AYESHA HAMID L1F17BSCM0024

QUIZ: 4

SECTION: B

ILLUSTRATION: 1

Mr. Mahmood is the engagement partner for the audit of Khyber Limited (KL), a listed
company. In a meeting of the partners of the firm he had declared that Better Life Trust (BLT),
in which he is a trustee, intends to purchase fifty thousand shares of KL from the open market.

Required:

(a) State how should the firm deal with the above situation.

(b) What would the firm’s response be if Mr. Mahmood inadvertently fails to disclose the above
fact before the purchase of shares and it comes to the knowledge of the firm after the shares have
been purchased?

(a)
Circumstances in which the shares of KL can be purchased by BLT: If BLT makes investment in
shares of KL Mr. Mahmood may continue to act as the audit engagement partner of KL as well
as a Trustee in BLT, if:

 Mr. Mahmood or any of his immediate family members is not a beneficiary of the trust;
and
 The value of shares purchased is not material to BLT (Trust); and
 Even after purchase of shares, BLT will not be able to exercise significant influence over
the assurance client; and
 Mr. Mahmood and the firm does not have significant influence over any investment
decision involving a financial interest in KL. In case the answer to any of the above is in
negative, the firm shall require that the shares held by the Trust are disposed of or shall
have to change the engagement partner. ICAP Recommended solution Page 100
Auditing, Assurance & Related Services

(b)
Circumstances And Actions: If Mr. Mahmood has inadvertently not disclosed the fact about
purchasing shares of KL and the shares are subsequently purchased, the firm should take the
following steps in order to ensure that the independence of the firm is not impaired:
  In case where Mr. Mahmood discloses the fact regarding purchase of shares to the firm
immediately after the purchase of shares, the firm should require him to either ensure that
the shares are sold by the Trust immediately. If that is not possible, he should be removed
from the engagement team.
 In case where Mr. Mahmood does not discloses the fact regarding purchase of shares to
the firm immediately after the purchase of shares, the firm should consider involving an
additional chartered accountant who did not take part in the assurance engagement to
review the work done by Mr. Mahmood.

ILLUSTRATION: 2

The financial statements of Modern Equipment (Pvt) Limited reveal that the company has paid a
donation of Rs. 15 million to a charitable organization where one of the directors of the company
is a trustee. The company has earned a gross profit of Rs. 40 million. The selling and
administration expenses including the donation amount to Rs. 60 million and as a result the
company has incurred a net loss of Rs. 20 million.

Required:

(a) Discuss the significance of the above donation, to the auditor and design appropriate audit
procedures to address the issue.

(b) Discuss the possible impact of the above issue on the auditor’s report.

(a)
The following issues are significant in respect of the donation of Rs. 15 million:

 Donations represent 25% of the total selling and administration expenses.

 Such a huge amount of donation by a company which has already incurred a loss casts
serious doubts about the motive behind such donation.

Audit procedures to address the issue may involve the following:

(i) Obtain information about the charitable institution i.e. its name, nature, registration
and reputation.
(ii) Scrutinize possibility of any relationship between the two organizations, their
directors/trustees and their spouses and relatives etc.
(iii) Verify mode of payment i.e. cash, bearer cheques, crossed cheques etc.
(iv) Verify approval and authorization.
(v) Assess the relevance of the donation to the nature of business of the company.
 (b)
Since appropriate business consideration does not seem to be involved, mere approval by the
Board would not confirm that the expenditure has been incurred for the purpose of the
company’s business. If the auditor is unable to satisfy himself on the above issue he will have to
qualify the report by:

(i) Stating the brief facts of the case.

(ii) Using the “except for” type of qualification, while certifying that the business has
been conducted in accordance with the objects of the company.