an audit manager of Pink Partners | My Assignment Tutor

Declan Faughey Auditing Spring 2021Past Paper December 2015Q1You are an audit manager of Pink Partners & Co (Pink) and are planning theaudit of Golden Finance Co (Golden), a banking institution which provides arange of financial services including loans. Your firm has audited Golden forfour years and the company’s year-end is 30 September 2015.At the end of August, Golden’s financial controller left, and the newreplacement is not due to start until approximately two months after the yearend. The finance director, who is the sister-in-law of the audit engagementpartner, has asked if a member of the audit team can be seconded to Goldenfor three months to act as the temporary financial controller.You are aware that a number of the audit team members currently bank withGolden, and two team members have significant loans owing to the company.Pink’s taxation department also provides services to Golden. They have beenapproached by Golden to represent them in negotiations to resolve someoutstanding issues with the taxation authorities, for which the fees quoted aresubstantial.The finance director has informed the audit engagement partner that whenthe audit is complete, she would like the whole team to attend an eveningwatching the national football team play a match followed by a luxury meal.Required: Using the information above: (i)Identify and explain FIVE ethical threats which may affect theindependence of Pink Partners & Co’s audit of Golden Finance Co;andFor each threat, explain how it might be reduced to an acceptable(ii) level. Note: The total marks will be split equally between each part.Declan Faughey Auditing Spring 2021(10 marks)(i) Ethical threat (ii) Managing these risks Ethical ThreatSafeguard1. FamiliarityThe finance director is the sister in lawof the engagement partner and hencethere is a family relationship creatinga familiarity threat.As both hold senior positions, theycould influence the outcome of theaudit and there is a threat they mayplace their family relationship abovethe needs of the users of the financialstatements, with the auditoroverlooking accounting issues as aresult.To reduce this threat to an acceptablelevel it would be advisable for theengagement partner to be removedfrom the audit and an alternativepartner appointed.2. Self-ReviewThe client’s finance director has askedif a member of the audit team can beseconded to fill the role of financialcontroller.A self –review threat arises if the teammember is involved in the preparationof the financial statements and is thenpart of the audit team responsible forauditing these, they are unlikely tocriticise their own work.As a financial controller it is likely theteam member will be involved in thepreparation of the financialstatements. As such, the request fromthe financial controller should bepolitely declined, or the team membershould be removed from the audit ofGolden Finance Co.3. Self – InterestTwo members of the audit team havesignificant loans owing to Golden. Thisis likely to be within the normal courseof business as Golden are a bank.The terms of the loans should bereviewed to ascertain whether theyare in any way preferential.If not, no further action is required. Declan Faughey Auditing Spring 2021 However, if the loan has preferentialterms, the team members may feelindebted to Golden and be willing tooverlook certain accountingtreatments in return for thepreferential terms.However, if the terms are preferentialthen either the terms should beamended, or these two teammembers should be removed from theaudit team.4. AdvocacyGolden has requested that Pink’staxation department represents themin negotiations with the taxationauthorities.If the audit firm is seen to bepromoting the client’s position, thefirm may no longer be seen to beindependent.To maintain their objectivity andperception of independence, it isadvisable that the audit firm politelydeclines this request.5. Self – InterestThe finance director has invited theaudit team to a football match andluxury meal. The team may be willingto give a favourable audit opinion inreturn for such hospitality, creating aself-interest threat.As it is unlikely the football tickets andluxury meal for the whole team isinsignificant in value, this offer shouldbe politely declined. The acceptanceof gifts and hospitality, unlessinsignificant in value, is not permitted. Declan Faughey Auditing Spring 2021Past Paper December 2015Q4You are an audit supervisor of Pluto & Co and are currently planning the auditof your client, Venus Magnets Co (Venus) which manufactures decorativemagnets. Its year end is 31 December 2015 and the forecast profit before tax is$9·6 million.During the year, the directors reviewed the useful lives and depreciation ratesof all classes of plant and machinery. This resulted in an overall increase in theasset lives and a reduction in the depreciation charge for the year.Inventory is held in five warehouses and on 28 and 29 December a fullinventory count will be held with adjustments for movements to the year end.This is due to a lack of available staff on 31 December. In October, there was afire in one of the warehouses; inventory of $0·9 million was damaged and thishas been written down to its scrap value of $0·2 million. An insurance claimhas been submitted for the difference of $0·7 million. Venus is still waiting tohear from the insurance company with regards to this claim, but has includedthe insurance proceeds within the statement of profit or loss and thestatement of financial position.The finance director has informed the audit manager that the October andNovember bank reconciliations each contained unreconciled differences;however, he considers the overall differences involved to be immaterial.A directors’ bonus scheme was introduced during the year which is based onachieving a target profit before tax. In order to finalise the bonus figures, thefinance director of Venus would like the audit to commence earlier so that thefinal results are available earlier this year.Required: Describe FIVE audit risks, and explain the auditor’s response toeach risk, in planning the audit of Venus Magnets Co(10 marks)Declan Faughey Auditing Spring 2021 Audit RiskAuditor’s Response1.The directors have reviewed the assetlives and depreciation rates of plantand machinery, resulting in thedepreciation charge reducing.There is a risk that this reduction hasoccurred in order to achieve profittargets, due to the introduction of thebonus scheme. There is a risk thatplant and machinery is overvalued andprofit overstated.Discuss with the director’s therationale for any extensions of assetlives and reduction of depreciationrates.The revised useful life of assets shouldbe compared to how often the assetsare replaced, as this provides evidenceof the useful life of assets.2.Due to staff availability, the companyis planning to undertake a full yearend inventory count two days beforethe year end and then adjust formovements to the year end.There is a risk that these adjustmentsare not carried out correctly and thatthe year-end inventory is over orunderstated as a result.The year-end inventory adjustmentsschedule should be reviewed in detailand supporting documentationobtained for all adjusting items.The audit team should also increasethe extent of inventory cut-off testingat the year-end.3.An insurance claim for $0.7m hasbeen submitted and included in theprofit and loss. As the company hasnot received a reply from theinsurance company yet, thisrepresents a contingent asset.IAS 37 requires the receipt of acontingent asset to be virtually certainfor it to be recognised. There is a riskthat this claim is not virtually certainand therefore profit and receivablesare overstated.Discuss with management whetherany correspondence has beenreceived from the insurance companyand if so, review the correspondenceto ascertain if payment is virtuallycertain.If no correspondence received,management should be requested toremove the amount from profit andreceivables. If receipt is probable, theauditor should request managementinclude a disclosure note on the item. Declan Faughey Auditing Spring 2021 4.A director’s bonus scheme wasintroduced which is based onachieving a target profit before tax.There is a risk the directors may feelunder pressure to manipulate theresults through judgements taken orthrough the use of provisions whichcould lead to overstated profits.Throughout the audit the team willneed to be alert to this risk andmaintain professional scepticism.Detailed testing on judgementaldecisions and provisions is requiredwith treatment compared to prioryears. Any journal adjustmentsaffecting profit should be tested indetail.5.The finance director has requestedthat the audit commences earlier thannormal as he wishes to report resultsearlier.A reduction in the audit timetable willincrease detection risk and placeadditional pressure on the auditteam’s ability to obtain sufficientappropriate evidence.The timetable should be discussedwith the finance director.If it is to be reduced, thenconsideration should be given toperforming an interim audit in lateDecember or early January, whichwould reduce the pressure on thefinal audit.6.In October, a fire damaged inventorysuch that it has been written downfrom $0·9m to $0·2m which is its scrapvalue.This write down should have beencharged to profit or loss. If the goodsremain unsold after the year end,there is the risk that the scrap value isoverstated, and inventory overvaluedDiscuss with management the basis ofthe $0·2m scrap value attributed.Review whether any of the goodswere sold pre or post year end and atwhat value; this should assesswhether the attributed scrap value isreasonable. If none have been sold,discuss with management thepossibility of further write downs. Declan Faughey Auditing Spring 2021 7.The bank reconciliations for Octoberand November both containunreconciled amounts, and thefinance director believes the overalldifferences to be immaterial.Errors in bank reconciliations couldactually represent large errors whichnet off to a small amount. If thedifferences are not fully reconciled, itcould result in bank balances beingunder or overstated.In addition, unreconciled amounts inthe bank could have arisen due tofraudDiscuss this issue with the financedirector and request that theDecember reconciliation is fullyreconciled.The reconciling items should be testedin detail and agreed to supportingdocumentation. Throughout the audit,the team should be alert to the risk offraud and maintain professionalscepticism Declan Faughey Auditing Spring 2021December 2010Q3 c)You are the audit senior of White & Co and are planning the audit of RedsmithCo for the year ended 30 September 2010. The company produces printers andhas been a client of your firm for two years; your audit manager has alreadyhad a planning meeting with the finance director. He has provided you withthe following notes of his meeting and financial statement extracts.Redsmith’s management were disappointed with the 2009 results and so in2010 undertook a number of strategies to improve the trading results. Thisincluded the introduction of a generous sales-related bonus scheme for theirsalesmen and a high profile advertising campaign. In addition, as marketconditions are difficult for their customers, they have extended the creditperiod given to them.The finance director of Redsmith has reviewed the inventory valuation policyand has included additional overheads incurred this year as he considers themto be production related. He is happy with the 2010 results and feels that theyare a good reflection of the improved trading levels.Declan Faughey Auditing Spring 2021Financial statement extracts for year ended 30 September DRAFT ACTUAL2010 2009$m $mRevenue 23·0 18·0Cost of sales (11·0) (10·0)––––– –––––Gross profit 12·0 8·0Operating expenses (7·5) (4·0)––––– –––––Profit before interest and taxation 4·5 4·0Inventory 2·1 1·6Receivables 4·5 3·0Cash – 2·3Trade payables 1·6 1·2Overdraft 0·9 –Required:Using the information above: (i)Calculate FIVE ratios, for BOTH years, which would assist the auditsenior in planning the audit; and (5 marks)(ii) From a review of the above information and the ratios calculated,explain the audit risks that arise and describe the appropriateresponse to these risks.(10 marks)(20 marks)Declan Faughey Auditing Spring 2021C (i) Ratios: 2010 2009Gross Margin 12/23 = 52.2% 8/18 = 44.4%Operating Margin 4.5/23 = 19.6% 4/18 = 22.2%Inventory Days 2.1/11 x 365 = 70 days 1.6/10 x 365 = 58 daysReceivables Days 4.5/23 x 365 = 71 days 3/18 x 365 = 61 daysPayables Days 1.6/11 x 365 = 53 days 1.2/10 x 365 = 44 daysCurrent Ratio 6.6/2.5 = 2.6 times 6.9/1.2 = 5.8 timesQuick Ratio 4.5/2.5= 1.8 times 5.3/1.2 = 4.4 times Audit RiskResponse to Risk1.Management have undertakenstrategies to improve 2010 results.There is a risk that management mightfeel under pressure to manipulateresults through judgements taken orthrough the use of provisions, leadingto overstated profitsThroughout the audit team thereneeds to be an increase inprofessional scepticism and a need tobe alert to the risk.They will need to carefully reviewjudgemental decisions and comparetreatment to prior years.2.A generous sales related bonusscheme has been introduced in theyear.This may lead to sales cut – off errorswith employees aiming to maximisetheir current year’s bonus. There is arisk that sales could be overstated as aresult.Increased sales cut-off testing shouldbe performed along with a review ofpost year – end sales returns whichmay indicate cut-off errors.3.Revenue has grown by 5m (28%) inthe year; however cost of sales hasonly increased by 1m (10%).The increased sales may be explainedby the bonus scheme motivating thestaff, but the cost of sales should goup in proportion also. Sales maytherefore be overstated.During the audit a detailed breakdownof sales should be obtained, discussedwith management and tested in detailin order to understand the salesincrease. Declan Faughey Auditing Spring 2021 4.Gross margin has gone from 44.4%to 52.2% but operating profit marginis down from 22.2% to 19.6%.There is a risk that costs have beenomitted or included in operatingexpenses instead of cost of sales.The classification of costs betweencost of sales and operating expensesshould be compared with prior yearsto ensure consistency.5.The finance director has made achange to the inventory valuation inthe year with additional overheadsincluded. In addition inventory dayshave increased from 58 days to 70days.There is a risk that inventory mayneed to be written down and if notdone then inventory is overvaluedThe change in inventory policy shouldbe discussed with management and areview performed of the additionaloverheads to ensure they are of aproduction nature.Detailed cost and net realisable valuetesting should also be performed andthe aged inventory report should bereviewed to assess if inventory shouldbe written down. The question is only asking for 5 risks, so providing more could mean that timeis used up in an exam, leaving less time for other questionsYou should pick the 5 risks that you can best describe and best give a responseto, and you should only write about these!Additional risks will now be discussed but this is purely for tutorial purposes ->Only 5 risks were requested. Audit RiskResponse to Risk6. Receivables days have increasedfrom 61 days to 71 days andmanagement have extended thecredit period given to customers. Thisleads to an increased risk ofrecoverability of receivables whichmay be overstated as a result.Extend post year – end cash receiptstesting and a review of the agedreceivables ledger to be performed toassess valuation.Discuss with management the needfor a write down of receivables. Declan Faughey Auditing Spring 2021 7.The current and quick ratios havedecreased from 5.8 to 2.6 and 4.4 to1.8 respectively.In addition, the cash balances havedecreased significantly over the year.Although the ratios are above theminimum levels, this is still asignificant decrease and along withthe increase of sales could beevidence of overtrading which couldresult in going concern difficulties.There is a risk the accounts areprepared on an incorrect basis.Detailed going concern testing shouldbe performed during the audit anddiscussed with management to ensurethat the going concern basis isreasonable.Post year end position of the businessshould be analysed to understand thelatest position and identify any furtherdeterioration in the liquidity position.– Review Post year end receipts andpayments

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