Auditing and assurance services questions are in attachment.

Auditing and Assurance Services - Questions: ! Question 1 (20 marks) ! As the audit senior for the First Hardware Ltd.'s (First Hardware) audit, you are happy with the smoothness of the audit undertaken for the year ended 30 June 2015. Today, your audit partner tells you that First Hardware has gone into liquidation. The financial controller was diverting company funds into a Swiss bank account and has left the country to live in Majorca. The lawyers for First Hardware are taking action against the audit partner for not performing an appropriate audit. They believe that a properly conducted audit should have detected such a fraud. The fraud was substantial, however it was not material from the company's point of view. You explain to the partner that the audit was performed in accordance with all auditing standards and nothing was found to arouse suspicion during the audit. The audit took the same amount of time as last year's, and all appropriate work steps were performed. Your work was reviewed by a manager and the entire file was reviewed by the audit partner. The audit partner is still concerned. He rings an audit partner is an associated office of your accounting firm and asks her to review the audit file. She agrees and spends a day reviewing the file. After completing her review, she is satisfied that the audit was performed properly. Required: Explain the following: 1. 2. (b) How the lawyers for First Hardware might present the case against the auditor. 3. (c) How the auditor partner might defend the claim. 4. (d) What you think the court's decision will be if the case goes to trial. 5. ! ! ! ! ! ! ! ! (a) Whether your accounting firm has acted with reasonable care and skill. (e) Why the audit partner may offer First Hardware a substantial settlement amount, even if the partner is convinced he acted with reasonable care and skill. ! Question 2 (15 marks) You are the audit senior responsible for the audit of Anglers Limited. You are currently planning the audit for the year ended 31 December 2014. During your initial planning meeting held with the financial controller, he told you of the following changes in the company's operations. 1) Due to the financial controller's workload the company has employed a treasurer. The financial controller is excited about the appointment. In the two months the treasurer has been with the company he has generated a small profit for the company through foreign-exchange transactions in yen. 2) To help achieve the budgeted sales for the year, Anglers is about to introduce bonuses for its sales staff. The bonuses will be an increasing percentage of the gross sales made, by each salesperson, above certain monthly targets. 3) The managing director has returned from the USA, where he signed a contract to import a line of clothing that has become the latest fashion fad in the USA. The company has not previously been engaged in the clothing industry. Required: For each of the scenarios above: 1. (a) Identify if and how inherent or control risk is affected. 2. (b) Explain how that will impact on audit risk. 3. (c) Explain how detection risk will be affected in response to (b). ! Question 3 (30 marks) You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of Futuristic Toys Ltd, a toy manufacturer. This is your firm's first year as auditor of Futuristic Toys. The information shown on the next page was prepared for a board meeting and Rachel felt it might be assist your preparation of the forthcoming audit for the year ended 30 June 2015. During a brief telephone call with Rachel, you made the following notes: 1) One of the conditions of the long-term loan is that the company is not to exceed a debt-toequity ratio of 2:1 at any time. The loan is reviewed each year on 30 June. 2) Provision for inventory obsolescence is now a flat rate of 10% of closing inventory. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products. 3) The long-term loan receivable is from a company involved in the development and production of computer software. The company is owned by one of the directors. The 2015 pre-audit financials have been received, together with the actual figures for 2014 and 2013. The details for the Income Statement and Balance Sheet are provided below. Futuristic Toys Ltd Income Statement 2015 2014 2013 $'000 $'000 $'000 Sales 72,945 74,927 89,734 Cost of slaes 51,840 51,765 63,066 Gross profit 21,105 23,162 26,668 Depreciation 5,595 4,332 2,796 Inventory obsolescence 1,650 2,346 1,439 Marketing expense 1,345 1,980 2,548 Administration 8,925 8,727 11,516 Interest expense 1,040 1,275 1,140 Total expenses 18,555 18,660 19,439 Profit before tax 2,550 4,502 7,229 918 1,621 2,386 1,632 2,881 4,843 Tax expense Profit after tax ! ! ! ! ! ! ! ! ! ! Futuristic Toys Ltd Balance Sheet 2015 2014 2013 $'000 $'000 $'000 Current assets Cash 1,586 1,743 830 Inventory 16,498 11,731 7,197 Trade debtors 12,134 10,700 9,323 Total current assets 30,218 24,174 17,350 14,606 12,840 9,572 5,200 3,600 3,300 Total non-current assets 19,806 16,440 12,872 Total assets 50,024 40,614 30,222 Trade payables 9,012 6,288 2,021 Provisions 4,875 3,821 4,577 13,887 10,109 6,598 Long-term loan payable 20,000 16,000 12,000 Total liabilities 33,887 26,109 18,598 Net assets 16,137 14,505 11,624 2,000 2,000 2,000 Retained earnings 14,137 12,505 9,624 Total shareholders' equity 16,137 14,505 11,624 Non-current assets Property, plant and equipment Long-term loan receivable Current liabilities Total current liabilities Non-current liabilities Shareholders' equity Share capital ! ! You have obtained the following industry averages: ! 2015 2014 Current ratio 1.8 1.6 Quick ratio 1 0.8 Receivables turnover 7 6.6 Inventory turnover 3.7 3.8 Gross Profit 0.3 0.33 Profit after tax 0.06 0.06 Return on assets 0.07 0.05 Return on shareholder equity 0.11 0.13 Debt to equity ratio 2 2 Times interest earned 4.5 5.5 ! ! Required: (a) Explain the use of ratios in the audit process. (b) Using the financial data provided perform ratio calculations as part of your preliminary analytical procedures. Present your information in a table format. (c) Analyse the background information and the results of preliminary ratio analysis to identify and explain three (3) key areas that would require special attention during the audit of the 30 June 2015 financial statements. ! ! ! ! ! ! ! ! Question 4 (15 marks) You have been assigned to the audit of Orix Ltd, a large manufacturing company. The audit strategy indicates that a 'lower assessed level of control risk' strategy has been adopted. Key controls on which the team intends to rely for the revenue cycle are as follows: 1. All sales orders are taken over the phone. At the time the sale is taken the customer service officer checks that the customer is approved and that the sale will not result in the customer exceeding their credit limit. 2. All sales must be followed up by a written sales order (in triplicate) before goods are shipped from the warehouse. 3. On receipt of the sales order, one copy is matched to the computer records and the customer order is flagged as 'OK to proceed' within the system. A second copy is sent to the debtors clerk and a third copy is forwarded to the warehouse. Required For each of the controls identified above: 1. (a) Indicate the purpose of the control (i.e. what is the control designed to prevent or detect?); 2. (b) Indicate the account and assertion which this control will impact in the financial report; and 3. (c) Describe one procedure which could be used to test the control. Please present your answer in the following format: Control 1 2 3 ! Purpose of control Balance and assertion Example of procedure