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The University of Melbourne Department of Accounting & Business Information Systems ACCT30004 Auditing and Assurance Services Semester 2, 2010 Student Number Student Number in words: Reading Time: 15 minutes This paper has 25 pages. Writing Time: 3 hours COPY Authorized Materials: Only English or foreign language dictionaries are allowed. No calculators or other materials are allowed Instructions to Invigilators: No part of this paper is to be removed by the candidate from the examination venue. Students must submit the examination paper intact. Instructions to Students: All questions on this examination paper should be attempted. Answer all questions in the spaces provided in the examination paper. Write clearly and legibly in black or blue pen. This examination paper is not to be removed from the venue and is to be submitted intact. Failure to return an examination without the correct student number may result in a grade being withheld. For official use only: Question 1 Question 2 Question 3 Question 4 Question 5 Question 6 Question 7 Question 8 Total Possible Mark 13 12 9 16 15 12 9 14 100 Achieved Mark Copies of this paper are NOT TO BE RELEASED to the Baillieu Library. ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 1 of 31 This page has been left blank intentionally COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 3 of 31 Question 1 [ 13 Marks] Peters Grantham (PG) is a medium-sized accounting firm. Although PG does not have a computer audit section, they have hired a number of graduates over the last few years, with majors in both information technology and accounting. The staff with computer skills are used to review client computer systems and are sent each year for a one-week computer training course to bring them up to date with the latest technology. One of PG's clients, Lowe Corporation, is in the wood furniture manufacturing industry. During the year Lowe replaced its old, out of date computer system with a new state of the art system, newly developed in the US. Lowe's staff installed the new system themselves and after running the new and old systems together for two months, Lowe abandoned the old system. The final numbers used in the 30 June 2009 accounts were derived using the new system. COPY Two of PG's staff, an audit senior (SR) with computer skills and an IT graduate (JR), attended Lowe's premises before the year end audit to learn more about the new computer system. JR asked SR if Lowe's staff had the necessary skills to complete the installation successfully. SR said he wasn't sure. SR and JR tested the transition from the old to the new system. During the year end audit SR had a meeting with Lowe's accountant. The accountant said that she had to cut their meeting short because she had a meeting with a representative of Big Bank. She told SR that the meeting involved an application for a loan to expand Lowe's business by 20%. SR told his manager that Lowe was hoping to borrow enough money from Big Bank to implement a major expansion. The manager made a note of this in the audit work papers. PG completed its audit of Lowe's financial statements and issued an unmodified audit report. During September 2009, Big Bank made a substantial loan to Lowe for their expansion. After completing their major expansion, Lowe discovered a major fault in their new computer system. They found that certain figures were grossly overstated due to miscalculations by the new system. The system was set up to make calculations based on feet and inches (used in the US), not metres and centimetres. The miscalculations meant Lowe's 2009 profit of $2 million should have been a loss of $200,000 and inventory was also materially overstated. This meant that Lowe did not have the funds to meet interest payments to Big Bank or to generate the level of sales necessary to repay the loan in the future. Lowe was forced into liquidation. Big Bank was not able to recover the money lent to Lowe and now wants to recover its losses by suing PG. ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 4 of 31 Required: From the above information: 1. Identify whether there are possible breaches of APES 110 Code of Ethics for Professional Accountants and discuss the possible effect on the audit. [3 marks] 2. Determine whether the actions of Peters Grantham (PG) amounted to a breach of the duty of care owed by auditors. [5 marks] 3. Assuming that Peters Grantham's actions were a breach of duty of care, assess Big Bank's likely success in its action against PG. [5 marks] Answers to the above questions should include reference to relevant auditing standards, case law, or other applicable regulations. COPY Answer these questions in the spaces below. [ 3 + 5 + 5 = 13 Marks ] 1. Identify whether there are possible breaches of APES 110 Code of Ethics for Professional Accountants and discuss the possible effect on the audit. ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 5 of 31 2. Determine whether the actions of Peters Grantham (PG) amounted to a breach of the duty of care owed by auditors. COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 7 of 31 3. Assuming that Peters Grantham's actions were a breach of duty of care, assess Big Bank's likely success in its action against PG COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 8 of 31 Question 2 [12 Marks ] Consider each of the following situations separately. Assume that all of the events are highly material. In all situations: the balance date for the companies is 30 June 2010 the field work for the companies was completed 20 August 2010 the financial statements and audit report were signed on 3 September 2010 the financial statements and audit report were mailed to the members on 10 September 2010. a) A draft investigative report commissioned by a government inquiry was leaked to the media on 25 August 2010. The report has questioned the continued need for a segment of your client's business. Accordingly, there is significant uncertainty regarding the future necessity for one of the services offered by the company and its industry colleagues. There has been significant media attention and speculation on this issue. COPY b) On 20 October 2010, you discover that a debtor of NACD Limited at 30 June 2010 had gone bankrupt on 1 October 2010. The debt had appeared collectible at 30 June 2010 and 3 September 2010. c) On 7 September 2010, you discover an uninsured legal action against the client that had originated in January 2007. d) On 20 August 2010, you discover that a debtor had gone bankrupt on 3 August 2010. The last sale took place on 1 July 2010. The cause of the bankruptcy was a major uninsured fire at one of the debtor's premises. Required: For each of the situations above: 1. State which of the following actions should the auditor determine to be undertaken: [1 mark each] a. Adjust the 30 June 2010 financial statements b. Disclose the information in the notes to the 30 June 2010 financial statements c. Request the client to recall the 30 June 2010 financial statements for revision d. No action is required 2. Give reasons as to why the particular action should be taken and any further action that the auditor should undertake prior to forming the audit opinion. [2 marks each] [ 4 + 8 = 12 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 9 of 31 Situation Action Reasons (a) COPY (b) ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 10 of 31 Situation Action Reasons (c) COPY (d) ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 11 of 31 Question 3 [ 9 Marks ] Consider each of the following independent situations. a) You are auditing a charity where net income is generally about 50% of gross revenues. Due to the small size of the charity's staff, there is a lack of control over the completeness of inventory. Despite your best efforts you feel that you do not have enough evidence to conclude that revenue is complete. b) Inventory on hand at year end has been valued by the client at cost in the financial statements. However, net realisable value is 10% below cost according to the audit findings. c) Your client has several bank accounts, one of which is in a foreign country. Cash balances total $740,000 with the account maintained in the foreign country totaling $528,740. You have been unable to obtain a bank audit certificate or any third party confirmation with respect to the foreign bank account. The client has been unable to supply you with bank statements or other supporting documentation in relation to this bank account. Materiality for the client has been set at $480,000. All cash balances are classified as current assets in the client's financial statements. COPY Required: For each of the situations above; 1. Identify the appropriate audit opinion to be issued by the audit partner. [1 mark each] 2. Give reasons as to why the particular audit opinion should be issued and any action that the auditor should undertake prior to giving the audit opinion. [2 marks each] [ 3 + 6 = 9 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 12 of 31 Situation Audit Opinion Reasons (a) (b) COPY (c) ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 13 of 31 Question 4 [ 16 Marks ] Consider each of the following situations, which are independent of each other. a) Your audit plan for sales places substantial reliance on the system of internal control and the use of analytical review. Your testing of the internal control system for sales has found a significant number of instances where customer credit ratings have not been checked and abnormally large discounts have been given. The sales manager states that these changes have been the result of difficulties in maintaining past sales levels. b) You are carrying out the annual audit of a tractor retailer. You are aware of significant problems in the rural industry over the past six months and little improvement is in sight. COPY c) Since the last audit your client has introduced a new management compensation scheme with the result that top managers' salaries are closely tied to the company's profitability. d) A new competitor of your client entered the market two months before year end and, since that time, selling prices have fallen significantly. Your inquiries have revealed that the industry expects heavy discounting to continue for the whole of next year. Required: In each case 1. Identify how the situation impacts on audit risk [1 mark each] 2. How does the situation effect audit planning? [2 marks each] 3. How does the situation affect audit sampling? [1 mark each] [ 4 + 8 + 4 = 16 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 14 of 31 Situation Effect on AR Effect on audit planning (a) (b) COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 15 of 31 Effect on sampling Situation Effect on AR Effect on audit planning (c) (d) COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 16 of 31 Effect on sampling Question 5 [ 15 Marks ] Consider each of the following situations, which are independent of each other. a) While observing your client's stocktake in progress you notice that the 'count team' and the 'checking team' are working together, ie. the counting team counts the stock and the checking team records the details on the stock tag and then signs off as having checked the count. When asked to explain the reason for this approach the staff indicate that it makes the stocktake go twice as fast and they are hoping to finish early and go down to the pub to watch the cricket. b) Your client proposes to conduct the stocktake one month before year end and wishes to discuss the impact this will have on your audit. c) Your client is a manufacturing business who expects to receive a large order from a government department for items that they do not normally produce. As such, they have purchased large amounts of raw materials on the assumption that they will receive the order. Manufacturing of the items for the expected order has already commenced and a significant amount of WIP exists. COPY Required: In each case: 1. Identify the possible effect in relation to inventory if tests of control indicate a low control risk in relation to inventory [2 marks each] 2. Describe what additional procedures you would complete at year end [3 marks each] [ 6 + 9 = 15 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 17 of 31 Situation Effect on Inventory Additional Procedures (a) (b) COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 18 of 31 Situation Effect on Inventory Additional Procedures (c) COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 20 of 31 Question 6 [ 12 Marks ] For each of the following statements: 1. Identify whether the statement is TRUE or FALSE 2. Give reasons as to why the statement is true or false [ 4 x ( 1 + 2 ) = 12 Marks ] a) If internal control systems in an audit segment are poor, this will mean that the Control Risk assessment is high. Statement is: COPY b) An unqualified audit report can be either 'except for', 'adverse', or 'inability to form an opinion'. Statement is: ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 21 of 31 c) The information hypothesis argues that management will always act in their own interests when making decisions. Statement is: COPY d) Materiality has an inverse relationship with Detection Risk Statement is: ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 22 of 31 Question 7 [ 9 Marks ] You have been assigned to the audit of Carson Ltd and are currently involved in a review of control procedures in the cash disbursements area. As part of your review you have noted the following procedures: 1. A pre-numbered cheque requisition is prepared by the clerk for all payments 2. The cheque requisition requires the clerk to indicate that he has performed the following procedures for each payment: Checked the additions on the invoice Ensured that the details on the invoice have been matched to a delivery note by the warehousing department Ensured that a valid purchase order exists for the goods COPY 3. The cheque requisition with supporting documentation (invoice and any other relevant correspondence) is forwarded to the financial controller for approval Required: For each of the three (3) controls identified above: 1. State what the control is designed to prevent or detect [1 mark] 2. State which assertion the control provides evidence for [1 mark] 3. Identify one procedure which could be used to test the control [1 mark] [ 3 + 3 + 3 = 9 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 23 of 31 Situation Misstatement Prevented or Detected Assertion Audit Procedure (a) (b) COPY (c) ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 24 of 31 Question 8 [ 14 Marks ] You are an assurance services senior and your client is Antique Collectibles Pty Ltd (AC), a small company that specialises in buying and selling antique Australian-made bush furniture. AC purchases pieces at auction, cleans and repairs them, then sells them to the general public. This is the first year that your firm has conducted AC's audit. AC is a small owner-managed business that does not have a complex organizational structure or an advanced information system. Due to the size of the entity, there is very little separation of duties at AC, and most employees at AC are related to the owner. AC tends to focus purely on sales and market share, and the owner has admitted to that, at times, he has treated the finance department as a bit of an afterthought. He has also admitted that he hasn't paid too much attention to the controls at AC, as he trusts the staff members, due to their relationships with him. Required: COPY 1. Describe the responsibilities of the auditor when taking on a new client such as AC [3 marks] 2. Describe the additional factors that need to be considered in relation to audit planning by the auditor if the new client has not been audited previously [3 marks] 3. Describe whether the auditor will take a substantive approach or a combined tests of controls and substantive approach to the audit. Explain your answer. [4 marks] 4. Assume that the audit has been completed. What issues would you as the auditor communicate with the client about in relation to the information identified above? [4 marks] [ 3 + 3 + 4 + 4 = 14 Marks ] ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 25 of 31 1. Describe the responsibilities of the auditor when taking on a new client such as AC COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 26 of 31 2. Describe the additional factors that need to be considered in relation to audit planning by the auditor if the new client has not been audited previously COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 27 of 31 3. Describe whether the auditor will take a substantive approach or a combined tests of controls and substantive approach to the audit. Explain your answer. COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 28 of 31 4. Assume that the audit has been completed. What issues would you as the auditor communicate with the client about in relation to the information identified above? COPY End of Examination ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 29 of 31 Additional Space if Required COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 30 of 31 COPY ACCT30004 Auditing and Assurance Services Examination - Semester 2, 2010 Page 31 of 31