Professional Documents
Culture Documents
[N.B. – Figures in the margin indicate full marks. Question must be answered in English. Examiner will take
account of the quality of language and of the way in which the answer are presented. Different parts,
if any, of the same question must be answered in one place in order of sequence.]
Marks
1. You are J Sikder, the senior in charge of the final audit work on Sun Ltd. for the financial year
ended 30 June 2011. Sun is based in Barisal and sells and installs hot tubs, saunas and Jacuzzis. It
was incorporated 5 years ago by Jony and Mary Sirker, both of whom invested money they had
earned in the music industry. Jony and Mary each own 50% of the issued share capital of Sun and
are also directors. They delegate the day to day running of the company to the only other director,
Ahmed, a more experienced businessman. Until recently, Sun focused on sales to wealthy
individuals in its local area. Its range of products and installation expertise made it very successful
and the business grew rapidly. However, the year ended 30 June 2010 it was less successful.
Revenue fell to Tk.4 million and the company broke even. Ahmed decided to expand operations to
cover the whole of Bangladesh and also introduced a range of larger products suitable for spas
and hotels. These changes required investment of Tk.2 million. Jony and Mary were not willing to
invest more money so Ahmed arranged for Sun to borrow Tk.2 million from a bank on 1 July 2010.
Under the terms of the loan, Sun was required for the first time to have an audit and, in April
2011, your firm was appointed as auditors for the year ended 30 June 2011. The final audit visit
commenced in September 2011 but progressed slowly. The financial controller, M Joynal, was not
ready for your team and could not provide you with the information to complete the audit
procedures. Your team left at the end of the scheduled audit visit with matters still outstanding.
Last week M Joynal contacted you to let you know he was ready for a follow up audit visit and provided
you with summary financial information (Exhibit 1) incorporating all audit adjustments identified at your
previous visit and, in addition, two late client adjustments requested by the directors. You arranged for a
junior member of staff, Selim, to visit Sun to complete the necessary audit procedures. Selim has sent you
an email (Exhibit 2) summarizing the audit procedures he has performed.
Exhibit 1 – Sun Ltd.
Summary financial information for the year ended 30 June 2011 prepared by Joynal
Per draft
Per trial Audit Late client financial
Balance adjustments adjustments statements
Taka ‘000 Taka ‘000 Taka ‘000 Taka ‘000
Operating profit 651 (134) (50) 467
Exceptional items - (42) (42)
Interest payable (100) (100)
Profit before taxation 551 (134) (92) 325
Taxation . - (125) (125)
Profit after taxation 551 (259) (92) 200
Assets
Property, plant and equipment 357 35 392
Intangible asset 500 500
Inventories 1,392 1,392
Trade receivables 1,629 (42) 1,587
Other current assets 40 40
Cash and cash equivalents 555 555
4,473 35 (42) 4,466
Equity and liabilities
Share capital 1,000 1,000
Retained earnings 551 (259) (92) 200
Long-term borrowings 2,000 2,000
Trade and other payables 922 169 50 1,141
Tax payable . - 125 125
4,473 35 (42) 4,466
2. You are a senior in the corporate services department of your firm which has been approached by
GP Global Fund Managers the venture capital arm of a leading investment bank. GP is
investigating a management buy-out of U Ltd.
U was formed as a start-up three years ago, as a wholly-owned subsidiary of an IT hardware
supplier, DatLinks Ltd. (D). D and U both operate entirely within the Bd. The group’s accounting
year end is 30 September, U provides a “one stop service” for client extranets to the financial
services industry (i.e. intranets which can be securely accessed by customers to obtain
information, pay bills etc). U provides hardware, which is sourced exclusively from its parent
company DatLinks, plus software, support, web design and security services.
It was initially successful, but some highly publicized problems surrounding security breaches in
similar products, together with cash-flow problems, have resulted in a server breakdown in the
relationship between U’s management team and directors of DatLinks. DatLinks is therefore keen
to divest itself on its interest in U.
The proposed deal would involve GP providing the funding for the MBO. Its exist route will be via a
planned flotation of U in two to four years’ time. GP has worked with U’s management to produce
a detailed business plan and financial projections up to the date of the floatation under a variety
of scenarios.
Your firm has been asked to quote for the full range of advisory services, including the following:
¾ Due diligence on the MBO
¾ Review of the business plan and the financial projections
¾ Tax structuring advice on the acquisition
¾ U’s audit and advisory work on an ongoing basis
¾ Advisory work on the planned floatation of U.
[Please turn over]
–4–
Performance management
The gross assets of U are Tk.9.5 million. The acquisition price is estimated at this stage to be in the
region of Tk.45 million, although this will depend on the outcome of the due diligence work and
the review of the financial projections.
GP informs you that the price looks very attractive, since it is based upon historical-earnings levels
which have been depressed by DatLink’s group accounting policies. Discussions with U’s
management team have revealed that the vendor group’s transfer pricing policies had the effect
of reducing the results of its subsidiaries and inflating the results of the patent. U’s finance
director has provided GP with revised financial statements, together with detailed reconciliations
which reverse the effects of these policies and restate U’s historical results on a “stand alone”
basis. These would indicate a true market value in the region of Tk.60 million.
GP believes that, in addition to an early cash injection, the success of U depends upon the
retention of its key asset – the design team. The deal depends upon the retention of up to 25
identified individuals, at least until GP’s exit on flotation. To this end, and to protect its
investment, GP wishes to grant share options, with current values per employee ranging from
Tk.50,00 to Tk.100,000, be exercisable in two to four year’s time – depending upon how quickly
the flotation takes place. The poor relationship between the management teams of U and
DatLinks means that access to DatLinks’ management team during the due diligence process will
be restricted. A data room containing detailed financial, legal and commercial information will be
provided at the premises of DtLinks’ lawyers. U’s management team will, however, be freely
available to answer questions and provide any information that might be requested. DatLinks have
indicated that they will not provide any warranties in respect of the acquisition.
The engagement partner from your firm is meeting GP shortly to discuss the potential assignment.
He has asked you to provide him with a briefing note that will assess the risks associated with the
assignment including the due diligence, the business plan review and the ongoing audit.
Requirement
Prepare the briefing note for the engagement partner. 12
3. (a) “The ICAB has adopted the IFAC Code of Ethics which centers around five fundamental
principles”, what are those principles? 5
(b) P Ltd. is a private company that produces organic food products. These are sold in a variety of
outlets from specialized food shops to supermarkets.
The marketing director believes that the following are key selling points of the brand:
¾ All the ingredients are organically produced and free from genetically modified (GM) products.
¾ Fair prices are paid to producers (including fair wages).
¾ The company’s processing plant in Bangladesh is carbon neutral.
¾ Packaging makes use of recycled materials and is itself recyclable.
The directors want to produce a social and environmental report as part of the company’s
annual report and it is to include the four assertions above. You firm, as the statutory auditor
of P Ltd., has been asked to produce a verification report in relation to the social and
environmental report.
Requirements
(a) Discuss the matters the audit engagement partner for P Ltd. should consider in relation to
whether the firm could accept the engagement to report on the social and environmental
report. 7
(b) In order to issue a report in relation to the four assertions, explain the mattes that your
firm, as auditors, should consider and describe the evidence that should be obtained. 8
(c) E Ltd. is a company that has traditionally sold kitchen utensils to retail outlets. The products
have been sourced from approved suppliers in a number of countries, but mainly from
Bangladesh – this leads to relatively few delays in getting new inventories. Inventory is held at
two warehouses located in different parts of the country.
During the last financial year E Ltd. set up an e-commerce division of its business to sell the goods
directly to the public. This involves customers being able to browse the product catalogue and then
place orders and pay for goods (by either credit or debit card) online. Once an order has been placed
and the payment approved, the details are automatically referred to the appropriate warehouse to
initiate the delivery process. Inventory records are updated automatically and new orders for goods
are automatically initiated based on predetermined reorder levels.
Requirement
There are variety of business risks associated with e-commerce. Discuss these both generally
and with specific reference to E Ltd. 10
4. CD Sales Ltd., a listed company, was a growth orientated company that was dominated by its
managing director, Mr. A Long. The company sold quality music systems direct to the public. A
large number of sales persons were employed on a commission only basis. The music systems
were sent to the sales agents who then sold them direct to the public using telephone sales
techniques. The music systems were supplied to the sales agents on a sale or return basis and CD
Sales recognized the sale of the equipment when it was received by the sales agents. Any returns
of the music systems were treated as re-purchases in the period concerned.
The company enjoyed a tremendous growth record. The main reasons for this apparent expansion
were as follows:
(a) Mr. A Long falsified the sales records. He created several fictitious sales agents who were
responsible for 25% of the company’s revenue.
(b) At the year end. Mr. Long dispatched nearly all of his inventories of music systems to the sales
agents and re-purchased those that they wished to return after the year end.
(c) Twenty per cent of the cost of sales were capitalized. This was achieved by falsification of the
purchase invoices with the co-operation of the supplier company. Suppliers furnished the
company with invoices for non-current assets but supplied music systems.
(d) The directors of the company enjoyed a bonus plan linked to reported profits. Executives
could earn bonuses ranging from 50% to 75% of their basic salaries. The directors did not
query the unusually rapid growth of the company, and were unaware of the fraud perpetrated
by Mr. A Long.
Mr. A Long spent large sums of money in creating false records and bribing accomplices in order to
conceal the fraud from the auditor. He insisted that the auditor should sign a ‘confidentiality’
agreement which effectively precluded the auditor from corroborating sales with independent
third parties, and from examining the service contracts of the directors. This agreement had the
effect of preventing the auditor from discussing the affairs of the company with the sales agents.
The fraud was discovered when a disgruntled director wrote an anonymous letter to the Stock
Exchange concerning the reasons for the CD Sales growth. The auditor was subsequently sued by a
major bank that had granted a loan to CD Sales on the basis of interim financial statements. These
financial statements had been reviewed by the auditor and a review report issued.
Requirements
(a) Explain the key audit tests which would normally ensure that such a fraud as that perpetrated
by Mr. A Long would be detected. 8
(b) Discuss the implications of the signing of the ‘confidentiality’ agreement by the auditor. 5
(c) Explain how the ‘review report’ issued by the auditor on the interim financial statements
differs in terms of its level of assurance from the auditor’s report on the year-end financial
statements. 5
(d) Discuss where you feel that the auditor is guilty of professional negligence in not detecting the
fraud. 5
– The End –