QUESTION 1 (10 MARKS)

Consider the following independent situations: a) Keira Knight, sole proprietor of an audit firm, plans to establish a separate business that will provide management consulting services. She intends to operate both businesses simultaneously.

b) Warren Brown is the partner-in-charge of the audit of Cedar Ltd. Over the years, he has become a golfing buddy of Cedar's CEO, Craig Phillips. During the current year, Warren and Craig jointly purchased an exclusive holiday house on the Gold Coast. The holiday house represents more than 10 per cent of Warren's personal wealth.

c) Leah White, sole proprietor of an audit firm, has provided extensive advisory services for her audit client Grace Furniture Ltd. She has interpreted financial reports, provided forecasts and other analyses, counselled on potential expansion plans and counselled on banking relationships.

d) Garbo & Associates recently won the audit of Unique Fashions Ltd (UFL), a large manufacturer of women's clothing. Ken Greenland, one of the partners in Garbo & Associates, had a substantial investment in UFL prior to bidding on the engagement. In anticipation of winning the engagement, Ken placed his UFL shares in a blind trust, where he would not know what action the trust had taken with regard to any shares or other investments.

e) Barry Smith, a sole practitioner, audited Galaxy Lights Pty Ltd's financial report for the year ended 30 June 2022, and was issued shares by the client as payment of the audit fee. Barry disposed of the shares before commencing fieldwork planning for the audit of the 30 June 2023 financial report.

REQUIRED: For each situation, determine whether the Code of Ethics for Professional Accountants has been breached and explain your answer. (10 marks)

QUESTION 2 (20 MARKS)

Carmelo Cruz is a sole practitioner in the professional accounting firm of Cruz & Lopez, operating from a small office in Alice Springs, Northern Territory. The firm has two employees:

Susan Gomez, the receptionist/data entry assistant, who has just completed her higher school certificate. She completed two week's work experience at Cruz & Lopez prior to being hired. Her only accounting knowledge is based on feedback that 'she did well in an MYOB assignment at school'.

Fred Soto, who was hired 18 months ago as a junior accountant. Prior to joining Cruz & Lopez, Fred was attending a course in Certificate-III in Bookkeeping at the local community college.

Carmelo believes that continuous professional development is a waste of time and money and has consistently turned down staff training requests. The firm's core assignments are monthly bookkeeping jobs for local owner-operated small businesses, personal income tax returns of public servants from the local Alice Springs Water Authority and Carmelo's friends in his volunteer rural fire brigade.

However, Cruz & Lopez has one major client, which comprises the audit of R&D Equities (R&D), a boutique private investment fund based in Darwin. Craig Smith, its founder, chairman and chief executive officer (CEO), is a high-profile personality in the Australian investment community and a governor of the Australian Securities Exchange (ASX), as well as a founding member of the Darwin Futures Exchange. In the world of finance and investment, his word is law.

R&D's funds under management exceed $15 billion and its annual reports and brochures issued to investors boast annual returns after tax of 35% against the industry average of 12%. Smith claims that this is a direct result of his proprietary investment strategy, which he keeps as a closely guarded secret. R&D's fund requires a minimum investment of $15 million and its main clients are wealthy individuals and large private organisations.

In August each year, Cruz & Lopez receives a package from R&D containing a fully completed set of typed-up financial statements, tax and all other statutory returns with 'sign here' stickers on all relevant pages for Cruz's signature. A large cheque for Cruz & Lopez's fees accompanies this parcel with a with-compliments slip personally notated by Smith with the following message: 'Ready Monday, please!' Last year's cheque for $500,000 was an amount set by Smith, who always sets the fee.

The first time Carmelo Cruz received the package, he called Smith to discuss the prospective engagement and queried the figures as he knew nothing about finance and investment. The technical terms were foreign to him and still are. However, Smith ended the phone conversation by screaming down the phone: 'There are hundreds of accountants who would give anything to be associated with me, so be honoured that I chose you. My team of internal accountants and auditors go through every last detail with a fine-toothed comb so you can be assured it's 100% correct. All you have to do is sign the stuff and return it - and the deadline is tomorrow!' Cruz caved in under pressure and obliged, and has continued to do so each year thereafter.

There were shockwaves in the financial community late last year when Smith confessed that he was operating a Ponzi scheme and R&D's supposed portfolio was non-existent. Smith was convicted and heavily sentenced under a string of serious charges. The authorities have now arrested Carmelo Cruz for his role in the scheme.

REQUIRED:

a) Refer to the APES110 Code of Ethics for Professional Accountants and identify the key fundamental principles that Carmelo Cruz has breached. Explain your answer. (12 marks)

b) Identify two (2) threats to compliance with the fundamental principle identified in (a) above. (4 marks)

c) Outline two (2) safeguards that may have eliminated these threats, or reduced it to an acceptable level. (4 marks)

QUESTION 3 (20 MARKS)

PART A

The audit partner has just advised you that he has been approached to accept the appointment of auditor to Apex Limited. Apex Limited is a manufacturer of gaming machines and has been named in a recent anti-corruption enquiry as having offered incentives to state government members to support a proposed bill which would allow an increased number of gaming machines in licensed premises. No charges have yet been laid against Apex Limited or any of its employees. The audit partner explains to you that Apex Limited's auditors were re-appointed for the current financial year at the Annual General Meeting held two months ago. However, Apex Limited's managing director is unhappy with the existing auditing firm as the audit partner assigned to Apex Limited has been changed.

REQUIRED: The audit partner is unsure whether he should accept the appointment and has asked you to outline any ethical, legal and other factors to be considered in his decision about whether to accept the appointment for the current year, and to indicate the steps that need to be taken prior to the appointment. (10 marks)

PART B

You are an assurance services senior at Clark & Associates and have noted the following independent issues in relation to the audit of Shine Pty Ltd:

1. The accounting system at Shine Pty Ltd did not operate effectively during the first year of operations. Consequently, some general ledger accounts had to be based on estimates, as the actual data relating to these balances had been lost.
2. (ii) As a result of cost constraints, the directors of Shine Pty Ltd did not implement effective internal controls for debt collection. The debtors' turnover is 3.2 times.
3. (iii) Due to increased competitive pressures, Shine Pty Ltd has recently moved the manufacture of some of its clothing lines out of Melbourne into regional areas. While Shine Pty Ltd saves around 20% in costs, the manufacturing process takes longer and on several occasions late delivery has resulted in lost sales.

REQUIRED:

(a) Describe the components of the Audit Risk Model. (2 marks)

(b) Explain the impact of each of these separate issues on your assessment of audit risk, the materiality level and the audit strategy that would be adopted. (8 marks)

QUESTION 4 (20 MARKS)

Case Background Knack Ltd (Knack) operates 25 specialty gift stores. The company's year-end is 30 June 2023. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. You are the audit senior, and this is your first year on this audit. The audit manager has asked you to undertake some research to gain an understanding of Knack, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes below and also consider how the team should respond to these risks.

Knack spent $2.1 million in refurbishing all of its stores and extending their central warehouse. In order to finance this refurbishment, Knack borrowed $2 million from the bank. This is due to be repaid over five years.

The company will be performing a year-end inventory count at the central warehouse, as well as at all 30 stores, on 30 June 2023. Inventory is valued at selling price less an average profit margin, as the finance director believes that this is a close approximation of cost.

Prior to the 2023 financial year, each store maintained its own financial records and submitted returns monthly to head office. During the 2023 financial year all accounting records were centralised within head office. Therefore, at the beginning of the 2023 financial year, each store's opening balances were transferred into head office's accounting records. The increased workload at head office has led to some changes in the finance department and in May 2023 the financial controller left. Her replacement will start in late June 2023.

PART A REQUIRED:

(a) List two (2) sources of information that would be of use in gaining an understanding of Knack Ltd, and for each source describe what information you would expect to obtain. (4 Marks)

(b) Using the background information provided above, identify six (6) audit risks and explain the auditor's response to each risk in planning the audit of Knack. (12 Marks)

PART B

The finance director of Knack is considering establishing an internal audit department and is unsure what factors he should consider when making his decision.

REQUIRED: Bearing in mind the differences and similarities between the roles of an internal auditor compared to an external auditor, outline four (4) factors the finance director should consider before establishing an internal audit department. (4 Marks)