Mar 2020

Question 1

a) Audit risks to be considered in planning

Segmental reporting

Accounting std require the listed entities to prepare the segmental reporting that indicate clearly the
contribution made by the respective component if their contribution is 10% or more to the combine
revenue of all the segment. The fact that Rick Group operate in 8 countries, they are geographical
segment, and therefore necessitate the preparation of segmental reporting. Failure to prepare the
said reporting or failure to allocate the asset revenue and PBT accurately to respective segment
constitutes to a form of misstatement to the financial statement.

Daryl Co

The fact that Daryl Co is a foreign subsidiary, necessitated the alignment of Daryl Co accounting
policy’s with that of the group accounting policy, i.e the IFRS standard. There is a risk that the client
may not have made the said alignment, or may have done it wrongly.

Daryl Co would be audited by a local firm auditor. Considering that Daryl Co is a significant
component whose TA of 140m represent 17.9% of the Consoled TA. Any errors made by the
component auditor in the auditing of the component will have a material effect on the consoled
financial statement.

Annual incentive scheme

Bonus payment of $8.2375m represent 14% of previous year PBT. And if this amount continues to be
paid in current year, it still material at 13.7%. The bonus payment can be subjected to manipulation
as its partly linked to the profitability, which means the director can adopt more aggressive
accounting policy that will have the effect of increasing the profit and therefore increasing the bonus
payable. This may be the case for client unwillingness to recognise a provision relating to a legal case
as well as the choice to amortize the licences to a longer period.

Legal Case

Accounting stand require a provision to be made when a present obligation exist due to the past
event that can be legal or constructive. In addition, the provision can be determined with certainty
and accuracy and its probable that there will be an outflow of economic resources from the
company. The legal case initiated against the client by Glenn Co represent past events. Even though
there is no relevant documentation available for evaluation, the group FD is not willing to recognise
the legal case within the financial statement and does not want to discuss it further with the audit
team. This may be motivated by the reluctant to reduce the current year PBT which was only higher
by the previous year by 0.4m. As a listed entity, the finance director is under pressure to report
favourable result in order to sustain the investor. The failure to recognise the provision when the
present obligation exist means that the profit has been overstated and the liability understated.

Client management integrity

The reaction of the FD

The reaction of FD in treating the legal case as well as the licensing period, raised question regarding
the integrity of the finance director. This will necessitate the group auditor to change the nature,
timing and extent of audit.

Group Revenue

Group revenue increase by 25.6% in 30 September 20X5. The revenue can be misstated due to the
following two issue, accounting standard require revenue to be recognise only when the
performance obligation has been fulfilled. Owing to the Rick Group nature of business, the
performance obligation will be to make available and uninterrupted internet streaming for films and
tv programme. This means that the service is being provided at period of time, whereas the revenue
is being recognise at a point in time, when the billed is sent to the customer, and the service has yet
to be rendered. This would result in overstatement of revenue and understatement of deferred
income.

The second issue is that the auditor own calculation of the revenue based on the monthly
subscription of $8.20 and on the basis of 10.5m subscription customer, produces a $1033.2m, which
was higher than the recorded revenue of $980m. The different of $53.2m or 5.4% of revenue
represent possible understatement of revenue.

Content Licences Amortization

The licences of 580m represent the 74.4% of TA and is therefore material to the SOFP. Despite the
time period for the content licences, vary between 3 and 5 years, the client has chosen to amortized
the licences over 5-year period. This would have the effect of understating the amortization expense
and overstating the intangible asset. Again, this can be due to the unwillingness of the Group FD to
report a reduce on the PBT.

Goodwill

Goodwill of 135m represent 17.3% of TA, and is therefore material to the SOFP. Similar to other asset
accounting standard, goodwill to be subjected to impairment review where the situation warrants it.
The significant reduction in the number of customer due to the disruption of internet services in the
country where Daryl Co. operates, has resulted the company to projected to be making loss for this
year, and yet the client continues to report no changes in the goodwill. The effect of this is that the
goodwill in the consoled financial statement has been overstated with the resulting overstatement in
the profit. In addition, the holding company investment in Daryl Co and the asset in Daryl Co
separate financial statement have also been overstated.

Potential acquisition of new subsidiary

The acquisition the new subsidiary is at the advance stage and is expected to take place in October
20X5. This investment represents a post reporting period due to past event. However, owing to its
materiality, accounting standard require the disclosure of this transaction in the notes of account.
The risk is the client may not disclose this or may disclosed it but not adequate.

b) I)

Materiality

For the current year audit, the component auditor has proposed to determine the materiality based
on the total asset, instead of the revenue due to the significant reduction in revenue and profit. As
the result of the change of the basis, the materiality level was determined at $1.4m higher than the
previous year at $1.2m the increase is only justified if the perceived risk in Daryl Co has reduced,
because higher materiality level will result in lesser work to be carried out. However, this was not the
case for Daryl CO because the company is subjected to make due to the reduction of number in
customer. The impairment of the asset requires significant adjustment. Instead, the component
auditor, should continue do to determine based on the revenue at the average level.

Payroll

During the year, the component auditor provides payroll accounting services to Daryl Co. The
outcome of the payroll service will be included in the financial statement and to be subjected to
audit by legal associate. At the holding company level, the code of ethics from IFAC prohibit the
group auditor from providing non-audit service to the group if self-review threat to objectivity.

The component auditor, even though located in the different country, is expected to comply with the
same code of ethics as group auditor. As such, the provision of should not be carried out.

Based on the planned audit procedures, it was clear that the component auditor has suffered from
self-review threat that resulted in minimal work being carried out on the payroll figure. Due to over -
reliance, on the work perform by fellow PA from the firm. The group auditor, should instruct the
component auditor to carry out additional audit work can, there are no different compared to if the
payroll were prepared by the client. They should not continue the service

Sale of property

No doubt the sales of property, that amounted to $50,000 was immaterial to Daryl Co financial
statement as it represents only 0.04% of Daryl Co’s total asset. However, the buyer was the CEO and
is therefore a related party transaction. This transaction is therefore material on th ground of its
nature. Even though the local did not require the disclosure, but similar to the code of ethics, this
transaction would, have to comply with the holding company accounting policy. The group auditor
will therefore construct the group auditor to obtain the information, for the disclosure at the group
level.

B Ii)

- Review the sales and ppurchase agreement entered into between the CEo and the Daryl
Co for two thins,t he sales proceed as well as the term of the sales.
- Review the board minutes for approval of the sales to the CEO.
- Review post reporting period of cash book for payment or outstanding
- Enquire the CEO for confirmation of the amount outstanding as the year end.
- Discussion with component auditor that indicate the required information relating to the
sales of the property to the CEO
- Comparison of the sales proceed with similar property within the same vicinity advertise
for sales.

C) Joint audit is appropriate for the reason below:

- The group auditor is different compared to the component auditor and yet the group
auditor will be personally responsible for the consoled financial statement which
included the result of the component.
- Joint audit will allow the group auditor to be involved in auditing the new component
thereby compensate any risk associated with reliance on the component auditor.
 - The group auditor has no offices in Farland, and therefore the client cannot appoint the
network firm in Farland, to be the auditor of the new component. Joint audit offers an
alternative for the group auditor to be involved.
- The component auditor is a small local firm of chartered accountant, due to it lacks of
resources, such as competent staff, as well as audit software, a joint audit would ensure
that the quality of the component audit will not be compromised because of such
shortage of the resources.
- The component auditor will be more familiar with the local country accounting policy
and also the laws and regulation compared to if the group auditor were to audit the
company alone.
- Advantages : it helps overcome the shortage of manpower issue especially during the
peak periods
- Joint audit can promote deliberation of an issue between the firm, thereby reduce the
audit risk.
- Disadvantages: Much time will be spent in agreeing the methodology to be use
- In the event of the litigation, the liability that we shared is not in the font of

2)

a) i)

Implication

The conclusion made by the auditor that the fraud is immaterial and no further work is
needed, is purely based on the confession made by the suspect. Who confirm that he has
stolen $40,000, which was far below the materiality level of $400,000. However, the
confession is regarded as internally generated evidence and there is high tendency that the
suspect may not have disclose the full amount that he has stolen in order to be seen as less
guilty. It therefore necessitated verification from the auditor by undertaking audit
procedures as seen below.

By requesting the audit team not to perform any procedure related to the fraud, the Finance
Director may be one of the culprits involved in the fraud. However, considering that the
Group FD was the person who inform the audit team about the fraud, he may not be the
suspect, and his reluctant to let the audit team to perform any procedure related to the
fraud may be an attempt not to report the losses in the financial statement and deteriorate
the company financial performance. On the other hand, he may also have made reporting to
the auditor in order not to be seen as one of the suspects. The actual situation will depend
on the outcome, of the additional procedure carried out.

The fact that fraud had occurred in the client company suggested that the control over the
procurement area is weak. Hence, it will not be appropriate for the auditor to rely on the
existing control to reduce the substantive testing. Instead, extensive substantive procedure
would have to be carried out. If Finance Director who is a senior personnel, is subsequently
found to be involved in the fraud, his integrity would be question, and this would have
implication on the audit in term of the nature, extent and the timing.

Action to be taken by auditor

 We need to explain to the FD that the auditor cannot accept the written representation and
the list of fictitious invoices which had been raised by the manager, without carried out
independent work on our own.

Reluctant of the information to be obtain, Auditor may need to report to TCWG, and the
report will be qualified opinion on the ground of inability to obtain sufficient evidence.

a) Ii)
Development cost

The development cost of $600,000 exceeded the materiality level of $400,000 and is
therefore material, and warrant the auditor attention to audit these balances in the financial
statement.

The agreement on the sample of the costs included in the $600000 in the supporting
documentation is appropriate. As this will ensure that the reported cost had actually be
incurred. The nature of the expenses should have been review to ensure that no research
expenditure has been capitalised.

Even though the arithmetic checking of the cash flow possession is appropriate in ensuring
that no calculation error has occurred, that should also be review of the assumption used to
prepare the cash flow projection for reasonableness.

The written representation from management, is a form of internally generated evidence,

and should only be obtain for situation where sufficient appropriate evidence cannot be
obtain due to involvement of the management estimation adjustment. This certainly is not
the case for auditing the development of the new product. Accounting standard require the
development to be technically feasible. Failing which, the development will not be
successful. The auditor ought to have review the status of the development, instead of
relying on the management representation.

In addition, accounting standard require that the outcome of the development to be

commercially viable which means there will be a demand for the new security system to be
developed, but there was no procedure to review the market survey that has been carried
out for this new security system.

The fact that the FD was unwilling to answer the question relating to cash flow projection
and to provide the password to assess the group business plan where the assumption can be
found, suggest that he was hiding something away from the auditor. This should heighten
the auditor scepticisms and be more thorough in obtaining the evidence.

Trade receivables
 The amount owed by Hamlyn Co of $500,000 exceeded the materiality level and is therefore
individually material. The long outstanding balance has raised the question of whether the
amount is recoverable.

The agreement of the balance on invoices and the original customer order is appropriate, as
it confirm the accuracy of the amount recorded by the client.

Similarly, the discussion with group credit controller, regarding the status of Hamlyn Co, is
also appropriate but not sufficient due to the representation of the credit controller is
regarded as internally generated evident. The credit controller may be under pressure and
therefore bias in the representation made. This is especially so when the auditor did not
receive reply from Hamlyn Co from the securitisation which suggest that Hamlyn Co may no
longer exist.

For this reason, that ought to be further additional evidence to be carried out:
- The review of post reporting cash book, for any payment made by Hamlyn Co.
- The review of post reporting period corresponding file for any notification of winding up
of the Hamlyn Co.
- The review of the post reporting period board minutes for discussion by the Board on
the status on this material trade receivable.
b)
- Basis opinion paragraph should be separated with the opinion paragraph appearing
before the basis for opinion paragraph.
- No indication that the report was qualified.
- Since the opinion is adverse, the title must be ‘Basis for Adverse opinion’ and ‘Adverse
opinion’ paragraph title.
- the opinion issue is inappropriate, because the misstatement was confined to the only
trade receivable and . The misstatement did not constitute the
- Emphasis of the matter should only be use to highlight those matter that are deemed
fundamental to the user understanding of the financial statement. Such as matter that
are involved uncertainty, development in the company that have the effect of affecting
the following year performance.
- The occurrence of fraud should not be mention in the report for two reasons. Firstly,
There was no conclusion made by the court of whether the fraud has happened.
Therefore, the fraud cannot be mention in the audit report. This can be subjected to
legal argument by the client company as defamation. Including this in the report may
damage the client reputation and attract legal action. And such auditor should only
comment on the effect on the fraud only, such as the misstatement and the limitation.
However, in this case, the partner has concluded that the fraud is immaterial. Then this
should not be in the report totally. The comment regarding the limitation impose by the
finance director can be seen as personal attack to the finance director and make the
auditor not seen to behave professionally. When the auditor had issue with the FD, the
proper channel is to report to TCWG.

3)

(b) Ethical
The fact that Beaufort Co intend to list on the stock market, shortly after the year end would
create a pressure on the management to report favourable result so that the success of the
listing would be high. This would inevitably increase the chances of fraudulent financial
reporting.

Frances Stein have been the engagement partner of Beaufort Co for the last 8 years. The long
association with the client can result in relationship being establish between Frances and the
client management. Giving rise to familiarity threat to objectivity. This can result in Frances
over-sympathize with the client situation to the extent that he is unwilling to criticize the
financial statement. Following the listing of Beaufort Co, the code of ethics only allow
Frances to continue to be the engagement partner for further 2 years before he is required
to step down to observe of the cooling off period of less than 5 years.

For two consecutive years i.e 20X5 and 20X4, Beaufort Co contribute more than 15% to the
firm total fee income, which can give rise to self-interest threat to objectivity. The fear of
losing the client can result in the firm compromising their independent in the expression in
the opinion in order not to upset the client. Following the listing of Beaufort Co, this
dependency would have to reduce to below 15%. The code of ethics require the firm to step
down as auditor if it continue to exceed the 15% beyond the two year limit.

The provision of accounting and book keeping and the preparation of monthly payroll will
result in the outcome being included in the financial statement and subjected to audit.
Giving rise to self-review threat to objectivity. The auditor concern will not be undertaking
the same amount of audit work compared to where the work done by client or the third
party. The code of ethics prohibits the firm from providing any services to the client that has
the effect of generating the self-review threat. And so, all these services must be
discontinued after the listing.

The assistant in the preparation of the share prospectus document and the subsequent
issuance of the accounting report on the prospectus can give rise to self-review threat similar
to those mention earlier. Even if issue were found in the prospectus document, the reviewer
of the prospectus document will be reluctant to criticise in order to a safeguard the interest
of their fellow colleague and the firm. Giving rise to self-interest threat to objectivity.

The preparation of the profit forecast as well as the summary of the key risk relating to the
client’s business and the business plan outlining the future prospects involve in making the
managerial decision, which will then make the PA concern will be seen as a member of client
management, and the firm will no longer qualified to be the auditor. The law prohibits the
director and the officer of a company to be its own auditor.

The request to recommend the client to investor, can result in the firm promoting Beaufort
Co situation to the extent that objectivity is compromised. Giving rise to advocacy to
objectivity.

The fact that Beaufort Co is currently reviewing the audit appointment and is looking.. means
that only firm that can provide all the needed services will be appointed. This represents a
form of intimidation threat to a form of professional competence and due care. Putting
pressure on the firm to provide those services and it was not encouraged to accept.