’t material. 5 For the past five years, a public accountant has audited the financial statements manufacturing company. During this period, the examination scope was limited by the clients to the observation of the annual physical inventory. As the public accountant considered the inventories to be of the material amount and she wasn’t able to satisfy herself by other auditing procedures, she wasn’t able to express an unqualified opinion on the financial statements in each five years. The public accountant was allowed to observe physical inventories for the current year ended 31December 20X0 because the client’s banker would no longer accept the audit reports. In the interests of economy, the client requested the auditor not to extend her audit procedures to the inventory of 1 January 20X0. 6 During the course of his examination of the financial statements of a company, an auditor is refused permission to inspect the minute books. The company secretary instead offers to give the auditor a certified copy of all resolutions and actions relating to accounting matters. 7 A public accountant has completed an examination of the financial statements of a bus company for the year ended 31 December 20X0. Prior 20X0. The company had been depreciating its buses over a 10-year period. During 20X0, the company determined that a more realistic estimated for its buses was 12 years and calculated the 20X0 depreciation on the basis of revised estimate. The public accountant is satisfied that the 12-year life is reasonable. The company has adequately disclosed the change in estimated useful lives of its buses and the effect of change on 20X0 profit in a note to the financial statements. REQUIRED a. For each situation, identify whether each of conditions requiring a deviation from an unqualified opinion is applicable. b. State the appropriate audit report from the following alternatives: 1) Unqualified 2) Unqualified-emphasis of matter 3) Qualified 4) Disclaimer 5) adverse. Answer: a. and b. Condition Type of Report Comment 1. Disagreement with management (3) Qualified or (5) Adverse Disclosure of this information is required in a footnote. Failure to do so is a violation of accounting standards. 2. Scope limitation (1) Unqualified Because the auditor was able to obtain alternative evidence, no qualification is necessary. 3. Disagreement with management (3) Qualified Retail Auto Parts has used a replacement cost inventory value rather than lower of cost or net realisable value. It is not sufficiently material to warrant an adverse opinion. 4. Disagreement with management (1) Unqualified The impact of the failure to recognise revenue when goods are shipped is not material. 5. Scope limitation (3) Qualified or (4) Disclaimer Because the auditor was unable to satisfy herself about beginning inventories, it would be necessary to issue a qualified opinion on the income statement and statement of cash flows. 6. Scope limitation (4) Disclaimer Failure to allow the auditor to inspect the minutes book would be a material client-imposed restriction. Due to the importance of the minutes book, a disclaimer of opinion would be necessary. Examining the certified copy of all resolutions and actions would not be a satisfactory alternative procedure. 7. N/A (1) Unqualified There is adequate disclosure in this case. Q20. Each of the following situations involves a possible violation of the relevant ethical rules or legal obligations. For each one, state any applicable ethical rules and Corporations Act provisions and say whether it is a violation. a. A client requests assistance of J. Bacon, a chartered accountant, in the installation of a computer system for maintaining production records. Bacon has no experience in this type of work and no knowledge of the client’s production records, so he obtains assistance from a computer consultant. The consultant is not in the practice of public accounting, but Bacon is confident of his professional skills. Because of the highly technical nature of the work, Bacon is not able to review the consultant’s work. b. Five small Sydney public accounting firms have become involved in an information project by taking part in an inter-firm working paper review program. Under the program, each firm designates two partners to review the working papers, including the tax returns and the financial statements of another public accounting firm taking part in the program. At the end of each review, the auditors who prepared the working papers and the reviewers have a conference to discuss the strengths and weaknesses of the audit. They don’t obtain authorisation from the client before the review takes place. c. Shirley Morris, a public accountant, applies to Apple & George, public accountants, for a permanent job as a senior auditor. Morris informs Apple & George that she works for another public accounting firm in the same city but won’t permit them to contract her present employer. Apple & George hire Morris without contacting the other public accounting firm. d. James Thurgood, a public accountant, stays longer than he should at annual Christmas party of Thurgood & Thurgood, public accountants. On his way home he drives through a red light and is stopped by the police, who observe that he is intoxicated. Later, Thurgood is found guilty of driving under the influence of alcohol. As this isn’t his first offence, he is sentenced to 30 days in gaol and his driver’s licence is revoked for one year. e. Bill Wendal, a chartered accountant, sets up a casualty and fire insurance agency to complement his auditing and tax services. He doesn’t use his own name on anything pertaining to the insurance agency and has a highly competent manager, Sandra Jones who runs it. Wendal often requests that Jones review the adequacy of a client’s insurance with management if it seems underinsured. He feels that he provides a valuable to clients by informing them when they are underinsured. f. Louise Rankin, a public accountant, provides tax services, management advisory services and bookkeeping services, and conducts audits for the same client. As the firm is small, the same person often provides all the services. Q21. Each of the following situations involves possible violations of relevant ethical rules or independence requirements. For each one, state whether or not it is a violation. In those cases in which it is a violation, explain the nature of the violation and the rationale for the existing rule. a. Theresa Barnes has an audit client, Smith Pty Ltd, which uses another public accountant for management services work. Barnes sends her firm’s literature covering its management services capabilities to Smith on a monthly basis, unsolicited. b. Judith Williams is the partner on the audit of a non-profit charitable organisation. She is also a member of the board of directors, but this position is honorary and doesn’t involve performing a management function. c. Fenn & Company, Chartered Accountants, has time available on a computer that it uses primarily for its own record keeping. Aware that the computer facilities of Delta Equipment Company Ltd, one of Fenn’s audit clients, are inadequate for company needs. Fenn maintains on its computer certain routine accounting records for Delta. d. A bank issued a notice to its depositors that it was being audited and requested them to comply with the auditor’s effort to obtain a confirmation on the deposit balances. The bank printed the name and address of the auditor in the notice. The auditor has knowledge of the notice. e. Pound sells his public accounting practice, which includes bookkeeping, tax services and auditing, to Lyons. Pound obtains permission from all clients for release of audit-related working papers before making them available to Lyons. He doesn’t get client permission before releasing tax- and management services-related working papers. f. Murphy & Associates is the principal auditor of the consolidated financial statements of Lowe Ltd and subsidiaries. Lowe accounts for about 98% of consolidated assets and consolidated operating profit. The two subsidiaries are audited by Trotman & Partners, a public accounting firm with an excellent professional reputation. Murphy insists on auditing the two subsidiaries because he deems this necessary to warrant the expression of an opinion. Q22. The following situations may violate the Code of Ethics for Professional Accountants. Assume, in each case, that the public accountant is a partner. 1 Able, CA, owns a substantial limited unit trust in a block of units in Tasmania. Frederick Marshall is a 100% owner in Marshall Marine Company Ltd. Marshall also owns a substantial interest in the same unit as Able. Able does the audit of Marshall Marine Company Ltd. 2 Baker, CA, approaches a new client and tells the general manager that she has an idea that could result in a substantial tax refund in the prior year’s tax return by application of a technical provision in the tax law that the client had overlooked. Baker adds that the fee will be 50% of the tax refund after it has been resolved by the ATO. The client agrees to the proposal. 3 Contel, CPA, advertises in the local paper that his firm does the audit of six of the eight largest finance companies in the city. The advertisement also states that the average audit fee, as a percentage of total assets for the companies he audits, is lower than that of any other public accounting firm in the city. 4 Davis, CA sets up a small-loan company specialising in loans to business executives and small companies. Davis doesn’t spend much time in the business because she works full-time in her accounting practice. No employees of Davis’s accounting firm are involved in the small-loan company. 5 Elbert, FCPA, owns a material number of shares in a mutual fund investment company, which in turn owns shares in Elbert’s largest audit client. Reading the investment company’s most recent financial report, Elbert is surprised to learn that the company’s ownership in his client has increased dramatically. 6 Finigan, CPA, does the audit, tax return, bookkeeping and management services work for Gilligan Construction Company Pty Ltd. Mildred Gilligan follows the practice of calling Finigan before she makes any major business decision to determine the effect on her company’s taxes and the financial statements. Finigan attends continuing education courses in the construction industry to make sure she is technically competent and knowledgeable about this industry. Finigan normally attends board of directors meetings and accompanies Gilligan when she is seeking loans. Mildred Gilligan often jokingly introduces Finigan with this statement: ‘I have my three business partners—my banker, the government and my accountant; but Finny’s the only one who is on my side.’ REQUIRED Discuss whether these facts in any of the situations indicate violations of the ethical rules. If so, identify the nature of the violation(s). Answer: Q.23 Below are six situations that involve the audit risk model as it is used for planning audit evidence requirements in the audit of inventory. REQUIRED a. Explain what ‘low’, ‘medium’ and ‘high’ mean for each of the four risks and the implication for planned evidence. b. Fill in the blanks for planned detection risk and planned evidence using the term ‘low’, ‘medium’ or ‘high’. c. Using your knowledge of the relationships between the foregoing factors, state the effect on planned evidence (increase or decrease) of changing each of the following four factors, while the other three remain constant: (1) An increase in acceptable audit risk (2) An increase in control risk (3) An increase in planned detection risk (4) An increase in inherent risk (5) An increase in inherent risk and a decrease in control risk of the same amount. b. L = low, M = medium, H = high c. Q24. Below are 10 independent risk factors: 1. The client lacks sufficient working capital to continue operations. 2. The client fails to detect employee theft of inventory from the warehouse because there are no restrictions on warehouse access and the client doesn’t reconcile inventory on hand to recorded amounts on a timely basis. 3. The company is publicly traded. 4. The auditor has identified numerous material misstatements during prior-year audit engagements. 5. The assigned staff on the audit engagement lacks the necessary skills to identify actual errors in an account balance when examining audit evidence accumulated. 6. The client is one of the industry’s largest based on size and market share. 7. The client engages in several material transactions with entities owned by family members of several of the client’s senior executives. 8. The allowance for doubtful debts is based on significant assumptions made by management. 9. The audit plan omits several necessary audit procedures. 10. The client fails to reconcile bank accounts to recorded bank balances. REQUIRED Identify which of the following audit risk model components relates to each of the ten risk factors: (1) Acceptable audit risk (2) Inherent risk (3) Control risk (4) Planned detection risk. Q25. The following are partial descriptions of internal controls for companies engaged in the manufacturing business. 1. When Len Clark orders materials for his machine-rebuilding plant, he sends a duplicate purchase order to the receiving department. During the delivery of materials, Adam Smith, the receiving clerk, records the receipt of shipment on this purchase order. After recording, Adam sends the purchase order to the accounting department, where it is used to record materials purchased and accounts payable. The materials are transported to the storage area by forklifts. The additional purchased quantities are recorded on storage records. 2. Every day, hundreds of employees clock in using time cards at generous motors c. Ltd. The timekeepers collect these cards once a week and deliver them to the computer department. There, the data on these time cards are entered in the computer. The information entered in the computer is used in the preparation of the labour cost distribution records, the payroll journal and the payroll cheques. The financial controller, Ann Webber, compares the payroll journal with the payroll cheques, signs the cheques and the returns them to Steve Strode, supervisor of the computer department. The payroll cheques are distributed to the employees by Steve. 3. The smallest branch of Connor Cosmetics in south Brisbane employs Mary Cooper, branch manager, and her sales assistant, Janet Hendrix. The branch uses a bank account in south Brisbane to pay expenses. The account is kept in the name of ‘Connor Cosmetics-Special Account’. To pay expenses, cheques must be signed by Mary or by the financial controller of connor Cosmetics, John Winters. Mary receives the cancelled cheques and bank statements. She reconciles the branch account herself and files cancelled cheques and bank statements in her records. She also periodically prepares reports of cash payments and send them to head office. REQUIRED a. List the weaknesses in internal controls for each of the above. b. For each weaknesses, state the type(s) of misstatement(s) that is (are) likely to result. Be as specific as possible. c. How would you improve internal controls for each of the three companies? Q26. Each year near 30 June, when the managing director of Bargon Construction Ltd takes a three-week holiday to the Barrier Reef, she signs several cheques to pay major bills during the period she is absent. Jack Mogan, head accountant for the company, uses this practice to his advantage. Morgan makes out a cheque to himself for the amount of a large vendor’s invoice, and because there is no acquisition journal he records the amount in the cash payments journal as an acquisition from the supplier listed on the invoice. He holds the cheque until several weeks into the subsequent period to make sure that the auditors don’t get an opportunity to examine the cancelled cheque. Shortly after the commencement of the new financial year when the managing director returns, Morgan resubmits the invoice for payment and again records the cheque in the cash payments journal. At that point, he marks the invoice ‘paid’ and files it with all other paid invoices. Morgan has been following this practice successfully for several years and feels confident that he has developed a foolproof method. REQUIRED a. What is the auditor’s responsibility for discovering this type of embezzlement? b. What weaknesses exist in the client’s internal controls? c. What evidence could the auditor use to uncover the fraud? Q26. The fieldwork for the 30 June 20X0 audit of Tracy Brewing Company Ltd was finished on 19 August 20X0 and the completed financial statements, accompanied by the signed audit reports, were mailed on 6 September 20X0. In each of the highly material independent events (a) to (i) below, state the appropriate action (1) to (4) for the situation and justify your response. The alternative actions are as follows: 1. Adjust the 30 June 20X0 financial statements. 2. Disclose the information in a footnote in the 30 June 20X0 financial statements. 3. Request the client to recall the 30 June 20X0 statements for revision. 4. No action required. The events are as follows: a. On 14 December 20X0 the auditor discovered that a debtor of Tracy Brewing had been placed in liquidation on 2 October 20X0. The sale had taken place on 15 April 20X0, but the amount appeared collectible at 30 June 20X0 and 19 August 20X0. b. On 15 August 20X0 the auditor discovered that a debtor of Tracy Brewing had been placed in liquidation on 1 August 20X0. The most recent sale had taken place on 2 April 20X9 and cash receipts had been received since that date. c. On 14 December 20X0 the auditor discovered that a debtor of Tracy Brewing had been placed in liquidation on 15 July 20X0, due to declining financial health. The sale had taken place on 15 January 20X0. d. On 6 August 20X0 the auditor discovered that a debtor of Tracy Brewing had been placed in liquidation on 30 July 20X0. The cause of the insolvency was an unexpected loss of a major legal action on 15 July 20X0, resulting from a product deficiency action by a different customer. e. On 6 August 20X0 the auditor discovered that a debtor of Tracy Brewing had been placed in liquidation on 30 July 20X0 for a sale that took place on 23 July 20X0. The cause of the insolvency was a main uninsured fire on 20 July 20X0. f. On 31 May 20X0 the auditor discovered an uninsured legal action against Tracy Brewing that had originated on 28 February 20X0. g. On 20 July 20X0 Tracy Brewing settled a legal action out of court that had originated in 20X7 and is currently listed as a contingent liability. h. On 14 September 20X0 Tracy Brewing lost a court case that had originated in 20X9 for an amount equal to the legal action. The 30 June 20X0 footnotes state that in the opinion of legal counsel there will be a favourable settlement. i. On 20 July 20X0 a legal action was filed against Tracy Brewing for a patent infringement action that allegedly took place in early 20X0. Legal advice suggested there is a danger of a significant loss to the client. [Show More]

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