SECTION A: Case Study(Total = 50 Marks)

Background and Context:

You have just been appointed as a junior with Zulu Partners, an audit firm.

Zulu Partners is in reality a sole practitioner, Mr Smith, who has been auditing businesses in the local town for 50 years. He is considered by locals to be a very nice man with a strong reputation for honesty.

In late April, the firm is approached by Mr Bill Drake, the Chairman of the Board of Property Developments (PD) a wholesale business with three warehouses to conduct the audit of PD. Mr Drake explains that the previous auditor was too expensive, and they are looking for a more economical audit. Mr Smith asks you to undertake the preliminary review.

As part of your review of PD you undertake enquiries of businessmen in the neighbourhood. There is nothing directly adverse known about PD, however there is a rumour that is circulating that Mr Drake ran a toy store for some years in another state. Further enquiries indicate that this toy store failed about fifteen years ago, and ASIC barred Mr Drake from holding a company directorship for 6 years.

On behalf of Mr Smith, you approach Mr Drake to obtain a letter of authority to the previous auditor to discuss the audit history with you. Mr Drake explains that he is so disappointed with the previous auditor, that he will not correspond with him at all. On being told this Mr Smith says the previous auditor was an expensive clown and "We can do much better job than him, I will accept the audit!"

Question 1 (5 marks)

Required:

Should Zulu Partners has accepted PD as a client? If not why not? if so, why so?

Question 2(6 marks)

Required:

Now that Zulu partners has accepted PD as a client, you are instructed by Mr Smith to draft an engagement letter. Briefly set out the key headings you will put in your engagement letter.

Question 3(8 marks)

Mr Smith asks you to come into his office so that he can plan the audit of PD with you. He says all you need to do is verify the bank account and see if you can find the assets listed by Mr Drake. If you cannot, then you should ask the office manager for guidance. You ask about controls and Mr Smith replies that "we do not have to consider controls. It is a waste of time." You decide to tell Mr Smith about how control based audits can reduce audit costs. You decide to draft a memo about modern audit attitudes to controls and the audit risk model.

Required:

Draft a memo to Mr Smith setting out the requirements of the auditing standards regarding controls and how the Audit Risk Model works.

Question 4 (5 Marks)

Mr Smith reads your memo and decides that he can save time by relying on the controls of PD. He sends you out to test the controls. You arrive and ask Mr Drake about the company's internal controls. He calls in the office manager, Mr Duck, who pulls a thin dusty manual from the book shelf labelled "Property Developments - Internal Control Manual 1985". You take this to Mr Smith who grabs it with glee, and states that he can now rely on the manual.

Required:

(a)Explain the audit strategy Zulu Partners will follow based on Mr Smith's decision.

(b)Given your meeting with Mr Duck and Mr Drake mentioned above, explain whether the strategy will work?

Question 5 (6 Marks)

During the next meeting with Mr Smith, you tell him that to prove the assets and liabilities, you need to start by proving the management assertions behind the Balance Sheet Items. Mr Smith replies "what assertions?"

Required:

Prepare memo to Mr Smith listing the management assertions surrounding Balances.

Question 6(6 marks)

You set out to confirm the inventory held in the three warehouses operated by PD.

On arrival you find it locked, and on contacting Mr Duck are told that to minimise staff, the warehouse operation rotates between the three warehouses, all of which hold substantial quantities of high value stock. You are told that this particular warehouse will be in full operation tomorrow and you should return then. You return the next day, and complete testing of the inventory in the warehouse. All appears to be in order. Mr Smith decides that no further testing is required.

Required:

Explain the term used to describe the nature of the audit evidence being gathered by your tests.

Given everything is in order, would you require further testing of the inventory?

Question 7 (4 marks)

It is now the end of July, and you are finalising the audit. On 3^rd July, one of PD's warehouses burnt out. You note from your working papers that insurance does not cover the huge amount of valuable items stored in the warehouse, and there is a material discrepancy between the expected insurance payout and the loss.

Required:

Explain what you expect PD's management to do relative to the accounts in this circumstance.

Question 8(10 Marks)

Mr Drake has been asking Mr Smith daily when he might be ready to sign the audit report.

As the accounts seem to be in order, Mr Smith is putting pressure on you to finish the working papers and hand them to him so that he can sign off the audit. You finish tidying up, and prepare to give the working papers to Mr Smith tomorrow. As it is late you decide to drop by a local restaurant on the way home. While eating your meal you meet a member of the local fire brigade, who starts to tell you about the fire in PD's warehouse, as it is the talk of the town. "Funny thing, normally when a warehouse burns down there is rubbish everywhere from the stuff stored inside, but this one appears to have virtually nothing in it."

Required:

Write detailed report to Mr Smith explaining what type of audit report he should give.