HI6026 Audit, Assurance and Compliance Assignment

Tutorial Questions Assignment

Q1 - Week 6

As the auditor of Komsu Air Limited (KAL) that manufactures and installs large commercial air-conditioning systems. KAL typically has two or three large contracts (ranging from $6 million to $10 million each) in progress at any one time. The contracts usually take up to six months to complete, although unexpected on-site difficulties can result in lengthy delays in completion (of up to 12 months). KAL finances its operations with a mixture of equity, long-term debt (secured by fixed assets) and short-term bank loans.

It is now May 2017 and your planning of the audit of KAL for the year ended 30 June 2017 is nearing completion. You have met with the management of KAL and, from those discussions and a review of the preliminary information provided by KAL, you have identified several issues that may have implications for the company’s ability to continue as a going concern. The relevant issues are as follows:

-Competition in the industry is becoming more intense, with some customers now installing their own systems.

- KAL’s bank has requested cash flow forecasts for the coming year to support the short-term loans. It has indicated that it may need to withdraw funding or restructure debt if the forecasts are not adequate. The review of work-in-progress indicates that all the contracts in progress at year end are due for completion within six months of the balance date. There are no new contracts in place for the coming year, although management has indicated that there are orders currently being negotiated. The nature of the business is such that sales will fluctuate considerably from year to year depending on the timing of one or two large contracts.

-Assets consist chiefly of plant and equipment, some of which is specialised to the industry. Debtors are significant, but recoverability is not considered an issue as the ongoing projects are with reputable customers and management is not aware of any problems. Creditor balances are at normal levels, and the company is in a positive working capital position.

-Included in provisions is a large provision for warranty for one of KAL’s jobs completed at a hotel two years ago. It appears that the air-conditioning system is still not working and the hotel is now requesting a substantial refund of the contract price.

Required:

Explain whether you believe the area of going concern should be assessed as high risk and mitigating factors for KAL’s audit for the year ended 30 June 2017. (10 marks, maximum 300 words)

Solution 1: KAL’s ability to do business in future is really difficult due to the various situations it faces currently. The reality is that competition in the industry is increasing due to some of their customers implementing their own system which means this will cut out their already floating sales level and affect their profitability. This is a high risk for going concern.  KAL has no contracts for the coming year till yet this is indeed risky as banks would restructure their short term debts and KAL’s operations depend on it. Banks would not accept on only basis of negotiation as it is not concrete. Long term debts are tied with fixed assets which are essential to the business if KAL has not enough cash to repay back this loan due to lower sales then it will lose out on any its main assets and go out of business for sure. This again is quite risky. The less risky point here is that they have positive working capital and as a result cash for day to day expenses is present. Hotel must be a large contract which means it will heavily affect the cash flows of KAL if it has to return the amount as warranty so it is also high risk.

There are several solutions to KAL’s problems which should be implemented. They should try to diversify their business as competition is rising and not focus on a single product. They should try to go for debtor financing instead of using short term bank loans as there sales are fluctuating. They should try to negotiate with the hotel before paying them back and try to solve their problem regarding their air conditioning. They should avoid using specialized industry assets for long term loans and can raise corporate bonds instead.

Q2- Week 7

Wares king supplies custom-fitted curtains and blinds to retail customers. It has recently expanded to offer a wide variety of home decorating products through its six stores across the state. After some initial problems with stock control it installed a new automated inventory system in April this year. The system replaced another automated system that had been modified so often over the years that the auditor had advised Wares’s management that they did not regard it as reliable. That is, the auditor was unable to rely on the old system sufficiently to assess control risk for inventory as anything less than high.

Required:

1. a) Explain the normal process an auditor would expect to find in the client’s systems governing changes to computer programs. Why is an auditor concerned about program changes? (3 marks, maximum 100 words)
2. b) Wares kings’ financial year-end is 31 December. Does the auditor need to obtain evidence about the performance of the inventory control system from every month in the year or from a sample of months? Explain. (3 marks, maximum 100 words)
3. c) If the auditor conducts test of the inventory controls at an interim date, is it appropriate to conclude that the controls also relate to the end of period date? Why? (4 marks, maximum 150 words)

Solution 2:

1. The normal process involved in change of control systems need to go through a specified system of the organization. The internal audit department needs to consider changes by following the necessary policies and regulations placed in an organization. The shortcomings if any are identified by external auditors. This also makes sure that sudden changes in controls do not happen and only proper planned changes happen in controls. Auditors are concerned about these changes as they have to make sure that the change in controls are fulfilling its purpose or not.
2. Not every month needs to be checked out. Samples before April from the old system needs to be checked and compared with the new system installed in April and observe the relevant findings. The auditor needs to check if this system has improved inventory controls or not. Whether this system is fulfilling the needs which were pointed out in previous audits. This will actually give an idea also regarding whether if there are still any shortcomings which can be conveyed to management for further review.
3. The fact is that they should relate as test of controls were updated in April while an interim date would be in June as opposed to the end date which will be in December. But in order to get a better idea of how these controls are performing the auditor will have a much larger sample at the end date as opposed to an interim date. When checking the controls through re-performance the auditor can do it easily on both dates specified and check by entering any transaction. While when it comes to checking through inspection and observation it would be better served to do it on an end date as the data would be much spread out. This will help the auditor understand the processes in a much better way.

Q3- Week 8

You are the audit manager at KPMG & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Vesta Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Vesta Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, Jonathon Marshall, the husband of the finance director, Nimat Marshall provided electronic components to Vesta Tech Ltd through his private company. There is no formal agreement in place with Jonathon Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that Jonathon Marshall’s company is supplying, because his products are new to the market and you have heard some of Vesta Tech Ltd’s staff complaining that they are of poor quality.

The board has informed you that although sales have been strong this year, Vesta Tech Ltd has suffered significant cash flow problems because a major debtor, Mimosa Ltd, is experiencing financial difficulties. As a result, Mimosa Ltd is taking well over 120 days to pay outstanding amounts, despite Mimosa Ltd’s terms of trade being payment within 30 days. Mimosa Ltd makes up 40 per cent of Vesta Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Vesta Tech Ltd has had to increase its dependency on its line of credit, and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with WestPac Bank Ltd.

The management of CGL is currently reviewing the structure of its audit committee to ensure that it complies with the requirements of the ASX Corporate Governance Principles and Recommendations.

However, the board is confused by the reference in the ASX Corporate Governance Principles and Recommendations to both independent directors and non-executive directors, as they thought that they were the same thing. As a result, they have sought your advice concerning the structure of their audit committee.

Required:

1. a) Identify two key account balances at risk of material misstatement. (2 marks)
2. b) For each account balance identify the key assertion at risk. (2 marks)
3. c) Explain why the account balance and assertion are at risk. (2 marks, maximum 100 words)
4. d) Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified. (4 marks, maximum 200 words)

Solution 3:

1. a) Inventory (Asset) and Bank loan (Liability)
2. b) In case of inventory the assertion at risk is its valuation.

In case of Bank Loan the assertion at risk is its completeness.

1. c) Account balance of inventory and its assertion in terms of valuation is at risk as the inventory items are of a poor quality as opposed to the previous supplier. So there can be misrepresentation in terms of its valuation as its value should be lower as compared to the previous supplier’s.

Account balance of bank loan and its assertion in terms of completeness is at risk as they have to maintain a specific debt to equity ratio so there are chances that debt is not shown completely in statement of financial position so this can be met.

1. d) In case of Account balance of Inventory and its assertion regarding valuation we will need to perform a substantive test of detail by going through inventory valuation calculations. We will need to refer to IAS2 and use lower of cost or NRV method to value the inventory which is of a poor quality. We will need to find out market value of electronic components which are of a same quality so we can use to calculate NRV of the product and this will help us get a fair value for the inventory.

In case of Account balance of Bank Loan and its assertion regarding completeness we will need to perform a substantive test of detail involving information from different banks regarding loans taken in form of documentation. We will need to compare breakdown of loans with those presented in financial statements through bank confirmation letters so that no loan is left out to fulfill covenant of specific debt to equity ratio requirement. This will help to provide a real picture regarding loans and give accurate financial statements.

Q4 - Week 9

1. a) What are key audit matters? How do these affect the format of the audit report? (2 marks, maximum 200 words)
2. b) Stewart Jones is reviewing the results of the subsequent events audit procedures. Stewart is writing a report for his audit partner based on these results and will be attending a meeting tomorrow with the partner and representatives of the company to discuss them. The issue will be whether the financial report should be amended, or additional notes included for these subsequent events.

Many of the items are not material and Stewart will recommend that no action be taken with respect to these. However, there are several items that Stewart believes are material and should be discussed at the meeting. These are as follows.

(a) The board is planning to issue shares in a private placement on 15 August. (2 marks)

(b) The share issue is to fund the purchase of a 60 per cent stake in another company. The negotiations are in the final stages and although the contract is not yet signed it will be signed by 15 August. (2 marks)

(c) A writ was lodged in the Supreme Court in the week after year-end claiming damages for illness allegedly caused by chemicals used at a subsidiary company’s manufacturing plant in the 1990s. This is the tenth such writ lodged, and the client has denied responsibility in all cases because it was unreasonable to believe at that time that these chemicals had adverse health effects. The claimant has new scientific evidence that counters this defence. (2 marks)

(d) The review of subsequent cash receipts has revealed that several of the trade receivables that were considered doubtful have now been paid. However, the audit procedures have shown that a large debtor that was considered safe at 30 June was unexpectedly declared bankrupt on 20 July. (2 marks)

The year-end for the company is 30 June and the audit report is due to be signed on 20 August.

Required:

For each of the items above, explain what type of subsequent event it is and the appropriate treatment of the item in the financial report. (8 marks, maximum 300 words)

Solution 4:

1. a) Key Audit Matters are items to audit which according to the auditor’s professional judgment are the most significant items in the audit of financial statements. These items are given special importance in the audit and are actually closely looked at. These items can be pertaining to those of which the auditor believes that can have higher chances of material misstatements happening. These can also be items of which the auditor tends to believe that are based on higher levels of estimation and thus could have errors in them. ISA 701 is a guiding standard for an auditor to choose an item as a Key Audit Matter.

In the format of auditor’s report Key Audit Matters are shown in a detailed way that why it was taken as a Key Audit Matter and it explains this. There should also be explanation regarding that what procedures were used in analyzing the Key Audit Matter and what outcomes were drilled out as a result. Usually Key Audit Matters are written in between of basis for opinion paragraph and Management responsibility paragraph.

1. b) 1) Issue of shares for a private placement. (Type 2 Non-Adjusting Subsequent Event)

As this event has no previous occurrence so it is non-adjusting. On 15 Aug it was decided to issue shares it will not be shown in financial statements as it will not impact users’ decision regarding the company.

2) The purchase of a company after financial statements has been prepared. (Type 2 Non-Adjusting Subsequent Event)

As this event has no previous occurrence so it is non-adjusting although a company is being bought on 15 Aug and so it is necessary to show material effects on financial statements. The users of these statements need to be informed of this transaction as this will impact their decision regarding the company in notes to accounts.

3) The issue was regarding writs lodged against subsidiary company to claim damages due to illness caused by chemicals. (Types 1 Adjusting Subsequent Event)

The tenth writ was lodged against the company on the ongoing issue since 1990s. The company has scientific proof regarding their chemicals and should be able to end this issue soon as a result there will be no impact on financial statements regarding contingent liabilities.

4) The audit procedure show a large debtor that was safe has been declared bankrupt. (Types 1 Adjusting Subsequent Event)

Adjustments needs to be made in account receivable and provision for doubtful debts in which those debts that were doubtful should be cleared and thus provisions will reduce while account receivable should increase. This major debtor was declared bankrupt on 20 July and should be treated as bad debt as no chance of getting money from him.

Q5- Week 10

You are the audit partner at Parkville & Associates, a mid-tier audit firm. You are responsible for the audits of the following four independent entities for the year ended 30 June 2018:

(a) Human Help Ltd is a non-profit entity. You have discovered that it has not kept substantiating vouchers or receipts for more than 55 per cent of its expenses, excluding salaries and allowances (2.5 marks)

(b) JJ King Ltd is a building contractor with a varying workload. In order to compensate for the irregularity of its contracted building projects, JJ King also purchases large vacant blocks of land that it later subdivides for the construction of houses and units. JJ King then sells these on its own account. Your analysis strongly suggests that the apportionment of costs to houses and units sold has been kept low to boost profits. In your opinion, this has resulted in the overvaluation of the unsold properties. The directors of the company do not agree and hold to their view that the stock of properties is correctly valued (2.5 marks)

(c) You have completed the audit of Grand Resort Ltd (Grand Resort) for the year ended 30 June 2015. The audit partner suggested that the value of properties on the Gold Coast were overstated by $16 million, a figure which was twice the level of materiality set for the audit. As a result of discussions with the audit committee, the CEO of Grand Resort agreed to revise the valuations downward by $10 million. All other issues were resolved to the satisfaction of the audit partner, resulting in an overall misstatement of the financial report of $6 million. The audit partner is now considering the effect of the misstatement on the auditor’s report. (2.5 marks)

(d) Grand Event Ltd arranges for popular overseas entertainment artists to perform in Australia. The band Eclipse was booked by Grand Event to play in major cities across the country. Grand Event’s written contract required the company to pay the band in US dollars but, in order to reduce costs, it did not hedge the amounts. Subsequent to year end, the Australian dollar fell against the US dollar and a substantial loss relating to the band’s tour was predicted. The management of Grand Event tried unsuccessfully to renegotiate the band’s contract and has been unable to obtain finance to cover the expected shortfall. Grand Event has now cancelled the tour and expects a substantial claim from Eclipse. It is clear to you, as the auditor, that Grand Event does not have the income, cash or other assets to sustain such a loss. (2.5 marks)

Required:

Assuming no amendments have been made, identify and explain the type of auditor’s opinion required for each issue outlined above. (10 marks, maximum 300 words)

Solution 5:

1. a) There are no receipts for more than 55% of expenses excluding salaries and allowances. (Disclaimer of opinion)

As there is no information regarding these expenses so it is not possible for the auditor to give out any opinion based on current situation regarding the financial statements.  If that information is available, then only a solid opinion can be formed. Disclaimer of opinion is given when there is limited information for auditor to give opinion.

1. b) Wrong valuation of properties to be sold as inventory is overstated. (Unqualified opinion)

Even after the mentioning that the properties’ value was overstated still the management went with the same valuations. To value inventory it is important to use IAS 2 in which we use lower of cost or NRV method. Unqualified opinion is given when there deviations from accounting standards but not fraudulent.

1. c) Value of properties overstated by firstly 16m and later corrected but still exceeded by 6m. (Adverse Opinion)

This actually is a serious offence and can be termed as fraud as they are window dressing their financial statements for their users. They need to value their assets properly according to their fair value or market value available. Adverse opinion is given when there are serious allegations present and violations of accounting standards.

1. d) Legal issue as they did not hedge currency risk which arose later when currency fluctuated. (Unqualified opinion with emphasis of matter paragraph)

There is no problem with regards to reporting issues, but the fact is it is evident that a legal issue could arise in the current situation that is why the auditor here is pointing out this situation so that it can be undertaken in an efficient way. Unqualified opinion with emphasis of matter paragraph is given when auditor requires special attention of management.