Qi (a) You are an audit manager of Morline & Co, a Public Accounting firm. The audit engagement partner, Joe Tan, has called you into his office to discuss a new audit client. You have been assigned to take charge of the audit for the financial year end, 31 December 2019 of Crown Hotel Group Bhd. (Crown Group) a listed company. The Group operates a chain of luxury hotels across Malaysia. As part of the expansion strategy, Crown Group has recently acquired a new hotel in Melbourne. You are very excited about auditing this luxury group of hotels, and are hoping that you may get to stay in one of the hotels during the audit. Recently you had a meeting with Joe Tan, Datuk Paul Wong, the managing director of Crown Group, and Lisa Goh, the finance director of Crown Group. From detailed discussions with them, you note the following information: Background information: Crown Group owns four hotels in Malaysia namely Dolce, Corus, Korma, Morib, one hotel, Belux in Singapore and a newly acquired hotel in Melbourne namely Aston, which was acquired in September 2019. Each hotel operates through a separate legal entity, and Crown Group owns 100% of each entity. The Group prepares consolidated financial statements on an annual basis. The Head Office is located in Petaling Jaya, Malaysia. In 2019, the Crown Group had total revenues of RM 90 million (2018: RM 80 million), and operating profits of RM 8,500,000 (2018: RM 11,000,000). Lisa Goh explained that all the hotels have been performing well over the last year, with the exception of Hotel Belux. See notes below Information Technology (IT) Lisa Goh highlighted that the Crown Group relies heavily on the use of information technology (IT) and noted that approximately 96% of bookings are made online via its website. The Group invested significantly in IT over the last six months, which resulted in an extensive upgrade of its website and the development of a user-friendly app. Datuk Paul Wong said, We have spent a significant amount of money developing our IT systems and ensuring they are secure, as the rapid increase in cybercrime in Malaysia is frightening." This development cost was capitalised in Financial Year 2019. 01(a) (continued) Finance team Each hotel has a finance team, including a financial controller. At the end of every month, a reporting pack is prepared by the financial controller, including a copy of the management accounts, key completed reconciliations and iled commentary on how the hotel has met the key performance indicators for that particular month. Each reporting pack is submitted to the head office, and the group financial controller reviews them and performs additional reconciliations. The group financial controller also prepares the year-end consolidated financial statements. Lisa Goh has, however, infomed you that the group financial controller resigned in November 2019 because he could not cope with the pressure of the job. She has not been able to find a suitable replacement as to date. Lisa has asked if your firm would be able to help with the finalisation of the consolidated financial statements for the year ended 31 December 2019, as her team is currently struggling to find the time needed. New acquisition The hotel in Melbourne, Aston was acquired in September 2019 for RM 8,500,000, and will be included in the consolidated financial statements at 31 December 2019. The purchase of the hotel was financed by a bank loan. Datuk Paul Wong explained this was a significant investment for the Crown Group and that a further RM 2 million has since been spent on capital expenditure to ensure it meets the exceptionally high standards of the Group. Datuk Paul Wong has invited the entire audit team to travel to Melbourne for the opening of the hotel in June 2020 as his guests. He has also assured the team will be treated very well while there. Valuation of the hotel properties The group policy is to value Land and Buildings at fair value. The calculation of fair value and the allocation of fair value to Land and Buildings requires significant judgement. Datuk Paul Wong confirmed professional valuation experts were appointed to value Land and Buildings at 31 December 2019. Land and Buildings at that date were valued at RM 110 million, representing a revaluation increase of RM 12 million Loans and Borrowings During the financial year to 31 December 2019, the Group borrowed RM 10,500,000 in order to finance the purchase of the Aston, and to complete the renovation work required. The loan is repayable over 10 years and the Group must adhere to strict loan covenants. The bank requires the Group to provide management accounts on a quarterly basis, if a loan covenant is breached, the loan may be due for repayment immediately. Lisa Goh has informed you that the group is also struggling to ensure management accounts for the quarter ended 31 December 2019 will be submitted within the allocated timeframe. The amount of interest paid was extremely significant Q1(a) (continued) Bonus During the year, a new bonus scheme was introduced for both managers and directors for all the hotel within the group in order to increase revenue. The bonus is directly linked to revenue. Advance payment Advance deposits of 50% are collected for those booking for conferences and wedding packages. Hotel Belux The hotel Belux is one of the biggest in the Group, and contributes 25% of total revenue is located in Singapore. Although revenue has increased in 2019, it has fallen significantly due to a number of special offers in both accommodation rates and the restaurant. Datuk Paul Wong believes the main causes for this fall are reduced gross margins (due to the successful uptake of the various special offer promotions during the year) and increasing costs (mainly driven by payroll). The number of special offers were approved by management in a bid to counter the tough economic environment within which the hotel operates and thereby increase revenue. Required: (1) Identify and explain to the audit partner SEVEN (7) key audit risks in respect of Crown Group (14 marks) Describe the matters Morline & Co should consider in the context of ISA 620 in order to evaluate the adequacy of the expert's work in relation to engaging the services of a property expert to value Land and (5 marks) Buildings. Evaluate the ethical issues() if any in respect of the Crown Group audit engagement and recommend appropriate safeguard(s). (5 marks) (6) You are the senior manager in charge of the audit of Southern Bhd. (South) for the year ended 30 April 2020. Southern owns and manages a chain of ten gourmet sandwich outlets. Sandwiches are prepared on demand for customers, from a range of fresh ingredients that local suppliers deliver on a daily basis. You are aware that the directors of Southern are currently discussing opportunities for expansion and are pursuing a listing on Bursa Securities. The listing rules of the stock exchange require compliance with corporate governance principles, and the directors have indicated that they are fairly confident they are adhering to best practice. You have documented the following in relation to corporate governance in Southern: Q1 (b) (continued) Corporate Governance The board comprises six directors; four executives who originally set up the company and two non-executive directors who recently joined Southern. Each director has a specific area of responsibility and only the finance director reviews the financial statements and budgets. As the board is relatively small, and to save costs, the chief executive officer, Dato Tommy Mak, has recently taken on the role of chairman. Dato Tommy Mak, originally set up the audit committee and he sits on this sub-committee along with the finance director and the non-executive directors. The finance director and the chairman make decisions regarding the nomination of the external auditors and their remuneration. To save costs, an internal audit function has not been established to monitor internal controls. The executive directors' remuneration is proposed by the finance director and approved by the chairman. They are paid an annual salary, as well as a generous annual revenue-related bonus. The audit is nearing completion, and the audit manager is currently drafting the management letter to communicate relevant audit matters to those charged with governance. Required: Describe FOUR (4) corporate governance weaknesses faced by Southern Bhd., and provide recommendation(s) to address each weakness in order to ensure compliance with corporate governance principles. (8 marks) An Audit Committee member of public listed entities, mentioned that he solely relied on the work of the external auditors to detect financial reporting fraud in his company. Comment on this statement. (3 marks) (d) Critically assess the reasonableness of the assumption that since statistical sampling techniques do not require auditors to exercise professional judgement and these techniques are of no benefit to the auditor. (5 marks) [Total 40 marks]