ACCA P7 (INT) Advanced Audit & Assurance - Study Text

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The general rule is that client information is confidential and may not be

disclosed unless the client gives his permission. However, there are some

exceptions to this rule.

The auditor may be obliged to disclose client information in the following

circumstances:

 Where he is ordered to do so by a court order.

 Where he suspects his client to be undertaking activities such as drug

trafficking, terrorism or money laundering.

 If, according to the Banking, Insurance, Insolvency and Financial Services

legislation, the auditor considers that the client has been acting recklessly

or is not a fit and proper person to be managing a business.

 If the auditor becomes aware of a suspected or actual non-compliance with

laws and regulations, which gives rise to a statutory right or duty to

report, he should report this to the proper authority immediately.

Even if the auditor is wrong in his suspicions, he will be protected against

defamation claims by the client under the legal principle of ‘general privilege’.

In such cases he would have to prove that his suspicions were justified, and

should be able to provide relevant evidence to support his case.

The auditor may voluntarily disclose relevant information in order to protect

himself in legal proceedings, if authorised by statute, to sue for fees or when

he considers it appropriate to report in the public interest in which case the

following circumstances should apply:

 He must report to an appropriate authority.

 Members of the public are likely to be affected.

 The matter is serious, and likely to be repeated.

In such circumstances the auditor should also consider:

 the relative size of the amounts involved

 the extent of the likely financial damage

 the client’s reasons for being unwilling to disclose the matters to the

appropriate authority.

If a member is approached by any authority where prosecution is the main

intention, he should act very carefully. He should seek legal advice before

disclosing any client information and ascertain whether the authority has

sufficient authority for requesting such information.

If the auditor discloses client information recklessly then he will be in breach

of his contractual duty of confidentiality and could be sued by the client.

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5 Frame-it

Integrity of the client

The reason for the proposed change in auditors should be ascertained via discussion

with the directors. It is possible that the reason may prevent acceptance of the

nomination (e.g. the existing auditors intend to qualify their opinion and your firm

agrees with their view).

The permission of Frame-it must be sought in order to communicate with the

existing auditors to assess any reasons for not accepting the nomination. If

permission is not granted, the nomination should be declined.

The response of the existing auditors should be carefully considered, especially in

the light of the reasons given by the directors. If the reasons differ, this will reflect

upon the directors’ integrity and, again, the nomination should be declined.

Frame-it’s reputation (employee relations, investigation by the authorities and any

other adverse opinions) will also impact on the assessment of the directors’

integrity.

Auditor independence

Auditor independence should not be in any doubt. For example, there should be no

family or personal relationships with key staff at Frame-it, or beneficial

shareholdings in Frame-it held by audit staff.

If existing audit clients have any relationships with Frame-it (e.g. competitor,

supplier, customer) a conflict of interest could arise. As a small firm (only four

partners) appropriate safeguards may not be feasible.

The firm must also be careful not to become unduly dependent on one client. As a

listed company, Frame-it’s audit fee should not exceed 10% of practice income.

Furthermore, an audit fee based on a percentage of profits would seem to detract

from objectivity as it would be in the auditors’ interests to allow profits to be

overstated. Even if the auditors would not allow this to happen, the acceptance of

an appointment with such a bonus would detract from the appearance of objectivity.

Practical considerations

Sufficient staff at the right time of year will be required to undertake the audit.

Audit staff must be sufficiently competent to deal with a listed company

manufacturer and retailer. If the firm’s expertise lies in other market sectors this

may not be the case.

If a flat fee is to be accepted, it should be fair and reasonable with regards to the

level of staff needed on the audit and time spent by them. If the fee is likely to be

insufficient to cover such costs then this may give the appearance to the outside

world that a poor quality audit is being performed. The flat fee should also leave the

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directors in no doubt as to the range of services being offered (i.e. statutory audit

only).

Regardless of the integrity of the directors, Frame-it’s poor reputation may affect the

auditors’ reputation and they might therefore not wish to be associated with such a

company, as existing and potential clients might be influenced by such adverse

publicity.

6 Bloodhound Investigations

(a) Impact of the three pieces of information

Major service provider to your firm

Bloodhound Investigations (BI) is therefore potentially an important element

of the firm’s business. In deciding whether to accept the nomination as BI’s

auditors, a decision needs to be made as to how this current business

relationship could impair objectivity and business judgements.

If BI provided a material level of income to the firm, this could be seen as a

clear case in which the independence of the auditor may be in question.

However, the situation here is different in that the income is being derived by

BI, who is employed by the firm. It is important to understand how close and

important this connection is. If the firm is heavily reliant on BI for the

provision of such services, that could be said to have an influence in the way

that the audit is conducted and must be a factor in deciding on whether or not

to accept the appointment.

Acrimonious parting with the previous auditors

It is important to understand the situation relating to this because it will

impact on the decision as to whether or not to accept the nomination. The

suggestion is that BI was unhappy with the competence of the auditors

concerned. However, more detailed evaluation may show that there were

underlying problems such as the auditors challenging accounting policies.

Where the previous auditors feel aggrieved by proposed removal, they have a

statutory right to make representations to the shareholders.

BI are also withholding fees from the previous firm – this will be a factor in

agreeing to take on the appointment, since this suggests an issue over

payment for professional services received and may be an indication of other

issues relating to recovery of fees.

The firm already represents the Technical Investigations Group (TIG), a

company involved in a hostile take-over of BI.

This could give rise to a conflict of interest if the firm were to undertake the

audits for both entities. It may also lead to concerns over confidentiality since

information relevant to one audit could be identified from the other entity’s

audit process.

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(b) Other factors to consider in making a decision as to whether to accept BI as

a client

 Whether a partner or anyone closely connected with a partner has a

beneficial interest in BI. This may be particularly relevant in view of the

existing relationship with BI.

 Whether there are any other factors that together mean that the firm would

have undue dependence on BI. This would mean looking at the expected

fees from the audit relative to other fee income.

 Practical considerations such as the relative size of the firm and client,

expertise required and geographical issues.

 Consideration of any relevant legal requirements.

 Whether the prospective client is one that the firm would wish to deal

with. The implication in the question is that since the firm already use BI to

provide services it must consider BI to be reputable. However, if BI had a

poor reputation and image within the industry, the firm may be less

willing to take on the audit.

 Fit with current business, for example, if the firm has chosen to specialise

in certain types of audit. The firm already represents TIG which may mean

that this is a niche that it is keen to represent.

 The level of risk associated with the client, in particular, the level of

potential audit risk. Since BI has parted company from its previous

auditors, this may be an indicator of a level of risk to the audit with

potential concerns over fee recoverability. The current uncertainty relating

to BI (i.e. the takeover bid) may also represent an audit risk.

 There may be opportunities for other services to be provided to BI,

particularly since the firm already has an effective business connection.

 Request BI’s permission to communicate with the current auditors by way

of a professional etiquette letter. This would be to inform the auditors of

the firm’s nomination as a matter of professional courtesy and to ascertain

whether there are any circumstances concerning the change of auditor that

might affect the firm’s decision. The firm would also need to obtain

reasonable handover information from the previous auditors including a

trial balance reconciled to the last set of financial statements.

 Send a letter of engagement in accordance with ISA 210. The contents of

this letter should already have been agreed with BI and receipt of the letter

should be acknowledged by BI.

 Accept the nomination and be appointed by resolution of shareholders or

directors.

 Meet with the client to agree the scope of the audit and basis for fees.

 In taking on the client, the firm needs to have established the risks

associated with BI and to have confirmed the planning approach and skills

required. In accepting the appointment, the firm has taken the decision

that the issues raised did not present an insurmountable barrier. The firm

therefore has to ensure that mechanisms are in place to avoid conflicts of

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interest and breaches of confidentiality in the conduct of audit. This will

include ensuring that the same partner and staff are not involved in the

audit of the two rival firms (TIG and BI) and that ‘Chinese walls’ operate

between the two areas. Both firms should have been made aware of the

potential conflict.

 The firms will also ensure that the auditor relationship did not impact on

the consultancy services relationship and, again, that conflicts of interest

were avoided, with no undue pressure on the auditors arising from the

heavy use of BI services.

 In accepting the appointment the firm should encourage payment of the

fees to the previous auditor.

7 SeaSun Yachting and Marina

(a) Difference between fraud and error and how the given issues could be

categorised

ISA 240 is concerned with the issues of fraud and error. Fraud relates to

intentional acts that may involve falsification of documents and records,

misappropriation of assets or misapplication of accounting policies. Error

relates to unintentional acts that may result in misapplication of accounting

policies, oversights or misinterpretations of fact and clerical errors. Failure to

correct an identified material error results in an unintentional act becoming an

intentional one. The audit procedures for fraud or error may be the same but

fraudulent activity may result in the need to disclose illegal acts to the

regulatory authorities.

(1) Double financing of yachts

There may be a significant issue with SYM’s procedures resulting from

this. The auditor will need to ascertain whether this was an

unintentional act caused by poor record keeping or a lack of

understanding of the financing arrangements. However, with the

amount of money involved, this could be a major fraudulent activity or

a mechanism to disguise the seriousness of the company’s financial

position.

(2) Missing yachts

The missing yachts may be a clear case of deliberate misappropriation of

assets and therefore fraud. However, they could also arise from

erroneous accounting and asset records and due to the poor

arrangements for capturing sales.

(3) Reconciliation differences

These may have arisen through error rather than fraud, but failure to act

on such differences could mean that the situation becomes more in the

nature of an irregularity.

(4) Overstatement of sales

This could arise from unintentional application of policies or poor

records. However, it may also arise from fraudulent activity.

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The reasons behind the absence of the financial director need to be

considered. His absence could indicate guilt (with the stress being caused by

the worry of being caught or the pressure he has been placed under to commit

fraud). However, his absence could be unrelated to fraud and these issues

could have arisen in his absence as staff struggle to deal with the accounting

system and controls.

(b) Roles in the prevention and detection of fraud and error

Management is responsible for the prevention and detection of fraud and

error through the implementation and operation of effective control systems

and accounting policies.

The auditor has no responsibility for the prevention and detection of fraud

and error although the annual audit may act as a deterrent.

The auditor’s role is to assess the potential for financial misstatement and to

establish with management whether there are any factors such as fraud that

may result in such a misstatement. To do this requires effective planning and

control, assessing risks associated with the company and directing audit

attention to the areas of risk. Audit procedures should be designed to obtain

reasonable assurance that material errors have not occurred or that where they

have occurred they have been corrected or properly disclosed in the financial

statements.

(1) Double financing of yachts

Clearly, this could have a material effect on the financial statements,

since it involves double financing of around 30% of yachts. The auditor

will need to perform additional procedures to establish how and why

this occurred, and whether it was a one-off intentional situation. These

problems should be factored into the risk assessment process and

consideration given to the reliability of management evidence. The

timing of the problems will be important, in particular, in establishing

whether there is a link with the absence of the finance director on

sickness leave for the last five months. The full scale and impact of the

problem needs to be established and whether this problem leads to a

question mark over the company’s future viability.

(2) Missing yachts

The level of assets missing is $5 million, which is likely to be material to

the financial statements. The auditor will need to carry out further audit

procedures and in particular, understand how assets are controlled and

whether missing yachts are an isolated occurrence.

The auditor will need to understand whether these are ‘missing’ because

of poor accounting, poor inventory control or fraudulent activity. It may

be that the yachts were sold but not correctly reflected in the accounts. It

will be important to establish the true facts as far as possible. It will also

be important to understand what controls should normally operate to

prevent such occurrence, how these controls have been operating

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(particularly in the absence of the financial director) and the length of

time since the problems have occurred. Yachts are large assets – not ones

that would be easy to mislay or miscount.

(3) Reconciliations

Reconciliations have not been performed for four months – so may be

linked to the finance director going on sick leave. The lack of control

over reconciliations including the failure to investigate and address

differences that have occurred suggests poor management of risk in the

company. The auditor needs to:

 establish responsibilities within SYM for undertaking reconciliations

 ensure that reconciliations are completed and that the full differences

are identified

 review whether the other problems identified with inventories and

financing are linked to these reconciliation problems

 establish whether the lack of reconciliations provides further

evidence of fraud

 fully understand the impact on the financial statements.

(4) Overstatement of sales

Again, the auditor needs to conduct additional audit procedures to

understand the impact of this situation. Sales are overstated by $10

million in the current financial statements, which is likely to be material.

The auditor needs to:

 confirm when and how this problem has occurred

 ascertain the reasons for the overstatement

 confirm what prior year investigations were undertaken and

whether there were any earlier indications

 establish what controls exist over sales and to what extent these are

in operation.

Overall impact on the financial statements

For all of the items referred to, the auditor will need to consider the overall

impact on the financial statements. The significant nature and size of the

problems may impact on the going concern status of the company and added

together, may be an indication of lack of control, poor risk management or

fraudulent activity. It is important that the auditor discusses the issues with

management to keep them informed of his concerns and to ascertain:

 whether they were aware of the problems

 how they have addressed their concerns

 what other issues may have arisen

 the impact of these issues and the likelihood of other risks materialising

 what reports they have received on the management of risk and the

operation of internal controls

 how the role of the finance director has been managed since his absence on

sick leave

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 what explanations have been received for the absence of the finance

director and what contact has been maintained in the five months of

absence

 whether the absence is linked to fraudulent activity or to stress arising

from the control issues that have subsequently been discovered.

8 Palomer Publications

The audit firm has statutory responsibilities under company law including a duty to

report on whether financial statements show a ‘true and fair view’ or ‘present fairly’

the financial position. If the firm is shown to be negligent in this process, they could

be subject to various types of action (civil and/or criminal).

In the specific case of Palomer, the problems relate to investments from reserves and

the collapse in share price resulting from the ‘rumours’ of a lack of reserves and lack

of financial viability. The suspension of the Palomer shares allows time to

investigate the true position and deal with fact rather than rumour.

During the audit of Palomer, the firm would have considered the going concern

basis of the company and would have examined the financial statements for

material error. This would include consideration of the level of reserves. Therefore if

there are substantiated problems, the firm would have been expected to identify the

situation. The audit process should have been carried out with a due level of skill,

care and diligence and with regard to the required professional standards. If the

firm can demonstrate that the audit was performed in accordance with professional

standards, then it will be difficult to demonstrate negligence. However, if the firm

had any suspicions of problems with the company’s financial position, it should

have fully pursued this to establish the facts and, if it has not done so, could be

accused of negligence.

The question does not identify the possible source of legal action. There is a

possibility of liability in tort, under which a third party could sue the firm for

damages. However, such a third party would have to prove that:

 the auditors owe a duty of care to the third party

 that appropriate standards of care have been breached, and

 that the third party has suffered loss as a direct result of this breach of standards.

A duty of care exists where the auditors knew (or reasonably should have foreseen

at the time of auditing the financial statements) that those financial statements

might be relied on for that particular purpose and that it would be reasonable for

such reliance to be placed for that purpose.

To avoid successful allegations of negligence, there are a number of key

mechanisms that the auditors of Palomer should have followed:

 Ensure that evidence is available to demonstrate that best practice procedures

were being followed, including effective quality control and supervision of work

undertaken on the client.

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 Effective planning of assignments, including the assignment of staff with the

appropriate skills and training, as well as effective direction of resources during

the assignment.

 The use of appropriate audit programmes and checklists to ensure appropriate

focus and effective documentation and capture of evidence.

 Review of business and audit risks. This may have indicated a longer term

viability problem, with both the heavy investment in e-commerce and the

reliance on reserves in making this investment being important business risks

that should have been managed.

 Regular technical training and updating of all staff and proper briefing.

 Supervision of audit work, including review of working papers.

 Monitoring of quality control procedures.

 Final review of the financial statements.

 Professional indemnity insurance would provide an insurance protection should

the company be faced with successful legal action.

9 Evans Engineering

(a) Potential liability

To whom

 Evans Engineering – the company with whom there was an audit

‘contract’.

 The individual shareholders of Evans Engineering – to whom the audit

report is addressed.

 The Diamond Corporation – if the auditors knew that the Diamond

Corporation would rely on the 30

April 20X5 financial statements in

deciding whether and how much to bid for Evans Engineering.

Grounds for liability

 The firm will be liable under contract law to Evans Engineering if it has

been negligent in the standard of work carried out.

 The firm may be liable under the tort of negligence to the shareholders of

Evans Engineering or to the Diamond Corporation if the plaintiff can

establish the following.

Plaintiff to establish

 Duty of care owed – case law would indicate that the auditor is unlikely to

be held as owing a duty of care to third parties (the Caparo case), but it is

possible in the particular circumstances that a duty would be held to be

owed. For example, in the BBH v ADT case, one of the audit partners had

verbally confirmed the accuracy of the accounts on which ADT relied to be

accurate during a meeting. At this point the firm took on a verbal contract

with ADT.

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 Breach of that duty – the plaintiff would have to show that the auditor did

not exercise a reasonable degree of care in carrying out his work.

 Resultant financial loss suffered – third parties must show that loss was

caused by reliance on the audited financial statements and that it was

reasonable to place reliance thereon. The plaintiff must show that they

would have taken different action had the financial statements shown the

true position.

(b) Principal concerns in file review

Planning memorandum – this should set out the audit approach and

document the evaluation of risk and materiality levels. There should be

evidence of a team briefing.

Review procedures – there should be clear evidence that all files and audit

work have been subject to adequate review. All significant/contentious

matters scheduled for partner/manager review should have been cleared. All

schedules should show evidence of review by more senior persons.

Verification of non-current assets – the extent to which the existence of non-

current assets was verified should be evaluated. Particular attention should be

paid to the procedures used to inspect assets transferred between sites.

Construction contracts in progress – the degree of reliance placed on the

evidence of an expert should have been appropriate. Consideration must have

been given to the degree of completion of contracts in progress, to estimates of

profits/losses and to the vouching of costs and estimates of expected future

costs.

Liabilities – the existence of unrecorded liabilities should have been tested via

post statement of financial position review and cut-off tests. Appropriate tests

should have been performed to test the adequacy of provisions for warranty

work.

Internal control evaluation – the accounting systems and internal controls

should have been adequately documented and evaluated. Particular attention

should be paid to segregation of duties, the lack of which could have helped

the fraud to be perpetrated.

Management letter – this should include all weaknesses identified and a

response from management should have been obtained.

Potential adjustments – a summary of all errors discovered and potential

adjustments should be on file with a note as to how they were dealt with.

Audit programmes – there should be a completed audit programme for all

material areas of the audit on file. Where standardised programmes are used

these should have been tailored to a construction company.

Audit administration – records of work done and a comparison to budget and

prior years should be on file to show that an appropriate amount of time was

devoted to the audit. The degree of supervision of the audit should have been

appropriate to the experience and proficiency of the audit staff.

Accounting policies – the accounting policies adopted should have been

appropriate to the industry, in particular, with regard to the recognition of

revenue and profits.

ACCA P7 (INT) Advanced Audit &amp; Assurance - Study Text - 2010 (Emile Woolf Publishing)

Подождите немного. Документ загружается.

ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)