You are the audit manager of Currant \& Co. and you are planning the audit of Urange Financials Co. (Orange), who specialize in the provision of loans and financial advice to individuals and companies. Currant \& Co. has audited Orange for many years. The directors are planning to list Orange on a stock exchange within the next few months and have asked if the engagement partner can attend the meetings with potential investors. In addition, as the finance director of Orange is likely to be quite busy with the listing, he has asked if Currant \& Co. can produce the financial statements for the current year. During the year, the assistant finance director of Orange left and joined Currant \& Co. as a partner. It has been suggested that due to his familiarity with Orange, he should be appointed to provide an independent partner review for the audit. Once Orange obtains its stock exchange listing it will require several assignments to be undertaken, for example, obtaining advice about corporate governance best practice. Currant \& Co. is very keen to be appointed to these engagements, however, Orange has implied that in order to gain this work Currant \& Co. needs to complete the external audit quickly and with minimal questions/issues. The finance director has informed you that once the stock exchange listing has been completed, he would like the engagement team to attend a weekend away at a luxury hotel with his team, as a thank you for all their hard work. In addition, he has offered a senior member of the engagement team a short-term loan at a significantly reduced interest rate. Discussion a. Explain SIX ethical threats which may affect the independence of Currant \& Co.'s audit of Orange Financials Co.; and b. For each threat explain how it might be reduced to an acceptable level. Fraud presents risks to an entity. Both internal and external auditors are required to deal with risks to the entity. However, the responsibilities of internal and external auditors in relation to the risk of fraud differ. Stone Holidays is an independent travel agency. It does not operate holidays itself. It takes commission on holidays sold to customers through its chain of high street shops. Staff are partly paid on a commission basis. Well-established tour operators run the holidays that Stone Holidays sells. The networked reservations system through which holidays are booked and the computerized accounting system are both well-established systems used by many independent travel agencies. Payments by customers, including deposits, are accepted in cash and by debit and credit card. Stone Holidays is legally required to pay an amount of money (based on its total sales for the year) into a central fund maintained to compensate customers if the agency should cease operations. Discussion b. Explain the responsibilities of external auditors in respect of the risk of fraud in an audit of financial statements. c. Describe the nature of the risks to which Stone Holidays is subject arising from fraud. (ACCA adapted) se 3 You are auditing the financial statements of Lam Company Limited ("Lam") for the year ended 30 September 2021 . The following is an exchange between Miss Lee, the financial controller of Lam, and your assistants during a meeting reviewing the draft financial statements prepared by Miss Lee: Assistants: We noticed that at 30 September 2021, your company held some inventories acquired for distribution to Western. Since the expected distribution agreement with Western did not materialize and the goods have been made to Western's specific requirements and USA standards, you may need to write off the inventories if you are not able to sell them at a price above their cost before the approval of the financial statements. This is also consistent with your company's established policy to write off all goods with an age over six months after the reporting period. Miss Lee: I am not sure I agree with you. The inventories at cost of HK$8 million were purchased for Western and we are in the process of claiming Western for the losses we suffered. We are also contacting other buyers in the USA to try to sell these specialized goods. Some of them may be willing to take the inventories although we don't know whether this will happen at this moment. Lam insists that the inventories ordered specifically for Western, which amounted to HK\$8 million at 30 September 2021, should be carried at cost. Your assistants proposed to qualify the auditor's report. The paragraphs on the basis of opinion and the opinion of their draft report are as follows: Basis for Qualified Opinion The evidence available to us was limited because the company's inventories at 30 September 2021 comprise inventories of HK$8 million ordered to the specific requirements of an intended customer who had not taken delivery of the goods. Since the company was negotiating with other potential buyers for the inventories, it was not certain as to the net realizable value of the inventories as at 30 September 2021. There were no other satisfactory audit procedures that we could adopt to confirm that the carrying amount of the inventories was properly stated. Qualified Opinion In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view of the state of the company's affairs as at 30 September 2021 and of its profit and cash flows for the year then ended and have been properly prepared in accordance with the Companies Ordinance. Discussion Explain to your assistants why the draft report is not appropriate and revise the wording of the draft report to your satisfaction. (HKICPA adapted)