Questions: 5 UNIVERSITY OF TASMANIA EXAMINATIONS FOR DEGREES AND DIPLOMAS October/November 2020 BFA303 Auditing First and Only Paper Ordinary Examination Examiner: Heinrich Oosthuizen Time Allowed: FOUR (4) hours Reading Time: 15 minutes Instructions: • This examination is worth 100 marks and consists of one section. • The exam contains five (5) case study questions. Answer all questions. Each question has different mark allocations (indicated in brackets) (100 marks). • The examination counts for 50% of the final mark. • This is an open book exam. You can only access your lecture slides, tutorial notes and textbook (you cannot use online sources). • Work independently, and you must not collaborate with any other person in order to complete this exam. Plagiarism is strictly prohibited. The questions are to be answered using the spaces/tables following each question. Question 1 The following are independent situations: (i) Warren Smith is an audit partner of Smithies. Warren is the responsible auditor on the audit of a non-profit organisation, the Australian Bonsai Society (ABS) Incorporated. As a favour to ABS, he also serves on the Remuneration Committee. The committee advises the board of directors on board meeting fees and oversees attendances of directors to ensure they qualify for payment in terms of the number of meetings attended. Warren is not paid for his services on the committee and he does not consider his duties to be a ‘management’ function. (ii) You are a senior partner in the audit firm AMG. AMG has performed the statutory audit of Grow Fast Pty Ltd, a large proprietary company for the last 10 years. Grow Fast has experienced phenomenal growth which resulted in them opening multiple branches. The scope and extent of audit procedures required to complete the audit has dramatically increased, resulting in Grow Fast becoming AMG’s biggest client by far, with annual audit fees constituting the bulk of AMG’s revenue. (iii) You are the partner in charge of the audit of New Age Designs Ltd. Sean Rice is a student studying accounting at UTAS. Sean is employed as a ‘holiday casual’ in your audit firm. Sean is also the son of the storeman of New Age Designs. You have discovered that the manager in charge assigned Sean to the audit of New Age Designs to assist with the annual year-end inventory count and related procedures. The inventory count has not commenced. (iv) You are nearing retirement and intend to sell your public accounting practice. The practice includes bookkeeping, tax services and auditing. As part of the negotiations in selling the practice, you make audit-related working papers, tax-related working papers, and management-services related working papers available for inspection by potential purchasers. (v) Livingstone and Associates is a medium-sized audit firm located in Hobart, TAS. The audit firm performs a wide range of small audits. The firm has been approached by Western Mining Ltd, a large mining group with its headquarters in Perth, WA. The mining operations are spread out over a number of licences held in remote Western Australia. Livingstone and Associates have not previously carried out audits of mining groups nor mining activities. The partners of the firm believe this is an excellent growth opportunity to ‘valuable to be missed’. Required Using Table 1 below, for each of the abovementioned independent situations: a. Briefly describe the primary principle (if any) which breaches the underpinnings of the practice of auditing. [5 marks] b. Briefly explain the impact of the breach with reference to the relevant auditing standards or regulatory framework. [5 marks] c. Interpret how the auditing standards, or Corporation Law, or Code of Professional Ethics apply to each situation, by suggesting safeguards to address breaches. Reference where appropriate. [5 marks] [Total 15 marks] Table 1 Event Part a. answer Part b. answer Part c. answer i ii iii iv v Question 2 You are the audit senior responsible for the audit of Killer App Limited, a company registered in Australia. You are currently planning the audit for the year ended 30 June 2020. During your initial planning meeting, your audit team considered the following changes in the company’s operations. (i) Due to the Covid-19 pandemic, the company has allowed administration and accounting personnel to work from home. The company now makes extensive use of application controls in the financial accounting system to replace some general controls no longer feasible as a result of the change in the employees’ working conditions. (ii) In response to a dramatic drop in revenue in the tourism sector and to improve its cash flow situation, Killer App has passed a directors’ resolution to enter into negotiations to sell some of its tourism related property investments in Victoria at a substantial loss. The negotiations will start before year end and disposal will be completed before the end of the next financial year. (iii) To counter the dramatic drop in sales revenue as a result of the Covid-19 pandemic, Killer App will introduce bonuses for its sales staff in the 4th quarter. The bonuses will be an increasing percentage of the gross sales, made by each salesperson, above certain monthly targets. (iv) To reduce the operating costs, the company is using a new popular general ledger software package. Your initial tests of controls found that the new system required only minor modifications and produces reliable monthly management accounts. The new system allows for detailed comparisons with budgets and prior-period figures across product lines and geographical areas. The conversion to the new system occurred with a minimum of fuss. (v) The company has made substantial investments in developing a computer application to scan and compare social media news coverage to flag ‘fake news’. A social media giant has filed a ‘cease and desist’ application in the Australian high court. If the application is upheld, Killer App will not be able to sell the app on the major PC operating systems’ app stores. Required Using Table 2 below, for each of the scenarios above, a. Analyse and assess business and audit risk and, if applicable, briefly describe the specific component(s) of audit risk affected. [5 x 1 marks] b. Interpret the effect of the business and audit risk assessment on the overall audit approach and briefly explain the impact of the risk assessment on audit planning decisions. Reference the appropriate audit standard where applicable. [5 x 3 marks] [Total = 20 marks] Table 2 Scenario Part a. answer Part b. answer i ii iii iv v Question 3 You are the audit manager at Uzi & Uzi, a medium-sized audit firm undertaking the audit for the year ended 30 June 2020 of Whiskey Holdings Ltd, a distillery located in the midlands of Tasmania. Whiskey Holdings Ltd distil and sell 200-L barrels of Whiskey to customers which they ‘age’ on site for periods up to 20 years. Customers are required to pay for the product on the date at which the barrel was sealed, with additional payments after every 5 years of aging. During the planning stage of the audit, you became aware of an article in the local newspaper that one of Whiskey Holdings Ltd’s major customers had difficulty in collecting a 10-year old barrel of whiskey and subsequently claimed it was only 5 years old. You are concerned about similar concerns other customers may hold and how this may impact on the potential for legal disputes. You are also concerned on how such disputes may have impacted on legal fees. In following up the impact of article with the chairperson of the audit committee of Whiskey Holdings Ltd, you were advised that the company has indeed incurred substantial, unrecorded legal costs because of similar, as yet unreported disputes with other customers. The audit committee has instructed the internal auditor of the company to investigate the validity of customer complaints. In an initial, highly confidential report, the internal auditor reports that they found it extremely difficult to distinguish company-owned barrels from customer-owned barrels. The customer-owned barrels were mostly not labelled, and they observed some instances of what appeared to be barrels with broken seals. Required Using Table 3 below, answer the following: a. Analyse the business and audit risk and assess which three key account balances are most at risk of material misstatement. [3 marks] b. For each account balance assess which key assertion is most at risk. [3 marks] c. Evaluate the audit evidence and explain why the account balance and assertion are at risk. [3 marks] d. Design one (1) substantive test of detail that you will carry out for each account to address the assertion and risk identified. [3 marks] e. Evaluate the evidence to explain two key going concern factors that place the going concern assumption at risk in relation to Whiskey Holdings Ltd’s financial report for the year ended 30 June 2020. Refer to the audit standards [4 marks] f. Design two (2) substantive tests of detail that you will undertake to respond to the going concern risk. Refer to the audit standards. [4 marks] g. You are very concerned about your potential liability to 3rd parties because your audit procedures for the year ended 30 June 2019 did not discover any material misstatements. There now appears to be a likelihood that the financial statements were fraudulently prepared. Interpret how the Corporation- and common law may impact on your potential liability. Refer to the Esanda case in your response. [5 marks] [Total 25 marks] Table 3 Part Answer a b c d e f g Question 4 The timeline for the release of Fishy Story Ltd’s 30 June 2020 financial statements is as follows: • 30 July 2020: Financial statements approved and signed by the directors and the auditors’ report is signed later on the same day. • 15 August 2020: Financial statements issued. The following material, as yet unrecorded information, obtained as the result of audit procedures performed subsequent to year end, has come to light: (i) On 23 July 2020, Free Divers Pty Ltd (a supplier to Fishy Story) issued an additional invoice amounting to $20,000 pertaining to urgent repairs on fishing pens in Macquarie Harbour. Free Divers attended to urgent repairs during a weekend in June, as a result of a once-in-10-year storm that hit the west coast of Tasmania. Fishy Story disputes the invoice as they argue it was already invoiced at the end of June, as part of the normal monthly maintenance contract. Your initial investigation suggests that the dispute will likely result in litigation. (ii) On 5 August 2020, one of Fishy Story’s fishing vessels was transporting fish on the Huon river. When approaching the wharf, the captain of the boat lost control and ran into a yacht moored at the wharf. The estimated damage to the yacht is $250,000. Fishy Story’s insurers are refusing to pay out as the captain involved tested positive for a prohibited substance subsequent to the event. (iii) On 28 July 2020, The Tasmanian Environmental Protection Authority issued a $150,000 fine for ecological damage caused by Fishy Story in 2018. The fine was issued for the illegal discharging of wastewater from the company’s fish cleaning operations. The company issued a media statement expressing regret for the unfortunate incident but indicated that in their opinion, no permanent damage was caused. (iv) During July 2020, Fishy Story was awarded a license to farm fish in Storm Bay, near Hobart, Tasmania. The process of applying for the license started in 2017. New Nets Pty Ltd has an exclusive supply contract with Fishy Story. A term of the contract is that New Nets must supply and install nets within 30 days from any new licenses being awarded to Fishy Story, to meet the terms of conditions of the license. The total cost of the nets, including their installation, is $150,000. The nets were installed and invoiced in July, and operations commenced on 1 August 2020. (v) On 10 August 2020, a violent community protest over the new Storm Bay operations erupted. Extensive damage was caused to the newly installed fishing nets in (iv) above. The insured loss of assets was estimated to be $100,000. The loss of current and future profits and the extent of insurance was not quantifiable at the date of signing of the audit report. Required Using Table 4 below, for each of the abovementioned events: a. Evaluate the results of the audit procures, and for the purposes of forming an audit opinion, explain whether it is an adjusting or non-adjusting event. [5 x 1 marks] b. Interpret and explain the auditing concepts and/or principles which impact on the specific aspects of the financial statements (if any). If there is no impact explain why. [5 x 1 marks] c. Describe the action the auditor should take by interpreting the relevant auditing standards). References must be shown. [5 x 2 marks] [Total 20 marks] Table 4 Event Part a. answer Part b. answer Part c. answer i ii iii iv v Question 5 The following are independent and material situations: (i) An auditor hires an expert to review the net-realisable value of a client’s highly specialised inventory at year end. Inventory on hand accounts for 25 percent of the client’s current assets and 10 percent of total assets. The expert reports that a material impairment to the inventory value would be appropriate. The client disagrees and refuses to make an adjustment. (ii) A customer of your audit client recently filed a voluntary bankruptcy petition. Your client refused to make the necessary adjustment to the customer balance owing to reduce the recorded value to its estimated recoverable amount. Your audit procedures discovered that the appointed liquidator estimated the recoverable amount to be approximately 20 percent of the recorded amount. You are of the opinion the event will cause substantial cash flow problems to your client. (iii) An auditor is engaged after year end to audit a client’s financial report. As a result, the auditor could not attend the physical year-end inventory count. The accounting records are not sufficiently reliable to enable the auditor to perform alternative audit procedures to satisfy themselves as to the year-end inventory balances. (iv) A client changes its method of accounting for the cost of Work-In-Progress inventories from FIFO to the weighted average. The auditor’s audit procures found that the weighted average method of valuation does approximate the FIFO method of valuation. However, the change has a material effect on the financial report and has not been disclosed. (v) As a result of the Covid-19 pandemic, an auditor has decided that a Tasmanian client in the tourism industry will not be able to continue as a going concern after the government incentives are discontinued. The client has adequately disclosed its financial difficulties in a note to its financial report as well as the director’s report. The financial statements do not include any adjustments that might result from the client going insolvent or ceasing to trade. Required Using Table 5 below, for each of the above situations: a. Evaluate the results of the audit procedures in each instance, and explain the type of audit opinion you would issue (refer to relevant auditing standards) [5 x 2 = 10 marks] b. Interpret the auditing standards and provide reasons for issuing the particular ‘level’ of audit opinion (refer to relevant auditing standards). [5 x 2 = 10 marks] [Total 20 marks] Table 5 Event Part a. answer Part b. answer i ii iii iv v ________________________________________