You are an audit manager of a Hong Kong CPA firm, XYZ & Co. (“XYZ”). Your firm has recently been engaged as the auditor of Victory Limited (“VL”) and you are currently in charge of the audit of VL for the year ended 31 December 2019. During a meeting with VL’s chief financial officer, Miss Karen Lam, you were informed of the followings: VL is a company listed on the Hong Kong Stock Exchange which is principally engaged in the manufacturing, wholesaling and retailing various kinds of high quality computer and AV games. VL’s customers are mainly in Mainland China, Hong Kong, Vietnam, Korea and Japan. As at 31 December 2019, over 65% of VL’s assets were located in Mainland China since all the manufacturing plants and subsidiaries are located in China. VL has around 800 retail outlets over the five regions. In view of the booming demands for AV games in Mainland China, VL embarked on an expansion plan two years ago to double the group’s turnover within four years. VL plan to implement this strategy through acquisition of other manufacturers as well as setting up new plant in strategic locations in Mainland China. In the last two years, an increasing trend in turnover and receivables has been noted. Although the AV games industry is very competitive, the management is very confident that the goal can be met. A new incentive scheme was introduced during the year whereby the remuneration of all VL’s senior managers is closely tied with the turnover. On 5 May 2019, VL succeeded in issuing debentures of US$240 million at an interest rate of 9% per annum. The debentures are listed on an overseas stock exchange. The proceeds received were used partly to repay bank loans when they become due in 2020, while the remaining cash were kept in banks in Mainland China. On 1 October 2019, VL installed a new computerized accounting and information system. The management did not identify any problem in the implementation. 7. There have been quality issues with VL’s games, which have resulted in legal claims being brought against the company by retailers, and retailers’ refusal to pay for the games. 

Required: 

(a) Identify risk of material misstatement at the financial statement level and at assertion level. Please state clearly whether the risk of material misstatements is at financial statement level or at assertion level.

(b) During the course of the audit on the financial statements of VL, the following events have come to your attention: 1. Mr Au, the engagement partner, has informed you that he would like his daughter Erica to be part of the audit team this year. Erica has just graduated with an accountancy degree from HKBU. 2. Mr Au also informs you that Calvin, the audit team senior, has been purchasing games from VL for a number of years. He will continue to do so in the coming years. 3. VL has invited the whole audit team to attend a party on its own yacht when the audit is completed. 4. XYZ is also engaged to represent VL in a dispute with Inland Revenue Department regarding the amount of profits tax payable. Explain the possible ethical threats in the above events and discuss the proper safeguards to be undertaken.

1. (c) You have requested written representations on a number of issues from VL but the management refuses to provide them. Explain the appropriate action to be taken.

   (d) An audit junior approached you to make an inquiry concerning auditor’s rights under the Hong Kong Companies Ordinance (Chapter 622). Briefly explain to her.