AF304

Auditing
Tutorial 2 Questions
Chapter 2
2.12 What is meant by earnings management? How do you think the concept of earnings
management might have influenced the auditor’s role in the audit of financial
statements?

2.13 What does the ASX suggest should be the makeup of an audit committee?

2.20 What is meant by economy, efficiency and effectiveness in relation to a performance
audit?


2.26 Performance audit **

The auditor general has been carrying out a performance audit on the funding provided
to agencies dealing with the provision of services to homeless Australians. The period of
the review covered the two years ending 30 June 2015 and the aims of the audit were to
assess whether:
1. the number of homeless people in Australia had fallen
2. the number of staff employed by the agencies had decreased
3. the total costs or running agencies had decreased.
The findings of the audit show there has been a moderate increase in the number of
homeless people in Australia over the two years considered. The review also established
that overall the number of staff employed in homelessness agencies had increased and
there had been a significant increase in agency operating costs.

Required
Identify the performance audit assertions applicable to each of the aims of the audit and
comment on the audit findings.

2.28 Madoff’s scheme ***

Bernard Madoff was operating a simple Ponzi scheme, Harry Markopolos explains. ‘He was
robbing Peter to pay Paul, so he needed a continual new stream of incoming cash to pay off the
old investors’, he says. ‘Investors who got in early would tell their friends and family how great
a money manager Madoff was, so they’d want to invest as well.’ The problem is, in a Ponzi
scheme there is no underlying investment activity or service provided. It is all, as Markopolos
notes, a charade. On the surface, Ponzi schemes offer alluring, steady returns. But the cold,
hard truth, as he puts it, is ‘those investment returns exist only on the monthly investment
statements because they are fiction’. The returns generated by most Ponzi schemes on paper
are so good that if you are not a professional investor you would definitely be tempted to invest
100% of your retirement money in them. It takes tremendous discipline and financial
knowledge to successfully avoid them.
Madoff enabled his US$65 billion scam by enlisting the apparent complicity of close to 350
‘feeder funds’ — companies that marketed his Ponzi scheme for him in more than 40 countries
and, in effect, fed him with new investors. Those funds all pretended to conduct exhaustive due
diligence, such as checking into each manager’s background, inspecting his or her operations,
verifying the assets, and vetting the strategies. But in reality Madoff paid them handsomely so
that they would look the other way. They were accomplices that enabled the scheme to get as
large as it did. Madoff alone could not have been able to reach a US$65 billion without their
help.
Source: Internal Auditor, June 2010, p. 46.

Required
Evaluate the case from an audit point of view, highlighting possible risks for an investor and a
fund manager who might be attracted to such a scheme.