ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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Practice questions
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37 QP Supermarkets
QP Supermarkets (QPS) has 200 stores throughout the country, with around 20
stores in Europe. QPS have been trying to compete with the large out of town
supermarkets for the last five years but have recently taken the decision to move
into the smaller stores in towns. Their aim is to be specialist in the type of value for
money ‘quality’ products that cannot normally be obtained in local shops. QPS has
also moved into sales via the internet. They receive orders through the internet and
arrange for the closest local store to distribute the shopping to the customer.
You have been assigned to the audit of QPS this year. You have obtained the
following information:
(1) The internet sales service has proved very successful with a 100% increase in
sales on last year. However, there have been complaints about the quality of
deliveries and that customers are failing to receive all items ordered.
(2) There have been interruptions to the internet sales service caused by the
higher than expected levels of sales. There have also been concerns over the
confidentiality and security of information accessed via the internet.
(3) Problems have arisen with two of the new sites selected by QPS for expansion.
− In respect of Site A, there has been substantial local opposition
accompanied by environmental concerns over potential contamination of
the site.
− In respect of Site B, planning permission has not yet been obtained and has
been deferred due to an alternative application in the locality by a major
competitor. This looks likely to delay planning decisions for a significant
period of time.
(4) QPS acquired Lopay Supermarkets last year as part of their business strategy.
Initially, the decision was taken to continue to operate Lopay separately and
integrate the stores on a phased basis over a two year period. This would
involve rebranding Lopay, investing and upgrading stores and ensuring the
same quality of staff as QPS. Lopay managers were retained to continue
managing stores and to ensure continuity. As the integration has commenced,
a number of problems have now become apparent with Lopay operations.
These include the following:
− Lopay employees have not been receiving the legal minimum wage.
− No records have been maintained of the number of hours worked by
employees, although anecdotal evidence has been received that in some
areas they have been regularly working 60 hour weeks.
− There are three ongoing complaints for unfair dismissal.
− Staff retention has been a major difficulty.
− Investigations are underway by the authorities over allegations of false
labelling of sales items.
− An investigation is underway over the sale of meat products in one store
that appear to have resulted in a local outbreak of food poisoning. The
most likely cause for this outbreak is the poor refrigeration and
maintenance of the products and sales beyond ‘sell by’ dates. Some local
press comment has already arisen.
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Required
Explain the risks facing QP Supermarkets in respect of the above, the controls you
would expect to operate in the scenario, the further work you would undertake and
the potential impact on the financial statements and the audit.
38 Environmental issues
In recent years, many commentators have been placing increasing emphasis on the
importance of the environment. Perhaps as a consequence of this, companies have
begun to recognise their environmental responsibilities and environmental issues
now often have important implications for companies. Such implications cannot be
ignored by company auditors. The profession needs to show an awareness of the
possible impact of environmental issues on clients’ financial statements.
Required
Discuss.
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Paper P7 (INT)
Advanced audit and assurance
Q&A
Answers
Contents
Page
The meaning of audit and assurance
1 Auditandassurance 400
The regulatory environment
2 Corporategovernance 401
3 MaloneyandCo 402
Rules of professional conduct
4 Ethics 403
5 Frame‐it 406
6 BloodhoundInvestigations 407
Professional responsibility and liability
7 SeaSunYachtingandMarina 409
8 PalomerPublications 412
9 EvansEngineering 413
Practice management
10 Qualitycontroldocumentation 415
11 TowerAccountants 416
12 LancasterLeisure 419
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The audit approach
13 Auditapproaches 421
14 ArtemisAviation 423
Planning
15 SystematicStores 425
16 TopToys 427
17 RedRecruitment 429
Audit evidence
18 PJ’sPowertools 430
19 ReadyRemovals 432
20 FineFeathers 434
Evaluation and review
21 MarvellousManufacturing 436
22 Wally’sWines 438
Group audits
23 ThePepperGroup 439
24 JupiterHoldings 441
Audit-related services
25 Audit‐relatedservices 444
Assurance services
26 Assurancework 445
27 ElleanderDesigns 447
28 CranfordCommunications 449
Internal audit and outsourcing
29 Internalandexternalaudit 451
30 HolidaySnacks 452
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Reporting
31 AaronAutomotivesandBlingBonnets 454
32 GorgeousGoodsandConradsContracts 455
33 PolarPublishing 457
Current issues
34 Non‐auditservices 458
35 Auditor’sliability 460
36 Theauditofsmallbusinesses 462
37 QPSupermarkets 463
38 Environmentalissues 468
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1 Audit and assurance
(a) The meaning of assurance
In an assurance engagement an assurance firm is engaged by one party to give
an opinion on a piece of information which has been prepared by another
party.
The most common example of assurance is the statutory audit. Rather than the
shareholders merely accepting the information provided by the financial
statements as being sufficiently accurate and reliable, the statutory audit
provides assurance as to the quality of that information. This makes the
information more reliable and therefore more useful to the user.
Because of the amount of work carried out, a statutory audit will provide a
high level of assurance. The level of assurance given by other assurance
engagements will depend on various factors.
Examples of ‘non-audit’ assurance engagements might include reports on
such matters as:
corporate social responsibility
environmental policy
employment policies
non-financial performance indicators.
(b) The difference between an audit and a review
The objective of an audit (as a form of assurance engagement) is to enable the
auditor to form an opinion on whether the financial statements of an entity
comply in all material respects with an identified financial reporting
framework, established by country-specific legislation, and accounting
standards (for example, International Financial Reporting Standards).
The audit opinion typically makes reference to whether the financial
statements give a ‘true and fair view’ or ‘present fairly’.
Audits are long-established formalised processes, tightly regulated by law and
professional practice. Audits were developed because of the separation
between ownership (by the shareholders) and stewardship (by the directors)
in the corporate form of business organisation. In order to protect the
shareholders, an audit is designed to provide a high level of assurance to the
user of the financial statements.
A review is an audit-related service as opposed to an audit. Whereas an audit
provides a high level of assurance, a review provides a moderate level of
assurance that the information under review is free of material misstatement.
The resultant opinion is usually expressed in the form of negative assurance
i.e. ‘nothing has come to our attention to suggest that the information is
misstated’.
The higher level of assurance provided by an audit will enhance the
credibility provided by the assurance process, but is likely to be more time-
consuming (and therefore more costly) than a review.
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2 Corporate governance
(a) The meaning of corporate governance
Corporate governance is the way in which companies are managed and
controlled. In particular, it focuses on the role of directors and their
responsibilities to shareholders and other stakeholders.
(b) Roles in achieving sound corporate governance
(i) The directors
The directors should guide the company strategically, monitor
management, and be accountable to the company and its shareholders.
In particular, the board of directors should:
act on a fully informed basis, in good faith, with due diligence and
care, and in the best interests of the company and the shareholders
treat all shareholders fairly
apply high ethical standards taking into account the interests of
stakeholders
fulfil certain key functions, including:
− reviewing and guiding corporate strategy, risk policy, annual
budgets and business plans; setting performance objectives;
monitoring performance; overseeing major capital expenditures,
acquisitions and divestments
− monitoring the effectiveness of the company’s governance
practices and making changes as needed
− selecting, compensating, monitoring and replacing key executives
and overseeing succession planning
− aligning key remuneration with the longer term interests of the
company and its shareholders
− ensuring a formal and transparent board nomination and election
process
− monitoring and managing potential conflicts of interest of
management, board members and shareholders, including
misuse of corporate assets and abuse in related party transactions
− ensuring the integrity of the accounting and financial reporting
systems, including the independent audit, and that appropriate
systems of control are in place, in particular, systems for risk
management, financial and operational control, and compliance
with the law and relevant standards
− overseeing the process of disclosure and communications.
(ii) The audit committee
In many countries the establishment of an audit committee has become a
major feature, or even a requirement, of corporate governance regimes.
The audit committee establishes a ‘buffer’ between the auditors and the
executive directors in order to minimise the risk of the auditors coming
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under undue pressure from the executive members of the board. In this
way the audit committee will:
strengthen the independence of the external auditors
increase public confidence as to the credibility of the auditing and
reporting process
assist the directors in meeting their responsibilities, including those
arising under corporate governance regulations.
(iii) The external auditors
It is the directors who are responsible for the preparation of financial
statements which comply with the relevant regulation. The external
auditors are responsible for reviewing that information and, in some
cases, reporting on the extent to which the directors have complied with
their responsibilities.
(iv) The internal auditors
As was seen above with regard to the role of the directors, it is the
directors who are responsible for setting up, implementing and
monitoring control systems. Part of their responsibility in this area is
often satisfied by the establishment of an effective internal audit
function.
3 Maloney and Co
Points to be included in paper for partners re money laundering
Money laundering can be defined as the process by which criminals attempt to
conceal the true origin and ownership of the proceeds of their criminal activities.
Such activities might include drug trafficking, terrorism, theft, fraud and tax
evasion.
The proceeds of any crime will come within the scope of the regulations if funds
are laundered and detected here, irrespective of where in the world the criminal
activity took place.
It is an offence to provide assistance to a criminal to obtain, conceal, retain or
invest funds if an individual knows or suspects that such funds are the product
of a criminal activity.
The specific obligations placed on firms include the following:
− Putting into place systems, controls and procedures to ensure that the firm is
not used for money laundering purposes.
− The appointment of a Money Laundering Reporting Officer (although the
responsibility for having appropriate systems in place to prevent and detect
money laundering rests collectively with the firm’s partners. They cannot
claim that the responsibility for compliance with the money laundering
regulations rests solely with the nominated individual.)
− Establishing/enhancing the record keeping systems for all transactions and
for verifying the identity of clients.
− Establishing suspicion reporting procedures within the firm.
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− Training and educating staff so that they are fully aware of the extent of their
obligations.
The ACCA’s Monitoring Unit will check to see if practitioners have understood
their obligations by asking a series of questions at visits.
In addition to any disciplinary action which may be taken by the ACCA,
penalties for not complying with money laundering obligations can render a
firm liable to unlimited fines and its partners to possible imprisonment.
The accountant’s normal professional duty of confidentiality to clients is not an
adequate defence where money laundering is concerned unless there is a legal
privilege (rare).
In the case of reporting suspicions of money laundering, practitioners will be
afforded statutory protection against claims for breach of confidence where
reports are made in good faith and to the appropriate authority. This will be so
even where suspicions later prove to be groundless.
4 Ethics
(a) Importance of the fundamental principles of professional conduct
These principles are considered to be so fundamental because they underpin
the way in which ACCA members should act during the course of their
professional work, and they specify behaviour expected from members during
the course of their work. ACCA is a professional body and has a high
reputation which can only be maintained if its members also adhere to the
high standards that are set by it.
Furthermore, any individual or organisation who employs the services of an
ACCA member should be able to expect a certain level of service from that
member. By stating the fundamental principles of professional conduct within
their rules of professional conduct, the ACCA are requiring their members to
adhere to those standards. If those standards are subsequently breached then
disciplinary action followed by a reprimand, fine or exclusion can follow.
These principles are therefore clearly fundamental to auditing as a profession
as ACCA members who are acting as auditors have certain responsibilities to
their clients and third parties when conducting their work. These principles
further demand high standards of conduct from such a person acting as
auditor.
(b) Importance of independence and how it can be demonstrated
Independence of auditors is a key area within the ACCA rules of professional
conduct. It is vital that not only is a member independent but he must be seen
to be independent if he is to act as an auditor – his objectivity must be beyond
question.
There are a many situations which may give the appearance that a member is
not independent. Such situations should be safeguarded against as avoided by
the auditor if he is to be seen as truly independent. Examples include:
Fee income from one client (or group of connected clients) should be less
than 15% of the gross practice income (10% for a public company). An
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audit firm should have procedures in place to ensure that existing clients
do not go over this threshold.
An audit firm should avoid auditing clients where a ‘close connection’
exists with that client firm as a whole or with an officer or employee of the
client. In addition, if an officer or employee is closely connected with a
partner or member of staff then audits of that client should be avoided.
Also, a person in an audit firm should not be involved in the audit of a
client if he has been an officer or employee of that client up to two years
previous to the audit.
An audit firm should not audit a company in which it has a financial
interest. Similarly, if a member of staff at the firm has a financial interest
then he should not be involved in the audit.
An audit firm (or anyone closely connected with it) should not, either
directly or indirectly, make a loan to or guarantee borrowings by an audit
client, or accept a loan from such a client or have borrowings or other
obligations guaranteed by such a client.
Accepting goods, services or hospitality from a client can threaten or
appear to threaten independence, and these should be avoided unless
clearly insignificant.
An audit firm may provide other services (such as taxation, consultancy)
as well as audit services to a client, and although ACCA does not object to
this in principle, it is stressed that the auditor should not participate in
executive decisions, or perform management functions. Care should
always be taken by any firm which is providing additional services to
clients to ensure that it maintains (and shows) its independence. Many of
the larger auditing firms do this by having different departments with
different staff who work on the different types of work.
Independence could be put at risk where there is actual or potential
litigation between the auditor and his client. It could be difficult for the
auditor to report fairly and impartially on the client’s financial statements,
and the client’s management may be unwilling to disclose all relevant
information.
If an audit firm has an associated firm supplying other services e.g.
insurance services, management consultancy, then it could be considered
to influence the audit firm’s actions when auditing a particular firm with a
view to obtaining additional work for the associated firm. The audit firm
should be aware of this threat to its independence and ensure that the
situation is regularly reviewed to maintain objectivity. Factors that need to
be considered include the closeness of the association and the degree to
which the associate firm wants the audit firm to retain the client.
If an auditor has to perform a specialist asset valuation for a client then
they should ensure that they maintain their independence.
If a member’s view is requested on the appropriateness of an accounting
standard he should ensure that he has all the information that is necessary,
as the opinion may influence the auditor’s judgement. Furthermore, if a
member is asked for a second opinion on the accounting treatment of items
then he should ensure that he contacts the present auditor to obtain all
necessary information and facts.